Today the Bank of England will raise its holdings of UK Gilts (government bonds) to £370.75 billion as part of its Quantitative Easing programme. It will undertake some of what I have christened “heavy-duty” QE this afternoon as Tuesday is the day that it buys longer-dated Gilts. For example the results of past Tuesdays have left it holding some £6.652 billion of our longest dated conventional Gilt which matures in January 2060. As the total planned for the current phase of this programme will be reached next Wednesday it is time to ask,with apologies to Monty Python,what has it done for us?
What was it supposed to do?
The Bank of England identified the primary purpose of the policy as being this.
The purpose of the purchases was and is to inject money directly into the economy in order to boost nominal demand
Actually I find myself disagreeing already as the “inject money directly” part is in many cases not true. In its own explanation the Bank of England talks of it buying Gilts off private investors who then buy shares and corporate bonds. There is one leakage in that they may then buy abroad but even if they buy UK assets exactly how much money is injected by asset prices being higher? We also have the assumption that asset prices are higher as a result of QE. Some probably are but I discussed back on the 24th of August on my Mindful Money blog that if you compare stock markets who have not had QE with the UK some of them have done better and even the Euro area with all its problems has done as well.
So I think that we have established an issue right at the beginning which is that due to the leakages described above the impact of QE is in my opinion far weaker than the £370 billion spent. If you like it has given a very poor “bang for its buck”. We have money slipping into foreign markets firstly then we require wealth effects due to higher asset prices on the rest to have an impact. So we end up with a rather indirect mechanism to my mind as we follow a game of financial pass the parcel to its end.
This should not have been a surprise as in the past the UK undertook what would be called anti-QE in the past where we over issued Gilts to soak up excess money in the system to slow down the economy. This was called overfunding and it worked fairly poorly too due to leakages and suchlike which were called as a group disintermediation. My argument has been from the beginning that anyone who understood the UK ‘s monetary past was unlikely to hold out much hope for QE doing any real good.
Even if you stick with the directly injected money argument look where it went
From the Bank of England’s paper of the 12th of July
By pushing up a range of asset prices, asset purchases have boosted the value of households’ financial wealth held outside pension funds, but holdings are heavily skewed with the top 5% of households holding 40% of these assets.
Making the already wealthy wealthier that will really kick-start the economy won’t it? Perhaps the Bank of England has lost faith itself as this from the same paper is hardly convincing or reassuring.
The effects of QE nevertheless appear economically significant, though subject to considerable uncertainty.
The Civil Service view
Yesterday Permanent secretary Sir Nicholas Macpherson told the Public Accounts Committee of the House of Commons this.
I’m confident that QE has had a positive effect but in one sense (this will be…) this is an experiment and we won’t know the ultimate answer for many years
Not quite the confidence expressed in the past is it? And just before this we saw a further reining in of past promises and expectations
This is an environment where monetary policy can only have a limited effect
And when really pressed at the end we got this on the effects.
We don’t really know
Is there any real evidence of the money being used?
Today the British Bankers Association has released its latest numbers on credit provision by the main high street lenders in the UK. If we look at lending by them to the UK private-sector then it has fallen every month in 2012 on a seasonally adjusted basis and fell by another £2.2 billion in September. Since QE began there have been 28 months of falls on this measure and only 14 rises. Interestingly six of the first seven months had rises so perhaps QE helped a little at the beginning but hopes faded. Of course all such numbers have many impacts on them but this is a crucial number in many ways for those claiming that it has helped our economy. After all it was supposed to be directly injected.
The British Bankers Association has tried to put a brave spin on many of these numbers but as you go through them you see gross mortgage lending lower than last year and falling business lending. In the end even the BBA has to sum it up thus.
Households are reducing borrowing requirements and have no appetite to take on more/new debt……. Firms are holding back on borrowing for investment until trade prospects improve
What about inflation?
The thinking here has been the most muddled of all as David Miles of the Monetary Policy Committee showed in a speech last month.
The decision of the MPC to embark on asset purchases on an enormous scale was not done because it had abandoned the inflation target; it was done because of the inflation target.
To those like me who point out that inflation has been above and not below target we got this.
The fact that many asset purchases were made at a time when inflation was substantially above target meant that many people interpreted it as an abandonment of the target.
Er well yes exactly David. If we look for evidence of how inflation might have behaved if we had not had QE then the cries of inflation collapsing do not get any support from our European neighbours. Even Greece still just about has a positive level of inflation and that is after an economic collapse and a depressionary scenario.
A consequence of raising inflation: falling real wages
What I do not think was ever thought through was the relationship between wages and prices. Before the credit crunch wages rose in real terms in the UK and growth was regularly 1.5% to 2% higher than prices. However that ended and they have consistently grown more slowly since. the Office for National Statistics has offered some insight into its effects of this morning.
In the second quarter of 2012 net national income per head in real terms was 13.2 per cent below its level in the first quarter of 2008; a sharper fall in economic well-being than the GDP data alone indicate
Household income has been put under pressure from price inflation, for example in September 2011 inflation peaked at 5.2 per cent whereas the annual change in household actual income per head rose by 1.9 per cent in the third quarter of 2011.
Indeed and it takes this further.
This fall in household actual income per head was primarily due to prices going up at an increasing rate over most of the period. Figure 6 shows that, by 2011, consumer price inflation was markedly stronger than it had been in recent years. Inflation hit a peak of 5.2 per cent in September of that year whereas the annual change in household actual income per head rose by 1.9 per cent in the third quarter of 2011. This peak equalled the September 2008 inflation rate and was otherwise the highest for almost twenty years. During 2011 high inflation was driven by rises in food prices, utility bills and fuel prices.
You might like to read the section concerning by David Miles’ thoughts again at this point.
My contention on the effects of QE is as follows. Its impact on the economy is weak because of all the leakages in its operation which make it an indirect monetary stimulus rather than the direct stimulus claimed. However the extra money has helped raise inflation which via its effect on real wages has had a contractionary impact on our economy and if we look at the numbers above maybe more than has been thought so far. An extra boost to inflation has come from the impact of loose world monetary policy on commodity prices. Here the Bank of England is a relatively minor player compared to the US Federal Reserve, the Bank of Japan and more latterly the European Central Bank but it has been a player and should take its share of the blame.
Once you start thinking like that you find yourself facing a grim possibility and that is that in spite of all the hype it may have done little or no good and one cannot rule out that it has had a deflationary (as in falling aggregate demand) impact.