There will be speculation about this for the rest of the year and beyond.

Back in the old days before 2007, the Bank had one focus for the ending of any period of monetary ease.  This was: signs that the real economy was overheating.   Back then, overheating meant “trying to buy more than it could produce or get overseas without triggering higher future inflation” – more or less.  It did NOT mean escalating house prices or soaring shares.  Unlike in the 1960s or 1970 – or during our period in the ERM – it did not mean attracting enough capital to keep the exchange rate strong.    While the Bank possessed hundreds of ways of viewing upcoming constraints in the real economy, its ultimate target was undivided.

Andrew Sentance’s interview with the Guardian felt like a blast from the past. He talked of inflation returning, robust consumer spending, and ‘global influences such as oil and commodity prices and the impact of the exchange rate which can lead to speed limits for the rate of growth’.  This might have been summer 2008, when the same influences may have started to slow the UK economy before the autumn financial crisis.

But after the crisis there are other limits to the continuation of QE.   The most prominent is fears of a new asset bubble.  On the MPC Spencer Dale is the most prominent hawk from this point of view, although Charles Goodhart (ex-MPC) has taken a similar view, and of course Roubini.   Significant monetary thinkers now call for rates to ‘lean against the wind’. There is therefore a risk that an asset-bubble will be the reason to end the policy early, before the real economy gets back on its legs.   The worst of both worlds?

A final constraint may stem from pressure exerted by the savers lobby.  Monetary policy is meant to work by making it more profitable to spend, and therefore less profitable to save.  This unambiguously makes savers worse off, particularly if they have no link to the productive economy any more.  So Nigel Masters in the FT calls for the Bank to ‘lift rates and think about the savers’.   He makes a fair point that

with the growth of the post retirement population, [the balance between borrowers and savers] is changing. In the UK alone, deposits of individuals are £900bn. A 1 per cent increase in returns on these monies would increase income by £9bn, much of which should be disposable income

If rates rose, it might cut away at banks’ margins, rather than affect borrowing terms – since the latter have largely failed to respond to QE and rate movements below 2% anyway.   This may not, however, be a welcome consequence: we need the banks to rebuild equity (even though they cave in to their staff, annoying the shareholders).

Still worse could be the effect on the currency.  Imagine if the UK raised rates to 3%, and the US remained ‘easy’.   The pound might return to $1.80, or a euro of 75 pence.  The long waited for export boost may never come. It is possible that a source of inflation -overseas items – would lessen, encouraging less consumption now.  Self-fulfilling deflation – Japan without the strong exports?

Also, as Jeremy Warner points out, imagine what would happen if Mortgage rates DID rise by 2-3%.

the Bank of England calculates that such is the extent of the debt overhang that a rise back to 4.5pc would impose the same crushing debt-servicing costs on the economy as ruled during the recession of the early 1990s, when interest rates were in double digits.  Any such regime would pole axe demand.

He thinks they will rise soon, but for reasons given above not by very much.  Whereas BNP Paribas thinks not till 2011.  This one really divides the experts.

Nigel Masters may have identified, in retirees, a group with growing political power.  But their exercise of that power might do a whole lot of harm to the economy.  The trouble is, with one party seeing savers as ‘innocent victims’, there is a real risk their voice may have a damaging effect on policy in the near future.  In fact, since financial decisions are forward facing (see Scott Sumner’s blog), anticipation of this might already have an effect on conditions.


4 thoughts on “The end of monetary easing?

  1. Who is borrowing? Who is lending? What were the M4 (lending) figures last month?
    If you want to see inflation you will kid yourself you are seeing inflation. You will kid yourself that the January sales’ queues are evidence of that inflation must be round the corner; that rising costs must lead to inflation. But where’s the demand, where’s the confidence for firms to invest, where’s the confidence for banks to lend to firms whose revenues are falling? Deleveraging continues. Demand is weak. Deflation remains the foe.
    QE was a central bankers’ solution. A reserves before lending solution.
    Still feels like January 2009 to me. The first lost year, then.
    Either we continue to sink towards a new equilibrium of lower activity or we engage is some real economic stimulus.
    Capital P Politics and small p politics do not bode well in preventing 2010 being lost too.

    1. I agree with 90% of what you say there. Though I would point out that most of the fall in activity had happened by March: some diddling around with lower investment in the N Sea in the late summer prolonged the formal recession. But your last sentence is a great summary of my concerns.

  2. Interesting snap of the battle line for Britain:

    Tory positioning –
    Vince and Labour position:

    June is a fork in the road (to mix metaphors). It’ll be a time to be counted.
    As important in determining the character of our future as ’06, ’45 and ’79

    I regret that the distinctions will be between two ‘Why we can’t’ options with no one energizing us all with ‘Yes, We Can’.

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