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.