IVAN PAVLOV, the psychologist who famously trained his dogs to respond to stimuli, would have been proud. Whenever the economy grinds to a halt, regardless of reason, well-conditioned policymakers from Beijing to Frankfurt always respond in the same way: they cut interest rates and wheel out the printing presses. It is the new orthodoxy: ever easier money is the answer to every economic problem. True to form, most people in the City backed yesterday’s news of £50bn in extra quantitative easing (QE).
There are some dissenters, of course. Only borrowers benefit from lower rates: Ros Altmann of Saga points out that annuity rates are down by 23 per cent since July 2008 and that QE has hit over 1m pensioners via annuity and drawdown income falls. Economists such as Simon Ward (see page 19), Andrew Sentance, the Institute of Economic Affairs’ shadow monetary policy committee, various Austrian-leaning analysts and some others all opposed this latest round of QE. But they were drowned out by the pro-QE voices.
The tragedy is that the supposed omnipotence of monetary policy is in fact a misunderstanding of the work of economists such as Milton Friedman. He rightly identified that the bursting of the bubble in 1929 only became a depression when the money supply was allowed to collapse by the Federal Reserve. Because there suddenly wasn’t enough money left in the economy, demand slumped and prices were forced down – but because the adjustment wasn’t immediate, especially with wages, it caused mass unemployment. Many firms and individuals went bust as the real value of debt shot up.
Central bankers have since pledged not to allow such deflationary episodes caused by monetary contraction to happen again, and quite rightly so. The point of QE is that it can create extra money. The Bank of England was therefore right to engage in its original round shortly after the banking implosion. But subsequent interventions have been increasingly desperate and useless. The money supply is already increasing, albeit slowly, in the UK, not collapsing. In real terms, the broad, adjusted measure rose by 1.3 per cent (not annualised) in the six months to May – the largest increases since April 2009. Given that the rate at which money is being passed around the economy is also going up, the case for more QE is non-existent.
Monetary policy errors can destroy the economy – but that doesn’t mean clever monetary policy can create a boom. Bad monetary policy is disastrous – but good monetary policy is neutral. It doesn’t mess things up. It allows the private sector to do its thing. QE is not like alchemy. It can’t cure an economy which is suffering from real ailments, such as excessive debt, bad skills, too much regulation, bad incentives and the like. These problems require real medicine, not a bit more money printing.
Friedman ended up advocating that the money supply should follow a very simple, unvarying rule to prevent governments from trying to manipulate the economy. Other economists of the Austrian persuasion believe in even more radical monetary policy rules. The crucial common ground is that manipulating money and interest rates can only work for short periods of time – and then only when it fools people into thinking that there is more real demand for their services than actually exists. Britain needs a real growth strategy – and that means incentivising companies to invest and hire and to produce more. That is a job for a reforming government, not an over-stretched Bank of England.