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Mervyn King over-ruled on QE economy boost

Bank of England's monetary policy committee only narrowly voted against an extension to their quantitative easing bond-buying programme in June.

 
Mervyn King over-ruled on QE economy boost

Support has grown for an extra round of quantitative easing, the policy designed to boost Britain’s ailing economy, with the Bank of England’s monetary policy committee only narrowly voting against an extension at their meeting earlier this month.

The minutes from June’s meeting show five members of the MPC voted against an extension to the existing £325 billion bond buying programme, with four calling for action.

Governor Mervyn King – who in a speech last week provided strong hints of more QE – wanted to increase the asset purchase programme by £50 billion to a total of £375 billion. Fellow committee members David Miles and Adam Posen agreed with King.

Paul Fisher wanted to increase the size of the asset purchase programme by £25 billion.

Other committee members, the minutes from the 6-7 June meeting show, 'expressed a wish for the MPC to consider additional policy tools'. The Bank of England has subsequently launched new measures to support bank lending.

The members who were against more QE said that they wanted to wait and see how events evolved in the weeks after the meeting, which came before Spain's €100 billion bank bailout and Greece's elections.

Amid warnings over the eurozone crisis, the closely-scrutinised minutes from the meeting actually point to some 'mildly encouraging recent signs for the near-term outlook for growth in the UK'.

They also point to a lower risk of inflation failing to fall down to target. Yesterday figures showed a sharp fall in the annual rate of CPI inflation to 2.8%

All nine MPC members were unanimous that interest rates should remain at their record low of 0.5%

20 comments so far. Why not have your say?

Jonathan

Jun 20, 2012 at 13:44

That is until next month. Supermarkets and Petrol prices seem to have control of inflation. The supermarkets can put their prices up one month to increase inflation then reduce them the next to make it fall and the BOE will react by printing massive amounts of money. The BOE also said they would create another £150 billion for lending at low rates to banks this is also a form of QE.

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John Tottle

Jun 20, 2012 at 15:09

I thought QE was inflationary. Why more QE when inflation is falling as the BOE wishes. How far off is hyper-inflation?

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William Bishop

Jun 20, 2012 at 15:38

In answer to John Tottle, a hell of a long way, unless and until stimulative monetary policy actually produces increased use of credit and greater economic activity. Even then, the B of E would have the option of pulling back in time, given sufficient foresight.

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Keith Cobby

Jun 20, 2012 at 15:43

Create money - buy debt - cancel debt - simples!

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Jonathan

Jun 20, 2012 at 16:02

@Keith Cobby

you forgot an intermediate step, the BOE are not allowed to buy government debt directly from the government. they have to buy it from someone like goldman Sacks who will make a profit out of the trade.

So it's:

Create money - buy debt - make Goldman Sacks a load of money - cancel debt

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R.Linger

Jun 20, 2012 at 17:31

Q.E can not and did not work as the economy is out of balance.

The risk reward which is so necessary can not work in this state while interest rates our so low in regard to inflation and the result is stagnation

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Pilgrim

Jun 21, 2012 at 11:01

Jonathan,

In substantial agreement with your description of QE.

However, this is incomplete.

In the view of the BoE the debt is not cancelled, it is retained on the books of the BoE who therefore receive the associated income stream. The BoE now hold Gilts equivalent to one third of the GIlts market on their books. The BoE states that it intends to return the Gilts to the market which will cause a market effect opposite to that engendered by QE! See recent speech by Charlie Bean on this subject (available on BoE website).

While a different form of QE could have been used to support the creation or maintenance of capital assets or trade goods and thus have been self justifying, the BoE evidently thought long and hard and came up with the only form of action which would distort markets while not achieving any identifiable stimulation of the wider economy.

While as you say the GS's have prospered from QE, the picture for pension providers is very different. Pension providers are obliged to hold gilts by the regulator and funds acquire gilts to match against their obligations. However, when the price of gilts is manipulated this increases the cost of funding pension obligations, hammers companies still operating defined benefit schemes, and reduces the income available to new pensioners seeking retirement annuities. Nice guys the BoE. Hit those in work. Hit those who retire.

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Jonathan

Jun 21, 2012 at 12:18

Pilgrim,

You will find there is no stated intention by the BOE that they will sell back the bonds back to the market to reduce their balance sheet. This is something other people have stated is the banks intention there is nothing from the BOE. They have discussed raising interest rates when the economy recovers to control inflation but not decreasing the monetary base. So the monetary inflation caused by printing x hundred billion pounds is here to stay.

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Pilgrim

Jun 21, 2012 at 13:06

Jonathan,

Sorry, but the BoE has stated its intention to sell the bonds back to the market. The following is a verbatim extract from the BoE speech given by Charlie Bean on 23rd May.

"Certainly the impact of QE on yields should ultimately reverse when the economic environment improves and we start to sell the gilts back to the market in order to withdraw the present exceptional monetary stimulus."

I do not see that QE is significantly inflationary either. This is because new pounds are promisory notes issued by the BoE and Gilts are promisory notes issued by the treasury. If one is used to cancel the other the overall level of debt remains substantially unaffected. Or as Charlie Bean puts it:

"QE essentially involves us trading one liability of the state – gilts – for another – monetary claims on the Bank of England."

As generally thought new money derives principally from the actions of the commercial banks. Requiring banks to raise capital ratios would therefore be expected to have a strong deflationary effect.

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Jonathan

Jun 21, 2012 at 14:05

I'll only believe it when I see it. I was listening to a program on Radio 4 a few months ago and a woman who sits on the MPC said that they would not reverse it by selling it back to the market but have discussed other methods like raising interest rates when the economy recovers.

You have got it wrong about creating money to buy government debt not being inflationary. As an example take a look at Zimbabwe, they used a method of QE with one level of indirection less than the BOE. They printed money to directly fund government spend. This is not much different from one arm of the government (the BOE) printing money to buy debt from another part of the government. Of course it is inflationary! What is not inflationary is issuing of government debt as this does not increase the monetary base.

In fact it is true that the only cause of long term inflation is printing of money by central banks. In 1974 everything was a tenth of the price it is today, wages were also a tenth of what they are today. How do you explain that other than an increase in the monetary base?

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Pilgrim

Jun 21, 2012 at 14:55

Johnathan,

Individual members of the MPC do not speak for the BoE, and often have strongly divergent opinions. I also find it almost impossible to imagine the BoE attempting to return the gilts to the market, given the huge volume held this would have a catastrophic effect upon the market price of gilts.

But I have quoted verbatim from the paper by Charlie Bean of the Bank of England. As noted that paper is available on the BoE website, and information, is, as it were, straight from the horses mouth! All I can suggest is that you do look it up, and then indeed you will see that it is true!

The situation is not the same as the position in Zimbabwe. Increasing government debt is inflationary, merely changing the form of the debt without changing the amount is largely neutral in its effect. As observed above, both by me and by Charlie Bean, the QE, of itself, does not vary the overall level of debt.

The fact is that at the same time as the BoE is buying back debt through QE the Treasury is selling new debt, so that the total volume of Gilts and currency in issue in the market is increased, which is an increased level of state borrowing. Increased state borrowing, if unmatched by appropriate fiscal countermeasures is likely to prove inflationary. But the extent to which this is inflationary is independent of the immediate effects of QE.

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Jonathan

Jun 21, 2012 at 16:52

Pilgrim

So you "find it almost impossible to imagine the BoE attempting to return the gilts to the market" but you still think they will?

Increasing government debt is not inflationary as they have to borrow the money from somewhere so the monetary base is not increased (it's a zero sum game). However, creating money to buy government debt is inflationary. One of the initial reasons given for introducing QE was to prevent deflation so it is also meant to be an inflationary instrument.

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Pilgrim

Jun 21, 2012 at 17:27

Jonathan

No I don't think so, but they say that this what they are going to do. It is just that from today's perspective it looks unlikely.

Apart from what Charlie Bean said in the speech, I also had a private conversation a couple of years ago with a BoE official. In that conversation the idea that the BoE had redeemed gilts at market value was resisted. No, he said, the gilts remained in issue and would be returned to the market when the time was right.

You say "Increasing government debt is not inflationary as they have to borrow the money from somewhere so the monetary base is not increased (it's a zero sum game)." I agree. It also holds for the reverse, otherwise known as QE. All HMG is doing is substituting one IOU for another!

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Jonathan

Jun 21, 2012 at 21:30

Pilgrim,

Are you saying QE is not inflationary???!!! They are not creating an IOU they are creating money, this is much more exchangeable than IOUs. They are increasing the monetary base and this is the primary cause of long term inflation. If you can't don't understand that it watch this explanation: http://www.investopedia.com/video/play/monetary-inflation

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John Tottle

Jun 21, 2012 at 22:31

Jonathan and Pilgrim.

All sounds very complicated.

To me printing money can only have one result in the end. Inflation and the more they print the greater the inflation.

Isn't this a basic economic rule.

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Pilgrim

Jun 22, 2012 at 13:12

There is little distinction between Gilts and money.

Both are promisory notes issued by HMG. Gilts held to maturity are like a deposit account which pays interest until a redemption date. Is the money you hold in a deposit account any less money because of it?

Further more there is an active market in Gilts, so a holder can convert Gilts into cash at market price at any time.

When we were on the Gold standard money was linked to the value of an identifiable scarce commodity, which gave money a demonstrable physical characteristic as a proxy for something which is essentially an abstract quantity. After all, how many cows is an ounce of gold worth? While the question may be a real question at a particular place and time, the answer is always variable depending upon circumstance. Now money has no physical proxy, but is a unit of measure used to express the relative value of goods and services. Inflation is apparent when the amount of goods and services offered in exchange for money diminishes.

The Bank of England is the ultimate guarantor for the value of sterling, but only a small part of the volume of sterling in circulation derives from the BoE. Most of it is generated by the commercial banks. Whether HMG debt is expressed as Gilts or money makes little difference, both are recognised in the assessment of bank caplital, and lending capacity.

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Pilgrim

Jun 22, 2012 at 13:52

A further thought.

The total value of Treasury debt as expressed in Gilts is equivalent to about £13150 for every citizen (on the basis of 60 million citizens).

If the BoE were to give every UK citizen £5400 without any strings attached that would be about the same amount in currency as the £325 billion used in QE.

It would be massively inflationary because it would have been issued without any exchange trade taking place.

However, in the exercise of QE an exchange trade is involved. The BoE has issued new currency but has used this to redeem the same present value in Gilts. The result is that the level of HMG debt is unaffected by the transaction, and all that has happened is that the form in which the debt is expressed has been changed.

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Jonathan

Jun 22, 2012 at 14:27

Pilgrim,

Q: What do you use to buy gilts?

A: Money.

So when gilts are purchased money is used as the other side of the trade so no increase in the monetary base.(A zero sum game and does not cause inflation).

But create a load money and buy government debt you have increased the monetary base and will cause inflation.

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Pilgrim

Jun 22, 2012 at 15:37

As noted before and as Charlie Bean of the BoE puts it:

"QE essentially involves us trading one liability of the state – gilts – for another – monetary claims on the Bank of England."

If you look at any bank note you will find the words "I promise to pay the bearer on demand the sum of 5, 10,,20, or 50 pounds." It is a promisory note. If you were to do the same with Treasury stock you would find a similar promise, but in this case the promise is to pay pounds at a future redemption date and to pay interest up until that time. In terms of the effect on inflation only the inefficiencies of the exchanging of types of promisory note is inflationary. Markets receive as it were a tip for enabling the exchange. The major effect of the transaction is not inflationary.

As I noted before an exchange of money for money's worth is not inflationary in whichever direction the trade arises. Producing money and issuing it without receiving money's worth in return is inflationary.

The main effect of QE is to force a distortion in the operation of the market. Whether a policy designed to artificially manipulate prices in an otherwise free market is ethical or not is a good question. And it seems clear that the effect of QE upon the markets must be transitory. The immediate consequence of attempting to reverse QE are most unattractive.

Should HMG intervened to stimulate the economy? My view is certainly it should.

Has QE as applied been an appropriate means of doing this? No I don't believe that it has.

Were there other possibilities in the way the economic activity could have been stimulated? Yes, I think so.

While the banking system is plainly relevant, does this constitute the only path by which the real economy could be stimulated? No I don't think so for a moment.

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Jonathan

Jun 22, 2012 at 16:37

Pilgrim

I suggest you try taking some gilts to the shops to try and buy something.

Also try to think of the difference between :

1. Zimbabwe printing money to fund government spend

2. the UK creating bonds for government debt and then buying them back with newly created money from the BOE. The difference is not much you have increased the monetary base and funded government spend with both methods and both are inflationary.

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