Quan­ti­ta­tive eas­ing has done its bit

The Pak Banker - - OPINION - Roger Boo­tle

TWO weeks ago, the Euro­pean Cen­tral Bank an­nounced a big in­crease in quan­ti­ta­tive eas­ing. The Bank of Eng­land and the US Fed, of course, have stopped QE but the ef­fects of pre­vi­ous pro­grammes con­tinue in the sys­tem. As many have urged, it is high time to take stock. Dur­ing and af­ter the fi­nan­cial cri­sis of 2007-09, QE made a huge con­tri­bu­tion to sta­bil­is­ing the fi­nan­cial mar­kets, help­ing to bring about eco­nomic re­cov­ery.

But once re­cov­ery had been se­cured, what more QE achieved is ques­tion­able. And there have been some un­de­sir­able con­se­quences. So, as with ev­ery­thing else in eco­nom­ics, the ver­dict is a mat­ter of bal­ance - of de­cid­ing when the mi­nuses out­weigh the pluses.Un­der QE, the cen­tral bank buys fi­nan­cial as­sets in the mar­kets (usu­ally gov­ern­ment bonds) with money that it is­sues it­self, thereby in­creas­ing both sides of its bal­ance-sheet. In prac­tice, hardly any ex­tra notes are printed. Rather, the ex­tra money is cre­ated elec­tron­i­cally.But since de­posits at the cen­tral bank are in­ter­change­able with notes, to de­scribe this as "print­ing money" is ac­cept­able short­hand. This pol­icy sounds ex­tra­or­di­nary, and per­haps even fool­hardy.

But it has fea­tured in stan­dard eco­nom­ics text­books for gen­er­a­tions (un­der the name Open Mar­ket Op­er­a­tions). More­over, it was ad­vo­cated not only by John May­nard Keynes, but also by Mil­ton Fried­man. Mind you, there are lim­its to what it can achieve, and it is not for all sea­sons.But ev­ery so of­ten the mone­tary sys­tem breaks down in a spec­tac­u­lar fash­ion. When that hap­pens, the real sources of pros­per­ity - hard work, in­vest­ment and tech­no­log­i­cal progress - are as noth­ing against the tsunami of mone­tary col­lapse. That's when print­ing money comes in.

In the Great De­pres­sion in the US in the 1930s, out­put fell by 30 per cent and un­em­ploy­ment soared to 25 per cent. The money sup­ply con­tracted by 25 per cent.Al­though dif­fer­ent schools of thought ar­gue about the pre­cise cause, all agree that the mone­tary con­trac­tion played a huge role. At the time, the US Fed­eral Re­serve did lit­tle to stop this process. In­deed, it prob­a­bly ex­ac­er­bated it.

By con­trast, af­ter 2008-09, what could have been a re-run of the Great De­pres­sion was stopped in its tracks by much lower in­ter­est rates and QE.

The Great Re­ces­sion's fall in out­put was mi­nor com­pared to the 1930s: only 4 per cent to 5 per cent.Some crit­ics ac­cept that with­out the in­ter­ven­tion of the cen­tral banks there would have been an eco­nomic col­lapse, but they ar­gue this would have been a good thing. A sys­tem purged of bad prac­tices and bad in­sti­tu­tions would have been health­ier when the econ­omy re­cov­ered.

Yet it wasn't ob­vi­ous that the col­lapse of the 1930s pro­vided a ben­e­fi­cial purge. In Ger­many, it led to the rise of Hitler. And in the US, the misery of the soup kitchens was only over­come to­wards the end of the decade once war pro­duc­tion raised ag­gre­gate de­mand.Other crit­ics ar­gue that the re­cov­ery cre­ated by QE is only tem­po­rary and that the sys­tem will ei­ther suc­cumb to a burst of hy­per-in­fla­tion or fall into a new cri­sis un­der the im­pact of the fi­nan­cial dis­tor­tions cre­ated by QE. But much higher in­fla­tion is not the inevitable con­se­quence of all this money cre­ation.

The pol­icy can be put into re­verse, as the cen­tral banks can off­load the bonds they have bought. Equally, they can im­pose re­serve re­quire­ments on the banks to ab­sorb ex­cess cash and they can raise in­ter­est rates.The ex­am­ple of Zim­babwe, which printed boat­loads of money and suc­cumbed to hy­per-in­fla­tion, is not a case of QE gone wrong. It was the re­sult of gov­ern­ment in­com­pe­tence in be­ing un­able to raise suf­fi­cient taxes to cover ex­pen­di­ture on a gross scale and re­sort­ing to money print­ing to cover the gap.In fact, when the mone­tary cri­sis is over and yet the mone­tary sys­tem re­mains se­verely im­paired, it is ques­tion­able whether buy­ing gov­ern­ment bonds, which are them­selves liq­uid and sup­pos­edly of unim­peach­able credit qual­ity, with liq­uid de­posits at the cen­tral bank will do very much at all.

It may just be ir­rel­e­vant. In prin­ci­ple, of course, it may help one coun­try by de­pre­ci­at­ing its ex­change rate. But even that chan­nel didn't ap­pear to work for the ECB. And, of course, cur­rency de­pre­ci­a­tion is not a so­lu­tion for ev­ery­one.As to the dis­tor­tions cre­ated by QE, they are cer­tainly there. There is cur­rently a quasi-bub­ble in gov­ern­ment bonds.

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