Thus not only does the price of gilts rise as a consequence of the Asset Purchase Facility’s initial purchases, but also the prices of a whole spectrum of other assets. That in turn lowers the cost of non-bank finance and encourages increased corporate issuance. Also the rise in asset prices increases wealth and improves balance sheets. In this way, Quantitative Easing helps to work around the blockage created by a banking system that is still undergoing a process of balance sheet repair. That is exactly what we have seen since the Monetary Policy Committee started its asset purchase program. Gilt yields fell sharply, though they have subsequently risen and fallen again (Chart 2). But gilt yields can move for a variety of reasons, including changing expectations of future interest rates. If we control for that by comparing gilt yields with a measure of market expectations of the future level of Bank Rate (Overnight Indexed Swap rates for an equivalent maturity), we find that this spread has fallen by around ¾ percentage point (Chart 3). Moreover, no such movement is observed in either the United States or euro  1  That is in contrast to the related policy conducted by the Bank of Japan in the early part of this decade, which was instead directed at purchases of Japanese government debt held by the banking sector. 2  BIS Review 126/2009  area, which strongly suggests that the movement may be related to our gilt purchases 2 .
No matter how rapidly or how slowly the economy is growing, or how fast or slow the money is circulating, the aggregate amount of reserves will be exactly the same. So it should be clear that the quantity of central bank reserves held by the commercial banks is useless as an indicator of the effectiveness of Quantitative Easing. Now obviously we would prefer that the money circulates more rapidly and that this is done through increased bank lending and deposit taking. In other words, we would like to see a further expansion of credit and broad money. Since the banks collectively are now awash with reserves, they should not be prevented from making additional loans because of any liquidity concerns. Banks are, though, constrained by a lack of capital and are looking to reduce leverage rather than increase it. Fortunately, increased bank lending is not necessary for Quantitative Easing to work. Indeed, it was precisely because the Monetary Policy Committee expected the additional monetary injection not to stimulate bank lending directly at the current juncture, that the Asset Purchase Facility’s purchases were targeted at assets held primarily by the non-bank private sector 1 . So if the Asset Purchase Facility buys gilts from pension funds or asset managers, they will then have to look for another home for their money. As it is not very rewarding just to hold it on deposit, they are likely to look to put their money into other assets, including equities and corporate bonds.