Everyone is talking about exit strategies, but what should be exited and when? No consensus from economic wiseguys, just a recognition that this issue is utterly critical.
Fathom Consulting have a direct go at Conservative economic policy.
“While we agree that the UK’s fiscal position is dreadful, Opposition plans to begin fiscal tightening next year could spell disaster. We are calling for an overhaul of the Bank’s QE programme to make it start delivering for the real economy: for all firms, not just the biggest; and to provide a cushion for cash-strapped households.”
This reminds me of Slash and Grow, and the conclusions on QE are similar to those I would make: focus QE better on the real economy, do less of it, don’t dismiss fiscal policy but use QE to support it.
Hamish Mcrae’s answer is to start thinking about exiting BOTH fiscal and monetary support, and by 2010.
What is clear is that QE has to end soon. Once growth is re-established, there can be no justification for continuing it. . . . Behind all this is a bigger question. It is to what extent is the present recovery – first, in financial markets and, now, in the real economy – an artificial creation of exceptional policies? It is a fiscal issue – how far, for example, was the American growth the result of the US government’s boost? And it is a monetary issue – how far have house prices here recovered merely on the back of QE? So when these policies are withdrawn, and I have seen no suggestions they can continue beyond 2010, will there be self-sustaining growth?
But Roger Bootle says More QE, and it’s good for us.
As far as things over which we have control are concerned, all we have is QE. It is without doubt a dangerous policy. The far bigger danger, though, would be to do nothing, allowing the recession to continue and the economy to sink into deflation.
Whereas Wolfgang Munchau says we must NOT be too late in preparing the Big Exit from . . . QE. But in the meanwhile, fiscal policy is the more effective.
Some recent economic research** has shown that stimulus programmes are particularly effective when interest rates are very low. It is no surprise therefore that even fiscal conservatives, like the Germans, are now borrowing as if there is no tomorrow. As the world economy heads into a still uncertain recovery, this is not the time to apply the fiscal brakes. But it is perhaps time for a moderate monetary tightening.
So QE is helpful because it helps fiscal policy. But is it risky? Roger Bootle thought not: it can be easily reversed. Richard Koo in his excellent book pointed out the hugely inflationary risks of the policy, while finding it utterly inert in the case of Japan when there are no willing borrowers.
Personally, I doubt the inflation risks while the output gap is so large. But the risk of asset bubbles – you know, those things that got us into all this mess – is bigger. Unsurprisingly, Nouriel Roubini is the most worried of all.
the perceived riskiness of individual asset classes is declining as volatility is diminished due to the Fed’s policy of buying everything in sight – . . . So the combined effect of the Fed policy of a zero Fed funds rate, quantitative easing and massive purchase of long-term debt instruments is seemingly making the world safe – for now – for the mother of all carry trades and mother of all highly leveraged global asset bubbles . . . the longer and bigger the carry trades and the larger the asset bubble, the bigger will be the ensuing asset bubble crash. The Fed and other policymakers seem unaware of the monster bubble they are creating. The longer they remain blind, the harder the markets will fall.
What is my verdict on all this? 1. I think QE really is riskier than Mervyn King lets on 2. I think fiscal policy has unusual traction for the next year or two whereas QE itself is potentially intert on demand, at least directly 3. I think QE has economic effects but they are little understood, and the mechanism of causing an asset bubble to boost demand is not a very good one 4. Now that it has happened, unwinding it quickly might provoke a huge crisis and 5. it might have been better doing less QE but using it for more direct demand-changing operations. Like funding a National Investment Corporation, perhaps?
A letter to the FT summarises point 2 very well. Well said, Andrew Kilminster:
The events of the last year have amply confirmed Mr Bernanke’s insight that it is possible to have a situation where there can be a great deal of money in the economy but hardly any credit available.
David Heigham (see comments on last post) has done me a big favour by alerting the blog to the existence of the Levy Centre. Like Richard Koo, the authors of a recent piece of research believe that you can’t ignore the debt-situation (i.e. balance sheets) of households and non-financial businesses.
While Washington’s focus is on the staggering government debt and unsustainable fiscal deficits, the real concern should be the debt level of the private domestic sector. It is important to recognize that government debt is low relative to the size of the U.S. economy, and deleveraging in the private sector cannot happen without an expansion of the government deficit. Otherwise, there is risk of a full-blown debt-deflation process.