Monetary Statistics, Money Supply, and Quantitative Easing Explained
This is post 9 in a series on Trading Economics: A Guide to Economic Statistics for Practitioners & Students by Trevor Williams and Victoria Turton (Wiley Finance, 2014, ISBN: 978-1-118-76641-5).
Way back in 1517, Nicolaus Copernicus wrote that money loses its value when it becomes too abundant. Yes, the same Copernicus who figured out the Earth revolves around the Sun. Turns out he also understood economics pretty well.
And that simple idea has been at the center of economic debate ever since.
Monetarism Has Been Around Forever
Here’s the thing. The idea that the amount of money floating around in an economy matters is not new. It’s been a core economic principle for centuries.
Money is how people access resources. It’s how you buy food, pay rent, invest in a business. When there’s too much money chasing too few goods, prices go up. When there’s too little, the economy stalls.
This is the heart of the quantity theory of money. It’s expressed as a simple equation:
MV = PT
- M = the money supply (how much money is out there)
- V = the velocity of money (how fast money changes hands)
- T = the number of transactions (how much stuff is being bought and sold)
- P = the price level
So the total amount of money times how fast it circulates equals the price of everything times the number of transactions. Makes sense when you think about it.
But here’s the problem. Velocity is volatile. It moves around a lot and is hard to predict. That makes using this formula for actual policy really tricky. You can control M (the money supply), but if V keeps jumping around, you can’t be sure what effect your policies will have on prices.
What Happened After 2007
After the 2007 financial crisis, money growth in the UK slowed dramatically. By the end of 2009, broad money growth had fallen below 1%. Banks weren’t lending. People weren’t spending. The money was just… stuck.
This was a huge problem. If money isn’t flowing through the economy, businesses can’t invest, people can’t buy houses, and the whole system grinds to a halt.
The Bank of England needed to do something. And the usual tool wasn’t working.
Interest Rates: The Main Tool
Normally, central banks control the economy through interest rates. Lower rates make borrowing cheaper, which encourages spending and investment. Higher rates cool things down when the economy overheats.
The UK base rate was cut to 0.5% in March 2009. That was the lowest rate in the Bank of England’s entire 300+ year history. UK monetary policy was, by any measure, the loosest it had ever been.
But even at 0.5%, the economy wasn’t recovering fast enough. You can lead a horse to water, but you can’t make it drink. Banks had cheap money available, but they weren’t lending it out.
So the Bank of England had to get creative.
Enter Quantitative Easing
Quantitative easing. QE. You’ve probably heard the term. But what does it actually mean?
Here’s how it works.
The Bank of England creates money electronically. Not printing physical cash. Just adding numbers to an account. Then it uses that new money to buy government bonds (called gilts) from financial institutions like pension funds, insurance companies, and banks.
Those sellers now have cash instead of bonds. They deposit that cash in banks. Banks now have more money on their balance sheets. In theory, they should lend more of it out to businesses and consumers.
At the same time, buying all those bonds pushes bond prices up and yields down. That makes other assets (stocks, corporate bonds, property) more attractive by comparison. So investors shift their money into those assets, pushing their prices up too. This is called the wealth effect. When people’s investments and homes are worth more, they feel richer and spend more.
The Bank of England’s QE program eventually reached a total of £375 billion. That’s a lot of money created from thin air.
The Four Channels of QE
Economists identified four main ways QE was supposed to work:
Portfolio rebalancing. When the central bank buys bonds, investors who sold those bonds need to put their money somewhere else. They buy other assets, spreading the stimulus effect across the whole financial system.
Confidence. Just the fact that the central bank is acting aggressively sends a signal. “We’re not going to let the economy collapse.” That can boost business and consumer confidence on its own.
Bank lending. Banks have more reserves. In theory, they lend more. In theory.
Exchange rate. More money in the system can weaken the currency, making exports cheaper and boosting the economy from the trade side.
But Did QE Actually Work?
Here’s where it gets interesting. QE had a limited impact on actual UK economic growth. The money wasn’t reaching the real economy.
Why? Because banks were busy repairing their own balance sheets. They’d taken huge losses during the financial crisis. Instead of lending out the new money, they sat on it. Used it to shore up their reserves. Paid down their own debts.
So the money went in at the top but didn’t flow down to businesses and households the way it was supposed to. The transmission mechanism was broken.
The Bank of England’s Fan Charts
One tool the Bank uses to communicate uncertainty is fan charts, published in its Quarterly Inflation Report.
These are basically probability distributions for future inflation and GDP growth. Instead of saying “inflation will be 2% next year,” the Bank shows a range of outcomes with different probabilities. The wider the fan, the more uncertain the outlook.
It’s actually a pretty honest way to communicate. Instead of pretending they know exactly what’s going to happen, they’re saying “here’s our best guess, and here’s how wrong we might be.”
Broad Money and Narrow Money
There are different ways to measure how much money is in an economy.
M0 (narrow money) is the most basic. Physical notes and coins in circulation, plus bank reserves held at the Bank of England. This is the actual, tangible money.
M4 (broad money) is a much wider measure. It includes everything in M0 plus all the deposits people and companies hold at banks. Your checking account, your savings account, corporate deposits. All of it.
M4 growth was extremely weak after the crisis. This confirmed what everyone could already feel: the banking system wasn’t creating enough new money through lending.
Who Holds the Money?
When economists look at money supply data, they also look at the counterparts to money. That means: who actually holds these deposits, and who’s borrowing?
You can break it down by sector:
- Households holding savings
- Companies keeping cash for operations and investment
- Financial firms holding deposits for trading and reserves
And on the borrowing side, you can see how much credit is going to each group. This tells you a lot about where the economy is healthy and where it’s not.
Money Supply and Inflation
Is there a link between how much money is in the system and inflation? Yes. But it’s complicated.
Over the long run, the relationship is pretty clear. Countries that print lots of money tend to have higher inflation. That’s basically what Copernicus said 500 years ago.
But in the short term, the connection is weak and unreliable. Money supply can grow quickly without inflation spiking, and vice versa. There are too many other variables involved: how fast money circulates, how much spare capacity the economy has, what’s happening with global commodity prices, and on and on.
Money Supply and GDP
There’s also a long-run relationship between broad money growth and nominal GDP growth. They tend to track each other over time. When the money supply expands, economic output generally follows.
But again, the short-term picture is messy. Quarter to quarter, the relationship can break down completely.
The Bottom Line
Monetary statistics matter. They tell you about the health of the banking system, how much money is flowing through the economy, and what the central bank is doing to influence things.
But they’re complex. And the 2008 crisis showed that even massive interventions like £375 billion in QE can have disappointing results when the banking system isn’t functioning properly.
QE was an unprecedented experiment. It probably prevented a much worse outcome. But it also showed the limits of what central banks can do on their own when the financial system is broken.
Book: Trading Economics: A Guide to Economic Statistics for Practitioners & Students by Trevor Williams and Victoria Turton (Wiley Finance, 2014, ISBN: 978-1-118-76641-5)
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