Bank of England QE is coming under increasing fire as inflation rises

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by Shaun Richards

This has been a bad week for central bankers as we have seen inflation soar above their predictions. The 5.4% for US CPI is not what the Federal Reserve explicitly targets but suggests a trend well above its thinking and that is before we get to the issue of the “transitory” or it you prefer “temporary” claims they have made. If you look at the statement to Congress of Chair Powell this week he shifted to expectations on inflation in response to this.

To avoid sustained periods of unusually low or high inflation, the Federal Open MarketCommittee’s (FOMC) monetary policy framework seeks longer-term inflation expectations thatare well anchored at 2 percent, the Committee’s longer-run inflation objective.

After all he can claim pretty much what he wants via them as opposed to workers and consumers paying higher prices who have no such choice. Also we had the UK with the targeted inflation measure going to 2.5% so 0.5% over and RPI at 3.9%. That is really rather awkward in a week where you have bought some £3.45 billion of UK bonds as part of a policy ( QE) to raise inflation.

House of Lords

They have published a report today which questions QE on a strategic level. One issue is how much of it is planned.

Since March 2020, the Bank of England has doubled the size of the quantitative easing programme. Between March and November 2020, the Bank of England announced it would buy £450 billion of Government bonds and £10 billion in non-financial investment-grade corporate bonds. In total, by the end of 2021, the Bank will own £875 billion of Government bonds and £20 billion in corporate bonds. This is equivalent to around 40% of UK GDP.

Those who have followed my “More! More! More!” theme which has been running for a decade will have a wry smile at this.

Therefore, the scale and persistence of the quantitative easing programme are substantially larger than the Bank envisaged in 2009.

It has also become the policy of first resort.

Once considered unconventional, more than a decade after its introduction, quantitative easing is now the Bank of England’s main tool for responding to a range of economic
problems.

Yet have things got better?

These problems are quite different from those of 2009.

The House of Lords does not explicitly say it at this point but let me point out that it has created problems along the way as the Cranberries told us.

In your head, in your head
Zombie, zombie, zombie-ie-ie

Inflation

Their Lordships have spotted the 2021 issue.

Despite a growing economy and expansionary monetary and fiscal policy, central banks in advanced economies appear to see the risks of inflation in terms of a transitory, rather than a more long-lasting, problem.

A fair point as after all whilst the flow may stop ( presently planned to be towards the end of 2021) the stock of £895 billion including corporate bonds will remain on the books. After all, so far, the Bank of England has not redeemed a single penny. So in monetary terms there will remain an extra £895 billion in the money supply although care is needed because what follows from it is not as simple as what was thought. especially by the Bank of England itself.

Quantitative easing’s precise effect on inflation is unclear.

It has been made less clear in my view by the establishment effort to remove ways measuring this by downgrading the RPI which is a pretty transparent effort to move the focus away from the house prices it includes. Can anybody think why?

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Since they finalised their thinking the statement below has been reinforced by inflation going over its target as well.

The official inflation rate is already higher than
the Bank of England’s previous forecasts.

These factors add to the challenges here.

The Bank of England forecasts that any rise in inflation will be “transitory”; others disagree.

They then pose a challenge whilst also issuing a critique. After all it should have made its thinking clear.

We call upon the Bank of England to set out in more detail why it believes higher inflation will be a short-term phenomenon, and why continuing with asset purchases is the right course of action.

This leads to the crux of the matter because as I have frequently pointed out monetary policy takes around 18 months to 2 years to have its full impact. That may even have lengthened in the modern era due to the increased numbers of fixed-rate mortgages which is considered a major transmission mechanism. Yet we have central bankers who ignore that and at times claim that they can act during or even after the event which to mt mind requires the ability to time-travel.

The Bank should clarify what it means by “transitory” inflation, share its analyses, and demonstrate that it has a plan to keep inflation in check.

Interest-Rates

Their Lordships seem to have stumbled on my point that we will not see many if any interest-rate increases because of the cost of them.

Quantitative easing hastens the increase in the cost of Government debt because interest on Government bonds purchased under quantitative easing is paid at Bank Rate, which could be much higher than it is now (0.1%) if the Bank of England had to increase Bank Rate to control inflation. As a result, we are concerned that if inflation continues to rise, the Bank may come under political
pressure not to take the necessary action to maintain price stability.

That is of course assuming they do not follow the path trod by the ECB and simply change the rules of the game.

These included an option to not pay interest on commercial bank reserves.

This bit made me laugh and I hope it is humour.

While the UK can be proud of the economic credibility of the Bank of England, this credibility rests on the strength of the Bank’s reputation for operational independence from political decision-making in the pursuit of price stability.
This reputation is fragile, and it will be difficult to regain if lost.

Like so many central banks they lost it years ago.

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Michael Saunders

We can now switch to the tactical rather than the strategic and yesterday one of the policy-makers said this.

In my view, if activity and inflation indicators remain in line with recent trends and downside risks to growth and inflation do not rise significantly (and these conditions are important), then it may become appropriate fairly soon to withdraw some of the current monetary stimulus in order to return inflation to the 2% target on a sustained basis. In this case, options might include curtailing the current asset purchase program – ending it in the next month or two and before the full £150bn has been purchased – and/or further monetary policy action next year.

So there may be several votes for ending the QE programme early. Not enough to win a vote but increasing.

Oh and his confession that they had for their forecasts wrong (most of you are no doubt thinking again) is rather devastating for their “transitory” claims.

Comment

If we switch to the benefits we seem to get ever more of something that has unclear results.

We found that the available evidence shows that quantitative easing has had a limited impact on
growth and aggregate demand over the last decade.

They do not point out the moral hazard of the evidence often coming from those operating the policy. There are also losses and problems.

Furthermore, the policy has also had the effect of inflating asset prices artificially, and this has benefited those who own them disproportionately, exacerbating
wealth inequalities.

I am glad they are making this point as I believe they did note my points about house price rises when I gave evidence to the RPI enquiry. Actually even the Financial Times may be forced into a rethink as it is its economics editor Chris Giles who led the charge to remove house prices from the RPI.

Finally it is hard not to have a wry smile at Lord King of Lothbury criticising a policy he started.

“I wonder if I’ve been changed in the night. Let me think. Was I the same when I got up this morning? I almost think I can remember feeling a little different. But if I’m not the same, the next question is ‘Who in the world am I?’ Ah, that’s the great puzzle!” ( Alice In Wonderland )

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