LONDON (Project Syndicate) – Amidst all the talk about when and how to end or reverse quantitative easing (QE), one question is hardly ever addressed: why the massive doses of bond purchases by banks plants in Europe and the United States since 2009 have so little effect on the general price level?
Between 2009 and 2019, the Bank of England injected £ 425 billion ($ 588 billion), or about 22.5% of the UK’s gross domestic product in 2012, into the UK economy. This was aimed at pushing inflation up to the BOE’s medium-term target of 2%, down from just 1.1% in 2009. But after 10 years of quantitative easing, inflation was below its level. of 2009, despite the fact that real estate and equities market prices were booming and GDP growth had not returned to its pre-crisis trend pace.
“The reason that QE had virtually no effect on the general price level may be that much of the new money fueled asset speculation, thus creating financial bubbles, while prices and production as a whole remained stable.“
Since the start of the COVID-19 pandemic in March 2020, the BOE has purchased an additional £ 450bn of UK government bonds, bringing the total to £ 875bn, or 40% of current GDP. The effects on inflation and output of this second round of QE are not yet felt, but asset prices have risen sharply again.
Little impact on the real economy
A plausible generalization is that increasing the quantity of money through QE gives a temporary strong boost to house and financial security prices, thus greatly benefiting the holders of these assets. A small proportion of this increased wealth spills over into the real economy, but most of it simply flows through the financial system.
The standard Keynesian argument, derived from that of John Maynard Keynes General theory, is that any economic collapse, whatever the cause, results in a sharp increase in hoarding. Money flows into reserves and savings increase, while spending decreases. This is why Keynes argued that economic recovery after a collapse should be driven by fiscal policy rather than monetary policy. The government must be the “last resort” to ensure that the new money is used for production rather than being accumulated.
But in his Money treatyKeynes provided a more realistic account based on “speculative demand for money.” During a severe economic recession, he argued, money is not necessarily hoarded, but passes from “industrial” circulation to “financial” circulation. Money in industrial circulation supports normal production processes, but in financial circulation it is used for “the business of holding and trading existing securities for wealth, including the SPX stock exchange,
and the money market TMUBMUSD01M,
transactions. “A depression is marked by a transfer of money from industrial to financial circulation – from investment to speculation
So the reason why QE had virtually no effect on the general price level may be that much of the new money fueled asset speculation, thus creating financial bubbles, while the prices and production as a whole remained stable.
State-created financial instability
One implication of this is that QE generates its own boom and bust cycles. Unlike orthodox Keynesians, who believed that crises were caused by an external shock, economist Hyman Minsky believed that the economic system could generate shocks through its own internal dynamics.
“The increase in the quantity of money via QE gives a temporary strong boost to the prices of houses and financial securities, thus greatly benefiting the holders of these assets. A small proportion of this increased wealth spills over into the real economy, but most of it simply flows through the financial system.“
Bank lending, according to Minsky, goes through three degenerative stages, which he dubbed hedging, speculation, and Ponzi. As a first step, the borrower’s income must be sufficient to repay both the principal and the interest on a loan. Then it must be high enough to cover only the interest payments. And in the final stage, finance simply becomes a bet that asset prices will rise enough to cover loans. When the inevitable reversal in asset prices produces a crash, the increase in paper wealth vanishes, dragging the real economy in its wake.
Minsky would thus regard QE as an example of state-created financial instability. Today there are already clear signs of excess in the mortgage market. UK house prices rose 10.2% through March 2021, the highest growth rate since August 2007, while indices of overvaluation in the US housing market “flash bright red”.
And an econometric study (unpublished to date) by Sandhya Krishnan of the Desai Academy of Economics in Mumbai shows no relationship between asset prices and property prices in the UK and US between 2000 and 2016.
A drug that cures the disease it causes
It is therefore not surprising that in its forecast for February 2021, the BOE’s Monetary Policy Committee estimated that there was a third chance that UK inflation would fall below 0% or exceed 4%. over the next few years. This relatively wide range partly reflects uncertainty about the future course of the pandemic, but also more fundamental uncertainty about the effects of QE itself.
In Margaret Atwood’s futuristic novel in 2003 Oryx and Crake, HelthWyzer, a drug development center that makes premium brand vitamin pills, inserts a random virus into its pills, in hopes of profiting from the sale of the pills and the antidote it has developed for it. virus. The best type of disease “from a commercial standpoint,” explains Crake, a mad scientist, “would be those that cause persistent disease. […] the patient would heal or die just before all his money was used up. It is a good calculation.
With QE, we have invented a wonder drug that cures the macroeconomic diseases it causes. This is why the questions about when to withdraw it are such a “good math”.
But the antidote is staring us in the face.
First, governments must abandon the fiction that central banks create money independently of government. Second, they must themselves spend the money created at their request. For example, governments should not accumulate leave funds that should be withdrawn as economic activity picks up, but rather use them to create jobs in the public sector.
This will lead to a recovery without creating financial instability. This is the only way to wean us from our ten year addiction to QE.
Robert Skidelsky, member of the British House of Lords, is professor emeritus of political economy at the University of Warwick. The author of a three-volume biography of John Maynard Keynes, he began his political career in the Labor Party, became the Conservative Party’s spokesperson for Treasury Affairs in the House of Lords, and was eventually expelled from the Conservative Party for his opposition to NATO intervention in Kosovo in 1999.
This comment was posted with permission from Project Syndicate — Where Did All the Money Go?
Other views on QE and inflation:
Andrés Velasco: Another reason to slow down: Fed should stop buying assets because QE is bad fiscal policy
Nouriel Roubini: Fed will surely weaken and let stagflation take root in economy, warns Roubini
Marc Hulbert: Why inflation isn’t higher even though money is flooding the economy