I can understand the objectives behind QE – that central banks have a responsibility to prevent a collapse in nominal spending. Few people now think that the Federal Reserve handled the great depression in the right way, by passively allowing the money supply to contract. However, I think this could be accomplished using the Bank of England’s existing authority as a lender of last resort. If the Bank is unable to follow Bagehot’s rule of lending to solvent banks at penalty rates then what is it good for?
The original justification for QE was twofold. First, as Sir Mervyn King wrote in his letter to Alistair Darling, “the Committee unanimously concluded that it might be necessary to use asset purchases at future meetings to meet the 2 per cent target for CPI inflation”. But even if you feel that CPI fully captures inflation, and even if you feel that the current level of 4.5 per cent is temporary, the Bank does not look in danger of delivering below target inflation.
The second justification was that the money supply would otherwise contract, and this may have been true in 2008. But in 2011 it is less clear. What we know is that the established measures that the Bank should be looking at – such as the broad money supply measure M4X – are rising.
My concern is that the power to engage in QE was granted in the middle of a liquidity crisis, but is now being used to quite different, far less economically legitimate ends: as a political tool to boost aggregate demand.
This should have been an evident danger from the start. There is a perverse dynamic to intervention whereby the failure of one policy tends to deliver even more discretion and power to policymakers next time around.
Witness the madness of Osborne’s credit easing, which is even less neutral than buying gilts, disrupts relative prices in a more harmful way, and deepens the socialisation of the banking system. It seems the rulebook has been tossed out of the window, and blind experimentation prevails. Rather than viewing central bankers as fallible bureaucrats, they are fast becoming a convenient scapegoat for incumbent politicians.
There was a naivety among economists who supported QE’s initial use. They failed to factor in how the precedent would alter incentives for future policy and grow the downside risks of inappropriate use in the future. This is why a plausible exit strategy should have been laid out. You don’t need to be a conspiracy theorist to assume that politicians and central bankers have an incentive to dramatise the situation – watch the testimony of Hank Paulson and Ben Bernanketo the Senate Banking Committee in 2008 over the Troubled Asset Relief Program (TARP) for a prime example.
The strongest argument against QE1 was that it made QE2 more likely. Now the genie is out of the bottle, who knows how this will all end?
Anthony J. Evans is Associate Professor of Economics at London’s ESCP Europe Business School, and Fulbright Scholar-in-Residence at San Jose State University. His website is www.anthonyjevans.com.