Why politicians should tread carefully before using Quantitative Easing to build infrastructure

At a time when politicians grapple with how to use the tools at their disposal to reduce inequality of opportunity and outcome, quantitative easing {QE) can seem like an easy option.

To those blessedly unversed in the intricacies of the monetary policy tool that has dominated more than anything else the economy of the UK since the financial crisis, QE sounds like, ‘printing money and spending it on infrastructure.’

If only it were that simple. QE is a policy of central banks to buy the bonds  issued by their own governments, the aim being to push interest rates down and drive capital into assets more likely to make the economy grow.

So the first problem with any idea of using QE to increase government spending is that, well, the government doesn’t have the power to do it, Politicians can issue the bonds, the Bank of England can choose not to buy them, and the Bank of England is independent of government. 

Given that QE is supposed to be inflationary, and with inflation already rising, the Bank of England may take the view that more QE, however the cash is deployed, is a bad idea if it is to meet its mandate of 2 per cent inflation over the long-term.

The second problem is that the Bank of England itself takes the view that Quantitative Easing is regressive, because it pushes asset prices upwards, and the rich have more assets than the poor.

So a policy of unpredictable outcomes, that may not be implementable, and is almost certainly regressive, surely there are better options to fund much needed infrastructure-in my next article I will explore three such ways.

 

* David Thorpe was the Liberal Democrat Prospective Parliamentary Candidate for East Ham in the 2015 General Election

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16 Comments

  • Jonathan Pile 24th Mar '17 - 4:51pm

    Excellent article David : One word HS2 – this £60bn perhaps £200bn White elephant is a prime example of the kind of ill thought out infrastructure project funded by govt debt/borrowing with a tiny BCR which crowds out the high quality business investment needed in renewables, high speed broadband, training etc that has a proven high return and actually adds value to the UK economy. Speaking as a businessman that this year has increased long term business investment in Yorkshire,London and Brussels as a positive response to Brexit and other negative events – I urge a business led approach to infrastructure investment which has a genuine business case based on sound finance. Business isn’t safe in Tory hands – rising debt & QE is a stealth tax on the poor.

  • Depends what they spend the money on. If they had used the QE money for infrastructure the rich might have got richer but at least we might have decent roads.

  • Steve Trevethan 24th Mar '17 - 8:26pm

    Thank you for the interesting and important article.

    Quantitative Easing was/is a policy to save banks and bondholders instead of the “real
    economy”.
    In the US, 95% of the population has seen its real income and net worth decline during 2008-2016, despite or because of the soaring stock and bond markets. [Hence Mr Trump]

    What is needed is debt relief, progressive taxes on rentier income and wealth and public money creation.

    From http://michael-hudson.com/2017/02/j-is-for-junk-economics-order-now/

  • Eddie Sammon 24th Mar '17 - 8:29pm

    I’ve been a critic of QE for about five years, but I have supported it once when I saw people’s (former clients) pensions getting hammered whilst the FTSE was falling. It’s an emergency policy, not one for general use.

    Regards

  • Bill le Breton 25th Mar '17 - 9:43am

    I look forward to David’s next article on how to fund ‘much needed infrastructure’.

    But first I think it is important to settle this fiction that the Bank of England is independent. It isn’t. It has operation independence given to it by the Bank of England Act 1998 – but responsibility for strategic monetary policy remains with HMT and therefore the Ch of the Ex, again according to that Act.

    After every general election and every spring thereafter HMT sets or confirms the objectives for the Bank of England. (But HMT could change strategy at any time if it so wished.) From the outset the strategy the Bank has been given is to pursue a target of 2% inflation (two or so years from the present). Each B of E Inflation Report sets out its expected future path of inflation which without variation over nearly 20 years has hit 2% two years out.

    It is the Central Bank following this ‘mission’ that sets the level of aggregate demand in the economy, not the Government through its Budget.

    Second point. QE has a bad name, especially among Liberal Democrats. But those monetary authorities which used QE the quickest and to the greatest extent recovered from the Great Recession the soonest. Those that delayed or did so half heartedly were the slowest to recover – eg the European Central Bank.

    Was QE the best way to expand the money supply at a time when lack of investment and deleveraging were reducing the money supply?

    The other way, which I have always advocated for the crisis of 2008 was through monetary financing of Government Expenditure. One could have used the same quantity targets eg £375 billion or whatever, but rather than benefiting owners of the bonds which were purchased under QE, it would have benefited the future users of the infrastructure commissioned by Central and Local Government and those employed to produce it.

    I feel sure that this is what Keynes would have advocated had he been alive in 2008. He was of course a great monetarist.

  • Peter Martin 25th Mar '17 - 1:35pm

    “QE is a policy of central banks to buy the bonds issued by their own governments, the aim being to push interest rates down and drive capital into assets more likely to make the economy grow.”

    This is true. I might just make the point, though, that the supposed independence of central banks from government is a fiction. It is a fiction even in Germany where the idea originated. For years the Bundesbank has used the surplus dollars and pounds which the country acquires from its export surplus to buy up bonds from the US and UK governments. This kept first the DM, and now euro, lower on the 4X markets than they would be otherwise, keeping German exports “competitive”. Not to put too fine a point on it all, the Bundesbank manipulates the German currency.

    And they do this totally independently? I don’t think so.

    Government are in the happy position, unlike you or I, of being able to spend by issuing their own IOUs. Sometimes these IOUs bear interest, and they are called bonds. Sometimes they don’t and they are called cash. Sometimes Government swaps their cash IOUs for bond IOUs. That’s called QE. Usually it’s the other way around.

    There’s a bit more to QE than just pushing longer term interest rates down though. Some economists would say QE is just an asset swap. That’s true if we take a narrow definition of QE. But if we take a broader view and consider that the Government has instructed its central bank to buy bonds at the same time it is selling new bonds into the market, then we can see that it is really just a work-around to avoid the central bank providing cash directly to government in exchange for bonds. This is, generally speaking, frowned upon in polite economic circles.

    It doesn’t mean it is necessarily a bad thing though. If the government needs to issue cash to keep the economy going , then providing the inflation situation is kept under control, there really can be no objection. It is no more inflationary for governments to spend with cash rather than bonds. It keeps the interest bill down too.

  • Peter Martin 25th Mar '17 - 1:37pm

    “QE is a policy of central banks to buy the bonds issued by their own governments, the aim being to push interest rates down and drive capital into assets more likely to make the economy grow.”

    This is true. I might just make the point, though, that the supposed independence of central banks from government is a fiction. It is a fiction even in Germany where the idea originated. For years the Bundesbank has used the surplus dollars and pounds which the country acquires from its export surplus to buy up bonds from the US and UK governments. This kept first the DM, and now euro, lower on the 4X markets than they would be otherwise, keeping German exports “competitive”. Not to put too fine a point on it all, the Bundesbank manipulates the German currency.

    And they do this totally independently? I don’t think so.

    Government are in the happy position, unlike you or I, of being able to spend by issuing their own IOUs. Sometimes these IOUs bear interest, and they are called bonds. Sometimes they don’t and they are called cash. Sometimes Government swaps their cash IOUs for bond IOUs. That’s called QE. Usually it’s the other way around.

    There’s a bit more to QE than just pushing longer term interest rates down though. Some economists would say QE is just an asset swap. That’s true if we take a narrow definition of QE. But if we take a broader view and consider that the Government has instructed its central bank to buy bonds at the same time it is selling new bonds into the market, then we can see that it is really just a work-around to avoid the central bank providing cash directly to government in exchange for bonds. This is, generally speaking, frowned upon in polite economic circles.

    It doesn’t mean it is necessarily a bad thing though. If the government needs to issue cash to keep the economy going , then providing the inflation situation is kept under control, there really can be no objection. It is no more inflationary for governments to spend with cash rather than bonds. It keeps the interest bill down too.

  • Peter Martin 25th Mar '17 - 1:54pm

    @ Bill le Breton,

    Keyenes’ was a great monetarist? I suppose it depends on how you define the term! I agree with you though that Keynes very likely would have advocated “monetary financing of Government Expenditure”. Those on the left call that Peoples’ QE but I’d argue that we shouldn’t use that term QE quite in that way. Your term is better and more accurate.

    The simple point to make is that the UK economy has a GDP of £2.2 trillion. So it needs that amount of spending to keep it going. Too much spending means too much inflation. Too little spending means recession and high unemployment. If everyone else is spending too much Government needs to spend less. If we (including our overseas trading partners who are big savers) are spending too little then Government has to spend more to make up.

    Just where that money has to come from does cause some difficulty to nearly everyone who thinks that Government finances are just like their own but on a larger scale. They aren’t. Government is not a household.

  • Peter Martin 25th Mar '17 - 2:09pm

    @ Cllr Mark Wright,

    “QE is the main reason for the soaring property prices and stock markets, both of which benefit the top of society…”

    We had soaring property prices and stock markets before QE. Property prices rise when interest rates fall. So if we are looking for a single source of blame. I would point the finger towards the so-called “New Keynesians” , who aren’t really Keynesian at all, who have pushed the idea that the economy can be regulated solely by the adjustment of interest rates.

    So QE is just a part of a wider NK picture. A NK cock-up if you like. The problem is that lower interest rates only work for a while. The private debt which accumulates has a depressing effect on the economy. So interest rates have to be reduced again to compensate for them being reduced too much previously to encourage even more lending. That why we have QE and that’s why interest rates are now close to 0%.

    So what next for the NK’s? Abolish cash and have negative rates? Don’t laugh, but that’s exactly what some are suggesting!

  • Laurence Cox 25th Mar '17 - 5:38pm

    @Peter Martin,
    I think that Ted Heath found the right phrase when he described Nigel Lawson in the 1989 budget debate as a “one-club golfer stuck in a bunker”. If politicians hadn’t painted themselves into a corner by promising not to raise taxes (or at least taxes like income tax, NI and VAT that raise the most money) we would not need to be relying on interest rates alone to regulate the economy.

  • Joseph Bourke 25th Mar '17 - 5:58pm

    Good article from David Thorpe and excellent comments all around. The Science Museum has a model of the economy based on flows of funds from savings to investment, taxes to government spending, national income to consumer spending and debt. What is useful about this model is that it does not depict cause and effect but rather a a continual circulation of economic activity that can go in either direction and where increased flows of one element necessarily impact the stock or flows of all other elements.
    QE is an artificial construct designed to maintain the stock of debt in a deflating economy and enable government to increase borrowing with out pushing interest rates ever higher. It has it’s place as an emergency brake on falling prices, but as the article points out the measure exacerbates wealth/asset inequality and cannot be practically deployed under normal economic conditions without significantly impacting the equilibrium of the economic cycle.
    Government can temporarily create money to spend on infrastructure, but the increased money supply will need to recouped via taxation and/or debt issue in a relatively short period thereafter, to keep the stock on money in the economy and the inflation associated with an increasing supply of money under control.

  • Peter Martin 26th Mar '17 - 10:45am

    Gilts/Treasury Bonds 101

    When UK Citizens and Banks buy gilts:
    “Oh, how prudent and wise. Such an intelligent investment strategy.”

    When Germany, Denmark, Switzerland and China etc buy gilts:
    “Oh No. That’s not good. We shouldn’t have to sell bonds to foreigners”

    When the Treasury sells gilts to anyone:
    “Look I told you we were living beyond our means!”

    When the Treasury sells bonds to the BoE:
    “Hyperinflation, Hyperinflation, Zimababwe, Zimbabwe, The Weimar Republic, The Weimar Republic………”

  • david thorpe 27th Mar '17 - 1:49pm

    thanks for the comments. QE is both regressive and negative to economic gerowth, because it shunts wealth towards the old, who spend less than the young….hampering economic demand.

  • Peter Martin 27th Mar '17 - 9:22pm

    @ David Thorpe,

    “QE is both regressive and negative to economic gerowth, because it shunts wealth towards the old, who spend less than the young….hampering economic demand.”

    It sounds like you’ve got a bit of a chip on your shoulder about the older generation here! I suppose if you’d been writing on a Socialist blog you’d have said the wealthy instead.

    The flaw in your argument would still be that, by your own admission, QE has reduced interest rates. Therefore as the old (or the wealthy) are more reliant on interest payments for their income, they have to end up being worse off.

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