Government Bond Purchases Under Quantitative Easing: Understanding Sovereign Debt
Quantitative Easing (QE) has been a tool used by central banks globally to manage the economy during times of financial crisis. One of the key components of QE involves the central bank purchasing government bonds, which raises an important question: Are these purchases considered as a part of sovereign debt?
GOVERNMENTS AND QUANTITATIVE EASING: A NEEDED POLITICAL MANEUVER
Yes, by the government concerned, these transactions are counted as sovereign debt. Governments have their reasons for this, especially when it comes to the potential risks of revealing that they are using 'money printing' to finance their expenditures. Money printing is a politically acceptable method for bailing out banks and boosting government funds, making it a preferred approach for financing certain operations.
QUANTITATIVE EASING AND SOVEREIGN DEBT
Bonds purchased by central banks under quantitative easing programs still remain sovereign debt. In the UK, for example, these purchases are conducted by a subsidiary of the Bank of England known as the Asset Purchase Facility Fund (APF).
APF functions by borrowing money from the Bank of England and using it to buy government bonds from the secondary market, supplemented with a small amount of corporate bonds. The Treasury pays interest on these bonds to APF, much like any other lender. APF then uses this income to pay back the money it borrowed from the Bank of England and cover its operational costs. Any remaining profit is returned to the Treasury, after retaining a small buffer. In 2016, APF remitted around ￡13 billion to the Treasury.
Although the APF has successfully reduced the government's borrowing costs and increased liquidity in the gilt market, it has not diminished the overall stock of debt. Currently, APF holds about a quarter of all UK government debts, approximately ￡400 billion. As the APF winds down, bond yields and overall borrowing costs in the economy are expected to rise, and other asset prices will also adjust. This process is similar to what is occurring in the USA, where the Federal Reserve has taken an earlier lead.
US DEBT: SOVEREIGN DEBT BY DEFINITION
United States debt, by definition, is 'sovereign debt.' Quantitative Easing is fundamentally a fiscal issue that pertains to the money supply. When the Federal Reserve purchases federal debt with banknotes, it injects cash into the economy. This action increases the base money supply (Mo) and allows the economy to function at lower interest rates. If the Federal Reserve did not buy Treasury debt, the money supply would decrease, leading to higher borrowing costs and reduced economic activity.
Quantitative Easing, therefore, plays a critical role in managing liquidity and interest rates, thereby supporting the economy. It is an unconventional monetary policy that aims to stimulate the economy when traditional methods are not effective. The Federal Reserve's role in purchasing debt is a key part of this strategy. However, as with any economic tool, it has its limitations and can have unintended consequences, such as inflation or reduced interest rates.
CONCLUSION
In conclusion, while quantitative easing involves the central bank purchasing government bonds, these transactions are still considered sovereign debt. This is true for both the UK and the USA. Understanding the mechanisms and impacts of quantitative easing is crucial for comprehending the broader economic landscape and the strategies employed to manage it.