Central banks, led by the Fed, are expanding their range of tools for supplying liquidity to markets and promoting financial stability.
Some of these interventions have no impact on either the monetary base - currency in circulation and bank reserves held at the central bank - or broad money supply measures. Actions that expand the base may be termed "quantitative easing". The expression "printing money" should be reserved for interventions that directly boost the broad money supply. (These are my suggested definitions - economists often use the terms interchangeably.)
In theory, an increase in reserves held at the central bank encourages banks to expand their lending, thereby boosting broad money. In practice, however, many other factors also influence banks' lending behaviour, resulting in large swings in the "money multiplier" - the ratio of broad money to the monetary base.
With banks currently under pressure to raise capital ratios, and able to obtain wholesale funding only on expensive terms, a rise in the monetary base is unlikely to feed through to an expansion of bank lending and broad money. "Quantitative easing" may therefore provide limited support to financial markets and the wider economy - "printing money" is required.
Various central bank actions are classified below according to their impact on monetary measures, with more radical interventions lower down the list.
The Fed employed sterilised lending (1) until Lehman's failure in September but subsequently embarked on quantitative easing (2). Last week’s news that it would buy $600 billion of securities issued or guaranteed by government-sponsored enterprises implies printing money - either (3) or (4). If the full amount announced is bought from non-banks, money supply M2 would rise by 8%, other things being equal.
This shift was confirmed this week by Fed Chairman Bernanke's suggestion that the central bank "could purchase longer-term Treasury or agency securities on the open market in substantial quantities". If Fed buying of Treasuries substituted for debt sales to non-banks, this would amount to "underfunding" the budget deficit (5). Fed purchases used to finance an expanded deficit would be equivalent to Milton Friedman's "helicopter drop" of money (6).
Japan's policy of quantitative easing in 2001 targeted the monetary base but involved the Bank of Japan buying Japanese government bonds (JGBs) so it also resulted in an expansion of broad money - (4) below. In the year from March 2001 the BoJ bought ¥29 trillion of JGBs, equivalent to 4.5% of Japanese M2. (Some of these may have been purchased from banks, implying a smaller monetary impact.)
The ECB and Bank of England have engaged in quantitative easing since September - see chart - but neither central bank is yet printing money. The statement accompanying the MPC's latest interest rate cut hinted at further market interventions but it is unclear whether the Bank is yet ready to copy the Fed’s recent initiatives.
1. Sterilised central bank lending to banking system
Example: Fed lends to commercial bank via discount window, simultaneously reduces conventional repo loans to banking system
Result: no impact on broad money or monetary base
2. Unsterilised central bank lending to banking system
Example: As above, no offsetting fall in repo loans
Result: bank reserves and monetary base expand - "quantitative easing"
3. Sterilised central bank purchase of securities from non-banks
Example: Fed buys mortgage-backed securities from insurance company, simultaneously reduces repo loans
Result: broad money expands - "printing money"
4. Unsterilised central bank purchase of securities from non-banks
Example: As above, no offsetting fall in repo loans
Result: broad money and monetary base expand - "printing money / quantitative easing"
5. Sterilised central bank lending to government to finance existing budget deficit
Example: Fed lends to Treasury, Treasury reduces debt sales to non-banks, Fed reduces repo loans
Result: broad money expands - "printing money / underfunding"
6. Unsterilised central bank lending to government to finance higher deficit
Example: Fed lends to Treasury, Treasury cuts taxes
Result: broad money, monetary base and incomes expand - "printing money / quantitative easing / helicopter drop"
