The talk is once again of another round of quantitative easing. It is not being introduced immediately for two good reasons. The first is UK inflation is still high. The second is there are more sceptics second time around about how effective another dose of it might be.
The US experience is argued by both sides. The bulls of QE say at least two big doses of it in the US avoided deflation and helped the modest recovery which the economy experienced in 2009-11. The bears say it put prices up, squeezing consumers and cutting real incomes, added to world inflation which forced China and India to hike interest rates and try to slow their economies, and failed to lift the damaged US housing market.
The first round of UK QE was a strange device. The Uk government had to issue a large number of UK gilts to pay its bills. Meanwhile the Bank of England created new money to buy second hand gilts in the market place. The idea was the Bank would buy the gilts from individual and collective savers, who would then use the money from the sale of their bonds to buy a riskier investment or to spend on more consumption. The money would circulate through the banking system , which in turn would multiply the money deposited, helping the recovery.
In practice there were at least two problems with this. Firstly, many of the sellers of gilts simply bought the new gilts sold by the government instead of doing something more positive with their money. Secondly, the banks were placed under strict regulatory controls, making it difficult or impossible for them to increase the amount of lending and private sector money out there. They had to keep the newly deposited cash from the bond sales as cash or buy gilts themselves. Inbstead of expanding the money supply, the government created a closed loop. It printed money. It bought up its own debt with the money. It then sold more new debt to the people who had sold their gilts to the Bank of England. The net result was cheaper government borrowing by a very roundabout route. The £200 billion of money created was just over a year’s borrowing, at the high level of deficit the government was running.
It would have been cheaper and easier simply to print the money to pay the government’s wages, which was what underneath all the sophistication was happening.
Today there are people arguing for QEII in the UK with a variation. They say that instead of buying up government bonds, the newly printed money of QEII should be spent by the Bank of England on buying corporate bonds, or mortgage packages. The aim should be to buy riskier assets. This, they say would have a more direct effect on triggering recovery.
The Fed did do some of this in its QE programmes. It is true that if the Central Bank would relieve the corporate and banking sector of some of its riskier positions, that might free these organisations to undertake new loans and investments to promote growth. The problem with it is it represents in effect yet another subsidy to a banking system that has been awash with subsidies in the case of RBS and Lloyds/HBOS for many months. It would be bad politics, and I suspect also not very good economics. Why do we think RBS and LLoyds/HBOS would suddenly be transformed into dynamic generators of new businesses and wealth, because yet another way has been found of relieving them of past mistakes?
Tomorow I will set out an alternative to QEII which I think could address the problems of past bank errors, insufficiency of bank competition, and sluggishness of cash and credit for worthwhile new projects.