The Governor of the Bank has recently defended quantitative easing. He has also made clear that as far as he is concerned, all the bonds bought up by the Bank will one day be sold back. It will not, of course, happen on his watch. The longer we wait for the sales, the more bonds the Bank holds will be paid back by the state, paying itself. Effectively they are cancelled.
The Governor wisely did not overclaim favourable outcomes for quantitative easing. He was fairly gloomy about the state of the Uk economy, despite the likely news that the economy came out of recession again last quarter. He asserted that QE had limited the damage caused by the squeeze. He also hinted that we are fast approaching the limits of what monetary policy can achieve.
There is no doubt that there was a shortage of cash in the UK economy in recent years. That could have been dealt with by more radical and rapid moves to sort the commercial banks out. Instead, the previous government took large share stakes in them to leave them unreformed. They allowed a policy of extend and pretend on difficult loans delaying this process of sorting the banks out and recapitalising them. The Bank and government felt it had to create some more money and inject it by buying bonds off the private sector to offset the shortage of money. Money was not being generated in the more normal way through a growing economy financed by credit creating commercial banks.
We also need, however, to consider the other consequences of the unusual monetary policy that has been a striking feature of the last few years.
Firstly, it has hit savers hard. Low interest rates have slashed savings income. This in turn has reduced demand from the prudent and the retired who rely on savings income to supplement their budgets.
Secondly, it has led to large increases in the pension fund deficits of many companies. The liabilities of pension funds – the future pension payments – are valued based on current bond interest rates. If bond interest rates are low, the fund needs to buy many more bonds to generate the bond income to pay the pensions. At the ultra low rates available on bonds today, pension funds have serious problems. Under the new tougher rules, a company has to value the pension deficit, and then make payments into the fund to correct it. The company also has to put the pension deficit as a liability on its own balance sheeet, making it more difficult for the company to borrow to grow its business.
When people look at the better recent cash generation of big business, they ask why don’t they rush to invest this money in new plant and equipment? Their worries about the deficits in their pension funds, and the impact of them on their balance sheets, deters companies in that position from making new business investment.
Thirdly, the period of crisis followed by ultra low rates and QE has also seen a substantial devaluation of the pound. This has helped fuel a higher rate of inflation in the UK than in most other major advanced economies. This in turn has cut real incomes and reduced spending power in the economy.
Fourthly, people retiring have had to buy annuities at very poor rates, meaning they have much lower pensions than they expected. This has also reduced demand.
When this latest round of QE expires, would you do any more?