By Jonathan Eley, 09 February 2010
Last week, the Bank of England suspended its asset purchase programme, better known as quantitative easing or QE, having spent £200bn buying mostly government bonds. Was this unprecedented expansion of narrow money justified? Did it achieve much?
YES, says Hetal Mehta:
Think back to when the policy of quantitative easing (QE) was introduced early last year. Interest rates had been slashed aggressively to their lowest in history, the Chancellor had thus far provided only a minor stimulus package, and the recession showed no signs of abating.
Radical measures were required to kick-start the economy and help thaw the frozen credit markets. With all other policy levers cranked up to maximum, QE was the only option left.
QE works through two channels. First, newly created bank money is used to purchase assets from banks and other financial institutions, increasing the money supply. The second channel is through the impact on borrowing costs. With the Bank purchasing gilts and corporate bonds, this increases demand and liquidity, helping prices recover and pushing down yields. Lower yields reduce borrowing costs. The combination of greater credit availability at lower cost stimulates activity.
Almost immediately after the strategy was adopted, government and corporate bond yields fell back sharply, and the policy was also promptly implemented by the Federal Reserve. This has reduced borrowing costs and stimulated activity.
Meanwhile the spread of Libor over Bank Rate - a proxy for confidence in the banking sector - has fallen appreciably, from 130 basis points (bp) in early March to around 10bp now, below the long term average of 15-20bp, suggesting that the financial sector is returning to health.
Since the implementation of the policy, we have seen a strong recovery in asset prices. The FTSE All Share index is up over 45 per cent since hitting its trough last March. Residential and commercial property prices have also recovered.
While the risks surrounding the use of QE, namely inflation, cannot be ignored, they were outweighed by the danger of doing nothing. Given that the economy has only just emerged from recession by the skin of its teeth, it seems likely that without QE we would still be in recession.
Hetal Mehta is an independent economic consultant and adviser to Ernst & Young's ITEM Club.
NO, says John Redwood:
I can see why the Bank opted for quantitative easing. The money supply was contracting too quickly for comfort. The economy was plunging into a very nasty and deep recession. Keynsians and monetarists for once agreed that there needed to be both a monetary and a fiscal stimulus to try to limit the damage.
The problem is the method they choose did not release more credit and money for the hard pressed small business sector, or for much of the wider business community. As they were printing more money, the banking regulator was demanding that banks suddenly carry more cash and capital than they could afford, leading to a shortage of lending for business.
Between the banking regulator and the Bank of England they created a money go round to keep the price of government borrowing down, and a prodigious squeeze on the productive sector. The commercial banks could borrow cheaply again, but they had to lend it on the government to raise their liquidity. The government could borrow at rates depressed by the £200 billion buying programme initiated by the Bank of England. The Bank ended up owning one fifth of all the UK government bonds in issue. Such large scale buying kept the prices of the bonds higher than would otherwise have been the case.
Most of the printed money found its way into paying public sector bills, as the public sector deficit ballooned. This has merely created yet another distortion in a badly damaged economy. We soon have to start fixing the deficit, before the deficit drives government into bigger cuts than politicians would like.
Over the last five years the government has doubled public indebtedness and almost doubled the money supply. Despite this, or because of it, the economy has not grown overall. It is difficult to argue on this evidence that the monetary and fiscal stimuli have worked. Errant money policy, lurching from boom to bust and back to attempted boom, has disrupted the rest of the UK economy. It has left us poorer as a result.
WHAT DO YOU THINK?
Did QE save us from the abyss, or push us closer to it? Has it created more problems than it solved? Leave your views below!
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