Saving up

The deadline for written submissions to the Treasury Select Committee’s inquiry into the effectiveness and impact of post-2008 monetary policy is on Sunday. They put out a call for thoughts a few months ago with a very long list of very open-ended questions some time ago, and the very first one on the list is really interesting.

Their first question concerns “the effectiveness of holding Bank rate near zero and whether extremely low rates can encourage more, rather than less, saving”.

My first thought was that the UK parliament is contemplating following Turkish President Erdogan into the realms of neo-Fisherism. This would be quite a thing.

My second thought was the IPSOS cross-country survey that ING commissioned and analysed a little over a year ago about attitudes to saving in a low or negative rate environment. I found this pretty fascinating stuff. And even if it didn’t deliver a knock-out blow to the conventional notion that lower interest rates discourage rather than encourage savings in aggregate , it did find a considerable minority (14.5%) of UK consumers saved more in response to falling interest rates (although this proportion was much lower than the 27% who indicated that they had reduced saving in response to lower rates). The sample size is small, it lacks a time-series, is democratically rather than plutocratically-weighted. As such it is hard to draw from it sufficient inference to overturn the notion that lower rates would reduce saving/ increase borrowing or the inverse. But still.

 

My third thought though was my kids. I have blogged about the Nangle household bank twice before. My 7 year old ‘target saves’ for big ticket items, using compound interest to his advantage. If I cut rates would he save more or less? As I was on a train I put out a quick ten minute Twitter poll (to test your views on the matter). This is what I got back:

(Although Lorcan did also advise me to ditch this idea altogether.)

Most of the tiny sample of people replying reckoned lower rates = lower saving. This is how stuff tends to work in the real world, right? Lower rates encourage borrowing over saving. But my kids can’t borrow at an interest rate; they can only save at one. They literally ‘save up’ for things rather than debt-finance their spending ambitions. And the interesting thing is that they are not the only ones. In fact, I reckon that I could make the case that the group of people ‘saving up’ in the UK is bigger than it has ever been. And almost all of them are, like my 7 year old, are target savers, accruing savings for a big ticket item.

Two distinct and pretty large cohorts of people who are engaged in saving-up spring to mind.

The first cohort consists of those for whom credit is unavailable by design. This cohort includes highly creditworthy agents seeking to purchase items for which credit is not available (eg, housing, vehicles, plant) due to the lending appetite of lenders, and the macroprudential environment. If you’re a Millennial a few years out of university working in even a highly paid job and like the idea of buying a flat, you are probably in this category. Also in this category are people deemed so uncreditworthy by all lenders that no one will lend to them. Lower rates seem likely to increase savings and reduce borrowing for these agents as they are forced to save up rather than access finance.

Macroprudential regulation has the effect of changing the size of this cohort of agents for whom lower rates means more saving up rather than more consumption. As house prices have risen (partly due to low rates) and macroprudential policy has impeded mortgages from being advanced at ever-higher multiples of salaries, so prospective home-purchasers (first time-buyers and those moving up the housing chain) will be required to save up to a greater extent than in previous times. The chart below from @resi_analyst  shows the level of first time buyer deposit required as a proportion of their disposable income, calculated using the Council of Mortgage Lenders median loan to value and median loan-to-income ratios. It’s an amazing chart. Saving up is clearly a more central aspect today than it may have been in previous times among aspiring homeowners.

First time buyer deposits required as a proportion of disposable income

first-time-depo

The second cohort is those for whom credit will never be available no matter the macro prudential environment owing to the thing for which they are saving up. This cohort consists of people who want to generate a specific retirement income that they can look forward to spending. With the private sector defined benefit system a shadow of its former self, and retirement *the biggest lifetime purchase, bigger than a house* this cohort is probably large and growing.

This isn’t market failure, it’s just a thing. No lender is going to lend money to someone on an uncollateralized basis specifically so that the borrower can stop working (forever) and go spend their borrowed money  (although there is a market for heavily-over-collateralized lending designed to be repaid upon death). And so, for these folks, lower rates (and associated bond, dividend and rental yields that come from higher asset prices), will likely increase savings and reduce borrowing. Bottom line: these folks are forced to save up more than they would otherwise as rates fall to generate the same target retirement income. Or they could alternatively invest in riskier assets in the hope of getting higher returns, or adjust down their retirement ambitions through some combination of less time spent in retirement or lower income in retirement.

Savings rates tend to be higher amongst those in the two decades before retirement, in preparation for retirement. This cohort is better paid and so outsized economic influence per individual, and is larger in relation to the general population than it has been. Furthermore, the defined benefit pension system is meaningfully less-inclusive than it has been in previous periods, potentially leading to a change in savings behaviours. As such, we can speculate that the impact of lower rates in forcing higher levels of saving in this cohort is higher today than it would have been in previous times. The chart below is an elementary effort to capture the changing saving habits required over time to purchase a private pension income equivalent to 40% of median salary over time. As interest rates have fallen so required savings rates for ‘saver-uppers’ have increased, and at an economy-wide level the level of saving up is further boosted by the ageing demography.

Level of target savings required to deliver private income of 40% of median income in retirement[1]

saving-up

There is in addition a third group that is large and unstable in the form of defined benefit pension scheme sponsors, some of which sit in the camp of ‘saver-uppers’ who must save more as rates fall, and some of which sit in the camp of agents that can access borrowing who can save less as rates fall. The potential requirement of a pension fund-sponsor to ‘save-up’ for the retirement of its workers is contingent upon the market’s perception of its expected longevity. Businesses with a long-expected life can borrow from future profits to fund the retirement needs of past and current workers. Businesses with an uncertain life-expectancy will be unable to borrow to fund the short-fall at attractive rates, and will need to increase saving – and increasingly so in a lower rate environment. The shift towards a lower rate environment itself, given the unavoidable system-wide mismatch of pension fund assets and liabilities from an actuarial and accounting perspective, has increased the number of institutions sponsoring defined benefit pension schemes in deficit, a proportion of which have an uncertain life-expectancy.

So where does this leave me? With more questions than answers I’m afraid. How large and important are these different groups in the UK financial landscape, and to what extent are their actions swamped by the opposite actions of others? If they are important, what is the relative importance of: a) the combination of high house prices and macro prudential policy caution; b) the decline of the private sector defined benefit pension system; c) the demographic bulge working its way through the UK’s population pyramid. Is this all just another way of calling long-dated bonds a Giffen Good?

And my 7 year old? What did he do when I cut the Nangle household bank rate? Well in the end I didn’t. In matters of parenthood, as in matters of Eurosystem financial plumbing, it’s worth listening to what Lorcan says.

 

[1] This required level of saving is based on an age-indiscriminate savings rate, that savings are into annuity-purchase products, and that that inflation-linked annuity rates can be proxied by nominal long-dated Gilt yields.

LDI and the Efficient Market Hypothesis – my fictional pub chat with John Ralfe

A couple of weeks back I wrote a work piece about asset allocation. John Ralfe (@JohnRalfe1) sent a mini-Tweetstorm response and invited me to have public discussion about it on Twitter. I think that this would be better done over a pint in a pub, but since John doesn’t actually live in London and I wasn’t proposing to get on the train to Nottingham I’ve written this blog.

Given that my initial piece was a work thing (as opposed to a personal blog thing) I’m not going to go into it here, although you can easily read it on my employer’s website. It is basically an outline of how strategic asset allocation processes tend to operate, and active asset allocation can prospectively operate under forthcoming Local Government Pension Authority reform. Real Friday night stuff.

But John’s critique of it is not actually dependent upon the piece’s contents, so don’t worry about reading it to make sense of this blog. I understand John as instead wanting to critique the very notion that defined benefit pension funds should make ever asset allocation decisions.

For folks of you not familiar with John, he has quite a reputation in the world of institutional pension management. As former head of corporate finance for Boots (the biggest pharmacy chain in the UK) in the early noughties he was credited for shifting Boots’ pension assets out of equities and into bonds in an effort to match estimated liabilities with cashflows from fixed income securities (I am hazy on the detail, and you should ask him). This made headlines in not only trade press but mainstream press. As a 26 year old fixed income fund manager I followed the whole thing with great interest. Everyone in the industry did. Importantly, I understood his call to shift assets not as a call on the likely returns from the equity or the bond market, but rather a decision that Boots as a sponsor of a large pension fund should not be making calls on the likely returns from the equity and bond markets – even over very long investment horizons. Instead, they should be taking risks in its area of expertise (pharmacy retailing, and associated businesses).  The development of pensions regulation, invention of the Pensions Regulator and the Pension Protection Fund, the development of accountancy rules (think FRS17, IAS19 etc), and the frankly unreliable and volatile risk markets has led to the mass popularisation of this approach in the UK. I have met many a company finance director expressing the desire to want to get pensions out of the boardroom, and some of my day job involves helping them do so. So while it may not be technically true, I think of John as the founding father of LDI – Liability Driven Investment – in the UK.

LDI is a mammoth thing in the UK – so mammoth that anyone with a remote interest in finance or financial markets without a passing understanding of it should probably read up to familiarise yourselves with it. I draw a horribly crude thumbnail sketch in paragraphs below, but this is a very readable, short non-technical overview. In fact, as I’ve argued here the conditions that have led to its success are sufficiently mammoth a thing that they need to be considered when contemplating non-traditional monetary policy in the UK.

Around about the time that John invented LDI (or at least brought into the mainstream), markets were experiencing what we now refer to as the dotcom crash. This was accompanied by accountancy scandals at Enron, Worldcom, et al that ultimately brought about the dissolution of Arthur Andersen – one of what were the big five global accounting firms. Equity markets were all over the place and the vast bulk of UK defined benefit pension schemes were thrown into massive deficits. Why were they thrown into deficit? To answer this we need to step back and ask of what a defined benefit pension actually consists. The answer to this question has (I believe) changed from a legal perspective over the decades, and has ultimately landed as a form of deferred pay that ranks pari passu with senior unsecured creditors (this off-the-top-of-my-head legal definition is complicated by the creation of the PPF a few years back, and I’m happy to insert a snappy more correct definition of the legal status of someone’s defined benefit pension assets not yet in payment).

Firms that have promised to pay their retired ex-staff monthly payments until death don’t know the exact size of the final bill for which they have put themselves on the hook. They employ actuaries to estimate the size and timing of likely future payments that they have promised to make. Changes in the actuaries’ estimates of likely mortality developments will impact their assessment of payment sizes and timings; financial market volatility will not. Reasonable actuarial estimates of these likely payments can be huge for individual companies. Mega-humongous-huge for the UK in aggregate.

And so it would be weird if accountants didn’t want to represent within the financial statements of a firm some clues pertaining to these often very sizeable liabilities. But rather than reflecting the terminal (estimated) value of liabilities (eg, I owe Deborah £100 fifty years from now if she doesn’t first die), accountants decided that a more sensible approach would be to reflect the estimate of terminal liabilities discounted using market interest rates, so arriving at the present value of liabilities. So instead of showing that I owed Deborah £100, the accounts would show that I owed Deborah around [£100/(1+50yr bond yield)^50] which, when using a yield of 5% equates to me owing Deborah £8.71. This may sound barmy, but if I were to put £8.71 into a fifty year zero coupon bond at a yield of 5% I would get back £100 in fifty year’s time – just in time to pay off my debt to Deborah. So the accountants thought this a sensible approach, and put this way it does sound pretty reasonable.

What has happened in recent years is that bond yields have fallen (with my understanding of structural drivers of bond yields outlined here). Furthermore, bond yield declines have been most substantial during equity market falls (think flight to quality, anticipation of lower interest rates and lower inflation in forthcoming years due to the disruption associated with financial market crisis, etc). So using the example of my debt to Deborah, let’s say that 50yr bond yields fall from 5% to 3%, the present value of the debt I owe Deborah will have risen from £8.71 to £22.81. It is important to note that the amount I owe Deborah hasn’t changed (it is still £100), but the liability reflected in financial statements will have grown almost three-fold due to changes in market rates used to turn terminal values into present values. By discounting terminal values (estimated by actuaries) back to present values, accountants could present stakeholders with a fair picture of firms’ financial health in a manner consistent with the efficient market hypothesis which won Eugene Fama his Nobel prize.

Getting back to pension schemes being thrown into massive deficit by the dotcom crash, we can see that while the terminal value of pension liabilities did not change (ok, they did go up a bit as actuaries have for many years increased their life-expectancy expectations) the present value of liabilities shot up as bond yields fell, and – for funds that chose to invest in equities rather than cashflow-matching bonds – asset values fell. Falling assets and rising liabilities made for a toxic mix, the result of which has been wholesale closure of defined benefit pension schemes, the diversion of large amounts of corporate income into financial assets in order to begin to plug the deficit (especially in an environment which saw the birth of the Pensions Regulator and Pensions Protection Fund in the UK). Here’s a picture of the ongoing death of DB pensions from the Pension Regulator’s excellent annual Purple Book :

Screen Shot 2016-03-10 at 22.29.00

Meanwhile Boots pension funding levels would have been largely unaffected by falls in yields and falls in equity markets from the point at which it did the asset switch. It had largely closed down the mismatch between accountants’ estimates of the present value of actuaries’ estimates of ultimate cashflows payable to defined benefit pensioners by buying long-dated cashflows (in the form of fixed cashflows associated with bond coupons and principal payments). So while the accountants’ estimates of the present value of liabilities soared, so the value of assets also soared as bond prices rose (both being a function of long-dated yield collapse).

This has been a long preamble, and could have been skipped if John and I had met in the pub. Despite it being long I have skipped any discussion of real rates versus nominal rates (more than a little important), and a whole host of other real life (but complicating from a blog perspective) issues/ factors. But we have to move on to John’s Twitterstorm that he has since asked me to answer (a few times).

Here it is in text, with links to the original tweets embedded:

1 “Strategic Asset Allocation”, as correctly applied to an individuals fund, is a category mistake when applied to a DB pension fund @toby_n

2 A DB pension fund is not a self contained economic entity, but simply part of the capital structure of the sponsor @toby_n

3 Asset/liability mis-match in DB pension fund changes capital structure & increases financial risk for sponsor just like gearing @toby_n

4 If a sponsor wants to increase gearing, then directly borrow – transparent & tax efficient – not indirectly thro DB fund @toby_n

5 If a sponsor believes in “SAA” in DB fund, then borrow long term debt & buy financial assets & explain why to shareholders @toby_n

As you can see, it’s an entirely reasonable position from the founding father of LDI in the UK. And John makes very strong points that it would be silly to refute if one accepts his premises (which I have tried to relate in paragraphs above but may have got wrong, and with no John in pub, hard to know). Furthermore, his premises (if these indeed are his premises) are tricky to theoretically refute, rooted as they are in Nobel prize-winning stuff. The issues I have with John’s position (and the whole LDI edifice) can probably be summed up in a rambling question and a couple of observations.

My question:

Given that LDI is a hedge against changes in an accountant’s present value calculation of an actuary’s estimate of terminal cash flows, what is the best way to judge the correct price of this hedge; or rather, is it ever possible to overpay for this hedge, and if so, what tools would I need to employ to understand whether I was overpaying?

I have written about this before in relation to whether house prices (as an effective hedge) can ever be too expensive. I don’t have a definitive answer, but I suspect that hedges can be too expensive and asset prices can be wrong (and have bet my career on this suspicion). But I don’t observe anything in the LDI approach to help frame this judgement. Instead I understand it placing what looks to be an intolerable burden on the efficient market hypothesis to determine that a hedge must always be appropriately priced. In other words, this approach lends itself to the conclusion that it is impossible to overpay if you are paying the market price, no matter what the market price.

This leads on to my two observations:

  1. The size of UK defined benefit liabilities is larger than the market of physical hedging instruments on a duration-weighted basis.* Simply put, while it might be theoretically possible for  DB funds to collectively go down the LDI route, (an practically possible for some of them to go down the LDI route), it is not practically possible for them to collectively so do. This will be of surprise to no one working in UK fixed income markets, but surely throws doubt on the idea that pension funds seeking to hedge liabilities can do so without distorting the price of that hedge (seeming to undermine a central tenet behind the use of the efficient market hypothesis by accountants and actuaries).
  1. While fixed rate assets can be used to match accountants’ estimates of actuaries’ estimated liabilities, this is true because of the tautological construct. And as such while I accept that the LDI approach will be the very best possible hedge against my accountants’ estimate of my actuaries’ estimates of my liabilities, I am not convinced that the reality of the tautology should define the investment structure of pension fund assets in the UK (especially given observation 1 above, and my unwillingness to believe that it is impossible to overpay for a hedge). Fixed rate corporate bonds, equities, and commercial property are all just claims on corporate profits. Despite all being but claims on future profitability/ future economic activity, only one of these claims has any place in a full LDI construct. That just seems odd to me.

If I was having my pint with John rather than answering his Tweetstorm in this overly-long blog, I would expect he would parry by repeating point 2-4 (which are super-strong points). And I would probably repeat my question and observations. And I genuinely don’t know what would happen after that. I’m fairly sure that neither of us would change the other’s mind. But I also hope that we would emerge the wiser about the other’s position (and perhaps even with enhanced respect for each other’s position). Hence the interest in the pint.

 

 

* I should share my extremely back-of-envelope workings so that they can be properly challenged.

The Pension Regulator’s annual Purple Book indicates that UK private sector DB pensions have combined liabilities on a buy-out basis of £2.1 trillion. They also say that a 10bps fall in Gilt yields increases these liabilities by 2%, inferring a duration of around 20yrs.

Let’s look at how much UK fixed income duration exists that might be used to match these liabilities. (Yes, I know that most LDI is done synthetically, but can’t get away form the idea that the duration has to reside somewhere. This may be my fatal gap in understanding.)

First, let’s take the entire stock of UK fixed income securities (as represented in the BAML Broad Sterling Market UK00 index). This has a face value of £1.47 trillion, but a market value of £1.78tn and a duration of 10.2yrs. Leaving aside curves in our hunger for UK duration *of any description* let’s call this £908 billion of 20yr equivalent duration paper.

And let’s add on to this the entire stock of inflation-linked Gilts with a market value of £540bn and a duration of 12.4yrs and call this another £335bn of 20yr equivalent duration paper. Summing these together we get to £1.24 trillion of 20yr duration equivalent paper.

What about the missing £857bn of 20yr duration securities that needs to be bought so that DB pension funds can cashflow match? It doesn’t look like it exists.

John Ralfe has written a reply here that you should have a read of. 

Printing clever weird stuff … aka money

The ECB is warming up to engage in quantitative easing this quarter. Again the newspapers will be filled with stories of money printing. And so it seems an opportune time to again ask ‘what do we mean by money printing?’

The phrase appears pretty self-explanatory, but kind of assumes that we know what money is. But we all do know what money is, right? It is possible that I was late this. So I thought it might be worth skimming through some basics with respect to what money actually might be in case anyone else has become a bit confused along the way. Then a bit on what money printing is. I apologise in advance.

First of all, there is not just one sort of money, but two: Inside Money and Outside Money. The distinction is not trivial.

Inside Money is private sector money endogenous to the financial system; it constitutes the vast majority of what we tend to think of as money (c£1.7tn in the UK if we exclude things that probably need to be excluded), but is more handily remembered as ‘stuff’ that is kept inside banks, and can never ever ever leave them. This is because Inside Money is short-term tradable bank debt (often also known as a bank deposit) effectively sitting on a series of giant interconnected spreadsheets. Put another way, most of what people understand as their own money is just a massive series of interconnected spreadsheets. People will give you real-life things in exchange for you instructing your bank to reduce the number in your spreadsheet cell and increase the number in your counterpart’s spreadsheet cell, but it would be a bit silly to think you could take the actual numbers out of the spreadsheet.

Outside Money on the other hand is stuff that looks like stuff we tend to refer to as money: banknotes with physical form, (but also bank reserves, more on which later). Outside Money is more handily remembered as stuff that can exist outside of banks although most of this stuff still only exists on spreadsheets. How much Outside Money is there in the UK? There are about £70bn notes (and coins), and another £300bn in reserves (spreadsheet Outside Money that only banks can own) in the last weekly Bank of England return (although there are a few other things on the balance sheet that might also qualify, taking the total up to maybe c£400bn).

The trick that any functioning banking system needs to pull off is to make these two sorts of money appear utterly interchangeable (when in fact they are oil and water). Or as Ha-Joon Chang pithily puts it ‘banking is a confidence trick (of a sort), but a socially useful one (if managed well)’. I agree.

What sort of money is being printed when central banks quantitatively ease? Outside Money. Outside Money is the liability of a Central Bank (and HM Treasury), that is to say, like Inside Money, it’s a sort of debt. Crucially, it is a liability of a State that is short-term rather than long-term. It’s short-termness defines its moneyness. What do I mean by short-term? An overnight deposit would be short-term obligation of the State. A ten-year government bond on the other hand would be a long-term obligation of the State.  (The weird thing about the short-term obligations is that they are repayable only in themselves. But don’t get too hung up on this quite yet.)

In fact money, whether Inside or Outside, will always be someone’s debt. If you have deposits at a bank, you are on the creditor of the bank. If you have notes and coins in your pocket you are a creditor of the State. As long as not everyone tries this together your bank should be able to redeem its debt to you (ie, pay you back the Inside Money that you have on deposit in the form of Outside Money) without notice. But in a fiat money world, the state never needs to pay you out. This might make Outside Money sound like a bad deal (forgetting for a moment that Inside Money is in some ways just a sort of ersatz Outside Money).

So what is Outside Money actually good for?

  1. The quick answer is paying taxes. Having a heavily-armed State threatening to exercise its monopoly use of violence against you to extract payment in a currency of its choosing concentrates the mind. Taxes are debts that are invented by the State in a manner that its controllers see fit (the People, the political classes, the Autocrat, whoever). They can be progressive or regressive, life-enhancing or otherwise. But by projecting debt unto the people, the State projects a widespread and regular demand for its Outside Money into an economy.
  2. The long answer is society.

I think that this is pretty amazing.

Secondly, how do Central Banks print this money?

In straightforward quantitative easing (as opposed to quantitative and qualitative easing as seen in Japan) they buy government bonds from people/ firms/ agents. In so doing they take a long-term tradable debt security (aka a bond) out of the market, exchanging it for bank reserves (a Central Bank deposit of sorts). (NB, if financial intermediaries are using these bonds as collateral – that is to say in money-like ways – things possibly get complicated.)

And given that money is always a debt (and it is), we can see that by engaging in quantitative easing, a Central Bank exchanges one State debt (a long term government bond) for another (bank reserves) without actually increasing or decreasing the total debt of the State. What has occurred? The maturity of the State’s debt has been changed.

So money-printing doesn’t change the amount of State liabilities out there, it just shortens their maturity profile. Does this create refinancing risk? I would argue not, given that Outside Money is at once short-term (eg an overnight Central Bank deposit rather than a 10 year government bond) and perpetual (eg unredeemable in anything other than itself). Outside Money is clever weird stuff.

Finally, in saying that QE ‘just’ changes the maturity profile of government liabilities I am not intending to diminish it. Unlike private debt (issued by non-financials to fund expenditure within a household budget constraint), monetary sovereigns issue debt to monetarily sterilise their fiscal expenditures. That is to say that they sell government debt not because they need the money to finance government expenditure but because they don’t want quite so much Outside Money with which they have paid civil servants, government contractors, benefit recipients etc, sloshing around the system, and so they effectively mop it up by selling government bonds. Government bonds cannot be used in quite the way that overnight Outside Money can be (again, assuming that they aren’t used as collateral.) And so quantitative easing represents the desterilisation of past fiscal deficits – no more no less. But perhaps that’s for another day.

 

PS: Yes, I know that all the above is only questionably applicable to the ECB given that there is an ambiguity over what Inside Money is and what Outside Money is in the Eurozone. This rolling ambiguity is actually an essential characteristic of the Eurozone monetary crisis.

Why is the Debt Management Office no longer part of the Bank of England?

Click-bait of a title, I know. 10.25pm on a Sunday night too. But now that I have scared any potential readers away, I can get down to saying something that I think is quite interesting (without worrying whether it is sufficiently interesting). And it sort of relates to QE.

As a recap, it is worth reflecting (yes, again) on how QE works. While it is only possibly true that no-one knows, it is certainly the case that there is uncertainty and disagreement amongst the principal architects. As Bernanke quipped “the problem with QE is that it works in practice but it doesn’t work in theory”.

I have seen three main competing/ complimentary explanations as to how QE might work which are rather clumsily assembled on the diagram below:

Over the past month the Bank of England has published a couple of empirical studies on what effect a couple of these channels had. The first, on the portfolio balance channel (basically the belief that in buying gilts, the Bank would effectively force institutional investors into riskier assets) which most Central Bankers have relied on in public to articulate the mechanism through which QE translates into easier monetary condition, found that pension funds and insurance companies had increased corporate bond holdings and cash while reducing both gilt and equity holdings versus a counter factual simulation of their behaviour absent QE. This finding doesn’t dismiss the portfolio balance channel, but I read it as a statement that it was pretty disappointing versus the Bank’s expectations.

The second, on the bank lending channel, was pretty dismissive as to any potential empirical support. In the authors’ own words ‘we find no evidence to suggest that QE operated via a traditional bank lending channel’.

This leaves two possible transmission mechanisms: a confidence/ signalling effect, and Everything Else We Don’t Yet Understand (EEWDYU).

One could be forgiven for thinking that Mario Draghi has put in the hours in order to prove that signalling is what it is all about. After all, he delivered the most seismic easing in monetary conditions that Europe has seen in the last decade simply by deploying the phrase “whatever it takes” with a conviction few could doubt. But Europe’s inability to sustain an economic recovery to match its financial market recovery from the depths of the Eurozone crisis puts the idea that signalling is *all that* in doubt.

People seem pretty united around the idea that QE works. So, forgetting how QE might work for a second, let’s recall what QE is. It is basically a massive debt swap, exchanging long-term liabilities (aka gilts) for short-term government liabilities (aka high powered money). This is the case whether we think QE works via the portfolio balance effect, bank lending channel effect, confidence/ signalling effect or EEWDYU. In other words, if QE was worth doing, managing the term structure of the government’s liabilities appears to be a big deal.

Who is responsible for managing the term structure of the government’s liabilities? The UK Debt Management Office – an institution that used to be part of the Bank of England run by charming and capable professionals with whom I might be (I hope only temporarily) unpopular on account of my (very sensible) suggestion that they refinance the War Loan (which I recognise would be an administrative hassle for them although a very good thing for people keen to reduce the national debt and HMT interest payments).

There is also the possibility that QE actually made absolutely no difference whatsoever and has been a massive red herring.

So here’s the thing. If QE works through some mechanism other than a confidence/ signalling effect the rationale for splitting the DMO from the BoE appears defunct. Is it time for a reunion?