- As Covid pandemic wanes, Bank of England’s emergency policies should be paused.
- Money-tree policy has no clear end, but is inflating asset bubbles which may spill over into price inflation.
- Global central banks are not even clear that QE is needed as inflation is picking up.
QE is still a monetary experiment: When central banks introduced the money-printing idea of ‘quantitative easing’, in the teeth of the financial crisis, the policy was designed to stave off a 1930s-style deflation and economic collapse. With short-term interest rates around zero, central banks decided further stimulus could come from forcing long-term interest rates lower to revive growth and raise asset prices that would then stimulate spending elsewhere.
Bank of England has not stopped buying Government bonds: The purchase of hundreds of billions of pounds of gilts, with the Bank of England continually buying new gilts as its previous purchases mature, has had dramatic impacts on all other asset prices too. The transmission mechanism is very indirect because it relies on buying bonds in secondary markets, with investors then having to find other investments for the money they receive. This inflations house prices, equities, bonds and other asset price increases but this has unknown side-effects and maintains an air of unreality in markets. Speculation is encouraged as investors try to find other sources of return.
Bank of England should put final £50bn asset purchases on hold: Tomorrow, the Bank of England will decide whether to maintain its current policies or make some change. I hope they will decide to put the final £50bn of QE gilt purchases on hold, as the economy is clearly recovering and inflation has been far higher than anticipated. In the past ten years, central banks have been frightened away from withdrawing QE and this has further inflated asset prices, with ongoing money-creation being maintained, despite economic recovery.
Distorting gilt prices is a threat to capitalism itself: Central banks have tried to pretend that their actions did not unduly influence asset prices, but that is mere assertion, without any proof. The only real caveat imposed on gilt purchases by the BoE is its statement not to hold more than 70% of any single gilt issue, as if that somehow meant it would not be influencing the price too much! As any of the gilts matured, the BoE has kept buying more, to maintain the same level of gilt holdings and the programme will reach close to £1 trillion if it continues. Government bonds are supposed to be ‘risk-free’ assets. As the lowest risk asset class, other capital markets – and models of capital market pricing – use this as a benchmark. Capitalism assumes capital flows and market forces operating freely, to allocate resources and determine outcomes. However, it could be argued that global monetary policy has interfered with capitalism as QE has distorted this ‘risk-free’ rate, making traditional risk and asset price models unreliable. Artificially inflating asset prices may have caused market bubbles, which will not be obvious until the bubble bursts.
QE seems to have undermined central bank independence: QE has made it much easier for Governments to fund government borrowing and for banks to lend at better margins. Since the start of the pandemic, the Bank of England has created just enough money, coincidentally, to finance the Chancellor’s stimulus spending. So far, QE has acted rather like a back-door central bank deficit financing measure, with markets willing to be fooled in their own self-interest, but the political consequences should no longer be ignored.
Artificially boosting asset price has inflated wealth inequalities as assets are unevenly distributed: The top 5% of households own nearly half of UK assets and 80% of all assets are owned by the over-45s. So, the wealthiest and older households have become even wealthier, while QE-induced house price rises lead to higher rents, which have further disadvantaged non-homeowners and the young. Such social and distributional side-effects of unconventional monetary policies are under-recognised, perhaps because the policy is so beneficial to Governments, but politicians would do well to consider the potentially damaging political consequences. The BoE’s own analysis, showing that wealthiest groups have benefitted significantly from QE’s impact on asset. The policy has allowed the wealthy to become wealthier, and since 80% of financial assets are held by people aged over 45, younger generations have been left behind.
In effect, monetary policy has acted like regressive fiscal policy: QE is rather like a hidden tax rise on people who rent or don’t have many assets, alongside hidden tax cuts for those wealthy groups who benefit. In fact Claudio Borio at the Bank of International Settlements Economic and Monetary Department recently said ‘Unconventional monetary policy is just fiscal policy dressed up’. Such distributional impacts would be politically unacceptable if imposed overtly, but disguising such fiscal measures as monetary policy has achieved similar impacts without democratic accountability. The chart below shows the Bank of England estimated that the wealthiest groups in society had increased their wealth by over £350,000 up to 2014 – with further rises since then.
Can QE actually be unwound – will QT be possible?
There is a serious question mark over how the end of QE will play out. There is talk of ‘Quantitative Tightening’ or ‘QT’ where the central banks should start selling back the bonds they hold on their balance sheets. However, actually trying to sell such enormous sovereign debt holdings back into the markets would drive yields and fiscal financing costs up dramatically and may be unaffordable.
Just allowing bonds to run off without demanding capital repayment: Ultimately, could central banks be tempted to collude to cancel the bonds they bought – allowing them to mature without demanding Treasury repayment and never reinvesting? The same powerful groups who benefited from QE in the first place would once again benefit. Indeed, in that scenario, who would lose? Governments, banks, taxpayers and borrowers would all be winners – so who would make a fuss? Such a massive debt forgiveness could rebase currencies and markets. Effectively QE would have resulted in a permanent redistribution of wealth and income, achieved via monetary policy, rather than the usual fiscal route and without the necessity of repaying all the accumulated past debts. So how will history judge this period – time will tell.
Here is a summary of QE’s unintended consequences as I see them:
- QE has enabled Governments to borrow more and more cheaply
- QE has enabled banks to increase margins and clean up balance sheets
- QE has increased wealth inequality
- QE has increased inter-generational inequality
- QE has increased pension deficits and annuity costs
- QE has distorted investment risk, making asset allocation risk models less reliable, by adding risk to the supposedly risk-free asset
- QE has sparked a significant asset reallocation move away from potentially higher return equities towards lower potential return bonds, a vicious spiral for pension funds which has cost employers and taxpayers billions of pounds that could have been invested more productively
- QE may have undermined confidence in capitalism itself as the distribution of capital has changed.