QE is halted. All hail QT – The Mervyn and George Show
The end of Mervyn’s magic money creation had been heralded. It did not quite come today.
In truth, this is likely to prove the end of an extraordinary 11-month experiment. Right now though, understandably, the Bank of England needs to keep its options open. If the economy worsens, they want to be free to increase purchases of government bonds. If it’s better than expected, it may push on with beginning to withdraw this stimulus.
I’m convinced that at Threadneedle Street, they were shocked by the limpness of Britain’s exit from recession. They have been running their big computer model in the past weeks. When it reveals new economic forecasts next Wednesday, we are likely to see a marked downgrade to Britain’s economic prospects.
Today’s decision does mean that for the first time since quantitative easing began 11 months ago, the Bank of England will not be engaged in the purchase of gilts this month. We will now see what price real buyers want to charge the UK government to borrow money.
As Ed Conway at the Telegraph points out, the Bank appears to be convinced that the stock of £200bn of asset purchaes will continue to support the economy, even if that number is not being added to.
Certainly it is more expansionary than if the Bank of England began the tricky process of reversing quantitative easing by selling its stock of government debt at the exact same time as the government sells a further £200bn debt it needs to fund its operations next year. That process is what we might begin to call quantitative tightening.
Britain has never quantitatively tightened before. In theory it should work like QE but in reverse. It should destroy money instead of creating it. It probably will not begin before the election but all of this begins to explain why Cameron and Osborne have been talking (to me and others) about involving the Bank of England in decisions on fiscal policy, ie on tax and spending decisions.
In theory, the stock of £200bn of government debt owned by the independent Bank of England, could be dumped on the markets as quickly as they were acquired.
In that scenario, financial markets would have to absorb about £400bn of government debt during 2010 and 2011. Of course that is not going to happen. One option is that the BoE will never sell the government bonds it has bought with invented money, and instead issue new short term debt.
It makes the prospect of a 2010s reincarnation of the Ken and Eddie show rather intriguing.
The George and Merv Show will be a far more painful bit of theatre.
Nothing need go pop, unless inflation were to remain stubbornly high. Then the Bank would have to practise the inexact science of deciding the appropriate pace of QT, of asset sales, and interest rate rises.
Perhaps it can be achieved through rate rises alone. Merv would want to know how much debt George wants to sell but Merv could not decide monetary policy in a private meeting with George, because it’s supposed to be decided by a nine-strong independent committee.
Far from Mr Osborne determining monetary policy, Mr King may be unusually influential over tax and spend.
QE meant monetary policy was fiscalised. QT could monetarise fiscal policy. Navigating through this swamp without sacrificing either growth, Britain’s credit rating or the independence of the Bank of England, will not be easy.