In this essay, I'd like to look at quantitative easing and what exactly is going on there. Many characterise it as 'printing money', a term I hate because, not only is it inaccurate, it is generally being used to scare, raising images of Weimar Germany and Zimbabwe. I think the real mechanisms are a bit more subtle.
First, I need to outline the basic financial structure that lies at the centre of these operations. The government has a central bank, the Bank of England, which it owns and which carries out fiscal and monetary operations on its behalf. Therefore, the Bank of England is an agent of the government. Each of the commercial banks (for example, Lloyds, Barclays, Nat West) have accounts at the Bank of England known as reserve accounts. These accounts are where their reserves of money are kept and they are used to aid the clearing of transactions between banks. The Bank of England also acts as an intermediary between the commercial banks and the government.
As is normally the case, when the UK government carries out its agenda, it will run a deficit. That means that it spends more than it takes in by taxation which is not a problem in itself. After all, the government issues its own sovereign currency. However, arbitrary 'fiscal rules' invented by successive governments mean that whatever the size of the deficit, the government must 'borrow' that amount. This is kind of a meaningless term for an entity that issues its own currency.
Anyway, via the Bank of England, the government creates loans, which they call 'gilts' or 'bonds' that it sells to the commercial banks. This is a primary market. The commercial banks can then sell on those loans to investors like pension funds. This is a secondary market. However, what these gilts really do is to drain reserves out of the economy. (That's another way of saying that they reduce the size of the reserve accounts that the commercial banks hold with the Bank of England.)
These gilts pay interest and after a set time period they mature. When they do, the asset holder gets their money back as well as the interest they gained. That interest is essentially new currency that the government has created. In other words, this is government spending and the interest payments on gilts is a major part of overall government spending, never mind defence or health. Some have described it as 'welfare for the well-off' and there is a truth to that.
The government can never have a problem with making the interest payments on gilts, or repaying the original capital because it issues the currency. Bond investors know this and therefore understand that the bonds are risk free - they are 'gilt-edged' so to speak. Indeed, a long time ago, these bonds were sold as paper certificates that were gilded with gold leaf.
Suddenly, there is a crisis: 2008 - debt market collapse; 2020 - Covid-19. The government needs to stimulate the economy but it has a problem. Having made political capital out of 'fiscal responsibility', it can't be seen to be directly injecting new money without there appearing to be some sort of balancing action.
What the government does is to have the Bank of England buy back some of the gilts held by the commercial banks. The banks get their money returned to their reserve accounts merely by the number in those accounts being made larger. The Bank of England gets the loan assets back. This is why the government itself holds £735 billion of the £2 trillion of national debt recently discussed across the media. Imagine making a loan to yourself. Bonkers!
To use technical jargon, this operation is an asset swap. When the gilts were originally sold, the commercial banks simply swapped their cash assets for loan assets. Under quantitative easing, these loan assets are swapped back to being cash. It is very much like transferring money from your current account to your savings account and back again. This is all that occurs in quantitative easing.
Although the commercial banks' reserve accounts at the Bank of England have grown, they are essentially back where they started. Furthermore, the interest-bearing side of the arrangement is curtailed. In principle, the banks won't get all of the new currency they were expecting as interest, had the gilts matured. Having said that, in recent years, the Bank of England has begun to pay interest on reserve accounts as well.
With the quantitative easing having occurred and now with fatter reserves, the theory is that the banks ought to be able to give out loans more easily. However, that is only if businesses actually want such loans. If the economy is in trouble, like it is at the moment, one wonders whether businesses would wish to take on loans to invest in plant and equipment for the production of goods that people aren't buying. This is why I think quantitative easing is a very poor mechanism for stimulating the economy.
Sorry, that is not a very good explanation of QE at all. It obscures more than it elucidates, and certainly does not answer the question of whether it is "a quantitative con trick".
ReplyDeleteThe problem seems to be that current MMT explanations of this and other operations try to avoid talking about money and the money supply as such, which to me is rather peculiar.
We prefer to use digital terms these days, where most "money" exists only as ledger entries, in particular numbers in "reserve accounts" or "cash accounts" held at the central bank.
The "explanation" of QE is that it is simply a swap between central bank "cash asset accounts" and "loan asset accounts". When bonds, or gilts, are issued, numbers are transferred from cash to loans, and under QE "these loan asset accounts are swapped back to being cash".
Well, not really. That certainly describes what happens at the bank when bonds MATURE, but that is not at all what QE is about. Under QE, bonds are repurchased BEFORE they mature, and what happens to them at this stage is what makes QE interesting.
To be brief, QE is an accounting trick devised by central bankers to cope with and sidestep the political need to issue bonds to "cover" deficits.
When the treasury bonds are issued on the primary market, money is withdrawn from the economy, and ceases to exist. When the bonds mature, money is recreated as required, and the bonds themselves cease to exist. What is obscured by the previous "asset swapping" explanation is this going into and out of existence.
Is that important? Well it is for understanding QE. For when government bonds are repurchased BEFORE they mature, the money is recreated to buy them, and the bonds then sit on the shelves at the central bank as a (fake) asset until they finally mature and disappear.
This is accounting trickery par excellence, and in the private sphere would be considered fraudulent. In that sphere, the company directors would probably end up in gaol for inflating their books with non-existent assets.
So why is it done in the public sphere? It allows the central bankers to retire public debt early without seeming to. Public debt is bought under control.
In doing this, the central bank gives various pseudo explanations to politicians and economically illiterate journalists that in their "open market" operations they are just trying to maintain the integrity of the market, and in QE they are adding a stimulus to the economy by "printing money" in a responsible way. Forget about that. It is just smoke and mirrors. Everyone knows that QE doesn't work as a stimulus. It just reintroduces liquidity in the economy by giving the financial industry money to gamble with again.
The interesting point about all this is that by a further extension of QE, where the primary and secondary markets are simply bypassed, the treasury bonds can be sold DIRECTLY to the central bank. It now becomes obvious that the government is just borrowing from itself, a nonsense concept if ever there was one.
Of course, in economic terms you do not even need to issue bonds in the first place, and just head straight into "direct monetary financing". However, in political terms you DO have to issue bonds, so that is why QE becomes useful.
Talking about the way numbers move around various accounts does not allow you to see behind the real mystery of QE.