The secret advantage of more quantitative easing
Monetising the deficit is frowned on by many, but it could help us out of this hole
WHEN he was in Opposition, George Osborne famously condemned quantitative easing (QE) as the last resort of desperate governments. Now he is at the Treasury, it seems he can’t get enough of it.
Addressing the Conservative Party conference last week, he made it as clear as he decently could that he was looking to the Bank of England to start priming the economy again with freshly created money.
Bang on cue, the Bank obliged. On Thursday its Monetary Policy Committee announced that it will buy in another £75 billion of government debt, to add to the £200 billion stock pile it acquired two years ago when the economy plunged into recession.
In a recent report the Bank claimed that the first tranche of QE boosted growth by between 1.5 and two per cent, and resulted in interest rates that were between one and three per cent lower than they might otherwise have been. But even if the policy worked as advertised – and plenty of experts think otherwise - it proved a bumpy ride.
Homeowners and borrowers were among those who benefitted, because QE helped keep interest rates low. So did exporters, because it held the pound in check. Banks did well because they got ready cash when that was hard to come by. A chunk of it, needless to say, found its way into bonuses.
But, on the other side of the ledger, savers and pensioners were hit, and little of the extra money that QE pumped into the system ended up with small and medium-sized companies, as the authorities had hoped.
Instead, much of it leaked into commodity and other forms of speculation. This, in turn, fuelled inflation which was always the risk with QE, and which has been a special problem in this country thanks to the weak pound.
All of which raises the question: given the unevenness of its impact, should QE be limited just to buying in government gilts?
It was, after all, one of its most celebrated proponents, Milton Friedman, who postulated the "helicopter drop" theory of money, in which he considered the counter-deflationary effect if "a helicopter flies over this community and drops an additional $1,000 in bills from the sky".
A few weeks ago, in a similar vein, Peter Jay, former editor of The Economist and Ambassador to Washington, suggested in The Spectator that the government might attempt to revive the economy with an income tax holiday.
Sadly, Sir Mervyn King has yet to advocate going this far. Nor has the Federal Reserve in the US, nor the Bank of Japan, both of which also have large QE programmes. In Britain’s case the Bank has stuck almost exclusively to buying gilts, despite widespread suggestions – from Osborne among others – that it should broaden the programme to include corporate bonds and lending to small business.
But while the Bank has been condemned for its narrow approach, it does have one big advantage. Because it is highly likely that the gilts acquired by the Bank will never be redeemed, but end up being shredded instead, in effect QE is quietly but significantly cutting the national debt.
Potentially, the impact of this could be very dramatic indeed. By April next year the amount Britain owes is projected to hit £940 billion, up over 60 per cent in just three years. Knock off the £275 billion held by the Bank, however, and the total has risen by just 15 per cent over the same period.
You might have thought this was cause for celebration. But among central bankers, politicians and even most commentators, the conventional view is that once you start down this road the next stop could all too easily be inflation on a Zimbabwean level. Economists call it "monetising the deficit", and such is the stigma attached to it that even pointing out it is happening can elicit disapproval.
To which one can only reply that while inflation is above target at the moment, we are hardly expecting hyper-inflation any time soon. In the meantime, any practical way of reducing the huge liabilities we will leave to our children and grandchildren surely has to be good news.
I would not suggest that QE should be seen as a cure-all for our economic problems. Nor is it without side-effects. But taken in reasonable doses while the economy is weak, for countries like ours which need to reduce their national debt, it could turn out to be the nearest thing there is in economics to a free lunch. ·
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