Transcript Bank of England * Outright Purchases

BANK OF ENGLAND – OUTRIGHT
PURCHASES
27/05/2011
Guillermo Infante
Universidade de São Paulo
Technische Universität
Berlin
BANK OF ENGLAND’S
MISSION
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Core Purpose 1 - Monetary Stability
Monetary stability means stable prices and
confidence in the currency. Stable prices are
defined by the Government’s inflation target,
which the Bank seeks to meet through the
decisions delegated to the Monetary Policy
Committee.
Core Purpose 2 - Financial Stability
Financial stability entails detecting and reducing
threats to the financial system as a whole. Such
threats are detected through the Bank’s
surveillance and market intelligence functions.
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The inflation target
The inflation target of 2% is expressed in terms
of an annual rate of inflation based on the
Consumer Prices Index (CPI).
Interesting remark
The remit is not to achieve the lowest possible
inflation rate. Inflation below the target of 2% is
judged to be just as bad as inflation above the
target. The inflation target is therefore
symmetrical.
BANK RATE - CHAIN OF ECONOMIC
EFFECTS
HOW TO PROCEED IN TURBULENT TIMES?
WHAT TO DO IF THE BANK RATE IS ALMOST
ZERO AND THE ECONOMY CONTINUES TO
STRUGGLE?
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The BoE can increase the quantity of money – in
other words - injects money directly into the
economy.
That process is sometimes known as ‘quantitative
easing’.
The MPC makes its decision independently of the
government.
OUTRIGHT TRANSACTIONS
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They refer to the operations where the BoE buys
or sells securities outright (on the spot) in the
market. Such operations are not reversible and
have permanent effect in the money market
liquidity.
An outright transaction implies a full transfer of
ownership from the seller to the buyer with no
reverse transaction.
PROVIDING LIQUIDITY =
OUTRIGHT PURCHASE OF SAFE SECURITIES
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Outright purchases are used to provide liquidity
to the greater economy.
The BoE buys assets and pays them outright (on
the spot) with new created money. This newelectronically created money is deposited in the
commercial bank of the former owner of the
asset. This money can now be transformed in
consumption of goods, investment, or it can stay
“idle” in the bank, helping to restart the proper
functioning of the credit system.
QUANTITATIVE EASING - CHAIN ON ECONOMIC
EFFECTS
WHAT DID THE BOE CREATE TO FIGHT THE
RECESSION?
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extended the drawdown window for new debt under the
Government’s Credit Guarantee Scheme (CGS) which is
designed to reduce the risks on lending between banks;
established a new facility for asset backed securities;
extended the maturity date for the Bank of England’s
Discount Window Facility which provides liquidity to the
banking sector by allowing them to swap less liquid assets;
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established a new Bank of England facility for purchasing
high quality assets;
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offered capital and asset protection scheme for banks, with
proposals for this to be co-ordinated internationally;
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clarified the regulatory approach to capital requirements,
through an announcement by the Financial Services
Authority (FSA)
WHY DID THE BOE PROCEED WITH THE
OUTRIGHT PURCHASES OF FINANCIAL
ASSETS?
Creates excess reserves, boosting the economy
 Brings long-term yields down
 Eases the bank’s capital constraints
 Improves the funding liquidity situation of the banks
 Supports the funding liquidity of the issuing
institutions
 Supports secondary market liquidity
 Supports new issuance activity and refinance of the
real sector
 Supports asset prices
 Compresses spreads
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WHICH ASSETS CAN BE BOUGHT WITH THE
ASSET PURCHASE FACILITY “APF”?
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The Bank is currently purchasing three different
types of high-quality assets through the APF:
investment-grade commercial paper;
 investment-grade corporate bonds;
 UK government bonds (gilts).
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Other assets, such as paper issued under the
Credit Guarantee Scheme, syndicated loans and
certain types of asset-backed securities are also
included on the list of assets that are eligible for
purchase by the APF, and could be considered in
due course.
IN FINANCE: THE QUICKER, THE BETTER
The Bank buys assets from private sector
institutions (insurance companies, pension
funds, banks or non-financial firms) and credits
the seller’s bank account. So the seller has more
money in their bank account, while their bank
holds a corresponding claim against the Bank of
England
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Table A above summarizes the amount of assets
that the Fund has purchased and sold each week
of 2011 Q1
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Chart 1 shows the cumulative asset purchases by
type since the establishment of the Fund. As at
31 March 2011, cumulative assets purchased
totalled £200 billion.
THE EFFECT ON THE BOE BALANCE SHEET
The Bank can create new money electronically by increasing the
balance on a reserve account. So when the Bank purchases an asset
from a bank, for example, it simply credits that bank’s reserve
account with the additional funds. This generates an expansion in
the supply of central bank money.
CHALLENGES CONCERNING OUTRIGHT
PURCHASES
Isn’t liquidity only created if the haircuts on
private papers purchased are very high?
 What is the correct size of an outright purchase
program?
 Can the Central Bank build up the necessary
expertise and risk management capabilities?
 Isn’t the Central Bank paying too much for an
asset due to the illiquid market?
 How can the Central Bank define the eligible
universe of securities that can be purchased?
 What is the best purchase technique?
 Isn’t the Central Bank distorting the prices?
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THANK
YOU!