How I learned to stop worrying about inflation and love QE
Since output started to drop in late 2008 a number of financial instruments and practices have been attempted, but ultimately failed to stimulate growth. Central banks and their associated regulators have ground away at interest rates, trying, fruitlessly, to instigate a resurgence. While in that sense monetary policy has failed it would be foolish to turn our backs on quantitative easing.
QE has earned itself a nasty reputation because of its close and personal relationship with inflation, but in the current climate, it has become something of a necessary evil.
One of the worst consequences of the crisis has been that domestic demand in western economies has all but stalled. Deleveraging means that the level of interest rates, determined by the supply of savings and the demand for capital for investment, has hit rock bottom. Low interest rates should have the effect of boosting demand, but as there is nowhere south for interest rates to go, financial authorities are stuck. On top of that consumers are sitting on what cash they have – leading most economies into the jaws of the liquidity trap.
Logically most struggling economies turned to fiscal policy, running up huge deficits and throwing money at long term infrastructure projects that might never come to use.
And so we find a short term saviour in QE. To be most effective QE entails lower interest rates in the long-run – which has a negative effect of savings and pensions – but it also encourages spending now, greater demand and when well managed increased per capita GDP.
This is the case in Britain and in the US. Cutting taxes has been ruled out (thanks to our massive deficits), so we turn again to QE. The Bank of England has committed a total of £375bn and the Fed Res has pledged $40bn per month. These won’t be the first direct injections into the economy of course, but before naysayers and inflation infatuates rule it out completely, consider:
-Companies small and large are crying out for easing of capital restrictions. QE gives much needed breathing space for direct investment into immediate projects, which will be cheaper and more manageable to promote new products on international markets.
-Lower interest rates tend to make domestic currencies less attractive to foreign investors and therefore help hold their value down against the currencies of key trading partners, notably the euro. Again, this is good for competition.
-Lower interest rates mean lower mortgage rates, putting more money into the pocket of the man in the street
- Lower yields on government and corporate bonds and therefore higher share prices, because investors who sell their government bonds will be looking to invest their money in other assets
Ultimately, we can’t allow our economists to concern themselves with inflation control. As we’ve learnt recently from both China and the US, there’s a lot to be said for devaluing your currency. If governments can realise that GDP growth should be the sole target on a short term basis, we might get back on track.
Rita Lobo is a journalist and commentator for World Finance. Follow her @WorldNewsRita