Guest Commentary: Time to Call Time on More QE
It is hard not to feel some sympathy for my former colleagues on the Bank of England Monetary Policy Committee. The UK economy is being buffeted by a wide range of global economic forces over which they have little control – including the euro crisis and volatile oil and commodity prices. Growth has been disappointing and inflation too high.
This is in large part a reflection of the “New Normal” facing western economies as we grapple with the legacy of the financial crisis and the stresses and strains arising from the shift in the balance of economic power to the Asia-Pacific region and emerging markets.
In a different world – which existed before 2007 – it might have been right to respond to these threats to economic growth by providing extra monetary stimulus. But now that is not the right policy, and in my view it was a mistake for the MPC to return to its policy of Quantitative Easing (QE) last week.
First of all, the MPC has already injected a large amount of monetary stimulus into the UK economy since the financial crisis. The official Bank Rate has already been at a rock bottom level of 0.5% for over three years. This is not only the lowest rate of interest we have seen in modern times. It is much lower than the 2% rate set in the Great Depression of the 1930s and is the lowest official rate set by the Bank of England in its 300-plus year history.
In addition to these exceptionally low interest rates, the MPC has already sanctioned the injection of £325bn of new money into the economy through earlier rounds of QE – over £12,000 for each UK household. If these highly stimulatory monetary policies were going to be effective in lifting the economy back into sustained growth, we might have seen more benefits by now.
Second, the financial and economic circumstances are much less conducive to QE having an impact than was the case when the policy was first launched in 2009. QE involves the Bank buying bonds from the financial sector and hence one of its key influences on the economy is through the price of bonds and the yield they return. With bond yields now at very low levels, the policy is likely to have much less traction than when it started in 2009 – and may create other financial distortions.
Another way in which QE boosted the economy in 2009 was the “shock and awe” effect on confidence in financial markets and more generally as the Bank of England pulled out all the stops to turn the economy round. QE no longer has this impact and the muted response of financial markets last week shows that.
Third, even if the latest round of QE was effective, it would push up inflation in the UK. This is openly acknowledged by the MPC which still sees the main threat in terms of inflation being below the official 2% target. In my view, their preoccupation with below-target inflation is totally misplaced. Instead, we should welcome the prospect of inflation falling below the official target which would help ease the squeeze on consumer spending in a low wage growth environment. With the exception of a few brief episodes, UK inflation has been above target now since mid-2005. This inflation over-run has been equivalent to a cumulative squeeze on real living standards and consumer spending of 8% - close to £3,000 per annum for each UK household.
Finally, there is an increasing risk that continued injections of QE are creating an unsustainable position for the UK economy which will damage our growth prospects in the future. The larger the pile of government bonds that the Bank of England accumulates, the greater the difficulties which could arise in selling them back to the market. Other potentially negative impacts are the effect on the returns available to long-term savers and pension funds. Larger pension fund deficits will create a bigger drain on corporate finances and a prolonged period of very low interest rates cuts the income and consumption of pensioners and other long-term savers.
QE was probably effective in helping to turn the UK economy around in 2009 and halting a spiral of declining confidence and business activity. But to move the economy forward over the longer-term, we need a different set of policies. And we need monetary policy to build confidence that inflation will be low and stable. By taking risks with inflation, further QE undermines rather than builds this confidence .
There may be scope for the Bank of England to support the economy in the short-term in other ways – for example through the initiatives to ease constraints on bank lending announced last month at the Mansion House. And there are other ways in which the government can support growth – by easing the burden of business regulation, reforming the tax system, and by taking other steps to improve the employment and business climate here in the UK. It is these policies which should be the main focus now – and we should call time on further injections of QE.
Written by Dr. Andrew Sentence, former Bank of England Monetary Policy Committee member
Further commentaries are available from http://www.sentance.com/ or @ASentance on Twitter.
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