Your questions on QE answered
Photo credit: liamgrue
August 19, 2013 // By: Tony Greenham
Last month, we asked nef supporters for help communicating our new report on strategic quantitative easing – using central bank-created money to kickstart the economy and invest in green infrastructure. We asked you to send us questions on the areas of our research you felt needed a simpler explanation. A huge thank you to all who responded; now over to nef’s Head of Finance and Business, Tony Greenham, to tackle the top three puzzlers.
1. Won’t more use of strategic quantitative easing (QE) cause inflation? Isn’t this a bad thing?
No. Inflation can be caused when supply cannot keep up with demand. But in some parts of the economy we have the opposite problem: excess supply, for example of unemployed workers, and not enough demand. The idea of strategic QE is to channel new finance into productive parts of the economy that have the capacity to absorb it. Take house building. Everyone agrees that we need to build more homes, and the economy has the capacity to build them. Likewise, bringing existing homes up to modern standards of energy efficiency would create many new jobs and cut carbon emissions and waste, but there is a shortage of finance for this investment. Strategic QE targets the money to the places where it will do most to increase employment and improve our infrastructure.
QE as it stands is a different matter. It takes a scattergun approach, pumping money into financial markets in the hope this will encourage more private sector investment and consumption. Our evidence suggests that the result of financing these markets is not to create jobs or new investments, but simply to inflate the price of stocks, shares, commodities, land and property higher and higher. This enriches their owners, and is the real inflationary danger – the danger of creating new asset bubbles that create no new wealth while they inflate, but do create problems in the wider economy when they burst.
2.What are the risks of strategic QE?
Strategic QE would carry the same risk as any other policy, in that there’s always a chance it could be done badly. The process of identifying truly beneficial projects and businesses to invest would take time, and skill. That’s why in our strategic QE report we suggest how to improve the governance, transparency and accountability of how the Bank of England goes about it. The likelihood of growing pains would be pretty high, and it could take time before the benefits of strategic QE – new jobs, better infrastructure, greener energy – started to kick in. Rather than seeing this as a risk, I think it’s a reason to get on with it as soon as possible to get things right.
3. What if the Bank of England (BoE) stopped using QE all together?
First off, let’s be clear that – as of November last year – the Bank of England has already stopped creating new money. Up until then it had created £375 billion to spend buying up government bonds or ‘gilts’ from financial investors.
So perhaps the question should be ‘what if the Bank started selling the gilts it currently owns back onto the financial markets?’. The prospects do not look pretty. In the USA, even the anticipation that the US central bank was going to start selling its government bonds sent the markets into turmoil. So the Bank will probably not increase the amount of QE from £375 billion, but I don’t think it will reduce it any time soon, either.
But here’s the really interesting bit. Gilts are basically I.O.U notes that the Government must pay back to the bearer at a given maturity date. So the BoE is continuously receiving money from the Government as the gilts it owns mature, which naturally reduces the total amount of QE. Each time this has happened the Bank has decided to use the money to buy more gilts to top up the balance back to £375 billion.
We calculate that around £100 billion of gilts are due to be repaid in the next five years.
What if, instead of just buying more gilts, the Bank were to buy different assets that directly boosted the real economy? That’s the essence of strategic QE. Even £20 billion each year for the next five years invested into new homes, energy efficiency and financing small and medium businesses would make a huge difference to rebalancing the UK economy, creating jobs and reducing carbon emissions. We want QE that has better economic, social and environmental impacts – and that means being strategic with it.
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