David Blanchflower: Hawks are wrong - QE works and we need it
The last thing our economies need is to worsen the situation for borrowers in order to help savers
Tuesday 28 August 2012
Economic Outlook Last week I appeared on The Hays Advantage, which is a national radio show on Bloomberg, hosted by my good friend Kathleen Hays. I debated with the inflation hawk William Ford, ex-president of the Atlanta Federal Reserve and the US's equivalent of Andrew "Death" Sentance, the role of the Fed and its actions to prevent economic meltdown. Ford, who seemed to believe the Fed was the main cause of it, recently signed up as one of 400 economists who support Romney's unbalanced budget plan, which lowers Medicare and Medicaid spending to pay for tax cuts on the rich. Ford currently teaches at Middle Tennessee State University. To put it mildly there was absolutely no meeting of minds: the producer even sounded the bell, as they do in a boxing match, at the start of each section as we returned from adverts.
Twice I blurted out that I didn't agree with a single word Ford said. The most outrageous claims he made included that what is really needed is zero inflation; QE hasn't worked and, in any case, rates have to be raised now and QE reversed because of the possibility of hyperinflation – plus this tightening was justified because of the effect this was having on savers. His justification for destroying the US economy was that unless we tightened now, hyperinflation was coming, just as it did when he was on the Fed with Paul Volcker in the 1970s. Nonsense. Ford also didn't seem to realise that slowing the economy right now would likely push the US economy into deflation, which causes major problems for borrowers. I borrow a million pounds today but the money I have to use to pay it back diminishes in value in a deflationary world so defaults rise, firms close – and here comes the death spiral of decline.
Ford also didn't seem to take well to the point I made that his policy proposals were designed to solve a non-existent problem of inflation – wage growth and core inflation are benign – and would worsen the very real problem that is present right now of high unemployment and especially high long-term unemployment. He didn't take kindly to my point that the world had changed since the 1980s, we are in a global recession, banks aren't lending, and there are major downside risks to the US economy from a potential break-up of the eurozone. Plus, as Simon English noted in his Independent column this week, savers just have to suck it up, as all else is worse. As Simon says, the Saga louts need to put a sock in it. Don't savers, who tend to be older, care about their grandkids? Savers have benefited from asset price increases that occurred as a major goal of the QE as it pushed up other asset prices. Plus many of these very savers likely gained from the house price rises while the young didn't. The last thing the US or UK economies need is to worsen the situation for borrowers to help savers.
Ford's most egregious claim was that QE hadn't worked. He gave no evidence to support his claim; all the empirical evidence is to the contrary. If it worked or not depends on the scale of the counterfactual; that is what the world would have looked like, absent the policy measures. A consensus has emerged among empirical studies that the Fed's QE probably lowered the yield on the 10-year Treasury note, as well as on high-grade corporate bonds, had sizeable impacts on GDP growth, lowered unemployment, raised inflation and eased mortgage-market conditions. The evidence suggests that unconventional monetary stimulus has had broadly similar impacts to conventional monetary stimulus. Ford is full of it.
Evidence on whether QE had worked in the UK or not was provided by the Bank of England in an important report a few days after my radio battle. Without the asset purchases, the Bank estimates credibly, most people in the United Kingdom would have been worse off. Economic growth would have been lower and unemployment would have been higher. Many more companies would have gone out of business. This, the Bank argues, "would have had a significant detrimental impact on savers and pensioners along with every other group in our society". The Bank's asset purchases have increased the prices of a wide range of assets, not just gilts. In fact, the Bank's assessment is that asset purchases have pushed up the price of equities by at least as much as they have pushed up the price of gilts.
The Bank estimates that the £200bn of QE between March 2009 and January 2010 is likely to have raised the level of real GDP by 1½ to 2 per cent relative to what might otherwise have happened, and increased annual CPI inflation by ¾ to 1½ percentage points. Assuming that the additional £125bn of purchases made between October 2011 and May 2012 had the same proportionate impact, this would translate into an impact from the £325bn of completed purchases to date of roughly £500 to £800 per person in aggregate. The Bank estimates a substantial cut in interest rates of between 250 and 500 basis points would have been required to achieve the same effect.
It concludes, though, that the benefits of loose monetary policy have not been shared equally across all individuals. Many households have received lower interest income on their deposits. But changes in interest rates – not asset purchases – have been the dominant influence on the interest households receive on bank deposits and pay on bank loans. By pushing up a range of asset prices, asset purchases have boosted the value of households' financial wealth held outside pension funds, although holdings are heavily skewed with the top 5 per cent of households holding 40 per cent of these assets.
QE has clearly exacerbated inequality at the same time as the fiscal policy is doing the same, being heavily focused on public spending cuts that impact the poor most along with an increase in VAT that is regressive. We never were all in this together.
Sorry Bill: QE did work, and there is likely more of it to come. I dread to think what the world would have looked like if you had been in charge of the Fed. Maybe you are a supporter of the US going back on Gold Standard too?
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