I was criticised by some commentators yesterday for what they thought to be a harsh comment by me on a comment by Neil Wilson on a post.
He claimed that the QE process simply involves an asset swap where a central bank reserve account balance is substituted for a bond.
I suggested that this was wholly untrue because it represented an incomplete understanding of the QE process. As a consequence, I wrote this glossary entry to explain what the QE process is. I am aware that I contradict some modern monetary theory exponents by doing so, but think what follows is economically correct, in my opinion:
The QE process describes the whole process of quantitative easing (QE). It ignores the fact that there are three apparent stages to this process and instead views them as a whole.
In the first stage of the QE process the government instructs its central bank to make a payment, as is its normal practice, day in and day out. Presume that the payment is for £100. The central bank records this by:
A) Increasing the value on the loan account that the government has with it by £100.
B) Increasing the value of the central bank reserve account that the commercial bank that will make payment to the intended recipient has with it by £100.
The commercial bank will then match its receipt of £100 from the government via the central bank reserve accounts by making the required payment to the account that the recipient maintains with it.
In summary, each of the following has increased by £100:
1) The sum owed by the government to the central bank.
2) The sum owed by the central bank to the commercial bank on its CBRA.
3) The sum owed by the commercial bank to the intended recipient.
Note that as a result the commercial bank is a neutral player in this. It only gets a sum on deposit because existing rules do not allow individuals to bank with most countries' central banks.
The process could end at this stage. It does not because by convention, backed in some countries by regulation, central banks cannot make loans to the governments that own them.
As a result, stage two happens. In this stage, the government sells a bond (which is just a form of deposit account) to someone other than the central bank. It does not matter who they are. The result is that the following payments are made:
A) The purchaser of the bond pays the commercial bank £100 for the bond by reducing the balance on their account with that commercial bank.
B) The commercial bank then pays the central bank £100 by reducing the balance on their central bank reserve account with the central bank.
C) The central bank pays the government by reducing the sum owed by the government to it.
The central bank reserve accounts are now back where they were before this process started.
So is the loan between the central bank and government back where it started.
But the recipient of the government's payment still has their money, and the government now owes someone else £100.
The process could be ended here, at stage 2. In fact, it is very often the case that it does.
However, when the QE process is in operation, the process was never intended to stop at stage one or two. Stage three was always intended.
In stage 3 the central bank buys the £100 bond that the government sold to someone in the private sector economy. To do this:
A) The central bank pays the commercial bank that holds the account of the person who owns the £100 bond by increasing the balance on that commercial bank's central bank reserve account.
B) The commercial bank in question then pays £100 to the owner of the bond.
C) The central bank now owns the bond. As a result, it is now owed £100 by the government. The previous bond owner has been repaid in full.
But note that the position now achieved is in substance identical to that achieved at the end of stage 1. The recipient has their money, the commercial bank central bank reserve account is up £100, and the government owes the central bank £100 as a result. All that has changed is the government now owes the central bank £100 in respect of a bond rather than £100 in respect of an overdraft. Everything else is the same as at the end of stage 1.
This now requires interpretation. First, note that to consider each of these stages in isolation is wrong when the QE process plans that all three be undertaken. It is a straightforward error to claim that they are separable if QE is planned. In particular, it cannot be claimed that stage 3, which some describe as QE, is independent of stages 1 and 2 when that clearly cannot be the case. Stage 3 is wholly dependent on stages 1 and 2 taking place.
What that then means is that stage 3, and so QE itself, is not, as some claim, a simple asset swap by a commercial bank that gives up a bond to hold a central bank reserve account balance instead. That is not true because the central bank reserve account balance already existed at the end of stage 1 of this process and is still there at the end of stage 3. So there was in effect no asset swap involving a central bank reserve account in stage 3: a balance was restored, not swapped.
Instead what there is instead is a wholly bogus or sham sale of a bond which the government always intended to repurchase. In fact, the only asset swap is that the government now owes the central bank on a bond and not on a bank overdraft account.
If QE is only stage 3 it would be correct to say that QE does not create new money because that stage does not involve new money creation.
But the QE process is stages 1, 2 and 3 together. As a result new money is created, and is the balance of £100 that exists at the end of stages 1 and 3 and which only disappeared at stage 2 because of the sham bond transaction that then took place.
As such QE does create money, albeit at stage 1, and those claiming otherwise have failed to view the transaction as a whole.
The unintended consequence of all this is that it is the government's spending at stage 1 (not the transactions at stage 3) that creates a central bank reserve account balance that a commercial bank has no role in creating except by acting as a conduit and yet, as a result, it is owed base rate interest on the resulting balance by the Bank of England. It is that outcome that makes almost no sense in all this.
Also note that if QE does create money for the reason noted then quantitative tightening does, when properly understood, destroy money by removing it from use.
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A very thorough explanation. Different from standard MMT one as you say. Too opaque a process (deliberately so?) and very round the houses.
nb
Typo in second last para – except not expect ? – and in the last para the i/o typo rears its head as nite not note (:
Typo corrected and thank you
” the only asset swap is that the government now owes the central bank on a bond and not on a bank overdraft account.” Since the central bank is itself part of govt, and we know the govt can’t owe itself, how would the (now defunct, I gather) Whole of Govt accounts have recorded this, were it/they still functioning?
They wouldn’t because it would fall out on consolidation
It does also not appear in the BoE accounts as they do not consolidate the Asset Purchase Facility because that is actually under the control of HMT although that is not said – but it is the only possible explanation.
When did HMG stop publishing Whole of Gvmt Accounts? Who made that decision? What reason was given?
It is still maent to do so
They claim Covid delays…
Thanks for the comprehensive explanation. The phrase “can I owe myself money?” went through my head several times when reading (e.g.:” and the government owes the central bank £100 as a result”… ….I owe myself £100 – the left hand giveth and the right hand taketh).
I was stuck by this “backed in some countries by regulation, central banks cannot make loans to the governments that own them.” One supposes this is done to keep banks that sell (and buy) gov bonds in business. Indeed, Stage 3 seems to be designed to keep banks in business (one supposes all the transactions have “costs” bolted on to them & thus nice littel earners?).
Your first questiion is, noi yiu can’t, which shows the sham in all this
The answer to the second question is that, of course, there is a rake off in all this.
Hi Richard, I’ve just been in direct touch with Neil Wilson who tells me that he did not make the “NeilW” comment.
He has asked me to say that he has not commented on this blog since before the Brexit vote, when I gather you had a dispute about corporation tax and he was banned from your blog. So “NeilW” is not Neil Wilson.
Fair enough
He has a mimic who will now be banned
I’ve also submitted a comment to that effect on the blog where the “NeilW” comment appeared – https://www.taxresearch.org.uk/Blog/2023/06/19/how-to-find-30-billion-to-provide-support-to-households-facing-mortgage-debt-crises
Perhaps you could remove the references to Neil Wilson in both places.
I simply won’t have time
NeilW is now banned
This might be really basic, Richard. I think I’ve worked out what you are saying , but could you clarify. Am I right in assuming that the initial £100 which the BoE puts in the CBRA is ‘created’ money? ‘Numbers on a keyboard’ money in just the same way that commercial bank loans are created?
And the government creates bonds, too, doesn’t it? There isn’t a finite amount in circulation?
Yes
It is created by the BoE for the government at stage 1
Bonds are, as you say, government created
Are you saying the BoE buys the £100 Gilt issued by the DMO on the same day the gilt is issued?
No
They always left it in the market for at least 7 days
But that is immaterial
Well in some senses immaterial but since if I’m not mistaken there’s profit involved for the bond dealers then the process creates a wealthy & powerful group in favour of maintaining the opaque-to-most status quo.
“A) The purchaser of the bond pays the commercial bank £100 for the bond by reducing the balance on their account with that commercial bank.”
“A) The central bank pays the commercial bank that holds the account of the person who owns the £100 bond by increasing the balance on that commercial bank’s central bank reserve account.
B) The commercial bank in question then pays £100 to the owner of the bond.”
The purchaser of the bond makes no profit at all?
Of course they do
But that’s an irrelevant distraction
It’s hardly a distraction when it’s billions of pounds of completely unearned profits.
It is a distraction to the argument I was making
Relevant to others, but not that one
F**k me! I know my limitations only too well but phew, I’m flying close to the sun here.
Can we have a diagram please!!!!
I get half way down and I have to keep going back!!!
And I do so want to understand!
It sounds to me as though part of the audit trail is being deliberately left out by the orthodox view.
That was version 2
You should have seen version 1
I could try this on Minsky…..
Thanks for this.
It took some time to get my head around there being three accounts up by £100 but that not meaning that £300 has been created! I did wonder if QE meant that we technically spent the money twice (I.e. paying the recipient and buying the bond) but this makes a lot more sense.
I think a video with funky graphics showing the accounts going up and down and so on would reduce the head hurtyness.
So do I , but that would take more time than I have
I’m going to read all of this again tomorrow when I have time and pen and paper, but where is this process officially specified and who controls it, the Treasury? How long has it been done in this way?
Thanks.
This has been happening since 2009
The process is totally under the control of HMT
A correct explanation.
The ‘just an asset swap’ line is nonsense in both a narrow and broad sense.
Broadly…. as you describe.
Narrowly… because it is simply not an asset swap as the term is used in financial markets. Are they gong to tell me I didn’t buy the gilt I ‘own’…. that I merely swapped it? In any case, my behaviour is different if I have cash instead of a gilt… and that is the essential point.
Agreed
Hello Richard.
I did have to read through this a few times, with some scrolling up and down included. It seems to make sense, and flow, to me anyway.
It makes me wonder about efficiency and inefficiency. These are two terms that have come to widespread use since at least the coming to power of Maggie Thatcher in 1979.
However I think these two terms are only ever applied in an incomplete way.
– Government is always inefficient
– The private sector is always efficient with respect to Government
– The private sector can be either efficient or inefficient with respect to itself. I guess this is the ‘market’.
– unions and their members are always inefficient
– entrepreneurs are always efficient
I’m sure there are other situations but this shall do for my comment.
Your outlining of a complete 3-step process for QE shows inefficiency in Government but crucially one that is deliberately forced upon it by neoliberal theory to suit their ends of a captured state, with unearned income arising from it. If the neoliberal position was for an efficient Government, for the public, then it would be pursuing a policy of the Bank of England lending directly to Government, and not this QE process.
However, they can’t say or do this, as it would open up other policy areas to scrutiny. This would show that direct Government provision of services to the people, to be more efficient for the public than the current privatisation policies, which are inefficient for the public, but very efficient for private capital.
The public have also been encouraged to believe that efficiency in employment always means creating more profit for employers and not asking for improved wages, and conditions for employees, as this would be inefficient. Too much inefficiency leading to a loss of jobs. I don’t think this is the full picture though. Companies could still have profits, but reduced profits, and still remain in business, in the same location, with the same employees. Those employees could have improved wages and conditions, with the same employer. This would be more efficient, for the employees.
I’d like a better quality of life return for a much greater proportion of society, than at present. I believe it’s possible to create this. I believe an efficient government is important for achieving this, but efficient from the public’s perspective, not private capital.
Showing that the ideology of the market can be also inefficient, with respect to government, might get people thinking that there can be an alternative to this neoliberal way of running the country. One that gives a better return for the public.
Thanks
If Stage 3, taken alone, does not create new money, would you consider it correct to say that Stage 3 “re-creates” ( or, as you say, “restores” ) the CB balance created in Stage 1 and destroyed in Stage 2? * fingers crossed 🙂 *
Sort of…