Monetary Policy RIP

So the markets were disappointed that Bernanke didn't announce Quantitative Easing (QE) round 3 for the US.

And the markets were disappointed that the Bank of England's Monetary Policy Committee (MPC) didn't announce a second round of QE for the UK.

Both Bernanke and the MPC have in effect said "monetary policy is dead in the water". Base lending rates are on the floor and neither has come up with any measures to reduce real interest rates further. Yes, Bernanke did suggest that there were some other measures the Federal Reserve could take to depress interest rates along the yield curve and so encourage investment. And neither the MPC nor the Fed have ruled out further QE at some point. But their reluctance to act suggests that they are now - belatedly - doubting the wisdom of throwing more money at the markets in the hope of stimulating demand in the real economy on either side of the Atlantic.

And about time. Business investment is low and consumer spending is on the floor.  Those businesses that have cash aren't investing it - they are hoarding it instead because of worries about lack of sales. Those businesses that don't have cash are either paying down debt or avoiding borrowing for investment, again because of worries about lack of sales (different link!).  Yes, there are of course some businesses that do want to borrow. But guess what - banks don't want to lend to them. Not because they don't have any money to lend. They do. But they would rather hang on to that money and park it safely at the central bank (which pays interest, of course) or invest it in nice safe assets such as government bonds. That's what they did with the money from the last round of QE. Which is why it didn't work.

As I've pointed out in a previous blogpost, QE only works as a domestic demand stimulus if banks are lending to businesses and individuals. But they aren't.  It is therefore completely pointless.

Unfortunately those who work in financial markets can't tell the difference between the bubble they live in and the real economy. If there's more money around and bond yields are down, QE must be working, yes? No. QE does affect investor behaviour: it floods the market with cash and reduces the supply of safe long-dated securities, which is supposed to push investors towards investing in riskier assets such as equities. Trouble is, what they are actually doing is hoarding cash in insured deposit accounts and safe haven currencies. So arguably QE didn't work even for the markets. All it did was create loads of cash that is now sloshing around the world desperately seeking a refuge.  Heaven alone knows why they want more. They can't find enough hiding places for the cash they've already got.

Monetary policy has nothing more to contribute. The only solution to the economic decline on both sides of the Atlantic lies in the fiscal realm. It is time that the politicians stepped up and accepted their responsibility for getting us out of this mess.


  1. I only understand one word in ten. But I get your drift. Money is a means with which to exchange goods and services. If it can't be used in that way, we will have to resort to bartering.

  2. I agree (almost) entirely. QE is effective at 1) injecting liquidity during market panic and 2) signalling that central banks are determined to avoid deflation

    What it is not effective at is stimulating growth in the current circumstances. Monetary policy relies on banks to transmit it. In "fair weather" conditions banks will prefer to lend (and thus make money) rather than park new liquidity in reserves. But because banks are afraid of sovereign defaults, further credit losses and the impact of new regulation and lawsuits they are inclined to hoard cash.

    The result of QE in the UK has been a more than tripling of bank reserves (see for source). Broad money growth has fallen from 4% before QE to about 2% now (see for graph).

    So why George Osborne seems to be dropping heavy hints that he would like to see more QE is beyond me.

    All that said, I'm not sure fiscal stimulus is necessarily the way out. Banks and companies (who need to invest and hire to return the economy to growth) are being paralysed by uncertainty. The politicians' first job is to sort out the European sovereign debt mess (and dare I say it the American one as well) and to give companies reason to invest (tax credits? public infrastructure investment?).

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