Sean O’Grady: Is quantitative easing working? The Bank's latest projections won't tell us

Economic View
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The Independent Online

In a few days' time we ought to get a definitive view from the Bank of England about the prospects for the economy over the next couple of years.

Definitive, though not necessarily right. For on Wednesday we will see the latest quarterly Inflation Report. This is as close to holy writ as a secular organisation such as the Bank can get. The first, back in 1993, was personally written by the Bank's then chief economist, now Governor, Mervyn King. Working on it is regarded as one of the more fun-time activities by those toiling in Threadneedle Street's vineyards.

The Bank tries to cope with the inevitable vagaries of this sort of activity by producing something it calls a fan chart; a range of possible economic outcomes rather than a bald figure for growth or inflation.

These fan charts have become wider and wider during the credit crunch, so balanced have been the risks of either rampant inflation or 1930s-style deflation, and they have started to get a bit meaningless. I wouldn't hold out much hope of anything too precise when the Bank makes its pronouncements. Besides, we know from the £50bn extension of quantitative easing last week that it is worried about the economy: by their deeds shall ye know them, not their fan charts.

So economic predictions, even from those clever souls at the Bank, can be no more reliable than those from the (equally brainy) Met Office. As far as the economy is concerned, we are not enjoying "barbecue weather".

But, to be fair to the Bank, through its extension of quantitative easing by £50bn to £175bn, it is concentrating on the one big problem that we do know about. In doing so, the Bank is behaving like a hedgehog, in the sense that Isaiah Berlin meant when he divided thinkers into two categories – foxes and hedgehogs: "The fox knows many things, but the hedgehog knows one big thing."

In this case, the Bank, along with the rest of us, knows one big thing: the banks are still broke. Hence the Bank's efforts to boost bank lending though quantitative easing. How it does that – the "transmission mechanism" as economists call it – is summarised in its own admirable graphic included in the Bank's helpful little leaflet on the subject, available via its website. For some reason the leaflet has missed out the bit about some overseas owners of UK gilts selling them to buy foreign currency assets instead, which reduces the value of the pound and boosts exports. There's been some doubt about whether this channel works, so maybe that's the reason for the omission.

Anyway, the big fact of contemporary economic life was made perfectly apparent in the big banks' results last week. The picture was pretty simple. Behind all those mindboggling numbers on writedowns, capital adequacy, and wrangles over bonuses, was a clear pattern. The various groups' investment banking arms have done very well out of the revival in markets since the spring. The rest of the domestic banking scene is fairly sick, weighed down by write-offs, bad debts and arrears. Those groups that have big investment banking arms did better, for example Barclays. Those with none, such as Northern Rock, exposed the weaknesses. Something approaching £40bn was written off last week, a sobering figure that explains why the banks are so wary of lending to any but the most rock-solid credit risks – they don't want to lose any more money by lending to people and firms where there is the remotest risk that the money won't be coming back.

The banks, whatever they say, are not lending enough to secure the recovery. It may be because there aren't better lending opportunities out there; lending may be more or less than some notional government target; it may be more or less than it was a year ago; it may be that companies and households are more interested in paying off debts than taking new ones on. But the picture is the same. Credit is not running sufficiently smoothly to propel us decisively out of recession.

So does that mean that the Bank's policy has been a failure? No. First, it needs time to take effect. Second, look at what has been happening in the corporate bond and equity markets lately. Researchers at Dealogic tell me that some £88bn of new capital has been raised via equity and convertible bond issues this year alone, against £117bn for the whole of last year and £110bn for 2007. That is quite a turnaround and may well help some of the more heavily indebted big companies survive. Think back six or 12 months; who would have thought such sums could be raised via rights issues, including those offered by banks?

This resurgence of animal spirits, or "risk appetite", can't be solely down to the credit and quantitative easing efforts of the G20's governments and central banks, but it must be a material factor. Which helps answer the Bank's own question, posed in its QE-for-beginners leaflet as a test of success: "Is it cheaper and easier for companies and households to borrow than it would otherwise have been?"

Handily for the Bank, no one can prove the counterfactual either way, but the circumstantial evidence is there. Bond yields have been driven down, sharply so last Thursday when the £50bn extension was announced, and that makes them less attractive compared to equities and corporate bonds, just as the Bank intended. The fact that, as the critics maintain, the money supply and lending haven't risen by as much as they ought in an ideal world – also undoubtedly true – is surely just another reason for going even further, which is now what the Bank has done.

The danger of a double dip, or W- shaped recession therefore remains, and will, frankly, for as long as we have to deal with our overhang of debt. And getting rid of our debt is what the authorities wish us to do to rebalance the economy, but – in true Augustinian style – not yet. So we now have the perverse situation of the Bank encouraging us to take on more debt at the time we've decided to be sensible and start paying off the credit cards, the overdraft and the career development loan.

The unsettling thought arises that the Bank may well be doing all the right things now, but it has started doing them just a little late. There was a crucial "lost" period for policy. The six months between the collapse of Lehman Brothers and the launch of quantitative easing witnessed many radical moves, including the £37bn recapitalisation of our banks and the slashing of the Bank Rate to 0.5 per cent, the lowest since the Bank was founded in 1694. It may well be, as the Bank argues, that things would be much worse now without quantitative easing, but one can't help wondering if they could have gotten away with doing less, but earlier. Then again, I admit, predicting the past is an awful lot easier than predicting the future.

Even the scrappage subsidy can't take the shine off used cars

The car is usually said to be the second most expensive asset purchased by most individuals, after their home. It might more accurately said that a second-hand car is the second most important item most of us buy, given that sales of used vehicles far outstrip those of new cars. The news on the scrappage scheme last week was good – that is, for those who buy new or almost-new cars, though it has to be said that Korean makers such as Hyundai are enjoying the most benefit, though they don't make cars here.

The news is not so good for those of us who wouldn't dream of buying new. British Car Auctions says that the average value of used cars is up for the ninth successive month. Second-hand car prices went up again in July, by 3 per cent, and the price of the average used car has breached the £6,000 barrier for the first time. The annual increase in older car prices stands at a remarkable £1,079, or 21.8 per cent, way ahead of new-car price inflation. Used-car prices have been bucking the market.

Of course, that covers a multitude of motors, from barely used Ferraris and Rolls-Royces with price tags well into six figures, to those old Nissan Micras that just refuse to lie down and die (still worth a few hundred pounds, if they've got an MOT). But it is interesting that the average used-car price has now crept up to overtake the list prices of many budget hatches, and even more once the £2,000 benefit of the scrappage scheme is factored in.

One can only assume that the impact of the credit crunch has made more of us switch from new to used. Maybe we now realise what those in the trade have long known; that the biggest single cost in running a car is invariably depreciation, and most new cars lose 20 per cent of their value the moment they leave the showroom. More and more of us, strapped for cash, are turning to used cars as a way of avoiding that depreciation trap. Modern cars are built so much better than their predecessors that it is a slight mystery to me as to why anyone buys new, even with the scrappage subsidy.

Happy motoring!