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.