The Asset Purchase Facility, operated by the Bank for the Government, will purchase up to £ billion worth of commercial paper, corporate bonds and similar securities, with the aim of increasing the liquidity of these instruments, reducing the cost of capital to businesses and stimulating increased debt issuance. As we estimate that illiquidity presently accounts for getting on for half of the 5½ percentage points interest rate spread of investment-grade corporate bonds over government debt, these actions, if successful, could have a powerful impact on the cost and availability of funds to corporate borrowers. The first purchase under this facility was made last Friday. In the first instance, purchases are to be financed by government borrowing. But, subject to the agreement of the Chancellor, this facility can also be used by the Monetary Policy Committee to undertake further easing of monetary policy in pursuit of the inflation target. That is likely to prove useful now that Bank Rate is nearing its floor. In that case, purchases would be financed by the creation of so-called central bank money – effectively IOUs drawn on the Bank of England. At such point, we might also want to expand the range of assets purchased under the scheme to include government debt. The purpose of these actions would be twofold: to push down the yields on a wider range of assets than usual; and to increase the supply of broad money (bank deposits plus banks' own reserves) in the economy. Both should help to boost nominal spending.
Of course, since interest rates cannot fall below zero, we are running out of room for further cuts. But it must not be forgotten that even if Bank Rate remains where it is, the recent cuts in Bank Rate will continue to provide a building boost to demand through this year and beyond – we don’t have to keep on cutting rates in order to provide a stimulus. Second, in November, the Government announced a temporary cut in VAT and an acceleration of spending on public investment projects, which should help support demand in the near term. Third, and most importantly, to supplement the measures taken last October, the Government has launched a five-point plan to ensure an adequate supply of credit to households and business. This comprises measures: to reduce uncertainty about the adequacy of bank capital by capping the losses on their holdings of risky assets; to facilitate  2  BIS Review 19/2009  bank funding through the attachment of state guarantees; to boost the availability of funds to business through direct purchases of company debt; to raise the availability of mortgage finance to households by halting the running down of Northern Rock’s mortgage book; and, finally, to establish a concordat with the banks under which they will maintain an adequate flow of credit to the real economy.