One of the things that bugs me about the explanations for Quantitative easing (QE) is that the narrative focuses near exclusively on the sellers of the assets. For example the Bank of England Quantitative Easing Explained Pamphlet states:Direct injections of money into the economy, primarily by buying gilts, can have a number of effects. The sellers of the assets have more money so may go out and spend it. That will help to boost growth. Or they may buy other assets instead, such as shares or company bonds.Yet this misses the obvious point. Assuming that the transactions were conducted in an open fashion, these sellers would have sold anyway. They were already predisposed to sell and would have done so regardless of the QE process. The timing may have been different but the transaction would have happened. So there is no alteration in sellers' behaviour. They were going to sell and buy something else, and that is precisely what they did.
With QE, and more broadly with any sort of government spending, it seems to me that it is not the people who receive the money directly that we should be focussing on. Instead we should be looking for the people who were outbid by the public intervention and discover what they did instead.
It is the legions of the outbid that have to change their initial decisions. What they do next determine what effect the policy has. Focus on the outbid buyers and a slightly different mental picture forms.
Therefore with QE these were people who had decided to save in aggregate and wanted the security of a government asset, but at a slightly higher yield than that on offer. I'm not sure that those people looking to buy that sort of asset would then suddenly switch to corporate bonds or shares. Nor do I see them throwing a bunk and going off and buying a yacht instead.
Similarly with other changes to government intervention. When purchases are cut who in the private sector do they supply instead and at what price? And that may be the same as the unemployed - ie nobody at any price.
So let's start looking at this horse from the right end. Let's focus on the buyers and their substitution behaviours.
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I don’t see why “these sellers would have sold anyway”. When a new buyer enters a market, for apples or anything else, the additional apples sold are apples which would NOT have been sold anyway, seems to me.
I agree that those who sell are already “predisposed to sell” in the sense that they are on the verge of selling. But absent the new buyer, i.e. government, they would not actually have sold.
They may not have sold on that day, but they would have sold when the right buyer entered the market.
Therefore their behaviour has not changed, perhaps just the timing.
Therefore focussing on what the seller did afterwards is a mistake. They would have done that anyway eventually.
Particularly with gilts the buyer is literally denied access to that product in aggregate. There will always be a shortfall of gilts. The buyers that would have gone to gilts have to go to something else.
And that's the point. By shifting your viewpoint from what the sellers did, which hasn't changed, to what the buyers did, which has to have changed as a matter of construction, you get a different idea of what happens.
In other words it is not the amount of apples sold in a day or who to that matters, nor even the price in a sense.
It is the effect that an artificial shortage of apples has on people who are natural apple buyers that matters.
Neil, I still don’t get it.
Suppose that in the aggregate the private sector has its preferred assortment of assets (which at the moment includes more liquid stuff than usual). I agree that even if the government does not do QE, some INDIVIDUAL gilt holders who are predisposed to sell will actually sell “when the right buyer enters the market”. But that is only because the preferences of INDIVIDUAL asset holder are constantly shifting.
Put another way, gilt holders who are predisposed to sell will eventually sell because they will eventually find someone with spare cash who is predisposed to buy.
But the important question is what is happening in the aggregate. And this is that the private sector is trying to get and/or keep an assortment of assets which is more weighted towards the liquid end of the scale than usual. I.e. we have a recession caused by Keynes’s paradox of thrift. David Beckworth has produced evidence that this is actually happening. See:
http://macromarketmusings.blogspot.com/2011/08/other-side-of-households-balance-sheets.html
In this scenario it’s a good idea for some buyer with oodles of cash to enter the market and raise aggregate demand for gilts. That will result in some gilt holders selling who would NOT have sold anyway.
Ralph,
You are still looking at it from the sellers point of view in aggregate.
Try looking at it from the outbid buyers point of view in aggregate.
That's what I'm suggesting.
At least £200bn of natural gilt buyers have been outbid by brand new introduced money.
Those gilts have been removed from the system completely. There are no longer enough gilts for everybody with spare reserves to have them.
So what did those buyers do instead in aggregate?
Unless you are suggesting that things have got so bad that people would rather have a 0.5% interest liability than a 2.5% interest one or that the GEMM market isn't liquid.
And the evidence counters that view, because bank reserves at the BoE continue to go down. Those who ended up with bank reserves want the higher interest of gilts.
If the DMO auctioned £100bn of gilts tomorrow they'd have buyers - as long as the rate was right.
Neil - very interesting post. It certainly seems wrong to ignore the buyers. But I do share Ralph's difficulty with your interpretation: if it's incorrect to focus exclusively on the sellers, as commentators typically do, why should it be correct to focus exclusively on the buyers?
Put it another way: if focusing on the sellers incorrectly assumes a 'static' counterfactual where the sellers would hold their bonds long term, why is a 'dynamic' counterfactual, that the sellers were definitely going to sell in the short term anyway, correct?
It seems that rsj manages to rise above a focus on buyers or on sellers by treating all participants as potential buyers or sellers of bonds and focusing on elasticity of net supply.
http://windyanabasis.wordpress.com/2011/06/16/pushing-on-a-string-supply-demand-version/#more-557
The environment the neo-classicals are talking about is the fear of bond yields rising. That is why they are 'QE'ing in the first place.
That only happens if there are more sellers than buyers.
Neither am I suggesting that you focus exclusively on buyers, more that focussing exclusively on what the sellers do next is incorrect. What the outbid buyers do next is important.
I see rsj's point (active links here and here) as supporting what I'm saying. The focus on the sellers is incorrect.
And what the outbid buyers do next is not to spend the money, but to buy a product from the financial sector - probably a savings account or some other such private sector device.
So essentially they replace the government bond with a financial sector bond - which is what rsj neatly describes in his posts.
(Although in the case of the UK very few households hold bonds. UK QE was about trying to force foreigners to hold more cash).
Actually Neil when you say "UK QE was about trying to force foreigners to hold more cash", I'm struggling to tie this to the data.
Looking at the total increase in gilts between 4Q08 and 1Q10 of £262bn, MFIs (incl BoE) increased by £238bn (I guess £200bn at BoE, £38bn at private banks), Insurance/Pensions increased by £39bn and RoW increased by £52bn. The decreases were at non-monetary financial institutions (£65bn) and households (£3bn).
The sellers here seem to have been non-monetary financial institutions. Based on rsj's interesting framework, one would expect the sellers to have been those with the highest elasticity of net supply - which are those with leverage. I would have expected this to be banks, not non-monetary financial institutions. Interesting result.
I didn't say they'd succeeded :)
The BoE bought gilts from the insurance companies, etc as a policy who probably then just bought other gilts from the other financial institutions when the dust had settled.
MFIs tend to hold gilts so they can do reverse repos with the central bank. It's liquidity management.
They only started to hold gilts in quantity when the excess reserves showed up. And they can only do that because the DMO is over-issuing gilts to pay the interest on the Gilts held in the Asset Purchase Facilty.
That cash pile is about £20bn at the moment - all paid for by QE reversing itself.
Neil - that sounds fine, except it does challenge the 'elasticity of net supply'-based rationale for money endogeneity which rsj fleshed out at his site.
So I feel a bit adrift, unclear as to what the knock-down argument is to the Congdons and Peppers of this world, when they maintain that under-funding could lead to persistent (as opposed to fleeting) excess deposits in the non-bank sector which would then prompt asset price, and then consumer price, inflation.
Separately, you have focused on the movements of BoE reserves over time. I would have expected these to remain fairly constant pre- and post-QE, with only minor movements for timing differences of the gilt issuance to sterilise budget deficits. However, the BL38 series in FinStats has been fairly unstable - its December value was £20bn in 2006, £25bn in 2007 and £37bn in 2008. Have you written anything commenting on this?
Not yet. I'm waiting for the Bank of England to answer my Freedom of Information request regarding the cash account in the Asset Purchase Facility.
That's the missing part of the jigsaw puzzle.
Which they've just turned down.
Apparently money owed/paid to HM Treasury falls under 'monetary policy'.
Neil that's pretty irritating of them. Sounds similar to HMT whom I was quizzing on the full funding / Consolidated Fund stuff; they say all the banking is commercially sensitive so won't go into the details of how bank accounts are credited during spending. Bizarre.
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