Last year, as the gravity of the threat of the pandemic became clear, the major central banks – which still had QE programs running – expanded them aggressively in tandem with unprecedented levels of fiscal stimulus from their governments in response to what was a more conventional threat of a severe economic downturn, albeit one that had emerged from an unconventional source.
Even the RBA, which had avoided using QE during the financial crisis and was somewhat sceptical of its efficacy, was forced to follow suit because, by driving their interest rates down and flooding their systems with ultra-cheap funds, the major central banks threatened to force the currencies of countries with higher interest rates up sharply, exaggerating the depressive impact of the pandemic.
QE has done little, if anything, for investment and growth rates.
The House of Lord’s committee concluded that the UK’s QE in 2009 had been effective in preventing a recurrence of the Great Depression and stabilising financial markets but had been “an imperfect policy tool” that had limited impact on economic growth and demand over the past decade.
There was, it concluded, limited evidence that it had increased bank lending, investment or spending by assets holders but it had inflated asset prices artificially, benefiting those who owned them disproportionately and exacerbating wealth inequalities.
What was once seen as unconventional is now seen, it said, as the BoE’s main tool for responding to a range of economic problems even though the problems now were quite different to those in 2009.
This year there has been considerable discussion by economists and central bankers about the spike in inflation rates in developed economies and whether they are transitory – driven by supply chain disruptions and other pandemic-related influences – or entrenched, and therefore whether expansive monetary settings remain necessary or risk contributing to an inflation break-out.
The BoE view, like the US Fed’s, is that the spike in inflation – 2.5 per cent last month in the UK, 5.4 per cent in the US – is transitory but the UK committee called on its central bank to justify its view with more detail, clarify what it meant by “transitory inflation,” share its analyses and demonstrate that it had a plan to keep inflation in check.
It saw continuing QE as not just an inflationary threat but a risk to public finances, with a one percentage point rise in the cost of government debt adding about £21 billion, or 0.8 per cent of GDP, to government interest costs in 2025-26.
It was also concerned that the coincidence of UK QE with the UK government’s fiscal response to the pandemic – the BoE’s purchases have been closely aligned to the issuance of UK government debt to fund its deficit by the UK Treasury – would generate allegations of deficit financing and undermine the credibility of the central bank and its ability to control inflation and maintain financial stability.
It made the point that no central bank has thus far been able to reverse QE over any sustained period, exacerbating the challenge of unwinding the policy without triggering panic in financial markets and recommended the BoE set out a plan for restoring policy to “sustainable” levels.
Markets are undecided as to whether the inflationary threat is transitory or real but the shift in the major central banks’ policies – from pre-empting inflation to reacting to it – means that if it is real interest rates would have to be ratcheted up quite aggressively, with obvious adverse implications for real economies, financial markets and the finances of governments, businesses and households that are as addicted to debt as the chair of the committee, Lord Michael Forsyth, says central banks are to QE.
With the obvious caveat that the pandemic and mutations of the coronavirus represent a continuing threat, the scepticism of the committee is warranted.
Even before the pandemic it was highly questionable whether continuation of the major QE programs was benefiting anyone other than the financial market participants whose threats of tantrums and another financial crisis coerced the banks into maintaining their programs. QE has done little, if anything, for investment and growth rates.
With growth stimulated by the extraordinary levels of government spending, household savings in developed economies bloated by a combination of consumers’ responses to the pandemic and the generosity of government relief packages and inflation rekindled it is a valid question whether the central banks should start to back out of the peaks of their QE programs sooner rather than later.
There are many, of course, who believe that, had the central banks stared down the markets and begun winding down their purchased once it became clear the global financial system and their banks had been stabilised, we’d all be in a better place today, with less distortion of savings decisions, better (some?) pricing for risk and more sustainable/less vulnerable economic and financial markets settings.
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