12th June 2012
Yesterday Adam Posen who is a member of the UK's Monetary Policy Committee gave a speech suggesting a change of course for the Bank of England. This speech was a refinement of ideas that he had first put forward in September 2011 but to fully understand the position we need to go back to the 5th of February 2010 and an article I wrote then when my Notayesmanseconomics blog was in its early stages.
What happened then?
Well if we "Step Back In Time" as Kylie Minogue would have it we saw that as the first wave of conventional Quantitative Easing ended in February 2010 the Bank of England retained permission to continue a policy which had been announced with the original QE documentation. This had been formally approved by the then Chancellor Alistair Darling on March 3rd 2009.
What Was It?
"This letter authorises the Bank of England to spend up to £50 billion on asset purchases. However these will now be private sector assets as opposed to the public sector ones that the Bank of England's QE programme mostly ended up purchasing. It will buy commercial paper, corporate bonds and secured commercial bonds. It will be financed by the issue of Treasury Bills. So just to make it clear whilst the Bank of England will no longer buy government bonds it will continue to buy corporate bonds."
So from the beginning of the QE era the Bank of England has been given permission to buy private-sector assets. And let me give you my view on it from February 5th 2010:
"Actually on a first reading this policy looks preferable to the Quantitative Easing policy which had previously been pursued. This is more in line with the way the US Federal Reserve has operated and as I wrote yesterday it has had more success than we have had with unconventional monetary operations so far. So hopefully companies will find it easier and cheaper to finance long-term borrowings. This does seem to have been the American experience…..We should have done more of this and less of QE. If we had our economy would be in better shape now."
So as you can see that in principle I welcomed a plan which aimed to help the real as opposed to the financial economy and that this was from over 2 years ago. If it had been pursued more and conventional QE had been pursued less than we would be likely to be in better shape now.
Stepping Forwards In Time To Today
Adam Posen made the following suggestions yesterday:
"A further round of asset purchases by central banks should focus on private sector assets in order to make a sustained improvement in perceptions of risk, if not in risk aversion;
Such asset purchases can be targeted on dysfunctional financial markets that are both important and potentially sizable, and can encourage securitization in those markets;
There are straightforward transparent ways to minimize the credit risk on central bank balance sheets, and any negative spillovers on markets or politics, from so doing;"
As you can see I have a lot of sympathy with the first statement and have done so since I discussed it in February 2010. The immediate catch is why has it not happened? There has been over two years for the policy to have been progressed and as of its latest update the Bank of England has purchased £324,753 million of UK Gilts (government bonds) and £261 million of private-sector assets. That is a ratio of around 1240 to 1!
As Adam Posen has been on the MPC since the 1st of September 2009 you can see that he has been part of a body that has pursued a completely different policy to the one he is arguing for now! And I do not recall the meeting minutes telling us that he wanted a change of plan, indeed with one recent exception Adam has been a man for More More More.
As he now wants a change it would appear that even More,More,More is not enough. It is also a matter for him and his conscience whether he feels that this is yet another failure on his watch. So when he says this:
"I believe it is time for the major central banks, including the Bank of England, to engage in purchases of assets other than government bonds"
The question to ask him is why was it not in February 2010 Adam? The answer in my opinion is that he was so convinced that conventional QE would work he did not think that it would be necessary. Also it is interesting that a disciple of and indeed preacher for Monetary Activism finds himself having to address this point:
"First, quantitative easing may be ineffective under the present circumstances."
Those who look at the state of the UK economy -even this morning we see manufacturing output down 0.7% in April- the conclusion is that QE has failed to produce any meaningful improvement.
If we address point two then at first it looks sensible. But what are "dysfunctional financial markets"? You could argue (and I often do) that many markets are dysfunctional because of the sort of central bank activism that Adam Posen proposes! And I note that he is looking for markets large enough to intervene in which I am afraid excludes many of those ( for example small firms) who most need help in these times.
His point three is riddled with problems. For example one section is quite plainly untrue and he should be thoroughly embarrassed about claiming it:
"minimize….. any negative spillovers on markets"
Central bank activism has had enormous spillovers on markets and has contributed to our current problems. One clear example of this is the way that our banks have pursued investment banking- nice juicy profits have been offered here by central bank moves- and increasingly abandoned conventional banking. If you take that logic the type of central bank activism proposed by Adam Posen has helped create the problems he has discussed here! In my opinion if he is given his sway he
will continually be putting out fire he himself has created.
As to this point:
"There are straightforward transparent ways to minimize the credit risk on central bank balance sheets"
You might like to look up the concept of "phantom securities" at the Bank of England where its own specialists indulging in the type of activism suggested here thought exactly the reverse! They feared that in many cases the Bank of England had been sold a pup. For laymen/women in this area you just need to concentrate on the idea of a "phantom security" being held by the Bank of England in return for liquidity/cash then you get the issue.
What can we do then Shaun?
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