Sean O'Grady: A little bit of QE now might ease the pain of eurozone crises to come

Economic Life: Low interest rates are the gift that keeps on giving. Someone with an average tracker mortgage could save tens of thousands of pounds

Click to follow
The Independent Online

QE or not QE? Without being too self-referential, I have already compared the men (no women) of the Bank of England's Monetary Policy Committee to Macbeth – urging them to screw their courage to the sticking point and announce another burst of quantitative easing, or asset purchases as the Bank prefers to term it. It's also colloquially termed printing money.

Click HERE to view graphic (199k jpg)

Just to recap, by the way, we're talking about the creation of money by the central bank when it writes a cheque, or alters some entries on a spreadsheet, to buy gilts or other bonds in the private sector, thus indeed creating a larger quantity of money, and thus easing monetary policy. In case you'd forgotten what it was all about.

My view, for a little while now, is that the weak state of confidence in the economy, especially over investment, is really threatening the recovery. Given that the debt crises in the US and the eurozone are things the UK authorities can do little about, and given that the deficit reduction plan is rightly immutable for reasons of political and market confidence, one of the few things domestic policy makers can do about that is to ease monetary policy. I still think it's worth a try.

The balance of opinion on the MPC is obviously swinging that way, with the chief economist, Spencer Dale, and independent member Martin Weale dropping their support for a rise in rates earlier this month. There is no shame for them in doing so.

Quite apart from Keynes's famous remark about the facts changing his mind, MPC members are supposed to take a month-by-month view. In the great get-out clause beloved of journalists whose stories later prove slightly wide of the mark, they were "right at the time". By the same token, Adam Posen, the long-term dogged proponent of more QE, might have been "wrong at the time" earlier in the year, and only correct at this juncture, although I'm guessing which of the nine chaps on the MPC is feeling most vindicated right now.

So the answer to Hamlet in this instance is "yes to QE". With reservations. The argument for QE is a pretty familiar one, but the scale of the switchback in market sentiment and the wider economy has been dramatic in recent weeks and reinforced it. Recall that at the start of the year the working assumption of most commentators and market participants was that rates would rise, if only a little, by the autumn or perhaps even the summer of this year.

Although small in headline terms, an incremental rise in the Bank rate from 0.5 per cent to 0.75 per cent would have had huge psychological implications, ones that the Bank might have found difficult to manage, what with its insistence that it cannot commit monetary policy months in advance. People and businesses might easily misinterpret the turning point in the interest rate cycle for a more dramatic ramping up of rates, something that is realistically not on the agenda.

Such worries can now be safely shelved. The latest City consensus seems to be that rates might not yet rise for another year. If so, it would imply rates at their lowest level in the Bank's history for one of the longest periods in the Bank's history. Previously long runs of low rates – much of the 19th century, for example, as well as the 1930s and 1950s, were in an era of much less activist monetary policy. Allowing for inflation, it might be the easiest monetary policy in real terms in centuries.

So it is unprecedented. This matters beyond mere record setting; low interest rates are the gift that keeps on giving. Month in, month out, for example, those on tracker mortgages feel the benefit of hundreds of pounds in interest payments saved. Someone on an average sized sort of tracker might have saved tens of thousands of pounds on interest by the time this experiment comes to an end.

So the "big picture" is that monetary policy is already super-expansionary, and, perversely, the weakness of the UK economy and the crises in the eurozone have pushed longer term UK market rates down some more in recent weeks. Thus we have had a sort of private sector version of quantitative easing, as foreign investors especially dump euro and US bonds and buy gilts, driving their yields down still further. This might be termed the "safe haven" effect, after George Osborne's recent speech extolling the virtues of the UK as a financial asylum. Given that, then the pressure for more official QE is that much less. It might have knocked as much as 0.25 percentage points off UK rates, again all to the good for householders and businesses alike.

Still, the outlook for growth and inflation is hardly a bullish one, and we should not allow favourable movements in market rates caused by financial flows to distract us from the bigger risks to the real economy caused by turmoil beyond these shores.

Our banks are intimately connected to those in the rest of the world, and half our exports go to the eurozone. Britain, despite geography, is not an economic island entire of itself. The Bank explicitly excludes the eurzone debt crisis from its forecasts because you can't really factor in cataclysms. Arguably though, you can factor them into policy action, if such a move might prove a preventive measure, a building up of the sandbags, if you will.

All that said, QE is subject to the law of diminishing returns. In the severe crisis of 2008-09 QE was symbolically and substantively useful; but its scope is more limited now simply because rates have come so low, and, for now, market forces are driving UK rates still lower. It is a dilemma, but one that ought to be resolved in favour of caution – which does not mean leaving policy where it is.

One more point: so far from easing up on his plan to reduce the Budget deficit and go for "Plan B", George Osborne may soon be forced to actually intensify the squeeze. Call it "Plan A Minus".

It all depends on the "output gap". This is simply the difference between what the economy produces and what it is capable, at full chat, of producing. At the moment there is obviously a gap, but measuring it is tricky. Indeed, you only know for sure long after the event.

If the Office for Budget Responsibility, implicitly backed by the likes of the Bank of England and the National Institute for Economic and Social Research, judge that the output gap is and has been smaller than thought, it means the cyclical element of the budget deficit is also smaller than thought and the structural bit – the part that will disappear when the economy returns to normal – is bigger. Since the Chancellor is targeting the structural deficit, that means that the structural deficit will need to be cut some more – more tax rises or public spending cuts, or both.

That may well be the unwelcome news when Mr Osborne delivers his Autumn Statement. He ought to postpone the additional adjustment for economic reasons, although politically he will want to hit his targets on the existing five-year horizon and get the pain out of the way long before the scheduled 2015 election. The pressure on him, the Government and the nation will be acute. A small dose of QE now might help ease some of the coming anguish. After all, we don't want another tragedy unfolding.

Comments