Sunday, 18 September 2011

Focus on the Buyers

Bank of EnglandOne 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.