Broad money also includes physical cash circulating outside the banking system but this is only a fraction (4%) of the total: the vast majority is accounted for by sterling deposits in commercial banks (the precise definition of M4 is here). Traditionally, narrow money has been defined as physical cash plus reserves (the deposits of commercial banks at the central bank). However, the nature of these reserves changed significantly in 2006, when the Bank of England began remunerating them, at Bank Rate (this was done to ensure short-term rates in interbank markets stayed close to the official interest rate – Clews (2005)). see and). It no longer made sense to group them with (non-interest-bearing) cash and at that point the Bank ceased publishing a combined series for “narrow money” (Janssen and Andrews (2005) ). This change explains the initial, pre-QE jump in reserves around that time (evident in Chart 1). As I try and explain in the body of the talk I think it also has some bearing on the impact of QE. 2. I’ll say a little more about this process later on, when discussing the contrasting patterns of “narrow” and “broad” money growth over the past. 3. Reflecting this point commercial bank deposits are sometimes referred to as “inside” money – they’re assets within the (private-sector) financial system, not for the system as a whole. By distinction, central bank reserves are sometimes called “outside” money. 4. Even a “helicopter drop” may not add to net wealth.
QT and the MPC’s forecasts I want to turn now to the second question I posed at the beginning: should the MPC not recognise in its forecasts some particular and additional drag on demand and on inflation, on top of that induced by higher Bank Rate, from the ongoing “quantitative tightening” (or “QT”)? This began over a year ago, initially by failing to replace maturing gilts in the APF. In September, the MPC commenced outright sales of assets and said that, by both means, it would reduce the size its size by £ over the following year. Page 28  Readers who’ve come this far will be glad to hear that this section will be pretty brief because I’ve actually gone through the main points already. There are two. First, because the impact of QE has been variable I don’t think it would be right to pretend there’s some fixed, unchanging effect on the economy – to translate, for example, a given quantity of asset purchases (or sales) into some notional equivalent in terms of Bank Rate. It’s partly because of this, and the fact that we can only be less sure of its impact than that of conventional policy, that the MPC views Bank Rate is its “primary” policy instrument. By design, the Committee did not embark on QT until the official interest rate reached a certain threshold – a level from which (were the need to arise) it could then be cut.