On QE

The Bank of England is likely to announce more quantitative easing on Thursday. Six quick points:

1. Richard Murphy is basically right to say that this means that government debt is lower than official figures show, if we consider the government and Bank of England as a single entity. What’s happening is that government borrowing is being financed not by debt sales to the private sector but by an increase in base money. This is entirely consistent with the government budget constraint (pdf). Warren Buffett was quite correct to say that you cannot have a debt crisis if the authorities can print their own money.

2. Complaints that “printing money” is inflationary miss the point. It is meant to be so. As Sir Mervyn King said (p14 of this pdf):

we were concerned that, had we not made those asset purchases, the chances were that inflation might fall below the target.

3. The claim that QE will lead to very much higher inflation requires two assumptions:

- That QE gives a big stimulus to aggregate demand. This is questionable. There are several channels through which QE boosts demand - most obviously by raising asset prices (shares and corporate bonds as well as gilts) thus boost corporate demand for credit - but these are not strong.  Bank of England economists estimate that the first £200bn of QE only raised real GDP by around 1.5% and inflation by up to 1.25%. This implies a rise in money GDP of less than £50bn - a quarter of the monetary injection.

- That the aggregate supply curve is vertical-ish, so higher nominal aggregate demand will lead to price rises rather than output increases. Whilst I agree that the recession has reduced capacity, and that there’s a mismatch between unemployed workers and job vacancies, the belief in a near-vertical curve seems rather strong.

4. It’s possible that QE will be reversed in coming years. As Sir Mervyn said, such a policy would be “exactly equivalent to the overfunding in the 1980s” - when the government issued more gilts than was necessary to finance the budget deficit with the intention of reducing monetary growth. Richard thinks this would be impossible, as it would - when combined with big budget deficits - swamp the market with gilts. However, there’s no reason why a reversal of QE couldn’t wait until deficits were smaller.

I suspect a bigger factor preventing negative QE is that - in contrast to the 1980s - bank lending will not be a force for great monetary growth, in which case negative QE would shrink the money stock, which would be a risky policy.

5. If “negative QE” has merely the opposite effect of QE, each £100bn of it would raise gilt yields by half a percentage point. Reversing all the QE we’re likely to get by the end of this year would thus add less than two percentage points to yields. This would take 10 year yields to around 4% - their summer 2008 levels. On top of this, yields are likely to rise because the circumstances in which the Bank reverses QE - a stronger economy - are circumstances in which investors will be switching away from safe haven assets (which gilts are perceived to be) into riskier ones such as equities.

6. Low gilt yields are NOT desirable in themselves. Insofar as they signify a weak economy, they are a bad thing. And insofar as they rise because of expectations of recovery, we should welcome this.

Comments

[Luis Enrique]

Somebody claiming QE will not be reversed - NONE of the gilts will be sold - is not "basically right".

[Luis Enrique]

if he'd written "government debt is lower than official figures show, to the extent some QE is not reversed and translates into a permanent expansion of the monetary base" he would have been right.

[alastair harris]

although of course the government and the bank of england are not a single entity!

[Luis Enrique]

If Murphy is even half right, let's say 50% of the gilts purchased translate into permanent monetary expansion and debt monetisation, the BoE could loudly trumpet this fact, which would:
1) change expectations concerning future monetary policy in a fashion that theory says will stimulate the economy today
2) take some pressure off the public finances and reduce the need for austerity, something which I believe Merv would like; he's spoken about needing some help from the fiscal side of things.
So, why is the BoE claiming that QE will be reversed?

[lee]

thank you foryour infromation!

[JustAnotherTaxpayer]

"Richard Murphy is basically right to say that this means that government debt is lower than official figures show"

If you consolidate the BoE and fiscal accounts you MUST consider Bank of England reserves as a liability of the public sector.

a) They correspond to an asset of the private sector.

b) They are interest bearing.

The MMT guys have been banging on about this for long enough. They are right about the accounting, if not about the macro.

So Murphy is not "basically right". He is "basically wrong", and doubly so because he weirdly insists there is some practical (theoretical?) constraint which prevents QE being unwound.

Another interesting aside is that NK theory says QE will only stimulate AD if the central bank can credibly promise to make it a permanent expansion.

Krugman: "A credible commitment to expand not only the current but also future money supplies, which therefore raises expected future prices - or, equivalently, a credible commitment to future inflation - will still succeed in raising the equilibrium current price level and hence current output."

Really I don't know why anybody listens to Murphy on macro. If he can't even get the accounting right, he is not going to get the macro right.

[Bill le Breton]

If we accept that QE can only stimulate when the Central Bank convinces markets that it will not be reversed and if the CB is saying it will be reversed, then, its object is not to stimulate. Sounds odd, but … if QE leads to an increase in bank reserves and the CB pays a safe return on those reserves in unsafe times, then, its prime purpose would appear to be to make commercial banks more profitable/less at risk.
An increase in the money supply does not have to be ‘pushing on a string’ if the money is created by Government Expenditure financed by private bank lending to the public sector. G yanks on the string.
But that would introduce a new generation of politicians to a forgotten power, which is another way of explaining to them that they, ‘cannot have a debt crisis (when they) can print their own money’. Austerity is more a political strategy than an economic necessity.

[Luis Enrique]

I have long wondered why, if the BoE wishes to stimulate the economy, it does not announce that (some proportion of) QE will be a permanent expansion of the monetary base, and commit itself to taking those gilts onto its balance sheet and rolling them over in perpetuity.

When I asked around on economics blogs, I was told that nobody would believe it, and there is no commitment device. It was also explained to me that would be the equivalent of trying to commit to expansionary monetary policy over the long-term, no matter what happens to inflation. The argument goes that should the BoE attempt to do that, at some point in the future banks would stop hoarding all that base money on reserve, inflation would kick off and the BoE will want to reverse QE to suck money out of the economy again. Knowing that, any such commitment would be non-credible.

[BT]

Chris seems a little confused on this one. If you want to understand QE, read Cullen Roche.

[Frances Coppola]

Warren Buffett is correct. Any sovereign that issues its own fiat currency cannot have a debt crisis, because it can always create the money to meet its debt obligations (provided they are denominated in its own currency, of course). But it can have a currency crisis - which amounts to the same thing.

QE does not work if banks are not lending normally, as the money is hoarded rather than being spent into the real economy. As a demand stimulus, therefore, its effect is seriously limited. Depressing bond yields in theory should push investors towards riskier assets such as corporate bonds, thus making it easier for companies to obtain finance for expansion, but this also doesn't work if investors' dominant motivation is safety rather than returns and companies are retrenching rather than expanding.

I therefore have serious reservations about the effectiveness of QE. However, the alternative - direct fiscal expansion using created money ("helicopter drops") - carries a much higher risk of inflation as it can only be reversed by means of higher taxes and/or spending cuts, both of which are likely to be pretty unpopular with the electorate. I'd guess that's why no government so far has opted for this solution to the current economic downturn.