Given that the non-bank private sector is likely to have been the source for much of this funding, this is likely to have squeezed broad money growth. But the counterpart to this fall in private sector deposits is a strengthening in banks balance sheets which should in turn aid the recovery by improving the availability of bank lending. So the monetary impulse still operates. One approach to help mitigate the counterfactual problem is to use event studies which consider the impact of QE announcements on asset prices over relatively short windows. 7 Gilt yields may respond to such policy announcements both because of the impact gilt purchases have on the yields at which investors are willing to hold the reduced supply of gilts – the portfolio balance effect – and because of the information the announcement may be perceived to contain about the future stance of monetary policy – one element of the expectations channel. It is possible to get some indication of the size of the portfolio effect by considering movements in the spread of gilt yields to Overnight Indexed Swap (OIS) rates, which should not be affected by changes in the relative supply of gilts. Although precise estimates vary according to the maturity of the gilts and the size of the window, summing movements in giltOIS spreads following our announcements suggests that the portfolio balance effect may have reduced gilt yields by around 100 basis points. Again, a pretty sizeable effect. 6  This excludes the money holdings of intermediate OFCs.
The attraction of this class of models, as typified for example by Woodford (2003) and Walsh (2003), is that its relative simplicity and tractability means that it can be used to derive clear and precise policy prescriptions. And indeed that is the case when used to analyse monetary policy at the zero bound. The only way policy can gain traction at the lower bound in such a model is through influencing expectations – the most well known reference here being Eggertsson and Woodford (2003). This result stems from the fact that the economy behaves as if, in effect, there are only two assets in existence, typically modelled as money and bonds. Agents hold more money up to the point at which the marginal benefit from the liquidity services it confers equals the marginal cost: the nominal interest rate. At the zero bound, both the marginal benefit and marginal cost are effectively zero, and money and bonds become perfect substitutes. It follows that exchanging money for bonds at this point has no impact on activity or inflation. The economy is assumed – by construction – to be in a liquidity trap. As is well known, the optimal policy within this class of models is for the central bank to commit to low interest rates for an extended period and to a temporary overshoot of the inflation target. Exchange rate depreciations (Svensson 2001) and interest rate commitments (Krugman 1998, Woodford 2003) are examples of policy recommendations stemming from this result.