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Working Paper No. 442
The impact of QE on the UK economy —
some supportive monetarist arithmetic
Jonathan Bridges and Ryland Thomas

January 2012

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Working Paper No. 442

The impact of QE on the UK economy —
some supportive monetarist arithmetic
Jonathan Bridges

(1)
and Ryland Thomas

(2)

Abstract

This paper uses a simple money demand and supply framework to estimate the impact of quantitative

easing (QE) on asset prices and nominal spending. We use standard money accounting to try to

establish the impact of asset purchases on broad money holdings. We show that the initial impact of

£200 billion of asset purchases on the money supply was partially offset by other ‘shocks’ to the money

supply. Some of these offsets may have been the indirect result of QE. Our central case estimate is

that QE boosted the broad money supply by £122 billion or 8%. We apply our estimates of the impact

of QE on the money supply to a set of ‘monetarist’ econometric models that articulate the extent to

which asset prices and spending need to adjust to make the demand for money consistent with the

increased broad money supply associated with QE. Our preferred, central case estimate is that an 8%

increase in money holdings may have pushed down on yields by an average of around 150 basis points

in 2010 and increased asset values by approximately 20%. This in turn would have had a peak impact

on output of 2% by the start of 2011, with an impact on inflation of 1 percentage point around a year

later. These estimates are necessarily uncertain and we show the sensitivity of our results to different

assumptions about the size of the shock to the money supply and the nature of the transmission

mechanism.

Key words: Quantitative easing, money demand, monetary policy.

JEL classification: C11, C32, E52, E58.

(1) Bank of England. Email: [email protected]

(2) Bank of England. Email: [email protected]

The views expressed in this paper are those of the authors, and not necessarily those of the Bank of England. We are grateful

to various Bank colleagues, especially Mark Cornelius, Simon Price, James Talbot, Martin Weale and Robert Woods for helpful

comments. This paper was finalised on 24 October 2011.

The Bank of England’s working paper series is externally refereed.

Information on the Bank’s working paper series can be found at

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Working Paper No. 442 January 2012 25

The simulations suggest that QE has a positive initial impact on nominal asset prices of just over
20% in the central case and lowers the spread of gilt yields over Bank Rate by around 175 basis
points on impact. The nominal exchange rate response shows a slight initial appreciation
followed by larger depreciation. The depreciation is commensurate with the overall price level
impact in Chart 11b reflecting the long-run neutrality of money in the model. As a result, the
long-run impact on the real exchange rate is zero. These financial market responses lead to a
peak positive impact on the level of real GDP of around 1.5% at the start of 2010. The peak
impact on inflation is a little larger than that on GDP at around 2 percentage points and occurs in
2011. The inflation response is likely to reflect both an impact of higher spending on the output
gap and higher import prices arising from the depreciation of sterling.

The estimated impact of QE on asset prices and yields in this aggregate model look plausible
and are in line with the expected transmission of a ‘QE-like’ shock. The magnitude of the boost
to equity prices is also broadly in line with the event study findings of Joyce et al (2010). The
only responses that we would treat with caution are the exchange rate response (and the implied
impact on CPI inflation) and the relatively temporary effect on the level of GDP. As noted
earlier, a substantial depreciation in response to QE was not evident in the data, with little
movement in sterling since the onset of QE (Chart 4). But it is hard to know the counterfactual
of how the exchange rate would have behaved in the absence of QE. The event study analysis
of Joyce et al (2010), suggests that the exchange rate impact from QE was at most about half the
size of the depreciation predicted in this model. That would lead us to aim off our exchange rate
impact and, as a result, would suggest that the estimated impact on inflation is likely to be
overstated in this simulation. The lack of persistence in the GDP response is probably due to the
fact that there is a stabilising reaction of the short rate of interest after the initial period of the
shock, reflecting the average policy response to these QE-like shocks in the past. In contrast
over the QE period Bank Rate was held at 0.5%.

So as a sensitivity check we run the same shock through the SVAR but shut off the equations for
the policy rate and the real exchange rate. The inflation and GDP impacts are shown as the
dotted lines in Chart 11b. They show that the impact on GDP would initially be a little lower
but would be considerably more persistent in the medium term when interest rates do not work
against the QE impulse. And the lagged impact on inflation would be around only ½ the size of
the GDP impact once the role of the exchange rate is removed. In the longer term the GDP
response does not return to the baseline because we have switched off the stabilising role of
policy and the exchange rate. But overall this simulation does given an idea of the potential
persistence of the medium-term impact of QE on GDP when short-term interest rates are held
fixed.

Overall it is encouraging that the responses of this aggregate model to a ‘QE-like’ shock are
qualitatively in line with what we might have expected. But we are wary of attempting to
squeeze much more from these simulations. We largely view them as offering an initial guide to
the overall empirical plausibility of our hypothesised transmission mechanism of QE. The
channels of that mechanism can be explored in more detail and with more precision using our
sectoral models, where there is more scope to trace out the impact of QE in detail.

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Working Paper No. 442 January 2012 26

4.3 Sectoral models of money and spending

Although aggregate models are useful, as they allow us to look at the complete macroeconomic
response to a QE shock, the linkages between money, asset prices and spending have tended to
be clearer at the sectoral level in the UK data (see Congdon and Ward (1993), Fisher and Vega
(1993), Thomas (1997a,b), Thomas (1997b), Brigden and Mizen (2004), Chrystal and Mizen
(2005a,b),). Moreover, the fact that asset purchases initially affect the money holdings of the
financial company sector means that tracing the impact of the QE shock at a sectoral level is
likely to be revealing. We therefore also attempt to calibrate the impact of QE using a preferred
set of sectoral money models.

The key challenge with these sectoral models is that they need to be augmented with
assumptions that allow us to link the sectors together to produce an aggregate impact. The
identification method is also different to that used in the aggregate model. The models start off
as small co-integrated VARs estimated at the sectoral level. These systems are conditioned on
certain variables that are treated as exogenous to the sector for estimation purposes. Some
structural restrictions are then placed on the short-term contemporaneous relationships between
the variables. Unlike the structural VAR approach adopted in the aggregate model, it is more
difficult to identify independent ‘shocks’ at the sectoral level using theoretical restrictions.
Instead, the models are identified by placing restrictions on the short-run interactions between
the variables or on how the long-run cointegrating relationships enter particular equations. In
this sense, the aim is to identify structural ‘equations’ that have some plausible theoretical
interpretation, rather than to identify specific ‘shocks’. In the econometric literature these
models are known as structural econometric models or ‘SECMs’. This framework raises an
issue of how to introduce a QE-like shock into the system. This depends on the
exogeneity/endogeneity of money holdings in the sectoral models as is discussed below.

We use three sectoral models, one for the household sector, one for the PNFC (private
non-financial company sector) and one for the financial company sector. The key properties of
each model are briefly articulated in turn, and the model equations are listed in the appendix.12
We then discuss how the three models can be combined to produce an estimate of the aggregate
impact of QE.

The financial company sector model


The financial company sector model consists of a four-equation VAR of financial company real
sterling money holdings, real sterling asset values, the real deposit rate and a composite yield
that weights together the dividend yield of the FTSE All-Share (plus a constant 3% as a proxy
for real dividend growth) and the ten-year real zero coupon government bond yield. The
weights reflect the shares of gilts and equities in financial companies’ portfolios.

The appropriate definition of the financial company sector is a difficult one. Our preferred
measure would be to include the range of institutions that would typically hold the assets
purchased by the APF. This would include insurance companies and pension funds, asset

12 More details on the econometric approach and identification procedure can be found in Thomas (1997a,b) and
Brigden and Mizen (2004).

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Working Paper No. 442 January 2012 50

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