6 March 2012
Here in Part 1 I’ll be looking at the background to these calls and, in Part 2, I’ll look at why, if we are to experiment further with QE, we should look to housing as the alternative to gilts or at least one of them.
There’s no getting away from the fact that the calls for a more “directed” form of QE are getting louder. They came very much to the fore when the BoE came in for a grilling by the Parliamentary Treasury Committee last week over its asset purchase facility or “quantitative easing” as it is more widely known.
Meanwhile, last week business secretary Vince Cable, who is said to support the idea that the Bank should buy other assets than gilts, interestingly described the “unorthodox” monetary policy tool as an “experiment”.
He said the effects were “imperfectly understood”, but the alternative was “probably a disaster”.
Little wonder that the attitude to QE is mixed.
Some are keen to harness its potential to boost weak sectors of the economy. Others are angered by its impact on redistributing wealth, while there are those who fear the QE experiment is sowing the seeds of future inflation.
It’s fair to say that those three views are not mutually exclusive. Indeed I hold them all myself to a greater or lesser degree.
But just as drugs have side effects, so do economic policies. The question is the balance of risk.
In front of the Treasury Committee meeting representing the BoE were governor Sir Mervyn King, deputy governor Charlie Bean, deputy governor Paul Tucker and external monetary policy committee member Dr Adam Posen (regarded as the most dovish on the MPC and the strongest proponent of greater monetary stimulus).
Reassuringly, perhaps, when quizzed by the committee the Bank representatives were all fairly confident that the mechanism worked in a manner closely analogous to raising and lowering interest rates.
The Bank estimates that the effect of the initial £200 billion of QE was equivalent to 150 to 300 basis point cut in Bank Rate – that’s a cut of 1.5% to 3.0%.
The rule of thumb the Bank is working on is that the latest £125 billion of QE is equivalent to about 1% cut in Bank Rate.
Not surprisingly, much of the quizzing of the Bank team reflected popular irritation among savers and pensioners that the effect of QE was to benefit banks and borrowers at the expense of savers.
Given that savers were among the least responsible for the financial crisis it seems to many that it is a bit rich that they should be the ones to bail out irresponsible lenders and borrowers.
Mervyn King provided a stout defence.
His case was simple.
While he was clearly sympathetic, he argued that if we had not dropped interest rates and implemented QE the economy would be in far worse shape and we would all be suffering far more than we are.
Furthermore, the Bank executive pointed out that while pensioners may be getting lower annuity rates, these were on bigger pots that had been boosted by the asset inflation caused by QE.
But the other line of attack on QE was how the Bank was pumping money into the system. (For those who are dazed by the mechanism, the Bank has put together a pretty helpful video)
This was more fascinating as a spectacle, not least because clearly there are differences of view within the MPC.
There was implicit criticism that the Bank was sticking rigidly to its approach of buying predominantly gilts, although the mandate does provide for buying corporate bonds.
This point came up a few days earlier at the recent press briefing and I reported it in an earlier blog.
Indeed, there has clearly been questioning of the current approach to focusing on gilts within the Monetary Policy Committee. Dr Posen said that at various formal and informal meetings MPC members had discussed alternatives to buying gilts.
He openly suggested two options in a speech in Gloucestershire last autumn.
He proposed using QE to provide capital for a small business bank and an institution to bundle and securitise loans made to small and medium-sized enterprises.
However, as he pointed out to at Treasury Committee meeting, the decision on what to buy lies with the Bank’s executive not with the MPC and it was reluctant to stray from gilts.
There are clear signs that Sir Mervyn and his executive team are and would be very reluctant to buy assets other than Gilts. Sir Mervyn consistently raises the point that to buy private sector assets selectively raises the issue of subsidy. And he argues that it is not the Bank’s role to decide which firms or sectors receive subsidies.
The core of his argument for not buying other assets rests on his view that the Bank has no mandate to buy assets that put the taxpayer at risk.
He told the committee: “You have the right to decide which instruments of policy to ask us to implement. That’s your decision not ours. We have no right to appropriate to ourselves the choice of instruments that we should be using.”
Adding: “We have no remit or authority from the chancellor or from Parliament to carry out the actions you seem to be suggesting.”
And later said: “If the chancellor wishes us to implement other instruments then we can discuss that.”
He, quite rightly in my opinion, stressed that the decision was political and should be taken by the Government or Parliament.
The suggestion was made by Treasury Committee member Andy Love that both Alastair Darling and George Osborne had urged the Bank to buy other assets through the facility.
But even if this is so, a clear and explicit written direction would seem appropriate given the decision to buy private sector assets does raise awkward issues both or risks to taxpayers’ money and subsidy.
Given a direct instruction it would be hard for the Bank’s executive to refuse. But the suggestion would have to be sound and overcome at least some of the concerns raised by risking taxpayers’ money and of subsidising a sector of the UK economy.
It was amusing to see an irritated Sir Mervyn throw the question back at Mr Love.
He asked: “Can you give me an example of the asset you think we should be purchasing? I asked the previous Chancellor and got no reply.”
There is a strong case, for many reasons, to expand the assets bought under QE, but given the political nature of buying other assets than gilts, it is, in my opinion, for the Government to answer the question of what to buy.
And also it is the Government’s job to create the terms and framework within which these assets should be bought, albeit in collaboration with the Bank.
Anyway, if I were asked by Sir Mervyn I would have no hesitation in suggesting that the asset purchase facility should be used to finance house-building.
But this would require a mechanism that was both practical and could address the issues of subsidy and risk.
I think this can be done.