QUANTITATIVE easing (QE) is like macroeconomic doping. America is like Lance Armstrong.” Or so a British journalist overheard at Davos. Relative to the size of the economy, of course, the UK is a more likely Armstrong than the US. Central bank asset purchases here have been about 25 per cent of GDP, compared to less than 15 per cent in the US and 5 per cent in the Eurozone.
There’s understandably an increasing scepticism about the effectiveness of QE and continued low interest rates. The Treasury line since 2010 has been that fiscal contraction and monetary activism would lead to recovery. The reality has been quite different. In 2010, the Bank of England forecast real GDP growth for 2011 would be 3 per cent. The outcome was 0.7 per cent. We’re now heading towards a triple-dip recession, and the combination has clearly not worked as expected.
In a speech last week, even Bank governor Sir Mervyn King abandoned the pretence that monetary policy was all-powerful: it was “no panacea,” he said. Structural factors were holding the UK economy back and QE was stealing spending from the future. Others have pointed out how QE and low rates risk mal-investment, zombie companies, deficits for pension funds and encouraging governments to put off necessary fiscal adjustments.
Opinion seems to be turning against extraordinary measures. This makes it all the more intriguing that future Bank governor Mark Carney clearly disagrees with the new King prognosis. At Davos, he insisted central banks could loosen policy further through “communication” and “other unconventional instruments”. This means tolerating above-target inflation for longer – a “flexible inflation target” – or publicly committing to low interest rates in the future, even if inflation picks up, to affect expectations today. It could even mean buying up different types of assets.
If it’s unclear whether these are even options, it’s less clear whether they are desirable. “Open mouth operations,” saying that you will keep interest rates low in future even if it is undesirable, does not seem credible, given the lack of a firm commitment. Would the Bank commit to stand aside if inflation really took off, as in the 1970s? I doubt it. And buying other assets, as advocated by former Monetary Policy Committee member Adam Posen, would be fiscal policy (socialising certain risks) and rightly beyond the remit of a body not directly accountable to the public.
But overall, it’s difficult to argue that the UK inflation target has not already been very flexible. Inflation has been above target since 2009. Indeed, the Office for Budgetary Responsibility argues that falling real incomes, as a result of above-target inflation (rising as high as 5.2 per cent in 2011), have been a key factor in suppressing recovery. Investec forecasts that rising electricity, petrol and food prices will push consumer price index inflation back to 3.5 per cent by June. In this environment, a deliberate decision to tolerate above-target inflation risks entrenching higher inflation expectations.
Ryan Bourne is head of economic research at the Centre for Policy Studies.