Obligatory QE Post

This is a well written article on an important subject by Faisal Islam, but he makes a lot of factual mistakes that stem from unfamiliarity with actual BoE operations., which leads him to some conclusions unsupported by the actual facts of the matter.

Printing money

“Printing money”: there is no “magic” or “mystery” to this phenomenon. When any economic entity wants to acquire an asset, it funds the acquisition by issuing liabilities. These liabilities are created exh nihilo, right out of thin air! This voodoo is entirely generic and unremarkable (Starbucks Satanism, if you will).

All liabilities have a particular liquidity profile. Certain liabilities are very liquid, and circulate around the economy as “money”–in particular, bank and central bank liabilities.

In general, central banks are monopoly issuers of specific types of liabilities: the bits of paper that are sometimes used in day-to-day retail transactions and the bank reserves used in the interbank clearing and settlement system.

When the Bank of England decided in early 2009 to expand its balance sheet in order to support its policy goals, an increase in its liabilities (i.e. reserve creation) was the necessary consequence. In more normal times, the Bank would have offset its asset purchases by selling longer-term govt liabilities via the DMO and so “mopped-up” the initial reserve creation to keep total reserves at that demanded by the banking system. But these were not normal times and the pace of purchases was so rapid (by design) that it outstripped the ability of Bank to sterilise these operations immediately (though since then it has created, and sold £100bn worth of, one week Bank of England bills to address this very problem).

Reserves have a very special and dual purpose here. On the one hand, they are liabilities of the central bank, and the central bank issues them whenever it wants to purchase an asset, just like any other economic entity. On the other hand, reserves are used by the banking system for final settlement of obligations. The level of reserves that the banking system wants to hold for this purpose is determined under the Bank’s current framework (the Sterling Monetary Framework, introduced in May 2006) by the banks themselves and is unconnected to the BoE’s QE programme.

So the amount of lending that will or won’t happen has nothing to do with the amount of reserves that the Bank of England created in order to fund its asset purchasing programme, commonly known as “QE”, other than in the sense that the magnitude of reserve creation might signal QE’s contribution to producing different credit conditions in the economy.

Where did the money go?

The Asset Purchase Facility (APF), created by the Bank in January 2009, is the vehicle for what is known in the UK as “quantitative easing” (other countries have used different systems that are also commonly referred to as QE).  As noted above, the Bank initially financed the APF via Treasury bill issuance by the DMO, but the rate of purchases was such that from March 09, the Bank financed the fund via reserve creation. Important point (take note Faisal): the MPC deliberately used the fund to target assets held by non-banks, precisely so new money would enter the economy  rather than just sit in the banking sector. Mr Islam knows this at the start of the article, but has forgotten it by the time he gets half way through. Where did the money go? What did the banks do with it?

The money went to the non-banks (pension funds, etc), per Mr Islam’s initial position, because that was the BoE’s programme of quantitative easing as it actually happened in this country; and so £200bn in asset purchases must have increased non-bank deposit balances by 200bn. What did the banks do with “the money”? Nothing, because the banks never got the money. The non-bank holders of the assets the APF bought got the money.  However, those deposit accounts credited after the sale of the assets are held in banks. Where else? Charles Bean describes the process in this 2009 speech:

Technically what happens is the following. The Asset Purchase Facility buys assets funded by a loan from the Bank. In turn, the Bank funds that loan through additional reserve creation. If this sounds like financial alchemy, consider how the money flows through the system. When the Asset Purchase Facility buys a gilt from a pension fund, say, it can be thought of as paying with a cheque drawn on the Bank of England. The pension fund will then bank the cheque with its own commercial bank, so the latter now has a claim on the Bank of England – that is what reserves are. In reality, these payments are not made by cheque, but rather are carried out electronically. But the principle is the same, though one key difference is that we pay Bank Rate to the commercial bank on its claim on us, as well as charging Bank Rate on the loan we make to the Asset Purchase Facility.

As the Deputy Governor goes on to explain, when the fund manager uses this deposit balance to purchase some other asset, this claim against the Bank is passed on to some other agent, who nevertheless holds it in a bank. Wherever “the money” goes, it always ends up in a bank.

What has happened to the new deposits? We have a £200bn QE programme but only £8bn in broad money growth–that doesn’t make sense, does it? I think the most likely explanation is that ultimately these balances are being used by corporates to pay down existing loans and so effectively allow the sector to refinance current investment at more favourable rates (thanks to Luis Enrique and Marc Lavoie for this insight).


Charles Bean, “Quantitative Easing: An Interim Report“, Speech 2009

Paul Fisher, “An unconventional journey: The Bank of England’s Asset Purchase Programme“, Speech 2010

Cross, Fisher and Weeken, (2010), ‘The Bank’s Balance Sheet During the Crisis’, Quarterly Bulletin, 50, 1, pages 34-42