Question 1. Transmission mechanism of QE

Explain the transmission mechanism by which QE leads to higher spending in the economy.

Question 2. Impact of QE on balance sheet

Explain the link between QE and quantities of money. Draw Figure 3 on a separate sheet to supplement your explanation.

Question 3. Two misconceptions about how QE works

a) Explain why the extra reserves of commercial banks in the third row of Figure 3 are not free money for banks.

b) As you answered in Question 1 above, the transmission mechanism of QE aims to increase private spending directly, rather than aiming at increasing bank lending by providing more reserves to the banking system. Explain why the extra reserves of commercial banks in the third row of Figure 3 are not multiplied up into new loans and broad money (bank deposits plus cash)?

Figure 3 Impact of QE on balance sheets(a) Before asset purchase After asset purchase Pension fund Assns Liabilitles Other Deposits debt Central bank(b) Assets Liabilitles Government debt Assets Reserves Reserves Other assets Commercial bank Liablities Liabilities Reserves (a) Balance sheets are highly stylised for ease of exposition: quantities of assets and liabilities shown do not correspond to the quantities actually held by those sectors. The figure only shows assets and liabilities relevant to the transaction. b) Government debt is actually purchased by the Bank of England's Asset Purchase Facility using a loan from the Bank of England, so does not actually appear directly on the Bank's official consolidated balance sheet. Figure 3 Impact of QE on balance sheets(a) Before asset purchase After asset purchase Pension fund Assns Liabilitles Other Deposits debt Central bank(b) Assets Liabilitles Government debt Assets Reserves Reserves Other assets Commercial bank Liablities Liabilities Reserves (a) Balance sheets are highly stylised for ease of exposition: quantities of assets and liabilities shown do not correspond to the quantities actually held by those sectors. The figure only shows assets and liabilities relevant to the transaction. b) Government debt is actually purchased by the Bank of England's Asset Purchase Facility using a loan from the Bank of England, so does not actually appear directly on the Bank's official consolidated balance sheet