Monetary conditions in an economy are considered to be a forerunner of economic activity to come in the real or actual economy. For example a change in official short-term interest-rates is expected to have its full impact after a period of 18/24 months. However over the period of the credit crunch we have seen that the interest-rate weapon has been deployed pretty much to its maximum in the UK as base rates were cut to 0.5% as long ago as the 5th of March 2009 making a fall of 5.25% from the previous peak. So on the logic described earlier in this paragraph the effect of this has been and gone. As the UK economy has struggled you are excused for missing it!
So as the Bank of England quite quickly found that it had used its interest-rate weapon as far as it felt it could it then moved from the price of money to the quantity of money in the UK system. Today I wish to analyse the impact of these policies and examine where we stand.
As the interest-rate revolver fired its last round in March 2009 (so far anyway) the Bank of England started a programme to increase the quantity of money in the UK system called Quantitative Easing. Here is it’s explanation of this.
The Bank of England electronically creates new money and uses it to purchase gilts from private investors such as pension funds and insurance companies.
I do not think that you could get a clearer description of an attempt to raise the money supply or the quantity of money than that! The effect of this according to the Bank of England should be this.
The purpose of the purchases was and is to inject money directly into the economy in order to boost nominal demand
They do not explicitly say this but nominal demand was supposed to lead into higher real demand in our economy giving it a boost and helping us to recover. Job done? Er not quite, as in practice a lot of the boost to nominal demand from the £375 billion of QE went into rising prices or inflation. Inflation went above its official target for CPI inflation in December 2009 and has remained there ever since and is currently running at an annual rate of 2.7% by this measure. Sadly economic growth was revealed earlier this week to be running at an annual rate of -0.1%. As you can see this is certainly not the sort of mixture implied by this statement from Paul Fisher of the Bank of England from March.
Really the effects have been quite powerful
Perhaps he forgot to say on inflation!
The Bank of England moves from narrow to broad money
In essence the main original impact of QE was on what is called narrow money as it created funds. It is true that this also increases broad money and was hoped to lead to further increases in broad money. However as this disappointed it has moved onto a plan which it hopes will increase the growth of broad money.
Funding for Lending
This is designed to directly raise the money supply by encouraging UK banks to lend via the mechanism described below.
It will do this by providing funding to banks and building societies for an extended period, at below current elevated market rates, with both the price and quantity of funding provided linked to their performance in lending to the UK non-financial sector.
So if they lend more they will get the carrot of cheaping funding and finance. You may spot that this is something of a Holy Grail too for UK economic policy as on its way to hopefully boosting bank lending it will also boost bank profits! How often will we find ourselves observing such “coincidences” over the credit crunch and its consequences? Actually I could take away the plural of coincidence because it is always the same one is it not?
Returning to the monetary system then FLS is supposed to have this consequence on the real economy.
Easier access to cheaper bank borrowing should boost spending in the economy, for example by allowing families to purchase homes, or by allowing firms to finance investment in new and productive enterprises. In turn, higher spending should create jobs and raise incomes.
Magnificent is it not? Or at least it would be if that was what was happening! So far there appears to be an issue with lending to businesses.
Adding this up
So we have monetary policy is nearly every guise here. First interest-rates were cut heavily then we saw narrow money increased via QE (with hopes for a broad money boost) and now we have the FLS for broad money. If you also feel that the depreciation of sterling of 2007/08 was tacit official policy then you would have what a card player calls a full deck.
So where do we stand?
If we move on from the hype and the promises above let us take a look at the UK monetary system from today’s data.
Rather inconveniently for all the methods deployed above this continues to struggle. Net business lending on the Bank of England’s favourite definition which excludes financial corporations did rise but by only £100 million in October. On a three month basis it fell by 2.7% and on a year on year basis it fell by 2.9%.
Lending to individuals had a growth of £200 million in October and a year on year growth rate of 0.7% which represent weaker numbers than earlier in the year. If we consider the efforts described above to increase mortgage lending we are further troubled because across all categories it was £9.9 billion in October 2011 and it was £9.7 billion this October. So a fall before we allow for inflation.
Perhaps if we step back from the hype telling us about mortgage rate cuts etc. we may find a possible clue to this in the fact that according to the Bank of England’s overall measure mortgage rates are a quarter point higher than a year ago! Also new business lending is at a rate 0.4% higher!
M4 Money Supply
If we look at the money supply itself we do see signs of growth but if you look at the numbers below we also see a problem.
M4 excluding intermediate OFCs increased by £6.8 billion in October, compared to an average monthly increase of £6.9 billion in the previous six months. The three-month annualised growth rate was 5.4%.
The problem is that we have pretty much the same rate of growth as the past six months and if you review what has happened over that period you will get my point. If it is going to help then it should be doing so soon! Worryingly the rate of growth in percentage terms is in fact slipping back as September was 4.2% and October 4.1%.
So we can conclude that it looks like official policy has helped raise the money supply but so far it has failed to help bank lending. Also we need to note that money supply is rising on the Bank of England’s preferred measure and we have seen in the past how picking and choosing between measures can explode like a hand grenade on economic policy. In case you were wondering how we went from M3 (actually £M3) to M4 then as Run DMC put it.
it’s like that,
Today I have looked at the UK monetary system which if it was a tap would have been turned to pretty much full on by the various efforts of the Bank of England. However to their professed surprise, but not mine, it has failed to have the impact desired on the real economy. Rather than growth it has given us inflation.
So if we analyse the increase in the money supply that is taking place on the Bank of England’s favourite measure I feel that we return to the same question. How will it be split between economic growth and inflation?Personally I fear that much or all of it will be lost in the direction of higher inflation again. We also know that via its impact on real wages that inflation has had a depressing influence on our economy in the credit crunch era. I do not know the exact mix because it will depend on factors such as future oil and commodity prices but whilst I hope for growth I fear more inflation.
One factor we can be sure of is that official policy keeps time and time again returning to policies which will boost bank profits. I will let readers decide whether the report from the Financial Policy Committee has confirmed this today.
Our aim must be to get to a point where private investors again have confidence in banks
Personally I think that there is a conflict here as those with thinking faculties will always find their mind returning to the question, why do banks need all this support? To that question there is no good answer.
Whilst such thoughts are by their very nature subjective it is my opinion that such factors are a major reason why our economy is not recovering. We as people have learnt things and are not the same as we were before the credit crunch and to work official policy needs to change. Sadly those in charge are either unwilling or unable to figure this out.