All QE is ""people's QE" - just not the right people


There is a widespread belief that the Bank of England’s QE only benefited banks. Promoters of Jeremy Corbyn’s “People’s QE” use the strapline “QE for the people, not for banks”, and describe conventional QE as “bankers’ QE”.
So is this true? Did QE primarily benefit banks?
The Bank of England’s QE programme did not purchase gilts directly from banks, but from non-banks – pension funds, insurance companies, asset managers, high net worth individuals. However, because the Bank of England does not deal directly with non-banks, banks intermediated QE purchases. Banks bought gilts from investors, and sold those gilts to the Bank of England. Customer deposits increased as a consequence of the banks’ gilt purchases: bank reserves increased as a consequence of the banks’ gilt sales. The end result was a vast increase in both base money M0 (bank reserves) and broad money M1 (customer deposits).
Because QE has vastly increased bank reserves, many people are angry that banks have cut back lending severely since the 2008 financial crisis. What is the point of giving banks all this money if they don’t lend it out? But banks don’t lend out reserves. They don’t lend out customer deposits, either. Throwing money at banks doesn’t make them lend. The extra money that landed on bank balance sheets left them with far more reserves than they needed to settle payments, but made no difference to lending.
The Bank of England pays interest on reserves at base rate ("bank rate"), currently 0.5%. Some people say that this is in effect paying banks not to lend, and blame this payment for the fall in bank lending. But this is mistaken. Banks collectively have no choice but to hold the extra reserves created by the Bank of England through QE. When investors spend the proceeds of QE on other assets, such as corporate bonds, equities and commodities, the money simply moves from one bank to another. QE money does not leave the banking system unless it is converted into physical notes & coins.
But do banks benefit from interest on reserves? Slightly, since they pay less than 0.5% on demand deposits. But against this should be set the opportunity cost. If they did not hold so many reserves, what would they hold instead?
Banks must hold sufficient safe liquid assets to meet liquidity buffer requirements, which have increased considerably since 2008. The safest and most liquid assets are reserves, but there are substitutes such as Treasury bills and gilts. Banks' holdings of gilts have actually risen since 2008. 
But for banks to earn money, they must do riskier lending. A few basis points spread between customer deposits and reserves or T-bills isn’t going to satisfy their shareholders. Far from discouraging risky lending, therefore, the presence of excess low-earning assets on bank balance sheets should encourage it. If banks aren’t lending, therefore, other factors are at play – such as depressed consumer demand and a very large private sector debt overhang.
The main effects of QE are to support asset prices and depress longer- term interest rates. So banks with balance sheets stuffed full of poorly-performing loans collateralised by risky assets undoubtedly benefited from QE, because it prevented wholesale destruction of their balance sheets through sharply falling asset prices and swathes of household and corporate bankruptcies. But although QE helped keep banks alive, it has made it far more difficult for them to return to profit. When interest rates are close to zero and yield curves are flat, banks can’t make money.
All in all, it is hard to see that QE could fairly be described as “QE for banks”. But if banks were not the main beneficiaries, who were? In 2013, the Bank of England admitted that the principal beneficiaries were asset holders, particularly those in the top 5% of the income distribution:
By pushing up a range of asset prices, asset purchases have boosted the value of households’ financial wealth held outside pension funds, but holdings are heavily skewed with the top 5% of households holding 40% of these assets.
Rich people, in other words. So conventional QE is QE “for the people”. Just not the people that Jeremy Corbyn would like to help.
Of course the Bank of England argued that conventional QE actually benefited everyone:
Without the Bank’s asset purchases, most people in the United Kingdom would have been worse off. Economic growth would have been lower. Unemployment would have been higher. Many more companies would have gone out of business. This would have had a significant detrimental impact on savers and pensioners along with every other group in our society. All assessments of the effect of asset purchases must be seen in that light.
Those who suffered years of unemployment, under-employment and depressed real incomes might regard this as cold comfort. Would direct reflation of the economy through a modern Debt Jubilee, “helicopter money”, and/or a money-financed investment programme have worked better? I am one of many who think that it would. When asset prices are in freefall and the economy is collapsing, conventional QE works: but when the problem is lack of demand due to damaged bank and household balance sheets, conventional QE is inadequate.
We have relied far too much on conventional QE. Whether it has helped restore the UK’s fortunes we do not know. But we do know that further reflation of the economy is not at present needed: the debate at the moment is when to raise interest rates, not whether to do more QE. We need investment, yes, but while interest rates remain low we can have this through conventional bond financing at little cost. To my mind the attention of the new Labour leadership should be elsewhere.

For too long we have turned a blind eye to QE's regressive nature. Surely the top priority now must be to address the inequality that "QE for the rich" has helped to cause.
This post first appeared on The Exchange at the FT. Image from secretsofthefed.com

Comments

  1. Spot on. It was far better to make sure banks survived than to suffer the acute pain of any further collapses for all of us. But we could have found much better ways of using £375 billion. Investment in a move to a low energy economy would have permanently helped the balance of payments and reduced the cost base for UK industry thus helping industry, workers and the planet. Investment in productive infrastructure would also have done a lot of good. But we do have to be careful about at what point in the cycle quantitative easing is used. When you do it is a matter of skilful judgement of need. How you do it should also have been a matter of skill and judgement. It got derailed by an ideology that says only the free market can ever know what is best.

    ReplyDelete
  2. Further. All spending is "QE" or "money creation."
    The govt just borrows back what it first spent.

    ReplyDelete
    Replies
    1. Quite. Which raises the question: why spend so much that rich people then have more money than they want, and thus have to be paid interest to induce them not to spend too much? I.e. why have a nation debt at all? Milton Friedman said don't have one, and Warren Mosler likewise.

      Delete
  3. I agree almost completely, except when you say "QE money does not leave the banking system unless it is converted into physical notes & coins." well, I can imagine a series of decision that increase GDP without necessity of paying in money & coins. For example, a new credit to public sector to building a motorway. That will origins a chain of expenditure from government to consumption of the later employee through banking account without physical money.
    I coincide in it is the credit that mobilize monetary base, but in don't see the necessity of physical money.

    ReplyDelete
    Replies
    1. Miguel,

      What I said is entirely correct. QE money does not leave the banking system. Even if it were spent on infrastructure development it still would simply move from one bank to another. I agree with you totally that spending the money on productive investments such as motorways would probably increase GDP far more than spending the money on unproductive investments such as secondary market corporate bonds.

      Delete
  4. I agree entirely! What tends to be overlooked also is that not all assets and liabilities are equal. Bank reserves are effectively super-senior, now interest bearing, capital claims on the central bank. By contrast, demand deposits are deeply subordinated to derivatives and bail in workouts. And even richer, they now wish to close the door to the prole's access to central bank counterparties, I.e. Banknotes. Priceless!

    ReplyDelete
    Replies
    1. Hang on, hang on. You are mixing up assets and liabilities. Bank reserves are assets. Demand deposits are liabilities. They are senior debt and certainly aren't "subordinated to derivatives", which are off balance sheet contingent liabilities. They are, however, junior to secured debt such as covered bonds and repos.

      Delete
    2. Hi, Frances I'm clear on balance sheet assets and liabilities. What I note is that bank liabilities such as deposits are properly unsecured creditors that are vulnerable to bail-ins. Referring back to your "premier league" piece, the M3 is effectively unsecured and vulnerable to insolvency workouts, while M0 is super-senior central bank liabilities. In short, commercial banks go insolvent, and the central bank never does.

      The CB emits super senior capital into the banks, while nonbank actors are left with unsecured claims in lieu of their once senior treasury debt. The banking system absorbs senior assets and emits unsecured funding. This is, of sorts, a funding mismatch - the public is left with more net risk, I.e. more unsecured, fewer secured cash assets. This problem would worsen if banknotes were eliminated for the public.

      Re derivatives, I only see the status of bank depositors as being unsecured. As such, I can only presume that a severely impacted balance sheet could and would claim bank deposits as part of a bail in. I'm not certain that a contingent-derivative-led insolvency would would leave bank deposit liabilities untouched.

      Delete
    3. This is very muddled. There is nothing to stop people keeping savings in the form of 100% guaranteed Treasury debt if they so choose. They are not compelled to keep savings in banks in excess of the guarantee limit, and if they choose to do so they are indeed putting their savings at risk. But it is their choice.

      You seem to think that there used to be an unlimited Treasury guarantee for bank deposits which has somehow been revoked. There never has been.

      Reserves in banks are needed to settle payments - ie to support flows, not stocks. Of course they are 100% guaranteed. If they were not, the payment system would be unstable, and that is the lifeblood of the economy.

      Delete
  5. We need public investment not just as a reflationary mechanism - and if not needed for that now it might soon be again - but also to fill gaps left by the private sector: housing, infrastructure, environment, skills, etc. The PQE debate has focused too much on funding and not enough on the investment itself, which will be needed in good times as well as bad.

    ReplyDelete
    Replies
    1. Totally agree, Lyn. I really would rather we did not mix up a cyclical demand stimulus mechanism with a long-term fiscal investment programme. They serve entirely different purposes.

      Delete
  6. "All people that on QE do dwell", perhaps it is a matter of faith more than anything hell. Going down?

    ReplyDelete
  7. "All people that on QE do dwell", perhaps it is a matter of faith more than anything hell. Going down?

    ReplyDelete

Post a Comment

Popular posts from this blog

Game theory in Brexitland

Calculus for journalists

Crypto-tulips