Quantitative Easing - universal panacea or addictive painkiller?

By Adam Lloyd

In November the Bank of England (BoE) announced a further £150 billion of Quantitative Easing as part of the wider economic response to the pandemic, taking the total amount of QE since the financial crisis to a whopping £895 billion. That is the amount of freshly printed money that has been specifically created by the BoE to purchase UK government bonds from the banks since 2009. In theory the UK government has to repay that money to the BoE when those bonds fall due, a seldom referred to process known as Quantitative Tightening (QT) wherein the government issues new bonds to the banks to raise the funds necessary to pay the debt. QE injects money into the banks and QT takes the money back. Whether QT actually happens remains to be seen and only time will tell.

Printing money is not a new policy tool. Roll back the clocks to 1544 and the Great Debasement, when Henry VIII ordered the amount of precious metal in gold and silver coins be reduced or replaced entirely with cheaper metals like copper. Henry needed more money for the wars and his notoriously lavish lifestyle. By devaluing the coin of the realm Henry was able to generate more money for the Crown by minting more coins without having to use more gold or silver to make them. 

Time and time again history has shown that printing more money does not increase economic output it only increases the amount of money in the economy. With more money in circulation people want to buy more things and the expectation of the hopeful policy makers is that the increase in demand will lead to more production and more economic output. Unfortunately, it takes time to increase output but only a moment to push up prices and inflation has always been one of the unpleasant side effects of increasing the money supply in this way.

As a policy tool to prevent all the banks from going bust after the 2008 financial crisis QE certainly did its job but it has now been adopted by central banks and governments around the world as their best and possibly only defence against recession. In the Bank of England’s own words “Quantitative easing is a tool that central banks, like us, can use to inject money directly into the economy.” As bankers they inevitably look at the economy through that prism and regard other banks as their main agent for economic and monetary policy. In QE they have this beautifully simple tool that keeps the other banks nicely liquid regardless of how well they are being run and everyone is happy because printing new money is really easy. Governments love it too because, as the freshly minted cash pours into the bond markets, it drives up bond prices pushing down the interest rates on those bonds and therefore reducing the cost of government borrowing. Who needs complex economic policy solutions that are hard to explain when you have the economic silver bullet?

The assertion by the BoE that giving lots of new money to the banks is good for the economy has not been borne out by the facts. Banks are notoriously bad at lending to those that need money the most. Their track record of bank lending to non-financial businesses since the financial crisis is not a good one despite all that QE bail out money. Rather than adopt lending policies that help out small businesses and individuals the banks have stuck to their traditional role of lending to those that need it least. The upshot has been an increasing concentration of wealth that is evident in the soaring bond and equity markets and record valuations for the more esoteric asset classes such as fine art, classic cars and other luxury goods that are the preserve of the wealthy. The BoE’s own data suggests that the richest 10% of UK households have seen their wealth increase by more than £350,000 since the start of QE in 2009 while the rest of society has not kept pace. QE has become the drug of choice for central banks and economic policy makers.  It makes them feel good because it keeps interest rates low and financial markets booming. They feel vindicated by the initial success of the policy back in 2009 and because they are all doing it - the US Federal Reserve Bank and the European Central Bank both have significant QE programmes of their own - they think that it’s fine.

So what if the rich have to pay more for their cars and holiday homes I here you say. If that were the only consequence it wouldn’t be so bad but the low interest rates and asset inflation caused by QE have serious repercussions for the rest of us.  Not only that, having got accustomed to the flow of new money how will the world’s financial markets behave if and when it stops? Given the unprecedented strength of the bond and equity markets under the influence of QE what will a bear market be like without QE or even worse with QT?

Cheap borrowing has been great for property prices -a perfect example of the inflationary effects of printing money. The over 45s in the UK own more than 80% of the financial assets (mainly property) that have been inflated by this injection of cheap debt but first time buyers have not been beneficiaries. Those higher prices have not fed through to greater output so that first rung of the property ladder keeps going up while average incomes have not kept pace. Perversely, those low borrowing rates have not filtered down to the cost of consumer debt. The interest rates on credit cards and overdraughts are higher today than ten years ago with the banks taking advantage of QE and low interest rates to increase their profitability with no apparent incentive to pass on their reduced costs to consumers.

For all our savings, be they deposit accounts or our pensions, the effects of low interest rates have been devastating. Deposit rates these days are almost zero and annuity rates for pensioners are so low that many don’t have the income they planned and saved for. In many cases pension funds are running such huge deficits the UK’s largest companies are often dwarfed by the size of their pension liabilities.

QE did its job ten years ago when it definitely stopped the banks going bust. The attraction to policy makers of a single simple tool is alluring but like painkillers it should only be a short term remedy. At its worst, QE risks driving a wedge into society, pitting rich against poor and young against old. Maybe QE is here to stay and QT never happens with the BoE just allowing those government bonds to lapse. If that is the case the financial markets will breath more easily but we will need to see meaningful policies from government to address the worst side effects of QE.