The objection is sometimes raised that the major holders of gilts are pension funds and insurance companies, and they will not "spend" the extra money in the shops. But the big long-term savings institutions are reluctant to hold large amounts of money in their portfolios, because in the long run it is an asset with negligible returns. At the end of 2008 UK savings institutions had total bank deposits of about £130 billion. They will be reluctant to let the number double, but — if the £150 billion were allowed to pile up uselessly — that would be the result. 

What is the likely sequence of events? First, pension funds, insurance companies, hedge funds and so on try to get rid of their excess money by purchasing more securities. Let us, for the sake of argument, say that they want to acquire more equities. To a large extent they are buying from other pension funds, insurance companies and so on, and the efforts of all market participants taken together to disembarrass themselves of the excess money seem self-cancelling and unavailing. To the extent that buyers and sellers are in a closed circuit, they cannot get rid of it by transactions between themselves. However, there is a way out. They all have an excess supply of money and an excess demand for equities, which will put upward pressure on equity prices. If equity prices rise sharply, the ratio of their money holdings to total assets will drop back to the desired level. Indeed, on the face of it a doubling of the stock market would mean (more or less) that the £150 billion of extra cash could be added to portfolios and yet leave UK financial institutions' money-to-total-assets ratio unchanged. 

Secondly, once the stock market starts to rise because of the process just described, companies find it easier to raise money by issuing new shares and bonds. At first, only strong companies have the credibility to embark on large-scale fund raising, but they can use their extra money to pay bills to weaker companies threatened with bankruptcy (and also perhaps to purchase land and subsidiaries from them). 

In short, although the cash injected into the economy by the Bank of England's quantitative easing may in the first instance be held by pension funds, insurance companies and other financial institutions, it soon passes to profitable companies with strong balance sheets and then to marginal businesses with weak balance sheets, and so on. The cash strains throughout the economy are eliminated, asset prices recover, and demand, output and employment all revive. So the monetary (or monetarist) view of banking policy is in sharp contrast to the credit (or creditist) view. Contrary to much newspaper coverage, the monetary view contains a clear account of how money affects spending and jobs. The revival in spending, as agents try to rid themselves of excess money, would occur even if bank lending were static or falling. 

Photo: PA Photos