Download What is wrong with QE? Download the Saturday Economist Discussion Paper, to find out how the Bank bought £325 billion of gilts but may have damaged the pension fund industry and the UK economic recovery in the process.
At the Bank of England Conference on Quantitative easing and other unconventional monetary policies: in November last year the following conclusion was drawn. Overall, the papers presented at the Bank’s November conference broadly supported the emerging consensus that QE and other unconventional monetary policies have helped to mitigate the macroeconomic effects of the global financial crisis. Evidence presented at the conference suggested that asset purchases by the Bank of England and the Federal Reserve had led to significant falls in government bond yields. There was also evidence that asset purchases and other balance sheet policies resulted in significant effects on the wider economy.
That said, there was less agreement about the magnitude of the effects and the main mechanisms through which the policies may have worked. Nor was there agreement on whether there was scope to use these policies in normal times.
We are prepared to concede the first conclusion that asset purchases by the Bank of England have led to a significant increase in gilt prices and falls in government bond yields but would seriously question the idea the asset purchases produced “significant effects on the wider economy”. There appears to be no theoretical evidence to support the statement and not empirical evidence to sustain the proposition.
Gilt prices have risen, yields have fallen but bank lending remains subdued, money supply remains below long term trends, consumer spending is constrained, investment is contained despite the lower cost of capital available to investors.
The fall in exchange rate has compounded the problem of higher import prices particularly, energy, oil, food and basic commodities, placing greater pressure on household incomes reducing domestic demand.
Lower gilts rates reduce incomes for savers, increase annuity costs and create a negative wealth effect on pension funds by creating a yield gap which can only be met by the purchase of more gilts or other low risk assets.
According to the National Association of Pension Funds, QE has cost the pension fund industry £200 billion in the second phase alone.
Ten year gilts at around 2% distort the yield curve, producing a negative real return on investment according to the Bank’s own disaggregated model, forcing pension funds to buy more gilts to fund the yield gap.
All stakeholders of gilts have increased their holdings during the asset purchase programme. The Bank of England appears to be buying gilts directly or indirectly from the debt management office. There appears to be no injection of liquidity into the economy increasing money supply leading to a stimulation of domestic demand,
The purchase of over 30% of the conventional gilt stock and over 60% of the new debt issued since 2009 eases the gilt issue challenge of the debt management office but little more.
QE compounds the real income problem for households, reduces the return on savings and does nothing to stimulate domestic demand.
The UK economy is flatlining despite a promising recovery in 2010 which hit the buffers in Q1 2011. The lack of recovery is unprecedented in comparison with the recessions of the 1930s, 1980 and 1990.
Household expenditure remains under pressure from low incomes, high inflation, a fiscal policy which increases VAT and raises fears about job security. Domestic demand is constrained by low investment, government spending and household constraint.
QE is creating more problems for the UK economy than it appears to be resolving. If we cannot be sure about the treatment, it is surely time to stop the application. Such is the economics of the cuckoo’s nest.
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