Friday, October 30, 2009

Asset Purchase Scheme and Money Supply

Assets bought by the Bank of England in the Asset Purchase Facility source: B of E

The theory behind quantitative easing is that it should increase - the money supply, bank lending and economic activity.

To simplify the scheme.

  • The Bank of England creates money electronically. (They just increase their balances.)
  • They use this created money to purchase assets. (As you can see, so far, this is mostly government gilts - useful for financing government debt, though as the Bank says, this a pure co-incidental side effect...)
  • Banks and financial institutions are selling their gilts to the Bank of England, therefore, they should have an increase in their money balances. In theory, with greater cash reserves, they should be willing to lend this out to private enterprise helping investment and economic activity.
  • Also, by buying gilts, the price goes up and the yield (interest rate) goes down. This decline in gilt yields (interest rates) should also help to increase economic activity (more incentive to spend rather than save.
How Effective is It?

It is still difficult to say how effective the scheme is. It will be subject to time delays, and the economy may have been much worse than without it. However, data released by the Bank of England, suggests the UK is still suffering from low growth in the money supply and low economic activity. Whilst other countries like US and Eurozone are escaping recession, the UK may need further quantitative easing to boost its prospects.

An Adjusted Version of M4 Growth

  • An Adjusted measure of M4 fell 0.9% in September (OFC stands for other financial corporations)
  • The household sector’s holdings of M4 rose by £3.0 billion in September. The annual growth rate fell to 2.5%.
  • M4 lending (excluding the effects of securitisations etc) to the household sector rose by £1.6 billion. The annual growth rate fell further, to 2.0%.
  • source: B of E
  • M4 is a measure of broad money - It includes the amount of notes and coins in circulation, plus bank and building society deposits.

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