Central banks, led by the Fed, are expanding their range of tools for supplying liquidity to markets and promoting financial stability.

Some of these interventions have no impact on either the monetary base - currency in circulation and bank reserves held at the central bank - or broad money supply measures. Actions that expand the base may be termed "quantitative easing". The expression "printing money" should be reserved for interventions that directly boost the broad money supply. (These are my suggested definitions - economists often use the terms interchangeably.)

In theory, an increase in reserves held at the central bank encourages banks to expand their lending, thereby boosting broad money. In practice, however, many other factors also influence banks' lending behaviour, resulting in large swings in the "money multiplier" - the ratio of broad money to the monetary base.

With banks currently under pressure to raise capital ratios, and able to obtain wholesale funding only on expensive terms, a rise in the monetary base is unlikely to feed through to an expansion of bank lending and broad money. "Quantitative easing" may therefore provide limited support to financial markets and the wider economy - "printing money" is required.

Various central bank actions are classified below according to their impact on monetary measures, with more radical interventions lower down the list.

The Fed employed sterilised lending (1) until Lehman's failure in September but subsequently embarked on quantitative easing (2). Last week’s news that it would buy $600 billion of securities issued or guaranteed by government-sponsored enterprises implies printing money - either (3) or (4). If the full amount announced is bought from non-banks, money supply M2 would rise by 8%, other things being equal.

This shift was confirmed this week by Fed Chairman Bernanke's suggestion that the central bank "could purchase longer-term Treasury or agency securities on the open market in substantial quantities". If Fed buying of Treasuries substituted for debt sales to non-banks, this would amount to "underfunding" the budget deficit (5). Fed purchases used to finance an expanded deficit would be equivalent to Milton Friedman's "helicopter drop" of money (6).

Japan's policy of quantitative easing in 2001 targeted the monetary base but involved the Bank of Japan buying Japanese government bonds (JGBs) so it also resulted in an expansion of broad money - (4) below. In the year from March 2001 the BoJ bought ¥29 trillion of JGBs, equivalent to 4.5% of Japanese M2. (Some of these may have been purchased from banks, implying a smaller monetary impact.)

The ECB and Bank of England have engaged in quantitative easing since September - see chart - but neither central bank is yet printing money. The statement accompanying the MPC's latest interest rate cut hinted at further market interventions but it is unclear whether the Bank is yet ready to copy the Fed’s recent initiatives.

1. Sterilised central bank lending to banking system
Example: Fed lends to commercial bank via discount window, simultaneously reduces conventional repo loans to banking system
Result: no impact on broad money or monetary base

2. Unsterilised central bank lending to banking system
Example: As above, no offsetting fall in repo loans
Result: bank reserves and monetary base expand - "quantitative easing"

3. Sterilised central bank purchase of securities from non-banks
Example: Fed buys mortgage-backed securities from insurance company, simultaneously reduces repo loans
Result: broad money expands - "printing money"

4. Unsterilised central bank purchase of securities from non-banks
Example: As above, no offsetting fall in repo loans
Result: broad money and monetary base expand - "printing money / quantitative easing"

5. Sterilised central bank lending to government to finance existing budget deficit
Example: Fed lends to Treasury, Treasury reduces debt sales to non-banks, Fed reduces repo loans
Result: broad money expands - "printing money / underfunding"

6. Unsterilised central bank lending to government to finance higher deficit
Example: Fed lends to Treasury, Treasury cuts taxes
Result: broad money, monetary base and incomes expand - "printing money / quantitative easing / helicopter drop"

The MPC delivered the full-point cut expected by the market but the accompanying statement suggests its focus is shifting towards additional Fed-style interventions to improve money and credit flows. This would be a welcome if belated change and could imply Bank rate has reached a temporary floor at 2%.

With market conditions still “extremely difficult” despite the government’s financial support package, “the MPC noted that it was unlikely that a normal volume of lending would be restored without further measures”. Hopefully, this means the Bank of England emulating recent Fed actions designed to improve credit availability and boost the money supply rather than forcing banks to expand lending under threat of nationalisation.

The statement justified the rate cut with reference to the below-target inflation forecast in the November Inflation Report, weak activity data and further falls in commodity prices. The recent plunge in sterling was downplayed, as was the substantially weaker fiscal position revealed by the Pre-Budget Report. Indeed, the statement claims that “the new fiscal plans are unlikely to have a significant effect on inflation” over the longer term, despite the risk of an explosive rise in government debt.

With full data now available, both my MPC-ometer and ECB-ometer models suggest rate cuts tomorrow of 50 basis points, though with risks tilted towards more.

Models can break down under extreme conditions. Markets are priced for a full-point UK move and 75 bp from the ECB. It would take a brave central bank to disappoint expectations under current circumstances.

At least in the UK’s case, however, the model’s suggestion that a 50 bp cut is sufficient appears sensible given the 200 bp move in the prior two months, a 7% decline in the effective exchange rate since the November meeting and massive fiscal loosening announced in the Pre-Budget Report (with plans for later tightening predicated on a highly-optimistic economic forecast).

A headline-grabbing big cut in Bank rate may give the impression that the MPC is “doing something” but efforts would be better focused on direct actions to boost money and credit growth, including “underfunding” and Bank of England purchases of private paper. In the US, the Fed’s initiatives in this direction are bearing fruit, with narrow money M1 picking up and the three-month LIBOR / OIS spread of 180 bp well below the UK level of 250 bp.

Reflecting fears of financial meltdown, UK savers withdrew cash from bank and building society accounts at a record pace in October. According to Bank of England data published today, households’ M4 money holdings fell by £5.2 billion, compared with an average rise of £5.6 billion over the prior 12 months. The cash withdrawn from banks appears to have been reinvested mainly in National Savings products and Treasury bills, which attracted £4.7 billion and £12.3 billion respectively – also records.

Other key features of the detailed monetary data for October include:

• M4 excluding money holdings of financial corporations slowed to an annual growth rate of 3.6% – the lowest since 1993.

• In addition to the decline in household deposits, M4 holdings of non-financial private corporations fell again, to stand 5.2% lower than a year before. This suggests ongoing severe pressure on profits – likely to be reflected in significant cuts in jobs and investment.

• Consistent with anecdotal evidence of a reduction in credit availability, bank borrowing by non-financial corporations grew at an annualised rate of just 2.4% in the three months to October, compared with a 10.7% rise in the prior year.

• Narrow money M1 – currency plus instant-access deposits – fell by 1.8% in the year to October, the largest annual decline since 1969. This compares unfavourably with recent trends in the US and Euroland, where M1 has been picking up.

• Banks replaced traditional interbank loans with purchases of bills issued by other banks and backed by the government under the Credit Guarantee Scheme. Market loans to other banks fell by £34.2 billion in October, while purchases of bank bills soared to £17.5 billion.

• The estimated spread between the average interest rate received on banks’ and building societies’ M4 lending and the rate paid on M4 deposit liabilities – a proxy for their net interest margin – fell slightly to a new low. Banks need a wider margin to enable them to rebuild capital to support higher lending.

The monetary data confirm a grim near-term economic outlook and warrant a further rate cut at this week’s MPC meeting. However, calls for Bank rate to fall quickly to 1% or even lower are questionable. Considerable stimulus is already in the pipeline in the form of the 2 percentage point reduction since September, a 17% fall in sterling's effective rate over the last year and a projected rise in cyclically-adjusted public borrowing of 4.3% of GDP in 2008-09 and 2009-10 combined. The authorities’ efforts should now focus on improving the transmission mechanism and taking direct action to lift money and credit growth. Specifically, the Debt Management Office could fund the deficit partly by borrowing from banks, boosting M4, while the Bank of England could emulate the Fed by buying commercial paper and mortgage-backed securities, thereby easing credit supply.