The Bank’s last official Statement, and the Deputy Governor Mr Bean’s recent remarks, tell us that the Bank has little idea how much quantitative easing to do, or how to assess its impact.
The Bank’s main economic view is based on the economic theory that if there is excess capacity in an economy then you will not get price rises. Businesses will bring more capacity into use as people’s income and spending rises. In competitive businesses the presence of spare capacity elsewhere should prevent any one comapny raising its prices. Because there has been such a sharp drop in output, the Bank reaons there must be plenty of spare capacity. As money is injected so more goods will be produced without inflation.
Like many economic theories, the answer to that is it all depends. The Bank should take more seriously these points:
One, if the pound starts to fall again as it did last year, we will experience substantial price rises on the many goods we import. The authorities should not be so lax that they jeopardise the currency.
Two, this severe recession will remove capacity, as well as temporarily reducing it. Today we hear that the last TV manufacturing plant in England is closing for good. Many factories are being shut down, not to re-open.
Three, quantitative easing on both sides of the Atlantic, and the huge monetary stimulus in China, is boosting commodity prices. This will exert some upward price pressure on finished goods.
Four, because many companies cannot get more bank credit they are taking a tough line on price levels despite falling output. Some may continue to do so in the upturn.
There is a bigger worry. Both the Bank of England and the Fed ignored price bubbles in assets in the long boom prior to the 2007-8 collapse. The Bank of England seemed to take the view that high and rising house, property and share prices were not in themselves inflationary or a worry, yet they were fuelling the boom which in due course led to faster overall price increases. It seems that both the Bank and the Fed want to create another asset price bubble,and are beginning to do so. They should learn from the past. Asset bubbles in the end have to be deflated. They can also be inflationary.
At least the Bank now accepts that printing more money will not necessarily create more credit, the original aim of the policy. They need to persuade the FSA to change its bank regulations if they want more credit. It would also help if the government didn’t want to pre-empt all the money for its own borrowing.