UK asset purchase scheme is best news for months
Simon Ward
4 Comments
The most important parts of today’s package of financial support measures are the new Bank of England asset purchase facility and the commitments by Northern Rock and RBS to expand lending relative to previous plans. These have the potential to have an immediate impact on credit supply and monetary growth.
The asset purchase facility is significantly smaller than equivalent Federal Reserve initiatives but can be expanded at the request of the Monetary Policy Committee. The Fed has bought $335 billion of commercial paper and plans to purchase up to $500 billion of mortgage-backed securities – the $835 billion total is the equivalent of 10% of the broad money supply M2. The Bank’s asset purchase facility has been set initially at £50 billion, equivalent to 2.6% of broad money M4 (a wider definition than US M2).
The monetary impact of this programme will be supplemented by a slowdown in the rate of contraction of Northern Rock’s mortgage book and the commitment by RBS to maintain credit availability to large corporations as well as homeowners and small businesses and increase lending by a further £6 billion over the next 12 months. Rock’s previous business plan implied a further £20-25 billion reduction in its mortgage lending in 2009. If its mortgage book is now stabilised, the Rock / RBS initiatives together could add £30 billion to credit supply in 2009 – equivalent to a further 1.6% of M4.
The initial £50 billion purchase under the Bank of England asset purchase scheme will be financed by issuing Treasury bills, implying no impact on the monetary base – so it does not amount to “quantitative easing”. However, growth in the base has already picked up as a result of the Bank’s expanded lending to the banking system and the priority now is to boost broad money M4. The scheme will achieve this providing 1) the Bank buys assets from UK companies and non-bank financial institutions and 2) new Treasury bills are bought mainly by banks, as is likely. In other words, if successful, the scheme will amount to “printing money” to buy private-sector assets. (In theory, the MPC could request that the monetary base impact of a future expansion of the programme is not sterilised by issuing more Treasury bills, implying “quantitative easing”.)
The other parts of today’s package – in particular, the asset protection scheme and the guarantee scheme for asset-backed securities – have the potential to boost credit supply and monetary growth over the medium term but only if fees are set at non-penal levels. Prior UK financial support measures have been more expensive than equivalent schemes in other countries, reducing their effectiveness.
While welcome, today’s package is not all that might have been desired. In particular, the authorities continue to resist pressure to “underfund” the budget deficit in order to boost M4. This could have an immediate and significant impact in relieving the current corporate liquidity squeeze and would complement efforts to improve credit availability.
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Reader Comments (4)
I think this is semantics to argue that this is not quantitative easing. Ok, I take your point that its not expanding the monetary base in the way the Fed is.
But as you note yourself, financing purchase of longer-term assets using T-Bills is still 'printing money' via the fractional-reserve banking system.
I think you are still committing this Friedman/Schwartz error of believing that a monetary contraction is the cause of the difficulty - some sort of exogenous shock such that all you have to do is reverse this - rather than a symptom.
This is economics without a capital theory.
True, there are some profitable activities out there who are suffering from the secondary effects as the over-inflated value of collateral collapses and bank credit contracts.
But printing more money is as likely to prevent the correction in asset-values and the liquidation of malinvestments as it is to relieve the secondary effects.
The UK is at risk of following Japan's path of a lost decade as a result of all these stimulas ideas - more so the monetary ones that actually have a short-term influence unlike cutting VAT!!
Targeting a moderate, stable rate of monetary growth would have tempered the excesses of the boom and would now help to avoid unnecessary collateral damage from the economy's inevitable adjustment.
There is a difference between quantitative action to prevent a monetary contraction and printing money on whatever scale is necessary to support the current level of asset prices.
Japan's lost decade does not demonstrate the futility of monetary stimulus measures. The authorities never focused on boosting broad money and annual M2 growth remained below 5% throughout the 1990s - insufficient to create "excess" liquidity given a rising demand for money due to falling prices.
In fact the Japanese figures for Broad money growth are even tighter than you mention - as you get into the period of BoJ's attempts at quantitative easing: the growth in M2 plus certificates of deposits fell from 3.6% to 1.7% in the 5 years to 2003 inc. I'll come back to that...
If "quantitative action to prevent a monetary contraction" does not "support the current level of asset prices", what would be the point in doing it? (Assuming, of course, this is possible with broad money).
I mean, what is the transmission mechanism by which the increased money supply impacts 'demand' in the monetarist models? Surely, this is primarily 2-fold as per Congdon: (1) a wealth effect from the new money being used in the first instance to purchase existing (inelastic) assets and so increasing their prices, and so funding "mortgage equity withdrawal" etc; and/or (2) more money going into bonds so as to lower market interest-rates and hence the 'cost of capital' (by increasing bond prices).
Or are you working off a Pantinkin style 'real balance effect' with seemingly no assets? Or simply relying on what Gov. Benanke referred to as a 'black box' transmission mechanism?
If asset prices are allowed to continue correcting themselves, the result is continued deleveraging and contraction in bank credit as losses mount and the value of collateral declines i.e. broad money contracts as a symptom of the correction rather than as a cause of the recession.
Returning to Japan, this is precisely what happened and can explain M2+CDs - the loan books of commercial banks contracted from 476trillion yen to 407 between 97-03 while land prices (collateral) continued to fall in value.
In other words, for an increase in the money supply to take the edge off the recession, it must surely do so by continuing to distort the structure of relative prices and asset prices generally? If attempts at monetary stimulus do not do this, then you will be pushing on a piece of string while broad money contracts...
On a lighter note, perhaps this is indeed the 3rd (or 4th?) case in my lifetime of the Treasury/BoE not understanding that ignoring the supply of money and credit so as to focus on other things (the exchange rate, CPI-targets) is a recipe for boom-bust. But is this an argument for monetary targeting? Or for binning the fractional reserve banking system and this misplaced belief in the ability of central banks and the State to centrally plan the money supply?
There is absolutely no difficulty in boosting broad money. The government simply finances the budget deficit by borrowing from the central bank instead of selling gilts to non-banks. If it wishes, the central bank can sterilise the impact on the monetary base by reducing its normal lending to the banking system – this aspect is of secondary importance. Whether it does or not, broad money is higher (base expansion could magnify the impact but that depends on banks lending out additional reserves).
The supply of money has now expanded relative to the demand for money based on existing levels of income, wealth, interest rates etc. Except in the extreme case of a liquidity trap – an intellectual curiosity – this will lead to an increase in spending on goods and services and / or investment in financial or real assets as individual firms and households attempt to rebalance their portfolios. If spending on goods and services rises there is a direct impact on the economy unrelated to any asset price effect.
Efforts by individuals to restore equilibrium in their portfolios result in money being transferred to other agents, who will then undertake similar reallocations. The process continues until aggregate income, wealth etc. have adjusted sufficiently to balance economy-wide money demand with the increased supply. Asset prices have risen but this is a side-effect rather than the essence of the transmission mechanism. (This is all standard Congdon.)