Quantitative easing essentially involves trading one liability of the state – gilts – for another – monetary claims on the Bank of England. We aim to buy mainly from non-bank private financial institutions, such as pension funds and insurance companies, not from the banks, as is sometimes erroneously claimed. When we buy a gilt, we simply credit the bank account of the seller with an appropriate sum. If the seller were indifferent between holding the gilt and holding the associated bank deposit, that is where things would stop. But because deposits tend to yield less than gilts and assets such as corporate bonds and equities, the seller is likely to want to buy some other asset instead. The consequence is upward pressure on the prices of a whole range of assets, including corporate bonds and equities. That increases the availability, and reduces the cost, of finance to corporates. It also boosts the value of people's wealth, which should encourage more spending.So, the former holder of the gilts gets credited with cash, and seeing as they can make more money elsewhere rather than hold onto the cash as cash, they invest the money somewhere else. I never would have imagined.......
This still raises the question of course of how well QE filters through to the rest of the economy. One of the explicit assumptions behind quantitative easing is that it will reduce the cost of finance for corporates, however, a characteristic of the current economy is weak business investment, even though corporate profits remain high (because corporates have been very good at cutting costs). The conclusion seems to be that the problem for corporates is not that they do not have access to finance, but that they are unwilling to make investments in the current uncertain conditions, and if this is the case, QE won't make much difference.
Interestingly for anyone who has picked up on the recent arguments that quantitative easing is affecting the value of pension payments in quite a serious way, Mr Bean has this to say:
someone with a £100,000 pension pot, who could have expected that to yield an annual pension of a little under £7,000 three years ago, would now get just under £6,000. That is a rather substantial income loss. But it is only part of the story. Those pension funds will typically have been invested in a mix of bonds and equities, with perhaps a bit of cash too. The rise in asset prices as a result of quantitative easing consequently also raises the value of the pension pot, providing an offset to the fall in annuity ratesMr Bean even goes onto say that in the long-term, the two effects will cancel each other out. Of course, in the long-term, we will all be dead.