What has quantitative easing (QE) done for us? Regular readers may be aware that your blogger is not the greatest fan of QE. But it should be criticised for the right reasons, not the wrong ones. It was not, as John McDonnell, the finance spokesman of Britain’s Labour party said on BBC Radio 4 today, about “saving the banks”.
QE was adopted in 2009 because central banks were running out of options. Short-term interest rates had been cut close to zero; it is hard to impose negative rates in an economy where consumers and businesses can hold physical cash. So the central banks decided to drive down long-term interest rates by buying bonds; when it did so, it credited the account of the seller with newly-created money. The aim, by reducing long-term yields, was to reduce the cost of borrowing for companies and households (through the mortgage market).
In the main, central banks bought government bonds but the Federal Reserve also bought mortgage-backed securities and the European Central Bank is buying some corporate debt. But the Bank of England owns only gilts, not convertible bonds and bank cocos as Jeremy Corbyn supporters on Twitter seem to believe. See p3 of the annual report of the Bank’s Asset Purchase Facility Fund
Since the inception of the Company, total purchases net of sales and redemptions amounted to £375 billion, all of which were held in gilts at the year end.
So the money wasn’t invested in the banks; RBS and Lloyds had been rescued in October 2008 and QE didn’t start until the following year. The Bank also operated a special liquidity scheme, designed to help the banks by lending money against the security of assets; this did not use QE money and was wound up in January 2012 with all the loans having been repaid. All the QE investment, by contrast, is still outstanding.
Did the Bank of England buy gilts from the banks, and help them that way? That certainly wasn’t the intention. Paul Fisher, the Bank’s executive director, markets said back in 2010 that the aim was
to target our purchases at assets held by the non-bank sector. The proposition is that, by buying gilts from pension and insurance funds (for example), those asset managers would have more cash in their portfolios than they desired, and would be incentivised to use that cash to invest in other, more risky instruments such as corporate bonds and equities.
Indeed, at the end of 2008, the commercial banks barely owned any gilts at all. More than two-thirds of all the bonds in issue were owned by pension funds, insurance companies and overseas investors. It makes sense that such investors were the bulk of the sellers. Of course, the Bank of England buys gilts through market-makers (which are banks) but that is not a hugely profitable business.
The net result of QE is to increase the size of bank deposits but they are a liability for the banking system, not an asset. And the hope was that banks would feel more able to lend to the corporate sector. This didn’t really happen, as explained by this Bank of England staff blog. To explain why, think of what happens; the Bank buys bonds from the Wheeltappers and Shunters’ pension fund; that gives the pension fund cash, which it uses to buy equities from the Acme Insurance company. Acme now has cash but uses it to buy corporate debt and so on. The money keeps churning round the system. All this may have boosted asset prices but the blog concludes that
we find no evidence to suggest that QE boosted bank lending in the UK through a bank lending channel, possibly because the high churn in deposits meant they were not viewed as a stable funding source by banks. In the process, we dispel the myth that money created by QE lay idly on banks’ balance sheets. Instead deposits and reserves moved more rapidly around the banking system, consistent with the portfolio rebalancing channel of QE.
Finally, it is worth remembering that QE flattened the yield curve; that is, long-term interest rates fell faster than short-term rates (which were already close to zero). But banks borrow short-term and lend long; they make more money when the yield curve is steep, not when it is flat. So if anything, QE may have hurt bank profitability more than it helped.
The main victims of QE were arguably elsewhere. Lower rates reduced the income of elderly savers and those who, on retirement, bought annuities. Pension funds use bond yields to discount their liabilities; as yields fell, the present value of the liabilities rose and funds fell deeper into deficit. Companies and employees have had to contribute more. It is also possible to argue that QE, by boosting asset prices, helped the rich and this widened inequality and that the first round of QE in 2009 was a lot more effective than subsequent efforts.
And the biggest gainer from QE has not been the banks but the governments, and thus the taxpayer. To the extent that central banks buy government bonds, it is easier and cheaper for governments to finance their deficits. That, of course, is why some commentators have always worried about QE; it is such a tempting option for a politician who doesn’t want the voter backlash from raising taxes or the market discipline that comes from persuading private investors to buy their debt. Once started, it will be hard to stop.