Here’s a piece on QE I wrote for the LSE student rag (with some help from Luis Enrique).
Printing £75bn does not sound like a plan to make us all richer. It sounds like a plan to turn us into Zimbabwe. But last week Mervyn King, Governor of the Bank of England, announced that is exactly what he will be doing. When complete, the Bank’s Quantitative Easing, or QE, programme will have seen £275bn leave the printing presses, nearly £5000 for every person living in the UK. Informing the Bank’s decision is the news that more than two and half million people are now unemployed, including nearly a million young people. In fact, many students reading this will have chosen to come to LSE because finding employment has been difficult. Urgent action is obviously needed to tackle this, but printing money appears a method of dubious merit. Of course, there is a logic to the Bank of England’s action that may mean students graduating this time next year will find it easier to get a job than they expect.
The Bank’s actions appear odd, even dangerous, only because of the rarity and extremity of our situation. In normal times the Bank doesn’t announce how much money it will be printing, it just changes the interest rate at which it will lend. To keep growth steady, when the economy is decelerating they cut interest rates to encourage spending and when the economy is accelerating they raise interest rates to discourage spending. You can raise interest rates as high as you like, but can only cut them to zero, and that is where they’ve been since March 2009. This means they have to try to encourage spending through other methods.
Over the last nine months the economy has seen no growth when normally it would be almost two per cent larger. If an economy stops growing it may be because bad policies prevent new companies from setting up shop and creating and employing new technologies. Alternatively, an economy may falter because there is too little demand for those new industries and technologies. Whether the Bank’s actions are wise will depend very much on which describes our current situation.
The idea that firms and people may be lying idle because nobody wants their produce is a strange idea at first. If people are willing to work that must mean they want to consume. If they didn’t people would be happy to stay at home and relax. But there is one good people want to buy which won’t put others to work. You buy a car to get from A to B and you employ a mechanic. You buy a sheep because you want mutton or wool and you employ a shepherd. You “buy” money to swap it for something else by working or saving, but you don’t employ anyone because money can be created for free.
In nervous times, we all would like to improve our balance sheets, we all want to build up buffers of savings, and that often involves wanting to hold more money in our current accounts. When one person does this it causes no problems, but when we all become more nervous we all end up wanting to build up a safety buffer. Now with only so much money in circulation this can only happen if we each spend less than we earn. But this is impossible because everyone’s spending is someone else’s earnings. Unless extra money is put into circulation we get slowly poorer until people decide they have the right amount of money relative to their earning and spending. We have a recession. We have our current stagnation. QE is designed to put more money into circulation and to create more safe places to invest that money. That should lead to healthier balance sheets and more demand to employ people and will bring the economy back to life.
In an economy held back by bad policy, printing money does exactly what you would expect it to and makes everything more expensive. At a time of stagnant wages and austerity budgeting this would be a terrible result. Some people have pointed to high inflation as proof the bank has already printed too much money. In one story growth falters because people start demanding relatively more money than goods and services. In that world, printing money -whether through changing interest rates, QE or targeting total cash spending – will make us richer. In the other it makes us poorer.
Looking at the UK and global economy, three things imply the Bank’s actions will help more than hinder. One major source of inflation has been successive increases in VAT. In the last two years it has increased from 15% to 20%, adding at least a percentage point to inflation. A lot of inflation is also still working through import prices since sterling devalued. Lastly, crisis in Europe and continued depression in the US means the UK’s economy can expect little external support. The Bank of England has little influence over any of these and has ignored them to focus on what it can influence in the domestic economy.
In the last three years a lot has changed. Whether more QE is a good idea or not depends on whether the economy has been damaged to the point where we can employ a million fewer people than we used to. If the financial crisis or government policy has wrought such damage upon us then QE will merely produce ever higher prices. If there is still some slack in the economy then we will see more people employed and better living conditions for everyone. Simplistic comparisons with Zimbabwe may be attention grabbing, but in reality QE may be the best hope we have to get the UK back on track.