Sunday, October 09, 2011
The wrong kind of easing for Britain
Posted by David Smith at 09:00 AM
Category: Thoughts and responses

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My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.

In the last few days we have had a big additional burst of £75 billion of quantitative easing from the Bank of England, backed up by Sir Mervyn King’s observation that this may be the “most serious financial crisis ever”. We also had, from George Osborne, a desire for credit easing but no hint of any fiscal easing.

Official statisticians have revised up the level of gross domestic product, while also saying the recession was deeper and the recovery weaker than previously thought. Puzzled?. All will become clear.

Let me start with quantitative easing (QE). For weeks I have been arguing against it, though never rising to the rhetorical heights of Ros Altmann, director general of Saga, who said it was “like launching the Titanic”. If you believe King, it was because of fear of Armageddon.

My arguments can be briefly summarised. This is not 2009, when the first £200 billion of QE was launched. King may know something we do not but September purchasing managers’ surveys suggest an economy that grew in the third quarter.

Inflation, meanwhile, is heading for 5% and, while the Bank says it will drop sharply, its record is poor. The Bank’s announcement pushed down the pound, which will push up inflation.

Most of all, it is questionable whether it will have much effect. The Bank, in its assessment of the programme so far, calculated that it boosted the economy by between 1.5% and 2% through a range of channels, including monetary effects and confidence. Many economists believe, however, the main route was via lower yields on government bonds (gilts).

When the Bank was contemplating QE last time, yields on 10-year gilts were close to 5%. Its decision last week was taken with yields at less than half of that, at 50-year low, and plainly with less scope to fall. The Bank may be firing blanks.

It has already told the markets the full £75 billion of QE will be in gilt purchases. There is still something uncomfortable about a government issuing lots of debt openly encouraging the Bank to buy it up, as George Osborne was doing last week. QE, crucially, does not boost bank lending.

The deed is done on QE, which brings me to credit easing,. In his letter to the governor giving permission for QE (which he has to authorise), the chancellor repeated his hit line from the Tory conference, that he had asked the Treasury to explore options for improving credit to small and medium-sized enterprises (SMEs).

Quantitative easing is intended to boost the quantity of money in the economy. Credit easing is intended to boost the flow of credit. They should be interchangeable but are not. I am much keener on the latter, having first written about it back in April 2008 and returned to it frequently.

Then the issue was the drying up of mortgage lending. From the start of 2009 it became the slump in lending to SMEs, which is what I have been writing about more recently. How do you address it? Put simply the Bank, on behalf of the Treasury, agrees to buy bundles of SME loans.

If the problem is funding such loans in markets, having an official buyer would overcome it. If the problem is confidence, an official buyer would ease investor worries about buying such securities.

So the chancellor’s commitment to explore credit easing was welcome but has to overcome a lukewarm Treasury and a hostile Bank. It is also very late. SME lending has been falling nearly three years.

Even if a plan is put in place it will be next year before anything happens. I would have loved to have seen the Treasury and Bank working together to get lending to where it is needed. I would love to have seen the Bank announce that it is ready and willing to buy up bundles of SME loans. Sadly it is not happening. Any credit easing will merely “complement” QE. A pity.

Is the recovery happening? As I promised last week, the Office for National Statistics has rewritten history. It has done so, however, in a way few expected.

All the headlines were grabbed by downward revisions to growth this year to 0.1% in the second quarter (form 0.2%) and 0.4% (from 0.5%) in the first. Take in the 0.5% snow-related fall in the final quarter of last year and there has apparently been zero growth in the past nine months.

I would not be too concerned about those figures, which are too recent to have undergone significant revisions. The really surprising thing was, according to the ONS, the economy shrank by 7.1% in the recession, rather than the 6.4% thought. That is hard to square with the employment figures and the message from the surveys but so be it, for now at least.

The other news was that growth in the 2000s - before the crisis - was revised up. As Michael Saunders of Citi points out, cumulative growth from 2001 to 2007 is now put at 21.1%, compared with 17.9% before. That is why, despite a deeper recession and a slower recovery, gross domestic product now is higher than we thought.

The revisions confirmed why GDP data are hopeless for short-term policy decisions. Now we know that in summer 2008, when the Bank was dithering about cutting rates, the economy was dropping like a stone, by 1% in the second quarter. At the time it was reported as a 0.2% rise.

The recovery is now estimated to have begun in the third quarter of 2009, as many of us said at the time. Then, it was apparently refusing to recover at all. Maybe this is for the nerds. But it is important. We do not get the numbers we need.

What those numbers tell us now, however, is also important. Consumer spending, down 0.8% in the latest quarter, is in recession; no higher now than in 2005.

It is my strong view that while some of that reflects the squeeze on real incomes from the government’s fiscal tightening, notably the Vat hike, the overwhelming majority is from the unintended income squeeze from high inflation. The recovery needs rising consumer spending. It will not rise as long as incomes are so squeezed.

In announcing more QE the Bank said it was more likely inflation would undershoot its 2% target in the medium-term. That is not good enough. It needs to be certain of an undershoot. A sustained period of high inflation needs to be followed by a long period of below-target inflation to restore real incomes. Easing that squeeze is the easing the economy really needs.