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Quantitative Easing

Hi,

I'm studying using the Osborne Books and want to clarify my understanding of how Quantitative Easing works.

The book states: "The aim of Quantitative Easing is to increase the amount of money circulating and being spent in the economy directly, through purchases by the Bank of high quality assets, mainly gilts (Government Stock) from private sector institutions, financed by the creation of central bank reserves. For example, when the Bank purchases £100 million of gilts from an insurance company, it credits the company's bank account with £100 million."

My understanding is that if a gilt is government stock then the Bank of England buying a gilt means they are lending the government money. But the book states that the Bank (Bank of England) purchases £100 million of gilts from an insurance company and credits the company's bank account with £100 million; so in this example, the insurance company is receiving the money, not the government. I don't understand the link between the insurance company and the government:
  1. 1/ Are gilts purchased via private sector institutions such as insurance companies? I thought that it was the Government departments who wanted the funding issued the gilts eg 'Treasury 4% 2016.'
  2. 2/ Is the insurance company acting as an intermediary between the Bank of England and the Government?
  3. 3/ If the insurance company is receiving the money, how is this providing lending to the Government?
I'm confused about how this links together; can anybody clarify please?

Comments

  • PeterCPeterC Registered, Tutor Posts: 214
    The insurance company buys the gilts from the government, via market makers

    In the insurance company's accounts:
    Dr Gilts a/c £100m
    Cr Bank (Bank of England) a/c £100m

    Then the Bank of England buys the gilts from the insurance company

    In the insurance company's accounts:
    Dr Bank a/c £100m
    Cr Gilts a/c £100m

    The insurance company has got its money back and can use it in the economy

    Magic!
  • BiscuitBiscuit Registered Posts: 6
    Thank you @PeterC
    I think I've got this now:
    So it's the insurance company buying the gilt from the government as opposed to the Bank of England buying the gilt from the Government.
    The insurance company buys the gilt from Government, so the government has money it can use in the economy; in turn, the Bank of England then buys the gilt from the insurance company, as you say, the insurance company now has its money back and can also use this in the economy. The Bank of England can do this because it is creating money.
    I suppose gilts are used because they are backed by the Government making it low risk. Quantitative Easing needs to have low risk securities so that the money can keep going around the economy. Thinking this through, if high-risk securities were used such as corporate bonds, there is the risk of a company becoming insolvent and losing the money; so no benefit to the economy.
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