The recent comments from Bank Of England Governor Mevyn King , regarding the possibility of quantitative easing make little sense in the context of the Coalition’s current economic strategy and are contrary to broad Lib Dem principals.
The pre-election debate on the economy centred on whether the recovery was strong enough at present to sustain cuts, it is the opinion of Lib Dems, and a view I agree with, that the economy is strong enough to sustain such an action.
This view can be boiled down to believing that the level of aggregate demand in the economy has reached a point where the economy is in danger of overheating, and tipping into inflation. Government cuts will reduce the level of aggregate demand, but the theory is that the level of demand is strong enough to allow growth to continue at a rate that is strong enough for the economy to develop but that demand will be reduced by a large enough margin to prevent unstable levels of inflation occurring.
In recent months the Bank Of England have written to the government to apologise for the fact that the rate of inflation was higher than the government target of 2%. The Bank of England Monetary Policy committee have consistently been doves when it comes to inflation, believing that a low rate of inflation will consistency occur in the coming months, indeed they believe that deflation will be a bigger threat than inflation in the medium term.
The Banks response to the rate of inflation being higher than they expected, and higher than the government’s 2% target, was to say that they ‘didn’t know’ why the inflation rate was so high. The fact that inflation was running above target seems to indicate that the government’s view concerning the level of aggregate demand in the economy is the correct one.
And so to quantitative easing. Injecting cash directly into the economy is an inflationary measure, as the more cash there is swirling around the less real value that cash will have. Obviously if the government believe that the level of aggregate demand is to high, pumping demand into the economy to increase demand further would run counter to the government’s economic strategy at present. It is also a supply side economic policy, when the vast majority of Liberal Democrats are Keynesian in Economic outlook, and thus believe that supply side measures such as quantitative easing are ineffective.
The idea appears to be to use the newly printed currency directly to pay the holders of United Kingdom sovereign debt. This would reduce some of the supply side inflationary pressures which are present in the UK economy as a result of the high levels of debt forcing the value of the British currency down relative to some of its international peers. While this could have a positive effect on the economy, it will also inject inflation as prices in the domestic economy on non imported goods are increased, while the whole whole point of the government’s strategy to date has been to reduce inflationary pressures.
A difference in overall aims and objectives between the Treasury and the Bank of England is never likely to have a positive impact on the economy, and could mean that the current wave of cuts are in vain, and the legacy of this coalition will be a double dip recession.