BBC BLOGS - Stephanomics
« Previous | Main | Next »

QE Day

Post categories:

Stephanie Flanders | 09:28 UK time, Thursday, 5 March 2009

This could be the day you've all been waiting for. The day that "quantitative easing" (QE) stops being a rather ugly talking point and becomes a reality.

Bank of EnglandLater today, all the signs are that the MPC will release a statement saying that they have authorised the Bank of England to start buying government and corporate securities on its behalf - paid for with money it has created for itself. The policymakers will probably vote to cut the Bank Rate to half a percent as well. Either way, it will be the move to QE that will be the big news.

I've explained in some previous posts exactly what this policy entails. In effect, by buying the assets, the Bank is trying to engineer an unexpected cash windfall for the institutions selling the bonds to the Bank. If that cash is spent or lent on to other parts of the economy, boosting 'broad money growth' (also known as credit growth) and the amount of activity in the economy, then the purchases will have done their job.

Today's big questions are (a) will it work? And (b) how much will the Bank need to spend? If you polled the brainiest economists in the land, I bet the answers you'd get would be: "maybe" and "we don't know". The demand for money is a fickle thing - it doesn't always do what you want it to do. Monetarists learned that one the hard way in the 1980s.

In his most recent press conference, the Bank's Governor, Mervyn King, seemed pretty confident that QE could work. But even he would admit he has no idea how long it will take - or how much money he will have to print to get there.

Depending on your point of view, there are two big reasons to think that QE will boost the economy. Trouble is, none is guaranteed to work - especially in today's unusual times.

First, and most talked about, is the direct "bank lending" channel for QE. The extra cash in banks' accounts encourages them to lend some of that money out, when that loan gets spent, another bank has more money in its account, some of which they lend out, and so on, and so on - until you end up with a much bigger increase in the amount of broad money (M4) in the economy than the initial deposit by the Bank. That's the "textbook" money multiplier.

Looking at the ratio of narrow money to GDP you might think that multiplier was pretty high - in the region of 15 (so every £1 spent by the Bank would increase the amount of broad money running around the economy by £15). If so, the Bank might not have to spend much at all.

But, we know that banks aren't too keen to lend at the moment. Will having some excess cash on deposit with the Bank of England make them any keener? Maybe not. In that case, the "money multiplier" could be quite small and the Bank would have to spend a lot more.

There's another complication - which is that even if you raised the broad money supply by the desired amount, we don't know exactly how much that will boost national income (GDP). That depends on not just the amount of money around but the speed it's moving around the economy - the velocity of circulation.

In these times of great economic uncertainty and fear about the health of the financial system, the velocity of money will almost certainly be lower than usual, meaning the Bank will need to engineer an even larger rise in broad money to have a given effect on national income, nominal GDP.

That leaves the second channel - the effect on asset prices. There are several different sides to this, but the basic idea is that by purchasing these bonds, the Bank of England will raise the price.

Why? Well, by buying the assets they've reduced the relative supply in the market. They might also have raised liquidity in that market and so made the asset more valuable to investors (this would apply to some corporate bond markets). Or they might have raised the price by increasing demand for those assets indirectly, by giving the sellers some spare cash to spend on something else. (Assuming they do anything with it - they, too, might simply hold on to the cash).

Now, the way bonds work, a higher price means lower borrowing costs for whoever is issuing that debt. Put it another way, if demand has gone up for corporate bonds (for any or all of the reasons above) then companies will need to pay less to raise a given amount of debt.

This asset price effect could be quite powerful, but only if the purchases are large enough to have a significant effect on the price of the assets in question. In the case of gilts, that might be a large number, but it will probably happen.

Of course, simply lowering gilt yields doesn't change much - you've just made it cheaper for the government to borrow, which is already doing plenty of. But you hope that by lowering gilt yields you might make other, higher yielding (corporate) assets more attractive, thereby raising their price as well.

How do you translate all of this theorising into hard numbers? With difficulty. But assume the goal is to raise nominal GDP by around £150bn - that's a common estimate for the shortfall in demand in the economy this year. If you think the money multiplier is alive and kicking and all the banks need is a gentle nudge to lend more, you might think that £10bn in bond purchases would be enough to achieve that.

But, if you think the money multiplier is all messed up because of the credit crunch, and a low velocity of money is going to blunt the policy even more, the ratio will move closer to 1 to 1. And the Bank might have to spend upwards of £100bn to get the desired effect.

It's even harder to produce sensible estimates of the asset price effect. The total stock of outstanding gilts was around £700bn at the end of 2008, and estimates of the amount to be issues this year are rising almost by the week. But how much the Bank affects gilt prices (and yields) through its purchases will be down to market psychology as much as straight arithmetic.

That poses a quandary of its own: the Bank doesn't want to overdo it on its first shopping spree, but if it seems too tentative about the whole endeavour, investors are less likely to think there's been a lasting change in the demand for bonds, and prices won't change.

Where does the Bank come out in all this? The phrase I have heard used by Bank officials more than once is "suck it and see". Given the nature of the stakes, you might find that a bit disturbing. I call it an honest assessment of where we are.

Update 1327: More, and a response to your comments in this post.

Comments

  • Comment number 1.

    are there any examples of QE actually working? it certainly did not work in Japan, or Zimbabwe....or are we relying on the same economic theories that got us in to this position in the first place...

  • Comment number 2.

    Q: Will the British pound have more zero's then the Italian Lira?

  • Comment number 3.

    The truth is they simply do not know.

    I prefer the idea of the Bank buying corporate bonds which addresses a problem of the credit crunch directly i.e helping companies to borrow. The idea of one arm of the government buying debt off another part is fraught with hazard. With this lot it will be hard for people to believe it will do any good and a rational person might expect higher prices rather than higher GDP.

    Even buying corporate bonds is a risk....

  • Comment number 4.

    RIP GBP

  • Comment number 5.

    So...Keynes was right all along..?

  • Comment number 6.

    Wrong solution to the wrong problem.

    Absolutely typical of the Bank of England they are still addressing an historic problem and are out of date.

    The problem is lack of demand - not liquidity.

    The Bank seem to think that by tinkering in the bond market they can some how kick start the economy again. They are, as usual, wrong.

    The desire to spend by the tens of millions of normal people who make up the mass of consumers is being savagely eroded and depressed by squeezing their savings income and salaries at the same time as the mortgage support schemes talked of by the government are yet to be implemented.

    If you take the icing off the cake (savings income) consumers will cut back viciously. There must be today an explicit indication that interest rates will go up very soon to 4 or 5 percent to overcome this massive error by the Bank.

    The bank should be concentrating on schemes such as scrapping old cars 'gifts' and such like to get people spending rather than continuing to bail out their friends in the city.

    The Nation is being ruined by these (possibly - I am being charitable) well intentioned moves by the Bank and they are as out of touch now as they were last autumn.

  • Comment number 7.

    Quantitative Easing should certainly work to boost the money supply (in its true sense of the amount of money available to be "bought" i.e. borrowed).

    BUT this policy is directly opposed to the policy of low interest rates.

    The problem here stems from the confusing use of the phrase "money supply" to mean the quantity of money in the economy. This is boosted by lower rates IF the amount of money is being limited by people's propensity to borrow.

    But like any other commodity, the true "money supply" (the amount of money available to "buy" i.e. borrow) is decreased by a lower price.

    Lower interest rates will WORSEN the credit crunch. Maybe the numpties in the BoE who have brought us into this mess should remember how the price mechanism works. If there's a shortage of something, the worst thing you can do is reduce the price!!!

  • Comment number 8.

    But what could be the negative affects of Quantitative Easibility?

    QE attempts the impossible in finance - a one sided accounting entry. It attempts to create an asset with no corresponding liability. If it was that easy, the government would be using it all the time, and there would be no want, unemployment or poverty anywhere in the world.

    In business and finance, there is always a liability, there is always a price which must be paid. The liability which will arise from QE is a fall in the value of sterling. Our currency will depreciate, as our underlying economic activity is not strong enough to support the volume of money in the UK economy.

    Britain has a trade deficit, a fiscal deficit, and a shrinking economy.

    Therefore, we have two likely outcomes:
    (i) QE has no affect at all. Demand is not stimulated by the money printing. The increased money just sits in deposit accounts as no-one borrows it; or
    (ii) QE causes sterling to fall, as investors worry that the British government is simply printing money to pay for its stimulus plans. The government is spending more than it can raise through taxation. Our currency falls, as foreign investors who nromally buy gilts decide that the British Government's credit rating is not worth the risk of default. These investors will then sell their gilts and take there money abroad, to somewhere safer.

  • Comment number 9.

    "... the Bank is trying to engineer an unexpected cash windfall for the institutions selling the bonds..."

    This is precisely what is wrong. Institutions that have made bad investments will get a windfall. Is there even any guarantee that this money will even stay in the UK?

    QE/Printing Money will devalue savings in Sterling which will be a double-wammy to savers onto of the expected cut in interest rates.

    Surely, everyone in the UK is going to end up paying for this when our currency devalues!? In which case, why does the government not just print money to go into the Treasury so that there can be tax cuts for everyone?

    It seems that this is yet another scheme that will be cost us all, but primarily benefit only the bankers that have screwed up.

  • Comment number 10.

    "Brigadier Brown...."

    "Yes, Major Darling?"

    "We're caught in a terrible crossfire.
    We've got over-supply and over-capacity on one flank, and over-indebtedness and lack of demand on the other flank."

    "It's a killing ground out there. We're facing unsustainable losses."

    "Contact the BoE and tell them to parachute in more reinforcements."
    "We have to show our allies we won't let them down."

    "If we send in reinforcements they'll be cut down like the rest."
    "We'll simply bleed the country dry....."

    "We won't retreat - pour in more resources, I tell you!!"

    "Yes sir, Brigadier Brown, sir!!"

  • Comment number 11.

    Jings ! This sounds complicated, if not surreal.

    Any one for a game of Monopoly ?

    If the Government were playing, they would land on "Go to jail, do not pass Go, do not collect £200".

  • Comment number 12.

    I cannot say I understand finance, especially on this scale but I have a nasty feeling that this QE suggestion is going to backfire.
    What, for example, would be the effect on our currency with all that that means on imports of food products in particular.
    And is this a backdoor way of reducing longer term government obligations on pensions and benefits, remembering that governments are notoriously slow in equalising the effects of a reducing monetary value?
    Seems to me that 'The pound in your pocket' argument is about to reassert itself and once again the weakest will suffer most.


  • Comment number 13.

    So, this all relies on Consumers, eventually borrowing more to spend in the shops.

    It won't work.

    Workers at the moment are struggling with the debts they already have.

    They are not receiving pay rises.

    In very many cases their dispoable incomes have fallen.

    So buying Bonds in the Bond markets will not have an appreciable effect on the High Street.

    This means Consumer dependant Industries will continue to suffer.

    The Gov't needs to look at introducing policies that will create more export driven economic activity (manufacturing or otherwise), and policies that will create real jobs.

    It needs to reverse its pay restraint straitjacket (especially on the Public sector).

    It should consider limiting certain types of imports, in order to give local manufacturing a chance to compete on a fair basis.

  • Comment number 14.

    The truth is no one really knows how effective QE is and so what.

    What is clear is that the MPC is obsolete and should be abolished immediately. It is entirely possible that the reduction in interest rates is like overcorrecting a skid of a car and it will unleash enormous dissaving
    and a spending - borrowing spree with many undesirable consequences in the medium term.

    Monetary theory I recall says that there is a lag of two years or so before the effects of large changes in the money supply are seen.

    Mind you this theory is 30 years or more old and there have been many structural changes to economies and banking practices since then.

    Have we a tiger by the tail?

  • Comment number 15.

    This is the final madness to try one last throw of the dice for Labour, not for Britain. Printing money is no different to a rights issue by a failing company. The shares in circulation become watered down.I t is nothing short of criminal negligence. You, Madame, ought to realise that. However your pension from the taxpayer funded BBC will be OK. Just need a bigger barrow. As for us ordinary people, our pensions will be even further eroded. That's what depressions do. To print money is an admission that control is lost.

  • Comment number 16.

    stephanie you ask,

    "Today's big questions are (a) will it work? And (b) how much will the Bank need to spend?"

    I think we all know the answer. no and everything.

  • Comment number 17.

    The bank is issuing gilts to fund government expenditure, and buying gilts to reduce supply and thus increase gilt prices.

    Why not just issues fewer gilts?

  • Comment number 18.

    An excellent explanation to the uninitiated of the principles of QE. Thank you.

  • Comment number 19.

    Just to depress everyone further,

    This is the planet of the apes moment, You know the one, where Charlton Heston looksup at the Empire State Building.

    Yep they really are going to do it, Every decision the Government and the BOE have taken has lead us down one path.

    This will destroy Britain as a nation for my lifetime, Its going to be very, very bad.

    I can think of hundreds of things the government could have done, and yet Gordon Brown is almost autistic in his belief that there is only one solution.

    Recreating the very conditions that got us here in the first place, he is Captain Ahab pursuing his very own white whale (wash).

  • Comment number 20.

    Will we have access to the sorts of sums the BoE are "trading"? ie 10Bn or 100Bn?? What will this QE effect be on the value of the Pound against say the Euro where we source a vast amount of fresh and processed foods?

  • Comment number 21.

    QE will be a disaster.

    The markets have routinely trashed the currencies of countries which have done this, rightly regarding them as banana republics.

    QE is addictive as well as destructive.

    Any benefits from QE will be lost through the higher interest rates that will be needed, in short order, in an effort to stave off a currency collapse.

    QE is idiocy.

  • Comment number 22.

    Stephanie

    We know "they" don't know how much and whether it will work. I sense we are still in palliative mode with BoE/government trying to fill the void left by collapse of wholesale credit markets.

    QE as a policy seems to be indifferent as to how the multiplier allocates any benefit generated - if the money supply generated is all spent by UK consumers/investors on imported goods/assets then there is no net benefit to UK economy having incurred a potentially enormous liability.

    Without heading off too far down the corporatist state planning route is there no sense in trying to implement a mid term focused fiscal policy/structural plan to push the economy into a positive more sustainable structure and direction for the (20-25 year) future (i.e. not dependent on financial services, d-i-y, and estate agents)?

    There is surely a political trick being missed here. The BoE and government have their hands full but need to also look to the future beyond all the current problems to define where we want to end up in the post bubble real economy.

  • Comment number 23.

    11. newsjock:

    "If the Government were playing, they would land on "Go to jail, do not pass Go, do not collect ?200"."

    Absolutely right, but in this instance, surely it would be "Go to jail, do not pass Go, do not PRINT ?200"!

  • Comment number 24.

    Although nobody knows which element of any stimulous is the more effective, nor how much of each is optimum, we do know that sentiment is also vital. So every time commentators and others proclaim that this or that "won't work" or are "ruinous", they also promote the paradox of thrift that will divert our recovery. That paradox also slows the circulation of spending money.

    Which presents a political problem for HM Opposition. How much can they afford to spin that this or that stimulous "isn't working" without making themselves part of our global problem? On the other hand, if Opposition don't make contrary claims, they stand to look irrelevant in the battle to bring the collapse of confidence to a speedy end. It's a fine gamble in this crisis.

  • Comment number 25.

    The hair of the dog that bit you.

    The government doesn't like the drunk who is not drinking because he's passed out.

    The government slaps the drunk about the face, by reducing interest rates. This partly revives the drunk, but he still doesn't want to drink.

    The government holds the drunk's mouth open while the Bank of England pours whisky down the drunk's throat. QE.

    The drunk then dies of alcohol poisoning.

    Whoops.

    The government then says it couldn't have seen it coming.......it could not foresee the outcome.

  • Comment number 26.


    So if I understand correctly....

    Because our savings are gathering little more than dust and the value of sterling is going down, we are being "encouraged" to spend; thereby money circulates, the economy staggers up on to its knees.

    Banks will be able to lend to businesses so we can buy whatever they produce. Then inflation kicks in and we all live on bread and water, because no one has any savings left?

    Isn't anyone, sometime soon, prepared to accept that those who have overspent are in debt up to their ears and CANNOT spend and the rest of us (the canny savers) have no intention of going down that route?

  • Comment number 27.

    Money supply is not the problem - it's trust!

    Bankers no longer trust each other, and the public has had a nasty shock from the use of credit and how violent a backlash it can have when used excessively.

    Trying to restart the economy to put it back where it was before is not going to inspire anyone.

    We need new ground rules on how things are run, that inspire confidence because they are transparent and honestly policed, and then the money can arrive.

    There is no substitute for a return to integrity as the spearhead to getting us out of the mess we are now in - why is Obama so popular?!

  • Comment number 28.

    Macroeconomic and standard microeconomics only go so far in predicting the effectiveness of this policy.

    The really decisive factor is going to be people's behaviour and how they perceive the extra money in their accounts. Will it work? There are two ways that the Bank of England can make this happen:
    http://www.knowingandmaking.com/2009/03/quantitative-easing-and-psychology.html

  • Comment number 29.

    Solution seems quite easy to me:

    The gov should give first time buyers (yep... me too) the 25% deposit that they now require.

    This will be spent immediately... the banks will lend and house prices are kept at the artificially high level that the gov desires.

    Yes... I know it's not fair but maybe they could help with neg equity too!

  • Comment number 30.

    Are there any instances where QE has worked?

    What QE boils down to is this: transferring wealth from individuals and smaller businesses to the Government and selected large institutions.

    QE is the ultimate stealth tax, and a regressive tax in its disproportionality.

    Worse still it is taking from the innocent victims and giving to those who are responsible for the creating the current crisis.

  • Comment number 31.

    One final thing,

    Capitalism is predicated upon hope and trust.

    The hope that if i start a business i will make a profit.

    The trust that if i dont recieve my pay in gold, then the shop will accept my promisary note for its equivalent worth.

    The hope that if i invest in a currency i will recieve a return from said currency.

    Hope and trust.

    I and many others have very little hope and no trust.

    To borrow from the awful business lexicon:
    "its time to shift some paradigms"

  • Comment number 32.

    That's it. I'm off to buy a huge stack of tinned beans this afternoon. I recommend everyone else do the same. 29p per tin at Aldi's, so it won't cost too much to protect yourself for when the Depression goes into its death spiral.

  • Comment number 33.

    I understand the theory but not the logic. The hope is that injecting a relatively small amount of extra money into the bond market will lead to a cascade of consequent activity. But, as Ms Flanders says, the concern must be that cautious investment institutions will simply hoard the money. Perhaps the government should just buy up the whole of the HSBC rights issue.

    The trouble with adding money to the economy in this way is that it is inherently inflationary and we all know where that leads. Doesn't classic Keynesian theory tell us that the way to proceed is for the government to spend money on capital projects thereby forcing economic activity to take place and generating extra tax revenues as a consequence?

    QE as proposed is introducing a middle man who may not act as predicted/hoped. Then more will have to be spent, and more, and more...

  • Comment number 34.

    This seems ridiculous to even contemplate. Granted, I'm not a finance expert.. but as I see it for the man and small business in the High St, this issue is not about the actual availability of assets, its about the trust to loan which is the issue. As someone rather sadly wrote - RIP GBP. Up until today I really thought the Govt were incompetent. Now I'm convinced this is a deliberate breaking of the economy and devaluing the pound to such a level that we have no choice but to join the Euro... which of course is going to benefit big business rather than the man on the street.

  • Comment number 35.

    my question at #1 was really rhetorical......

    ..what if i start to copy £20 notes on the photocopier and buy bonds with the proceeds, will that work, of course not. so why should the government 's action work, is there any guarantee that the increased money supply will not just be hoarded by the banks like all the other so called bailouts?
    in fact has any one of Gordon Brown's great ideas worked?

  • Comment number 36.

    This looks like Big Government bailing out their friends in Big Business at the expense of the taxpayer.

    Will it work? The answer is that nobody knows. The acrid smell of panic permeates our streets.

    Is this the fear itself which we should be fearful of?

    The questions raised on this blog are numerous.

    How certain are we that the money raised will stay in the UK, or is that just being `protectionist'?

    Are there other measures we can take before QE which we haven't tried yet? The so called fiscal stimulus of a VAT cut wowed the audience in the aisles, didn't it?

    How long and for how much will QE be applied? Can someone put some figures on this please so we can measure cause and aeffect?

    Will we end up with hyper-inflation?

    I must confess that I am now begining to panic as it seems the lunatics are now running the asylum.

  • Comment number 37.

    The fruit of free market ideology? The Take: Occupy, Resist, Produce

    "With a massive economic crisis underway I thought it timely to post The Take by Naomi Klein and Avi Lewis on Argentina’s experience. An inspirational look at how workers reacted to losing their livelihoods by occupying their factories, resisting the authorities and co-operatively producing goods for the benefit of themselves and their communities."
    Invest in wheelbarrows - a growth industry in an economy of expanding money supply..

    ;-)
    ed

    “Freedom of the press is guaranteed only to those who own one.” - H. L. Mencken
  • Comment number 38.

    Meanwhile... two steps down, one step up, and down we go again

    Meeeeoooowwwww!
    ed

  • Comment number 39.

    In the immortal words of Einstein -

    "The same thinking that created the problem cannot resolve it".

    We desperately need new leadership that understands this wisdom.

  • Comment number 40.

    The only thing left after QE is the wealth tax - instead of interest you give, say, 10% of your savings to the government every year (a bit like with pensions). They then squander it, as they have done with all the other taxes, and just maybe the economy gets going again.

    This is a bit like inflation, but more controllable, certainly better than QE. The only problem is that if you took away all of the savings and assets of people in the UK, it is probably not enough to pay off all the debts!

    Do we live in a mad world - or is it just the people running it who are bonkers?

  • Comment number 41.

    I seem to remember a little while back something about QE 2 heading off to somewhere in the middle east. Have I missed QE 1 ? I think we should be told.

  • Comment number 42.

    The US publishes its money multiplier and it is under 1. We cannot be far removed. Eventually, if this point has not already been reached, expansion of the monetary base will cease to provide any economic benefit. News like this may encourage people to repay or default debt and lenders and investors to keep their capital out of play. People are a fickle bunch and nobody can say how they will respond to news like this, the printing of electrons. The effect may be quite unexpected.

  • Comment number 43.

    Regarding this bloating of the money supply, I keep hearing on the news bulletins that "the policy has not been tried here before."

    Short memories! I believe a very similar ploy on the part of one Chancellor named Barber led to the inflation of the 1970s.

    Between 1970 and 1982, I seem to recall the real purchasing power of Sterling fell by two thirds...

    It may not be too late to buy gold.

    "Anthony Perrinott Lysberg Barber, Baron Barber, PC (born 4 July 1920), is a Conservative member of the House of Lords. He was appointed Chancellor of the Exchequer by Edward Heath in 1970.

    During his term the economy suffered due to stagflation and industrial unrest. In 1972 he delivered a Budget which was designed to return the Conservative Party to power in an election expected in 1974 or 1975.

    This inflationary Budget led to a period known as "The Barber Boom". The measures in the Budget were to come back to haunt the Government who were hit by high inflation and wage demands from Public Sector workers.
    ...
    Anthony Barber was made a Life Peer in 1975"

    I thought so!
    Those who refuse to learn from history....

    ;-)
    ed
  • Comment number 44.

    Taking the ratio of base money to GDP as the multiplier implies a velocity of 1, does it not?Would it be better to take the ratio of M0 to M4?
    Not being a professional economist, I don't know where to look for those figures, but I suppose they are published somewhere.

 

BBC © 2014 The BBC is not responsible for the content of external sites. Read more.

This page is best viewed in an up-to-date web browser with style sheets (CSS) enabled. While you will be able to view the content of this page in your current browser, you will not be able to get the full visual experience. Please consider upgrading your browser software or enabling style sheets (CSS) if you are able to do so.