Summary
Quantitative easing (QE) was created to obscure the fact that central banks lend money to their own governments. Initiated after the 2008 financial crisis, it involved the Bank of England purchasing government and corporate bonds to stimulate investment. However, this was a disguise for funding government spending via newly created money. Since the inception of QE, the government incurred significant costs from bond issuance and repurchase. The entire approach was convoluted and unnecessary, highlighting inefficiencies in macroeconomic practices.
Quantitative easing, or QE as it is usually called, was, and always will be, a sham to disguise the fact that a central bank is lending money to the government that owns it. In this video, I explain the ins and outs and costs of this ridiculous denial of the truth.
The audio version is here:
This is the transcript:
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To understand modern macroeconomics, you have to understand quantitative easing.
Quantitative easing was started in the UK and other countries after the 2008 financial crisis. The objective which Alistair Darling had when he was the last Labour Chancellor of the Exchequer in the 1997 to 2010 government was to require the Bank of England to go into financial markets to buy both government bonds and corporate bonds with the aim of reducing the rate of return available on them by increasing their price (which is what happens when the government creates demand for them), and as a consequence to force people into investing, as he saw it, in shares and other risky assets instead, as a consequence boosting, he thought, the overall rate of investment in the real economy, which would, he believed, reduce the risk of there being a recession at that time.
You will notice that I caveated a lot of the statements I just made very heavily. I did so for very good reason.
The truth was that actually, in 2009, what Alistair Darling and the Bank of England really wanted to do was to boost the amount of money that was being made available by the Bank of England to the UK's commercial banks to ensure that they had sufficient solvency that they could settle the debts arising between them on a day-to-day basis without having too much recourse to the Bank for borrowing facilities. That required that their central bank reserve accounts - the accounts that the commercial banks hold with the Bank of England - be boosted.
And the way to do that was to effectively allow the Bank of England to create money that would be used to fund government spending which would, in turn, inflate the central bank reserve account balances because that money would not be reclaimed from the economy. by way of either taxation or bond sales.
The trouble was that the European Union, which, of course, we were a member of at the time, did not approve of central banks providing that sort of finance to their governments by boosting government expenditure without requiring either bond sales or taxation. And, therefore, they had to come up with a ruse to cover the fact that this was exactly what they were doing.
Quantitative easing is the ruse that covers up the fact that from 2009 until 2021, the UK government was in large part funded by the Bank of England and the capacity that it has to create new money to fund government expenditure. Over that period, in total, £895bn of new money was created by the Bank of England for this purpose, but it was disguised using quantitative easing.
So let me explain what quantitative easing really did. What happened was, the government had to spend. It needed to because the economy was in crisis. In 2009, tax revenues were collapsing. In 2020, tax revenues were also collapsing because of massive downturns in economic activity. Therefore, it had a shortfall in revenue, but it had to spend all the sam. The consequence was that it had to get money from somewhere.
It had three choices. It could have increased tax rates, but that would have been no good because tax revenues were already falling.
It could have tried to borrow from financial markets, but that would have caused a financial crisis.
Or it could have called on its central bank to create the money in question, which is what it did.
But to disguise the fact that it was calling on its central bank to raise the money, it appeared to sell a bond equivalent to the amount of the shortfall that it was getting in tax receipts. So, if in a month the government was short of £10 billion in tax receipts because the economy was in crisis, it appeared to sell a bond for £10 billion pounds as well. But within a week of that bond being issued, what happened was that the government went into the financial markets and via the Bank of England it repurchased £10bn worth of government bonds. They weren't necessarily the ones that had been issued by the Treasury the week before. They could have been.
But what happened was that whatever value was being issued was, broadly speaking, being almost immediately repurchased by the Bank of England.
Why did they bother to add this stage to the process? The spending was easy to understand.
The Bank of England extended an overdraft to the government, and the government spent.
The government then issued a bond, and so it claimed back from the financial markets the amount that it had just spent.
But, almost immediately, the Bank of England returned that money to the financial markets by repurchasing bonds to equivalent amount to the value of the bonds just issued.
If you're confused, I think that's deliberate. The government did this to be confusing. They were pretending, by issuing these bonds, that they were not being funded by the Bank of England, when indirectly they were, because the consequence was that if the bonds were issued and then repurchased, they clearly weren't available to the financial markets.
They weren't really in issue at all, in my opinion. But the Bank of England was instead, in effect, making the provision of a loan to the government disguised behind the fact that the government had issued bonds which had been bought by the Bank of England.
That's what quantitative easing did. It was a ruse to cover up the fact that the government was, in fact, running up an overdraft with the Bank of England.
But it was a ruse with an enormous cost in it. Firstly, that cost was because of the financial dealing costs of issuing and then repurchasing bonds, which gave an immediate bung in terms of profits to the banks who handled these deals, knowing full well that they would make the return because they knew full well that whatever bonds were being issued by the government from 2009, to a certain value, until 2021, again to a certain value, were going to be repurchased because announcements were made in advance as to how much was to be bought at any point in time.
Secondly, there was a cost because if the Bank of England owned bonds issued by the government, then the government had to pay the Bank of England interest. Now, this became ludicrous by 2013. It became apparent that there was an enormous sum of money being paid by the Treasury to the Bank of England, which was apparently profiting the Bank, when the Bank obviously was owned by the Treasury and therefore there was no real profit in this system at all. And that money was then returned on George Osborne's instruction to the Treasury. The net effect of the Bank of England owning these bonds was cancelled as a consequence.
But, that problem still remained, and it remained sufficiently present, so that people could argue that it was necessary for the government to get rid of this burden and send it back into the financial markets by selling the bonds back eventually, and that was stated to always be the plan.
It was this part of the ruse which has proved to be so costly. There are two costs to it. One is the fact that now the government is selling back some of the bonds that it supposedly bought. And I know the Bank of England says that it's making its own independent decision, but if you believe that you also believe there are fairies at the bottom of your garden.
So those bonds that the Bank of England bought are being resold into the financial markets, and that is increasing the government's real financial cost, because it is now paying interest to financial markets when previously it was paying the Bank of England.
And also it is selling those bonds at a loss because they were bought at a time when the government was trying to hype the price by increasing demand for government bonds, and now it's trying to sell too many bonds into the market, and when you try to sell too many bonds, you lower the price, and the consequence has been a cost of well over a hundred billion pounds so far to the government in terms of supposed financial losses on supposedly reissuing bonds, which would, frankly, and should frankly, have been cancelled at the time that they were repurchased.
So, this ruse to pretend that the government was not borrowing on overdraft from the Bank of England has cost a significant amount of money, all to pretend that macroeconomics does not allow the government to borrow from its central bank when in reality, it does.
Does that sound totally confusing? I'm really sorry if it does. I tried to make it as simple as possible. But the fact is that this was meant to sound confusing. It was meant to sound very clever. It was meant to sound very complicated, and it need not have been any of those things. There could have been a simple straightforward statement by the government that it was going to borrow from the central bank and that was it, the circumstances required it, and there was no complication, no financial market involvement, no bung to banks, and no losses as a consequence.
All of that could have happened.
QE was entirely unnecessary.
We could simply have let the government run an overdraft.
The price of pretending that economics is something other than it is has been enormous, and we should never let that happen again.
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And that just leaves Quantitative Tightening (QT).
Presumably if Quantitative Easing (QE) is where the Government indirectly lends money to itself before repaying it, then QT is just the reverse?
That’s to come
Not made yet
QE video is excellent. One of your best.
Just watched it on your very busy YouTube channel.
Thanks
Thanks Richard, that filled in some gaps as well as created some new ones (plus a headache).
You make the point that direct CB funding of Gov’t spending was frowned upon by the EU, thus requiring the QE ruse, so why did we do the same in 2020, once we were out of the EU? Is the “no direct funding” rule baked into our own economic policies?
Yes
That’s neoliberalism for you
Thank-you for that. As a pensioner on the MileEnd Rd. Omnibus with no economic background, I’ve spent the last few years trying to understand economics, so I can counter the constant stream of lies & obfuscation coming from the Austerity Party that seems to have permanent power nowadays. I want to be able to explain it to fellow passengers in simple language. I’ve read some Thomas Piketty, some Danny Blanchflower, listened to Stephanie Kelton, & have been greatly assisted by (reading) Richard’s 2 minute videos. I’ve got my head round where government spending comes from, & what taxes are for, & why GDP is a poor measure of “growth”. I’ve grasped why balanced budgets are a bad thing, & why the National Debt is not as scary as it sounds. I think I can have a discussion on all of these while sitting next to an interested fellow Omnibus passenger (I live on a council estate in a v poor ward). But I’m struggling with government bonds & borrowing, along with QE/QT and the relationship between the BoE & commercial Banks & those “reserve accounts” (despite Richard’s valiant efforts above). As he says, it’s MEANT to be confusing. But if I don’t understand it, I can’t have a conversation on the Omnibus about it & I can’t help them see through the Austerity myth. They will find the member for Clacton & America North, more appealing.
This blog is a bubble for people who move in more elevated circles than I do, but it’s helpful. Richard has seen the value of YouTube & social media for reaching my fellow Omnibus passengers (even the MileEnd Rd. Omnibus must have some NON economists on it.
I like the idea of a MileEnd Rd thinktank, & an “Event”, or series of events. I think a focused effort to educate/shame financial journalists/editors is vital. But until my Omnibus journeys involve my fellow passengers complaining not just about the EFFECTS of austerity, but also telling each other that the government is talking bollocks about the £22bn black hole because “taxes don’t finance public spending” then the Austerity Party (& Farage) will continue to dominate. I’ve (so far) not come across a single neighbour/fellow passenger who does NOT believe that taxes finance gov’t spending.
We have a LONG way to go to banish this 40yr old monetarist myth about the “public purse”. Keep up the GOOD WORK.
Now, where did I put those paracetamol?
All noted
And thank you
QE was all about controlling long term interest rates to get them lower. Part of this process was to increase the demand for riskier assets namely corporate bonds to reduce the funding costs for corporations as by crushing gilt yields it forced institutional money into corporate debt. And QE was successful and achieved its aim. I know you think everything is a “conspiracy” which you can unravel. QE was really this simple.
No it wasn’t
I know that was said but explaim any relevance to that claim after 2011 if you can, let alone 2020
You won’t be able to do so
So why post deliberate misinformation?
In effect then – the way I read it is that they made the private banks look like the originator of the money that was actually Central Bank, government QE? This then works towards legitimising the fears that the markets will call time on public spending to pop up in the ‘discourse’.
The Neo-liberals were/are covering their Keynesian tracks.
I think your exposition of what is happening is really good Richard and befitting of an accountant. But, also deeply troubling. This is for want of a better word pure lying and the abuse of power to make it happen. This is clandestine and working against what – 90% of people in this country?
It also reifies the fact that the state financial system has been captured by those who fund politics – that is the only explanation for how this is happening. The Neo-libs deny the existence of the state to anyone – but themselves of course because they need its legislature and its money-power.
And as you say, we are left with the consequences and Labour it seems are not going to challenge this.
You see – what you are saying to me is what I expect an opposition politician to talk about. It’s fundamental.
This is why I cannot accept our ‘democracy’. This is why our democracy has become illegitimate and why all avenues to the stopping of this behaviour have to be on the table.
In short , we are dealing with a bunch of extremists who have managed to cloak themselves in the power of the state. In effect, they have stolen the state from us.
The whole thing was a deliberate misrepresentation of the truth
I’m sorry but I am just going to add this.
I think that we should rejoin the EU as best as we possibly can – particularly the trade issues and freedom of movement.
But if a condition of going back in was to lose our currency or have rules imposed upon on us about how much money and where and when we spent it within our borders?
No.
The whole QE and QT exercises can be said to be about obfuscating the fact the government does have the ability to create money from thin air for its programmes. Remember Margaret Thatcher denying this reality in a speech during the Eighties when she roundly declared “government has no money of its own” without explaining how money did come into being and absolutely no one at the time challenged her. Since the basis of democracy is about programmes to deal with the problems a nation faces and these programmes are executed using money it seems reasonable to say that the UK doesn’t have a fully fledged and informed democracy. We still have corrupt people at high level involved in the running of the country who deliberately set out to distort reality for the country’s citizens.
Slightly off message, but part of the same dystopia:
The DWP has just published its Equality Analysis of winter fuel payment cuts (yes, on Friday night).
Around 71% of pensioners with a disability and 83% of the over-80s will lose the benefit.
(Thanks @georgeeaton)
https://assets.publishing.service.gov.uk/media/66e479bfe47cfc6de429d713/FOI2024_65546_13_09_24.pdf
But they are still going for it
But no impact assessment on deaths, I presume?
Aargh, I now have a headache, and it got worse after viewing this video a couple more times! What might help me and others is a series of graphics showing what was happening to the money and the bonds throughout the whole era of QE – would that help to simplify things? I might forward this link to others, but I reckon they’d be equally confused.
Would anyone from the Treasury and BoE agree with your analysis of QE?
Re the diagrams, see chapter 16 of the Taxing Wealth Report
Re The Treasury, I am sure they would not
I agree with the thrust of your critique and recognise that a short video can’t capture nuance or detail on such a short time… but I think there is some important things (well, important to me) missing and some where I disagree.
In 2008 the banking system collapsed suddenly. It was a liquidity crisis that could easily have become a crisis of solvency. Banks refused to lend to each other and the BoE stepped in to lend and the Government stepped in to bail out those banks that required it. This was not QE – that came later. Short rates were cut from 5% to 0.5% but gilt yields only fell from 5% to about 4%. In previous banking crises (S+L in the US in the 80’s, Japan and Sweden in the 90’s) that very steep yield curve allowed banks to rebuild their balance sheets by “borrowing short (at 0.5%) and lending long (buying gilts at 4%)”. However, in 2008/09 it was unclear that this would work if the economic recession deepened and collateral values (mainly property) tanked. So, to push gilt yields lower QE was dreamed up. Yes, government could have borrowed directly on overdraft from the BoE or issued gilts directly to the BoE at a rate of BoE/HMT’s choosing but this would have been against the law as we were in the EU; QE was a sensible way to achieve the goal within the law. It also had the merit of pushing open market gilt yields lower and supporting asset prices generally… but only to a modest degree – gilt yields stayed above 3.5% (until the Eurozone crisis hit in 2011).
Now, we got a lot of things wrong in 2008/09 but a complete collapse was averted. We also (re)learned a few things – first, that low rates does not deliver increased investment in the real economy (Keynes’s: you can’t push on string). But low rates did help preserve asset prices which was important in preventing a downward spiral becoming depression. QE played its part in this and was, in my view, the right action at the time.
Wind forward to 2020 and COVID.
If 2008 was a banking crisis that could have become a crisis for the real economy; COVID was a real economy crisis that could have become a banking crisis. This meant that monetary policy would have limited impact. In the absence of sensible government policy the BoE used the tools at its disposal and in the most aggressive way they could. They cut base rate to (almost) zero and used QE to push gilt yields down to 1%… but the real need was for government to spend – and it took an age before the penny dropped and we had furlough etc.. The correct approach should have been a combination of QE and overdraft – QE to keep gilt yields at reasonable levels (2% to 3% in my view) and cover the rest of the spending on overdraft. Pushing gilt yields to 1% stored up problems for later.
Finally, I would add that the gilt dealers did not make huge amounts out of QE; indeed, the stability that QE delivered hurt the dealers. I am sure that they would have made more money without QE.
I hear your issues related to the costs associated with the policy and its unwinding (QT) but, at the heart of all these costs is the current base rate… which is at the wrong level on so many grounds. If base rates were 2 or 3% most of your complaints would disappear…. Ie. they are not intrinsic to QE, merely the way the BoE have chosen to implement it.
In conclusion, QE and QT are absolutely legitimate tools of monetary policy. So, too, is overdraft funding of government spending. Don’t discard a tool just because it has been misused.
I am not sure where we are disagreeing Clive
And what I will repeat is that if the first £100 billion of QE was done in the mistaken belief that this would change the yield curve, what was the next £800 bn for?
And why was it used during Covid?
Or in 2016?
None of that makes any sense at all, unless I am right.
Our disagreement? My impression from reading your video transcript was that QE was always a bad idea; I think bond buying (and selling) ARE sensible tools to achieve appropriate rates for gilts.
In 2008 deficits (by law) had to be “financed” by bond issuance. I think the first £100bn of BoE bond buying DID impact the shape of the yield curve (we will never know what would have happened without it); BoE research (several separate studies) suggests the £375bn QE after 2008 reduced gilt yields by 1% from where they might otherwise have been. But (in 2008) yields were not pointlessly driven down to extremely low levels. In short QE was a good thing and reasonably well executed.
During COVID BoE bond buying was still an appropriate policy but poorly executed. Outside the EU we could have financed spending by overdraft but even if an overdraft was possible I think bond buying WAS still a good policy to control yields… just that they went too far in driving yields to 1%.
In 2016 is was a bad idea because it drove yields far to low (below 1%, briefly).
A good tool if sensibly used.
Clive
I agree that there is a role for open market operations
QE is not OMO. It is not needed
And 1% saved on less than £1 trillion then?
So QE of £375 bn at a massive subsequent cost was rquired to reduce interest by maybe £10 billion then? That is not good policy.
We will have to disagree on that
Richard
Richard you are misunderstanding what clive is saying about QE..you imply it was to reduce the cost of the interest charge to the Nation..no it was to reduce gilt yields to a point where it would force investors to buy corporate debt and reduce the debt burden to corporates. At that point in 2008/9 there was no buying of corporate bonds and credit spreads blew out to incredible levels. QE succeeded in changing that thereby shoring up the balance sheets of banks and life companies etc who owned much of this credit.
I totally understna that was what he was saying and my rtesoponse is:
a) If that was the ibjectiucve for a few months it was not thereafter
b) Tbis was not required to shore up those balance sheets
c) If support was required it should have been given, directly
d) From 2011 onwards this was never true but QE was still used
e) I therefore doubt it was ever true
What massive subsequent cost on the £375bn? This was conducted at yields of between 3 and 4%… and “financed” (ie. interest paid on Reserves) at 0.5% so earning about 3% per annum over the average life of the portfolio (7 to 10 years??). A substantial profit.
As I have said before it was the “Q” in QE that was the problem – committing to buy at a certain amount at any price. This meant rolling over existing QE and engaging in new QE at ever lower yields that did nothing for the real economy and is costing money as gilts bought at 1 to 2% are financed at 5%.
QT is the cost
Unnecessary, but in the mind of the BoE at least, inextricably linked.
I thought this started under Bill Clinton, belief government shouldn’t run deficit created lack of bonds as securities which was filled with George W Bush Ninja mortgages repackaged as securities. Wouldn’t ensuring bonds were used as securities stop it happening again also quantitative easing for the rich and austerity for the poor, just as it’s the poor that’s forced to pay back the quantitative easing they never got.
“In previous banking crises (S+L in the US in the 80’s, Japan and Sweden in the 90’s) that very steep yield curve allowed banks to rebuild their balance sheets by ‘borrowing short (at 0.5%) and lending long (buying gilts at 4%)’. However, in 2008/09 it was unclear that this would work if the economic recession deepened and collateral values (mainly property) tanked. So, to push gilt yields lower QE was dreamed up.”
The BoE had already intervened to shore up the banks. This policy was all about gilt yields. At this point Clive you are arguing the overdraft method was not possible only because of EU law. I am not clear what you are saying about collateral. In fact property prices in the UK in 2008 fell 20%. Are you saying here that only QE would work on gilt yields effectively in a tanking property market?
On a lighter but waspish note, you also say, “But low rates did help preserve asset prices which was important in preventing a downward spiral becoming depression”. Understandable of course, but a reminder perhaps that we are now living in an economic system that seems essentially to have become an asset preservation society for the protection of ropy financial investment vehicles.
I am arguing there were better, more honest and cheaper ways to support the economy and banks than QE, which may not, in my opinion, have worked at either level as was claimed.
John, yes, I agree, QE IS all about control of gilt yields. I think controlling gilt yields is a good idea so don’t agree with Richard that QE/QT is always bad. In 2008/09 it was a valuable policy tool and (reasonably) well used.
More recently it was badly used. Getting gilt yields down to 3% might have been a good idea but pushing them to 1% was bad – it delivered nothing to the real economy and stored up problems (losses in the APF, LDI debacle))
My point about previous banking crises elsewhere was that a steep yield curve allowed banks (after initial liquidity support or sometimes equity injection) to ‘earn’ enough (borrow overnight and buy 3 to 5 year bonds) to cover loan losses that would surely be coming along and keep things afloat. QE was a different approach – the idea being lower gilt yields might preserve asset prices and reduce future loan losses. Did it work? Well, by and large yes….. prices did fall but bounced back and loan losses to banks undershot all expectations. And, on your lighter/waspish point…. yes – it worked….. for the wealthy.
It would have been much better to takes stakes in the banks.
Thanks for the responses, I found this exchange invaluable*. One reason for my light-waspish observation was indeed the LDI fiasco. The fact that you relate it to QE (even in error – some error!) is itself troubling.
Which brings me to Richard’s point; “It would have been much better to take stakes in the banks.” My waspish point reflected a similar thought: although they took a stake in RBS, but not sure what that produced, constructively. The others escaped. The problem, it seems to me is not process, or back-ups, or fail-safes; the problem is institutional. The problem is major (system threatening) financial institutions, and dangerous market and tecnical developments in the digital, AI age.
* I note that although this area is what I feel the Blog is for, I don’t think this will be read as much as matters that are lively, but far less illuminating.
Thanks
And I agree with your footnote
Thankfully, I will accommodate both, as I will on the YouTube channel
We did take a stake in some banks… and other banks survived as a result (which they like to forget). We should have used the stakes in RBS to create a new “Giro Bank”… but the opportunity was missed.
Besides, that was a decision that was above the BoE’s paygrade; QE was about as far as they could push monetary policy.
The problem was that having been a successful (and profitable) policy in 2009 they kept replaying it when it was the wrong policy.
I think we can agree this was a mess
Apologies for disturbing your well earned rest!
May I endorse the above comment by P S R about Neoliberalism hiding its use of Keynesian economics?
Might it be that Q.E is direct Keynesian governmental involvement to remedy a severe malfunction in “market”/ Neoliberal economics?
Might it be the case that Neoliberal economics can only be continued because it is saved by occasional Keynesian econo-financial interventions?
The discussion between Richard, Clive and John Warren is quite interesting although it has not changed my view that most decisions about QE did not really help the general economy as much those essentially operating the market system that supposedly allocates money into the economy (the money may belong to the government, but it is the private sector that gets to allocate it, indeed they take huge cut as the money works its way into the system to the rest of us. Even in a system of fiat money, private banks will always benefit first – Clive’s observation about a state bank – advocated over time by Richard also, is a good point).
Taking that into account ultimately is what matters to me. Noting slight improvements here and there in yields etc does not mean much to me as I am not a gilt owner and I don’t know many who are. These are small points which may have an aggregate effect in markets that might have negative and even positive effects elsewhere (Clive?). But what it does point out is that even if we get the money allocation system that we want, we have to be aware of the systemic effects and, how that might be seen politically and how it might work against more benign policy makers – I think that is the inherent warning in Clive’s comments – well, until we sort our party political funding methods.
But to me what the post and even the discussion above points out is that the money distribution system in this poxy country of ours is fundamentally dishonest and says a lot about our ‘democracy’ and the people who run it. They have it all it seems to me and they just want more.
With regard to what this blog is about – well it is about technical discussions (it has to be when looking at the criminal and self -serving behaviour in a system purporting to be a ‘democracy’ – for the people – but which people?) but we must remember surely that these discussions happen because of emotions like disgust, unhappiness, feelings about unfairness etc.
We cannot split the human from the economic gentlemen; because it will always be up close and personal at the end of the day, either in our own pockets or of those around us.
“We cannot split the human from the economic”.
No we can’t, but difficult, unavoidable critically important effects with very serious consequences are produced through “technical” issues (they are not a sideshow), and there are what Americans call “the hard yards”, that can only be earned and won by the hard work of thinking through what is actually happening in difficult, tough, complex networks of technical inter-relationships (the time value of money, risk, uncertainty, reward or loss); and through which, alone real insight and the illumination of serious problems may be found: and to which “disgust, unhappiness, feelings” add precisely nothing at all to solving the real technical problems that are at stake. The ‘hard yards’ are what I believe is where the real substantive value of Richard’s Blog resides. The title, ‘Funding The Future’ (Tax Research UK in an earlier metamorphosis), is the clue.
It has cost a great deal of money, you say.
Someone has to pay and someone gets the benefit. I think we can guess who in both cases.
I remember reading QE was to recapitalise the banks. I have often wondered if the Govt had just spent directly into the economy, the extra economic activity would have given more money into the banks as their customers banked their profits? And enabled them to increase their CRBAs?
CRBA = ?????
Central bank reserve account
Like an onion, or Russian Dolls, layers within layers. If I have an overdraft it’s because I don’t have enough cash at the bank. How does the government have an overdraft at the bank it owns and can tell it to create the money as it sees fit? Isn’t the government also the bank, which is another arm of the government?
The BoE and the government are one and the same thing
I am wary of saying that spending in excess of taxes must be financed by increased taxes, borrowing from the private sector or calling on the central bank to create money.
Government spending is always financed in the same way. The central bank creates money and gives the government a loan. Tax revenues may subsequently reduce the size of the loan.
Selling bonds, as you have often pointed out, is not to finance government spending but to allow the wealthy to acquire interest paying safe assets.
Richard, is there any circumstance in which you would advocate quantative easing please? Because I thought in previous writings you had actually said it could be used in a positive way, should the need arise, so much so that I genuinely thought you condoned it. I am not criticising you in anyway, but has anything important changed in financial affairs that has switched your point of view, or was I simply mistaken as to your original opinion? Thank you.
It has sometimes been convenient to use QE as a shorthand for government money creation
If it was genuine Green QE (which was nothing like the QE we are talking about, but is long term government funding of invetsment) that’s one thing
Is QE ever needed? No, because it is a deliberately confusing and costly sham tnat cannot be justified, ever. It existed only to break the law, after all
Can the government do what are called open market operations, buying and seeling its own bonds to influence rates in the short term? Yes, but again it is something quite differemt.
Yes, I believe it was the Green QE idea that I was thinking of. Many thanks.
Thanks for an excellent explanation of QE. For what it’s worth, I agree it was a deliberately confusing ruse.
I have been thinking about the amount of QE. The £895 billion you mention is a lot of money!
I have argued, here, previously that, on average, the government needs to create money every year. So we need, and should expect, a growing government ” debt”. Since that debt need only be to the BoE, owned by the government, it needs be of no consequence. But I digress.
The amount of money the government needs to create is about 4 or 5% of GDP. 2% is to allow for growth, and 2 or 3% is to allow for inflation; money creation is needed in both cases. Since GDP is about £2.7 trillion, then the amount of money creation need per annum, on average, is 5% of £2.7trillion, or about £135billion. Set in this context £895 billion doesn’t seem so much.
For the past 4 decades or so we have been bombarded by the false mantra of balanced budgets. As far as I know (please correct me if I’m wrong), until QE in 2009 the government didn’t directly create money. The economy still needed increased money, which was provided by bank lending. But bank lending is temporary, in the sense that money created is destroyed when a loan is repaid. So, to create the money required by the economy, private borrowing had to increase year on year. This happened for a long while, notably via increasing mortgage lending (according to the FCA the total outstanding value of all residential mortgage loans is £1661 billion). But there is a limit to private borrowing; even at zero rates you still have to pay off the capital. So, AFAICS, interest rates have had to trend down so that private borrowing can increase. But perhaps we are getting close to the end of that cycle. After all, the base rate was very low for more than a decade and although higher now needs to be much lower.
If private borrowing cannot increase sufficiently to provide the needed increase in money, then the government needs to increase its money creation.
Perhaps there is a lot more QE, or preferably direct money creation, to come?
Does that line of thought make sense?
I agree with your opening arguments
What I do not agree with is that no new government was created during QE. There was. The £895 billion was new money disguised by QE. QE did nit make the money. It disguised that the BoE had created it.
Thanks Richard.
Yes, I agree, that the government/BoE created £895 billion through QE.
I’m saying that was not enough; more is needed.
If we need about £135billion created every year, then the £895 billion created through QE only represents the requirement for about 7 years (and that’s ignoring the unusual circumstances of the pandemic).
In the 15 intervening years since 2009 we needed, perhaps, £1.5 trillion of money creation (this is a crude estimate, assuming £100billion needed on average, because GDP has increased substantially since 2009). So, the economy need perhaps £600 billion of additional money creation, beyond QE, to achieve 2% growth at 2 to 3% inflation. This additional money creation would need to come from commercial banks making loans.
I’m arguing that, perhaps, we are approaching a limit in how much personal (and commercial) debt people (and companies) can take on. If so then perhaps, the failure of government to create sufficient money (via QE or directly) is one reason why the economy has been faring so badly.
Great article, Richard.
I work in the construction sector. QE ushered in an era of low interest loans that resulted in a huge speculative construction boom. Could you explain why this particular outcome of QE came to be?
It’s what low interest rates deliver
My point is, they happened without QE. Low interest rates to achieve that happened anyway.
The usual objection to OMF is that any government that implemented significant overt monetary financing is likely to cause the pound to crash on the F X markets and a crash in the value of gilts ie an economic crisis would result, and the “Liz Truss experience” is usually cited for her “unfunded” budget. ( I am aware that the BoE is largely to blame there).
1.What is the counter argument?
2. If we rejoin the EU, OMF will once again have to be made illegal. Is this a good argument for not rejoining the EU?
I agree with and like the way Robert J expresses his understanding of macro-economics. I describe myself as from working class roots, I didn’t go to university but luckily found a way through an apprenticeship and college to get into what is seen as a middle class profession as an engineer surveyor. I have made friends with two genuinely middle class people where I live who also have a hunger to understand macro-economics and we never cease to discuss this matter and the austerity of the Labour Party. We call ourselves The Three Fiscateers. Thanks to Richard’s ceaseless desire to try and explain economics the fog is clearing and I am starting to get to grips with QE and QT and this latest blog – Understanding QE has helped immensely. I also think The Mile-End Rd is a great one to develop.
Please keep up the great work you are doing Richard.
Thanks Tim
I am pleased to be of use to someone
Richard. Re “I am arguing there were better, more honest and cheaper ways to support the economy and banks than QE, which may not, in my opinion, have worked at either level as was claimed.”
I quite agree. Professor Collins describes a better way. Collins shows in WW2 there was central bank purchasing of bonds, better use of banks to support the war effort, and a development bank to produce productive capacity. These measures continued after the war to generate peacetime productive capacity, much in the way you have recommended.
Is Monetary Financing Inflationary? A Case Study of the Canadian Economy, 1935–75 (levyinstitute.org)
https://www.levyinstitute.org/pubs/wp_848.pdf
Thanks
Richard, I think one element that you could also focus on is central banks have lost their vision of working on behalf of the government and the people. They demand independence of the government, but seem beholding to the banks. They have an unconstitutional position as stated by the Bank of Canada in a paper on Quantitative Easing “It’s important for central banks to be independent from the government. Simply put, the power to create money should be kept separate from the power to spend money. ”
https://www.bankofcanada.ca/2022/06/understanding-quantitative-easing/
If the money is not created through government through its central bank, then how is the money supply increased – through the private banks. And who benefits directly – the shareholders instead of the Canadian people.
Deputy Governor of the Bank of Canada Paul Beaudry called money creation by government a ‘free lunch’. “To put it simply: we are not providing a free lunch for the government. The government will have to repay the bonds that we purchase through our QE program when they reach maturity.”
Well if money creation is a free lunch, and the banks are doing it, what are the banks getting – a free lunch
https://www.bankofcanada.ca/2020/12/our-quantitative-easing-operations-looking-under-the-hood/
Thanks
And without QE the entire banking system would have gone bust. Including the Bank of England.
The money created and injected into the economy by QE was without strings. Effectively a gift to a prodigal financial sector (that believed this time was {really was} different)
We are living with the consequences af Brown/Darling bailing the banks without any quid pro quo.
It really it’s that simple isn’t it? Everyone else pays and the bankers get unlimited bonuses for pretending to do something useful at the casino.
Well. Sod that for a game of soldiers.
Richard The Economic Committee report did not seem to respond to many experts who objected to paying interest on reserves – did I miss something
This was from the evidence https://publications.parliament.uk/pa/ld5802/ldselect/ldeconaf/42/4207.htm
140.Charles Goodhart proposed that the Bank of England could return to paying zero interest on central bank reserves. He said that it will be politically difficult to maintain the policy of paying interest on reserves were interest rates to rise and the Bank of England were required to make large payments to commercial banks as a result. If there was a period of paying zero interest on reserves, he said that the fiscal cost of interest rate rises would be minimised.153 Philip Aldrick, Economics Editor of The Times, set out the case for Charles Goodhart’s proposal. He said that if interest rates on reserves were removed, the Bank of England would have no requirement to pay interest on its liabilities to the private sector, and the coupon on gilts would instead transfer “back and forth between the Government” and the Bank of England at no fiscal cost.154 Both witnesses agreed that paying no interest on reserves would in effect operate as a tax on the commercial banking sector, whilst Charles Goodhart said that any decision to return to paying zero interest on reserves would have to be taken by the Chancellor.155
141.Sir Paul Tucker told us that in order to make the management of its debt more sustainable, “there must be a chance at some point that the Government will say to the Bank of England, “For God’s sake, can you not stop paying interest on reserves?”” He said that if the Government and the Bank of England were to choose to do so, it would reduce the cost of servicing Government debt and transfer the costs to the banking sector.156
142.Lord Turner of Ecchinswell suggested that, rather than the Bank of England paying zero interest on all reserves, a tranche of reserves could be renumerated at zero interest, while marginal reserves above a certain level could be renumerated at Bank Rate.157
Their response – when citing me – was to say that those suggesting not doing so did not believe in a fiscal framework, which was absurd. Believing in a quite different fiscal framework is not the same as not thinking we need one.
Thanks Richard. I looked up the report – perhaps you provided a link and I missed it. But I am very disappointed in the dismissal of your analysis, and those of other noteworthy experts
https://publications.parliament.uk/pa/ld5901/ldselect/ldeconaf/5/5.pdf
I will look at it in more depth, but in a first scan there seems to be a confirmation bias dynamic. I see nothing on interest on reserves. I see many references to Goodhart. yet nothing on his or others saying it should be stopped:
140.Charles Goodhart proposed that the Bank of England could return to paying zero interest on central bank reserves. He said that it will be politically difficult to maintain the policy of paying interest on reserves were interest rates to rise and the Bank of England were required to make large payments to commercial banks as a result. If there was a period of paying zero interest on reserves, he said that the fiscal cost of interest rate rises would be minimised.153 Philip Aldrick, Economics Editor of The Times, set out the case for Charles Goodhart’s proposal. He said that if interest rates on reserves were removed, the Bank of England would have no requirement to pay interest on its liabilities to the private sector, and the coupon on gilts would instead transfer “back and forth between the Government” and the Bank of England at no fiscal cost.154 Both witnesses agreed that paying no interest on reserves would in effect operate as a tax on the commercial banking sector, whilst Charles Goodhart said that any decision to return to paying zero interest on reserves would have to be taken by the Chancellor.155
141.Sir Paul Tucker told us that in order to make the management of its debt more sustainable, “there must be a chance at some point that the Government will say to the Bank of England, “For God’s sake, can you not stop paying interest on reserves?”” He said that if the Government and the Bank of England were to choose to do so, it would reduce the cost of servicing Government debt and transfer the costs to the banking sector.156
142.Lord Turner of Ecchinswell suggested that, rather than the Bank of England paying zero interest on all reserves, a tranche of reserves could be renumerated at zero interest, while marginal reserves above a certain level could be renumerated at Bank Rate.157
Thanks
In fact no interest on reserves is only one option. The princpal alternative is tiered reserves (not mentioned). It has been mentioned before on this Blog. In typical British exceptionalist fashion the practice elsewhere in the world has also not been mentioned; presumably because it is of no consequence, because we don’t do it. In fact the European Central Bank (ECB), Danmarks National-Bank, Sveriges Riksbank and the Swiss National Bank (SNB) all operate variations of a two-tier system; the Bank of Japan (BoJ) I understand operates a three-tier system. One estitmate is that at least ten central banks operates some form of tiered reserves.
But this is Britain and we talk big about controlling government spending, but that is not the problem. The real problem is that our governments are wantonly spendthrift on what we actually spend public money on; subsidising commercial banks, papering over the cracks on a collapsing public sector, covering over disasters like the Blood Scandal, Waspi women, Post Office, the Covid catastrophe, the NHS-Lansley reforms, privatising utilities in water, or rail, or energy at catastrophic cost for no return; investing in dud defence contracts, and on, and on, and on.
I entirely agree with the tiered intersst option.
It tickes all the required boxes.
Richard … The New Zealand Treasury agrees with you
https://www.treasury.govt.nz/sites/default/files/2023-04/t2022-2562-interest-settlement-cash%20balances.pdf
Treasury Report: Interest on settlement cash balances [reserves]
Indeed…..