QE is Probably Going to Have to be Paid Back

I’ve already taken a pop at Richie today over QE and now I’m going to have a go at Chris, which is an all the more worrying prospect, intellectually speaking.

1. Richard Murphy is basically right to say that this means that government debt is lower than official figures show, if we consider the government and Bank of England as a single entity. What’s happening is that government borrowing is being financed not by debt sales to the private sector but by an increase in base money. This is entirely consistent with the government budget constraint (pdf). Warren Buffett was quite correct to say that you cannot have a debt crisis if the authorities can print their own money.

I think the collorary to this is that if actual government debt is lower than the official figures then the price level is about to become much higher than it is now. QE is backed by a credible commitment to unwind it to reduce the amount of base money circulating. Taking the Bank and Government as one does not lead us to the situation described above where some debt does not exist. We have a situation where some debt exists in the odd form of a credible promise that at a future date someone will be being burning money.

Evidence for this abounds. The price level is not significantly above where it should be if the Bank of England had fanatically maintain an inflation rate of 2%. According to some rough calculations, since 1997 the price level is about 20% higher than a 2% level rule would suggest. Since QE was initiated in 2009 it is somewhat above even than high trend, but that was the point of QE, there is very little evidence that investors view QE as bound to be inflationary due to it being later monetised.

That low inflation isn’t consistent with a large scale monetisation of Government debt unless there is significant slack in the economy such that nominal increases mostly show up as increased real activity. I think there is room for more monetary expansion, and a little credible commitment to recklessness may be useful at the moment, but I know Chris holds that this is unlikely.  

If markets are pricing in a monetisation of UK debt (and subsequent change in price level) they are pricing in only a very modest erosion of the Bank of England’s holdings. Chris can argue that we don’t need to consider Gilts held by the Bank of England under QE as real liabilities, but he needs to take that up with the markets, not me, it is they who are predicting much lower inflation for the UK ahead.


10 thoughts on “QE is Probably Going to Have to be Paid Back

  1. Why on earth should the price level rise?

    All the signs are of deflation, not the opposite

    We just created some money – and not enough to even get M4 to rise

    Commercial banks did that every day without inflation

    What’s the worry if they don;t and the BoE does?

    Stop reading the text books. They don’t work. 2008 proved that. Look at the evidence from first principles instead and ‘don’t panic’ – because there’s no reason to do so

  2. Richard

    It really isn’t that simple. It is possible for there to be imported CPI inflation, which may be partly or wholly due to currency debasement as a consequence of QE, at the same time as M4 is collapsing because of private sector deleveraging. So it is possible to have both inflation and deflation at the same time. Which is the situation we currently have.

    You also need to distinguish between broad money (M4) created by commercial banks and the monetary base (M0) created by the central bank. If banks aren’t lending, then it is entirely possible for M4 to continue to collapse even when M0 is rising because of QE. Which is also happening at the moment.

    As I pointed out in my original criticism of your consolidation exercise, eliminating the debt in the process of consolidating the BoE and Treasury accounts does not mean it ceases to exist. In the accounts it is expressed as a cash liability instead of a debt, but it is still a promise to pay. And I agree with Left Outside that at some point some or all of it will have to be paid.

    I accept that there probably is considerable slack in the economy, so arguably not all of it will have to be paid back – some will, we hope, be mopped up by increased production as the economy grows. But to assume that such an extensive debt monetisation will never have to be paid back at all is quite a leap of faith and not consistent in my view with the MPC’s mandate to maintain inflation at around 2% (a mandate it is singularly failing to fulfil anyway).

  3. I fear we’re talking at cross-purposes here. When I said “debt is lower than official figures show” I was referring to gilts.
    Govt debt can be financed by issues of gilts or money. QE, in effect, means it is the latter.
    I suppose you can reasonably say that money is debt, but this is mere sematics. When people refer to a “debt crisis”, I interpret them as meaning that investors are unwilling to hold government bonds.
    Richard and I say – and low gilt yields suggest the market agrees – that this means there’s no immediate danger of a debt crisis, in this sense.
    Instead, the question becomes: will they be willing to hold the extra money?
    If the answer’s no, then we’ll get an increase in either other asset prices (foreign currency, shares, commodities, whatever) or in demand for goods and services, as folk try to offload their excess money balances.
    How far this is inflationary depends on the slope of the AS curve.
    To assert that it is inflationary, however, is to beg the questions about money demand and the AS curve.

    1. Okay, what I intended to argue was that other things equal (which they won’t be) it will be inflationary.

      Monetising existing QE would imply less monetary support in the forward, because it will already have been provided, except at a reputational cost the the BoE and the Government. (Something which could lead to slightly higher (or more variable) inflation if the BoE loses some credibility, that is not an argument I’m interested in making).

  4. Is this ultimately a question of the burden of debt?

    Does QE reduce the burden of debt on current and future taxpayers? Is that the argument that Richard/Chris are really making?

    You could attack that from several angles. QE => NGDP => tax revenue => deficit reduction would be the obvious one.

    But I would not like to defend the argument that QE reduces the burden of debt on current and future tax revenues because N% of the outstanding gilt stock will NEVER have to be redeemed. That way lies madness.

  5. Chris,

    If you have sufficient debt to make investors unwilling to hold it, and you replace that debt with additional currency issuance, it is likely that investors (domestic and international) will be equally unwilling to hold the extra currency. In which case, yes, there would be increased domestic demand which may be mopped up by increased production and/or by increased imports. But internationally, rejection of a fiat currency causes collapse of the exchange rate. I can’t see how inflation can be avoided if both domestic and international investors refuse to hold sterling, except by serious hikes in interest rates (and even that may not be enough). At present that isn’t happening, and I would be willing to bet that’s because investors are expecting the gilts to be returned to the market. If they started to believe that monetisation is not only permanent but will be continued in order to finance future deficits, as Richard suggests, they just might not be too keen on sterling any more.

    I do wish Richard would pay more attention to international effects. He always talks as if the UK is a closed economy.

  6. Frances – you’re right to say that investors now are happy to hold the extra pounds. And I agree, up to a point, that this might be partly because they expect QE to be reversed; the steep yield curve is consistent with long yields rising in future as this happens.
    But I’m not sure this is the only reason for their willingness to hold sterling, Another (bigger?) reason is simply that the weak state of the global economy makes sterling cash attractive even at low interest rates.
    Incidentally – and curiously – the Bank’s own research onto the effects of QE found no big impact upon sterling.
    That said, you could argue that a weaker pound – if it happens – would be a desirable stimulus to the economy (though as an elasticity pessimist I’d not put much weight on this)

  7. Chris,

    I’d absolutely agree that the general weakness of the global economy is a major factor in the fact that sterling is holding up. Cash generally is a popular investment at the moment and the better the record of the sovereign in managing its debts and protecting its currency, the more attractive it will be. The UK’s record on both of these is exemplary, really. Hence I agree with Richard that we don’t have a debt crisis, but not for the reasons that he gives. We don’t have a debt crisis because internationally the UK is still seen as a very safe bet. And we don’t have a currency crisis (the other possibility for a currency-issuing sovereign in hard times) for exactly the same reason. The two are the same.

    I’m not terribly surprised that the Bank’s research found no great impact on sterling. Compared to interest rate cuts, it’s chicken feed. You’d have to do an awful lot of QE to have the same effect as a one percent cut in the base rate. If there were to be a significant effect on sterling, though, I would expect to see it when the economy starts growing, not while it is deflating, so I’m not sure the Bank’s research is all that meaningful at the moment.

    I’m not wildly keen on a weaker pound either. Lower sterling might help exporters, but only if they have no need for imports of raw materials. And as the UK is a net importer, it would undoubtedly raise prices.

  8. I understand the basic logic that the UK is unlikely to face a debt crisis – we have printing press, an excellent record at paying back debt, cross party acceptance (even Callaghan!) that cuts need to be made in order to prioritise debt service, we have a large liquid debt market – but I am just astonished that Richard wants to bring the possibility of monetising QE into it.

    It may work as monetary stimulus and thus not be very inflationary, but it isn’t much relevant to the UK’s vulnerability to debt crisis. The BoE can simply interpret its mandate for stable prices to include not contributing to a debt crisis. Eventually the Bank will be able to unwind its position. So long as they don’t appoint Trichet…

  9. I think it is distinctly possible that some of the QE will never be unwound, simply because raising interest rates is a much more effective way of controlling inflation and supporting sterling. But I certainly wouldn’t be shouting that from the treetops right now. And I’ve deliberately said “some”. I think it is very important for investor confidence that the Bank of England is at some point seen to be doing reverse QE, even though it may not be strictly necessary to control inflation.

    Where I really take issue with Richard is his notion that because QE gilts can be excluded from UK debt/GDP figures, that gives us an opportunity to borrow much more. And I also object to his idea that future deficits would be QE-funded. Either of these would in my view be irresponsible financial management and we would pay the price in higher interest rates and sterling weakness.

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