Opinion: Intelligent quantitative easing is best hope to stop the bleeding and begin reviving the patient

At our party Conference in Birmingham I described accelerated fiscal consolidation as pure poison: “Poison for the party, poison for the Coalition and, most important, poison for the country.”

I know that Liberal Democrats in ministerial office cannot be heard to say such things in public. But Liberal Democrats who do not have to labour under the restraints of office should be making it plain how oxymoronic ‘expansionary accelerated fiscal consolidation’ really is.

They will be in good and growing company.

The announcement of a further round of Quantitative Easing (QE) – much larger than the financial press had anticipated and a month earlier than many economic pundits had thought likely – by the Monetary Policy Committee, sends an unmistakeable signal to the Government and the British public about how concerned MPC members now are about the rapidly deteriorating condition of both the domestic and the international economy.

Rahm Emmanuel is said to have advised President Obama not to let the crisis go to waste. Unfortunately the President tried but was unable to go anything like far enough in stimulating the US economy. Now that the UK’s economic problems are growing – approaching crisis proportions – it is time to make the most of crisis.

Providing an additional £75 billion in QE to the banks, so that they can sit on it or speculate with it, is simply not good enough.

Liberal Democrats, in government and outside of it, have to do everything they can to encourage and facilitate the use of QE to support businesses that can enhance the prospects and opportunities of tens of thousands of Britons who desperately want to work and contribute to the future of their country.

On another day it might be appropriate to write something about the creation of money and how it is intimately connected with the banking system’s ability to create credit. But, right now, we all need to focus on how best to counteract powerful deflationary forces at work in both the UK and the international economic system, without getting sidetracked into a technical discussion about the nature of money and credit.

The economic picture is dire for the UK: the Office for National Statistics has confirmed what those who have had their fingers on the pulse of the UK economy already knew; the recession was far deeper than official data originally suggested. GDP is currently 4.4 per cent below its pre-recession peak, rather than 3.9 per cent below. Economic growth, using conventional measures of domestic product, was 0.5 per cent, rather than 0.7 per cent, in the first half of 2011; forecasters have – almost without exception – been unduly optimistic about the prospects for recovery.

The MPC did not wait until November to launch another round of QE because it had advance knowledge of data confirming its member’s worst fears about the scale of threats to domestic recovery and the severity of the international headwinds against which the UK economy will have to battle.

I have little time for Ed Balls – who now calls on the Coalition government to do more – when he failed so badly in government. He was the one operating the bellows, when mutant financial capitalism was allowed to trumpet its profitability and dramatically expand its risk taking in London. I don’t take Balls’ recent apology for his role in urging on the wild-west brigade in the City the least bit seriously. He simply has to have known that the Government, of which he was a part, was orchestrating the official equivalent of protection racket: ‘light touch regulation’ was a promissory note, another way of saying – if you give us our share we are ready to look the other way.

I do have a great deal of time for David Kern, chief economist at the British Chambers of Commerce, who is reported as having said: “Higher QE on its own is not enough…we urge the MPC to look at other radical methods. There is a strong case for the MPC to help boost bank lending to businesses by immediately raising its purchases of private sector assets.”

The precise details need to be worked out very quickly, and BIS and DECC may well have vital – indeed leading – roles to play.

Liberal Democrats in government are well placed not only to explain and justify radical and innovative policy steps, which are indisputably long overdue, but also to help implement innovative forms of QE that show just how important a liberal inspired government can be in both minimising economic harms and reviving Britain’s economic fortunes.

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  • JustAnotherVoter 7th Oct '11 - 3:15pm

    Providing an additional £75 billion in QE to the banks, so that they can sit on it or speculate with it, is simply not good enough.

    That kind of populist nonsense is very disappointing to read here. That statement does not provide any analysis into the effects of QE.

    1) If a commercial bank wants to exchange any of its gilts for central bank reserves, it can do that at any time, because the gilt market is very liquid. So what? Why is it better or worse for a bank to be holding central bank reserves or gilts?

    2) Banks always “sit on” central bank reserves. The purpose of central bank reserves is to be “sat on” by clearing banks. When I spend £100 at Tesco, £100 of reserves that my clearing bank was “sitting on” get transferred to Tesco’s clearing bank. Which then “sits on” them. So what?

    3) To the extent that any given bank turns gilts into reserves, it is lowering its income, because gilts yield more than reserves. Why would a bank deliberately lower its risk-free income? Probably, it would only do this if it wants to move the reserves to another bank in the clearing process, as with (2). So to the extent that QE encourages movement of reserves, that is a reflection of more activity in the real economy. Ergo, it is a good thing.

  • Simon McGrath 7th Oct '11 - 7:32pm

    Will simply lead to more inflation.

    There is little evidence that banks are failing to lend to customers who will actually pay the money back. one of the problems our economy has is that many large corporate have big cash piles which they will not invest because they don’t see attractive opportunities.

    It is very easy to lend money as the banks found out before the recession, trick is to lend to people who can pay back the money.

  • Thanks to ‘JustAnotherVoter’, Liberal Eye, Jane Leaper, Stephen W and Simon McGrath.

    In response to JAV. I honestly doubt that there is anything populist about QE. Whether it makes sense as a policy is surely dependent on the impact it has or can have on economic activity and that depends, in my view, on how it is managed.

    Unfortunately you appear confused about what QE entails. The asset purchases – in a programme of QE – are made by the central bank, at its discretion. It simply does not make sense to compare them with discretionary sales or purchases of gilts by commercial banks/financial institutions on their own account.

    If you want a formal analysis of how the BoE’s QE programme operated between March 2009 and January 2010 then you could take a look at the paper by Michael Joyce, Matthew Tong and Roberts Woods, recently published in the Bank’s Quarterly Bulletin. I personally doubt the economic impact has been as great as Joyce, Tong and Woods suggest for the first round of QE. They claim that the “evidence suggests that the policy had economically significant effects – equivalent to a 150 to 300 basis point cut in Bank rate”, but they go on to acknowledge “considerable uncertainty around the precise magnitude of the impact. I think that Jane Leaper has a better grasp of the real impact that QE can have.

    I am afraid you have simply muddled up reserves held at the central bank with asset purchases made by the central bank, which do have an impact on the cost of borrowing. So far as I am concerned the big issue is the extent to which QE feeds through to businesses that are finding it difficult to borrow and have what an intelligent lender would judge to be a good business plan/proposition in less exceptional and scary times.

    In response to Liberal Eye. I didn’t write about Obama’s MAIN failing…but a specific failure (I’d call it inability) to get Congress to behave more sensibly. Obama had a window of opportunity – as Paul Krugman has argued – and I am afraid he blew it; at least his economic advisers blew it (including Larry Summers, who has now changed his tune).

    I agree strongly with James Galbraith that the US authorities didn’t simply stand idly by, when there was rampant fraud, they positively encouraged it. The pass was mostly sold by the time Obama got into the White House. That was the work of financial team Clinton (Summers, Greenspan and Rubin and others) and Bush and co who drove the proverbially coach and horses through what remained when Clinton left office. The regulatory system and the enforcement agencies had been fatally weakened long before Obama entered the White House. I honestly doubt that anyone likely to be elected to the US presidency will have what it takes to launch an effective attack on the financial predators who have been out of control for some time. Greenspan span and his associates span quite a period. It will take a popular movement to shift the centre of US political gravity. There are a few hopeful signs…but it still seems to me to be a long way off.

    Earlier this evening Lord Oakeshott appeared on Newsnight and made the point that banks owned by the British public/Government, which would have gone bust without public support, should now be used to support economic recovery and to fulfil the objectives that were supposed to be part of the Merlin deal. I agree.

    The credit system is very badly damaged, but what we are going through is no ordinary bust; it is a balance sheet recession and we need to make use of the instruments [the defective instruments] we have to make the most effective temporary repair of the credit system we can. If you are asking me to agree that we are faced with awful choices, between third and fourth best and something even more unpalatable, then I’d agree.

    Jane Leaper – I think your comments demonstrate that what I’m proposing is far from being populist. I agree with your assessment of JustAnotherVoter (but prefer to use less provocative language). Amongst the real effects that QE has – as the Bank of England’s own research demonstrates – is a reduction in interest rates. That does amount to a transfer of income and wealth from many people with savings, most particularly pensioners, to others in the UK economy. I have seen estimates that the sums involved run into tens of billions of pounds. I am certain it is no comfort to you to be told that we (that is the whole of British society) are between a rock and a hard place and that the best that policy-makers can do is to modify the severity of the impact of what Liberal Eye has called rampant fraud. I don’t disagree with Liberal Eye about this.

    For my own part I believe that in striking a balance we need to do more to maintain and generate employment and that QE – managed much more intelligently than it was last time around – is better than doing nothing. I would prefer the government to make more use of the room for manoeuvre, which I believe it has, to adopt fiscal measures designed to counteract deflationary forces; but government ministers appear to be trapped by their own language about accelerated deficit reduction and about sticking to plan A.

    Stephen W – I disagree with what you say about inflation. The BoE MPC should focus on inflation in two years time; that is sensible given the lags that exist in the economy. As the BoE has argued the inflation that clearly concerns you (and many other Britons) is driven by (a) a fall in the value of the pound and international commodity prices, and (b) an increase in the VAT rate, which will drop out of the prices index in the near term. It does not make sense to adopt an interest rate policy right now which will intensify the forces that are deflating the UK economy.

    Simon – banks, particularly banks in the US, have made a point of lending to people who could not be expected to pay them back; that is a major factor in the problems we now have. UK banks joined the party by putting money into CDOs, which they should have kept clear of.

    Now they are being asked to do contradictory things: rebuild their balance sheets and invest in SMEs. QE has the potential to make the banks we now own more effective instruments – than they otherwise would be – for a vital national purpose.

    As you explain “many large corporates have big cash piles”; it is also the case that households are doing their best to pay down debt. If Government does the same at the same time the result is reduced demand all round. The consequences of that are painful for almost everyone and pretty obvious; they include an increasing public sector deficit, as tax revenues fall further.

    As Stephen W explained, Keynes said he’d changed his mind when the facts changed. In a balance sheet recession, aware that what is rational for individuals and corporates, in isolation, can contribute to something that is profoundly damaging for the population as a whole, it is essential to identify the fallacy of composition [that everyone paying down debt and building up balances at the same time will make things better] and use the best means available to counteract it.

    Keynes was appalled by the advice and logic of Andrew Mellon: “liquidate labor, liquidate stocks, liquidate farmers, liquidate real estate… it will purge the rottenness out of the system”.

    You distrust BoE QE and write: “It will simply lead to more inflation”. There is nothing simple about it, but given the choices that are open to us I side with Keynes against Mellon.

    Perhaps it is worth quoting what Mellon went on to say: “High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people.”

    I don’t buy Mellon’s morality tale for a moment. It’s the rich wot gets the gravy and it’s the poor what gets the blame; especially when a society hits the worst of times.

    I’ve no doubt times are going to be hard but I am equally certain that we have choices about how hard and how quickly we adjust to a world in which much of what was valued and rewarded in the City turned out to be fools gold. Most of the population feel they have been made fools of and those who made the bets (the one way bets) and got the gold have left a financial system behind them that is going to be extraordinarily difficult to repair, however we go about it.

  • Andrew Duffield 8th Oct '11 - 6:56pm

    It’s the unfettered creation of interest-bearing, debt-based money by private banks that largely fuels inflation. Government issue of debt-free money (now reduced to the mere 3% of money supply comprising notes and coins) has a negligible inflationary effect – provided it is spent into circulation in direct exchange for productive wealth creation of course. If 100% of money supply was created in this way, inflation could be readily controlled and the massive unearned element of private bank profits (together with much bonus excess) would revert to the state – allowing for huge potential reductions in deadweight taxation on economic growth.

  • Matthew Huntbach 8th Oct '11 - 11:42pm

    Anyone who had any real feel for the real world as most people in this country find it would know very well what is happening now. People are shutting down, not making the long-term plans, not engaging in economic co-operation, not being entrepreneurial, because they are scared. If they are in jobs, they are scared they will lose them, and if they lose them they will never work again. When this is how you are, you don’t go out and buy things, you shelve all those plans you had, you just spend on the necessities. With the result that others lose their jobs. All around me this is what I am seeing – small businesses going down because no-one in this current climate of fear wants to spend money on anything but the bare necessities. Those who have put time and energy into setting up businesses are finding it just means they get driven further into debt for nothing – how sad it is when I see in the streets around so many new shop fronts with the shops already closed down all those hopes dashed, all that entrepreneurial spirit shown up as useless when we are governed by the people who govern us now (I mean those who hold the money, not just those who are formally the government). Those in work for big organisations, private or public, know that the best way to survive is to keep your head down, do what you are told however stupid, don’t think for yourself, don’t try anything new which might fail – again all this quashes any sort of entrepreneurial spirit.

    Yet what do those who govern us tell us is the way to increase entrepreneurialism – this is it, they say it is to increase fear levels. They want to remove employment protection, they want to force people through the fear of marketisation that they will lose their jobs, they want cuts to government services which places fear in those working in this area, they want to cut welfare to raise the fear levels still further. THIS WILL NOT WORK! No doubt this dog-eat-dog competion seems fun and invigorating if you are stinking rich, so you will never REALLY lose, because whatever happens you have your wealth and contacts to fall back on, so it’s all a game. But the stinking rich don’t seem to be able to realise that most people are not like them.

    If you really want ordinary people to feel more courageous, to feel free to take more risks, to try out entrepeneurial ideas that may or may not work, what you actually need to do is to take away the fear element, by having a stronger safety net, by having a decent welfare state, by ensuring there is small but acceptable housing for all. I remember when I was growig up the security of council housing actually did enable people, my father was one, to be more adventurous and try out ideas of a sort no-one with a mortgage could dare try. Yet how often do the wealthy and those paid for by the wealthy to spout the propaganda of the wealthy (i.e. the Conservative Party, and those trying to take over the Liberal Democrats and turn it into an Ayn Rand party) ever say things like this? Are they even capable of thinking things like that? No, their brains have been stultified by their wealth, they cannot think outside the box it imposes on them, and that is why this country is going down the pans fast, because these people run it.

  • Andrew, Stephen W and Matthew thank you for your thoughts and contributions.

    Andrew, I think we are on the same page. You have put key elements of the argument succinctly and clearly. Thanks.

    Stephen W I can only ask you what it is that we lack evidence for? An economy that is failing to utilise its human resources? An economy facing an extended period of depressed demand? An economy that is encountering higher prices for imported raw materials and manufactures but in which there is little or no evidence of domestically generated pressure on prices?

    The BoE has mostly followed the herd when it has come to making forecasts and I don’t have a great deal of faith in the herd or their forecasts. What’s most interesting to me isn’t how wide of the mark they have been when it comes to inflation prediction but how wide of the mark they have been in forecasting ‘recovery’.

    Adam Posen and, when the next set of MPC minutes come out, his colleagues on the MPC have been able to look at the overall economic picture and (I predict) they have come to conclusion that the downside risks for the UK economy are immense and growing. Mervyn King used what by any standards is extraordinary language for a central banker – it is worth asking why.

    I think you’d find in illuminating to look at what Posen has been saying in public, about the downside risks (and how to try and counteract them), for some time now. Posen’s public utterances and economic judgements are available via the BoE’s web pages.

    Matthew, I agree. When David Cameron and/or his speech writers got themselves into such a pickle a few days ago over their advice to ordinary Britons it was clear not only that their economic understanding was superficial (to put it gently) but also that they had little real understanding of the daily lives of millions of their fellow Britons. I hope and pray that team Cable/Huhne/Clegg and Alexander manage to communicate with one another and their Coalition Cabinet colleagues and aid the only Government we are likely to have for a while fashion an economic strategy that matches the times were are living in.

  • Matthew Huntbach 10th Oct '11 - 6:20pm

    Ed Randall

    Matthew, I agree. When David Cameron and/or his speech writers got themselves into such a pickle a few days ago over their advice to ordinary Britons it was clear not only that their economic understanding was superficial (to put it gently) but also that they had little real understanding of the daily lives of millions of their fellow Britons.

    Thanks Ed. I wish I could be convinced that the people who lead our party see it as you and I see it. I wish I could believe there were substantial numbers of people lower down in our party who could see it and were pushing forcefully in that way. I have steered clear of LibDem bloggery recently, mostly because I have little time, but also because I find it too depressing. But I looked at a little just now, and I found it REALLY depressing. Maybe the bloggers aren’t typical of the rest, but I saw far too many people identifying themselves as “LibDem bloggers” but spouting out stuff that was either enthusiastic extreme right-wing economics, or naively accepting the way a small minority has managed to move our party so that this sort of thing is now seen as mainstream in a way it never was just a few years ago. I fear that even if it is still fairly minority opinion, it seems to be what many new recruits are into. I think I must go back to steering clear of LibDem bloggery because I don’t have time or energy to argue with that lot. But what has it come to when I find myself saying things like I said and I feel like an interloper for saying them because when I say them I turn round and find I’m the only one saying things like this?

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