But sadly it is a phrase that we are now well and truly stuck with. Like a lot of our operations, Quantitative Easing can seem a bit mysterious and confusing to those not steeped in what central banks do. As much of this confusion arises from a misunderstanding of the Bank of England’s accounts, I am therefore delighted to be speaking to an audience of accountants, who might find this arcane subject rather exciting! In January this year, the Chancellor authorised the Bank to create a new fund – the Asset Purchase Facility – for the purpose of buying assets from the private sector. Any profits on the Asset Purchase Facility are passed to Her Majesty’s Treasury, while any losses are also indemnified by the Exchequer. The accounts are therefore not consolidated with the Bank’s own accounts, as the Bank has no economic interest in the fund. Initially, the Facility purchased commercial paper, funded by the proceeds of sales of shortterm Treasury bills by the Debt Management Office. This asset swap took credit risk onto the public sector’s balance sheet and was therefore more akin to a fiscal operation. But since March, purchases have been on a much larger scale and funded through the issuance of central bank reserves rather than Treasury bills. The bulk of the purchases have been of government bonds, though a small quantity of investment-grade corporate bonds have also been bought.
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.