Quantative Easing a guide.

Some time ago in a discussion with a colleague at the office I ended up writing a paper for him (not sure he ever read it though!) he was worrried that QE was inflationary, currency disbasement yadda yadda so thought as I will be going off down the monetary system rabbit hole it was worth doing again as it has some basic concepts.


Money

Base money,outside money,central bank money, bank reserve cash,High Powered Money HPM.....money banks use to settle between themselves.   This money doesnt pay interest or has a duration. (im ignoring Interest on Reserves at the moment as that doesnt play a part in what we are discussing)

Broad money (inside money)  bank commercial credit... the money we use.(this also includes the notes and coins we use, the government sell this to the banks and profits on the difference between minting/printing which is called seniorage. but only makes up around 3% of broad money)

Gilts (or bonds) im putting this here as itself is a form of money,  it has a duration and pays interest (the Yield)


What the Bank of England actually did.

The BoE uses the buying and selling of gilts in its monetary policy through open market operations to hit its target interest rate.   When we started approaching zero (or zirp) they needed some other way to influence monetary policy, they were seeking a way of driving investors away from owning gilts and to push them into other assets or so they said, either this was an outright lie or a misunderstanding of banking so you can make your own mind up there with the results.    So what they did in buying gilts and swapping for cash was actually alter the composition of private sector assets  swapping government liabilities.  What they didnt do was actually add any extra net financial assets to the system so in essence it was an asset swap.

Now that was done through the commercial banks which added bank reserve cash to the system.   Now thats great if you assume via Fractional Reserve Banking that they then go on to loan through having these extra reserves above what the reserve requirment is  (note for Sabrina Canadian Banks dont have a reserve requirement which is kinda curious in a so called FRB system as that would assume they could create an infinate amount of credit)
Now the central banks know without a shadow of a doubt banks do not work like that as it implies that a money multiplier is at work but its a myth (as any Post Keynesian or MMT economist will tell you) even the fed themselves admit this in a recent paper. 

http://www.federalreserve.gov/pubs/feds/2010/201041/201041pap.pdf

“Changes in reserves are unrelated to changes in lending, and open market operations do not have a direct impact on lending. We conclude that the textbook treatment of money in the transmission mechanism can be rejected.”⁹

Banks loan on what their capital position is  which is basically its equity (shareholder value,retained earnings that sort of thing)  and then seek reserves if they need to after to satisfy any reserve requirement is (as above)

You can see by this that means that you can add as many reserves to the system as you want and it will make no difference on how much banks loan.  When a loan is made that adds to the amount of commercial bank credit and also creates a deposit through double entry bookeeping.    This shows you that its loans that drive reserves not vice versa.

Ok so what happened to those gilts and interest payments on them, well in the UKs case the BoE then put them into something called the Asset Purchase Facility (APF) where they are sitting and the interest being put there as well which is somewhere around 30 billion GBP.   Think about it they are basically paying themselves interest but its sitting there doing nothing.   Thats a lot of money sitting there that has effectively been taken out of the economy.

From this we can deduce that it isnt inflationary and  by adding reserves to the system they have stabilized the payment system saving the banks and holding asset prices up (banks havent had to foreclose and have firesale prices)   Just because its stopped deflation for the moment it doesnt mean its inflationary.... in fact in the end it will be deflationary as money as in the interest payments has been lost to the non government sector.