the sterling claim with a commercial bank that holds an account with us, if it does not do so itself. the only way that the claim can be eliminated from the system is if a bank chooses to exchange it for cash, which would make little sense since cash pays no interest at all. the reason for going through this in such mind - numbing detail is to make the point that the level of commercial banks ’ reserves in aggregate is determined by the way we have funded the asset purchases, not by the commercial banks ’ own decisions. the size of banks ’ reserves cannot, as is frequently claimed, be a sign that they are “ sitting on them ”. no matter how rapidly or how slowly the economy is growing, or how fast or slow the money is circulating, the aggregate amount of reserves will be exactly the same. so it should be clear that the quantity of central bank reserves held by the commercial banks is useless as an indicator of the effectiveness of quantitative easing. now obviously we would prefer that the money circulates more rapidly and that this is done through increased bank lending and deposit taking. in other words, we would like to see a further expansion of credit and broad money. since the banks collectively are now awash with reserves, they should not be prevented from making additional loans because of any liquidity concerns. banks are, though, constrained by a lack of capital and are looking to reduce leverage rather than increase it. fortunately, increased bank lending is not necessary for quantitative easing to work. indeed, it was precisely because the monetary policy committee expected the additional monetary injection not to stimulate bank lending directly at the current juncture, that the asset purchase facility ’ s purchases were targeted at assets held primarily by the non - bank private sector 1. so if the asset purchase facility buys gilts from pension funds or asset managers, they will then have to look for another home for their money. as it is not very rewarding just to hold it on deposit, they are likely to look to put their money into other assets, including equities and corporate bonds. thus not only does the price of gilts rise as a consequence of the asset purchase facility ’ s initial purchases, but also the prices of a whole spectrum of other assets. that in turn lowers the cost of non - bank finance and encourages increased corporate issuance. also the rise in asset prices increases wealth and improves balance sheets. in this way, quantitative easing helps to work around the blockage created by a banking system that

the debt management office. this asset swap took credit risk onto the public sector ’ s balance sheet and was therefore more akin to a fiscal operation. but since march, purchases have been on a much larger scale and funded through the issuance of central bank reserves rather than treasury bills. the bulk of the purchases have been of government bonds, though a small quantity of investment - grade corporate bonds have also been bought. so far, about £164 billion of assets have been purchased in this way, as against the monetary policy committee ’ s current target of £175 billion. to put that in perspective, £175 billion represents roughly 12 % of annual gdp. technically what happens is the following. the asset purchase facility buys assets funded by a loan from the bank. in turn, the bank funds that loan through additional reserve creation ( chart 1 ). if this sounds like financial alchemy, consider how the money flows through the system. when the asset purchase facility buys a gilt from a pension fund, say, it can be thought of as paying with a cheque drawn on the bank of england. the pension fund will then bank the cheque with its own commercial bank, so the latter now has a claim on the bank of england – that is what reserves are. in reality, these payments are not made by cheque, but rather are carried out electronically. but the principle is the same, though one key difference is that we pay bank rate to the commercial bank on its claim on us, as well as charging bank rate on the loan we make to the asset purchase facility. now i can add detours for the money at any point in this cycle. for example, the pension fund that sold the gilt to the asset purchase facility might now withdraw its deposit and use it to purchase a newly issued corporate bond. the company issuing the bond then deposits that money in their own bank. so now it is the corporate ’ s bank that holds the claim on us. a similar sort of circle occurs if the corporate then uses its deposit to buy a new piece of machinery, because the seller of that machinery will end up putting the proceeds into her bank, so that the claim on the bank of england is now held by the capital goods producer ’ s bank. whatever the type of purchase, it will always end up with someone ’ s commercial bank having a claim on us. that is even the case if the money is used to buy foreign goods, as the foreign commercial bank will need to exchange