Sunday, September 02, 2012
Quantitative easing has failed to pump up the economy
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


My regular column is available to subscribers on This is an excerpt.

The Bank of England’s monetary policy committee (MPC) meets this week, and quantitative easing will be on the agenda.

Though it is probably too soon for the Bank to add to the £375 billion it has already sanctioned - not all of which has yet been done - the City thinks there is more to come, probably in November.

If £375 billion of quantitative easing (QE) sounds a lot, equivalent to a quarter of Britain’s annual gross domestic product, some think it has not gone far enough.

Adam Posen, who left the MPC on Friday, said in an interview one of his biggest regrets was not persuading the rest of the committee to do more in 2010 and 2011.

So QE is a hot topic. Every time I give a talk, I get questions on it. People are engaged, and sometimes enraged.

What the Bank may have thought was a technical exercise has people interested, puzzled and worried. Many see it as an exercise in propping up undeserving banks, while others cannot understand why £375 billion, £6,000 a head, is not simply handed out to the public, or used for something worthwhile, like infrastructure or housing.

Others think QE is the kind of policy associated with dodgy dictatorships. When a central bank buys the debt of its own government, is it time to stock up on gold bars or move to Switzerland?

Most of these questions are quite easily answered. The Bank prefer to call QE asset purchases. It involves expanding the Bank’s balance sheet - electronically creating money - and using it to buy assets, overwhelmingly government bonds (gilts).

So far the Bank has bought just under £350 billion of gilts, nearly 39% of the total of so-called conventional stocks in issuance. It does not buy index-linked gilts.

The clue to why that money could not just have been handed out is in the name, asset purchases. The new money is used to buy gilts from pension funds, insurance companies and overseas institutions (the banks do not hold many). When QE has done its work, the assets will be sold back.

Unless households had assets to hand over, say a share of their property, there could be no equivalent policy for them. It would be a massive, unfunded tax cut.

The same applies, with a little qualification, to the arguments about infrastructure, housing or small businesses. It would have been possible for the Bank to buy infrastructure bonds, bundles of new mortgages or packaged small business loans, directing money to parts of the economy where it is needed. But the Bank is a conservative institution, and chose the least risky assets.

Buying gilts may be low risk, but is it dodgy? The figleaf of propriety is preserved by the fact that the Bank’s gilt purchases are not direct from government, or its Debt Management Office, but private holders.

It is, however, a figleaf. Many private holders of gilts are very short-term owners. There is no doubt funding a record budget deficit has been made infinitely easier by QE. A new buyer for gilts has come on to the scene when the government needed it.

Desperate times call for desperate measures, however, which is why I backed the first £200 billion of QE in 2009, though not the second round launched last autumn. The question is whether the policy has been as successful as the Bank claims.

In its most recent research, last month, the Bank looked at the effects of QE on different groups, largely to deflect criticism that it has hurt pensioners.

It identified four potential boosts to the economy. Gilt purchases give sellers money to move into other assets, including corporate bonds, equities and property.

They boost market liquidity, send a signal that interest rates are likely to remain low for longer (the Bank will not raise rates while doing more QE) and, it suggests, could boost consumer confidence.

Adding all this up, it concluded: “Without the Bank’s asset purchases, most people in the United Kingdom would have been worse off. Economic growth would have been lower. Unemployment would have been higher. More companies would have gone out of business.”

In earlier research, endorsed in its latest publication, it suggested that the first £200 billion of QE boosted the level of GDP by between 1.5 and 2 percentage points. The second round. launched last October, is not yet complete but, allowing for that, and the fact that the policy operates with a lag, suggests a total GDP effect so far, according to the Bank, of 2.5 to 3.5 percentage points.

Is this plausible? Latest official figures suggest the economy is only 2.1% above its recession low in mid-2009. The Bank’s numbers imply all that growth - and more - is due to QE. Without it, it seems, the economy would have shrunk. Tied to the fact that on current data it has shrunk in the past nine months, and the growth benefits look to be exaggerated.

In 2010, for example, Britain benefited from a strong rebound in the global economy, which grew by more than 5%, and by the turnaround in inventories - stocks - that always follows the worst phase of a recession. Every other economy began to recover in the middle of 2009, whether or not they adopted QE.

For me the simplest test is to look at what QE is supposed to do: boost the money supply. Since 2009, M4 money supply measure has risen around 5%, adjusting for financial sector deleveraging.

Though the relationship between money and other economic variables is never perfect, that does not cover the 10%-plus rise in prices in the past three years, leaving no room for a growth boost.

The Bank would say it is impossible to know what would have happened in the absence of QE. The same applies, however, to claims of its effects on other asset prices. Financial markets are international. Ascribing those rises to QE is pushing it.

If scepticism about the growth benefits of QE is in order, is it harmless? Not necessarily. At some stage the Bank will have to sell the gilts it has acquired, an exit strategy that might not be easy.

There is an inflation risk, though not a big one with the money supply so depressed. My argument has been that, though sterling is higher than when the policy first started, regular QE hints or announcements have kept it from rising more, contributing to higher imported inflation than necessary. Disappointingly, we may be seeing a re-run of that now.

The biggest problem is that markets are addicted to QE, in the way they used to be addicted to low interest rates before the crisis. If there is a bond market bubble, the Bank is helping to keep it inflated. We should be sceptical of the claimed benefits of QE. The sooner it ends, the better.