The ECB has said that it has mechanisms in place that can be used by banks to access liquidity should they need it, but this does not involve new QE.

Policymakers say they can use (higher) rates to control inflation while utilizing the balance sheet to cope with the sort of financial instability seen recently, with seemingly no conflict between the two. However, this may depend on how the balance sheet is utilized.

To show this, we should prove whether quantitative easing (QE) can be regarded as a means to increase monetary growth and similarly whether quantitative tightening (QT) reduces monetary growth. We cited BoE member Tenreyro’s argument that QE (or QT) is an asset swap with no consequences for monetary growth. Instead, QE acts through the interest rate channel, as it produces lower rates than would have otherwise existed.

Mr. Steve Barrow, Head of Standard Bank G10 Strategy, doesn’t disagree with much of this. But the problem is that if it is argued that quantitative easing works through the interest rate channel, then using the central bank’s balance sheet to ease financial strains via quantitative easing is potentially different from other ways of using the balance sheet that are not expected to have a bearing on rates. In other words, using QE to temporarily ease financial strains, as the Bank of England did back in September and October to cope with gilt market and pension industry strains, can interfere with the thrust of monetary policy when there is a need to lift rates to bear down on inflation.

If we look at other central banks that have used their balance sheets to ease financial strains, such as the Fed and the SNB, they have not done so through re-starting quantitative easing or even stopping quantitative tightening (in the Fed’s case). Instead, the Fed, for instance, introduced a new facility, the Bank Term Funding Program (BTFP), whereby it loans banks cash for up to a year against collateral that is valued by the Fed at par rather than the true market value. It is a measure that does not have a clear implication for lowering rates in the same way as QE.

The ECB, as well, has said that it has mechanisms in place that can be used by banks to access liquidity should they need it, but this does not involve new QE. Of course, the Bank of England could argue that the gilt purchases last September and October were very temporary and that it faced a problem specific to the gilt market, which is unlike the banking strains we have seen more recently in the US and Europe.

However, in Mr. Steve Barrow’s view, it is not a question of how long the bank held the gilts (which was just over three months) because the benefits of lower rates resulting from QE stem largely from the signaling effect of the policy, not the duration of the holding. In other words, this temporary QE did effectively ease policy through the interest rate channel, something that was in conflict with the rate hikes that the Bank has been doing to lower inflation back towards target. Having said all this, were the amounts involved and the likely rate reductions that resulted sufficient to dramatically alter the stance of policy? Put another way, did the bank really compromise its fight against inflation by having to undertake this action?

Probably not. However, that may have been due to the fact that other policy changes, such as the rescinding of egregious tax cuts in the September mini-budget, helped steady the ship alongside the renewed QE. "Looking ahead, if banking systems fracture some more in the US and/or Europe and central banks are forced to use their balance sheets to steady the ship via QE, then we’d be extremely suspicious of any claims that they are keeping monetary policy and financial stability operations separate", said Mr. Steve Barrow.