My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.
It is more than six years since the Bank of England launched quantitative easing (QE) and more than three years since it last actively did any. But QE opened up a Pandora’s box, and it may be only now that we are seeing the consequences of that.
The Labour leadership candidate Jeremy Corbyn has talked of a “QE for the people”, in which the Bank would print money to pay for infrastructure and other projects. Some economists have picked up on an idea, “helicopter money”, originally attributed to Milton Friedman but floated again by Lord (Adair) Turner a couple of years ago, in which in the event of a downturn – or even in the absence of a downturn – the Bank would print money in an open-ended way to finance the budget defciit, and perhaps to hand out to households.
It was perhaps inevitable that a policy which appears to magically conjure up money out of thin air, which can then be used to boost the economy, risked being the first step on a slippery slope. The Bank, in my view, could and should have done more to prevent that from happening.
Let me elaborate, starting with a brief account of what the QE undertaken by the Bank QE is and what it was meant to achieve.
QE was launched in March 2009, the moment the MPC reduced official interest rates to an all-time low of 0.5%. That was when it launched its asset purchase programme (its name for QE); buying assets, overwhelmingly British government bonds – gilts – using newly created “money”. “Money” in this case means, not cash, but central bank reserves. The new “money” is not costless. Interest has to be paid, at Bank rate, on the reserves created.
Over a 10-month period in 2009-10, the Bank created £200bn of such reserves and used it to purchase £200bn of assets. This was not, as is often wrongly thought, part of the bank bailout programme. The assets were largely bought from pension funds and insurance companies, as well as foreign investors in gilts.
QE in 2009 was hard not to support. I certainly did. This was an emergency “all hands to the pumps” period, when the economy needed rescuing. The institutions which sold assets to the Bank used the proceeds to buy corporate bonds, equities (shares) and other assets. This ensured that businesses, particularly larger ones, could access capital markets to keep going, and fund growth.
The key effect of QE was to reduce long-term interest rates. Cutting Bank rate to 0.5% had reduced short-term rates. Asset purchases reduced long rates – significant for investment – and also lowered the spread between government bond yields and those on other long-term investments. Not only did QE make it possible for larger businesses to raise money, bypassing the banks, but it made it cheaper for them to do so.
There were other routes QE boosted the economy, boosting confidence, signalling to the market the Bank was prepared to do whatever was necessary and improving liquidity. It may have helped keep sterling down. The effects of that first £200bn were significant. The Bank estimated it boosted GDP by between 1.5% and 2% and, when there were worries about “bad” deflation – falling prices due to weak growth – it pushed up inflation by 0.75 to 1.5 percentage points.
There were two important things about 2009’s QE. It was fully reversible. The gilts the Bank bought meant that it has assets alongside the reserves it created. When the gilts are sold back into the markets, or allowed to run off as they mature, the “money” created – will also be wound down.
The other is that it was undertaken very much in emergency circumstances, which was why I was less enthusiastic about the second wave of an additional £175bn of QE, which began in the autumn of 2011 and lasted well into 2012. You could argue that with the euro apparently on the brink of falling apart, hitting confidence and growth in Britain, this was also an emergency. But it was less pressing than in 2009.
So what about Corbyn’s “People’s QE” and helicopter drops? I am not sure how serious the Labour leadership candidate is about the policy. It may be a way of diverting discussion from some of his other policies, which I will look into in more detail in coming weeks. Certainly, he does not seem to know a lot about it.
Responding to questions on Radio 4’s World at One a few days ago, he described QE as a £325bn (sic) “loan” to banks, and suggested part of that loan instead should go towards the setting up of a new National Investment Bank, promising to establish a commission to investigate.
In his speech The Economy in 2020 he talked about People’s QE as “one option, under which the Bank would “be given a new mandate to upgrade our economy to invest in new large scale housing, energy, transport and digital projects”. The other option was to slash what he described as £93bn of “huge tax reliefs and subsidies” and fund infrastructure spending that way.
There is nothing new about what some of Corbyn’s supporters think of as a slightly different kind of “People’s QE”. A few years ago I used to get lots of e-mails from advocates of “Green QE” who said the Bank should invest in green projects rather than in the banks. I pointed out to them that QE was not about the banks and that to work, these green projects would need to be funded by the issue of government-backed bonds, which the Bank could buy if it chose to. Issuing these government-backed bonds to fund spending would, of course, add to government debt.
The twist in the People’s QE debate, from Corbyn’s supporters if not yet from him, is that the Bank would be compelled to buy bonds issued by a National Investment/Infrastructure Bank, and not just in emergencies. Compelling the Bank to undertake this kind of QE would kill Bank independence, one of Labour’s proudest achievements. Unless there was a commitment to sell these bonds back, the policy would be irreversible. It would be a strange and roundabout way of doing things, destroying the Bank’s reputation on the way.
Helicopter money would have a similar effect. Handing out cheques to households would clearly be irreversible. The Bank would not take any assets in return. It would have huge liabilities on its balance sheet, but no offsetting assets, requiring the Treasury to keep it keep it solvent. As David Miles, the outgoing MPC member, put it to me last week: “When people say helicopter drop, what they mean is, why doesn’t the government run a larger fiscal deficit?”
An article by Fergus Cumming, a Bank official, on the Bank’s new “blog” site says any extra boost from helicopter money “is either non-existent or comes with a sky-high price tag”. If Lord Turner was suggesting it in his interview to be Bank governor ahead of Mark Carney’s appointment, I can understand why he did not get the job.
That said, you can see why these ideas are around. When the Bank launched QE in 2009, it did not expect to be stimulating a debate six years later. In my view it could have done more to head it off. While the MPC’s reluctance to raise interest rates has been clear, there was no strong reason why it could not have begun to move away from “emergency” policy by selling off in the past couple of years some of the gilts it acquired in 2009-10 and 2011-12.
Had it done so even passively, not reinvesting the proceeds when the gilts it has on its books mature, then including its latest decision it could have run down the stock of gilts it has by around £52bn. But it has decided not do so before raising interest rates.
As for rates, the longer they are kept at 0.5%, the more the clamour will grow for experiments such as People’s QE and helicopter money in the event of the next downturn. The common feature of these is the belief that you can have money for nothing. Sadly, it is not true.