Asset Purchase Program (UK)

At the beginning of 2009, economic forecasts for the United Kingdom predicted a recession worse than that of the 1990s. To offset this contraction, the Bank of England employed conventional monetary policy and slashed the Bank Rate to its effective lower bound, but predictions remained grim, so in March 2009, the Bank introduced the first episode of its Asset Purchase Program. The stated aim of this program was to increase nominal spending and bring inflation back to its 2% target.

Therefore, on March 5, 2009, the MPC announced that the APP would purchase £75 billion of assets over the course of the next three months.

This adjustment was made to accommodate the newly enlarged purchase range mentioned in Eligible Collateral or Assets category (Joyce and Tong 2012).

The Bank periodically disclosed how much it would continue to purchase through the program, which helped to maintain order in the markets (Joyce, Tong, and Woods 2011).

QE was not explicitly planned to be a recurring event; but “amid fears of a double-dip recession and a crisis in the Eurozone,” the Bank resumed the program. In a statement released on October 6, 2011, the Bank detailed its strategy: “The pace of global expansion has slackened, especially in the United Kingdom’s main export markets. Vulnerabilities associated with the indebtedness of some euro-area sovereigns and banks have resulted in severe strains in bank funding markets and financial markets more generally. These tensions in the world economy threaten the UK recovery” (Allen 2011; Telegraph 2011).

​​​​​​More specifically, the purchases were primarily targeted at life insurance companies and pension funds, which were known for holding long-term gilts. However, these gilts represented only a small amount of the institutions’ portfolios, “which indicated that they might be prepared to reinvest money from gilt sales into other assets”; this would lead to the Bank’s portfolio rebalancing channel (Joyce, Tong, and Woods 2011).

The Bank’s plan for quantitative easing involved five channels through which QE would impact the economy: money, liquidity, portfolio rebalancing, policy signaling, and confidence, which would operate in tandem to achieve the program’s desired results (Joyce, Tong, and Woods 2011).

Additionally, by operating in this way, QE avoided directly targeting banks, as “any impact on banks was thought likely to be small due to the desire to deleverage” (Haldane et al. 2016; Joyce 2013; Joyce, Tong, and Woods 2011).

This preference addressed a trade-off in priorities between improving market conditions and increasing nominal demand. The Bank prioritized the latter; additionally, “buying primarily private sector assets means that the government chooses to act in specific sectors or even in specific companies, which can distort economic activity. Buying gilts increases the amount of money in a more ‘economically neutral’ way” (Lilico 2011).

Over the course of the program, the Bank had come to hold a large proportion of gilts in issue at the five- 25-year maturity range, and this change was another strategic measure to avoid dislocation of the gilt market (Joyce, Tong, and Woods 2011).

Lowering the interest rate so near to its effective lower bound was already a significant “loosening” of what was considered conventional monetary policy. However, in the face of a growing financial crisis and “one of the largest falls in output ever recorded in the UK […] There was a consensus among members of the MPC that this loosening of conventional policy would not be enough to combat the GFC, and so the Bank opted to combine conventional monetary policy with the unconventional method of quantitative easing in the hopes that the effects of the two strategies would give the economy the boost it needed” (Fisher 2010).

As the Figure 3 shows, the Bank’s plan for quantitative easing involved five channels through which QE would impact the economy: money, liquidity, portfolio rebalancing, policy signaling, and confidence, which would operate in tandem to achieve the program’s desired results (Joyce, Tong, and Woods 2011).

Source: Haldane et al. 2016.

The first channel was portfolio rebalancing, which was considered to be particularly important. By way of this channel, “central bank asset purchases push up the prices of assets bought, along with other assets … higher asset prices mean lower yields, lower borrowing costs […and] an increase in net wealth of asset holders […] which stimulate[s] spending” (Joyce, Tong, and Woods 2011).

The second channel was liquidity, which QE would achieve by “actively encouraging trading” (Joyce, Tong, and Woods 2011). However, the effectiveness of this channel may be limited to the period in which the central bank is actively making purchases. As such, “this channel was not expected to be very important in terms of gilt purchases—instead, it would [focus] on the Bank’s (relatively) small-scale purchases of private sector assets and directly improve the availability of capital market finance to companies” (Joyce, Tong, and Woods 2011).

The third channel was confidence. Consumers would see the Bank’s willingness to employ unconventional monetary policy and would become more confident about the market outlook (Haldane et al. 2016; Joyce, Tong, and Woods 2011).

The fourth channel was money. QE expanded the balance sheet, loosened the money supply, and facilitated bank lending (Haldane et al. 2016; Joyce, Tong, and Woods 2011).

The fifth and final channel was policy signaling. The methods by which QE was conducted provided information to economic participants about “potential future paths of monetary policy” and would thus inform those participants’ future actions (Joyce, Tong, and Woods 2011).

Finally, the Bank’s plan included a two-step process through which QE would impact the macroeconomy.

The first “impact” phase involved portfolio rebalancing—when reinforced by policy signaling and a rise in asset prices, this would in turn foster demand. The second “adjustment phase” would lessen the imbalance between money and asset markets, “and price level would slowly increase until it restored real money balances, real asset prices, and real output to their desired levels” (Joyce, Tong, and Woods 2011).

During QE1, the Bank purchased a large proportion of certain gilts in issue, which created risk that sections of the gilt market would become dislocated. By lending out some of the gilts purchased, the Bank was able to lessen that risk. The Bank deliberately did not lend out the gilts against cash, as “that would reverse some of the effects of the first asset purchases” (Joyce, Tong, and Woods 2011). This scheme successfully alleviated issues within the gilt market, and market contacts reported that “the spread between repo rates and the general collateral secured rate somewhat normalized for the types of gilts that had been heavily affected by the Bank’s purchases” (Joyce and Tong 2012).