I read the August 2020 Bank of England Staff Working Paper (No.883)—— Does quantitative easing increase banks’ lending to the real economy or cause other banks to reallocate assets?The situation in the UK – Recently, investigating whether banks’ large bond purchase plans will stimulate bank loans. They found no stimulus loans. If people think mainstream monetary economics is useful, it will only be a surprise. Modern Monetary Theory (MMT) economists are not surprised by this discovery. The reality is that the lack of bank loans during the global financial crisis has nothing to do with the lack of liquidity in the banking industry. This is all related to the lack of creditworthy borrowers-this should tell you that bank reserves will not limit bank loans. It is an interesting fact that mainstream institutions like the Bank of England are now publishing this kind of research that disrupts mainstream theories.
The reason this is an interesting exercise is that it uses a unique data set that includes “the exact bank that receives the reserve injection through the Bank of England app (Quantitative Easing Bank)”.
This allows researchers to perform so-called “differences in differences” methods, which basically pinpoint the reasons for differences between observations in a data set.
The practical importance of such studies is that they provide real-world evidence that enables us to understand how the monetary system works and reject the way mainstream economists construct these operations.
In a recent blog post- The European Central Bank is almost innocent-higher fiscal deficits, higher quantitative easing (July 20, 2021)-I discussed the report issued by the Economic Affairs Committee of the House of Lords on July 16, 2021- Quantitative easing: a dangerous addiction? (July 16, 2021)-They rehearsed all the common mistakes related to quantitative easing.
These are errors introduced by mainstream economists in policy debates and their teaching plans.
Therefore, real-world evidence that refutes basic mainstream propositions is always welcome.
I also considered these issues in a series of blog posts 12 years ago-when people began to wonder what impact the large central bank bond purchase program would have.
They worry that the so-called “money printing” interventions of central banks in the early stages of the global financial crisis will lead to inflation.
They think so because they have either received this teaching in university economics courses, or because they have been listening to politicians and their crony mainstream economists ruthlessly promoting this message in the media.
This set of blog posts was designed at the time to clarify the record.
1. Quantitative Easing 101 (March 13, 2009).
2. Building bank reserves will not expand credit (December 13, 2009).
3. Building bank reserves will not cause inflation (December 14, 2009).
4. Loans are capital-not subject to reserve restrictions (2010, April 5).
Surprisingly, it took so long for bank officials to acknowledge what modern monetary theory (MMT) economists have always known.
Quantitative easing will not increase the economy’s inflation risk.
If this is the case, then considering that the Bank of Japan has purchased a large amount of government bonds in about 20 years, Japan should now have hyperinflation.
The problem that mainstream economists encounter here is that their views on the private banking system are flawed.
They believe that bank loans are limited by their reserves in the treasury, and quantitative easing solves this shortage by providing these reserves.
Therefore, banks are considered “desks” where officials wait for cash to enter in the form of deposits and then lend them out, profiting from the difference between deposit interest rates and loan interest rates.
But this is a complete mischaracterization of how the bank operates.
Bank loans are not subject to “reserve constraints.”
Banks provide loans to any creditworthy customers they can find, and then worry about their reserve positions.
Remember, the role of bank reserves is to facilitate a clearing system for transactions that have cross-bank impact.
Therefore, if Bank A creates a loan and at the same time creates a deposit in its books, the person can withdraw the deposit and use the cash for bank A’s banking business, or for other banking businesses, such as Bank B.
In the former case, there is no liquidation problem. Bank A simply transfers the deposit funds from the customer to the enterprise.
In the latter case, Bank B will ask Bank A to transfer funds to its business customer’s account.
These transfers are the job of the clearing house, and there are millions of such transfers every day.
This is the purpose of bank reserves.
Therefore, banks A and B have accounts in the central bank, and relevant entries are made in these accounts to satisfy the above-mentioned transactions.
Banks never lend reserves to commercial customers (borrowers).
They sometimes lend each other excess reserves to clean up the liquidation system.
If banks lack reserves (their reserve accounts must maintain a positive balance every day, and in some countries the central bank requires a certain ratio), then they will borrow from each other in the interbank market, or eventually borrow from between banks. The central bank passes the so-called discount window.
They are reluctant to use the latter convenience, because it usually brings penalties (higher interest costs).
The key is that the establishment of bank reserves will not increase the bank’s lending capacity.
Loans create deposits, generate reserves and not the other way around.
The main institutional restrictions on bank loans (except for the flow of creditworthy customers) are reflected in the capital adequacy requirements set by the Bank for International Settlements (BIS), which is the central bank’s head to the central bank.
They are related to the asset quality and capital required by the bank.
These requirements are reflected in the loan interest rates charged by banks to customers
But despite what is taught in mainstream courses in monetary economics, bank loans will never be restricted by insufficient reserves.
This is why MMT economists never considered quantitative easing to be a suitable tool for increasing bank loans to stimulate the economy.
Quantitative easing only involves the central bank buying bonds (or other bank assets) in exchange for the central bank’s deposits in the commercial banking system—that is, crediting its reserve account.
Quantitative easing is actually just accounting adjustments in each account to reflect the exchange of assets. Commercial banks obtain a new deposit (central bank funds) and reduce their holdings of assets for sale.
Obviously, the reason why commercial banks were reluctant to issue loans during the global financial crisis was that they did not believe that they had reputable customers on their doorstep.
In addition, after years of lax evaluation of credit, once the global financial crisis threatens the solvency of banks, banks will tighten rules.
The 2020 Bank of England report reflected on this issue and constructed a unique data set.
The paper still emphasizes:
As a direct effect of the asset purchase plan, banks obtain cheap liquidity in the form of central bank reserve injections. This should encourage banks to provide more loans to households and businesses, thereby spreading the impact to the real economy.
This continues the myth that bank loans are limited by reserves to some extent.
But their mission-“The impact of the two main waves of the UK Asset Purchase Program (APP) (March 2009 to November 2009 and October 2011 to October 2012) on the balance of British banks”, see It is interesting to see if there is any connection with bank lending practices.
The empirical data is clear:
1. The Bank of England QE plan was launched in March 2009, following the Fed’s launch of the plan in November 2008.
Of course, the Bank of Japan launched a large-scale bond purchase program in 2001. So we already know what happened.
However, due to cultural differences, mainstream economists have always considered the Japanese case to be “special.”
This is a terrible statement. They don’t know why the Japanese monetary system reacted in violation of all the textbook predictions made by mainstream economists.
2. Bank loans have no obvious impact. For a period of time after the start of the UK QE program, bank loans have “declined or barely increased.”
Between the beginning of 2009 and 2014, loans to non-financial companies fell sharply.
The authors collected a data set that allowed them to compare “British banks that received reserve injections from APF, called QE banks, with those that did not.”
They have 18 years of data from the second half of 2000 to the first half of 2018.
The author pointed out:
When the Bank of England implemented QE, the reserve was credited to the seller’s bank’s reserve account, and the bank then credited the same amount to the seller’s deposit account. Therefore, banks participating in QE operations (QE banks) will initially receive additional liquidity (as reserves), while other banks (non-QE banks) will not.
They pointed out that the initial increase in the QE bank reserve balance may be “leaked” to other banks through the payment system-as I described above.
However, due to the UK’s institutional structure, quantitative easing banks “mainly conduct business with a small number of banks, which are also participants in the bank’s quantitative easing actions”, so the leakage is considered small.
The author also pointed out that there is no “currency multiplier” in the UK, and that:
… The supply of credit is mainly driven by banks’ lending capacity and/or incentives.
However, they still claim that quantitative easing has “improved banks’ lending capacity,” but other factors such as “capital position exhaustion” and other regulatory issues have intervened.
Their results are interesting:
1. “Compared to the control group, the additional liquidity did not incentivize quantitative easing banks to increase loans. There is no evidence that these results are driven by changes in the relative loan demand faced by the two groups.”
2. They “have no evidence that the reduction in QE bank loans after the two waves of quantitative easing was due to the difference in loan demand between the treatment group and the control group.”
3. “Compared to the control group, QE banks increased their reserves and reduced loans to other banks after QE1. They also increased their holdings of government securities, especially after QE2. This shows that quantitative easing banks diverted their resources from loans Switch to government securities with low risk weights.”
This is very important.
A lot of things happened at that time.
Banks are scrambling to improve the quality of their capital base-which is why they have increased their holdings of government bonds, which are considered riskier than retail loans.
The bank also reduced its exposure to the European debt crisis by reallocating assets to British bonds.
As a result, asset reallocation is in progress, but bank loans have not increased due to the increase in the reserve balance.
The overall conclusion of the paper is that “if the policy goal is to further boost the economy by supporting bank loans in times of stress and uncertainty, then it may be worthwhile to consider the use of alternative credit easing tools.”
This is really a confession.
Quantitative easing will never break the deadlock in the loan market that occurred during the global financial crisis, because deep-seated uncertainty will plunge borrowers into the ground.
Families who are worried about losing their jobs do not want to take risks.
Companies know that household spending is restricted and that there is excess production capital, so even if they borrow more money at lower interest rates, there is little incentive.
in conclusion
Another piece of evidence tells any aspiring student not to study mainstream monetary economics unless you like novels.
Enough for today!
(c) Copyright 2021 William Mitchell. all rights reserved.
