QE & inflation/deflation

lemonjelly

Query for a few of those in the know if you don't mind...

Please forgive a combination of ignorance, and some very poor descriptions...

I've been reading posts about the impact of QE, withdrawing it, inflation, deflation etc for a while now.

Now, I am aware the BoE has printed an extra £lots. This money is now (in theory) circulating in our economic system, in the hope that everyone feels a bit richer and then goes off spending and investing and speculating. The hope is that this will improve the economy, a form of kick-start/CPD (depending on perspective).

I hadn't really thought about what happens to this extra cash much

However, Generali has posted a couple of times about it being burnt. Is that really what happens?:eek:

How does the BoE go about taking the money out of the system? & how does it decide whether to take all of it out? & Lastly, how will this affect the economy, the high street, & me paypacket?

inspector_monkfish

it'll be a bit like this - only on a much grander scale...

http://en.wikipedia.org/wiki/K_Foundation_Burn_a_Million_Quid

tomterm8

The first question is quite easy, the government changes numbers on a computer. In essence, what is happening with QE is that the government is buying its own bonds, with money it creates out of thin air. To drain money out of the economy, it sells bonds, and destroys the money it recieves from the sale.

The second question... the government is trying to keep base money stable, so when it starts increasing faster than the economy, and so causes inflatiom above target, the government needs to take cash out of the system.

How will it affect you? Basically, as the government puts money into the system, there is inflation, and as it takes money out of the system, there is deflation. In an ideal world, the BoE would be able to predict exactly how much money to put in/take out, so the result is a steady rate of inflation. And so, you wouldn't notice much effect. In practice, the models are crap, and it doesn't work that way.

The other side of the story is that as money is drained out of the system, the government has to rely on other people to fund it. Over the last year or so, most of the budget deficit has been funded by printing money. This won't continue during QT, and so interest rates will rise, and the economy could suffer as a result.

zygurat789

As I understand it, it wasn't a case of actually printing notes but adding a few 000s to the balances held by certain financial establishments (mainly clearing banks?) with BoE. It effectively amounts to printing electronic money.
So nothing to burn. No waste and no CO2 Very green

princeofpounds

Hey there, the money isn't necessarily circulating (what we call the velocity of money). That's a slightly different issue to it being created - it's perfectly capable of sitting in an account somewhere.

Obviously the BoE hopes that it will circulate!

In practice what is happening to the QE money specifically is that it is being used to buy debt that the government issues. The BoE is printing money and handing it to the government in return for a promise that it will be paid back with interest. The trick is that the BoE doesn't have to demand commercial market rates as it can print money and so make it much cheaper for the government to borrow.

The government likes to have the money now so it can spend more and cushion the economy against the recession. But it will pay a price in the future as more money will have to go to paying down this debt so future government spending will be more restricted.

Now this isn't free money. Although it can make it cheaper for the government to borrow in the short term, printing too much money can lead to a host of problems including inflation. More money swilling around chasing the same amount of materials goods means that each unit of money is actually worth less and prices have to rise. There are lots of reasons why high inflation is bad but I won't go into that now.

One other distinction to make is that QE is not quite the same as *just* printing money. That's because although the BoE is putting cash into the government's hands (or people who have bought government debt and want to sell it in the secondary market) it is taking that promise of repayment in return. If the bank likes, it can absolve the government of that promise and then it literally would have printed money. This process is called monetisation of government debt.

Now QE is just one way of 'loosening' monetary policy (which broadly means increasing the supply of money). There are other techniques like low interest rates that achieve similar effects but through different mechanisms.

There is of course an analogous method of tightening policy. What the bank would do here is sell some of its government debt and receive cash in return. It will then cancel that cash; the reverse of printing it and buying stuff. This is the 'burning' you have heard about, although of course no fires are involved!

princeofpounds

Sorry, i realised I only answered part 1 of your question.

How do they decide to do this? The bank is targeting a particular range of inflation rates (because most economists agree that low but positive inflation is the best situation for an economy). They aren't targeting inflation today, but their estimate of what it will be some months down the line. This is because it takes time for the economy to adjust to changes the BoE makes (usually ~9 months).

The models they have to do this are many and varied. Like most economics models they involve a lot of uncertainties and are not always right - in this respect they are very similar to weather forecasting. The final decision then is one of judgement as much as anything scientific.

So the whole thing is one big balancing act, but one where you are piloting a supertanker, the steering is delayed and the radar fuzzy!

HAMISH_MCTAVISH

A lot of answers so far, very little in the way of facts though....:rolleyes:

Quantititive Easing is nothing more or less than adjusting liquidity within the economy to target inflation.

The BoE normally uses interest rates to adjust liquidity, but with rates at close to zero, and a significant lack of liquidity due to the "credit crunch", an increase in liquidity was achieved by creating money out of thin air, and using it to buy back financial assets (primarily gilts) from the market (banks, pension funds, etc) in return for cash. This money is then lent out into the wider economy, increasing liquidity.

It is important to note that the government did not buy it's own newly issued debt with this newly created money. It would be illegal to do so, as monetising debt is prohibited under international treaty.

There is slightly more credibility to the claim that by buying stocks of existing gilts from the market, the government freed up funds for those institutions to buy more gilts, however a baseline of gilts purchases would have been expected anyway, as financial institutions are mandated by law to hold a certain percentage of assets in AAA rated instruments.

Regardless, it is also clear that QE has in fact resulted in an increase in liquidity and lending within the economy, and that to some extent, the programme has been working.

The next steps are to stop issuing further QE, which will be done once the BoE MPC is convinced none is needed to maintain liquidity and inflation at targeted levels, and then eventually to reverse existing QE by selling off the assets purchased and then "destroying" the funds received, once liquidity within the economy reaches excess levels and inflation of above target results.

inspector_monkfish

Found this article........

14:39 13Jan10 UK Tensions Rising Ahead Of QE Pause


The Bank of England's GBP200 billion quantitative easing experiment is
drawing close to an end, with less than GBP10 billion left in the coffers to
spend on government bonds. Policymaker Andrew Sentance says the point is
approaching where enough stimulus has been introduced, suggesting the BOE could call a halt to its gilt purchases at its next monetary policy meeting in
February. That puts the U.K. in an unenviable position: while it is lagging other
countries in emerging from recession, it seems set to be among the first to test market reaction to de facto monetary tightening.

The U.K. is hardly an ideal test-bed for central bank exit strategies. Its
budget deficit of 13% this year is likely to be the highest of any major
industrialized country, yet thanks to the BOE's GBP200 billion target for gilt
purchases net supply in the U.K. government bond market has been effectively zero this year; no one knows what will happen to yields once BOE purchases end. Optimists can point to the U.S. Federal Reserve's announcement last month that it will halt purchases of mortgage securities this year, calmly received by the market. On the other hand, the European Central Bank's warning to banks not to rely on its liquidity facilities sparked volatility in government bonds.

In theory, withdrawing quantitative easing should not disrupt the market. The BOE has argued that it is the stock of government bond purchases, rather than the flow, that is the key to the success of the policy. But neither the gilt market nor at times the BOE itself appears to hold this view with any degree of conviction. Evidence suggests that BOE purchases have greased the wheels: Wednesday's potentially tricky sale of 40-year gilts may have been helped by Tuesday's buyback of long-dated gilts. The risk remains that there is a gap between the stock of purchases having a lagged effect on demand in the economy and the halt in the flow having an immediate impact on market interest rates.

Of course, the BOE might yet decide to extend its purchases in February,
seizing on any weakness in U.K. macroeconomic data to avoid taking such a
contentious decision weeks before an election. On Wednesday it emerged that
manufacturing output in November stalled for a second month. But with inflation persistently above the BOE's forecasts and set to climb well above its target this year, there are risks to continuing the policy too. Announcing a pause would give the BOE room for maneuver, although that message will need careful crafting if any resumption in gilt purchases is to be effective. Other central banks will be watching to see whether the BOE can pull it off.

princeofpounds

There is slightly more credibility to the claim that by buying stocks of existing gilts from the market, the government freed up funds for those institutions to buy more gilts, however a baseline of gilts purchases would have been expected anyway, as financial institutions are mandated by law to hold a certain percentage of assets in AAA rated instruments.

Slightly more? That's the whole point - you are right to say the QE deals are done in the secondary market but it is done with the very real intention of distorting the primary market.

I'm not sure that anyone has posted anything that is different to the rest of what you wrote.

lemonjelly

Interesting stuff.

The main thing I've gathered from all this, is that the media know phuq all!:D

Oh, & my head hurts!:o

In summary, am I right in thinking that effectively, the government/BoE has stepped in to ensure money continues to circulate around the economy in the times where, for whatever concerns, usual sources of money supply are not allowing this money to circulate. The idea being, that the economy doesn't suffer, & the usual sources see risk reduce, & are therefore willing to return to the process of circulating the money? Once this is observed, the money printers withdraw their cash from the economy, allowing it to maintain itself?

I assume they take out the money they put in? Do they do this in 1 go? Or in bits? (Or does it depend on the context?)

& then, what do they do with their money that they "printed"?

Or have I got none of it?:D

Cheers one & all!

tomterm8

lemonjelly wrote: »

Do they do this in 1 go? Or in bits? (Or does it depend on the context?)

& then, what do they do with their money that they "printed"?

In bits, and in a nutshell they 'destroy' the money they have 'printed'. (in reality, they are numbers on a computer screen). The money simply no longer exists.