Green Quantitative Easing

The new report from Ritchie and friends. In the intro, how\’s this for a great piece of logic?

3. There was a shortage of gilts available for investment purposes as a result of the Bank
of England buying so many in the market. Large quantities of funds were invested
instead in other financial assets including the stock market and commodities such as
food stuffs and metals. The USA also undertook quantitative easing at the same time
as the UK, which meant that despite near recessionary conditions commodity prices
for coffee and basic metals such as copper have risen enormously. This has impacted
on inflation, which has stayed above the Bank of England target rate;
4. Deflation has been avoided, although the relative role of quantitative easing in this
versus the previous government’s reflation policies is unclear;

Got that? Quantitative easing caused inflation but we don\’t know whether it avoided deflation?

This is fun:

To explain this mathematically, suppose that the current gilt rate is 4%. In other words, new £100
gilt pays £4 of interest per annum. There are, however, gilts out there which were issued at 5% per
annum. The bond market does not ignore this difference, instead it adjusts the price of the gilt
already issued to reflect the current prevailing interest rate. As a result the price of the gilt already in
issue which is paying £5 a year is adjusted so that the effective rate of interest it plays is reduced to
the current 4% and rate of interest. It can do this by increasing the value of that gilt from £100, at
which it was issued, to £125. £5 is 4% of £125. The result is that the bank or pension funds that now
owns that gilt makes a profit of £25 on the original purchase price, if it can sell the gilt it owns that
has now gone up in value back to the Bank of England under the quantitative easing programme.

Err, no. For a start, they\’re assuming that the BoE has been buying up perpetuals (of which I think there are only Consols left). I\’m not sure, but I think that the BoE has been mainly buying up 10 year gilts. Meaning that the price change to effect the yield change will be much lower.

But even then they\’ve cocked the calculation, haven\’t they? Because 1% is 20% of 5%, not 25% (although now that we\’re playing with numbers I could well be wrong).

But where they\’ve really gone wrong is that they\’ve assumed (further up the report) that the banks made a huge profit by selling their old gilts to the BoE. And thus, given that old gilts were issued at lower prices (higher yields) the banks have made a huge profit by doing so.

That explanation, just like almost everything else in this report, revolves around money, and in this
case how the High Street and investment banks can make money out of the Treasury. The technical
explanation of this process is in Appendix 2 to this report. Suffice to say here that because the Bank
of England has pushed interest rates on gilts to their lowest level for many decades they have, as a
direct consequence, pushed gilt prices to record highs. That means that the banks and pension funds
that have sold government gilts to the Bank of England as part of the quantitative easing programme
have made profits since they would have bought these gilts previously at a lower price.
How much profit as being made in this way is hard to guess. It would be of enormous benefit to
know. What we suspect is that a significant part of the £200 billion of spending on QE was turned,
almost immediately into profit by UK based banks and we in turn suggest that it was this fact, and
little else that restored bank profitability and bank bonuses in 2009.

Well, no, for as we discussed earlier, the banks have been increasing their holdings of gilts, not reducing them. But even if they had been decreasing their holdings it would still be a load of cockammammie Ritchiebollocks.

Because the surge in gilt prices is only very marginally anything to do with QE. What\’s really caused the surge is the BoE lowering the interest rate. Of which most of it has been the BoE saying \”interest rates are now lower\”, not their QE through open market operations.

People more informed than me say that the profit to the banks from lower interest rates has been substantial (just as their losses when interest rates rise will be, assuming they\’re long gilts) but the profits from QE are around £nil.

Interesting little note: the cover photo is from R. Murphy: my, those rectories in Norfolk do need some maintenance, don\’t they?

Finally, and the most important point, they\’ve got horribly and terminally confused between monetary activities (of which QE is one) and fiscal or spending activities.

Monetary stuff is bits like lowering interest rates: and when you cannot do that then you print money (QE) to lower them even further. You do this because you want to lower interest rates. Further, you do it because you know it is reversible. Inflation starts soaring away and you can sell the gilts back to the banks/market/pension funds, stick the money back in the BoE and cancel said money\’s existence. It is a temporary thing you see?

They\’ve now run off and said \”Look! Free money! Now, what would we like to spend it on?\”

Squeal like a piggie! Windmills! Insulation! Solar Cells!

But this isn\’t temporary: this isn\’t reversible. This is not QE in effect: this is printing new money in order to go spend it on real assets. You know, Zimbabwenomics?

And here we come back to our old problem with Ritchie and his friends. They\’re quite simply too ignorant of economics, the basic nuts and bolts of the subject, to understand the difference. Printing up some money to lower interest rates a few points is one thing: printing up some money to go spend it is quite a different thing.

12 thoughts on “Green Quantitative Easing”

  1. Banks have not been selling gilts to the BoE; the Bank deliberately targeted (through a variety of measures) non-bank holders of gilts in order to have a direct effect on the money supply. In any case (IIRC), banks are not generally big holders of gilts. Murphy’s line here is misplaced.

    The effect of the Bank’s programme was to reduce the cost of non-bank corporate funding (i.e. debt and equity issuance).

    Don’t follow the latter half of your post. Are you saying that QE is not reversible & not monetary policy?

    Tim adds: No, QE is reversible and monetary policy. Which is why we can happily do £200 billion of it.

    Murph and the others are saying, well, let’s just print the £200 billion and go spend it! Ie, do something which isn’t monetary and isn’t reversible. They’re actually arguing for fiscal expansion through the printing of new high powered money. A very different thing, I think you’ll agree? And yes, they are saying there should be £200 billion of this.

  2. “Printing up some money to lower interest rates a few points is one thing: printing up some money to go spend it is quite a different thing.”

    I’ve always looked at QE as quantum tunnelling: you have no money, buy some stuff with created money, later you sell the stuff and destroy the money. As long as it balances out – and this is the intention – then all is fine. Well, in theory.

    The problem I see is that if the hippy dippy twits like Ritchie are in power when the “destroy money” bit comes, they will be rather reluctant to follow through on that, blissfully unaware of the consequences.

  3. Ah, okay, understood. Agree with your first para. Assuming no losses on the Bank’s portfolio, QE is monetary policy.

    Not sure about your second. In the limit (i.e, approaching the ZLB), risk free claims on money and money become indistinguishable. In other words, if we can borrow for free, what is the point of monetising the debt? Not much, since the debt is already effectively money.

    So again I disagree with Murphy but perhaps for different reasons than you.

  4. Now I am told that the money that is ‘printed’ exists only as entries on the BoE computer, and when a bank sells some gilts to the BoE, their account at the BoE is credited with the money. Is this correct?

    And can the bank withdraw that money from the BoE and do what it likes with it? Buy gold for example? Or is it somehow forced to keep it in the BoE as reserves?

    Because at the moment it seems all the QE money has ended up still at the BoE, in the balances of the various banks. It hasn’t hit the real economy, buying real stuff. Can it ever reach the real economy?

    Because if it can, and does, this will surely cause inflation, unless the BoE then sells the gilts back into the market and destroys the money it gets for them. This is the bit I reckon won’t ever happen. I think there will always be a reason not to reverse QE, and thus inflation is baked into the pie, so to speak.

    Is this right, or total nonsense?

  5. Jim,

    When the BoE buys an asset from the non-bank private sector, the sellers gets a cheque drawn upon the Bank (i.e. reserves). S/He deposits that in his bank, and now they have a cheque drawn on the Bank. So the immediate effect of QE is that system reserves increase. Furthermore, whatever the pension fund manager does with his deposit balance, the newly issued reserves will always stay in the banking system (at the BoE) until the Bank withdraws them.

    (It actually issued a new short maturity instrument to mop up most of the net reserves added over and above banks’ self-imposed reserve targets as a result of QE.)

    So you should expect to see these reserves sitting at the BoE regardless of whatever else is happening. Even if we get a lot of inflation and credit growth, reserves will stay the same–unless the Bank withdraws them.

  6. There is also this piece of wisdom in the retarded (or is it retired) accountant’s report:

    Green Quantitative Easing: Paying for the Economy We Need’ also notes that no one is sure for certain whether the first £200 Billion round quantitative easing worked and suggests that several things did happen:

    1.The banks profited enormously from the programme, which is why they bounced back into profit so soon after the crash – and bankers’ bonuses never went away;”

    The bonuses never went away because the vast majority of them (well over 50%) is paid by US investment banks (you know, JP Morgan, Goldman Sachs), and the rest mostly by their European brethrens (Deutsche Bank, Credit Suisse)….

    It is probably a waste of time to try to explain to Murphy that none of these entities are large holders of UK government bonds. Any treasury bonds they hold as part of their core equity books will be those from their countries of origin (i.e. the US, Germany, France, Switzerland). This is not the stuff that the BoE was buying.

    Bonuses are not related to QE. They are the results of the phenomenal rebound in earnings that well-capitalized and managed banks enjoyed following the near-nuclear experience of late 2008.

  7. @Vimothy: Whats in it for the banks then? They had an asset that was convertible to cash if they needed it, now they have a reserve balance at the BoE that they (seemingly) can’t spend on anything. Why would you do that?

    What about if I as a private holder of a gilt sold it in the market, and it happened to end up with the BoE? (or do they not purchase in the market, just in private deals?). Do I get my cash?

  8. Jim,

    As I pointed out above, the BoE deliberately targeted non-bank holders of of gilts. Commercial banks do some market making in this asset class, but generally have quite thin holdings (primarily for liquidity portfolios). In addition, the Bank took several steps to insure that it was indeed not buying from banks, in order to ensure that its purchases directly affected the money supply.

    The banks ended up holding these claims on the BoE because the sellers of gilts (pension funds, largely) deposit them in their own banks. And when they use their new deposit balances to buy another asset, these claims shift to the seller’s bank. And so on.

    If you as a private individual sell a gilt to the BoE, you end up with an increased deposit balance (and reduced holdings of gilts) and the banking system ends up with increased holdings of reserves, banked at the BoE.

  9. I would just like to point out that this bit is not a fallacy:

    “Quantitative easing caused inflation but we don’t know whether it avoided deflation”

    Both parts of the statement can be true. Of course QE causes inflation, that is the point of it, however it is does not follow that without it there would have been deflation. Both the RIPX and CPI measures of inflation never looked like they would go negative. That the RIP measure did can be put down to the massive reduction in the bank base rate being reflected in people’s mortgage costs, hence why RIPX stayed well above zero. It could well have been that general inflation would not have gone negative even without the extra inflation created (or rather transported in from the future if QE works as it says on the tin) by QE.

  10. Incidentally, if anyone is interested in Norfolk rectories and the development of the modern understanding of what a house should be, may I recommend Bill Bryson’s At Home, which explores the latter through consideration of the former…

  11. I know Ritchie-bashing is your main calling-card, but I think it would be better not to response to every post he does, especially when it’s an area you don’t know much about. You make three substantive points

    1. Something that causes inflation must be the reason deflation was avoided.
    2. An fall in rates from 5% to 4% would not increase the value of a 100 perpetual bond to 125.
    3. Interest rates are lowered by saying they are lowered rather than open market operations.

    I’d probably think a little harder about them.

  12. Missed this report when it came out, so sorry, I’m late to the party. As RM is still promoting his “Green QE” ideas, though, I think it’s worth commenting.

    This report is the biggest load of cobblers I’ve ever read. It’s so riddled with errors and muddled thinking I don’t know where to start.

    I’ve sent it to a proper development economist for fisking, and I shall write something dealing with the gobbledegook they wrote about QE – they clearly haven’t a clue what it is or what it’s supposed to do. They could have visited the BoE’s website for a nice clear explanation on a handy PDF download…which DOESN’T include their “stated intention” that QE was intended to provide funds so banks could lend. It wasn’t – in fact the BoE went to considerable lengths to avoid buying assets from banks.

    They’ve even suggested that QE recapitalised the banks, thereby confusing capital with cash. I thought RM was an accountant? SURELY an accountant knows what capital is! Yes, banks may have more cash sitting in reserve accounts as a consequence of QE, although as vimothy points out much of that is likely to be on deposit from institutional investors. But that does nothing whatsoever to improve banks’ capital cushions.

    Did anyone else notice that on page 12 they suddenly start talking about government borrowing money for investment to take advantage of low interest rates? Whatever QE is, it certainly isn’t borrowing. This isn’t any colour of QE if they are borrowing the money to fund investment. It’s good old-fashioned expansion of public investment funded by debt. As if we haven’t got enough of that already.

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