Sunday, March 10, 2019
Quantitative easing worked, just don't make a habit of it
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.

How time flies. It is hard to believe that it is 10 years since the Bank of England brought an entirely new type of monetary policy, for Britain at least, blinking into the sunlight. Quantitative easing (QE), a complicated name for something that many people do indeed find complicated, was launched then and is still with us.

The misunderstandings then were considerable. When the policy was launched in March 2009 Mervyn King, now Lord King, did a television interview with the then BBC economics editor Stephanie Flanders, to try to explain it.

His mission to explain was not helped by some hysterical comment. Though the worst offenders have often got the economy wrong, some predicted that the Bank’s initial tranche would lead to doom, disaster and hyperinflation, which was wrong on all three counts.

This is, however, a good time to look at QE, and not just because of the anniversary. The experiment, and experiment it was, may be coming to an end.

Theresa May, herself a former Bank official, said in her now notorious first party conference speech as prime minister in October 2016, the “citizen of nowhere” one, that QE had had “some bad side effects”. It had enriched people with assets and made those without them suffer, she said. Those in debt had benefited while those with savings had suffered. A flabbergasted Mark Carney was ready to hop on to the next plane to Canada.

The prime minister, not for the first time, got it wrong. QE was launched, with an initial £200bn in 2009, followed by a further £175bn in 2011-12 and a final (so far) £60bn in August 2016. It was done because, at the time, Bank rate had been cut to what was then the rock bottom of 0.5%, and that was deemed to be not enough to steer the economy away from deflation, falling prices, and towards a sustained recovery.

It worked, then as more recently, by ensuring that the drop in short-term interest rates – Bank rate – to a record low, was accompanied by a fall in long-term rates. Large-scale purchases of government bonds raised their prices and lowered their yields; the yield on government bonds, gilts, feeding through to lower long term interest rates throughout the economy.

There was no deflation, which was the great worry in 2009, and the recovery, while by no means strong in its early years, took hold and lasted. It did not lead to hyperinflation or, indeed, to very much inflation at all. There was no double-dip recession. As a policy which contributed to getting the economy off the sick bed, QE has to be seen as a success.

Nor is the criticism of QE, that it benefited the wealthy “haves” at the expense of the have-nots, valid. Bank researchers looked in detail at this last year, using official data for the distribution of wealth. It found that percentage gains from the policy were “broadly similar” across households and that, while those at retirement age saw the biggest increases in wealth, younger people benefited from stronger incomes. Andy Haldane, the Bank’s chief economist, said that the policy “did not have significant adverse distributional consequences”. The adverse distributional consequences were, as the research shows, more imagined than real.

So what should happen to QE? Central banks in recent weeks have been executing, if not handbrake turns, then at least important shifts in direction.

America’s Federal Reserve, which a few weeks ago was on course to persist with its strategy of raising interest rates, has entered a period of pause. It is still unwinding its QE, to the tune of $50bn (£38bn) a month but may come under pressure to pause that too.

The European Central Bank, which called a halt to its QE at the end of last year, on Thursday announced a downgrading of its growth forecasts and revived a policy intended to make cheap funding available to the banks, so-called TLTRO, targeted longer-term refinancing operations. Markets were a bit spooked by its announcement.

The Bank has also scaled down its interest rate language, partly because of Brexit, partly a slower global economy. It may not now raise interest rates this year, and at 0.75% Bank rate is half the level at which it would begin to unwind its QE. A no-deal Brexit would in all likelihood lead to lower interest rates and possibly more QE.
QE then, is very much still with us and, indeed, the assets purchased under it will be sitting on central bank balance sheets for some time to come. It is there to be used again.

But, despite the record, in future it should be used very sparingly, if at all. It should be kept for emergencies and their aftermath, not as a routing tool of monetary policy.

This is because of the danger of the slippery slope towards genuine magic money trees. For some people, the fact that central banks could electronically create money out of thin air offered just too much temptation.

It spawned a range of imitations which, unlike QE, were never properly anchored, and which were often promoted by people who did not understand the original. QE was kept honest because it is reversible; once the assets purchased under the policy are sold off, the money created to purchase them is cancelled. Over the long-term the policy is neutral.

The variations on QE are, however, not. “Helicopter money”, the idea of which became popular in the wake of QE, involved the equivalent of a helicopter drop of money on every household in the country. It is the equivalent of using monetary policy, and newly created money, to provide the kind of cash handout which is normally the preserve of fiscal policy. It is unanchored.

“People’s QE”, once favoured by Jeremy Corbyn – it may still be – involved the same sort of process but with the money created used to finance infrastructure projects. It can be made honest, if the money created was used, for example, to buy tradeable infrastructure bonds. But many of its proponents did not envisage that such a step was needed.

Then there is what many regard as the ultimate magic money tree, modern monetary theory (MMT). Though this was invented in the 1990s, before the recent wave of QE, it has increased in popularity, particularly among the left in America.

It argues that countries with their own sovereign currency and central bank, and a floating exchange rate, face no constraint on the size of budget deficit they can run, because the central bank can create the money needed to cover it. If that creates inflation, then taxes have to rise to rein it back. But inflation, not the deficit itself, is the constraint on policy.

A furious row has broken out in America, notably between conventional Keynesians such as Paul Krugman and Larry Summers, and the MMT crowd.

The fact is, however, that nobody would be even giving MMT a hearing were it not for the QE experiment undertaken by central banks over the past 10 years. That is as good a reason as any for locking QE away in a cabinet marked “only break glass in case of emergency”.