The last 24 hours have seen something of a sea change in the way that Quantitative Easing (QE) is being regarded by at least some in the world’s central banks and it is this that I will discuss today. This has come as a counterpoint to what has been described as “QE (to)infinity£ where the US Federal Reserve stated that it would keep applying the medicine until the US unemployment rate dropped to 6.5% assuming inflation stayed below 2.5%. It is also in stark contrast to Japan where her new government is applying ever more pressure on the Bank of Japan -already on QE11- to do ever more. Although the Yen is doing some of the job for them as it has dropped to over 88 Yen per US Dollar as I type this.
The Bank of England takes over 3 years to agree with me
Back in the early days of my blogging career I pointed out this in December 2009.
My belief is that the UK economy has shown a type of inflation inelasticity which has surprised virtually everyone and there is more to this than just QE. In the UK Gross Domestic Product has fallen from its peak by 6% and yet inflation is only 0.1% below its target. As we move into 2010 our inflation rate will exceed its target in the early months of the year.
So my opinion was that the UK had an inflation problem which QE was making worse. Our economy had then -and of course has continued to have – an inflation rate which is not only above its official target but also higher than our economic performance would suggest. A clear impact of this on our economy has been that this higher inflation combined with low increases in wages has meant that inflation has directly led to further economic weakness as it has caused the level of real wages to fall. We have found ourselves trapped in the opposite of a virtuous circle.
Step forwards to January 2013
The Bank of England has issued Discussion Paper 38
In the conclusion we are told this.
For instance, ignoring cross-sectional dependence would lead a researcher to believe mistakenly that recent weak UK output growth was entirely due to demand rather than permanent productivity shocks.
This matters because it has been Bank of England which has been arguing that UK “weak UK output growth was entirely due to demand” via the so-called output gap theory that I have been criticising for the past three years. So in my financial lexicon “a researcher” is now a euphemism for the whole UK Monetary Policy Committee.
This discussion paper also argues this and the emphasis is mine.
The previous conclusions are now clearly overturned. Both permanent labour productivity and temporary demand shocks now contribute roughly equal amounts to recent (2010 and 2011) weak output growth in the UK.
Let me now explain why this matters. Previously the Bank of England view was that UK output was way below capacity (with estimates varying but up to 14% of our Gross Domestic Product) and so boosts to the economy would have little or no effect on inflation. In textbooks this is often covered under demand pull inflation. However my argument was partly based on the fact that up until the credit crunch we were overvaluing our GDP in some areas and accordingly (sadly) some of it no longer existed and so any gap was much smaller than argued elsewhere . For example take a look at the UK’s banking sector. If it was not valued way over reality in 2007 why was so much direct support (Lloyds TSB,RBS,Northern Rock,Bradford and Bingley etc) and indeed indirect support such as QE,Supplementary Lending Scheme, base rate cut to 0.5% and now Funding for Lending provided? Oh and the backstop provided by the “Too Big To Fail” put option provided by our politicians with taxpayers financial backing.
Following this type of analysis also explains why we might also be measuring productivity changes incorrectly but I will leave a full discussion of that for another post.
Another factor in the UK’s problems with inflation has been what I have labelled institutionalised inflation. This is where UK government and organisations in or attached to the public-sector regularly raise prices at above inflation rates. We have seen this for example in the surge in prices the Royal Mail charges for a postage stamp or this week in the increases in train fares where I am suspicious of the “4.2% increase average” claimed. Even if we take the rail fares increase at face value it is double the official inflation target.
If I had been appointed onto the UK Monetary Policy Committee I would have used the role to argue against such increases. As they are mostly not something you can deal with by raising interest rates. I notice that the current MPC is virtually silent on this issue apaprt from sometimes using it as an excuse. As controlling inflation is supposed to be their job they should be addressing this and looking for and using new weapons rather than passively whining.
Today’s data contradicts what the Bank of England told us only yesterday
Yesterday I pointed out that the Bank of England was slapping itself on the back about its Funding for Lending Scheme in its credit conditons report. Today we have some actual numbers to peruse. Let us remind ourselves of what we were told.
The availability of secured credit to households was reported to have increased significantly in the three months to mid-December 2012…. Demand for secured lending for house purchase was reported to have increased in Q4
So supply and demand were up which leaves them with something to explain about their own statistics.
Within total lending, lending secured on dwellings fell by £0.2 billion, compared to the previous six-month average increase of £0.3 billion.
Is up the new down?
In the detail I think that these mortgage growth numbers are as weak as they have been.
The three-month annualised growth rate was unchanged at 0.1% and the twelve-month growth rate was 0.6%
The US Central Bank has worries too
Last night the latest minutes were released by the US Federal Reserve and if we consider that this was the meeting where QE to infinity was enacted they came with something of a surprise.
Several others thought that it would probably be appropriate to slow or to stop purchases well before the end of 2013, citing concerns about financial stability or the size of the balance sheet. One member viewed any additional purchases as unwarranted.
So not quite to infinity then? These individuals are likely to (wisely) have concerns over exactly how any exit strategy will be applied to an ever growing amount of QE. However some caution is needed about this becoming policy as non-voting members are currently more hawkish than the voting ones.
The Bank of England appears to be taking the path of using a discussion paper as a hint of a change in the official view on QE, a bit like a weather vane. Later perhaps we will see such views reflected in official speeches by a type of osmosis. If we “step back in time” three years we see that some members of the MPC were diometrically opposed to the idea that QE was inflationary.
One rather curious intervention by Adam Posen has been to claim that the mechanism espoused on the Bank of England’s website of QE influencing the money supply and then inflation does not work.
Frankly the Bank of England has had a very poor credit crunch and todays figures which directly contradict what its credit conditions report told us only yesterday is another nail in the coffin of its credibility. Also with Gilt yields continuing their recent rise (the ten-year yield is now 2.12%) the most recent tranche of QE is all at a loss which is food for thought for those who want to spend the “profits” and also for those who keep telling us that bond yields will stay low for ever.
However for the future for QE some care is needed. You see when push comes to shove I expect central bankers to revert to type and give us “More,more,more” after first parading their consciences. Or as newt put it in the film Aliens.
It won’t make any difference