In the USA the latest move from the Fed to say it will buy up some more Treasury bonds to try to stave off another slowdown or worse has been dubbed by some wags as QE2. Some here in the UK want the Bank of England to also run up another phase of quantitative easing so they too can have QE2 headlines.

The reaction of the markets to it was at first sight perverse. The dollar strengthened, when you might have thought it would weaken on news of more money printing. The Stock market weakened, when the authorities hoped that more QE would send a message of hope for a stronger recovery. The share market first of all took it as sign of weakness that it was needed. Poeple bought the dollar, perhaps because they have been borrowing too much in low interest rate dollars to invest elsewhere and want to cut their bets.

One of the problems the authorities on both sides of the Atlantic have trouble grasping is the move to make the banks hold more cash and capital is preventing much of the money they are printing from circulating in the private sector and adding to credit. If the banks were working as normal the amounts printed would already be offering a huge kick to activity and would be on course to trigger another bout of inflation. As the commercial banks are constrained,a Central bank buying in more bonds will not necessarily fix it in the way intended.

In the Uk the money printing was on an extreme scale. Most of the money simply fed excess public spending. It was inflationary only because it helped lower the value of the pound, and inflationary in the public sector where it was used to finance another round of pay increases and sloppy buying. We then imported some inflation. Local wages have not taken off in an inflationary spiral because the banks cannot lend the money on recklessly to the corporate sector, who cannot therefore pay much higher wages.

If the authorities really want to ensure higher growth rates next year they need to relax the controls on the banks, so more of the high powered money that is out there can be lent on.They need to do so at a sensible pace, to avoid an inflationary blow out again. the good news is that the leading commercial banks now have levels of cash and capital last seen in the prudent 1990s, before the extraordinary relaxation of money and bank capital controls seen in the period 2000-2007.


  1. Alan Jutson
    August 14, 2010

    QE2, at first thought you were off on another holiday John, then I realised that the old Cunard QE2 had been sold off for use as a hotel abroad, that had failed, and for the moment the old QE2 is unfit for purpose.

    Seems to sort of sum it up,

    The new proposed QE2 is also "Unfit for purpose" as it will devalue our currancy once more, will add to inflation, which is already rising, and will devalue savings further.

    Not really helping people who are trying to "do the right thing" by being sensible about their own finances.

  2. GJWyatt
    August 14, 2010

    Yes we'd like banks to channel private savings into loans for business. But government "borrowing requirements" always preempt any available savings. There is a hierarchy of borrowers, and private borrowers can only get what is left after leviathan has had its fill, one way or another.

    The idea that inflation can be "imported" is nonsense. A weak pound simply reflects home-grown inflationary tendencies.

  3. Stephen W
    August 14, 2010

    If the banks now have capital levels last seen in the 1990's does that mean they're soon going to stop amassing capital and start lending out again?

    1. Mark
      August 15, 2010

      I'd rather they used it to sort out their mortgage books rather than pretending there won't be any problems.

  4. Sally C.
    August 14, 2010

    As far as I can see, the banks are doing their best to lend money to credit worthy borrowers but they have tightened up their lending criteria.

    Borrowers of very large amounts of money, eg. mortgages, are having to stump up higher deposits, and this has made access to mortgages harder especially for first time buyers – but this is sensible behaviour on the part of the banks. Although mortgage lending is down, other loans are still available and what I am seeing is that everyone seems to have a new car. The roads are awash with 2010, 2009, and 2008 car registration plates, at least in and around London. So loans of £10,000 to £50,000 are clearly available and accessible to a lot of people.

    The question is where does this leave us?

    The availability of large loans whether for house purchases or businesses are going to be more constrained. This credit contraction will have a dampening effect on house prices and will force businesses to get their debt levels under control or face bankruptcy.

    This is no bad thing.

  5. forthurst
    August 14, 2010

    First of all we need to avoid looking at the USA with its Fed private and unsupervised central bank which has presided over a continuous process of inflationary low interest rates enabling chosen insiders to obtain cheap money to pillage the country's industrial assets whilst the plummeting value of the dollar destroyed the financial base of ordinary citizens.

    The way to get more money flowing in the economy is to reduce taxes wholly financed by tightening the screws further on government spending.

    There needs to be a halt to the provision of services or financial assistance of any sort to anyone who is not a citizen of this country.
    There needs to be an examination of all laws and repeal as many as possible which require private industry to employ more 'compliance officers' and the public sector to create statutary snoopers. Much of this legislation is unnecessary and some is very damaging, forcing companies to employ people who are manifestly not clever or competent enough to perform the alloted task. There are areas where the private citizen is the victim of this intrusive snooping and public bodies including the police are engaged in box ticking instead of getting on with their essential function. Only when job advertisements for the public sector start to appear as meaningful and necessary as most of those in the private sector we will know that things are moving in the right direction.

      August 15, 2010


      "Well there’s no doubt about it, there are definitely fewer public sector jobs going up on the Guardian jobsite. On the 11th November 2009 we reported that the number of jobs advertised had hit 556, and today there are just 188."

      TPA also produced a chart showing the salary scales of a further 278 government jobs recently advertised,
      We added up these salaries at the advertised mid-point and they totalled £8.4m pa (£32,600 each) plus, of course, the considerable on-costs of NI, pension entitlements etc, as well as advertising and recruitment costs.
      We have suggested to the TPA that they regularly update us on the number of Guardian-advertised jobs and the total cost if they are all filled to help measure and monitor, particularly as many of them can still be truly classified as non-jobs

      (continued below)

        August 15, 2010

        In amongst the throng lies a Consultation & Community Relations Manager (£41,421 – £48,060 per annum) and a Neighbourhood Action Team Officer (up to £36,099!) – healthy salaries for such questionable roles that may well have more to do with PR than improving services.
        Our non-job this week however can be found on the faithful old Guardian website, and is advertised by London Councils:
        “Head of Fair Funding
        £45,901 – £57,111 pa inc


    2. Stuart Fairney
      August 15, 2010

      Let me know if you ever stand so I can vote for you!

  6. Mark
    August 14, 2010

    Fractional reserve banking is the art of keeping plates spinning in the air. Quantitative easing is an experiment to find out how many plates it takes before they can't be kept spinning any more.

    I'm not sure that I follow your analysis. The dollar has been falling against the pound ever since the election, which offered the prospect of sounder money than under a Labour government. There was a spurt towards $1.60=£1 when Bernanke hinted that he was planning to resume QE. The pullback in the rate since then was entirely triggered by the implicit threat in the BoE Inflation Report to follow suit.

    As is often the case, the report contains interesting data open to rather different interpretation than the Bank's own presentation. Chart 1.9 shows the average CDS rates for the major UK banks – essentially the risk that they go broke. Despite the build in capital in balance sheets, the perceived risk remains as high as it was at the peak of the crisis. The market is saying that the balance sheets are not reflecting reality.

    Turning to the funding of business, we see that it has been a story of selling new shares and offering bonds to investors, the proceeds of which have paid down bank borrowings (Chart 1.14). For corporates, this is an entirely logical response. Equities are non-recourse finance, and the level of recourse can be agreed for bonds. Paying down banks loans avoids the risks that deposits disappear and loans recalled at short notice should a bank get into difficulties: the CDS signal adds to the incentive of high borrowing rates and poor deposit rates. Of course, it is SMEs without access to equity and bond markets that suffer (Chart 1.16).

    Commercial property prices have been through a big bust, falling 45% from their peak (Chart 1.12), before showing a modest recovery to pre-bubble prices. Values here look rather more robust, and commercial property probably represents good collateral. This is in stark contrast with housing, where heads remain firmly in the sand on bubble prices. The only saving grace here is that banks are reluctant to lend at high LTV ratios, and are demanding a high premium to do so (unlike in the bubble years) – Chart 1.17. However, write-off rates show that no attention is being paid to the biggest (£1,238bn) problem on the bank balance sheets – the reason why their CDS rates remain so high – the exposure to mortgages, where writedowns remain negligible (Chart 1.11).

    We know that banks have to find £800bn by 2012 to refinance their expiring customer funding gap loans, including those under the BoE Credit Guarantee Scheme and Special Liquidity Scheme. We know that banks have inadequate assets to pledge outside of mortgages to secure that funding. It would be deeply offensive if the bank is planning to try to use QE to provide replacement funds to banks. It will simply show that corporates are right not to touch banks with a bargepole. It will do nothing to attract real funds that the banks need – who will invest in a depreciating currency without the compensation of a positive real interest rate?

    As I suggested before, banks (and government) need to tackle the real problem they face – safely deflating the property bubble – before business will have the confidence to use them, and to invest. Everyone can see the elephant in the room, but they are worried that the bull in the china shop will cause those plates to fall and smash.

    1. Mark
      August 16, 2010

      Those who wish to refer to the BoE's charts I mentioned who have a Powerpoint viewer will find them here:

      They are also available (in rather smaller size) as accompaniment to the BoE's own interpretation of trends in money and asset prices here in PDF form:

    2. Denis Cooper
      August 16, 2010

      As I understand the banks lent out large sums of money which they can no longer hope to retrieve, and until they've somehow made good those losses their capacity for new lending will remain severely constrained. They can make gradually make good some of their losses by ripping off their customers, in effect forcing the mass of the population to share their losses, and they can cut their costs – most obviously, they could stop paying stonking great bonuses to a small minority of their employees. But complete recovery through those processes will take too long, especially as they've not yet been open about the full extent of their losses. So while it would be distasteful, there's still a case for the government to set up a body to take the "toxic assets" off the hands of the banks.

  7. David in Kent
    August 14, 2010

    I think you are the right track here, John. As the coalitions measures begin to cut back the public sector bloat it is important that the banks are in a position to lend to the private sector.
    Forcing higher capital ratios and more intrusive regulation on the banks as the Europeans seem to want is not the way to release lending.

  8. Steve
    August 14, 2010

    John, to say that the only inflationary effect of QE so far has been the decline in the value of Sterling may be true, but it's hiding the dreadful prospect of the hyperinflation to come unless the BoE starts UNWINDING QE soon. Ambrose Evans-Pritchard in the Telegraph, whose stance on deflation being the greatest threat has caused me considerable unease, explains the problem brilliantly in this article, the Death Of Paper Money:

    The key as you will see if you read it is an abstract concept, "the velocity of money". Well, it's abstract to me, as I don't see it published as an indicator in the FT or other press every day.

  9. Paul B
    August 14, 2010

    If the public sector is going to be cut back, we won't need more QE to fund it.

    If inflation = 'stuff getting more expensive', then why do we want it?

    If the money is lent to the corporate sector, and this in turn pushes wages up, how are going to rebalance our economy and compete in a globalised economy?

    Isn't more QE just to hide the fact that there hasn't been a real recovery of any sort, we're still mired in a financial crisis, and that the banks are still bankrupt?

    The americans are taking the easy route with more QE and delaying the day of reckoning.

    What do Messrs Osborne and Cameron have in store for us, I wonder?

    Although it won't be pleasant, I hope they have the stomach to take the difficult route.

  10. Denis Cooper
    August 14, 2010

    What has happened to those "toxic assets" which were contaminating the banks' balance sheets? All now written down (or off)? Or still some way to go on that?

      August 15, 2010

      Denis – our guess at the time, and blogged here, was that they would be written down to excess and then brought back as profits later. (Bonusable naturally!)

      We also suggested that an eye be kept on government cum taxpayer assets during the last year of Labour to help ensure value for money and total propriety.
      Lord James, of Michael Howard's 'James Report 'fame, offered his services to oversee and monitor these assets.
      No doubt this was declined by Mr Brown so we must wonder if the State's goodies were…are…being managed responsibly?

    2. Mark
      August 15, 2010

      Not a great deal of progress has been made – especially on mortgages. My main post contains pointers to information on this published by the BoE in their recent Inflation Report..

  11. Nick Drew
    August 14, 2010

    relax the controls on the banks – ?

    No, that's how we got here. The argument the banks (and you) are running can be turned on its head.

    It is provision of risk-capitalisation for the 'proprietary' (risk-taking) side of the banks (in order to defend the entire bank from going under) that is the problem. Answer: split the banks, into retail and speculative operations. Much less capital will be required for retail operations alone.

    And the only capital that will be required for 'proprietary trading' (= speculative operations) will be whatever stakeholders and counterparties demand, before they will let the traders do their thing. Their problem.

  12. Iain Gill
    August 14, 2010

    please bring back indexed linked national savings certificates

    it really is a scandal that this last savings measure for the prudent has been withdrawn just when its likley to be most useful

    1. Conrad Jones (Cheam)
      August 16, 2010

      There's no way any Government will bring back indexed linked savings – at the moment; as prudent savers are the ones who are going to pay for other peoples mistakes. Inflation will extract TAX from savings accounts, with only a few people noticing. The Government and BoE will then blame the Global Markets for Inflation or a drought in Russia, or Oil price rises etc etc. Anything other than the true reason which is excessive debt and financial mis-management. An example of which would be Gordon Brown's selling of half our Gold when Gold was at an alltime low, and then announcing the fact to the World, which drove the price even lower. Thank you Mr Brown. We savers are going to pay the price and there's nothing we can do about it.

  13. austin
    August 14, 2010

    Wouldn't a lower and broader based tax system, combined with the cuts in government spending, also help grow the private sector economy?

  14. Stephen W
    August 14, 2010

    Dear John Redwood,

    I am a very confused voter and I was wondering if you could help me with something. Guido has just put up a graph supporting your contention that there are no spending cuts in cash terms, as the total figure for government spending is set to rise. I was aware of this, and believed the spending cuts came from inflation, but even running the figures through an average of 3% inflation a year produces only minimal cuts, effectively a real terms freeze.

    What then are the totals for cuts each year published and repeated in the budget at great length and trumpeted across the media ever since? Does the public sector have some kind of alternate measure of inflation that impacts it but no-one else? Is something else going on? Or are we just being massively mislead on an almost daily basis?

    If you or any other commentator on here could explain this I would dearly appreciate it as I am not sure what I am missing.

    Steve Wigmore

    Reply: The government will examine cuts in different departments, in case it wishes spending in preferred areas to rise more quickly. There is the danger of more rapid rises in the costs of servicing the debt which will absorb some of the increase, but so far interest rates are lower than forecast so that will help the other way.

      August 15, 2010


      "We know that inflation is a monster in waiting – well already on our doorstep from the latest figures.
      However – and we speak as naive economists (not that this makes the ‘experts’ any better given recent performances!) – is inflation not working in our favour in reducing our enormous deficit?
      If folk can cope with low or non-pay rises whilst managing to pay higher prices is this not a less severe way of helping UK finances get back into shape?
      Certainly none of us who lived through the terrible years of 20%+ inflation in the 70’s would ever chance going there again but if we kept inflation at say 4% for the next 4 years and pay rises at say 2% how would that affect the overall deficit please?
      And could we therefore maintain the ultra-low interest rates borrowers and investors are currently enjoying and are necessary to promote growth."

      (Continued below)

    2. StevenL
      August 15, 2010

      On 'public sector inflation' you have to remember that a government department is not buying a CPI or RPI shopping basket with it's budget. Each department/council/institution would have to examine it's own rate of inflation.

      For all the bluff you hear from the public sector about pay freezes and cuts, the NJC payscales (google it) guarantee a lot of employees roughly a 2.5% to 3.5% payrise every year. According to the unions I got a 1% payrise last year, according to my payslip it was nearly 4%.

      Alistair Darling's 'Keynsian stimulus' in 2008 also involved bringing a load of PFI school and hospital building programs forward. The PFI debt is now appearing on local authority and NHS trust balance sheets. The repayments will take up a slice of future spending.

      If I ran up a credit card bill and my employer refused to give me a pay rise to compensate for the extra interest payments I was making would that mean I got a pay cut? A lot of the public sector equate 'cuts' to precisely that refusal.

  15. Stephen W
    August 14, 2010

    Right, fair enough.

    But then what are the totals for spending reductions in the budget totalling some £99 billion by 2015-16.

    I quote "This budget and the plans the government inherited represent a total consolidation […] of £128 billion per year by 2015-16, of which £99 billion a year comes from spending reductions".

    Spending reductions as compared to what? Obviously not the cash total we're spending now and apparently not the real total we're spending now either. What are these spending reductions compared to?

    August 15, 2010


    "To what extent would a 5% inflation rate but static wages and government costs impact on the currently projected deficit over the life of this parliament?"


  17. StevenL
    August 15, 2010

    Sterling rose when QE was annouced in March 09 here too. You have to buy the currency to buy the bonds to sell to the central bank surely? We've entered a new economic paradigm where the old theories don't apply.

  18. grahams
    August 15, 2010

    .You are right about QE but it is not all about capital ratios. Nugatory interest rates are fine as short-term shock therapy but have already become as counterproductive as in Japan. They imply that we are in an indefinite crisis. Why do we still have emergency rates after three straight quarters of GDP growth, 1.6 per cent growth over 12 months and an annual growth rate of 3 per cent in the first half of 2010? A normal psychological response is : something awful is on the way (double dip, some new crash, cuts Armageddon, high inflation) so we had better batten down the hatches. In other words, the crisis message from the BoE destroys confidence.
    Ultra-low interest rates also have the perverse effect of putting banks off from making relatively high-risk loans to small and medium business. It is so easy to make money on loans decreed low-risk by credit rating agencies. Why bother with the difficult stuff, especially when it requires more capital under Basel rules? If Bank Rate was low but "normal" – say 2.5 per cent – high street banks might make more "added-value" loans, using the expertise of their remaining bank managers.

  19. Conrad Jones (Cheam)
    August 15, 2010

    I believe there is a general acceptance that QE causes inflation. There is also a general acceptance that the Bank of England knows what it is doing and that what the BoE says has value and is accurate. Decisions made are partly based on what the BoE says is going to happen with the economy and inflation. If the BoE says that inflation will reach double figures next year – how would this affect a decision to use QE2 to further stimulate growth?

  20. Conrad Jones (Cheam)
    August 15, 2010

    It seems a paradox that in these so called times of austerity, where we are all in so much debt, we have high inflation rates. In a market economy, if an asset was in short supply (i.e. Money) then that asset would increase in value – not decrease.

    The only explanation for continued higher than normal inflation would be the Quantitative Easing program the last Government introduced. The only explanation for the BoE's incompetent forecasts (they are wrong 96% of the time), is that if they were truthful about inflation, then this would push inflation up even more as pay demands would increase. It would also make it difficult to justify further QE, as inflation tends to suggest a buoyant economy with a plentiful money supply.

  21. Conrad Jones (Cheam)
    August 15, 2010

    My view is that Quantitative Easing is a means by which the wealthiest and financially reckless in Society are given more money which is paid for by prudent savers.
    Self Certified mortgages were widely used to increase the amounts of money that people could borrow by encouraging fraudulent Salary claims. Mortgage Advisors were encouraging their clients to commit crime which was punishable by a prison sentence. If interest rates remained at 5% – as they were at the start of the "Crisis", then this widespread practice would have exposed the true extent of the fraud. The resultant property price collapse would have caused an economic depression which would have made the "Greek Tragedy" look like a picnic.

  22. FaustiesBlog
    August 15, 2010

    If the capitalisation constraints are so tough, how come the banks made a profit and</> managed to pay its staff outrageous bonuses?

    The bonuses alone would keep a few businesses afloat!

    In any case, businesses need to wean themselves off credit. It's utterly ridiculous that they need to borrow money to pay salaries/wages!

    What happened to the prudent British companies of olde?

  23. Conrad Jones (Cheam)
    August 15, 2010

    Financial Advisors (of low moral and ethical character) who encouraged their clients to commit fraud by lying about their salaries should have been arrested. But, these people are merely trying to make a living given the market circumstances; therefore there are other people higher up the food chain who actively encourage this practice in order to boost profits. Further QE will send a message to those people that what they did has no consequences and that lying and fraud are the only way that first time buyers can get onto the property ladder and achieve other things in life. Those Bank CEOs can quite honestly say that they only lend up to a maximum of 3.5 (or 3 perhaps) times annual income at the same time knowing that their subservient employees are actively encouraging their hapless borrowers to lie and provide a huge deposit, thereby taking ALL the risk. Please don't go down the same road that Labour did.

  24. Avikal
    August 15, 2010

    Over fifty year olds and those retired Savers are being brutally financially raped by present policies. The Government is frightened ( quite rightly) of Brown's huge debt and wants to pay it down whilst cutting the Public Sector. Yet the total spend by the Government is set to RISE over the next few years! Can you please explain this coherantly and simply for us? If Savers are being sacrificed what is the point? That we simply spend all our savings now to boost the Economy? That truly is the Road to Perdition.

  25. Richard Tebboth
    August 16, 2010

    The BoE has bought gilts when prices are high because the BoE has cut interest rates.
    As inflation rises the BoE will raise interest rates (the standard approach); gilt prices will fall.
    Who sustains the loss?

    1. Mark
      August 16, 2010

      Taxpayers (this is explicit in the agreements with HM Treasury that set up the process) – though it may take a long time before the gilts are sold to realise the loss. It may even be masked altogether if the gilts are held to maturity, because the loss would be realised in lower prices for the gilts issued to roll over the debt. If the BoE starts selling its portfolio it will do so alongside any need for government deficit finance.

      Detail on the agreement is here:

  26. RobertD
    August 17, 2010

    Even more important than reserve requirements, which many banks are already exceeding, there is a need to push up funding costs for the banks. At present the very low rates at which the banks can obtan funding, and the high rates and fees that they are extorting from small business and consumers because of the"scarcity" of loan funding, is giving them their fatest profit margin in history. They don't need a large volume of loans at these margins to support the highest level of management bonus and reported profits that they can risk without further political backlash.
    Putting up interest rate will cut their force the banks to seek a higher volume of loan business. If they seek just to pass on the rate increases they should be broken up to ensure sufficient competition in the market.

    It would also restore some balance between savers and borrowers, and provide some protection against the inflation that will flow from the excessively loose monetary conditions.

  27. Conrad Jones (Cheam)
    August 25, 2010

    I am confused. The Bank of England's main role – I assumed; was to keep Inflation at or below Inflation. It has frequently forecasted that inflation will be 2% two years from the frecast date. It acts surprised when inflation rises above 2% and cannot understand why it is so high,

    My confusion is this; if the BoE is tasked with keeping inflation at 2% (currently CPI 3.1%, RPI 4.8%), Why did Mervyn King vote to pump £200 billion pounds of our money into the economy and into his friends at the Banks? Why is he surprised that inflation is so high? Who exactly is running the United Kingdom at the moment? Why has an unelected official got so much power and in control of so much wealth. Why did Labour support this waste so readily? What is Labour's alliance with key members of the BoE?

  28. Conrad Jones (Cheam)
    August 25, 2010

    QE2 – Before the Lib-Con Alliance fire up the cannons to carpet bomb the economy with QE Mark 2, there should be an audit done on exactly where QE Mark I went. My belief is that it will financially cripple the UK (both in the public sector and private) by triggering a form of hyperinflation in the not so distant future. For this Gordon Brown should be held accountable. For his benefit I include in this comment definitions of the word "Treason":
    1. Violation of allegiance toward one's country or sovereign, especially the betrayal of one's country by waging war against it or by consciously and purposely acting to aid its enemies.
    2. A betrayal of trust or confidence

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