Stop right there! Hold it. Go back a bit… did you see that? Exactly at the moment when the QE operation happened, the bank balance went up. The money came from nowhere! QE is a form of money creation!!
Okay, so what is QE – Quantitative Easing?
Put simply, Quantitative Easing is when the Bank of England buys bonds. Most of the bonds purchased with QE are government bonds, but a small percentage – around 3% – are corporate bonds. I am only talking here about the government bonds component – the Gilts. The purchase of the Gilt by the Government results in the seller receiving money in their bank account. The money is placed there by the Bank of England.
Is this money creation?
As far as I can tell, the answer is approximately: yes, no, sort of, maybe, depends. Most of all it depends on your point of view.
We are going to tackle this question, but first a quick explanation of what a Gilt is.
Gilts and government accounting
A Gilt is a bond issued by the Government in the UK, and a bond is a fixed income investment. The Government sells Gilts at a face value of £100, with a fixed term/duration and fixed interest rate. The payment of interest is called the coupon and the Gilt is issued with set intervals of coupon payments, typically twice per year. At the end of the term the purchaser receives their principal back.
Functionally, a bond is very similar – but not identical – to a term deposit. Accounting wise, the savings balances held by banks are a liability to the bank, and so too are the term deposit balances a liability. The same is true for the Government accounting – central bank reserves are a liability of the National Loans Fund and Gilts are a liability of the Bank of England.
https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/221560/whole_of_government_accounts_31-03-2011.pdf – pp.65
Choose your own adventure
What you believe from here is up to you. The topic is contentious and there are different points of view.
Is a Gilt a form of money? Gilts are purchased by money. Like money, they are a liability to the issuer. Gilts are quite similar to the balance of money in a term deposit account at a bank. You could however argue that Gilts are not exactly money. For me, the clincher is in the accounting. Both money (central bank reserves) and Gilts are a liability to the government. Therefore, when the government repurchases a Gilt it is not creating new money, it is merely exchanging one form of money for another.
Is the Bank of England a part of government? We hear a lot about the independence of the Bank of England, but in reality it is a wholly owned part of government and the “independent” operations of the BOE are tightly constrained by rules set by Government. To say the BOE is independent is like saying the board of directors of a company is independent of the shareholders. Yes, the Board makes decisions without consulting the shareholders, but at the end of the day the rules are set by the shareholders (laid out in the constitution/rules) and the board is accountable to the shareholders. The Bank of England is not independent and anyway this isn’t the real question – the Bank of England is definitely a part of Government. Therefore, the accounting matters. Regardless of if you think Gilts are a form of money or not, they are definitely a financial liability to Government. Quantitative Easing from the perspective of the Government is merely a liability swap. From the perspective of the non-Government sector it is an asset swap.
Does the time window for analysis matter? Even if you don’t believe Gilts are money and even if you believe the Bank of England is not part of government, there remains an important question – what is our time window for analysis? See, Quantitative Easing is usually interrogated as a standalone operation, without considering what happened before the Gilt was repurchased by the Bank of England, or what might happen later. The fact is that Gilts are issued by the National Loans Fund and paid for with money provided to the Bank of England. From the perspective of the purchaser of the Gilt this is an asset swap. Quantiative easing is a reverse of the asset swap operation. Looking at just the second half of the overall operation – stopping and pausing right there – misses the bigger picture. Where do Gilts go when the Government repurchases them? Well, from what I can tell they are held by the Bank of England. The Bank recently announced they would be reselling some of the stock of Gilts it holds – this will take place across the month of November 2022. If you believe QE is money creation, then surely the reverse operation is money destruction. Well, nobody thinks that as far as I can tell.
Quantitative Easing is simply the repurchase of Gilts by the Government. Like central bank reserves, Gilts are a liability to the issuer. The Bank of England is not independent – it is wholly owned and controlled by the Government. The repurchase of Gilts is part of a broader set of operations – the Government issued the Gilts earlier and might resell them later.
Quantitative Easing is simply an asset swap for the non-government sector. It takes away a less liquid financial asset (a Gilt) and replaces it with a more liquid asset (increase in bank balances). No money was created to do this, unless you believe one or more of the following
- the purchase of the Gilt in first place is not relevant,
- Gilts are not money,
- the Bank of England is not part of Government.
You might have guessed, I don’t believe any of these things.