Now the Bank of England needs to deliver QE for the people
by Mark Blyth, Guardian For all the talk of policy change now that the Liberal Democrats have imploded, a strong continuity runs between the economic policies of the new government and its coalition predecessor in their shared belief that monetary policy can do all the heavy lifting. In short, “Rock Star” central banker Mark Carney can create growth with monetary magic, leaving fiscal policy to ignore cyclical conditions and focus on deficit reduction. This lopsided approach to policy has an inbuilt liability. If everything rests on the monetary magic of the Bank of England, what happens if the Bank runs out of tricks? Interest rates are close to zero, the yield curve is relatively flat, and the banking system is already flush with liquidity. Given our experience with “unconventional policy” to date, there are growing concerns that more of the same negative interest rates or further bouts of quantitative easing (QE) may cause more problems than they solve. Government policy is based upon a belief that now the crisis is over, the animal spirits of the private sector will awaken and interest rates gradually normalise. But this is policy-making based on hope. A genuinely responsible government needs a contingency plan in case hope fails us. And if the Bank is to be the leader, as well as the lender of last resort, we should at least give them the tools to do the job. With fiscal policy off the table, and existing monetary tools exhausted, we propose that the government legislates to empower the Bank of England with the ability to make payments directly to the household sector – QE for the people. With this tool the Bank would be equipped to mitigate any sharp slowdown in the economy, caused by domestic or external factors, such as a deflationary shock from a Chinese or US recession, or a continued slump in the eurozone. The empirical evidence from analogous policies – such as tax rebates in the US – suggests that transfers to the household sector would have a far greater impact on demand at a fraction of the size of QE. Consumers appear to quickly spend between a third and a half of any cash windfalls. So to increase consumption by 1% of GDP, you would need a transfer of 3% of GDP. UK QE currently stands at about 20% of annual GDP. The Bank of England estimates this raised GDP by 3%. Further QE would likely have less effect. So cash transfers to consumers are a far more effective stimulus than that provided by more QE for a lower spend. Consistent with operational independence of the Bank of England, the size of payments and their timing should be solely under its control, and subject to the inflation target. Parliament needs to equip the Bank with the infrastructure to administer payments, and determine in advance the recipients. An equal payment to all households is likely to be the least controversial rule. It would have an immediate impact on spending and it is transparent and fair – favouring neither borrowers nor savers, rich nor poor, nor one demographic over another. Some will object that this is fiscal policy, and should not be the remit of the monetary policy. This is misleading. If the distinction between monetary and fiscal policy hinges on the latter involving redistribution, then the Bank is already a fiscal policymaker insofar as changing interest rates redistributes between banks, savers and borrowers. If the distinction rests upon the risk of the Bank making losses on its balance sheet, then QE has already broken that line. What about longer-term inflationary effects? It is difficult to see why printing money on a far smaller scale than under QE should have a pernicious effect on inflation if the much larger costs associated with QE have failed to do so. If there is a sustained recovery in demand, the Bank can simply raise interest rates as per the inflation target. If the Bank ever runs out of the assets it needs to do this, the government can commit to provide them in much the same way as it has already done for potential QE losses. A government that would renege on this commitment and allow inflation is also a government that would abolish the independence of the Bank to achieve that aim. The last significant innovation in the Bank of England’s history was operational independence and the inflation-targeting mandate. Economic times have changed. Inflation credibility is no longer the only priority. The current economic plan is to rely on the Bank while hoping nothing goes wrong. Yet fundamental weaknesses in the tools of monetary policy have been revealed by the financial crisis and yet we keep asking the monetary authority to do more, not less. To do more, the Bank needs a new tool.