Yesterday the UK Bank and government announced a substantial addition to its quantitative easing (QE) programme, to extend it well into the autumn, as we expected. This had a perverse consequence. After several weeks of successfully talking up the green shoots in the economy, the Bank felt the need to dampen spirits by stressing how bad things still are. It needed to do this to justify the extraordinary action it is taking.
The UK QE programme has always been shrouded in some mystery or uncertainty. The Bank at first said it would lead to more bank lending. Then it said it would expand the money supply. So far it has not led to a proportionate increase in bank lending. If it has boosted the money supply, it has only done so against the background of arresting its fall.
It is possible one of the main aims of the programme was to stop interest rates going up and to allow the government to carry on borrowing large sums at low rates. It has not even succeeded in achieving this, as rates of interest on government debt have risen in recent months despite the massive official purchases. They may, of course, have risen further and faster without this intervention.
The idea of QE came from conventional monetarists. To them the aim was always to expand the money supply. They argue that so far it has enjoyed limited success, owing to the depth of the problem they are tackling. They favour doing more to expand money further. They accept that this may create asset price inflation. So far QE on both sides of the Atlantic has been good for holders of shares and commodities as speculative money and savings have flowed into riskier assets.
The government, following this policy, could strengthen its case by announcing formal money supply targets, so markets could know what they are trying to achieve, and would have greater certainty over judging how much more quantitative easing there might be and when the programme might end. At the moment we have the unhealthy position that markets are unsure of the purposes of the policy and therefore of its ultimate extent. Markets do know that the prices of government bonds are now artificial in the sense that at some point the main buyer, the government, has to withdraw from the market.
Yesterday it would have helped to have more answers from the authorities. How are they judging the programme and when will we know it has been successful? How do they work out the right amounts to inject? How long does it take for the full effects of this policy to be felt? Why doesn’t the Bank announce a formal target for money growth to be achieved under this programme? Does the Bank have any kind of interest rate target in its mind when it looks at the state of the bond markets?
The announcement came as a shock yesterday to many market participants and media commentators, who had bought into the recovery and green shoots story. To be told by the Bank that the recession was worse than expected hit their confidence. To see the authorities judging they needed to do more led to different stories being written.
Part of the art of getting us out of this long and deep recession is creating the right atmosphere. Confidence is a precious flower that needs nurturing. The authorities need to lead markets confidently, without changing the script more than they have to. The truth is that lower interest rates do work, and it always takes around a year for the beneficial effects from lower rates to come through. The big cuts in interest rates happened in the final quarter of 2008. The issue now is whether the Bank can manage bond and money markets to keep market rates down, at a time when their indicative and chosen rate of 0.5% is so far below normal transaction rates.