Hamish McRae: QE may increase the risk of inflation but it should help the UK avoid a recession
Economic Life: Maybe we should not blame QE for the surge in inflation; maybe the roots of the problem go back to the unsustainable nature of the Brown boom
Friday 07 October 2011
Just print the money! One of the things that a central bank can do and do without limit is to flood the markets with liquidity. To give you an order of magnitude, this latest £75 billion of quantitative easing is equivalent to 5 per cent of GDP – maybe not quite a flood of money but a decent wodge none the less.
Click HERE to view graphic (81k jpg)
The European Central Bank similarly announced that it would buy €40 billion of bonds and take other measures to put liquidity into the system. The headline number is more modest than the UK, particularly with reference to the economies concerned, but the market judgement is that the two central banks are following broadly similar strategies. Expect a rate cut from the ECB, reversing the two increases this year, soon.
So what should we make of this? Well, there is a genuine debate as to whether the money that the central banks have created goes principally into increasing output or principally into increasing inflation. In extreme situations, such as Germany in 1923 or Zimbabwe in 2008, the money generates hyper-inflation. But in normal times, while you would expect some inflationary impact you would also expect some increase in output. The Bank of England reckons that its previous action on QE added 1.5-2.0 per cent to growth and 0.75-1.5 per cent to inflation. But the trouble is we don't really know what would have happened had they done nothing and it is at least possible that the relationship was the other way round: the policy added more to inflation than growth.
But why is the Bank of England – and the ECB – now doing another bout? The obvious answer is that both are really worried about the global slowdown in general and the sovereign debt crisis in Europe in particular. From a narrow British perspective is it certainly true that any slowdown in Europe comes at a bad time, for the recovery has undoubtedly been disappointing. But the trouble is, we still don't fully understand why this should be so. The data does not seem to fit what intuitively seems to have been happening.
Have a look at the main graph. This comes from the revisions of GDP published earlier this week by the ONS and it shows the initial estimates for GDP and the latest ones. As you can see, the initial estimates grossly underestimated growth through the first half of the 2000s – or at least they did if the latest stats are right – and failed to catch the surge in 2008. Because the peak was higher than initially estimated and the decline even greater, the scale of the recession was apparently even worse than we thought.
Citigroup makes an interesting comment on this: "The UK's boom-bust cycle was even bigger than thought previously. In turn, that upward revision to spending in the boom – probably leaving real GDP even further above potential – may (along with the weak pound) have contributed to the persistent stickiness of inflation (including services inflation) in recent years."
So maybe we should not be blaming QE for the present surge in inflation; maybe the roots of the problem go back to the unsustainable nature of the Brown boom. If you want to think of the bottle as half empty, that may mean that there is less spare capacity in the economy than currently thought. The loss of output cannot quickly be recovered because the previous peak in output was way above the sustainable trend. If, on the other hand, you want to see the bottle as half full, the actual level of GDP now is somewhat higher than previously estimated because the base from which we started was higher than we thought. The next graph shows how the cumulative change in GDP has been reassessed.
My own "takeaway" from all this is that one should be extremely suspicious of initial estimates of GDP. If the statisticians have got the figures in the past so massively wrong, why should we trust them now? That is not to get at the people doing the job; it is simply a common sense reaction to these huge errors in the past. Let's remember too that even these revisions may still need to be further adjusted in the future. As for building great conclusions on the odd 0.1 percentage change in output, well, that is absurd.
My guess is still that the GDP data for last year will be revised upwards but that there is indeed a pause taking place now. That pause may become more prolonged if continental Europe fails to get a grip on its problems. However, while some European economies may indeed slip back into recession, the UK should manage to grow slowly. We will be protected in part by this new bout of QE. However ambivalent we feel about this (and the objection that this just creates more inflation is very real), it may be useful insurance ahead of a European sovereign debt crisis that may become quite nasty.
One final point: while the transmission mechanism is most unclear, some part of it seems to be through the housing market. In other words, some of the additional money that the Bank prints goes into higher house prices. The final graph would seem to support this, for the recovery in house prices began shortly after the first bout of QE and stopped when it stopped. Conclusion: expect house prices to recover a bit in the months ahead.
Steve Jobs was one of the few who changed everything
So much of the attention of economists is directed towards analysis of data that we tend to forget the starting point of our discipline: to understand the process of wealth creation and the relationship in that process between individual endeavour and group benefit. Adam Smith grasped that of course; witness his famous if tough-minded observation: "It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest."
It struck me, pondering the contribution to the world by Steve Jobs, that there are a handful of people that have made huge personal contributions to the quality of our dinner. Most improvements in the human condition come from the mass of small incremental advances made by millions of people but there are a tiny number of individuals who quite transform our daily lives. We would all have our own lists – top of mine would be Henry Ford and his invention of the moving production line – but I suspect that Steve Jobs will in another century join that list of people who changed everything and for two reasons.
The principal reason is that he was able to take the whole range of computer and computer-related products and make them intuitive to use. As a result everyone else in the business was forced to copy his innovations. As a colleague puts it: "You take it out of the box, you switch it on, and you know what you have to do."
The secondary reason was that he understood the importance of beauty in that subtle relationship between design and function. Others have done that in other lines of products but no one has been more influential in the kit that is changing our lives now.
It is far too soon to be able to do more than ponder about Steve Jobs' legacy. But perhaps it is worth observing that most business people, if they are remembered at all, end up being remembered for the way they give away their wealth rather than the way they create it: Carnegie was the classic model. Henry Ford was the rare exception. Whatever happens to Apple now, Steve Jobs will join him as someone who changed everything.
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