As the UK continues to bask in a period of further economic stagnation, the Bank of England last week announced a further £50bn of quantitative easing (QE) in order to soothe the economy’s ails. QE, it seems, has become the go-to stimulus for central banks over the past few quarters. But the question still remains as to just how effective QE is in reviving the demand and therefore economic growth. So far the dead cat hasn’t bounced, so much as made an indistinct ‘splat’. But hey, it’s worth another punt, right? Eventually something’s got to give…
As rounds of QE have passed, there is a growing school of thought that it isn’t as an effective tool as we’d like to think. The Bank for International Settlements (BIS), the central banks’ central bank, recently agreed as much in their 82nd Annual Report (Chapter IV, for anyone particularly keen to understand my ramblings). As Jeremy Warner recently wrote, in an excellent piece on the subject, “Ultra loose monetary policy might even be contributing to depressed levels of domestic consumption.” The questions therefore are: why isn’t QE the solution and why is it being implemented.
Technically, QE should be perfect as an initial stimulus package; the concept being that the Bank of England buys up assets – such as gilts/government bonds, corporate bonds or assets – from banks. This increases their liquidity stocks encouraging them to raise lending to businesses and households at a cheaper rate. More lending to these groups means more disposable income etc and therefore more spending. In theory this should boost demand in the economy and drag it into recovery/growth.
There are two problems preventing this economic utopia from being realised, but – so far – the Bank of England hasn’t adjusted its approach. The first is that banks are simply using QE to bolster capital reserves and come into line with Solvency II requirements. The banks are effectively sucking up this additional money like a giant sponge; money that should be going to consumers to spend. The transmission mechanism is failing. Believe it or not, QE is now the equivalent of £12,000 per household. But I doubt that anyone has felt this benefit in the slightest. If anything, banks’ arms are shorter and their pockets deeper. A more effective tool would be to give each household the money directly – I’m sure that would soon see consumption and, ultimately, growth ticking over again.
The second problem is that with the length and depth of the downturn, there is a belief that the supply capacity of the UK (i.e. the volume of goods and services that can be produced) has been markedly reduced. This means that QE won’t create growth because the economy simply can’t grow anymore. The result would be? Inflation and not much more than that. And the evidence that this is the case? The fact that we haven’t hit the target of 2% or less since 2009.
So why keep flogging a dead dog? QE lowers the debt to GDP ratio and allows a deficit to be financed at a low rate, lowering sovereign risk.
Actually, ECB, listen up – this is what you ought to be doing to rescue the euro…