Quantitative easing, the policy tool deployed across the Group of Seven to stimulate economies through the financial crisis and pandemic, is rapidly falling out of favor in Britain.
(Bloomberg) — Quantitative easing, the policy tool deployed across the Group of Seven to stimulate economies through the financial crisis and pandemic, is rapidly falling out of favor in Britain.
From politicians to economists and a former Bank of England governor, many are cooling rapidly on the merits of the tool as its cost to taxpayers and side effects become apparent. The result is likely to make it more difficult for the UK central bank to pull the QE lever in the same way again if the economy sours.
What’s changed is that the BOE’s QE program, now that it’s winding down rapidly, has absorbed blame for stoking the worst bout of inflation in four decades, deepening inequality and forcing the Treasury to fund the scheme’s losses at a time when the public finances are strained.
Economists are calling for the tool to be dramatically reined in for future crises and question what role it stands to play in a world of higher inflation. Their thoughts underscore the end of an era of cheap money and a return of more normal central bank tools to manage the economy, namely interest rates.
“Quantitative easing played a very successful role in stopping panics where people were turning to cash,” Charles Goodhart, a former BOE rate-setter, said. “What it wasn’t ever really was a useful tool for dealing with low inflation, and since we’re not going to have low inflation, it’s not going to be used for that ever again. But it could still be used for panics and people rushing into cash.”
The BOE this week begins a second year of sales from the QE program, a process dubbed quantitative tightening. The bank built up its Asset Purchase Facility to a peak of £895 billion in 2021. It will divest about £100 billion of assets through sales and allowing debt to mature from this month, up from £80 billion in the last period. The total APF stood at £757 billion last week.
Central banks adopted QE as an experimental tool to give markets and the economy a boost once they cut interest rates to near zero, buying bonds to push down long-term interest rates in financial markets.
The Bank of Japan was first to use it in 2001. The US Federal Reserve joined during the global financial crisis in 2008, the BOE followed in 2009 and the European Central Bank started in 2015.
The BOE, ECB and Fed are now unwinding their QE purchases, but the UK central bank is being the most aggressive in reversing the process.
There’s also been criticism of bond-buying programs elsewhere, notably in Germany where there is skepticism over the ECB’s purchases.
In the US, Republican lawmakers have periodically proposed legislation to restrict the Fed’s bond-buying activities over the past decade. Florida Senator Rick Scott introduced a bill in July that would cap the size of the central bank’s balance sheet at 10% of US gross domestic product.
Still, Fed officials have faced little opposition to asset purchases and haven’t given any indication that they are unlikely to return to such tools in the future as warranted. It’s Britain that’s had sharpest recent domestic backlash against QE.
Former BOE Governor Mervyn King and Conservative members of Parliaments blame the BOE for stoking double-digit inflation through excessive QE purchases that only finished in late 2021.
Many economists now oppose keeping central bank balance sheets inflated for such long periods and argue against QE’s use outside of times of extreme market stress, instead backing it as more of a tool for financial stability. There may also be less need for QE if permanently higher inflation reduces the risk that the BOE will run out of firepower from interest rate cuts.
“The risks of the tool are using it during a normal business cycle,” said Tomasz Wieladek, chief European economist at T. Rowe Price and an ex BOE economist. “It is much more powerful in certain situations when the market is disrupted.
“The big mistake with QE was that balance sheets stayed so large for such a long time. Central bankers adopted this view that r*, or the neutral interest rate, has fallen so low that this fiscal transfers issue is not going to be an issue in the future, and that turned out to be obviously completely wrong.”
Jagjit Chadha, director of the National Institute of Economic and Social Research, said there may be a case for using QE to intervene in times of market disruption but the BOE should not be “holding those bonds for a very long period.”
“As soon as the market is able to absorb those bonds, you should sell them back”, Chadha said. “If you do it that way, what you’re actually going to do is make some money because you’re going to be buying the bonds when they’re artificially low in price and selling them back when they’ve gone higher.”
Former Reserve Bank of India Governor Raghuram Rajan also previously urged for the tool to put back on the shelf until policymakers can study the risks better. “I do not think the benefits outweigh the costs,” he warned in June.
Almost 15 years after the first QE salvo from the BOE, its impact is still hotly contested.
The BOE rebuffs the criticisms and claims that QT has had little upward impact on borrowing costs. In April, Deputy Governor Ben Broadbent pushed back against monetarists, saying that their claims that rapid growth in the money supply led to excessive inflation are “not well supported by the evidence.” He pointed to periods where broad money grew rapidly but inflation was close to the BOE’s 2% target.
Later in July, Deputy Governor Dave Ramsden defended QT, arguing that it is having “a very slight impact on the economy” and providing only a small lift on gilt yields. He said reducing the balance sheet will boost the headroom the BOE has if it needs to use the stimulus again.
Even so, the BOE has signaled it’s ready to make interventions in markets on a big scale if needed. A year ago, it stepped in with billions of liquidity during a crisis, and last week it said officials are working on a tool to help pension funds and insurers in times of strain.
The debate over QE may soon rise up the agenda as recession warning lights begin to flash red.
The BOE has guided markets to expect rates to remain their current high level of 5.25% for a prolonged period but some economists believe it would have to respond to a downturn.
After such an aggressive tightening cycle, the BOE could cut its key rate 5 percentage points to fight a recession. If it used up that firepower, only then would it have to confront Britain’s growing skepticism over the QE tool.
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