Why Mark Carney must resist the temptation to do more QE

 
Allister Heath

TODAY is Mark Carney’s first vote on monetary policy. It is an important moment for the British economy, and there are many who desperately want the Bank of England’s new governor to announce another boost to quantitative easing (QE), or even to start buying private sector assets to inject additional liquidity into the economy. Even though his voice is just one of nine on the monetary policy committee, his clout will be immense: which other member would want to vote against and potentially defeat him in his first week as governor?

But Carney and the MPC should resist the temptation to loosen further. The economy is doing much better than it was – though of course that is merely relative – and there is already lots of “stimulus” (much of it misguided, including schemes to prop up house prices). As Simon Ward of Henderson has pointed out, even though the outstanding amount of QE was frozen in November 2012, the MPC has acquiesced in a form of stealth QE worth £23bn in the first half of this year and rising to £48bn by the end of 2013-14. The interest paid on the gilts owned by the Bank as part of QE is now being handed back to the Treasury in a bizarre circular motion, boosting the amount of money circulating in the economy.

The key point is that the money supply – defined specifically in this case as the holdings of households and private non-financial firms, the best measure for such purposes – is doing well. On the broad measure, it is up by an annual 5.5 per cent, a rate at which it has been expanding at for a while and a performance that was last equalled in 2008; on the narrow measure, it is up by 10.3 per cent, its fastest rate since 2006. There is therefore no need for an extra boost – in fact, the UK desperately needs to readjust to a world where interest rates are no longer at rock-bottom, where it pays again to save, where bond and gilt yields reflect inflation and expected growth, and where the authorities are no longer engaging in ultra-interventionist monetary policies. We are at a stage where cheap money is holding back the economy and creating more problems than it is solving.

Some believe that the increasing money supply means that the economy is set to bounce back. While I certainly think that the economy is doing better – especially when excluding North Sea oil and gas – we are nevertheless facing a new era of much weaker growth. The supply-side of the UK economy remains damaged, partly because public spending and taxes are too high and regulations too onerous.

The massive misallocation of capital and labour that took place during the bubble years has yet to be properly purged from the system – in part because ultra-low rates have kept zombie firms and households on life support – so increased demand won’t fully translate into increased supply and reduced unemployment. Too many people have the wrong skills for the kinds of jobs that are being created, or for which there is a need. So the increasing money supply, while good news and confirming that more QE is not needed, won’t be a panacea. There will be growth, but it will remain feeble. Let us hope that Carney realises this, understands that injecting more cash into the economy won’t make any real difference (though would further distort interest rates and risk bolstering inflation) and rejects the siren calls for more money-printing.

EGYPT’S COUP
It’s good riddance to Mohamed Morsi, ousted as Egypt’s president by the army last night. We must hope that the change will be for the best, though nobody really knows how this could end, and few in the West fully understand the chain of events set off by the ill-fated Arab Spring. The only certainty is that the dream of a pluralistic, capitalist Middle East remains a very long way off.


allister.heath@cityam.com
Follow me on Twitter: @allisterheath