Quantitative easing: To print or not to print? The battle rages
The decision to do more QE last week has split the City. Ex-MPC members Sushil Wadhwani and Andrew Sentance slug it out
Sushil Wadhwani: Yes
The Bank was right to ease policy, but remains behind the curve. As my colleague Mike Dicks and I have said for some time, using the money to buy gilts is unlikely to be very effective.
The Governor's arguments that the Bank "has no democratic mandate to put taxpayers' money at risk" is unconvincing. After all, it is doing precisely that every day it fails to deliver a recovery.
The case for easing is overwhelming. On consensus forecasts, by the start of 2013 – a full five years after the financial crisis began – UK GDP looks set to be still 3.5 per cent shy of its previous peak. Measured relative to its pre-crisis trend, the shortfall in GDP looks set to be a staggering 15 per cent. Even if the financial crisis has been associated with some fall in potential output, there must nevertheless still be significant spare capacity – which will bear down on inflation.
With core inflation already almost spot on the Bank's inflation target, and wages falling in real terms, it is hard to take the inflation doomsayers seriously. What is needed is an aggressive and effective boost to aggregate demand. This week's decision to add £50bn to the stock of QE was a small step in the right direction. But, although such purchases may have helped lower bond yields, the Bank is too optimistic about the impact of this on growth in an economy that is stuck in a Keynesian "liquidity trap". The Bank needs to be innovative and do more than just buying gilts.
We welcome the new "funding for lending" scheme announced by the Chancellor and the Governor at the Mansion House, although it is a pity the Bank agreed to it belatedly. It would have been rather more effective, say, two years ago – when businesses were less gloomy about the longer-term outlook. The Bank must continue to experiment. It might make a start by, for example, a purchase of equities and mortgage-backed securities and a cut in Base Rate to 0.25 per cent or even to zero.
We have previously suggested a scheme whereby each eligible individual in the UK receives a voucher to spend as they wish – a practical expression of the textbook "helicopter drop". It would represent a one-off fiscal stimulus that would not worry markets as it is explicitly temporary. The Bank could also team up with the Government to consider other imaginative ways of boosting demand.
For those with a fetish for precise budget deficit targets, some Bank-led policy options could be conceived which support demand but do not immediately impact on the deficit. These would be good complements to supply-side reforms that would help boost longer-term growth but, in themselves, would do little to help engineer a recovery, and might even be detrimental in the short-term.
It is time to end the waste associated with the under-utilisation of our working population. The Bank has made serious errors right through the crisis and has typically been too slow to do the right thing. It is time that it finally got ahead of the curve.
Andrew Sentance: No
It is hard not to feel 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.
In a different world – which existed before 2007 – it might have been right to respond 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.
Firstly, 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 0.5 per cent for more than three years. This is not only the lowest rate of interest we have seen in modern times, it is the lowest official rate set by the Bank of England in its 300-plus year history.
The MPC has already sanctioned the injection of £325bn of new money into the economy through earlier rounds of QE – more than £12,000 for each UK household. If these 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, so 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. Also, QE boosted the economy in 2009 by its "shock and awe" effect on confidence as the Bank of England pulled out all the stops to turn the economy around. QE no longer has this impact.
Third, even if the latest round of QE was effective, it would push up inflation in the UK. Rather than worry, as the MPC does, about below-target inflation, we should welcome the prospect of inflation falling as that would ease the squeeze on consumer spending.
Finally, continued injections of QE risk creating an unsustainable position for the UK economy which will damage our future growth. The larger the pile of government bonds the Bank accumulates, the greater the difficulties of selling them back to the market. Other negatives 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.
QE was probably effective in 2009. But now 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.
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