THE Bank of England may have recently decided to call a halt on the expansion of its quantitive easing (QE) programme. But the debate over the costs and benefits of QE continues. A full £375bn has already been injected into the UK financial system, and it’s still possible that more might follow.
The benefits of QE tend to be quickly visible. The evidence suggests that it has raised asset prices by 20 per cent, kept interest rates lower than they otherwise would have been, and boosted output by up to 2 per cent. If the goal was to loosen monetary policy in response to a financial crisis, it has succeeded. But the main danger of QE is that the costs are likely to emerge over time, and will be harder to spot. Some of the main costs are as follows:
1. Low interest rates force investors to look for more exotic ways to generate returns. They may take on more risk to prevent the emergence of destabilising capital flows into developing countries.
2. Interest rates give entrepreneurs an important signal about the time preferences of consumers. If the signal gets disrupted, there is a risk that they will invest in the wrong projects.
3. Low rates delay rebalancing, and entrench capital in inefficient uses.
4. There are also significant exit risks to QE. At some point in the future, the Bank of England has to sell almost 40 per cent of the total stock of conventional gilts back onto the market. It’s new territory for central banks with no experience.
5. Inflation has been above target for a long time, which damages the credibility of the central bank, and could lead the public to question whether it’s keeping inflation in check.
6. The Bank of England’s emergence in the gilt market has reduced incentives for the government to maintain fiscal discipline. QE looks a lot like our central bank is simply printing money to cover a profligate government. In monetary policy, perception is as important as reality. The threat of inflation leads the market to lose confidence in monetary authorities.
7. Current monetary policy is generating regime uncertainty. It is more about announcements and new ideas than sticking to simple rules that were already anticipated and understood. When the Bank of England signals that rates will remain low over the medium term, the public could respond positively and think it means things under control. On the other hand, the public could worry that the economy will stay weak over the medium term. When emergency policy becomes permanent, it harms expectations about recovery.
That inflation is close to 2 per cent does not mean that QE hasn’t caused damage: the previous boom happened under a stable price level. By the time inflation increases it will be too late. Interest rates must now return to more normal levels before even more harm is done to the economy.
Anthony J. Evans is associate professor of economics at ESCP Europe Business School. Web: www.anthonyjevans.com, Twitter: @anthonyjevans.