“An unconventional journey: The Bank of England’s Asset Purchase Programme”

In March 2009 the Bank of England’s Monetary Policy Committee (the MPC) embarked on an ‘unconventional’ journey. Having cut Bank Rate to an historic all-time low of just half of one per cent, the MPC initiated a programme of asset purchases financed by the issuance of central bank reserves – commonly known as “Quantitative Easing” or QE.1 To date the Bank, in line with MPC decisions, has bought £200bn of assets, equivalent to some 14% of UK annual nominal GDP.
In this talk, I would like to briefly recap on why we started the QE programme and how well it has worked. I then want to explain some of the details behind why it was done the way it was and some technical details on what we plan going forward. Let me be clear upfront that the purpose of this is to share some of our broader thinking about the asset purchase programme, not to drop any hints about the future direction of monetary policy. Why we did it and how well it worked
The global financial shock associated with the collapse of Lehman Brothers and AIG in September 2008 triggered a sharp and synchronised downturn in the world economy. In the UK, GDP fell nearly 4% in 2009 H1 alone, and by the end of that year was some 10% below where it would have been, if growth had continued at its previous trend. This was one of the largest falls in output ever recorded in the UK.
At its March 2009 meeting the MPC cut Bank Rate to just 0.5%, the lowest level in the Bank of England’s 300 year history. While that represented a significant loosening of monetary policy, the MPC agreed that more stimulus was required to mitigate the risk of depression and deflation.

Given that Bank Rate was close to its lower-bound, the MPC decided to increase the supply of money in the economy directly, by embarking on a programme of asset purchases, financed by the creation of central bank reserves (QE). This largely took the form of purchases of UK government bonds - ‘gilts’ - but included small purchases of corporate bonds and commercial paper undertaken in order to improve conditions in those markets.

Iwon’t say any more about the latter today.2 While the form of this policy was “unconventional”, the ultimate goal was identical to any normal reduction in Bank Rate –namely to stimulate nominal demand in the economy, and hence help the MPC achieve its remit of targeting 2% CPI inflation. The UK was not alone in adopting unconventional measures. Both the Federal Reserve Board in the United States, and the European Central Bank undertook a range of alternative measures too. Although the precise nature of the programmes differed from country to country, all three central banks saw their balance sheets expand, funded by an increase in commercial bank reserves.

At the time we started the asset purchases, it was far from clear how successful the policy would be. None of those involved had ever personally experienced a financial crisis as big as this, nor a recession so deep. And no one had direct experience of conducting a major asset purchase programme in the UK. In the press and amongst other economic commentators there was a lot of scepticism expressed about the likely efficacy of the policy.

It is of course, extremely difficult to know what would have happened in the absence of the asset purchase programme; not least because Bank Rate was at a record low and because other, major central banks also loosened policy sharply. There might never be agreement on a precise quantification of its effects but my own view is that the asset purchase programme was extremely successful in meeting its immediate objectives.4 In particular I would pick out the following points which were all consistent with the various channels through which QE can work:

• Broad money growth, although anaemic, did not fall by as much as should have been expected given previous contractions in nominal GDP growth (Chart 1);

• Analysis by some of my colleagues5 suggests that asset purchases may have lowered long term interest rates on gilts at 5-25 years maturity by around 100 basis points relative to what would otherwise have been the case;

• Demand for risky assets increased: spreads on corporate bonds fell markedly, and issuance of both corporate bonds and equities picked up to record rates in 2009 (Chart 2 and Table 1);

• Inter-bank borrowing rates fell back sharply, most likely because significant increases in commercial bank reserves reduced the need for banks to borrow from each other in the inter-bank market. For example, three-month sterling LIBOR6 rates fell from over 2% in late 2008 to under 1% during the course of 2009 (Chart 3). That was potentially a very important supportive step as a good proportion of businesses in the UK had floating rate loans which were linked to the LIBOR rate.

GDP stabilised by the end of 2009, and grew at close to trend rates in the first half of 2010. The prospect of deflation, which had been a hot topic during early 2009, now seems much less likely. Indeed, press commentary through 2010 has instead mostly been focused on the elevated rate of CPI inflation (which reflects the temporary impact of a series of short-term price level shocks).

For the full speech see: http://www.bankofengland.co.uk/publications/speeches/2010/speech453.pdf