When people talk about inflation and QE, the variety of responses range across a number of dimensions. It’s not just inflation, although at some point in the stereotypical Spectator discussion, some fool always mentions Wheelbarrows, and Weimar. (Try to avoid being stuck next to him in a saloon bar). But in that discussion Mark Bathgate makes a good-ish point:
QE has lowered government borrowing costs, this year. By 75bps, which might come down to £10-12bn or so – a lot of money. Not by 200bps, whatever some investment manager says. And so it may get more expensive to borrow when QE ends – and more likely when it is reversed.
So what is QE then? Well, since losses by the APF (the Asset Purchase Facility, which actually holds these bonds) are indemnified by the government, it is a future government that pays for that £10bn. In other words, it is fiscal policy. It allows lower fiscal constraints today in return for higher fiscal costs tomorrow. £10bn possibly being lent by a future government to a present one. Let’s be honest – it may be a Labour government borrowing off a Conservative one.
But this transfer is only likely if there is inflation, because without inflation, there will not be losses on the gilt portfolio for a future Tory administration to pay for. If there is no extra inflation, there will be profits, because the Bank borrows at 0.5%, and lends at 4%. Currently, the Bank is making rich returns. No fiscal problem there – just profit from the deflation and panic.
What if there is inflation, like the Spectator chaps seem to so earnestly hope for (and John Redwood, see posts passim)? Well, the APF loses money, perhaps a lot. Up to £50bn on the current portfolio, I reckon, if we get 6% inflation rapidly (though that is really unlikely). Does this make our fiscal burden even worse?
Um, not really. Remember how our revenues collapsed over 2008-9 (link to award winning publication)? This was because it was (a) a recession and (b) a nominal GDP recession. High inflation and growth wipes away debts, inflates revenues – and makes the government far better equipped to raise the funds to pay a bill like £50bn. So, in an important way, QE is a useful fiscal hedge. If it works and we get booming NGDP growth, the Bank loses, the Government gains, and the Government pays the Bank. If not, vice versa; the profits from the gilt purchases may help make deflation bearable.
I do not normally read all of Edmund Conway’s stuff, but his discussion of the inflation and QE issues is top notch. Unlike some rightwing blowhards, he seems to understand (like Chris) that QE does not lead to inflation without some intervening stage of higher output. People do not read that the Bank has swapped some money for gilts and then just go out and mark their prices up; they wait for some customers. So first output rises, then prices and output – that at least is my hope.
Conway also explains how high inflation does not produce the same trade off for the UK Gov as it did in the 1970s – a point I made in A Balancing Act when calling for more index-linked debt.
I don’t understand his views about “getting on with fiscal consolidation asap”. Wait until the private sector can take the strain, or you just do a Japan (see Koo post), is my view. But the article discussing government tradeoffs is good thoughtful stuff. It identifies that high inflation can only really happen if the government wills it. Hyperinflation is a fiscal phenomenon. At the least, monetary and fiscal easing can shock a depressed economy out of low expectations – a point that Eggertsson makes in his discussion of the Great Depression.
On that subject, we are still a long way from the level of debate about inflation you find in the US. If you have time, enjoy the discussion between Scott Sumner and Kling, and then Kling’s answer. Both are right wing, hating fiscal stimulus, but Sumner is convinced that the Fed can order high NGDP growth, and Kling is not. It is about the demand and supply of money in their world – as Simon Ward, UK’s answer to them, attests.
I am closer to Eggertsson, and Conway. Inflation can only really be made to happen if the government wills it, the people believe the government wills it and the economy gets near its output limits. Unlike the Speccie crowd, I could imagine deflation coming next year, and the government having to consider it as a policy. It has its costs, as Conway points out. But so does a decade of stagnation and high debts. There aren’t easy choices.