The money-go-round: QE in practice (2)

I've expounded on quantitative easing at length, but what it boils down to is commercial banks and government departments shuffling numbers on bits of paper (or on computer screens) around between themselves with little or no impact on the wider economy*.

An article in the FT, which is not easily available online sums it up:

In the UK, for example, nearly £140 billion has been injected into the economy through central bank purchases of government bonds and corporate assets, mainly from the commercial banks.

However, since the QE project was launched on March 5, a lot of this money, which in theory should be used by the commercial banks for lending to businesses and individuals has ended up at the Bank of England in reserves. Commercial bank deposits have risen from £31 bn in early March to £152 bn** at the end of July - the latest figure."

So all the commercial banks do is to swap one bit of paper saying "Government bond" for a bit of paper saying "Deposit with the Bank of England" (exactly the same as you paying cash into an account with a commercial bank); the Bank of England ends up with a new asset (a Government bond) and a new liability (the deposit from the commercial banks - don't forget that the depositor has an asset and the deposit taker has a liability) which net off to £nil; and the Debt Management Office no longer has to repay the commercial banks when the Government bonds mature, but another department in the Treasury (i.e. the Bank of England) instead. You can treat the two departments as one, for these purposes, actually, which makes it even easier to understand.

* Why do the commercial banks do it? Partly because the Bank of England is overpaying slightly (they must be - otherwise commercial banks who preferred cash to Government bonds would just sell them in the open market); and partly because commercial banks are prepared to forego the slightly higher interest rates on Government bonds compared to deposits with the Bank of England (the differential is about three per cent per annum, let's say) because they fear that the massive increases in Government borrowing that that have been promised (which is an entirely separate issue and nothing to do with quantitative easing as such) is going to depress the value of existing Government bonds by more than three per cent per annum.

This has little or no impact on the amount that commercial banks are prepared to businesses and individuals (net mortgage lending was a bare £1.6 billion last month), because the real-life commercial risks of doing so have not been reduced one iota.

** So £140 billion has been 'spent' and £121 billion has been deposited straight back with the Bank of England. Presumably the other £19 billion belonged to foreign investors who have shifted the money abroad.