Quantitative easing – what does it do?

When Labour first embarked on Quantitative Easing I was uneasy. My preference was for them to mend the commercial banks quickly. Indeed, my prior preference had been not to damage them so much in the first place. If they had mended or not damaged the commercial banks through their wild monetary and regulatory policies, swinging from too hot to too cold too abruptly, we would not have had to consider QE.

If the commercial banks had been buttressed swiftly – preferably in ways which left the original shareholders and senior executives with their losses, and the taxpayer with contingent guarantees or remunerated loans – we would not have needed QE. Instead, buying shares in the banks and then demanding they held much more capital meant painful surgery and a long delay before those banks could help finance a recovery.

Quantitative easing was very much a second best policy. It achieved something, but it also has lots of side effects which are difficult to handle. The main aim of a QE programme is to drive down long term interest rates, in the hope that then more people and businesses will invest and borrow. The programmes surely drove down the rate, but all the time banks are under a regulatory cosh to raise more capital, and all the time markets are hesitant about the future, not a lot of long term borrowing and investment takes place.

The secondary aim of a QE programme is to get people to take more risk. This again did work. By definition the individual investors and the investment funds that sold bonds to the Central banks, usually bought riskier shares with the money. Some of this money found its way into hands that would create new investments, and the stock markets were able to raise some money for companies in need of it.

The main side affect of the QE programmes has been to enrich the holders of bonds and shares by raising prices substantially. This has been most noticeable in US shares and in some continental European government bonds. The late and large ECB programme has already driven bond yields to crazy levels in Germany. Anyone lending to the German government for any time period up to nine years has to pay the German government for the privilege of lending to it!

Successive programmes of QE in Japan have not proved to be inflationary in terms of general prices, though there too they have proved inflationary for the prices of bonds and shares. It is a reminder that if there remain problems in the commercial banks, and if a society is determined to save more and spend less, QE does not solve all the problems.

QE mainly enriches the state. It allows governments to spend and borrow more at surprisingly low cost. It also gives a bonus to savers who own financial assets, but they need the capital gains to offset the loss of savings income, given how low the interest rates go.

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75 Comments

  1. Posted April 26, 2015 at 6:23 am | Permalink

    Although you would think that the state needed to maintain strength especially when set against the commercial concerns and European financial wars,

  2. Steve Cox
    Posted April 26, 2015 at 6:24 am | Permalink

    QE as implemented by the Fed and the BoE does indeed work as you describe, but there are other probably more efficient ways that it could have been implemented to help the economy if that had been the primary purpose. By buying government bonds and simply hoping forlornly that some of the money so released would find its way into productive investment rather than inflating asset bubbles it was clear from the start that the form of QE preferred by the BoE was mainly intended to benefit borrowers at the expense of savers. As the government is the biggest borrower of all it’s not hard to see why this version of QE was favoured. If the primary concern had been to stimulate the economy rather than allow the government to continue borrowing shed-loads of money at rock bottom rates then different forms of asset purchase would have been chosen, forcing the newly created money directly into (hopefully) productive investment instead of merely hoping for that effect. In years to come the economic historians may well pass a baleful judgement on the form of QE chosen by this country as short-termist and politically expedient rather than being the right version to maximise the benefits for the whole country.

    Now I’m not complaining about QE personally, I’m heavily invested in equities and so far I’ve done very nicely out of it, thank you very much, but I can still see clearly that with more selfless politicians we could have done much better for the UK than we have. What worries me most is the fact that QE of any sort sends incorrect messages to the markets and so is bound to result in sub-optimal decisions on capital allocation. Any government intervention in prices and supply sends the wrong messages, as we learnt to our cost during the seventies. I just wonder when (and if) the dust has settled in 10 or 20 years time what will have been the cost of keeping inefficient zombie companies alive with cheap credit when they shoudl have been allowed to go to the wall, and what the cost will have been of so many decisions on where to invest capital that were primarily influenced by QE rather than by market fundamentals, and so were actually sub-optimal for the economy?

    • outsider
      Posted April 26, 2015 at 12:22 pm | Permalink

      Dear Steve Cox, Agree with your main point but I doubt that QE is responsible for a share “boom” other than by reducing the adverse impact of high government borrowing. The dividend yield on the FTSE 100 index is still a little higher than it was in the two years before the crash, in spite of many companies cutting or eliminating their dividends. This implies that the valuation of shares is lower. But interest rates are only a fraction of what they were pre-crash, so the relative valuation of shares is much lower.

      • StevenL
        Posted April 27, 2015 at 7:47 am | Permalink

        But how many of these firms borrow at QE-induced low rates to sustain/raise their dividends?

    • acorn
      Posted April 26, 2015 at 4:51 pm | Permalink

      Could you please tell me what other forms of QE are available, that are different to the current version of swapping time dependant interest rewards (say, 20 year Bonds) for zero interest Cash / Reserves.

      • Denis Cooper
        Posted April 26, 2015 at 6:58 pm | Permalink

        I’ll answer that as follows:

        1. If you look at the table for “Asset Purchase Facility – Results”, here:

        http://www.bankofengland.co.uk/markets/Pages/apf/results.aspx

        you will see that there are three rows – one for “Gilts”, one for “Corporate Bonds”, and one for “Secured Commercial Paper”. But of those three classes of assets the Bank only bought “Gilts” in significant volumes, in the end to the value of £375 billion, despite the original stated intention, and in fact the instruction from Chancellor Darling, that a large part of the new money was to be used to buy up private sector assets.

        This was spotted as early as May 2009 by Fraser Nelson writing for the Spectator, in an article entitled:

        “The alarming trends surrounding quantitative easing”

        which pointed out:

        “The Bank of England today confirmed that less than 1% of the £44.5bn it has printed has gone to buy company loans – it had indicated that as much as a third of the £150bn pool would go to companies. Instead, it is a mechanism to help the government issue the £240bn of gilts it’s issuing this year.”

        But then for some reason he had nothing more to say on the subject, even though those “alarming trends” continued; it is only a conjecture, but it is possible that he had been given a message that Osborne would prefer not to have the truth about what was happening with QE exposed in the press, a decision which in my view was the most important factor in depriving the Tory party of an overall majority at the 2010 general election.

        2. Before that, Edmund Conway writing in the Telegraph had questioned why the Bank was buying so many gilts and not using the money to buy other assets such as property. Actually the answer was pretty obvious – as the government was not selling property there was no point in the Bank setting out to rig the property market in its favour, but the government was selling large volumes of gilts because it was having to borrow about a quarter of the money it was spending.

        3. Another possible use for new money would have been to buy up those so-called “toxic assets” which were contaminating the balance sheets of the banks and supposedly stopping them lending to businesses.

        Reply The Bank’s refusal to buy many corporate bonds was well known and written about at the time. The Bank said they only wanted to buy liquid assets which were easily traded, and did not want the specific company risks of individual corporate bonds. The Bank would also say they did not have the property expertise to buy up properties from bankrupt stock.

        • acorn
          Posted April 27, 2015 at 10:15 am | Permalink

          As JR says plus there were concerns about infringing EU state subsidy rules for private sector corporations.

    • gte
      Posted April 27, 2015 at 3:41 pm | Permalink

      The problem is that the deficit spending and QE are pretty much identical.

      The state didn’t have anyone willing or able to lend to them.

      So the set up QE, and move into Gilts, in order to carry on spending.

      Now they have a problem. How do they get out of the mess?

      Either they leave it, or they just cancel the debt.

  3. Lifelogic
    Posted April 26, 2015 at 7:01 am | Permalink

    You see it exactly as I do, as you say:

    If the commercial banks had been buttressed swiftly – preferably in ways which left the original shareholders and senior executives with their losses, and the taxpayer with contingent guarantees or remunerated loans – we would not have needed QE

    Quantitative easing was very much a second best policy.

    QE mainly enriches the state. It allows governments to spend (mainly waste in my opinion) and borrow more at surprisingly low cost.

    Meanwhile even after the rescue banks like RNS natwest continued to harm even their solid customers by demanding funds back or onerous terms for no good reason. It did huge damage to real businesses and growth. The government shooing itself in the foot as usual.

    More control by shareholders of their own businesses is needed the existing control mechanisms are far too weak, just as the control of the UK through MPs by the voters is absurdly weak and ineffective. Many directors (such Fred Goodwin) get away with destroying companies, while paying themselves a fortune for doing so. Executive pay is far too high, there are plenty of excellent people around who will work for circa £100-200K. There is no need at all to pay millions. Four people on £100K each (with a suitable split of responsibilities) is often far better than one on £10M. It is not like football where you are limited to eleven players.

    • outsider
      Posted April 26, 2015 at 12:37 pm | Permalink

      How right you are on the last point Lifelogic. The star boss system is wildly overrated. As in football, there are only a very a few brilliant managers around ( as opposed to brilliant entrepreneurs) but the global market drives up the price of the vast majority of able, hard-working but basically ordinary chief executives. In the UK, in particular, high boardroom pay has been driven by accountancy fees. The finance director has to earn as much as he could as a full partner in an accountancy firm, the chief executive has to be paid more than the finance director and so on.

      • Narrow Shoulders
        Posted April 26, 2015 at 2:23 pm | Permalink

        The solution to the Finance Director pay conundrum would then be to end LLP status for accountancy (and law) firms. The justification for a Partner taking home big pay would be the risk they are taking on potential liability. An FD of a listed company takes little risk (as now does an LLP partner) and so would not need to remunerated equally.

        Remuneration must be tied back to return on personal risk somehow. To return to the football analogy, there are too many journeymen out there picking up a wage rather than excelling and making a difference.

        • Lifelogic
          Posted April 26, 2015 at 5:13 pm | Permalink

          Indeed rewards for risk capital and rewards for just doing a job are very different. Directors currently often get away with almost murdering companies while bleeding them to death in director’s fees to boot.

          The difference with football is you can only have 11 players on the field you just need the very best and cannot replace them with two players who are only 96% as good. In industry you usefully can.

        • StevenL
          Posted April 27, 2015 at 7:50 am | Permalink

          Or deregulate the professions and simplify the rules?

    • acorn
      Posted April 26, 2015 at 3:54 pm | Permalink

      Can we get one thing straight on this site, QE has nothing to do with rescuing / bailing-out Commercial Banks, OK! Commercial Banks are only intermediaries in the QE process; between the Central Bank and the Commercial Banks’ customers who willingly sold their Gilt holdings for cash “reserves”.

      A must read is http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q102.pdf . “Money creation in the modern
      economy”.

      I paraphrase Neil Wilson. What actually happens is made much clearer if you study Whole of Government Accounts (WGA). This shows that QE is an asset swap and effectively eliminates any Gilts purchased.

      A second must read is https://www.gov.uk/government/collections/whole-of-government-accounts

      The WGA accounts agree in para 7.50 (pp 62) As at 31 March 2011, there were some £1,059 billion of gilts outstanding but the WGA shows a smaller figure of £746 billion (Figure 10). The WGA is not intended to include as liabilities gilts held as assets by entities in the WGA, such as the Bank of England Asset Purchase Facility Fund, as part of Quantitative Easing (paragraphs 7.53 to 7.54).

      Para 7.54 (pp65) expands on this and delivers the killer conclusion: Consolidating Quantitative Easing does not significantly reduce the overall liabilities of government but it does reduce the number reported as government borrowing. Once intra-government transactions are eliminated, the scheme represents an exchange of gilts (liabilities of the National Loans Fund) for central bank reserves (liabilities of the Bank of England).

      In addition the Consolidated Statement of Financial Position (pp94) contains the term “Financed by Taxpayers’ Equity”. Which is exactly correct. The net savings of the non-government sector is indeed Taxpayers’ Equity in UK plc.

      There is a voluntary restriction the Treasury places on itself. That is it will not run an overdraft on its own accounts at its own wholly owned Bank; the BoE. This needs an elaborate system of smoke and mirrors to make sure that the Treasury spending account at the BoE, is ALWAYS topped up.

      So we have a Consolidated Fund; National Loans Fund and the Debt Manage Office Fund, all existing just to play this silly game of swapping reserves holdings by Commercial Banks customers with Gilts and back again, as required to balance the daily deficit in Treasury accounts. The WGA accounts eliminate all this smoke and mirrors by consolidating the BoE and the Treasury as one entity. Exactly the same as every private sector corporation does under proper international accounting rules.

      The main thing to realize from the above is that it has little to do with government spending. They are all playing a game with “the Treasury sovereign fiat money of account”, that was previously spent into existence by the Treasury. All Gilts are bought with money the Treasury previously spent. It is not borrowing from anybody. And, nobody in the BoE is ever going to bounce a Treasury cheque, regardless!

      • Denis Cooper
        Posted April 26, 2015 at 7:34 pm | Permalink

        “This shows that QE is an asset swap and effectively eliminates any Gilts purchased.”

        It’s the Bank and the Treasury swapping their respective IOUs, which are liabilities for them and only assets for those who hold them; if the gilts are “effectively eliminated” why does the Bank say that it owns them?

        “There is a voluntary restriction the Treasury places on itself. That is it will not run an overdraft on its own accounts at its own wholly owned Bank; the BoE.”

        No, Parliament has imposed that restriction on the Treasury; if in no other way previously, it did so when it passed the Act to approve the Maastricht Treaty on European Union, one article of which prohibits the Bank from extending an overdraft to the Treasury.

        “All Gilts are bought with money the Treasury previously spent”

        Nope, not the £375 billion of gilts bought by the APF, they were bought using new money lent to it by the Bank of England.

  4. bluedog
    Posted April 26, 2015 at 7:14 am | Permalink

    This is a topic of critical importance to the role of the Parliament, Dr JR, and the history of the British Parliament is the history of the parliamentary control of taxation and expenditure by the executive, formerly the Monarch. The British government is formed by members of the largest political party, who sit on the Treasury benches and are led by the First Lord of the Treasury, who currently answers to Dave. Every year the Government prepares a Budget which sets out projected receipts and consequent expenditure. Nowhere in the Budget is there any mention of the Government’s intentions with regard to the money supply, let alone Quantitive Easing. Yet QE has become an increasingly important tool of financial management but it is controlled by the Bank of England, an institution that we are assured is completely independent. Which begs an important question. If the whole point of the Parliament is to supervise money bills and financial matters in general, why is the Bank of England managing the financial liquidity of the economy unsupervised and only indirectly accountable to the Parliament?

    • Denis Cooper
      Posted April 26, 2015 at 8:41 am | Permalink

      JR has previously said that is because there has been cross-party support for the policy, or at least the great majority of MPs have acquiesced to it, and therefore there has been little need even for debate about it let alone votes. Heaven forbid that ignorant MPs should start interfering with such matters, possibly calling on the Queen’s ministers to explain their actions and clarify the legal basis, or even demanding that they must allowed to vote on it!

    • outsider
      Posted April 26, 2015 at 12:48 pm | Permalink

      Dear Bluedog, the Bank operates under a brief from the Chancellor. It did not include QE, which had to be approved in principle by Alistair Darling and re-approved by George Osborne. The Bank only decides how much and when.

      • Denis Cooper
        Posted April 26, 2015 at 7:23 pm | Permalink

        Actually the Chancellor decides how much and also roughly when, as each letter of authorisation from the Chancellor to the Governor of the Bank specifies the additional sum being authorised by that letter.

  5. mickc
    Posted April 26, 2015 at 7:29 am | Permalink

    The “financial services industry” is a racket for stealing money from ordinary people and giving it to a small, politically favoured few.

    (A few of those? ed) who run it are self evidently incompetent, and corrupt.

    “Big Bang” was a catastrophic error by Thatcher, who presumably did not realise the consequences. In fact, I think Lawson has confirmed that.

    The banks should be broken up to create more competition, and there should be proper separation of the gambling operation from the lending operations.

    It is a matter of huge regret that the body politic has been captured by the City spivs.

    • Gary
      Posted April 26, 2015 at 8:17 am | Permalink

      I am glad that others are now addressing the myth of Thatcher. She was the facilitator of this financial catastrophe for the non-financiers.

      Reply Nonsense. Mrs Thatcher left office 17 years before Labour’s crash, with the banks in good order and soundly regulated for cash and capital. Labour out in an entirely new regulatory system, and lots of extra regulations 1997-2007, but failed to require sufficient cash and capital.

      • Lifelogic
        Posted April 26, 2015 at 10:23 am | Permalink

        I am no great fan of Lady Thatcher she gave far too many powers to the EU, allowed herself to be pushed in to the ERM by Major and the rest of the traitors and failed to cut the state sector down to a reasonable size. Clearly she was far better than any leader that followed her by miles.

        To say “She was the facilitator of this financial catastrophe” is clearly absurd.

        • mickc
          Posted April 26, 2015 at 6:34 pm | Permalink

          With respect, the entire casino capitalism error arose from Big Bang.

          It amounted to the nationalisation of the financial markets, and the scrapping of the conflict of interest rules. And that is what allowed the financiers to get out of control….they were playing with other peoples money and guaranteed by the taxpayer.

          Make no mistake, I am a firm Thatcherite, but it does nobody any favours to pretend the Lady made no mistakes.

          She was, of course, fighting on many fronts, and with the disadvantage of any enemy within…..being the Conservative party. She was a radical, not a Conservative; Conservatives are what we have now!

          Her triumphs were the trade union reforms, and helping to win, and end the Cold War. The Cold War was immensely dangerous, and there is no current world leader who has the stature and level judgement of anyone who was a leader during that period.

          Reply No, the mistakes came later from the failure of the Brown Treasury to control bank balance sheets, despite having the powers to do so.Many of us warned them that they were allowing a credit bubble.

      • Gary
        Posted April 26, 2015 at 7:11 pm | Permalink

        it was not cut and dried, as you suggest. You were there, you must have known about reservations some had at the time about regulation and the start of off book derivative dealings ?

        http://m.ft.com/cms/s/0/f3c0d500-8537-11e4-bb63-00144feabdc0.html

    • Posted April 26, 2015 at 8:20 am | Permalink

      I do not agree with much of that but certainly more competition in banking is badly needed. The barriers to entry are far too high and the regulation is badly targeted.

      How can it be right that banks can get away with paying say 0.1% interest on bank deposits yet then charging 5%-30% on lending it on to companies and individuals that are often far more credit worthy than the banks are themselves? Up to 50-300 times their cost of funds.

      If that does not indicate a lack of competition in the market what on earth does? Cut out the rip off middle man seem to be the sensible way to go.

      • gte
        Posted April 27, 2015 at 3:50 pm | Permalink

        The barriers to entry are far too high and the regulation is badly targeted.

        =========

        Spot on.


        How can it be right that banks can get away with paying say 0.1% interest on bank deposits yet then charging 5%-30% on lending it on to companies and individuals that are often far more credit worthy than the banks are themselves? Up to 50-300 times their cost of funds.

        Do the sums. It’s all about credit risk and the losses from defaults.

        Here’s a simple example. You can borrow at 5% and lend at x%. However, you’ve got a 20% default rate on your books. So what rate is x% so that you break even, ignoring costs like regulation etc.

        Well the 20% who default aren’t going to pay you anything. So from the 100 pounds lent you need to get back 105 pounds from the 80% who do pay you.

        That’s a 31% interest rate, just to break even.

        It’s not the cost of funds, its the cost of default that matters.

        If that does not indicate a lack of competition in the market what on earth does? Cut out the rip off middle man seem to be the sensible way to go.

        For stock markets and equity funding, I agree.

        However for lending, peer to peer has major issues. You don’t get the gearing and people misunderstand the cost of default. The reduction in gearing means that for every pound peer to peer lent instead of via the banking system, you have to pull 8 times that amount in loans from the banking system.

    • libertarian
      Posted April 26, 2015 at 12:33 pm | Permalink

      mickc

      I can assure you that if Big Bang hadn’t happened we would be in a far worse state. By the way I’m not sure you know exactly what Big Bang was and why it was unavoidable.

      • mickc
        Posted April 26, 2015 at 6:40 pm | Permalink

        Why would we be in a worse state?

        Big Bang forced the USA to follow, and abolish Glass Steagall. What could have been worse?

      • Gary
        Posted April 26, 2015 at 7:15 pm | Permalink

        three words : North Sea Oil

        one of the worlds richest oilfields came on stream in 1979. That was the reason for the economic turnaround. Thatcher got lucky.

        Reply The oil field came on stream in the 1970s when Labour had to go to the IMF for a bail out! I first visited the oil field in 1974.

        • mitchel
          Posted April 27, 2015 at 8:44 am | Permalink

          …and wasn’t North Sea oil something of a double-edged sword to the extent that we briefly became a petrocurrency which limited the effects of the then habitual process of Sterling devaluation that was keeping our inefficient manufactuers competitive in export markets?

    • mickc
      Posted April 26, 2015 at 6:38 pm | Permalink

      Sorry, just noticed your edit of my first comment.

      More than just “a few of….” methinks!

  6. Gary
    Posted April 26, 2015 at 8:14 am | Permalink

    “buttress the banks”

    straight out of Chairman Mao’s Little Red Book.

    And savers do not benefit from asset bubbles. Those are speculators. Savers lose, and lose.

    That we are even still debating the merits of theft is unbelievable. We have institutional theft and we cannot even call it that.

  7. Richard1
    Posted April 26, 2015 at 8:23 am | Permalink

    Labour have got off remarkably lightly in this election campaign for the shambles of their financial crisis response. They continue to deny that their tax-borrow-spend policies contributed to the crisis in the first place – of course they did with the U.K. going into the crisis with a 5% structural deficit when all well governed OECD countries were in surplus or balanced budget. Their £70bn bank recapitalisation was wholly unnecessary – as you have pointed out in the past. The banks could and should have been recapitalised at the expense of their shareholders and bondholders, as is now acknowledged would happen in any new banking crisis. It has also had a very unfortunate (intended by Brown even?) side effect of enabling Labour to raise a bogus cry of ‘market failure’ whenever they feel left-populist interventions might be popular. There will be long term damage from this period of bad Labour government which it will take a long time to shake off.

    • Posted April 26, 2015 at 3:37 pm | Permalink

      when all well governed OECD countries were in surplus or balanced budget.

      Like who?

      • Richard1
        Posted April 26, 2015 at 4:59 pm | Permalink

        Switzerland, Germany, Sweden, Norway, Hong Komg, Singapore, Korea, Canada….will that do?

        • Posted April 26, 2015 at 8:46 pm | Permalink

          Richard1,

          Apart from Canada these are all countries which regularly have large current account surpluses. This is the surplus in money flows caused by trade and other capital movements. In other words they are all net exporters.

          I have been harping on about the, generally ignored, link between the two surpluses for some time now so this is a good illustration of the point I’ve been making.

          It is possible for a government to have a budget surplus at the same time as running a current account deficit if the government stokes up a credit bubble but this is unsustainable and only lasts for a short time. That was Canada in 2007-2008.

          So, if this is your solution, you just have to figure out a way for us all to be net exporters!

          Switzerland 7% EXPORT SURPLUS
          Germany 7.5% EXPORT SURPLUS
          Sweden 6.5% EXPORT SURPLUS
          Norway 8.5% EXPORT SURPLUS
          Hong Kong 1.6% EXPORT SURPLUS
          Singapore 19% EXPORT SURPLUS
          Korea 6.3% EXPORT SURPLUS
          Canada – 2%

  8. Posted April 26, 2015 at 8:25 am | Permalink

    QE will only work while we have faith in fiat currencies. The day will surely come when we lose faith in the dollar and even the pound and those with assets, especially precious minerals, hold all the value.

    China has been accumulating precious metals and third country miners for decades.

    • Posted April 26, 2015 at 8:25 am | Permalink

      …I meant third world miners

  9. Denis Cooper
    Posted April 26, 2015 at 8:27 am | Permalink

    You disappoint me, JR; I thought that at least you understood that as practised in the UK the primary aim of QE was initially to make sure that the Labour government didn’t run out of money to pay its bills in the year leading up the 2010 general election, and then later to make it easier for the coalition government to pay its bills.

    Not at all to bail out the banks – that had already been done before QE was started in March 2009 – and not to “stimulate the economy”, or “inject liquidity into the financial system”, and not for the secondary benefit of lower interest rates, but primarily to make sure that the Labour government did not run out of money to pay its bills.

    We only have to look at Greece to see what happens when a government begins to run out of money to pay its bills; not only has the government been delaying payments of invoices, and probably wages as well, it has ordered all public bodies to hand over their cash reserves; and in every other way it has been scratching around trying to find bits of money here and there to keep itself going; as one commentator said, it is like looking for coins which may have dropped between the cushions of the couch. There is now talk that the Greek government may have to pay some of the bills in its own IOUs, so called scrip, rather than in the normal currency that is used in the country and that is legal tender, euros issued by, or under the authority of, the European Central Bank.

    Now I know that the case of the UK is different from that of Greece because we still have our own currency and in theory like any other sovereign state the UK state can create as much of its own currency as it likes. However Parliament has ordained that our normal currency shall be issued by the Bank of England, and that although the Treasury shall own all the shares in the Bank and therefore be entitled to all its profits the latter shall be an operationally independent central bank separate from the Treasury, an arm of the UK state but not part of the government.

    Moreover Parliament has legislated to make the monetary operations of the Bank of England subject to many of the relevant provisions of the EU treaties, which include a prohibition upon it extending an overdraft to the government – which is actually not only the owner of the Bank but one of its customers, the Treasury holding accounts with the Bank through which the government receipts and payments are channelled – or directly purchasing bonds issued by the Treasury to borrow money on behalf of the government so that it can pay its bills while running a budget deficit.

    Once all this is understood it becomes clear why a Labour government which was faced with the prospect of running out of money to pay its bills resorted to setting up what you yourself described as the “money-go-round”, JR, with the Bank creating new money and using it to buy up existing Treasury bonds, gilts, from normal gilts investors, while in parallel an agency of the Treasury, the Debt Management Office, sold new gilts to much the same set of gilts investors at much the same rate; so that the Bank’s IOUs, money, flowed in one direction through the gilts market, from the Bank to the Treasury, while the Treasury’s IOUs, gilts, flowed in the opposite direction from the Treasury to the Bank, with the end result that a wholly owned subsidiary of the Bank now owns gilts valued at £375 billion:

    http://www.bankofengland.co.uk/markets/Pages/apf/results.aspx

    with each of those gilts saying that the Treasury owes money to that subsidiary of the Bank, which in turn owes money to the Bank itself.

    Absent the EU treaties the Bank would have been free to lend that £375 billion direct to the Treasury, either by extending an overdraft on the Treasury’s account or by buying gilts direct from the Treasury; instead the Treasury and the Bank agreed to use this roundabout route to achieve the same effect, making sure that unlike the government of Greece the UK government did not run out of money to pay all of its bills on time and in full and in the familiar, normal currency as issued by the Bank, and the government did not have to resort to paying part of its bills in gilts or Treasury bonds or National Savings certificates or in a new and unfamiliar currency which it issued itself, like the Bradbury pounds issued during the First World War.

    And because in essence the Bank and its subsidiary were rigging the gilts market in favour of the Treasury, before it started up a single piece of secondary legislation was rushed through without any debate in Parliament, let alone a vote, an order to exempt these operations from the normal regulatory scrutiny by the FSA:

    http://www.legislation.gov.uk/uksi/2009/118/contents/made

    Financial Services and Markets Act 2000 (Exemption) (Amendment) Order 2009, which was rushed through on January 29th 2009.

    • Gary
      Posted April 26, 2015 at 10:05 am | Permalink

      Denis,

      You kep ignoring that the central bank ONLY deals through its primary dealers , chosen banks, and they are the ones who buy the gilts etc in the open market and sell them at a profit to the central banks. How is that NOT recapitalizing those banks ?!

      Also QE , at least as it was intended , was to buy already issued gilts ie. not from the govt who first issued them, but from thrid parties who held them, presumably as investments. The only way the govt benefits from that QE was indirectly from the falling gilt rates , and as the premiums rose, a better price for NEW gilts issued.

      But, we also know (about 2 years after the fact, well publicized on the internet) that after 2008 the FED funnelled an eye watering $16 TRILLION into the EU banks. That was a direct bailout. Who voted on that ?!

      All of this kills the prudent, debt free saver. Just the people who are supposed to be the bedrock of the economy.

      • Denis Cooper
        Posted April 26, 2015 at 5:53 pm | Permalink

        Gary, I’ve tried the patience of our host by submitting an inordinately long comment, but even so I couldn’t possibly cover every detail.

        So, firstly, I omitted any mention of transmission losses as money was passed from the Bank to the Treasury through the gilts market. Gilts investors were under no compulsion to sell part of their holdings of existing gilts to the Bank when the Bank offered to buy them, and they were under no compulsion to buy new gilts from the Treasury when they were offered for sale, often the next day; clearly to get them to join in with the “money-go-round” there would have to be a profit for them with every turn. However the profits made by the investors and any intermediaries would be a small fraction of the £375 billion, I guess maybe a few billion, and would have only a small impact on the recapitalisation of a bank if a bank happened to be involved.

        And, secondly, I also omitted to mention what I have pointed out before, that commercial banks were and are relatively small gilts investors, and most of the gilts purchased by the Bank came from insurance companies and pension funds, plus a range of investors other than banks. It is simply incorrect to visualise commercial banks raking in huge profits either by selling gilts to the Bank or by holding on to them as the prices rose and then selling them, because they did not hold large volumes of gilts.

        You say:

        “The only way the govt benefits from that QE was indirectly from the falling gilt rates , and as the premiums rose, a better price for NEW gilts issued.”

        but that’s rather understating its importance if the government can no longer find any normal investors who are willing to buy the new gilts which it needs to sell to fund its budget deficit, or the few remaining potential investors are demanding extremely high interest rates.

        The fact is that the UK government has borrowed £375 billion to help fund its annual budget deficits without having to ask normal gilts investors to increase the total sums they have lent to it by that £375 billion or even by a penny, because the government has instead indirectly borrowed it from a new captive investor, the Bank of England.

        Even if we hadn’t followed the “money-go-round” turn by turn we could deduce that the government had indirectly borrowed £375 billion from the Bank, or to be more precise its wholly owned subsidiary, simply because the latter now owns gilts valued at £375 billion, and each one of them says that the Treasury owes it money.

        And what has happened to that £375 billion which was indirectly lent to the government by the Bank? The government has spent it all when it paid its bills, with some going to public sector workers, some going to private sector contractors to the public sector, some going to state pensioners and social security recipients, some going to pay our dues to the EU, etc.

        I guess the government of Greece would much prefer to be in a similar position where the Greek central bank had indirectly lent it the money it needed to pay its bills, rather than having to go begging to the EU and the IMF, but that is one of the penalties of adopting the euro.

    • Tad Davison
      Posted April 26, 2015 at 10:36 am | Permalink

      That’s my impression too Denis, and it literally makes me go cold. I’m presently listening to the leader of the Welsh Nationalists on Sky News, and she consistently proclaims she wants an end to austerity.

      That’s fine, we all get fed up with belt-tightening, but how does she propose to do it?

      I have got a horrible feeling these lefties see QE as the cure-all. Given the chance, they will just print more money, with all the long-term dangers and consequences that brings with it.

      Of course the Tories will say, well Mr Cameron isn’t a leftie! Really? The Tory canvasser who came to my door yesterday afternoon will now have a different view of his party’s leader!

      Tad

      • Posted April 26, 2015 at 12:51 pm | Permalink

        No one with a brain could describe Cameron as other than a lefty. Worse still he is a greencrap/EUphile/fake equality/interventionist lefty and one who cannot even win elections against people as hopeless & dreadful as Brown and Miliband/SNP.

        All for want of a working compass and some uplifting vision.

        • Hefner
          Posted April 27, 2015 at 5:58 pm | Permalink

          And how would you describe yourself? A red in the teeth far-rightist, maybe?
          And what elections have you ever won yourself?

          Can’t you understand that your kind of diatribes do not generally bring anything useful to the debates, which sometimes happen between intelligent people on this site?

    • william
      Posted April 26, 2015 at 10:47 am | Permalink

      The fact is 2 governments have been unable to fund their borrowing requirements through the sale of gilts to the market, for cash, and have resorted to selling gilts to the central bank, which purchases them using electronically created ‘money’. This is the economics of a banana republic, and it is a Cameron led administration that has doubled the national debt in one parliament. Anybody remember the gilts strike of 1977 and the battle of Watling Street, when Labour issued gilts,partly paid, with a 17 percent coupon?

      • mitchel
        Posted April 27, 2015 at 8:55 am | Permalink

        Yes.As a sixth-former around 1980,I remember buying long-dated gilts,through the Post Office, at a yield of c15.5%,my first ever investment and very profitable it proved too!

        I wouldn’t touch them with a bargepole now;like an earlier contributor,I’ve followed the Chinese and Russians into gold and gold-related investments,much as I appreciate that the precious metals markets(like practically every other market it would seem) has been manipulated,if not actually rigged.

        Reply I recall an issue with a 15.5 coupon, but not one with a 17 coupon.

        • mitchel
          Posted April 27, 2015 at 9:44 am | Permalink

          @JR,I don’t recall there being an actual coupon as high as 17% either but I remember I bought my 15.5% at slightly below par and yields were already declining at that stage so perhaps the earlier respondent is confusing yield and coupon?

    • Posted April 26, 2015 at 3:04 pm | Permalink

      Denis,

      Some of the points you make are valid. I think we need to define just what exactly we mean by QE. Is it just the swapping of bonds for cash? The extra demand for bonds which is created by the purchase of bonds by the Govt from the private sector can increase the price of those bonds and so reduce longer term interest rates. The effect of that cannot be zero, but it won’t be huge either.

      The controversy starts when the money received by the private sector is then used to buy more Treasury bonds. Then QE becomes the de-facto purchase of Treasury bonds by the Central banks which is a work around of rules which may be in place to try to prevent that.

      No doubt the banks get their cut for their part in the process, so it would be cheaper if those rules were just scrapped.

      However, your comment

      “and not to ‘stimulate the economy’, or ‘inject liquidity into the financial system, ….but primarily to make sure that the Labour government did not run out of money to pay its bills.

      shows a misunderstanding of how the economy works. The government not running out of money is a necessary requirement to provide a stimulus to the economy and provide liquidity into the system. It’s not a question of either/or.

      The government creating IOUs in the form of cash in this way isn’t fundamentally any different from creating IOUs in the form of bonds. The idea that the former is highly inflationary whereas the latter isn’t is incorrect. Those predicting hyperinflation from QE have been shown to be spectacularly wrong. Bonds are spendable in the financial system too and even directly convertible to cash. So bonds aren’t the equivalent of time deposits. What matters is whether those bonds or that cash is spent in the economy. So the creation of both can be inflationary , but there’s no reason for one to be more inflationary than the other.

      Governments in both the USA and UK were quite correct to create cash if they needed it providing there’s no excess inflationary consequence. Both the US Fed and the BoE have inflation targets of 2%. Inflation, therefore, is now too low according to those targets. I’d ague for a slightly higher target until growth resumes. That can only happen when governments increase their deficit spending now that interest rates are as low as they are. If they need to create more cash then that’s what they should do.

      • Denis Cooper
        Posted April 26, 2015 at 7:17 pm | Permalink

        I don’t dispute that it would have been pretty disastrous for the economy if the Labour government had suddenly run out of money to pay its bills; it was involved in about half the economy, but it was having to borrow about a quarter of all the money it was spending; if it had run out of investors willing to lend it that money then cutting its spending by a quarter would have had a massive impact. Moreover in the end the cuts would have been more than just a quarter, because its tax revenues would have dropped as the economy sharply contracted and that would have opened up the deficit again, making further cuts necessary.

        • Posted April 28, 2015 at 4:29 am | Permalink

          Denis,

          I could just about have written your last comment myself. Especially the last sentence. Makes me think that my harping on about having to think further ahead, on economics decisions, than just one move isn’t a total waste of time.

          A knowledge of how the economy works is essential, IMO, regardless of any particular political opinion. I’ve long since given up trying to argue that anyone else should change those. But we need to know what the possibilities are for both a left and right political approach and we can’t do that if we think the govt’s budget considerations are just like our own.

          Even though a too rightish approach may not be to my personal liking, it doesn’t have to mean that high unemployment and recession is inevitable. If the present day Conservative party could convince the electorate on that point they’d be well ahead in the polls. There is a general fear that, freed from the Lib Dems influence, and the need to do try to do well in this election, austerity economics will be back with a vengeance afterwards.

          • Ted Monbiot
            Posted April 28, 2015 at 8:09 am | Permalink

            How can it be called “austerity” when State spending has doubled since 2000.
            State spending under the coalition has continued to rise and all parties in the election including the Conservatives, are promising us further rises in State spending.

            Austerity must be defined as an actual reduction in overall State spending.

          • Denis Cooper
            Posted April 28, 2015 at 9:31 am | Permalink

            Well, I was warning about the dangers of making rapid large scale cuts in public spending seven years ago when some of those commenting here favoured “shock treatment”.

          • Posted April 28, 2015 at 8:18 pm | Permalink

            Ted,

            I would define austerity as the process of deliberately constraining the government’s budget deficit such as to hinder the workings of the economy.

            There needs to be some constraint to prevent high inflation. But if it’s overdone that leads to poverty and austerity. Not for everyone of course!

  10. Brian Tomkinson
    Posted April 26, 2015 at 8:27 am | Permalink

    I seem to remember that we were told initially that this monetary easing was essential to prevent deflation. We were further told that at some stage the process would be reversed. Was there any truth in either of those statements? I suspect not.

    • Denis Cooper
      Posted April 26, 2015 at 7:02 pm | Permalink

      If it was to ward off deflation it went too far and caused excess inflation.

  11. Aatif Ahmad
    Posted April 26, 2015 at 9:24 am | Permalink

    People buying bunds aren’t paying for the privilege of lending to the German government (in real terms), given the prospect of deflation – they will actually still make a decent return.

    The problem is Britain’s low investment rate – around 13 to 17 %, compared to 20%+ for Germany and Japan. With the strong pound and costly energy it makes little sense to invest in new manufacturing plants or renew existing ones. It makes more sense to invest in real estate or care homes.

    • Lifelogic
      Posted April 26, 2015 at 10:29 am | Permalink

      “low investment rate” – indeed any why are they reluctant to invest in the UK? Because we will get the anti business Cameron or the very anti-business, landlord mugger Miliband.

      Lots of better places to invest. Places that have cheaper energy, sensible employments laws, lower taxes, simpler planning, governments that want enterprise and investment and have far fewer daft regulations too.

    • formula57
      Posted April 26, 2015 at 11:21 am | Permalink

      “A decent return” yet lower than if they put their monies not with the German sovereign but under their mattress!!!!

  12. Posted April 26, 2015 at 9:27 am | Permalink

    Sad thing about QE is it keeps interest rates at an artificial low and creates an impression that things are much better than they are . I have always believed that facing reality is the only way to manage and plan ones own economics . Life is tough at times but living within ones means is always the best way forward .

    • turbo terrier
      Posted April 26, 2015 at 1:49 pm | Permalink

      Bert. We are of an age when debt was a dirty word, today it is called credit.

      You are so right about facing reality, so I still marvel and shudder at the thought of our £1.7 trillion debt.

      Living within ones needs is what it really all about but all the time we have “leaders” with no apparent true life experiences then I suppose you cannot expect a lot else. They are all very good at spending other peoples money. that is the easy bit. paying it back is the harder part of the deal.

      If the country wants to remain at the top world table as an active member it means we have to replace Trident. Why has nobody thought of doing what many big business do every day, they lease the goods they want. Lease the new generation of boats and weapon systems from America, have all the refits and maintenance done in their yards and the change over of crews can take place at Plymouth. Old crew off, new crew on to pick up their next boat as the one they are on goes through to its maintenance schedule. They would still be under our control and command.

  13. formula57
    Posted April 26, 2015 at 11:30 am | Permalink

    QE is surely about inflating asset prices and all but eliminating the carrying cost of debt, thereby to put off the inevitable day when the excess debt held by banks (too many of them in a “zombie” condition) has to be written down. Recognizing we face an insolvency crisis results in very tough measures and outcomes so pretending we face a liquidity crisis allows for a much softer regime for a time and QE faciliates that. The case of Greece is demonstrative – and Syriza is spoiling the illusion by proclaiming Greece is bankrupt when the EZ needs it to join in pretending there are only liquidity problems. Ho hum! This will not end well.

  14. ian
    Posted April 26, 2015 at 2:49 pm | Permalink

    The income tax figures do not look right to me so I am going do them again.
    Yesterday I just add on 54billion on front of 162 billion which was 1/4 of the total but today I am going to start at the beginning, 162.6 billion – 7.6 billion = 155 billion that the 12.500 start tax limit and the 40% 50,000 pounds taken off at the start. so 155 billion 10% of that is 15.5 billion times 4 = 62 billion + 155 billion = 217 billion, which is 40% rise in income tax.

    I then translate that to jobs in economy which is 31 million jobs at the moment and 40% of that is 12.4 million extra jobs a cross the spectrum, ones that pay tax and one that do not pay tax. So I thought that a lot of jobs, to many, so I look at government spending, 8 billion for health and education 6 billion extra house building 4.5 billion a year from housing association 22.5 billion which 50% will go to building materials that leaves 11. 1/4 for workers pay and 50% that is 5.625 billion, even if I take 50% of all these figures, which is 9.8 billion only, I am still looking for 52.2 billion and I am five per cent over the top rate of income tax.
    So I thought it must be coming from pay rises but then I thought we going in to deflation because of QE so the pay rises like this year will be about 1.9%, so say 3 per cent a year that 15% on 155 billion which is 23 1/4 billion so I am up to 33 billion and all my workers are paying 50% tax which should be 45% at 9.8 billion.

    So now I am looking at IN tax 110.7 to 142.7 which is a 30% rise in tax but is split 50% employers and 50% employee which 15% each in at 16 billion which also go up with pay rises. It does not correspond with income tax because 15% of the work force is 4.6 million of the work force not 12.4 million of the work force.

    Do you think wet&mad could clarify his figures because I am at a loss to bridge the income tax gap.

  15. Posted April 26, 2015 at 4:14 pm | Permalink

    So JR’s “preference” was to “mend the commercial banks quickly.” I suspect that can be translated as “use taxpayers’ money to reimburse private banks for their reckless losses”.

    Any reason why every other business can’t be given barrow loads of taxpayers’ money when they make a loss?

    Reply Certainly not. As I stated at the time and now, shareholders/bondholders would have taken the hit, the banks would have sold assets/businesses and the state would have lent against assets.

    • Posted April 27, 2015 at 4:36 am | Permalink

      I’m all for shareholders “taking a hit”. But in additon, large amounts of public money were put into private banks, which has not all been returned, and may never be. In contrast, under full reserve banking (advocated by Milton Friedman, Positive Money and others), banks or “lending entities” are funded just by shares, thus it’s impossible for them to go insolvent: no more credit crunches.

  16. ian
    Posted April 26, 2015 at 4:41 pm | Permalink

    I thought I would the 2 million trainees they going to have, who will not be paying NI.
    So I thought 1 million at 15.000 thousand a year less 10.000 for starting rate of tax leaves 5000 pounds, 20% of 5000 is 1000 pounds times 1 million =1 billion pounds and then 500,000 thousand at 20.000 a year less 10.000 thousand pounds leaves 10.000 pounds, 20% of 10.000 pounds is 2000 pounds times 500.000 pounds is 1 billion pounds, then 500.000 trainees at 35.000 thousand pounds less 10.000 pounds leaves 25.000 pounds at 20% which is 5.000 pounds times 500.000 thousand is 2.5 billion pounds which altogether come to 4.5 billion pounds for 2 million trainees on good wages and if I took on another 2 million workers at 50.000 pounds a year less 10.000 which is 40.000 pounds at 20% come to 8 thousand pounds a worker is 16 billion pounds so I have just take on 4 million workers over 5 years on good wages and the income tax has gone up by 20.5 billion pounds and add on the 33 .5 billion last count that’s 54 billion pounds and I am still short of 8 billion pounds in tax with 3% per cent rises and over 4 million workers with another lot paying 50% tax and these pay 20% tax. you might say these workers 2 million on 50.000 pounds are in 40% tax bracket but the 40% tax limit go up over 5 years and the 10.000 pounds bracket go up to 12.500 pounds over 5 years

  17. ian
    Posted April 26, 2015 at 4:59 pm | Permalink

    I got it, he going sack half million low paid government workers and take on 250.000 pounds a year quango workers and say he has cut back, like the last three years, when he said he has cut the government work force but the government wages bill went up by 10 billion pounds in three years. That’s the old labour trick make out your cutting but take on highly paid workers who 2 days a month, for the elites kids.

  18. ian
    Posted April 26, 2015 at 5:03 pm | Permalink

    I don’t think quango worker pay IN do they

  19. miami.mode
    Posted April 27, 2015 at 9:06 am | Permalink

    Surely QE was in large part to get governments off the hook.

    In the normal course of events we would have had a huge bust with the consequent unemployment and reduction in asset prices. It would appear that QE has basically gone into asset prices which has had the effect of increasing the social divide and the current deflation is mostly imported – council tax is still going up by 1.99% in many places.

    By forcing interest rates low this has had a dramatic effect on housing as is evidenced by the huge rise in the rented sector aided by Housing Benefit, but it does mean that a whole generation of younger people in richer parts of the country have been locked out of the housing market for ever. All actions have consequences and we can see the government trying to rectify the situation with Help to Buy and other such schemes which will only scratch at the surface. £375bn would buy well in excess of 1 million houses in the southern half of the country.

  20. agricola
    Posted April 27, 2015 at 12:38 pm | Permalink

    Quantitative Easing is the golden bullet of government, an emetic, diuretic and laxative rolled into one. Applied by government to reduce the cost of their borrowing that covers the vast amount of government spending that the nation does not need. It puts the patient/ citizen in need of intensive care and eventually a nil by mouth, golden pathway scenario.

  21. Posted April 27, 2015 at 7:12 pm | Permalink

    Cash or bond, fixed interest carries an investment risk just like stocks and shares. The risk for cash etc is inflationary. The risk to shares is volatility but over the long term we know it gains. Look at the 1970’s for risk to cash savings against inflation.

    They are both investments and both not without risk. I sense here a favouritism to protect cash returns on an economy over and above others. Cash is another investment that carries a health warning just like shares or funds. One is the stockmarket, the other inflation. Inflation being so low means we didn’t see the catastrophic loss of value that was seen in the 70’s. In face it’s now in positive.

    Too much emphasis is put on the bull market whether it be inflation or shares and not enough on limiting the loss in a bear which is what we have seen and is equally important to retaining or improving wealth.

    • Posted April 27, 2015 at 7:21 pm | Permalink

      In fact I’d say cash savers have done exceptionally well this time round compared to the last time. I would say cash savers relative to risk taken may well have outperformed. The risk to cash savings went through the roof in 2008 but if you look at performance against inflation an awful lot of money value was retained Jon, there was a minor reduction and now turning positive.

      I would say QE and the measures taken, far from taking value for cash, gilt and bond savers, protected their value from far harsher losses.

  22. Dinero
    Posted April 27, 2015 at 7:15 pm | Permalink

    QE involves the aquisition of government bonds by the BoE , however, when the bonds are honoured on the day that they mature the issuer stumps up the capital sum.

  23. Posted April 28, 2015 at 1:13 am | Permalink

    Please, Mr Redwood, enlighten us by answering the following questions:

    (1) There has been £375 billion of UK QE, a larger proportion of monetary GDP than American QE. Where is that money now?
    (2) Does he advocate slowing unwinding that QE as soon as economic conditions permit it?

    Reply The money went to the bondholders who sold their gilts.The then bought other assets or spent it in other ways.
    The Bank should unwind when conditions – credit, potential inflation- warrant it

  • About John Redwood


    John Redwood won a free place at Kent College, Canterbury, and graduated from Magdalen College Oxford. He is a Distinguished fellow of All Souls, Oxford. A businessman by background, he has set up an investment management business, was both executive and non executive chairman of a quoted industrial PLC, and chaired a manufacturing company with factories in Birmingham, Chicago, India and China. He is the MP for Wokingham, first elected in 1987.

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