With the predictability of a partner changing ‘our’ plans at the last minute, the announcement that UK inflation has fallen to its lowest level for two and a half years has been greeted with calls for more Quantitative Easing (QE) to stimulate growth.
Much of the media presentation of the facts of this latest inflation data has focused on the fall being a ‘surprise’. In reality most of the drop was predictable enough, as the article I link to above states, the VAT increase in 2011 fell off the index for the first time in May, while the situation in Iran has stabilised, causing oil prices to fall.
Another factor, which is helping to reduce inflation, is the government’s austerity program. This is deflationary in the obvious way that it impacts on short-term demand, but also because when markets see a strong decisive program for economic recovery, they buy that government’s debt, and the more demand there is for a particular country’s debt, the stronger that currency becomes relative to its peers, driving down the cost of imports, such as oil.
So I would argue that a fall in the inflation rate at this stage was very predictable, but should also serve as a note of caution for those who wish to abandon austerity in favour of deficit-led spending to achieve growth.
But the central point I want to discuss in this article is whether QE is actually an instrument for achieving growth. The current financial crisis is actually based on two different, but interlinked events, requiring different, but complimentary remedies.
The first crisis was the credit crunch, the solution to which was to make more capital available to banks. Quantitive Easing certainly is a tool to fix this problem, but it ignores the second crisis and the impact of this later, much larger, collapse on the economy. By reducing credit in the economy, demand was drastically reduced, causing recessions across the world, and recessions reduce confidence.
Quantitative Easing can serve to increase the supply of credit in the economy, but it cannot increase the demand for borrowing. People and businesses will only want to borrow when they feel confident about their economic prospects.
On a day-to-day level, ordinary families and small businesses will not feel confident about their prospects while the cost of living is rising faster that wages. The inflationary impacts of QE mean that even the mechanism designed to increase the supply of credit also acts as a brake on the demand for credit.
QE was effective in ending the ‘credit crunch’ phase of the economic crisis, helping to prevent a further collapse in the banking sector. But QE is not an instrument to achieve wider economic growth, and indeed why, through its inflationary impacts, it could impede the coalition’s growth drivers, such as the infrastructure spending in the second half of the parliament which the coalition announced at the start of its time in office and is starting to roll out now.
So that begs the question, what should the Bank of England do to contribute to growth?
The answer, I would argue, is concentrate on that part of its remit which it ignored during the new Labour years, ensuring financial stability in the economy, through better regulation of the banking sector and the city.
Halting the credit crunch in its tracks was a task which could only principally be achieved by the powers the Bank of England has at its disposal to increase the supply of money, but achieving growth can only be achieved through the government using its powers to increase demand.
* David Thorpe was the Liberal Democrat Prospective Parliamentary Candidate for East Ham in the 2015 General Election
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15 Comments
QE as I see it, is the same as Harold Wilson’s devaluation of the pound at a time when we attempted to maintain a fixed exchange rate; and against a previous Tory administration’s control of the money supply when following Milton Friedman’s economic theories. QE increases the money supply causing underlying price inflation.
Since economic systems have oscillated between boom and bust for decades and all economies are in an unstable state, it surely follows that the economic systems we have ARE BROKEN. They do not work and cannot work as currently constructed. Any economic policy initiative that does not address the underlying instability is just so much “Gaffer tape” attempting to strap up a ramshackle system to try and hold it together. It wont work.
Assume you as an individual, had bought a house at the height of the boom 2007, only to find yourself in 2012, with a depreciated asset in negative equity.
I print £30,000 (QE), and give it to you. Do you :
1. Use it to install a German Poggenpohl kitchen, and take the family on a Caribbean holiday. (Inflationary).
2. Pay down your mortgage and reduce your debt (Deflationary)
Answers on a postcard please to………..
@John Dunn. If my next-door neighbour Bob gets £30,000, I want £30,000 too. I bought this house in 2007, just like Bob. The only difference is that I paid cash.
Richard – You make an excellent point my friend. I would love £30,000 too.
But my point is that QE (presently £325 billion?), simply goes to ‘mop the brow’ of the banks that are also in negative equity.
Whereas Richard, £30,000 might do a good service to yours/and my finances, £325 billion is a mere ‘waiters tip’ to the £3 to 4 trillion of negative equity of debt they [banks], have on their accounts.
Richard… We’re Royaly fcukd! Hang on to your hat,.. it’s all you have left.
Richard – I don’t agree with everything you say. But you are clearly a very caring man with a heart, and I would love to buy you a beer one day.
Thanks John! Personally, my heart has a couple of metal tubes holding the arteries open, but I can still drink a pint or ten! But in my writings, I am the construction industry, though just a minor player in it, and not in any official capacity. If banks can get £325 billion, why can’t I? There are plenty of good things I could do with it, http://www.ice.org.uk/Information-resources/Infrastructure-policy-and-reports
Richard says:
“I am the construction industry, though just a minor player in it,”
Given what is ahead, there is no such thing as a minor player Richard. If you want to make a difference, as you clearly do, you are a major player.
There is a pint of Timothy Taylor Landlords bitter waiting on the bar for you. Cheers
Get a room, guys. 😉
Lol….. Malcolm You’re right. It’s getting too cosy. Let’s get confrontational !
I am the Construction Industry, and I want £325 billion, I can do a lot more good with it than the banks can. For one thing, I can solve your unemployment problem for the next 5 to 10 years. For another, I can solve your housing problems, your floooding problems, your energy problems, your transport problems, and a whole lot more at the same time and at no extra cost. I can make you the envy of the world, but you gotta …
Gimme de money.
Thanks for the comments guys,
@ John
I think youve hit the nail on the head.
@John Dunn
Can I have £30,000 too, please? Only I’d like my money a few weeks ahead of everyone else in the country.
Thanks!
Richard makes an important point, the government would have been better to bail out the construction industry and infrastructure of this country.
The banks were, and still are, engaged in too much risk taking primarily with financial derivatives.
When it was explained to me what CDOs and CFDs are, I just wonder why the government is still allowed this ‘gambling’ to continue. Does derivatives have any real constructive purpose? Except for increasing traders bonuses?
Farming futures as a derivative have some uses to guarantee farmers a price, but financial derivatives are just gambling by playing the market with money or shares that are leveraged (borrowed).
I advise anyone that is interested to watch ‘The Keiser report’ an insiders view of the financial world.
@ ernest
If the banks go bust, there will be no one to buy what the construction industry build, but the government ARE spending bu=illions to help the construction industry, and have always been intending to, with the infrastructure investments in the pipleine
I see no reason at all why the banks should get QE, and certainly no more QE. If QE is used to support construction, it is QE that is buying what the construction industry builds, and any sales later can go directly towards reducing the accumulated QE. The banks really don’t need to get involved much at all, except that they will have the opportunity to provide a banking service for a change. Maybe they can learn to repair their industry in the way that every other industry does, by working rather than gambling.