Monday, 11 May 2009

Quantitative easing - how it works

It is quite simple really....

The Bank of England creates an accounting entry on the liabilities side of their balance sheet. It is called reserve balances. On January 1, it says reserves balances are ₤23 billion. On April 30th, it records that reserve balances have "increased" to ₤70 billion. It then gives these reserve balance accounts in return for government paper.

The banks then have an asset on their balance sheet called "reserve balances at the Bank of England", which they can exchange, if they want to, for cash.

Reserve balances are the route to monetizing the fiscal deficit and ultimately to higher inflation and macroeconomic chaos.


Anonymous said...

The gruesome mechanics of hyperinflation.

boiling frog said...

Yes but don't they keep the treasury rates down? Surely?? So we can have low interest rates forever here and in the US, quantitive easing will ensure low mortgage costs and boost the housing market. This will make everyone feel richer and go out and buy MFI furniture and improve their home with Focus doitall.
It will work, won't it?

Anonymous said...

@Boiling Frog.
Sadly it won't work, never has, never will. What will happen is that inflation will take off as more money is created. Foreign investors will flea, pushing up interest rates. Businesses mis-price goods and find that replacing stock costs more than what they sold their previous stock at, thus they go bankrupt. Then people begin to realise it is not prices that are going up, it is the value of paper money that is falling, so they run out of paper into real assets. Those on fixed incomes suffer the most, the elderly and the poor.
It is the path to the madhouse..