845 Quantitative Easing

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Quarterly Bulletin 2009 Q2

Quantitative easing

By James Ben ford, Stuart Berry, Kalin Niko lov and Chris Young of the Bank's Mo neta ry Analysis D ivision and

Mark Robson ofthe Bank's Notes Division.

The Monetary Policy Committee's recent decision to expand the money supply through large-sca

asset purchases (or 'quantitative easing') shifted the focus of monetary policy towards the quant

of m oney as we ll

as

the price of m oney. W ith Bank Rate close to zero, asset purchases should

provide an additional stimulus to nom inal spending and so help meet the inflation target. This

should come about through their impact on asset prices, expectations and the availability of cred

However, there is considerable uncertainty about the strength and pace with which these effects

w ill feed through. That wi ll depend in part on wha t sellers do w ith the money the y receive in

exchange for the assets they sell to the Bank of England and the response of banks to the addition

liquidity they ob tain. The MPC w ill be monitoring

a

range of indicators in order to assess the im

of its asset purchases and therefore judge the appropriate stance of m onetary policy.

Introduction

On 5 March, the M onetary Policy Com mittee (MPC) decided

to reduce Bank Rate to 0.5 and to und ertake wh at is

sometimes called 'quantitative easing'. This meant that it

began purchasing public and private sector assets using

central bank nnoney. In this way, the C om mitte e is injecting

money into the economy to provide an additional stimulus to

nominal spending in order to meet the inflation target. This

article sets out in more detail how asset purchases are

expected to w ork, bui lding on the informa tion provided in the

MPC m inutes, the

Inflation R eport

and a range of speeches by

MPC members.

The conventional way for the MPC to conduct monetary policy

is by setting Bank Rate. The introduction of asset purchases

has shifted the focus of m oneta ry p olicy, but the objectives

have no t changed. The MPC's rem it is stil l to ma intain price

stability

defined as an inflation rate of 2 on the CPI

measure and,subject to that, to support the Government's

econom ic policy, including its objectives for gro wth and

em ploym ent. Asset purchases provide an add itional too l to

help the Committee meet those objectives. The MPC

continues to decide on the app ropriate level of Bank Rate each

mo nth and is independent of the Covernme nt in form ulating

effectiveness. The article then b riefly considers the fram ew

through which policymakers will decide to expand and unw

asset purchases before concluding. The article does not ass

the impact of asset purchases so far. This is covered in poli

docum ents such as the

Inflation Report

and the m inutes o

MPC meetings, although the 'Markets and operations' artic

in this

Qua rterly Bulletin

provides some comm entary on r

market developments.

W hy is the MPC und ertaking asset purchase

The inflation target is symme tric. If inflation looks set to r

above target, then the MPC tightens monetary policy to slo

spending and reduce inflatio n. Similarly, if inflation looks s

to fa l l below2 ,the Bank loosens monetary policy to bo

spending and infla tion. Indeed, the MPC reduced Bank Rat

rapidly in response to the sharp tighten ing in credit con diti

and a globa l slump in confidence follo win g the collapse of

Lehman Brothers in September 20 08 . By March 200 9, Ban

Rate was at 0.5 .

Despite the substantial stimulus already in the pipeline fro

mon etary policy and other factors, such as fiscal policy and

sharp depreciation of sterling , the

MPC

judged at its Marc

me eting tha t a furthe r mo netary loosening was required. I


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Research and analysis Quantitative easing

91

Nominal GDP(^

Percentage change on a year e arl ier

I98S 88 91 94 97

min al interest rates cannot generally be negative. If they

there w ould be an incentive to hold cash, which delivers

ero return, rather than deposit m oney.ni So w ith Bank Rate

e to zero, a further stimulus co uld no longer be provided

gh a redu ction in the policy rate.(^) Instead, it required

t King (2009 ) describes as 'unconve ntional m easures'.

Banks hold cen tral bank mone y in the fo rm of reserve

reserves at Bank Rate. Banks the n face the choice of

ves or lending the m o ut in the marke t, and so

interest rates are influenced by the level of Bank Rate.

s then feeds throu gh to a who le range of interest rates

ds and companies w hich in turn affects their

operations. In norm al

to the dem and from banks at the preva iling level of

te.(3) W hen con du cting asset purchases, the Bank is

ditiona l reserves,H) This does no t mean thou gh

t the Bank no longer has influence over ma rket interest

s. Market interest rates w ill continue to be affected both

the level of Bank Rate and, in ad dition, by the am oun t of

scussed further in the section on econ omic channels below ).

there are a num ber of ways of increasing the supply

oney in the econo my, and a wider range of

how comp anies and households obtain finance. The next

section looks at how q uan titative easing is expected to w ork in

the United Kingdom.

Ho w do asset purchases w ork?

Injecting money into the economy

The aim of qua ntitative easing is to inject money into th e

econom y in order to revive n omina l spending. The Bank is

doing tha t by purchasing financial assets fro m th e private

sector. Wh en it pays for those assets with new cen tral bank

money, in addition to boosting the am ount of central bank

mon ey held by banks, it is also likely to boost the am oun t of

deposits held by firms and households. This addition al mo ney

then works throu gh a number of channels, discussed later, to

increase spending .

The Bank of England is the sole supplier of central bank money

in sterling. As we ll as banknotes, central bank money takes the

form of reserve balances held by banks at the Bank of England.

These balances are used to make paym ents b etween differen t

banks. The Bank can create new money electronically by

increasing the balance on a reserve accou nt. So whe n the Bank

purchases an asset from a bank, for example, it simply credits

tha t bank's reserve account wit h the add itional funds. This

generates an expansion in the supply of c entral bank m oney.

Commercial banks hold deposits for their customers, which

can be used by households and companies to buy goods and

services or assets. These deposits form the bulk of what is

know n as 'broad m oney'. ) If the Bank of England purchases

an asset from a non-bank compan y, it pays for th e asset via the

seller's bank. It credits the reserve accoun t of the se ller's bank

w ith th e funds, and the bank credits the accoun t of the seller

w ith a deposit, A stylised illustration of this flow of funds is

shown in

Figure

1

This means that wh ile asset purchases from

banks increase the mo netary base (or 'narrow mo ney'),

purchases from non-banks increase the m oneta ry base and

broad money a t the same tim e. The expansion of broad

money is a key part of the transm ission mechanism for

qua ntitative easing. It should ultima tely lead to an increase in

asset prices and spending and therefore bring inflatio n back to

target.

(1) Yates (ZOOZ) notes that if the storage costs of holdin g cash were significant, tha t

could reduce the return below zero and so in principle interest rates could be slightly

negative.

(2) In the minutes of i ts March meetin g, the Com mittee highl ighted i ts concerns about

further reductions in Bank Rate: there might be adverse effects on bank and building

society profits and hence their future le nding capacity; and, a sustained period of very

low interest rates could imp air th e functionin g of money markets, creating di ff icul t ies

in the future, when interest rates needed to rise.

(3) For more details see heframework for the Bank of England s operations


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Quarterly Bulletin 2 9 Q2

Asset purchases in othe r coun tries

The global nature of the economic slowdown has led

to

monetary policy being loosened around the world. Policy

rates are at very low levels and a num ber

of

cen tral banks have

moved towards asset purchases. A range of approaches has

been taken to easing monetary policy and improving

conditions in credit markets, in part reflecting the structure of

financial markets in different countries.

In the Un ited States, asset purchases have covered a range of

different types

of

assets, such as com m ercia l paper and

asset-backed securities. These purchases have either been

undertaken directly by the Federal Reserve or by providing

financing to financial companies to fa cilitate their purchase of

private sector assets. The Federal Reserve has also expanded

its purchases

of

USTreasuries, and begun to purchase debt

issued by hou sing-related go vernm ent sponsored enterprises.

Much of th e focus has been on interven ing in specific markets

to improve their functioning. However, the depth of capital

markets in the United States has meant that these operations

have resulted in a sizable expan sion

of

the monetary base,

Wh ile the European Central Bank s enhanced credit suppo

measures have mainly focused on providing support to ban

through its refinancing operations

it

has also announced t

wi ll begin purchases of covered bonds in the near future .

Since the start of this year, the Bank of

Japan

has introduce

outright purchases

of

private sector instrum ents such as

commercial paper and corporate bonds.

In March, the Swiss Na tiona l Bank announced th at

it

woul

purchase private sector assets and foreign currency to incr

liquidity and prevent a furthe r app reciation of the Swiss fra

against the euro.

The Bank of Canada published a repor t in April that set ou

how

it

m ight provide a further monetary stimulus

if

requir

with the policy rate at an effective lower bound. This inclu

purchasesofboth public and private sector assets, althoug

these tools have n ot been used so far.

Figure Flovi/ of funds for Bank of England asset

purchase from a non-bank company

Credit sel ler s bank s

reserve accountat

the BankolEngland

Bankot E n g l a n d

accQ.nt (deposi t )

Seller non-bank)

Assets purchased

In order to inject a large quan tity

of

money over a short period,

there needs to be a ready supply

of

assets to purchase.

The

bulk of the Bank s purchases to date have been in the gilt

marke t, where there is a large am oun t of assets w ith similar

characteristics, allowing large quantities to be purchased

quickly. How ever, the Bank is also purchasing private sector

assets such as com me rcial paper and c orporate bonds, albeit

in

smaller amo unts. The aim of these purchases is to improve

conditions in corporate credit markets by being a ready buyer

for such instrum ents. This should make

it

easier and cheaper

for com panies to access credit. The focus of these operations

number of different channels through whichitcan bo ost

spending. The box on pages 94- 95 sets out m ore details o

the operational framework for conducting purchases

of

the

different assets. As the box notes, the Bank had begun

to

purchase private sector assets before the MPC decided

to

undertake quantitative easing. This was to improve condit

in corpora te debt ma rkets. However, those purchases wer

funded by the issuance of Treasury bills, rather th an centra

bank money, and so did n ot increase the m oney supply.

Purchases

of

commercial paper and corporate bonds do no

need to be financed by central bank money to influence

conditions in those m arkets, but since quantitative easing

began they have been financed by centra l bank reserves an

contributed to the injection

of

money.

Economic channels

Injecting money into the economy, in return for other asse

increases the liquidity of private sector balance sheets. Th

the fundam ental mechanism through which such a monet

expansion influences spending and hence inflat ion. Money

highly liquid because

it

can easily be used to buy goods an

services or other assets. The increase in private sector liqu

wi ll depend on the liq uidity of the assets tha t are being

exchanged for m oney. There are a number o f channels

through which greater liquidity can have an impact. Three

channels are set out below. The transmission m echanism


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Research and analysis Qu ant itativ e easing

Styl ised transmiss ion mechanism for asset purchases

Money in

the economy

t

B inli

lending

yields, reducing the cost of bo rrowing for households and

companies leading to higher consumption and investment

spending. Cheaper and easier access to w ork ing ca pital for

companies should also help them to maintain o utpu t,

improving the prospects for employment and hence

consumer spending. Furthermore, higher asset prices

increase the we alth of asset holders, which should boost

their spen ding. The Bank s asset purchases influence asset

prices in a number of ways.

Wh en a financial comp any sells an asset to th e Bank, its

money holdings increase (ie it has additional deposits). If

the company does not regard this extra money to be a

perfect su bstitute for the assets it has

sold,

this would imply

tha t it is now h olding excess money balances. In order t o

rebalance the po rtfolio back to its desired comp osition, the

company may use the money t o purchase other assets.

However, that just shifts the excess balances to the seller of

those assets so that they look to purchase other assets as

well.

This process should bid up asset prices, in princip le to

the point where , in aggregate, the value of the o verall asset

po rtfolio has risen sufficiently to bring the share of money

relative to all assets to its desired level. This is sometimes

known as the portfolio balance effect.

More g enera lly, as prices rise for the assets purchased by the

Bank, their yield w ill fall relative to those on o ther assets.

Households and companies may be encouraged to switch

into othe r types of asset in search of a higher return . That

would push up on other asset prices as well. Moreove r, by

injecting more money into the economy, the Bank is making

liquidity cheaper and easier to ob tain. That should m ake

households and companies more will ing to hold other

illiquid assets on their balance sheets.

The Bank s purchases of com me rcial paper and corporate

price.

That has made it difficult or costly for some

companies to raise finance in the c apital m arkets, as

investors demand an additional return (or liquidity

prem ium) to compensate them for tha t risk. By offering to

be a ready buyer for commercial paper and corporate

bonds, the Bank should make investors more confiden t t ha t

they can sell such assets if required, and hence lower the

yield required to hold the asset back to more normal

levels. More investors sho uld also be encourage d to

participate in the market, increasing the amount of financing

available.

Bank lending and quantity effects

As noted earlier, banks

end up with higher reserve balances held at the Bank of

England as the result of asset purchases. These injections of

reserves may make it easier for banks to finance a higher

level of liqu id assets. Banks gain b oth new reserves anda

corresponding new cu stome r deposit wh en assets are

purchased from non-banks. A higher level of liquid assets

could encourage them to extend more new loans than they

wo uld othe rwise have done. Banks need to keep a stock of

liquid assets in order to be able to meet paym ent demands

arising from custom ers or financial transactions. As tha t

stock increases, banks should also be mo re w ill ing t o hold a

higher stock of il l iquid assets in the form of loans as they

have the funds to cope with the potentially higher level of

payments activity, unless they are constrained by other

factors (see below). More bank lending to householdsand

connpanies should help to sup port higher consum ption and

investme nt. And , even if banks do n ot choose to expand

their lending to households and corporates, the extra

reserves may contrib ute t o a decline in the interest rate th at

banks pay to borrow from each other.(i)


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Im plem enta tion o f asset purchases

Injections of money are implemented through the Asset

Purchase Facility (APF), The facility w as announ ced in January

(Table 1) and details were set out in a subsequent exchange of

letters between the G overnor of the Bank of England and the

Chancellor of the ExchequerH) TheAPFinitially began

purchases of private sector assets funded by the issuance of

Treasury bills. Its purpose at tha t tim e was focused solely on

improving the availability of credit to companies, by improving

the liqu idity in certain capital markets. However, once the

MPC decided tha t it wished to purchase assets financed by th e

creation o f c entra l bank reserves, the APF was then used for

mon etary policy purposes, and purchases of gilts were also

introduced.

Table Time line for asset purchases

Date Event

19 January Anno unce men t of Asset Purchase fac ility (APF) by Chancelior.

29 January Exchange of letters on details of APF.

13 February Launch of comm ercial paper facility

5 March MPC decision to use APF for mon etary policy purposes.

11 March FirstAPFpurchasesof gi l ts .

19 March Market notice for corpora te bond and Credit Guarantee Scheme facilit ies.

25 March First APF purchases of corpora te bonds.

The overall level of purchases is decided by the Monetary

Policy C om mittee , wit h the choice of assets to purchase

delegated to the Bank executive. The Bank is curre ntly

purchasing three d ifferent types of h igh-qu ality assets

through the APF: investment-grade commercial paper;

investment-grade corporate bonds; and UK government

bonds (g ilts). Oth er assets, such as paper issued under th e

Credit Guarantee Scheme, syndicated loans and certain types

of asset-backed securities are also included on the list of assets

that are eligible for purchase by the APF, and could be

considered in due course. Furth erm ore, the Bank can ask for

the C hancellor s app roval to add othe r assets to the eligible list

if it deems that appropriate.

Asset purchases are being con ducted t hro ugh a separate

wh olly-o wn ed subsidiary of the Bank of England, wi th an

indem nity provided by H M Treasury to cover any tosses tha t

migh t be incurred. The MPC is independent of the

Govern men t in ma king its decisions on the level of purchases.

Details of th e transactions are published throu gh the Bank s

statistical publications, operational announcements and a

quarterly report on the APF. The mechanisms through which

the purchases are currently being made are described below.(^)

previously acquired fro m issuers. A fixed spread to risk-fre

interest rates is charged, depend ing on the cred it ra ting of

paper. Marke t participan ts selling previou sly acquired pap

must pay an additiona l fee. To be eligible, com me rcial pap

should be of up to three mo nths m aturity, subject to minim

credit ratings (equ ivalent to inve stmen t grade) and issued

sterling by non-bank companies that make a material

contribu tion to economic activi ty in the United Kingdom.

The aim of this facility is to improve the liquid ity In the

com me rcial paper market by being a ready buyer of such

assets, making issuers and investors mo re con fident tha t th

can raise funds if necessary. This should encourage a retur

more normal market conditions and lower interest rates b

charged to hold such paper. The sterling non-bank comme

paper market is relatively sm all in the U nited Kingdom , at

around 6- 8 b i l l ion. As of2 May, theAPFheld around

Zy4 bill ion of commercial paper, about a third of the eligi

stock.

Co rpo rate bo nd fa cilit y. Reverse auctions are undertaken

three times a week to buy a wide range of sterling bonds fr

financial institution s tha t act as market makers for such bo

Participants subm it bids for the price (spread) at w hich the

are will in g to sell particular bonds, wi th th e cheapest bids

being accepted by the Bank up to a maxim um amo unt. Th

Bank privately sets a min imu m spread (equivalent t o a

ma ximu m price) at which it is prepared to purchase a bond

and so not a ll bonds w ill be boug ht at each auction, even i

bids are received for each bon d. Each auction is for a rela t

small amoun t of each bond (up to 5 m il l ion), but the

frequency of the auctions should make participants more

confide nt th at the y can sell bonds if necessary. T hat In tur

should reduce the interest rate they charge for holding the

The auctions also provide a regular source of info rma tion o

the pricing of individual bonds, helping to reduce uncertai

over their market value. The focus of these purchases is to

facilitate ma rket-m aking by banks and dealers and so remo

obstacles to corpora te access to ca pital m arkets.

The eligibility criteria for corp orate bonds are very similar

those for comm ercial paper. Bonds must be of inves tment

grade and issued in sterling by non-bank companies tha t m

a material contribution to econom ic activi ty in the

United Kingdom, The portfolio of corporate bonds held un

th e

APF

is likely to g row over time as more auctions are

he

As of

2

May, the

APF

held around 0.6 bill ion of corporate

bonds.

Gilt purchases. Conventional gilts in the maturity range o


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Research and analysis Qu anti tat ive easing

9

their custom ers. And the auctions also allow

agree to sell their gilts at the

age successful price in the com petitive auction ,

aim of the g ilt purchase program me is to allow the MPC to

e scale. The nomin al value of the stock of

the m atu rity range covered by the auctions is curren tly

270 b ill ion. The purchases are not aimed at particular

in that range. As of2 May, the APF had

to th e Bank s other op erations. Before quantitative

began,

the Bank im plem ented the MPC s decisions on

k Rate throug h a system of volun tary reserves targets.

ks wo uld choose what level of reserves they w ished to hold

ir accounts at the Bank of England on average each

money in aggregate to m eet those targ ets. Each bank s

reserves were remune rated a t Bank Rate provided the y were

close to their target. The terms on which central bank m oney

was provided helped to ensure that short-term market interest

rates were in line w ith Bank Rate. But once the focus switched

to the quan tity of money supplied, with the MPC deciding to

inject additional money into the economy, those reserves

targets became redund ant and were suspended. Banks simply

earn Interest at Bank Rate on any reserves they hold. The

Bank s othe r open market o perations that supply and withd raw

central bank money have continued, so that the injection of

add itional reserves is broadly equal to th e a mo unt of assets

purchased under th e APF.

(1) These are available on the Bank s website a t

www. bankofengland.co.uk/monetarypol icy/asselpurchases.htm.

(2} Full details are set out in the Market Notices Issued by the Bank. These are available

at www.bankofengland.co.uk/markets/apf / index.htm. A box on pages

7O 7^

o f t h e

Markets and operat ions art ic le in this Quartery Bulletin also discusses the Bank s

purchases of private sector assets. The Credit Guarantee Scheme facility has not been

act ivated,

but the Bank stands ready to do so if market condit ions deteriorate. A

consultation paper was published on 3 June containing proposals for possible

extensions to the APF to cover a broader range of instruments that are used to f inance

working capital .

The add itional deposits created by bank lending wil l be

passed on to other households and companies as they are

spent.0) In an analogous way to the po rtfolio effect

discussed earlier, if their money balances are pushed above

the desired level, they may respond by bu ying more goods

and services. This will furthe r b oost n om inal spending and

should u ltima tely bid up the prices of goods and services

leading to higher inflation. Higher money balances may also

provide working ca pital for companies, making it easier for

them to maintain employment levels.

Expe ctations. Asset purchases could have an impo rtan t

impact on expectations. By dem onstra ting tha t the MPC

ill do whatever it takes to meet the inflation target,

xpectations of future inflation shouid remain anchored to

the target when there was a risk that they might otherwise

have fallen. Even w ith nom inal interest rates fixed at very

low levels, this wou ld imply th at real interest rates are kept

at a lower level, which should encourage greater spending.

Higher Inflation expectations could also influence

price-setting behaviour by firms, leading to a more direct

impact on infla tion. More generally, a perceived

improvement in the economic outlook is likely to boost

onfidence and make people more will ing to spend. The

rticle on public attitudes to inflation and interest rates in

his edit ion ofthe

Quarterly Bulletin

provides a discussion of

ecent developments in household inflation expectations.

effects of asset purchases. We then discuss a number of key

drivers of the strength of the economic channels set out above:

first, the response by sellers of assets to the add itional mone y

they receive (most relevant to the effect of purchases on asset

prices); second, the response of capita l ma rkets to purchases

of corporate debt;

third,

the response by banks to the

add itional reserve balances they hold (relevant t o the bank

lending and qua ntity effects); and finally the wider response of

households and companies.

Empirical evidence

Increases in money should eventually lead to a rise in prices.

There is a well-established long-run em pirical relationship

between broad money growth and inflation across a variety

of countries and m onetary regimes (see for example

Benati (2005) and King (200 2)). However, there is

considerable uncertainty about the pace with which injections

of money will feed through to prices.

Qu antita tive easing has been used on few occasions in the

past, so there is little em pirical evidence on which to draw.

One obvious intern ationa l example is the experience of japan

earlier this decade. Bernanke

et al

(2004) found some

evidence of an impact on long-term interest rates from

quantitative easing. However, Babaetal (2005) concluded

tha t the Bank of japan s com mit m en t to keep policy rates low

was more important for reducing long-term interest rates than

its use of quantitative easing. Asset purchases have also been


7/12


United States in the past. Bernanke (2002) highlighted th at

the Federal Reserve was successful in maintaining a ceiling on

long -term Treasury bond yields in the 1940s. However, studies

suggest tha t an attem pt in the Un ited States in the 1960sto

raise sho rt-term interest rates while lov^/ering lon g-term

interest rates, the so-called 'Op era tion T wist', v fas less

successful (thoug h this may have been due to the sma ll size of

the operation).

Recent announcements of asset purchases by central banks

provide further evidence that such purchases can influence

asset prices. Kohn (2009) highlighted th at the Federal

Reserve's announcementsofpurchasesofmortgage-backed

securities and Treasury bonds reduced mortgage and oth er

long -term rates in the Un ited States appreciably by some

estimates by as muc h as a percentage po int. And the Bank

of

England's announcem ent o n 5 March that the Bank wo uld be

purchasing 75 bill ion

of

assets finance d by cen tral bank

money also appearedtohave an impact on UK governm ent

bond yields. Gilt yields in theS to 25 year maturity range

eligible for purchase fell around 4 0 -9 0 basis points by the end

of the day fol lowing the announcement.

Evidence on th e impactofmoney injections on output and

infla tion is sparser. For the Japanese episode, Kimura e ta /

(2003) found the effect to be small but highly uncertain. It is

diff icult to know how importa nt qu anti tative easing was in the

case of apanwithout knowing how much worse the recession

wo uld have been with ou tit.

The remainder of this section looks at the factors that w ill

influence the strength of the econom ic channels set out above.

Response by se l le rsofassets

In order for the p ortf olio rebalancing effect to w ork, sellers of

assets needtopurchase other assets with th e m oney they

receive, there by bidd ing up asset prices. As gilts have m ade up

the bulk

of

purchases, an imp orta nt consideration is who

typically own gilts and what they are likely to do with the

money. Looking at the final seller of the gilts purchased by the

Bank could be misleading. For example, some financ ial

institutions may have bought gilts in anticipation

of

selling

them to the Bank. In that case,

it

is the origina l seller tha t

ends up w ith extra money as a result of th e asset purchase

programme. The distribution of gilt holdings before the

announcement of the Bank's asset purchases may therefore be

more informative. At the endoflast year, the bulk of gilt

holdings we re accounted for by UK insurance com panies and

pension funds, other UK non-bank finan cial institution s and

overseas investors (Chart 2).

Chart 2 Distribution of to ta l gilt holdings as at the

endof2008W

oth er Ul i


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Research and analysis Quanti tat ive easing

asset returns. This is illustrate d in Figure 3. Money provides

rtunity cost because the return on holding money is

tower than on other assets. So the demand for

ey should rise as the yields on other assets fall (shown by

DQ ).

An increase in the

ty of money (from S to 5-i) witt only be wittingty hetd if

V i to Y Q .

ure 3 Changes in m oney demand and money supply

on assets r r

Money holdings

Asset purchases

i l l also be affected by other factors, such as

in the economy (given the need for money t o cond uct

). As asset prices rise, nom inal spending should

D Qto D i). That wi ll reduce the change in asset prices

g

to Y * .

ds (the slope of the demand curve) and the elasticity wit h

urve). One risk is tha t at low levels of yields the

high,

sellers are prepared to accept a higher p ropo rtion of

negate it altogether.l ) If tha t is the case, the injection

finance in corporate debt markets. However, their impact w ill

depend in part on wh at has driven the increase in the spread

between yields on corporate and government bonds over the

past tw o

years.

An illustrative decompo sition of the spread on

investment grade corporate bonds in the February 2009

Inflation Reportsuggested that the pickup had been driven by

both increased compensation for illiquidity and increased

com pensa tion for de fault losses. The Bank s facility is targeted

at reducing illiquidity premia, although credit risk premia may

be influenced indirectly through the general increase in

collateral values and nominal spending that arises through

money-financed asset purchases.

The impact on the availability of credit to companies wil l also

depend on the willingness of investors to expand the finance

they provide in corporate debt markets. D ue to the financial

risk invo lved, the Bank s purchases are focused on high -qua lity

debt, but they could still make it easier for companies with

lower-quality debt to raise finance if greater use of the

capital markets by investment-grade companies leaves banks

with more capacity to lend to non-investment grade

companies.

The Bank s commercial paper and corporate bond facilities

need not require large quantities of assets to be purchased by

the Bank In order to be effective, and so their success should

not be measured by the quantity of purchases. The aim is to

be a ready buyer if needed, so even if actu al purchases are

relatively small, the knowledge the Bank stands ready to

purchase assets should give confidence to investors to hod

such assets.

Response by banks to additional reserves

The impact of the additional reserves on banks overall

liquidity positions will depend on how the other com ponents

of banks balance sheets change. If banks holdings of gilts fall

(as wou ld be the case if gilts are purchased fro m the banks)

then banks overall holdings of liquid assets will be relatively

tittle changed, but if gilts are bought from non-banks, the

stock of liquid assets held by banks should increase relatively

more.The extent to which any improvement in the liquidity of

banks balance sheets wil l encourage them to increase their

lending will be driven by a number of considerations, including

whether they have sufficient capital to support such an

expansion of their balance sheet, whether they have access to

funding for the loans, and whether there is demand for the

loans in the first place.

Given the financ ial stresses tha t banks are curren tly facing, this

channel may be impaired, at least in the near term. However,


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lending.

These have included capital injections, guarantees on

debt issued by banks to o btain fund ing, and insurance against

losses on some assets held by banks. As the impa ct of the se

measures feed through, they should interact with the

additional liquidity provided by the Bank of England's asset

purchases to make the effect of higher reserves on lending (the

bank lending channel) more powerful.

One nneasure th at is som etime s used to analyse the c reatio n

of broad money through lending by commercial banks is the

'money multipl ier'the ratio of broad money to central bank

money. Given tha t the level of broad money is many times

larger than that of central bank money, this might suggest that

a small injection of reserves could have a substantial impac t on

broad money. However, this is not a direct causal relationship.

The level of broad m oney reflects all the factors discussed

above. In current con ditions, the m arginal impact on broad

money of

change in reserves is likely to be much smaller than

implied by the current ratio. And indeed, the mone y m ultiplier

has fallen sharply since the onset of the financial crisis in the

middle of 2007.

Even if banks do not increase lending at a ll, broad m oney w ill

still rise to the extent that the Bank's asset purchases create

deposits by buying from non-banks. The asset purchases

should therefore boost broad m oney regardless of the

response of the banks, but th e im pact could be mu ch larger if

banks increase lending as

well .

ide r response of households and companies

The overall impa ct o f asset purchases on spending will also

depend on how households and companies respond to

changes in their money holdings and asset prices. The impact

of higher money holdings will depend, for example, on the

extent to which households and companies choose to pay

dow n deb t or increase spending.

Companies facing a lower cost of borrowing,

as

yields

fall,

are

likely to spend more on investment projects, for example, but

the impact will also depend on the expected demand for their

products. The extent to which the policy stimulus contributes

to an improve me nt in confidence is therefore likely to be

important.

The impact on ho usehold spending of an increase in asset

prices wilt depend in part on whether it is perceived to be

persisten t. If househo lds expect asset prices to rem ain higher,

the im pact on spending is likely to be stronger. Alterna tively,

additional wealth may be used to provide a precautionary

buffer against futu re income shocks, and so have a more

limited impact on current spending. Some wealth will be tied

Asset purchases and the m one tary policy

process

At its March me eting, the MPC decided to purchase 75 b

of assets over the following three months. At its May mee

the Committee decided to purchase an additional 50 bill

of assets. This will leave the level of reserves held by banks

the Bank of England more than four times higher than it w

prior to th e asset purchases. The injection of central bank

money wil l be equivalent to around 8 of broad money (o

83/4

of annual GDP).(1)

As discussed in the minu tes of th e MPC's M arch m eeting, t

full impact of this stimulus is likely to take some time to c

through. There is also a considerable lag between Bank Ra

changes and their fina l effect on nom inal spending.

Ultimately, asset purchases will have been successful if the

have helped the Committee return inflation back to target

the m edium term . In practice, thoug h, i t w i l l be diff icult t o

assess the marginal impact of those purchases given the w

range of other policy measures and economic developmen

tha t w ill be affecting the econonny. Nevertheless, a range

indicators are likely to be useful in assessing the effects of

Bank's asset purchases at differ en t stages. Early ind icator s

include developme nts in financ ial markets and assets price

The 'Markets and operations' article in this

Quarterly Bulle

provides some comm entary on recent market developmen

Over time, the impact on bank lending and broad money

should become clearer, with the effects finally feeding thro

to nominal spending and inflation. MP judgements on th

impact of asset purchases and the outlook for the econom

wil l continue to be set out in the m inutes of i ts mo nthly

meetings and in quarterly/n//at/on Reports.

Exit strategy

As the economy recovers, the m edium -term outlook for

inflation wil l improve. As in normal t imes, the Com mittee

be guided by the me dium-te rm o utlook for inflation relati

the inflation target. Given that the Inflation target is

sym me tric, if inflatio n looks set to rise above the 2 targe

then the Committee wil l want to t ighten monetary pol icy

stow spending and reduce inflatio n.

Mo netary policy could be tighten ed in a number of ways.

could involve some combination of increases in Bank Rate

sales of assets in order to reduce the supply of money in th

economy. Alternatively, the supply of reserves could be

reduced with ou t asset sales, thro ugh t he issuance of


10/12

Research and analysis Qu ant itativ e easing

appropriate way to w ithdraw the policy stimulus based

circumstances prevailing at the tim e.

k m oney, or quan titative easing , shifted the focus towards

ntity of money as we ll as the price of money. Injecting

into the economy should boost spending, helping

to target in the m edium term .

households and companies use the new money to buy goods

and services or other assets, the more i t wi ll raise spending. If

banks use the a dditio nal reserves to expand the ir lending, the

impact could be even stronger,

It is too soon to say how powerful the stimulus will ultimately

be.

There is considerable uncertainty about the strength and

tim ing of the effects. Standard economic models are of

limited use in these unusual circumstances, and the empirical

evidence is extremely lim ited. However, the monetary policy

framework wi ll ensure that the appropriate measures are taken

over time so that the inflation target is met in the m edium

term.


11/12

100


References

Baba, N, Nishioka, S, Oda, N, Shirakawa, M, Ueda,K and Ugai,H

2005) , Japan s deflation, problems in the financial system and

monetary policy , IS Working Paperno. 188.

Benati,

L

2005) , lon g-r un evidence on money growthand inflation ,

Bank ofEnglandQuarterly Bulletin, Autumr: pages 34 9-5 5.

Bernanke,

S

2002) , Deflatio n: making sure it doesn t happen

here ,

remarks deiivered at the National Economists Club,

DC,

November.

Bernanke,

S, Reinhart, V

R

and Sack,

P 2004 ) , Monetary pol icy

alternative s at the zero boun d: an emp irical assessment ,Brookings

Paperson Economic Activity Issue 2, pages 1-78.

Kimura,

T

Kobayashi, H, Muran aga,

J

and Ugai, H 200 3), The

effect of the increase in the mon etary base on Japan s econom y a t

zero interest rates: an empiric al analysis , in IS Papersno. 19

Monetary policy in a changing env ironment .

King,

M A 2002) , No m oney, no inflation the role of money i

the econom y .

Bank of England Quarterly Bulletin.

Summer,

pages 162-77.

King,M A 2009),The Governor s speech to the CBI dinner,

Nottin gham , January.

Kohn,

D

L

2009 ) , Mone tary policy in the financial crisis , speech

delivered at the conference in honour of Dev^iey Daane, April.

Yates, A 20 02 ), Mone tary policy and the zero bound to interest

rates: a review .ECB Working Paperno. 190.

Yates, A 20 03 ), Monetary policy and the zero bound to nomina

interest rates ,Bank of England Quarterly Bulletin, Spring,

pages 27-37.


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Documents

845 Quantitative Easing