In 2009, when the economy was in danger of tanking in the aftermath of the global financial crisis, the Bank of England went from the conventional – cutting interest rates – to the unconventional and engaged in £50 billion of quantitative easing (QE). Over a decade later a temporary measure to deal with a severe crisis in aggregate demand has become the Bank’s main monetary policy tool, despite today’s problems being quite different to those of 2009. By the end of 2021, the Bank will own an eye-watering £875 billion of Government bonds and another £20 billion in corporate bonds. To put such a staggering sum into perspective, this is equivalent to 40 per cent of GDP. Successive waves of QE, which have doubled in size during the pandemic have placed central banks in the words of the Bank of England’s departing chief economist Andy Haldane in “ deep unchartered waters”.
It’s extraordinary that the Bank of England has faced little scrutiny for a policy that could have enormous implications for inflation, wealth inequality, and the sustainability of the public finances.
It has ramped up the Bank’s role and influence on the economy. “Trust us, the man in Threadneedle Street knows best” will no longer do. Its larger role requires considerable more accountability.
The Lords Economic Affairs Committee report – “Quantitative easing: a dangerous addiction?” – is the first serious attempt to rectify this. Our report is based on evidence from policymakers around the world, including former central bankers from the Fed, the ECB and the Bank of Japan. We found growing concern and unease about QE.
This is the third consecutive month of higher than expected inflation. We now need more than Delphic hints from the Governor and the MPC. The Bank must speak openly about the risks of sustained inflation and demonstrate it has a plan to keep it in check. The Bank’s commitment to continue with its asset purchases until the end of the year coincides with a growing economy, substantial government spending, extraordinary levels of personal savings, and a recovery in pent-up demand. Our report expressed concern that the Bank of England has not explained why continuing with asset purchases now is the right course of action.
Whether rising inflation proves to be transitory or not is the most important economic question facing our country. If the Bank is wrong and fails to curb inflation at an early stage it will be more difficult and painful to rein it in later.
Our report highlights the risks to the public finances from QE and inflation. QE makes the cost of servicing Government debt more vulnerable to increases in interest rates. So, if the Bank’s gamble does not pay off, and it hits the brakes hard by raising interest rates to see off inflation there will be a significant increase in the cost of servicing government debt.
The Bank has now been using QE for over a decade, and in a variety of economic situations but it has had a limited impact on growth and aggregate demand. There is little evidence to show that QE increased bank lending, investment, or consumer spending by asset holders. Although it has been effective at stabilising financial markets during periods of economic turmoil, its impact on the real economy has been negligible. It has however inflated asset prices artificially and exacerbated wealth inequalities. This makes it all the more remarkable that, faced with any problem or piece of bad news, the Bank’s default answer is to do more QE, without sufficient justification or public engagement about its side effects.
A recent survey found that 18 of the largest investors in government debt believe that the primary purpose of QE is to finance the governments deficit spending during the pandemic. This is dangerous and undermines the Bank’s ability to maintain financial stability.
No central bank has ever managed to successfully reverse QE, and the Bank appears to have no clear plan to do so. First, the Bank said it would raise interest rates before reversing QE, but now it is considering reversing QE before raising interest rates. Given the possibility that it may need to tighten policy to curb inflation, the lack of an exit strategy is concerning.
The Bank has become addicted to QE, and like any addiction, the risks, side-effects, and difficulty of kicking the habit grow larger the longer it persists.
Lord Forsyth of Drumlean is chairman of the House of Lords Economic Affairs Committee.