Simple Answer To Simple Question Please - What Is Qe?

[lets get it right]

Sorry, I've asked this before and been pointed to links on the BOE web site etc. - which I have read.

Still don't get it.

I know what government bonds are.

The government issues bonds which people buy in return for a promise of X% interest every year until the bond matures - at which point people get their money back. I understand that bonds are tradeable and that a bond bought for £100 might fluctuate up and down in price. If the price of the bond goes up the yield goes down, and vice versa.

I read that QE is the BOE using 'money' to buy bonds.

So, anyone able to provide a simple explanation of how QE is supposed to work? How it affects banks? How it affects us? Where the money comes from? Is it borrowed? Does it have to be paid back? Why don't we do it all the time if it's that easy? etc.

[Realistbear]

QE: The creation of wealth without effort.

Its been going on for decades, if not centuries and judgement day finally arrived in 2007 when the structural collapse got underway.

Edited September 24, 2010 by Realistbear

[<º))))><.·´¯`·.]

http://pragcap.com/quantitative-easing-the-greatest-monetary-non-event

[jonb]

Sorry, I've asked this before and been pointed to links on the BOE web site etc. - which I have read.

Still don't get it.

I know what government bonds are.

The government issues bonds which people buy in return for a promise of X% interest every year until the bond matures - at which point people get their money back. I understand that bonds are tradeable and that a bond bought for £100 might fluctuate up and down in price. If the price of the bond goes up the yield goes down, and vice versa.

I read that QE is the BOE using 'money' to buy bonds.

So, anyone able to provide a simple explanation of how QE is supposed to work? How it affects banks? How it affects us? Where the money comes from? Is it borrowed? Does it have to be paid back? Why don't we do it all the time if it's that easy? etc.

They print money, and use it to buy back government bonds. Bank notes appear on the Bank of England's balance sheet as a liability called notes in circulation.

[leicestersq]

Sorry, I've asked this before and been pointed to links on the BOE web site etc. - which I have read.

Still don't get it.

I know what government bonds are.

The government issues bonds which people buy in return for a promise of X% interest every year until the bond matures - at which point people get their money back. I understand that bonds are tradeable and that a bond bought for £100 might fluctuate up and down in price. If the price of the bond goes up the yield goes down, and vice versa.

I read that QE is the BOE using 'money' to buy bonds.

So, anyone able to provide a simple explanation of how QE is supposed to work? How it affects banks? How it affects us? Where the money comes from? Is it borrowed? Does it have to be paid back? Why don't we do it all the time if it's that easy? etc.

A lot of people dont know what QE is, but few will admit to it.

QE is the electronic or paper printing of money. That money is used by buy Government bonds, or in the US, any old rubbish that Goldman Sachs wants to get rid. The idea is that it will cause the price of bonds to be bid up, reducing interest rates, inducing more people to invest in productive capacity.

What the effect of all this will be though, is somewhat uncertain. Some say hyperinflation, some say it cannot stop the power of deflation, some say it will return us to a growth utopia.

FWIW, I think that if you want to grow the base money supply, the best way of doing it is to finance a portion of government expenditure with newly minted money, no debt.

A bit of real inflation will certainly ease the debt burden. But you dont want to ease it completely. It is important those who have made bad loans and taken on too much credit, feel the consequences of their bad decisions. At the same time, you dont want to punish those whose decisions would have been good in normal circumstances, but were caught up in the deflationary spiral of the economy.

In other words, QE yes, but dont buy bonds and bail the banks out.

[goldbug9999]

As I understand it the money is created by merv typing in a massive number into a field in a computer screen which then appears as "cash" in the BOEs account, then probably goes and "cracks one off" in the toilet thinking of all those billions hes just created. Said money is then used to buy bonds.

In theory those bonds should at some point in the future be sold again and the receipt from the sale destroyed thus no money "printing" actually occurred - it was some sort of virtual loan or a loan from god, or something. 'll leave it as a exercise to the reader to determine the odds of any of those bonds even being sold. It does raise an interesting question about what they do with the maturing ones though.

And to answer the question about what is it suppose to achieve ...

Forget all the b*llsh*t about benefiting the economy, QE is a form of stealth taxation on people with cash reserves: by increasing the proportion of cash in circulation that they "own" the gov/BOA increase their wealth at the expense of everyone else holding cash.

Edited September 24, 2010 by goldbug9999

[Alan B'Stard MP]

They print money, and use it to buy back government bonds. Bank notes appear on the Bank of England's balance sheet as a liability called notes in circulation.

Reserve balances

[DabHand]

Not sure what RB is saying there. No wealth is created just a fractional theft of existing "wealth" if stored in confetti form.

BOE prints the money and buys the treasuries/bonds from the government. Thus the govt doesnt have to risk going to the open market and having to offer higher interest rates to fund its excessive spending.

The supposed benefit of QE to anyone who isn't a drooling Whitehall spend spend spendocrat is as follows:

To increased govt borrowing means an increase in demand which would effectively crowd out other non-government borrowing unless they in turn offered a distinctly higher rate of interest to secure at least some of the available monies. To the man in the street it would mean these increased borrowing costs would be passed on and manifest in higher private and corporate borrowing costs/interest rates. e.g. You mortgage is probably the key one.

By the BOE printing they artificially increase supply and generally depress not only their own borrowing costs, but by not competing with other borrowers, they reduce the cost of borrowing for all secotrs indirectly.

The small flaw in this plan is that if lenders see increasing inflation or feel that the QE is excessive (it is after all printing by another name) they may demand a higher interest rate regardless as they lose faith in the future value of the confetti. This is a slippery slope because the govt will then declare that it must continue to print more and more to continue operating in the face of what would otherwise be crippling interest payments, until everyone stops using the confetti as any store of value and spend it as soon as they get it. Velocity explodes we get hyperinflation.

[Alan B'Stard MP]

That money created goes into Bank's reserves in an account held by the BoE at the commercial banks.

[Traktion]

So, anyone able to provide a simple explanation of how QE is supposed to work? How it affects banks? How it affects us? Where the money comes from? Is it borrowed? Does it have to be paid back? Why don't we do it all the time if it's that easy? etc.

QE is the BoE printing money to buy government bonds from existing holders (ie. not newly issued bonds). This money comes from nowhere, but the bonds are supposed to be sold back to private hands again at some point in the future - many have expressed doubt that they will. There is no set time scale for the BoE selling these bonds.

We could do it all the time, but as it adds base money into the system, it would be very inflationary to keep doing so. When the government borrows money from the private sector, to spend in the public sector, no new money is created - it's just transferred, with interest paid back to the private sector (bond holders - such as pension funds, private investors, foreign investors etc). QE, on the other hand, creates additional money and pumps it into the economy. If investors decide that they don't want to hold money which is being created from thin air, they may stop buying bonds, weakening Sterling and forcing more printing or cuts - neither is good.

QE could effect the banks, because the government can borrow more than a saturated market could deliver. This money could then, in turn, be used to recapitalise (buy shares in) the banks. It also means the government can spend more on stimulus, pet projects, wars etc, while slowing the need to bring down the deficit spending as quickly. It also means that they are diluting the base money supply, so those pounds will be worth less in time (with the initial spenders getting most - pre inflation - value from).

There were/are other schemes which the BoE was/is running though, such as the special liquidity scheme. Here, the BoE was swapping various paper for cash too, including various dubiously valued toxic assets. This has the effect of bailing the banks out and leaving the BoE holding the baby - or more precisely, an inflated money supply, as the assets weren't worth what they were paid for.

[Traktion]

BTW, Scepticus wrote up a good article here: http://knol.google.com/k/mechanics-of-fiat-money-and-credit#

It covers what QE is and details how the monetary system works nicely.

[lets get it right]

A lot of people dont know what QE is, but few will admit to it.

QE is the electronic or paper printing of money. That money is used by buy Government bonds, or in the US, any old rubbish that Goldman Sachs wants to get rid. The idea is that it will cause the price of bonds to be bid up, reducing interest rates, inducing more people to invest in productive capacity.

What the effect of all this will be though, is somewhat uncertain. Some say hyperinflation, some say it cannot stop the power of deflation, some say it will return us to a growth utopia.

FWIW, I think that if you want to grow the base money supply, the best way of doing it is to finance a portion of government expenditure with newly minted money, no debt.

A bit of real inflation will certainly ease the debt burden. But you dont want to ease it completely. It is important those who have made bad loans and taken on too much credit, feel the consequences of their bad decisions. At the same time, you dont want to punish those whose decisions would have been good in normal circumstances, but were caught up in the deflationary spiral of the economy.

In other words, QE yes, but dont buy bonds and bail the banks out.

Thank you for your reply.

So, please bear with me while I try to absorb this, out loud, as it were.

The BOE creates money (electronically or by printing) and uses it to buy Government debt.

So, the government needs to finance its spending plans by borrowing money, so the BOE 'creates' the money and lends it to the government by buying its bonds.

Am I right in thinking they are not buying new issues? (Seem to remember reading that somewhere) If this is true, I guess their action is putting a floor under bond prices? Putting a floor under bond prices prevents the yield from rising and, therefore, exerts effectively a downward pressure on interest rates by ensuring the price of bonds does not fall so low that the yield goes up to 5% or more? Is this all correct?

So, when you say the idea is to encourage people to invest in productive capacity - are you saying the idea is .... 'Look, bond yields are low (because the BOE is buying them with invented money) so you might as well invest in business rather than buying bonds'? Is that it?

If that worked to the nth degree, why would anyone buy new bond issues?

If the idea is that, one day, the BOE sells the bonds back into the market and thereby cancels out the money it created to buy them in the first place, what happens if the bond matures before the BOE sells them? The government has to give the BOE £100 for a bond which the BOE bought with money it created.

I guess this must make sense to someone, just wish I 'got it'.

[lets get it right]

BTW, Scepticus wrote up a good article here: http://knol.google.c...ney-and-credit#

It covers what QE is and details how the monetary system works nicely.

Thanks for the link. I've read his stuff before and have to admit a lot of it goes over my head. Which is why I was hoping someone had the gift for explaining this stuff in terms a simpleton like me would understand.

So far I've got that the BOE create money to buy government bonds which puts a floor under bond prices and keeps the yields down, encouraging people to invest in business rather than government bonds.

Not sure if that is right, but I can at least understand it!

What I don't get is how this affects the retail (mortgage) banks and the housing market in general.

[lets get it right]

QE is the BoE printing money to buy government bonds from existing holders (ie. not newly issued bonds). This money comes from nowhere, but the bonds are supposed to be sold back to private hands again at some point in the future - many have expressed doubt that they will. There is no set time scale for the BoE selling these bonds.

We could do it all the time, but as it adds base money into the system, it would be very inflationary to keep doing so. When the government borrows money from the private sector, to spend in the public sector, no new money is created - it's just transferred, with interest paid back to the private sector (bond holders - such as pension funds, private investors, foreign investors etc). QE, on the other hand, creates additional money and pumps it into the economy. If investors decide that they don't want to hold money which is being created from thin air, they may stop buying bonds, weakening Sterling and forcing more printing or cuts - neither is good.

QE could effect the banks, because the government can borrow more than a saturated market could deliver. This money could then, in turn, be used to recapitalise (buy shares in) the banks. It also means the government can spend more on stimulus, pet projects, wars etc, while slowing the need to bring down the deficit spending as quickly. It also means that they are diluting the base money supply, so those pounds will be worth less in time (with the initial spenders getting most - pre inflation - value from).

There were/are other schemes which the BoE was/is running though, such as the special liquidity scheme. Here, the BoE was swapping various paper for cash too, including various dubiously valued toxic assets. This has the effect of bailing the banks out and leaving the BoE holding the baby - or more precisely, an inflated money supply, as the assets weren't worth what they were paid for.

Thanks for that.

What is 'base money'?

And ... "QE could effect the banks, because the government can borrow more than a saturated market could deliver." ... could you explain that differently please?

[Nationalist]

Money created using QE is NOT given directly to the government!

It is used to buy bonds on the "secondary market", ie, from commercial banks.

The publicly-admitted intended effect is to convert banks' bond piles into cash piles which the banks can then lend to firms and people who will spend the cash one way or another into the economy and thus "stimulate" it.

QE was intended to offset the risk of DELFATION, by causing some counter-acting INFLATION.

There was a nice side-effect to QE. Last year the government needed to borrow £200bn from Joe Public (£160bn to fund its budget deficit; £40bn to roll-over existing debt) which they did by selling bonds.

The banks may have been a bit leery of lending the government so much money were it not for the fact that the government was immediately buying back the bonds using QE money, which by sheer coincidence also amounted to £200bn over the year.

Possibly without QE the government would have had to stop spending, and in an election year of all things! Certainly the borrowing would have been more expensive.

Of course QE is inflationary. It's supposed to be. And not surprisingly the inflation numbers have refused to drop down to the target of 2 percent.

Edited September 24, 2010 by Nationalist

[lets get it right]

Money created using QE is NOT given directly to the government!

It is used to buy bonds on the "secondary market", ie, from commercial banks.

The publicly-admitted intended effect is to convert banks' bond piles into cash piles which the banks can then lend to firms and people who will spend the cash one way or another into the economy and thus "stimulate" it.

If banks don't want to lend (and they certainly don't appear to want to lend) why would a bank convert its 'bond pile' into cash? Cash will sit there doing nothing (if they don't lend it out) whereas at least the bonds earn some interest. Either way, cash or bonds to hand, presumably their 'capital ratio' is not affected as government debt is regarded as being as good as cash (isn't it?)

[Toto deVeer]

Money created using QE is NOT given directly to the government!

It is used to buy bonds on the "secondary market", ie, from commercial banks.

The publicly-admitted intended effect is to convert banks' bond piles into cash piles which the banks can then lend to firms and people who will spend the cash one way or another into the economy and thus "stimulate" it.

QE was intended to offset the risk of DELFATION, by causing some counter-acting INFLATION.

There was a nice side-effect to QE. Last year the government needed to borrow £200bn from Joe Public (£160bn to fund its budget deficit; £40bn to roll-over existing debt) which they did by selling bonds.

The banks may have been a bit leery of lending the government so much money were it not for the fact that the government was immediately buying back the bonds using QE money, which by sheer coincidence also amounted to £200bn over the year.

Possibly without QE the government would have had to stop spending, and in an election year of all things! Certainly the borrowing would have been more expensive.

Of course QE is inflationary. It's supposed to be. And not surprisingly the inflation numbers have refused to drop down to the target of 2 percent.

Wasn't the real point of all this to unblock interbank lending and reduce LIBOR? I seem to recall that interbank lending completely seized up (precipitating the run on Northern Rock). But it has morphed into a ZIRP trap now, no?

[Traktion]

Thanks for that.

What is 'base money'?

To crib from Scepticus:

Unfunded Government Spending Creates Base Money

Base Money (M0) is created when the government spends money which is not funded by taxation or issuing bonds - i.e. it is printing money. This is the only way in which base money can be created - via a process of having the central bank buy bonds via open market operations, or in exceptional circumstances merely by crediting private sector bank accounts without seeking funding first.

Base money is used for only two purposes - as paper cash, and as bank reserves held by commercial banks and kept on deposit at the central bank. Between 1987 and 2007 the US government created around 500 billion dollars of new base money.

In the good (or bad, depending on perspective! ) old days, base money would have been gold - base money is the 'stuff' which the promises in the private sector (bank credit) are made against.

Scepticus goes on to say that money printing could be considered as just changing the 'make up of government securities' (ie. changing the interest rates of short term and long term debt to suit conditions), but this seems more like describing the intended side effects to me - by printing, you're diluting existing government bond promises.

From another perspective, if base money was still gold, you would have to dig a load more up to achieve the same effect, which would clearly be inflationary in the medium/long term (as the value of the promises - bank credit - will change in time to reflect this).

And ... "QE could effect the banks, because the government can borrow more than a saturated market could deliver." ... could you explain that differently please?

I should probably have added 'at a desired price' - ie. a saturated market could deliver the borrowing, but not at an interest rate which would be appealing. DabHand explained this bit better than me, tbh!

EDIT: added a bit

Edited September 24, 2010 by Traktion

[Alan B'Stard MP]

What is 'base money'?

Base money would be central bank issued liabilities and recorded on their balance sheet. It forms the basis of legal tender. It never leaves the central bank except as paper.

[Traktion]

Thanks for the link. I've read his stuff before and have to admit a lot of it goes over my head. Which is why I was hoping someone had the gift for explaining this stuff in terms a simpleton like me would understand.

So far I've got that the BOE create money to buy government bonds which puts a floor under bond prices and keeps the yields down, encouraging people to invest in business rather than government bonds.

Not sure if that is right, but I can at least understand it!

What I don't get is how this affects the retail (mortgage) banks and the housing market in general.

That sounds about right, except that the BoE only buys from existing holders, not directly from the government. This seems like a minor difference, IMO though as those who sold their bonds to the BoE, could buy some more from the government again - rinse and repeat.

It helps the banks survive, thus propping up the prices of assets. If they had to liquidate/auction the bank assets (loans, mortgages etc) off, then the price would likely be lower than they had them valued on their books (especially when many consider they are valued too high now).

Additionally, (IIRC) it helps tracker/variable type mortgages, as the banks can borrow short term from the BoE at near the base rate, to fund their mortgages. Keeping the rates low on these mortgages, helps keep people from defaulting, thus forcing more bank losses (and more printing and/or bank failures, falling asset prices etc).

EDIT: Could someone clarify the last paragraph? I may have got that one mixed up!

Edited September 24, 2010 by Traktion

[Traktion]

If banks don't want to lend (and they certainly don't appear to want to lend) why would a bank convert its 'bond pile' into cash? Cash will sit there doing nothing (if they don't lend it out) whereas at least the bonds earn some interest. Either way, cash or bonds to hand, presumably their 'capital ratio' is not affected as government debt is regarded as being as good as cash (isn't it?)

The banks receive interest on their cash deposits (at the BoE) too, at/near the base rate. Apparently, this needs to be similar to the base rate to keep the money markets functioning 'normally'. But yes, the risk level is the same - cash is basically a government bond without a maturity date, so they are very similar risk wise.

Additionally, if that newly printed money goes to the hands of the government (EDIT: by the previous bond holders, who sold to the BoE, buying more freshly issued bonds with their printed money), they can recapitalise the banks through share purchases (which will effect their capital ratio). They did this during 2007/2008, of course.

Edited September 24, 2010 by Traktion

[Flat Bear]

Sorry, I've asked this before and been pointed to links on the BOE web site etc. - which I have read.

Still don't get it.

I know what government bonds are.

The government issues bonds which people buy in return for a promise of X% interest every year until the bond matures - at which point people get their money back. I understand that bonds are tradeable and that a bond bought for £100 might fluctuate up and down in price. If the price of the bond goes up the yield goes down, and vice versa.

I read that QE is the BOE using 'money' to buy bonds.

So, anyone able to provide a simple explanation of how QE is supposed to work? How it affects banks? How it affects us? Where the money comes from? Is it borrowed? Does it have to be paid back? Why don't we do it all the time if it's that easy? etc.

I too would like an answer. As you know you won't get one as QE or more accurately making up money by offsetting future imaginary assets to convert to cash is a surreal concept.

The best answer has been from you IMHO with a few good technical reasoning from a poster or two.

It really is as stupid as you think.

[nixy]

Thanks for the link. I've read his stuff before and have to admit a lot of it goes over my head. Which is why I was hoping someone had the gift for explaining this stuff in terms a simpleton like me would understand.

So far I've got that the BOE create money to buy government bonds which puts a floor under bond prices and keeps the yields down, encouraging people to invest in business rather than government bonds.

Not sure if that is right, but I can at least understand it!

What I don't get is how this affects the retail (mortgage) banks and the housing market in general.

Thanks for asking the question again.

I'll have a go.

The BOE (the government) buys its own debt. This means only a few have access to government funds (created funds that is).

IN short, what this means, is if you are standing in a queue to purchase a good or service ..(or a house)..., and the bloke in front of you has newly printed money, chances are you will have to pay more. .............and here's the important bit......... The amount you lose (the extra you have to pay) if theft, just as it would be if he had reached into your pocket and taken it.

??

[lets get it right]

I'd like to thank you all for your answers. Althought this place can get a bit tiresome sort of arguing the toss all the time, it's very handy being able to access people who have a lot of knowledge of how finance/banks/the world works.

[Nationalist]

If banks don't want to lend (and they certainly don't appear to want to lend) why would a bank convert its 'bond pile' into cash? Cash will sit there doing nothing (if they don't lend it out) whereas at least the bonds earn some interest. Either way, cash or bonds to hand, presumably their 'capital ratio' is not affected as government debt is regarded as being as good as cash (isn't it?)

It's all marginal. But government bonds are likely to be paying 2-4% whereas cash can be lent for more than that, even if it's just overnight on the interbank market.