Friday, Jan 15, 2010
Mervyn King: Didn't understand inflation, didn't understand financial crisis, don't understand QE
Telegraph: Economists question success of Bank of England's £200bn money-printing plan
The Bank of England is coming round to admitting that it doesn't really understand what the effects of QE might be. It just can't say for sure. They know what they're doing though. Always. no really, they do.
Posted by paul @ 08:48 AM (1502 views) Add Comment
39 Comments
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1. estrader said...
"but the MPC has pointed to the sharp rise in equity prices and the demand for corporate bonds as signs that QE is working"
WHAT!? I don't ever recall them claiming that this was the purpose of Q.E. So I suppose the sharp rise in Gold price is proof that Q.E is "working"...so, basically, because 'something' happened, their conclusion is QE is working. The MPC is insane.
"Look, the snow is clearing, see, Q.E is working"
2. mark wadsworth said...
Indeed, the whole thing is madness and pointless, I have been saying this since it first kicked off.
The outcome of QE was to lose £3.6 billion for the taxpayer (because they overpaid for gilts by 2%) and to temporarily prop up gilts prices. Apart from that it was a pure paper shuffling exercise. It didn't "encourage banks to lend" because you cannot "encourage banks to lend", you can only "encourage people to borrow" (which is also nigh impossible except in asset bubble conditions).
To re-use my analogy, the govt. could not have helped the horse-drawn carriage industry by supplying them with more wood, leather, steel and rubber, even at subsidised prices. If people want to buy cars instead of horse drawn carriages then they will do so.
And, despite what a lot of people said, QE has clearly not led to general price inflation, which is also nigh impossible.
3. tyrellcorporation said...
Hasn't most of QE been used to buy government debt? Surely this was one of the main reasons as tax revenue collapsed and Labour's spending plans needed propping up before the election.
4. nickb said...
mark@2
You are right that merely buying guilts even with new credit from the BofE does not necessarily increase bank lending - Willem Buiter actually showed that when institutions with reserve accounts at the BofE were selling them they are just leaving their cash in the reserve accounts. However, it's not doing nothing, it's propping up bond prices, which means not only profits for bond sellers but low interest rates, and prevention of the housing collapse before the general election. If that is its effect, and the BofE is not short of brains to work this out for itself, perhaps that is the intention.
5. nickb said...
mark
You can allow people to borrow who want to. There is still a credit crisis in the real economy. The BofE could announce a shopping spree on company bonds with new credit instead of government bonds. Apparently the ECB has done this. This would directly ease credit conditions in the real economy. And won;t be inflationary because of all the excess capacity. The BofE won't do this because central bankers subscribe to a supply side model in which government 'intervention' is seen as heresy (except to prop up the banks of course). Now the central bank is independent (and a private corporation under changes brought in by Labour in 1997) it can do as it likes.
6. mark wadsworth said...
Tyrell
"Hasn't most of QE been used to buy government debt?"
Yes.
"Surely this was one of the main reasons as tax revenue collapsed and Labour's spending plans needed propping up before the election."
Nope. Tax revenues fell by £30 billion or something, welfare costs for a year might rise by £10 billion, i.e. the recession induced deficit was three percent of GDP (which is what you'd expect with a five per cent slump and a sixty per cent average tax rate). The horrendous annual deficits of £150 to £200 billion that Labour have got planned is largely due to a massive Keynesian/Socialist spending splurge from hell (a mystery to me what they are going to spend it on, but hey).
For the zillionth time QE does NOT increase the amount of money a government can spend. The stated aim was to increase the amount of money that banks can lend/spend. As it happens, QE achieves neither, but it certainly can't do both!!
For example, the government could if it wanted issue £1,000 trillion in gilts tomorrow and announce a £1,000 trillion QE package to buy it up. All that would happen is the BoE puts £1,000 trillion of gilts in its safe, and credits the Debt Management Office with £1,000 trillion as a deposit with BoE. This in itself achieves nothing apart from crashing bond markets. It does not add one penny to the amount of money the government can spend.
7. letthemfall said...
mark w
You may well be right that there is no more lending than before QE (are there any figures about on this?) but it may well be true that gilt yields are lower, making some borrowing cheaper. But it seems no one is sure about this
8. letthemfall said...
Incidentally, the deficit has been caused by a much needed increase in spending, especially on health and schools, coupled with a big drop in expected revenues as a result of the recession caused by the banks.
9. mark wadsworth said...
LTF:
"a much needed increase in spending, especially on health and schools"
Health doesn't need more spending, it needs less waste on quangos and nanny advertising on TV and translating "no smoking" leaflets into 23 languages. Real terms NHS spend has doubled over last ten years (surprisingly, it is still reasonably good value by international standards, separate topic).
State education doesn't need more spending (total cost per pupil = roughly the same as better value schools in private sector) it needs more discipline and fewer targets. Vouchers would help.
"a big drop in expected revenues" The fall in tax revenues was about £30 billion, that bears no relation to expected deficits of £150 billion to £200 billion over the next few years. I have already pointed this out.
"as a result of the recession caused by the banks."
As a result of the recession caused by wilful failure of govt's to properly supervise the banks (who are like naughty teenagers), because this allowed voters to be conned by the Fool's Gold of ever-rising house prices.
Next.
10. nickb said...
Mark
>The horrendous annual deficits of £150 to £200 billion that Labour have got planned is largely due to a massive Keynesian/Socialist spending splurge from hell (a mystery to me what they are going to spend it on, but hey).
If only that were true. But you said yourself what the government is doing is not increasing the total spending in the economy as a Keynesian would intend. All it (via the bond issues) is doing is increasing the level of government debt. Why? Perhaps to engineer a crisis so that there will be another round of deregulation, privatisation and public spending cuts. Furthering the interests of the banks.
11. nickb said...
Someone explain to me why the hell, if the ECB has bought company bonds with newly created credit, easing the debt crisis in the real economy, the BofE can't do it too.
12. 51ck-6-51x said...
As I've said before, QE would increase the liquidity in a very tight pool - that between the BoE and the banks which deposit there, and that it would do little to encourage lending* or increase the broad money supply much at all**.
The stated aim was encouraging lending to businesses; the real aim was, I believe, increasing the aforementioned liquidity [of the tight pool] in order to decrease the risk of bank failures, pure and simple, and it seems to have achieved that.
* It would, however, increase bank profits, which could encourage lending - but only if there was a catalyst - i.e. if lending became attractive to banks it would have encouraged lending further.
** It probably leaks a bit: the increased transactions will no doubt have had some fees.
---
"What kind of hippie am I? Man, I'm a business hippie, I understand the concept of supply and demand." - Harrold & Kumar go to White Castle [AKA Harold & Kumar Get the Munchies].
13. icarus said...
It works to "stimulate the economy by (causing the) re-investing (of) the proceeds in other assets".
True. But have they ever heard of asset price bubbles? Do asset price bubbles (a) stimulate the economy or (b) get us into the merde we're in now? The answer is a qualified yes to (a) and a resounding yes to (b).
And does QE cause investment inj the real economy (production of, and demand for, infrastructure, goods and services). Nope.
14. mark wadsworth said...
Nick B @ 10 ".. you said yourself what the government is doing is not increasing the total spending in the economy as a Keynesian would intend. All it (via the bond issues) is doing is increasing the level of government debt. Why? Perhaps to engineer a crisis so that there will be another round of deregulation, privatisation and public spending cuts. Furthering the interests of the banks."
Please note that govt deficits and QE are two completely separate issues, they may be intended to tackle the same problem, but they are quite independent. Whether politicians and journalists deliberately confuse the two, or whether they are just stupid, I do not know.
a) Deficits of £150 billion-plus are real and genuine deficits. The govt plans to spend £600 billion a year against tax and other revenues of £450 billion a year. Whether that is financed by bonds, IOU's, freshly printed notes or simply not paying suppliers and employees for a year or two is a separate issue.
b) QE is a paper shuffling exercise, which has, at best/worst/most the effect of keeping interest rates down a bit (largely for psychological reasons, it's all smoke and mirrors). Govt's nearly all run up deficits nearly every year (the UK was in surplus for about four years out of the last thirty), this was all achieved without QE.
15. icarus said...
QE just supports bank balance sheets by increasing the demand for (price of) gilts, thereby reducing gilt yields and long-term IRs, thereby increasing the demand for mortgages and property prices, thereby supporting the value of property loans held by banks.
16. icarus said...
Omit "prices" @15.
17. nickb said...
Mark
Yes the deficit is real and is independent of QE - I never said otherwise. You raised the issue of the government deficit. The government deficit will not increase the quantity of credit (money) being spent in the economy. So it can't have the effect a Keynesian would intend. To get that you also need to 'monetise the deficit'.
QE as counducted by the BofE is ineffective. But credit easing a la ECB would not be. Why doesn't the Bank of England do this instead? Is it because it has reverted into a creature of the banks that primarily acts in their interests rather than the public interest, or what?
18. letthemfall said...
MW:"Health doesn't need more spending, it needs less waste on quangos and nanny advertising.. "
I know, I know. But what you say sounds more and more like propaganda with no evidence to back it up.
The banks have been around for a long time - long enough to grow up. You seem very happy to blame most economic ills on govt and public sector. Perhaps that just what Ukippers do!
19. mark wadsworth said...
LTF, "You seem very happy to blame most economic ills on govt and public sector."
True, but I'd heap the most blame on the Home-Ownerists, then the EU, then the govt/public sector and then the banks (who will never grow up. They are eternal naughty teenagers.) That's not propaganda, and I can back it up.
20. letthemfall said...
MW:
I'll say banks, HOs - and then govt, though maybe they're to intertwined to order. I don't think the public sector has done any harm, nor the EU, which brings more benefits than disadvantages. (Which party did you say you belong to?). Please do back it up.
21. nickb said...
Health needs less management and bureacracy. Why is there so much? You need a lot of management to have an internal market, to have, manage and enforce contractual relations where none existed before. By all accounts the NHS was quite efficient before creeping privatisation came along.
Mark blames the govt then the banks. But who is in whose pocket?
22. mark wadsworth said...
I'll shut up now expect to agree with Icarus and NickB that none of this QE, or even the deficit spending, will achieve much in terms of getting the real economy going, i.e. people voluntarily exchanging goods and services (mainly their own labour) for mutual benefit. Govt and banks (and a lot of large corporates) are a symbiotic parasite that lives off taxpayers.
23. matt_the_hat said...
6. mark wadsworth - "For the zillionth time QE does NOT increase the amount of money a government can spend.... For example, the government could if it wanted issue £1,000 trillion in gilts tomorrow and announce a £1,000 trillion QE package to buy it up. All that would happen is the BoE puts £1,000 trillion of gilts in its safe, and credits the Debt Management Office with £1,000 trillion as a deposit with BoE. "
So the government has £1000 trillion more to spend, Mark I think you need to get out more, clearly this made sense in your bedroom or something. The question is - will eventually that £1000 trillion buy a loaf of bread - oooppps this might lead to inflation another thing MW said couldn't happen.
The governments aim is to prop up gilts by having a guaranteed buyer BoE who will pay a fixed price at the other end for investors. Watch QE closely, I'm guessing we will have near perfect correlation with the budget deficit, until the penny drops that the UK is bankrupt then get your wheel barrows out.
"Any intelligent fool can make things bigger, more complex, and more violent. It takes a touch of genius -- and a lot of courage -- to move in the opposite direction."
24. nickb said...
mark@22
Agree but only up to a point. The government could stimulate the economy with the assistance of the bank of England were it to do QE properly (credit easing). But this would be seen as "too interventionist for the UK". E.g. the government could issue new money and spend it in the real economy. How about a comprehensive program of home insualtion and training people to do it properly? how about the BofE buying bad debt with new credit? And then using credit controls to prevent bad lending in future? How about the B of E buying energy bonds to start getting renewables in place before fossil energy prices rocket again?
None of this is inflationary in a credit crunch because there is insufficient demand in the real (non-financial, non-parasite) economy.
25. mark wadsworth said...
@ M-T-H @ 23.
OK, if it were that easy - if the government would suddenly have all the money in the world to spend by one chap in HM Treasury's BoE department typing the number £1,000 trillion onto a computer screen and another chap in HM Treasury's Debt Management Office printing off a Gilt with a face value of £1,000 trillion and walking down the corridor and putting it in the BoE's safe - then why wouldn't a government just do it?
Don't forget that public sector NET debt would not change by one penny - it would merely inflate assets side and liabilties side which of course net off to £nil.
If they just did this, then the only way to "pay" people would be to credit them with a balance at the BoE (which would have the same credit rating as government bonds generally). As the government's net public sector debt remains unchanged, it is only when they actually "spend" the money that net debt goes up (and it is rocketing as we speak, with or without QE!). And until and unless we have exchange controls, the money would just seep abroad, so inflation is not an overriding concern.
26. nickb said...
Re 25
If the govt and BofE were to cooperate they could indeed have all the money they need without even having the gilt issued and without generating debt. the BofE could simply credit some government accounts. This is the government "printing money" but more less costly than actually printing money. They won't do this because they have made the BofE independent and are in thrall to an ideology that says it is a heinous economic sin to do any such thing. The markets would not like it either, for the same reason. Normally it would be inflationary, but a credit crunch is not normal.
27. mark wadsworth said...
Nick B "If the govt and BofE were to cooperate they could indeed have all the money they need without even having the gilt issued and without generating debt." ???
If the government pays for things by giving people credit balances at BoE then how is that not "government debt"? The BoE is part of the government, whatever people waffle about it being "independent". If you have a credit balance with a High Street Bank then that bank owes you money. If you have a credit balance with BoE then the BoE (and ultimately the government) owes you money.
If the government pays for things by physically printing money, then people deposit this at the bank, and the bank in turn deposits it with BoE and gets a credit balance with BoE. The BoE can at this stage burn the money again.
In other words, whichever way the government borrows money (electronic balances, new notes, new gilts) it all comes to the same sort of thing in the end.
28. nickb said...
Mark,
As I understand it that's not the way it works.
"If the government pays for things by physically printing money, then people deposit this at the bank, and the bank in turn deposits it with BoE and gets a credit balance with BoE. The BoE can at this stage burn the money again."
banks don't typically keep money deposited with them at the BofE, they lend it out and charge interest on it. I think you'll find that the US government issued (printed) its own money under Kennedy.
The government wouldn't pay for things by giving companies bank accounts at the BofE, it would simply pay them for goods and services from the governments' deparments' accounts (which have been credited).
29. nickb said...
"If the government pays for things by physically printing money, then people deposit this at the bank, and the bank in turn deposits it with BoE and gets a credit balance with BoE. The BoE can at this stage burn the money again."
Even if somethign like this did happen: if the BofE does not burn it, where is the government debt?
It's quite unlike the situation in which a bond has been issued and which must be paid with interest on maturity. Also, the things the government has paid for have been produced, and other payments generated to suppliers etc, which would not have happened in a credit crunch.
30. mark wadsworth said...
Nick B "The government wouldn't pay for things by giving companies bank accounts at the BofE, it would simply pay them for goods and services from the governments' departments' accounts (which have been credited)."
Indeed. But what difference does it make which govt department owes you money? In practice, what you want is a credit to your own personal bank account.
And how to we convert a balance with BoE (or a balance with Ministry of Drains) to a balance with a commercial bank?
Quite simple, you swap one for the other, and the commercial bank in turn gets a credit with the BoE (they already have £150 billion credit with BoE, being the proceeds of QE bond sales!!).
So commercial bank owes you money, and BoE owes commercial bank money. The commercial bank is just a middleman.
31. nickb said...
Mark,
I'm assuming that the government has does have bank accounts which it uses to make payments, there being such a thing as government spending after all. Then what is the problem you are alluding to? Alternatively, if you insist, we can imagine civil servants turning up at factories with suitcases full of cash. I think we can agree that would generate some real economic activity.
32. mark wadsworth said...
Nick B I'm not alluding to anything, I am trying to describe the world as it actually is, rather than engage in one-sided economics so beloved of everybody else, which is some sort of fantasy world, where there can be assets without liabilities; where there can be income without expenditure; where there can be profits without losses; and where wealth can be generated without anybody doing anything (or vice versa to all those things).
33. nickb said...
Mark,
You haven't answered the question. In YOUR fantasy world, nothing the government does can make any difference.
Suppose the government physically printed money and used it to buy ships. How has it increased its debt? Banks might end up with more balances at the bank of england if they are not lending. But this is not government debt. They can withdraw these balances at any time without the government having to print or raise more.
34. mark wadsworth said...
Nick B "In YOUR fantasy world, nothing the government does can make any difference."
I never said that! The government does all sorts of things and controls and redistributes, directly or indirectly, half of our economic output. It can funnel it into good, useful things (law and order, transport infrastucture, refuse collection); neutral things (like welfare and other universal benefits) or spend it on wasteful things (i.e. have millions of people filling in forms and checklists).
If your hypothetical ships were put to good use, i.e. rented out to shipping companies, then that particular transaction would be value neutral. It'd be a bummer for existing shipowners, as freight prices would go down, and it would push up steel and energy prices (bad effects, let's assume) but it would be good for steelworkers, good for exporters/importers, so possibly good for workers and consumers (good effects, let's assume).
It would have a million little knock on effects, which might overall be helpful or detrimental to the state of the economy (which is just individuals exchanging labour, goods and services), not for me to say whether the govt should or should not build ships, is it?
We can do the same exercise for e.g. windmills and find that the costs far, far outweigh the benefits, and so on.
What I said was, psychological effects aside, whether the government borrows by printing money; creating it electronically; issuing gilts; or indeed simply leaving certain future obligations (like public sector pensions) unfunded makes little difference in the grander scheme of things.
Could you explain please how a balance at the BoE is NOT government debt? The BoE IS the government (or part of it) and if you have a positive balance with them it OWES you money, ergo it is government debt, the same as banknotes or gilts or an entitlement to a pension in retirement.
35. nickb said...
Mark,
>Could you explain please how a balance at the BoE is NOT government debt? The BoE IS the government (or part of it) and if >you have a positive balance with them it OWES you money, ergo it is government debt, the same as banknotes or gilts or an >entitlement to a pension in retirement.
You are playing with words. If the government prints money and buys a ship and the shipyard puts it in its bank account and the bank increases its reserve account at the BofE (phew!), then the bank has a claim of the BofE equal to its deposit there, but there isn't a PROBLEM in the sense that government debt is a problem (ie that something needs to be done to service interest on a loan, the usual problem with government borrowing). The bank will have deposited its money at BofE and the money is there to take away whenever. Where is the PROBLEM?
Secondly, this kind of purchase (with credit, you don't need to physically print money as you must be aware) can easily generate additional economic activity in a credit crunch when shipyards, suppliers etc are lying idle and shedding labour. We don't have any shipyards, granted, but of course it's just an example.
36. mark wadsworth said...
Nick B: "... but there isn't a PROBLEM in the sense that government debt is a problem (ie that something needs to be done to service interest on a loan, the usual problem with government borrowing). The bank will have deposited its money at BofE and the money is there to take away whenever. Where is the PROBLEM?"
Ahem. I never said "problem", I am trying to describe the world the way it is. By the way, if a bank deposits money at BoE then it expects to be paid interest, so it is not correct to say that this type of loan "does not need to be serviced".
As to the spending side, I never said there weren't things on which the government can't usefully spend money, there are plenty of sensible things it could be building to take up the slack, obviously, like coal fired power stations, transport infrastructure, flood defences etc, i.e. stuff that will come in useful in future.
37. nickb said...
the banks get interest paid on their deposits at the BofE? If so then that is new information to me. But if so it can't be anything like the amount of interest paid on bonds.
It's usual for the banks to create credit via a process perhaps inaccurately described in the textbooks via the 'money multiplier' story. By your logic this is just as likely to increase government debt.
38. nickb said...
my mistake at 5 (in rant mode); BofE is not a private corporation. Not been able to make sense of what the constitutional changes were introduced by new labour though, in addition to "operational independence." Anyone?
39. mark wadsworth said...
Nick B
1. Of course banks get paid interest for BoE deposits! That is the very definition of "base rate", that is the one that everybody talks about once a month (currently 0.5%).
2. Of course BoE is part of the government, has been for centuries! All that happened in 1997 was that Labour said "We will allow MPC to set interest rates. Unless of course we want them to be lower, for political reasons". I think that over the past couple of years they have abandoned all pretence of the MPC being "independent". And the MPC is only a small bit of what the BoE does.
Maybe you ought to go back and re-read my comments.