Paul Fisher: An unconventional journey - the Bank of England's asset
purchase programme
Speech by Mr Paul Fisher, Executive Director for Markets and Member of the Monetary
Policy Committee of the Bank of England, based on a presentation to contacts of the Bank's
Agency for the South-West, Stonehouse, Gloucestershire, 11 October 2010.
* * *
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. I
won'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.3
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).7
Why we did it the way we did
Although QE was an "unconventional" monetary policy operation, it was not totally without
international precedent, having been tried most notably in recent times by Japan. The
Japanese programme is generally considered to have been a mixed success at best. Such a
judgement is perhaps unfair but there were a number of lessons to be learned from their
experience and those acted as a backdrop to our own operations. In the remainder of this
speech, I want to discuss how we structured the UK's asset purchases.
One aspect of our policy design for QE was to act decisively to prevent the risk of deflation.
In Japan, although their programme of outright purchases of government bonds (JGBs)
amounted to some 13% of nominal GDP, those purchases were conducted over a period of
5 years (2001-2006). And they only began after deflation had already been observed. It is
possible that this dampened the impact8 and other policies were being pursued at the same
time. In the UK we conducted the purchases in similarly large size (14% of GDP) but
relatively quickly (over 10 months), to ward off the threat of deflation rather than as a
response to it.
A second aspect of the design was to target our purchases at assets held by the non-bank
sector. The proposition is that, by buying gilts from pension and insurance funds (for
example), those asset managers would have more cash in their portfolios than they desired,
and would be incentivised to use that cash to invest in other, more risky instruments such as
corporate bonds and equities. That "portfolio rebalancing" channel is thought to have been
largely absent in Japan, where most of the Japanese government bonds purchased were
held by the banks, which in turn used the proceeds to directly de-leverage without obviously
increasing the demand for other assets (although the purchases may have had an impact
through other channels).
Buying assets held by non-banks was relatively straightforward in the UK. At the time,
insurance companies and pension funds were the largest category of holders of gilts in issue.
Although commercial banks act as market-makers for gilts, and were thus the immediate
conduit for the gilt purchases, they typically held only a very small amount on their own
balance sheets as part of their liquidity portfolios. Market-makers had to source gilts in the
market before selling on to the Bank. Moreover, because the banks' own liquidity holdings
were generally very short-dated, we were able to target our purchases by restricting them to
be longer-dated: initially we only bought gilts over 5 years maturity.9
We were also conscious of the pressures on pension funds and their need to match
longdated liabilities by buying index-linked and longer-dated nominal gilts. Real yields and
ultra-long nominal yields were already being driven to low levels by that demand. Hence, we
restricted the Bank's purchases to nominal gilts only and initially capped the maturity at
25 years. The latter restriction was later relaxed as the purchase programme expanded.
In order to deliver the high-level policy objective of the MPC to inject extra money into the
economy, there were a number of operational objectives for Bank staff. First we wanted to
make sure that we were actually able to buy the targeted quantity. There were market
participants who told us that this would not be possible as the asset managers would not be
able to move away from their benchmark holdings (the initial target being £75bn). Once the
programme was announced, the Bank took steps to proactively discuss our operations with
market participants, to allay that initial scepticism. In the weeks that followed the
announcement in March 2009, we called in our contacts at the Gilt-edged Market Makers
and many of the larger asset managers, to explain the operations and to encourage them to
participate. The market collectively responded very positively, and the total value of offers
exceeded the targeted purchases in every auction undertaken.
A second operational objective was to ensure that purchases were at a fair market price. We
had to consider this against the backdrop of a heavy UK Government issuance programme:
we were alert to the risk that market participants might buy direct from the Government's
Debt Management Office (DMO) and attempt to sell the same gilts to the Bank at a higher
price. The first mitigant was that the MPC set a targeted rate of purchases initially three times
faster than the DMO were issuing. In addition we incorporated several features into the
design of the operations:
(i) We designed the operations as competitive (reverse) auctions that would deliver a
clearing price close to the market.
(ii) We offered to buy from a bundle of 8-10 individual gilts in each operation not just a
single stock at a time. The selection of which gilts we then bought depended on the
prices offered. In that way, the purchases were less vulnerable to a "squeeze" in any
one particular gilt.
(iii) We eliminated from the operations any gilts which we knew the DMO were about to
issue or had issued in the previous week.
Maintaining the programme
I don't want to imply that implementing and maintaining our programme of asset purchases
was straightforward operationally. Far from it. For example, the gilt market became
somewhat more dislocated as the Bank accumulated a large percentage of some of the
particular gilts in issue. To alleviate stress in the market, in August 2009 we started to lend
out, via the DMO, a proportion of the gilts the Bank had bought, in exchange for others that
had readier availability.10 The market responded rapidly to that development and, towards
the end of the £200bn programme, some contacts were telling us that gilt market liquidity had
actually improved relative to March 2009.
One small point to clear up in relation to maintaining the programme is whether we should be
re-investing the interest receipts earned on the gilts. In the United States, the Federal Open
Market Committee recently decided that, to maintain the effectiveness of their asset
purchases they needed to re-invest the proceeds from maturing assets and interest receipts.
That reflects the fact that in large part they purchased (pass-through) mortgage-backed
securities where, in addition to receiving coupon payments, a proportion of the underlying
assets are constantly maturing or being pre-paid. Absent a re-investment programme, and
making assumptions about pre-payment rates, the stock of assets in the US programme
might have declined at a rate of around 17 1⁄2 % pa.
In the UK purchase programme we bought nearly all gilts11, with at least 3 years to maturity.
The earliest gilt redemption won't occur until the second half of 2012. We are receiving
dividend payments and those have currently cumulated to a value around 5% of the total
stock of purchases.12 These receipts were anticipated, are currently held in the Fund and will
contribute to repaying the original funding of the programme. A good argument can be made
that, to keep the monetary stimulus of asset purchases constant, this cash should be
reinvested in more gilts. We have taken the view that such fine-tuning is an unnecessary
complication at this stage. If the MPC want to undertake further purchases, it would be
straightforward to simply buy more gilts financed by issuing commercial bank reserves.
Eventual exit strategy
At this time, it is not clear whether the next step with the asset purchase programme is most
likely to be to sell the assets back or to buy more. The Bank is prepared for either but it might
be particularly helpful to set out in advance a few thoughts on the eventual exit strategy.
After purchasing £200bn of assets in just under a year, the MPC paused its programme of
asset purchases in February 2010. The bulk of the medium-term impact from the asset
purchases should come from the stock of purchases not the flow. There will be
approximately £200bn extra money stimulus in the system, until the MPC decides to
withdraw it (or to increase it).
When the time does come to unwind the purchases, the MPC will face a number of difficult
decisions. First, it will have to decide at what point monetary policy should be tightened. That
decision will, as with any decision to expand the purchases further, be judged on a
month-bymonth basis, taking into consideration developments in the economy, and the outlook for our
mandated target, CPI inflation. As the Governor said in June13, when the MPC does want to
tighten policy, it is most likely to raise interest rates first. Gilt sales would be started later and
conducted in an orderly programme over a period of time. That would leave Bank Rate as
the active or "marginal" instrument of monetary policy.
Second, the MPC will have to decide how fast to sell the gilts. Again, that would depend on
the outlook for inflation at the time, so we cannot commit now to any particular scale or pace.
But it is not in the interests of the UK economy to generate unnecessary volatility in the gilt
market. We will therefore be working closely with the DMO14 so as to plan any extra sales
operations that would be needed, with the intention of creating minimum disruption to the
market consistent with meeting the MPC's desired exit path.
A portfolio of £200bn of gilt purchases has a market value which constantly varies as market
prices change. Currently there is a large "mark-to-market" positive accounting position, given
the increase in gilt prices since the programme ended. But for the public sector as a whole
such fluctuations wash out: the (gilt) assets held by the Bank are the liabilities of the
Government and fluctuations in the value of one exactly offset the other in terms of the public
sector's notional balance sheet. Nevertheless, once all the assets have been sold, the Asset
Purchase Facility may end up with a cash deficit and I want to make a few points about that
possible outcome.
In conducting the buying operations, it was in part an intended policy objective that we would
push up gilt prices and hence lower long-term interest rates. When we sell the gilts back to
the market, we will be tightening policy by pushing up on interest rates and hence
necessarily making gilts cheaper. The net effect will depend on the path of interest rates
relative to those expected at the time of each buying operation but, given the policy objective,
the result of the sales programme could easily be a cash deficit. But I want to emphasise that
such an outcome would not mean that the public finances have been made worse off. The
ongoing dynamic effects of the programme will have been to make it cheaper for the
Government to issue its debt in the interim. More importantly, over the lifetime of the
programme, it would have delivered great benefits to the public purse by stimulating the
economy and avoiding deflation: the increase in taxes received as a result of higher nominal
GDP should be an order of magnitude larger than any financial deficit on the purchases
themselves. To genuinely assess the impact on the taxpayer, one would have to take these
and other factors into account. The counterfactual story will never be known precisely but the
scale of the boost to the economy means that the all-round financial benefits for the public
finances should far outweigh any cash deficit that might be left at the end of the programme.
The gilt sales programme will not be the only technical issue surrounding an exit from
unconventional policies. The Bank is also likely to re-introduce its reserves averaging
framework for commercial bank reserves, for example. That will give the bank the ability to
evaluate and then drain out any excess liquidity in the system. Unlike the US, we do not
need to develop new techniques to drain cash. The Bank can do that, for example, by issuing
one-week Bank of England bills as it did in 2008/09.
Conclusions
In this speech, I have commented on why the asset purchases were undertaken and how
well they worked. I have described some of the complicating factors in designing,
implementing and maintaining the operations. Finally I have covered some of the issues we
will face when we eventually come to sell the assets - noting that it is possible that we yet
might purchase more. The unconventional journey is not over yet!
BIS Review 135/2010