NEF senior economist James Meadway explains ‘people’s quantitative easing’, the economic policy of favourite to be Labour leader Jeremy Corbyn, to use printing of Bank of England money to support new infrastructure projects
THE New Economics Foundation (NEF) produce a weekly economics briefing. This week James Meadway looks at People’s quantitative easing.
Summary:
1. Quantitative easing (QE) is now used across the world to stimulate economies. The Bank of England has issued PS375bn of new money under its own QE programme. Despite this huge issuance of new money, inflation rates in the UK remain at record lows.
2. People’s Quantitative Easing, as suggested by the Jeremy Corbyn campaign, is nothing more than a slight extension of the existing QE scheme, but using the Bank of England’s money-creation powers to fuel investment in the real economy, rather than buying up old government debt. Because it is only an extension of existing QE, it is unlikely (under current economic conditions) to lead to huge increases in inflation.
3. There are dangers implicit in QE if its use (in any form) becomes excessive. Confidence in the central bank might collapse, leading to very high rates of inflation. People’s QE can be treated as a useful additional tool, to be used in case of further financial crises. It can be seen as part of the general, global shift into unconventional monetary policy following the 2008 crisis.
“People’s Quantitative Easing” has been suggested as a viable option for a future government by Jeremy Corbyn. The idea is that a government would use the technique of quantitative easing (QE) to fund infrastructure projects and other long-term investments, rather than (as at present) buying up its own debt.
The idea has been attacked by some as “printing money” that would lead to very high rates of inflation.
To make sense of this debate, we need to first understand how QE works. In the UK, the Bank of England has authorised the creation, between early 2009 and mid-2012, of PS375bn of new money. This money is electronic, comparable to the money held in your own bank account – it is not literally “printed”. Using this cash, the Bank then bought UK government debt held in the form of bonds from major financial institutions like banks and pension funds.
The idea was to very quickly get new cash into the economy. This was held to be necessary since the government’s conventional monetary policy tool, the Bank of England’s base rate, had been jammed to 0.5% in early 2009, and could not be made to go much lower. The base rate is the rate at which banks can borrow or deposit money with the Bank of England on a short-term basis. It sets the level at which other interest rates in the economy (on mortgages, credit cards, and so on) will be set. By cutting the base rate, the Bank of England hopes to make borrowing cheaper, stimulating the economy. When this rate cannot go much lower, further stimulation can only be provided by “unconventional” tools like QE.
“There is nothing unusual about the Bank of England creating extra money. It may be the UK’s central bank, but it is still a bank and so, like all banks, it has the power to create money.”
There is nothing unusual about the Bank of England creating extra money. It may be the UK’s central bank, but it is still a bank and so, like all banks, it has the power to create money. Conventional banks create new money every time they offer a new loan. This is how banks work. For People’s QE critics to raise concerns about “printing money” is to rather miss the point.
Nor has QE led, either here or elsewhere in the world, led to exceptionally high rates of inflation. In fact, inflation is at all-time lows, with deflation (falling prices) a serious possibility, despite the trillions of new monies being created by central banks. QE, by itself, does not lead automatically to high rates of inflation, let alone hyperinflation.
The reason, for the UK, is relatively simple. First, after the cataclysm of the 2008 crash, the UK was in an exceptionally deep recession. Creating new money at this point would be more likely to induce more employment than rising prices, since so many resources (both capital and labour) were unemployed, or underemployed. Employment has now recovered, but wage rises have remained notoriously low for many years. This has meant one route through which inflation can occur (wage rises compelling firms to put up their prices) has not operated.
Second, surprisingly little of this new cash has made its way into the wider economy. When launched, the hope was that the new QE money would cause banks to lend more money, stimulating recovery. In fact, lending to what we might think of as productive parts of the economy has fallen, with lending to small businesses, in particular, falling every year since 2012. Instead, the banks and other large financial institutions that have been paid QE cash for their government bonds have looked to invest the money in safe assets with high returns. For the UK, this has meant investing in property, particularly in London. For the US, much of the QE money has made its way into shares.
“The Bank of England’s own assessment of its QE programme has noted that it has acted to worsen inequality.
So one impact of QE has been to help stoke up bubbles in asset prices. This has had some impact on the wider economy, since it means those owning assets – principally in the UK, property – are richer and therefore more inclined to spend money, stoking demand. (This is the “wealth effect”.) The Bank of England’s own assessment of its QE programme has noted that it has acted to worsen inequality in this way.
Moreover, QE has been used to buy up government debt. But the Bank of England is also government owned. So the government now owes PS375bn to itself. If you or I claim to owe PS100 to ourselves, we would in reality owe ourselves nothing. The same applies to government debt; it could be argued that the Bank of England has simply written off a large amount of government debt and is (in effect) “printing money” to finance government borrowing – precisely what Chris Leslie accuses People’s QE of doing. The Bank of England insists that, one day, it will “unwind” QE, selling the government debt it owes back to the private sector, and therefore no longer owing itself the money. This should occur when the economy has settled back onto a more “normal” path. There are no signs of it happening yet.
In other words, People’s QE is little more than an extension of the existing QE programme, but instead of using the new money to buy up old government debt, it would be used to invest in new infrastructure and other major public investments. Adam Posen, a former member of the Monetary Policy Committee that sets the Bank of England’s interest rates, actually proposed a similar scheme to People’s QE to boost lending to small businesses, back in 2011.
“People’s QE would need to be used sparingly, if it was used at all. The government can just borrow money, at present very cheaply, to finance its investment plans.
This does not mean People’s QE is cost-free. New money created through QE is a liability of the central bank. In other words, it is a claim on the resources of the central bank. Should these liabilities become very large, the credibility of the central bank itself might be called into question. This is the concern raised by those opposing QE in general, and People’s QE in particular: that without tight controls, QE contains the risk that confidence in the central bank will collapse, resulting in very high inflation (or even hyperinflation).
People’s QE would need to be used sparingly, if it was used at all. The government can just borrow money, at present very cheaply, to finance its investment plans. One reason to avoid doing this is to dodge the media frenzy around government debt, since government borrowing (even to invest sensibly) would increase government debt but People’s QE would increase only the Bank of England’s liabilities. But that reduces People’s QE to a kind of off-balance sheet accounting trick, similar to the Private Finance Initiative schemes the last Labour government used to finance investment in public services. Supporters of People’s QE have suggested it would only be used in the event of a further financial crisis, which seems more reasonable.
More generally, one side effect of QE has been to produce currency devaluations (falling price of a currency relative to another). Simply put, creating more money leads to a decline in the price of that money relative to others. This has created fears of 1930s-style competitive devaluations – “currency wars” – as countries attempt cut the value of their currency faster than the other, racing each other to the bottom.
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Picture courtesy of Common Weal