austerity and quantitive easing

[q_w_e_r_t_y]

Could someone explain to me how these works.

As I understand it..

1. Quantitive easing is the g'ment decides to create more money
2. QE is likely to lead to inflation as there is more money for the same goods, so everything costs more
3. Austerity is where the g'ment decides to *spend* less money.
4. Austerity is likely to lead to deflation as the government is purchasing less, so the people that it purchases from have less to spend.

If the government arent spending it - and infact they are spending less - where does the money that the g'ment have created go? Does it just sit in government coffers? Does the government purchase overseas stuff use it to purchase overseas stuff, making that cheaper and supporting the balance of exports? Does it go to banks so that they can lend to businesses and individuals on the back of it under the fractional reserve system so that they will effectively spend the money?

Where is all the money going?

 

[militant atheist]

The banks........again.

 

[love detective]

I wrote a blog post on QE on the old MATB blog a year or so ago, most of which is still relevant now - might be of some use in answering some of your questions

-----------------------------

Aug 09

There’s been much talk about, and much hope invested in, the process of quantative easing lately. A couple of weeks ago the Bank of England surprised many by announcing it would increase its program of quantitative easing by another £50bn on top of the £125bn carried out so far since March this year. The surprise being that in the weeks preceding this announcement a cacophony of good news/optimism stories had emerged (house price increases, jobs losses slowing, manufacturing and services optimism indices increasing, return of record bank profits) suggesting a generalised view of economic recovery and emergence out of the crisis – which if true would suggest moves to unwind or stop the quantitative easing program. The decision to step it up a gear therefore made many realise that things weren’t quite as rosy as the picture was being made out to be. Today it was revealed that Mervyn King, Governor of the bank, would have preferred another £75bn, taking the total up to £200bn to date, striking more fear in the hearts of those who have claimed that we are over the worst.

What is quantitative easing though? It’s the creation of new central bank money to then purchase gilts in the financial markets. (gilts are essentially IOU’s that are issued by the government to investors to allow it fund the state’s financial obligations – these are ultimately paid back over time through the govt’s control of future tax revenues and/or the issue of more gilts). The central bank purchases the gilts from banks, insurance companies and pension funds – so the companies in question swap one highly liquid asset (gilts) for another highly liquid asset (money).

So what’s the point in doing all this? there are three main reasons underpinning the logic (of the bank of england) for doing so:-

1. The hope that the companies who have sold their gilts will then do something ‘useful’ or ‘productive’ with the money that they receive in exchange for them, i.e. lend it out to consumers or businesses, or invest in equity of other companies (or ironically buy more gilts freshly issued by the govt, see the last point below) in the hope that this will stimulate the economy through the demand created by the money in the hands of consumers or businesses. this is the mistaken monetarist belief that the supply of money in and off itself can be productive (of value) – but even for it to have a glimmer of chance of working in the first place the additional money has to find its way out of the banking/financial system and into the wider money supply, which so far in the UK it hasn’t – the broad measurement of money supply M4 (excluding the finance system) has hardly budged since quantitative easing started because the money created ends up being put back on deposit with the bank of england (rather than being multiplied through circulation/ fractional reserve lending into the wider economy) so it just sloshes around within the financial system, stimulating nothing but the minds of economists trying to work out why it’s not working. It was recently estimated that the £125bn of quantitative easing to date has resulted in an increase of only £1.8bn in the broad money supply – so even on its own terms, it’s not working.

2. The act of buying gilts in the market on this scale by the Central Bank creates increased demand for these assets, this pushes the price of those assets up and as these gilts pay a fixed rate of interest the yield percentage (interest earned by holding them) down - as a lot of other interest rates and borrowing rates in the market are linked to the yield on gilts, if the yield on gilts go down then the interest rates on lots of other things go down which has the impact of lowering market rates overall making money cheaper in the market and then supposedly more people/businesses will decide to borrow & spend/invest now that it’s cheaper to do so (assuming someone wants to lend it to them which they don’t). The yield on gilts however has not really changed much since start of quantitative easing so based on this objective it could also be said that it’s had no beneficial impact (although it’s impossible to tell what the yields would be if quantitative easing hadn’t been carried out)

3. The last, and the dirty little secret of quantitative easing is that it clears the way for the huge issuance of govt debt that will be needed over the next few years to fund the looming state budget deficits – as a result of the bank of england buying up huge proportions of currently issued government debt this means that the amount of gilts left on the market is drastically reduced ensuring that when new debt is issued by the govt to fund deficits there will still be plenty investors around who are willing to buy it (in the short term anyway) – if you cut out all the bits in the middle this effectively amounts to what’s known as monetising the debt – basically printing money to fund budget deficits and not too far away in principal from the so called ‘characterture’ of quantitative easing that has drawn parallels with Zimbabwe of late

This last point is an incredibly useful (in the short term at least) side effect/by product of carrying out what on the surface is a ‘credible’ monetarist attempt to achieve points 1 & 2 above - it’s perhaps getting too much into the realms of tinhatism to say point 3 is the real reason for the need for quantitative easing in the first place, as i believe that the BOE genuinely think that if they do enough of quantitative easing then ultimately they will have some success in relation to points 1 & 2 (even if it means having to supplement this with even more drastic measures like charging banks a negative interest rate on deposits to get them not to just redeposit the new money back with the bank of england or putting expiry dates on banknotes to encourage people to spend them) – but even if that succeeds in getting the money out into the wider system and increasing money supply, it still relies on the monetarist fable that the creation and circulation of money in itself is productive of value , so is still really destined to failure in the long term, even if it’s ‘successful’ in the short term

Overall however, all this is nothing but a frantic attempt focusing on the sphere of circulation alone to avoid the inevitable devaluation/destruction of capital (both real and fictitious) that religiously comes with each bout of over-accumulation – the idea is that you can somehow avoid the worst of a crisis and the resultant devaluation of commodity/productive capital through the devaluation of money through generalised inflation (which tends to socialise the costs of devaluation behind the shield of fiscal/monetary policy carried out by the state and to an extent defuses the conflict inherent in the situation by broadening it and refocusing it on the state itself). Even if they do end up being ‘successful’ however and generating inflation, the measures that they ultimately need to take to deal with that will inevitably result in the devaluation/destruction of capital anyway – they never seem to understand that they’ve ultimately no choice, within the confines of capitalism, but to let crisis do what it does (and has to do) – to irrationally rationalise an irrational system and re-equilibrate value relations at a level that allows for the whole thing to start over again

 

[butchersapron]

I forget, did we put some pictures with that

How much debt did the BOE end up buying in the end?

 

[love detective]

i think that was from before we knew how to do pictures

£200bn is the current figure i think - about a third of all debt issued in that particular maturity banding

 

[goldenecitrone]

The Bank of England authorises the printing of new money, which is given to the banks to pay off their shareholders and give bonuses to their upper echelons. And that's it.

 

[butchersapron]

The Bank of England authorises the printing of new money, which is given to the banks to pay off their shareholders and give bonuses to their upper echelons. And that's it.

It's really really not.

 

[goldenecitrone]

It's really really not.

I know. Forgive me for being a bit facetious. Although, it does seem like that.

 

[q_w_e_r_t_y]

I wrote a blog post on QE on the old MATB blog a year or so ago, most of which is still relevant now - might be of some use in answering some of your questions

Possibly but I still dont understand it.

Slower and simpler...for 1&2

1. the g'ment creates money through QE
2. the g'ment uses this money to buy guilts (which are like promissory notes with fixed interest used as investment vehicles yeah?)
3. guilts are debt that the g'ment has already built up and are now owned by insurance companies, pension companies and banks who are due the money back at a fixed time
4. by buying back the guilts they are essentially reducing their liabilities hence lowering the deficit
5. by creating the demand for the guilt they push up the price, so we pay more to get it back
6. the insurance companies, pension companies etc now have the money rather than the guilt.
7. the intention is for them to buy stuff with them to replace the money the g'ment wont be spending through austerity

Then 3

8. Printing more money to buy back guilts means that there will be more money spend by the private sector hence in the economy.
9. But this leads to inflation, and the devaluation of the currency, so that its worth less (compared to other currencies which havent QE'ed?)
10. The idea is to increase circulation of currency (why?), which leads to more money being taken out of production as investments.
11. The g'ment needs to issue more guilts to cover the gaps left through the money being taken out and invested, which generates a demand for guilts

Is that right?

...and I still dont think I quite understand where all the money has gone?

I feel like I've been Keyser Sosed.

 

[Divisive Cotton]

This is probably a complete dumb arse economics question, but if the government are printing off billions of pounds to revive the economy then why don't they just distribute it evenly over the population and let everybody spend, spend, spend our way out of recession with a consumer binge?

 

[sleaterkinney]

7. the intention is for them to buy stuff with them to replace the money the g'ment wont be spending through austerity

I'm not sure about this, I think the intention all along was for them to keep the money and prop up their balance sheets - it's another form of bailout.

 

[love detective]

1. the g'ment creates money through QE
2. the g'ment uses this money to buy guilts (which are like promissory notes with fixed interest used as investment vehicles yeah?)
3. guilts are debt that the g'ment has already built up and are now owned by insurance companies, pension companies and banks who are due the money back at a fixed time

This is all correct

4. by buying back the guilts they are essentially reducing their liabilities hence lowering the deficit

Technically they don't reduce the liabilities - it's just that a big chunk of the liabilities are owned by the Bank of England - the debt still exists and if the BOE were to unwind the QE policy it would mean selling them back onto the market (causing the reverse of what is intended through QE in the first place). If the BOE holds onto the gilts until their maturity the state still needs to find money to redeem them which would normally be done through issuing more debt. Also buying back the gilts doesn't reduce the deficit - the issue of gilts funds the deficit - once they have been issued then any other transactions between buyers & sellers of them (which is what QE is) doesn't affect the thing which required their issuance in the first place - it just changes the owner of the debt

5. by creating the demand for the guilt they push up the price, so we pay more to get it back

first part is correct, it pushes up price (purely because of the existence of large deep pocketed buyer entering the market) - not sure what you mean by the second part - the general effect is that it allows the state to temporarily issue debt at a cheaper interest rate (the effect of higher gilt prices)

6. the insurance companies, pension companies etc now have the money rather than the guilt.

yes - they've swapped one fairly liquid asset for another fairly liquid asset

7. the intention is for them to buy stuff with them to replace the money the g'ment wont be spending through austerity

not really - not the intention to buy stuff as such - the intention is that the money they get through the sale of their gilts to the BOE - begins to circulate in the wider economy through the financial system - either loaned out or invested in the equity of other companies - which in turn acts as a monetary stimulus to activity etc.. - the key thing is though that even though circulation is necessary it's not sufficient - and the initial chunk of QE from last year didn't even end up circulating, so failed at the first hurdle - instead most of it went straight back on deposit at the BOE - this was down to a combination of banks not wanting to lend and people/companies not wanting to borrow - this is why, contrary to popular perception, QE didn't make a spot of difference to inflation, as the money created didn't circulate in the wider economy - it was just effectively passed from the BOE to the banks and then back again


Then 3

8. Printing more money to buy back guilts means that there will be more money spend by the private sector hence in the economy.

in theory but only subject to what happened in (7) above not happening, which it did

9. But this leads to inflation, and the devaluation of the currency, so that its worth less (compared to other currencies which havent QE'ed?)

yes, again if what happened in (7) above didn't happen - but remember the intention of QE is to create inflation

10. The idea is to increase circulation of currency (why?), which leads to more money being taken out of production as investments.

the idea is to increase circulation of money yes - as to why, the mistaken belief that money circulating is sufficient for the production of value, it's generally necessary but not sufficient. this doesn't mean though that it's taken out of production as investments (not sure what that really means tbh) - the more it circulates the more it can help value complete the circuit of capital and valorise itself - but there's more to valorisation than circulation

11. The g'ment needs to issue more guilts to cover the gaps left through the money being taken out and invested, which generates a demand for guilts

nah they don't need to issue more gilts(!) because of that - they need to issue them to fund the deficit

...and I still dont think I quite understand where all the money has gone?

it hasn't gone anywhere really - the upshot of QE so far is that the bank of england has bigger liabiliites due to creating money to buy gilts from banks, but they also have bigger assets representing the fact that the banks put most of the money received back on deposit with the BOE. The banks themselves have just swapped one type of asset (gilts) for another (money) - nothing of substance has really happened - other than store up problems for the future when it all has to unwind

 

[ItWillNeverWork]

What happens when it does unwind?

 

[ymu]

Very clear, ld, thanks.

This is probably a complete dumb arse economics question, but if the government are printing off billions of pounds to revive the economy then why don't they just distribute it evenly over the population and let everybody spend, spend, spend our way out of recession with a consumer binge?

There was a lot of serious commentary at the time of QE1 suggesting exactly that. The £60bn bailout monies in the form of £1k per person in the UK would have had a much more direct stimulus effect - primarily because most people aren't rich enough to save it, so they'd spend it, keeping more people in jobs and paying taxes.

This article is more recent, and proposes something similar for QE2.

If we don't want to wait for Hayekian "natural forces", but at the same time recognise that orthodox Keynesian fiscal policy and monetary stimulus (if it works) will only recreate the old unsound structure of production, is there a way of speeding up recovery?

Two unorthodox policy moves to revive the economy are worth considering. First, in order to make consumers spend rather than save we could adopt Silvio Gesell's idea of stamped money. This money loses purchasing power if not spent immediately. The easiest way to put money in consumers' pockets would be to give them a shopping voucher valid for one month after issue.

Second, a recovery loan that will mop up money in banks, firms and households for which there is no present use – and use it for infrastructure projects: the high-speed rail link, road building and repairs, and house construction by local authorities; or projects to do with carbon emissions - insulating houses, and solar panels. A company could be set up to raise money for these projects that would not add to the deficit.

 

[Das Uberdog]

that policy has alreaady been tried though, in recent history, by the late Bush administration in the States (in the form of $500 worth of 'tax rebate cheques' for all households). it failed, and in no small part was that due to the fact that, as previously mentioned by love detective, liquidity is not the be all and end all of value creation. the problem for the Western market, currently, is that there are little opportunities for large-scale profitable (value-creating and viz 'aggregate profit creating') investments.

both nationally and internationally, there is a dearth of technological advance which could lead to potentially massive wealth creation and there is very little in the way of physical territory and 'untapped populations' to break into and expand previously untapped markets. even traditional forms of 'pillaging' and imperialism are proving to be more expensive to pursue than they're worth (foisting American money into previously 'closed' Iraqi and Afghani markets, for example). the greatest technological innovation of the last two decades (computing and the internet) has actually been a rationalizing one; labour saving and efficiency maximizing; the internet and computers have created less real-world wealth than they have 'saved money' for companies by de-skilling jobs and easing bureacratic administration.

without further technological innovation, the only concievable methods of profit creation in the West are negative; i.e. a) increasing the rate of exploitation of workers, b) the continued financial and political manipulation of organizations like the World Bank and IMF to parasitically drain capital from the 3rd World, or c) war (to break into Eastern markets). a) has been happening since the 1970s, b) is reaching the apex of all it can really achieve (and is being actively undermined by China's new role as an independent creditor to new emerging Markets) and c) is undesirable on many levels.. not least of which is the fact that we'd be unlikely to 'win'.

but hey, a dying animal often thrashes out wildly and self-destructively... i wouldn't put any cap on the level of stupidity possible if the Tea-Party takes power Stateside in the next decade or so. interesting to see how all this will pan out..

 

[love detective]

another £75bn of QE announced today - taking total to £275bn so far

 

[Smokeandsteam]

another £75bn of QE announced today - taking total to £275bn so far

While I try to understand the earlier explanation of QE could someone explain the theory that an additional £75 BN of QE here will somehow help to avoid the meltdown of the Eurozone/collapse of French/Belgian banks which is the latest 'crisis' that threatens another Lehmann Brothers meltdown?

 

[love detective]

it's utterly unexplainable i'd say!

 

[Smokeandsteam]

it's utterly unexplainable i'd say!

I've just read the BOE leaflet on QE. They state that QE is primarily an inflation control tool.

As I understand it the Eurozone problems are economic in the sense that every bailout in Greece has failed and another is now needed, Spain and Italy are about to tailspin and German and French banks are going to be hammered by the markets as they are seen as the most exposed by these events. It's also political because no government can control global capital and in that sense that the political class has gone into paralysis about what to do about it.

In such circumstances, it seems that more QE here is likely to be like using a pea shooter to stop a tank.

 

[Smokeandsteam]

This is probably a complete dumb arse economics question, but if the government are printing off billions of pounds to revive the economy then why don't they just distribute it evenly over the population and let everybody spend, spend, spend our way out of recession with a consumer binge?

The Guardian is running a QE blog now and 2 economists on there have said exactly that - instead of giving the money to banks etc give it to the 'real economy' i.e. us as we won't save it or use it to speculate overseas, we'll spend it!

However there are others saying Bush tried this in the US and it failed.

 

[Kizmet]

Isn't that the idea behind the government offering to buy up gilts in small businesses?

 

[littlebabyjesus]

The Guardian is running a QE blog now and 2 economists on there have said exactly that - instead of giving the money to banks etc give it to the 'real economy' i.e. us as we won't save it or use it to speculate overseas, we'll spend it!

However there are others saying Bush tried this in the US and it failed.

Or give it to housing associations to build houses with. As ld has pointed out in the past, creating new money for which there is no demand has very little effect on an economy if it doesn't circulate. What is needed is to get people doing things. Construction is in a slump yet there is a huge need for new housing. That is an obvious gap into which the state could step.

QE is an attempt to get the private sector moving again. At some point, it becomes very clear that no attempt at this will succeed - it is the public sector that the state can directly move along. That's what it needs to be doing. Quite a few right-wing commentators are even saying this now.

 

[butchersapron]

The Guardian is running a QE blog now and 2 economists on there have said exactly that - instead of giving the money to banks etc give it to the 'real economy' i.e. us as we won't save it or use it to speculate overseas, we'll spend it!

However there are others saying Bush tried this in the US and it failed.

The Bush thing was a bit different if i remember right, there is the Australian example which is often used to support these sort of transfers.

 

[love detective]

I've just read the BOE leaflet on QE. They state that QE is primarily an inflation control tool.

they say that, but it's not really true (the reason they say it is because pretty much the official fundamental objective of the BOE is monetary stability, so all that they do has to be couched in these terms)

it's more about trying to get money to circulate more in the hope that this stimulates activity in the economy - this whole process may or may not result in increasing inflation (i.e. the official stated purpose of QE)

the positively correlated link they (govt, state, BOE, 'economists') try to make between increased/stimulated activity in the economy and inflation has pretty much shown not to hold in times like this - generally (although not always correctly) more QE is associated with more inflation - yet at the moment inflation is at least double what the target rate is, yet there is a big push from both the government and the BOE to do more QE - this shows that it's not so much 'inflation control' that is the purpose of QE but the three things that are covered in the blog post above

In such circumstances, it seems that more QE here is likely to be like using a pea shooter to stop a tank.

I don't think anyone who is pushing QE (BOE, state, etc.) is saying it will help solve anything to do with the eurozone crisis though - their outward justification for it is to stimulate activity in the UK economy. However I doubt they actually believe it will work, but they realise they can't actually do anything about what is going on at the moment (within the framework of the neo-liberalised structures they are sanctioned to operate within) but they can't be seen to admit that openly and do nothing, so we get stuff like this which is just playing to the crowed really, not going to do much either way

 

[Barking_Mad]

“Printing money is the last resort of desperate governments when all other policies have failed. It can’t be ruled out as a last resort in the fight against deflation, but in the end printing money risks losing control of inflation and all the economic problems that high inflation brings.” ~ George Osborne, 2009

 

[Kizmet]

last resort, eh?

So... what's next?

 

[love detective]

The Guardian is running a QE blog now and 2 economists on there have said exactly that - instead of giving the money to banks etc give it to the 'real economy' i.e. us as we won't save it or use it to speculate overseas, we'll spend it!

I'm sure any of us who has seen what has happened over the last 40 years knows exactly why this kind of redistribution won't happen!

Yet it's easy for the state to justify why it can't happen due to the technical framework/mechanics of how QE is actually carried out :-

When QE creates money it doesn't involve creating the money and then just giving it away to somebody else for nothing (i.e. a distribution) - it uses the money to buy existing assets from banks - so it's a purchase & sale between two parties of one highly liquid asset (government gilts/securities) for another highly liquid asset (the created money). So the net impact for say a bank is not that it is any richer, it's just that it holds more of one asset and less of another - and as the asset it holds more of is cash (which yields less than the gilts it's just sold) the idea is that it will be more inclined to lend the cash into the wider economy (so that it earns more of a turn on it) which will then circulate all over the places and stimulate demand etc.

So the answer to the question as to why doesn't the BOE give it to us would be we'd need to have assets equivalent to the same amount to be able to sell to the BOE to get hold of that money

Also as an aside, the process by which QE works (creating money, then using it to buy assets from banks) goes on week in week out as part of the central bank's normal monetary operations, it's the way in which the central bank (in 'normal' times) controls the base rate, it does this by creating & injecting or extracting & destroying cash from the banking system via the process of buying or selling of government securities. So with QE the process is exactly the same, it's just really the reason for doing it (and scale) that's different

 

[littlebabyjesus]

Next is what should be done now - govt spends the money directly rather than giving it to banks. I don't see how they will have any other option in the end, but it goes against what the Tories say they stand for, so they're likely to resist it.

 

[A380]

The Guardian is running a QE blog now and 2 economists on there have said exactly that - instead of giving the money to banks etc give it to the 'real economy' i.e. us as we won't save it or use it to speculate overseas, we'll spend it!

However there are others saying Bush tried this in the US and it failed.

When this has been tried people have tended to use the money to pay off existing debt or put it into savings. In both cases not helping. However, it can be done (Singapore, I think) by issuing time limited vouchers for consumer goods.

However, part of the underlying problem, both for the ecconomy, and in the long term the planet is we in the west have been buying too much stuff which we, and the environment, can't afford.

Still Cameron can give me a free 3D telly if he wants. I'll still call him a tory wanker.

 

[Smokeandsteam]

Also as an aside, the process by which QE works (creating money, then using it to buy assets from banks) goes on week in week out as part of the central bank's normal monetary operations, it's the way in which the central bank (in 'normal' times) controls the base rate, it does this by creating & injecting or extracting & destroying cash from the banking system via the process of buying or selling of government securities. So with QE the process is exactly the same, it's just really the reason for doing it (and scale) that's different

Thanks very much for the help understanding this.

Larry Elliot in the Guardian is now saying today's announcement is "a display of shock and awe" by the MPC but on the other hand won't make any difference for the same reasons as the last round of QE didn't (the banks didn't use the money to lend etc they used it to speculate/invest overseas etc) so it seems more of a gesture of being seen to do so 'something' as you suggest.