There has been much media hullabaloo over the appointment of the new governor of the Bank of England, Mark Carney, who makes his first public appearance as Governor-elect in Britain today before the Treasury Select Committee.
Attention has focused on Mr Carney’s potential appetite for radical ideas designed to stimulate economic growth, and in particular on his hints that he may be minded to jettison the Bank’s inflation target in favour of one based on nominal GDP.
However, there is one huge elephant in the policy tool kit which deserves Mr Carney’s earliest attention. That is Quantitative Easing, the single most important and influential economic policy in place in Britain today. There is now an urgent case for a full, detailed and impartial review of QE by the Bank.
To recall: Quantitative Easing was first introduced by the Bank at the request of Alasdair Darling in 2009, and has continued ever since. Its original purpose was clear: “to increase the availability of corporate credit” by buying corporate bonds, commercial paper and the like.
This was an emergency measure, a radical move which went far beyond traditional monetary policy. The economy was in a deep crisis, the banking system was at risk of outright failure, interest rates were at rock bottom already and there were real fears of a deflationary spiral as the banks started to unwind their huge debts. The purpose of QE was to head off deflation, boost economic growth and support the banks.
The Bank of England interpreted Mr Darling’s mandate as one to purchase government bonds (Gilts), reducing long-term interest rates and injecting liquidity into the financial system as banks sold their Gilts for cash. The first round of QE totalled £200 billion, and three further rounds have taken it up to £375 billion. As long term Gilt rates have been pushed down, so too have those on other bonds, which are priced off Gilts. In the jargon, the yield curve has become flatter.
So where are we now? Of course QE is hardly the only factor affecting long-term interest rates. But in many ways it has been a significant success. Deflation has been avoided. The Bank estimates the first two rounds raised real GDP by 2-2.5% overall, and inflation by 1-2%; the equity market has rebounded as investors have rebalanced their portfolios away from bonds; Gilt yields have remained close to historic lows. The medicine has worked.
But like many medicines QE has also shown signs of being addictive, and concerns about its possible negative effects have started to multiply. Does it still make sense to have a policy known to be inflationary? How will it be unwound? What will the effect of unwinding be on equity and other markets?
There is a particular worry as to how QE redistributes money around the economy. All changes in monetary policy affect different groups of people differently. When interest rates go up savers see higher returns and borrowers feel the pinch, and vice versa when rates go down. In general these differences cancel each other out through the business cycle.
But QE is different, in its size and duration. Its effects on savers, older people, pensioners and pension funds have, it appears, been severe and are likely to continue. Millions of people in this country are directly affected, and millions more indirectly.
When I raised this issue with Sir Mervyn King and Paul Tucker at a Treasury Committee hearing last year, they were understandably keen to emphasize the policy’s overall successes. To its credit, having rejected the idea of doing a distributional analysis, the Bank then changed its mind and commissioned one, which broadly supported its position.
But that analysis was limited in scope. It did not really address the deep issues at stake. Falling interest rates may be pushing poorer savers not to spend more, but to cut their spending in anticipation of a protracted recession and their own uncertain financial prospects.
At the same time, rising asset prices benefit the better off but give relatively little stimulus to consumption. The Bank estimated last year that QE had raised shares and bonds by £600 billion, but the lion’s share of these gains will have gone to the richest households. After all, the top 5 per cent of households currently hold 40 per cent of the UK’s financial assets.
Finally, some specific groups are being much more heavily penalised than the Bank has recognised: in large part because of QE, the National Association of Pension Funds has estimated that there has been a 20% fall in cash income from a pension annuity since 2008. That’s a huge amount for someone on less than £10,000 a year.
Over 400,000 people buy annuities every year. They have been locked in for the rest of their lives to current ultra-low rates; nine out of ten of them have no inflation-proofing at all. A further 300,000-plus people who bought income drawdown policies, also tied to annuity rates, have been similarly affected.
The evidence, then, is that QE is becoming less effective and less fair with the passage of time. Unfortunately the Bank has not published any analysis of alternatives to QE which might allow us to judge whether different policy options would fare better.
Meanwhile, conflicting interests abound. A policy specifically introduced to support business has been targeted at Gilts, while the banking system has struggled to pass on the benefits of increased liquidity to companies. A policy of ultra-easy money has hugely cushioned the blow of recession on the economy, but it has also suspended the business cycle, and may be slowing down recovery. The cost of capital has been artificially reduced, distorting private sector capital allocation. The flat yield curve has pulled spending decisions forward, to the potential cost of future generations.
The economy is still far from well, but it is out of intensive care, so the plea of “emergency measures” no longer carries weight. The Bank of England has been very keen not to make“political” decisions, but its decisions over QE have been highly redistributive. If a policy with similar effects had been proposed in Parliament, there would have been enormous scrutiny and debate. It may on balance still be right. But the case for a full, detailed and open reassessment by the Bank is overwhelming.
[A version of this article first appeared in The Times]