Could someone hit Simon Jenkins with a monetary cluebat?

Oh dearie me. Sir Simon seems not to have grasped QE at all.

If the government really wanted to inject cash into the economy, it would address the liquidity trap head-on. It would order the Bank of England to add, say, £1,000 to the current account of every adult citizen as a \”people\’s bonus\”. Such an injection would not depend on Bank discretion. It would not await a government infrastructure project or a business wanting to invest. It would instantly transfuse between £30bn and £40bn of cash into the demand side of the economy.

This need have no impact on Osborne\’s borrowing targets or deficit, since it would be new money. The chancellor would declare the bonus \”off-limits\”, an emergency stimulus to growth. It might push up some prices and suck in some imports. It might seem to reward the feckless as well as the thrifty. But it would do what the government claims it wants to do – that is, \”inject money into the economy\”.

Opposition to doing this seems to be not practical but moral. It is basically about class. To bankers and politicians, giving cash to ordinary people is vulgar and indulgent. So they pretend. They pretend to pump money into the economy through lending, but do not even do that. They pretend to give money to banks, but in fact nothing is injected anywhere.

All of that is entirely true. This could be done. Known in the literature as a \”helicopter drop\”.

The thing is though it is nothing to do with QE nor is it supposed to be. It\’s an entirely different policy.

We know what QE is supposed to do. The Bank \”buys back\” the government bonds (or gilts) that were previously sold to banks. Since gilts are as good as cash, this merely replaces an interest-bearing bond with actual cash on the asset side of a bank\’s balance sheet. It is a paper transaction, moving sums from the bonds column to the cash column.

In theory, the banks have an interest in lending that cash at a profit to the public, or to companies. But that depends on buoyant demand and on finding businesses and individuals whose credit is secure. This is not the case when demand is stagnating. In addition, the banks are sitting on bad debts that need covering, and regulators are telling them to keep higher cash reserves. The banks duly sit on the cash or use it to buy more gilts. The money goes round in circles, collecting fees. It is like Irish truckers moving goods back and forth over the Northern Ireland border, picking up European Union bungs each time they pass customs.

Well, no, that is not what QE is supposed to do. What it is supposed to do is lower long term interest rates.

The basic point being that the Bank does control short term interest rates. But the longer term rates, the longer they are, are more controlled by the market than the Bank. If you desire lower long term interest rates you thus need some tool other than the base rate (or short term money market operations) in order to lower those rates. And that is what QE is. Buying long term bonds for newly minted cash raises the price of long term bonds. As yields are the inverse of price this lowers yields: et voila!

We have lower long term interest rates. This is the aim and purpose of QE and it works.

You could lock Friedman and Keynes in a room until they agreed this was a good idea: would take them perhaps 15 seconds to so agree. Both would argue that this is a necessary thing to do when facing monetary contraction. Friedman made his name (Monetary History of the United States) pointing out exactly that not doing so was the mistake the Fed made in the Great Depression.

There might be some disagreement later: Friedman perhaps arguing that this is sufficient, Keynes that it is necessary but not sufficient. But QE as QE is a good idea. The question really is, do we need to do something else as well?

If we do then Keynes also gives us the guide as to what we should do: lower NI rates.

20 thoughts on “Could someone hit Simon Jenkins with a monetary cluebat?”

  1. I don’t think you are correct. Modifying expectation of future inflation is the main channel for QE to affect the economy. The CB controls nominal rates, but real rates are what happens most.
    The advantage of QE is that is reversible. You can sell the bonds back if you do too much and inflation gets too high. It is also it’s disadvantage as it’s less powerful in moving expectations, since you don’t know if it’s going to be reverse tomorrow (leaving the monetary bases and inflation expectations unchanged). This is what happened in Japan, where the CB reduced the monetary base as soon as inflation increased a tiny bit, rendering the entire exercise futile…

  2. To be fair Simon Jenkins does admit in his third sentence that he doesn’t actually understand what QE is:

    “It must be the biggest confidence trick of all time. It is a cheat, a scam, a fiddle, a bankers’ ramp, a revenge of big money against an ungrateful world. It is called quantitative easing, and nobody has a clue what it means.”

  3. Wasn’t the “this would have made life easier in the depression” argument based on the fact that the couldn’t then provide emergency liquidity to banks (something to do with gold) facing runs? Thus once a run has started it is economically rational for the individual to get as close to the front of the queue as possible, that individually economically rational decision being collectively a disastarous economically rational decision.

    I don’t think the monetary problem in the depression was the scale of government debt (indeed there were all sorts of expensive stimulative programs of people digging ditches and filling them in again, followed by the war and still the government wasn’t bankrupt), it was more banks falling over because people wanted their dollars back, but I’m too lazy to go and find the numbers.

  4. That maybe a given reason, as would providing liquidity. Only a cynic like me would think that, happily for politicians, it also makes the task of funding the deficit so much easier….

  5. Isn’t the other point of QE that it’s reversible, so avoiding future inflation?

    Once the BoE has lots of gilts, it sells them back into the market later, sucking out spare cash and increasing yields.

    Mind you, who believes they’ll actually do that? (rather like the Keynsian policy of building up surpluses in the good times)

    I’d guess Guido’s right – QE is printing money for politicians without the journalists realising that this is a Weimar policy.

  6. Isn’t there a danger that the government never actually reverses QE and simply uses it as a trick to “retire” £350 bn of government debt. At some point, this would be inflationary but just think how tempting this is in a time of austerity.

  7. You’re all right. QE has more than one purpose. It is indeed, as Tim says, to lower long-term interest rates. It is also, as AC says, to modify inflation expectations to encourage spending now rather than later. And it is also, as Sir Simon says, to improve bank liquidity – although the Bank of England says this is a weak channel compared to the other ways in which QE may affect the economy. Oh, and among other things it also reduces the supply of safe assets, which is supposed to encourage investors into riskier investments – though what they seem to be doing is sitting on the cash instead (which is also a safe asset, of course). And it should debase sterling, which would discourage imports and help exporters, though there isn’t much evidence of this.

    My main problem with QE is that whatever stimulatory effect it has is weak at best, so you have to do an awful lot of it to make much difference. There are much more powerful tools – including the “helicopter drop” – but everyone’s terrified of using them.

  8. I do not see either why Jenkins sees this as a “class” issue with superior politicians and bankers looking down on the ordinary bloke. I guess it’s because he is a guardianista. The yanks did stuff like this at the start of the crisis by giving cheques to all adults. Not sure it did much longer term.

  9. I think this is an unhelpful way to think about QE, though it is one that the Bank do sometimes use – they send mixed messages.

    Ultimately the “aim and purpose” of QE is to ensure the Bank can hit their 2% CPI target. The methodology they use is to look at their forecast for CPI about two years out. If it is too low, they print some more money. If it’s not, they sit on their hands. They most often talk about “portfolio rebalancing” – the new base money has a hot potato effect, and stimulates new spending as it bounces around the economy.

    But when we talk about whether QE works… why are we not talking about the (persistently high) CPI rate? This baffles me.

    A more sophisticated view would be to look at market inflation expectations. These have indeed been volatile, and often dropping below 2%. Good criticisms are, in my book:

    1) QE is evidently sufficient to keep the CPI rate up, but the 2% CPI target is itself not sufficient for robust recovery of demand. Hence the campaign to target nominal GDP.

    2) QE (as practiced by the Bank) is not sufficient to stabilise market expectations of inflation, and the Bank is failing on that basis.

  10. @Fred: Australia did it as well. Apparently the main effect was a boost to the New Zealand tourism industry.

  11. @Richard

    “Isn’t the other point of QE that it’s reversible, so avoiding future inflation?Once the BoE has lots of gilts, it sells them back into the market later, sucking out spare cash and increasing yields.

    Mind you, who believes they’ll actually do that?”

    Isn’t that the Sage of Downham Market’s view. And therefore why he thinks QE is a means of dealing with the deficit without any nasty neo-liberal austerity.

  12. It’s a myth that …

    “Here is an interesting paper that claims it is a myth that …”

    If all it took to “prove” a conjecture was the publication of a detailed paper on the internet, we’d all be suffering under the iron jackboot of WGCE-land.

  13. “The advantage of QE is that is reversible. You can sell the bonds back if you do too much and inflation gets too high.”

    That may be the theory, but doesn’t it rather rely on finding suckers^H^H^H^Hbuyers to buy them?

    I’m not sure who’s supposed to do that if inflation is rising rapidly due to money printing, and particularly if it’s already higher than the yield on those bonds.

  14. It is a little unfair to ask the question “do we need something else as well? “as QE (see TW above) and then impugn Jenkins who has spent most of his article going out on a limb suggesting the “helicopter option”as well as, or instead of, QE.
    All programmes to improve demand by simply giving people unearned income are strictly off limits, in joke territory, now,although in the Thirties in the UK, various offshoots of the Social Credit movement were marching up and down,making broadcasts on the BBC ,and demanding “Pay National Dividends Now”(this being the 30’s original of the Jenkins proposal determined by working out how far under capacity the national economy was working then dishing out enough money to return the system to full production).
    The problem with this (apart from undermining the whole imperative to work, Major Douglas saying if people wanted to play golf instead,let them) would have been that the extra money would have set off a housing bubble. This was foreseen by the other big monetary reform movement of the time, inspired by Silvio Gesell, which would have nationalised land to stop this happening.(Keynes wrote in praise of Gesell and largely ripped his theory off but did n’t get the land values bit at all.)
    We are in Two Cultures territory here:national policy and the terms of this debate are fixed by Maths entrists into Economics who do n’t know enough Economic History. ( Lefty debate though is often centred on history,but they never go outside the box to look at complementary
    proposals such as Land Value Tax or Social Credit.Labour Land Campaign is an exception in regard to the former policy at least).

  15. EMG: inflation is higher than government bond yields now. Apparently investors can find nothing more attractive to do with their money anyway.

    DBCR: it’s a bit odd to say that Lefties never look at proposals such as LVT, then in the next breath acknowledge the Labour Land Campaign. Could it be that the facts don’t fit your theories?

  16. @PB I am being entirely logical:I said Labour Land Campaign is an exception to the rule that Lefties (of whom I am one)are now generally indifferent to lvt ,although it was a manifesto commitment until WW2and the Labour Party actually enacted one before being stabbed in the back upon entering the National Government.
    There are exceptions to rules.
    I have had long experience with Leftish audiences and I would say they are the most hostile to LVT-for reasons of sheer tribalism I would say.
    Also you don’t hear much of radical monetary reform in Leftish circles or on blogs.

  17. @DBC Reed: the reason Leftists tend not to be in favour of LVT is that they want to tax the rich. And LVT doesn’t tax the rich, not that much anyway, and is easily avoided by them by the obvious means of ‘not buying lots of land/houses’. The Left do not go into politics in order to allow rich people to retain their money.

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