I had a conversation yesterday in which the prospect of QE being unwound was discussed.
As regular readers of this blog know, I am firmly of the opinion that very little of the QE programme will ever be unwound, meaning that almost all the gilts that have been bought by the Bank of England on behalf of the Treasury (which did, of course, issue them in the first place) really are, in my opinion, effectively cancelled. The result is that the national debt is some £900 billion less than the government claims it to be.
The discussion very rapidly reached a number of conclusions. The first of these was that my suggestion was right. If there is ever any reversal of QE it will be in modest amount, at most.
Second, anything other than a reversal in very modest amount would run into massive financial market resistance. There is an appetite for UK government debt right now, and that is likely to continue, but there is no appetite in financial markets for £895 billion or so of debt to be returned to private ownership. The possibility of that happening, even over an extended period does not exist.
Third, a real attempt to achieve a reversal of the QE programme would have a massive economic consequence. That should not be hard to work out. Reversing even a small part of the QE programme will remove significant liquidity from the economy. The consequence will be fairly rapid reductions in cash available, most particularly to financial markets. They would need to sell other assets to buy bonds, and the only basis on which they might do that is if the bonds were sold at a significant discount to market price, meaning a loss might be suffered by the government on sale. This would also push up potential real interest rates considerably in the process. Consider all the knock on effects of that and asset prices would fall, rapidly. Even if we can all agree that asset prices are too high, rapid changes in their value will destabilise the finance system. Simultaneously falling share, bond, land and house prices because of an attempt by the government to sell significant numbers of old bonds in the market in an attempt to increase the real volume of public debt without there being government spending to match could trigger a financial collapse on a scale to make 2008 look like a picnic.
So, fourth, this is not going to happen.
In that case, fifth, the threat to unwind QE is in that case nothing more than a threat.Any reversal that does happen will in that case be mere token gestures.
In that case why is there a threat to reverse QE when it cannot happen, and why will token gestures take place when there is no real threat to follow through on the plan to reverse QE in any systematic way? The answer is that this is all politics. The objective is to say that QE could be reversed, and might have too be whilst debt is so high, but there is no real intention to do so because the real consequences are known. However, the messaging is sufficient to make people believe that austerity is essential, and that policy is what the proponents of this supposed plan really want.
QE is being used as a political tool in that case, and not as an economic one. The reality is that the moment that there is any stress in the economy again we all know that QE will be used. Even omicron could trigger its use in 2022. But, the threat to reverse it will always be used as a mechanism to limit desirable government action by those who would rather we have government inaction and suffer for it than have government action and reep the rewards.
QE is now at the core of economic policy in that case. But more than that, it is at the core of political economy. And that is where the real action is. Explaining this is really important in that case.
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Maybe I have been trading bonds for too long but QE is just a massive extension of standard Central Bank operations in the markets and it is all about getting the right level of reserves (money) in the banking system. Increasing or unwinding QE should be a technical issue that is a mere corollary to other bigger policy issues – taxation, spending and interest rates. Turning its reduction/elimination into a moral crusade is silly.
So, what is the right level of reserves in the economy? It’s hard to know…. but a few random thoughts are:
(1) “Normal” ended in 2008 and we have spent more than a decade wondering what the right answer is…. and that was before COVID.
(2) The level of reserves required in the system is a function of how big the economy is and how scared/cautious people are and this changes with time… so the right answer for today may not be right tomorrow.
(3) Too little money in the system and rates spike and economic activity is damaged; too much money in the system (above the level of reserves held as precautionary balances/regulation et.) and we see asset price inflation.
(4) 2008 permanently changed the desire to hold reserves… we saw this with the “taper tantrum” of 2013 in the US where the Fed thought it appropriate to drain reserves but had completely failed to realise that what they thought were excessive levels of reserves were, in fact, being held by choice and rates spiked. They reversed things quickly.
(5) COVID may well have changed behaviour that permanently changes the level of reserves required even if we “get back to normal”
So, given the deficits we are running right now, it seems highly unlikely that the BoE will need to drain reserves by selling its gilt portfolio. I can’t see this changing over the next 5 years…. but “forever”?, well, that IS a long time.
I think forever….
Quite possibly “forever” – structural changes in the demand to hold reserves are unlikely to be reversed. So I do agree with you but I guess the point I would like to make is that QE or not QE is the wrong question…. the starting point is
(1) How much (and on what) do we want the government to spend?
(2) How much of that spending do we need to drain?
(3) How much through tax? (and which taxes?); how much through gilt issuance?
(4) What is the right level of interest rates for the real economy? What open market operations (including QE) are required to meet this goal?
QE or not QE is pretty far down the list of decisions that need to be made…. indeed, it should be an “output” from other more important choices rather than a variable we target.
For government to use “debt levels” and “QE” as reasons for austerity is dishonest and relies on the public not really understanding the issues.
All good questions but why wife has just demanded I sit down and has put a glass in my hand
But in essence I agree – QE is a tool, not a policy
QE has created so many bubbles.. it really is akin to selling your financial soul to the devil
“There is an appetite for UK government debt right now, and that is likely to continue, but there is no appetite in financial markets for £895 billion or so of debt to be returned to private ownership.”
It has always seemed to me that those who insist QE must be unwound could make their argument both clearer and more persuasive if they explained what interest rate they proposed to write on the coupon to clear the whole amount.
🙂
On the otherside of La Manche, a somewhat different approach is being taken to raising lots of money to fund (EU) programmes.
https://www.euractiv.com/section/energy-environment/news/new-own-resources-for-eu-budget-will-come-from-carbon-market-executive-says/
The question never asked is, if QE was good enough for bail outs, why not use it for funding large-scale programnmes? If the Brits are doing it, why not the Euros? I have BTLed, It is noteworthy that the ECB was hosing Euro67bn/month (or thereabouts) at bonds markets – but apparently it is forbidden for the ECB to fund EU programmes – goodness, money to Euro-serfs, can’t have that.
Hope this is not too off-topic.
It is bang on topic….
Indeed, bang on topic – but our anger should be directed at the national politicians rather than the ECB (or even the Commission).
The ECB has pushed its mandate to the absolute limit – indeed, beyond that limit in the view of some. To do more (borrow directly and finance projects) would require a political mandate from Eurozone nations.
The buying of bonds is not really bailing out banks, it is allowing national governments to spend without having to sell bonds to the private sector which would push interest rates (and credit spreads) up.
The failure is of national leaders to take the opportunity to spend on the things we need.
Agreed
… furthermore, Macron and Draghi are in the FT pushing this point…. but there is opposition, of course.
I note…
I hope this is Ok as a follow up to Clive’s comments. I did a short piece, mostly for myself called “pathologies” (with a focus on the EU/member states). Below is the section on “Ideologies”: (feel free to chop it if it is too off-topic).
Ideology
The outstanding take-aways this year in this category are: energy market reform (or lack thereof) and how to fund the EU project. In both areas, the underlying ideology is that “markets” and the private sector have all the answers. They are good and provide “optimal” solutions.
Energy market reform discussions are dominated by belief systems, rather than rationale considerations (& evidence). These belief systems have an uncanny resemblance to the old “party line” held by the politburo in the old SovU. This leads to some/many people internalising the party line to the point where evidence that contradicts this party line is discounted. Electricity wholesale prices stand at circa €500/MWh (bit less in Spain) – believers will insist that this is the market working correctly. If it is pointed out to believers that other approaches to pricing electricity in a wholesale market would lead to prices 1/5th of the 500 – they would be ignored. The people doing the ignoring are well able to afford the extra costs in their energy bills and whilst some attention is given to the poor (energy poverty is a sub-set of poverty) they can be, most of the time be ignored, they don’t count and never have (and never will under current power structures).
In the case of money, & specifically government money a no less pervasive ideology/belief system holds sway, which can be summarised as “countries or regions have finances like a corner shop” – debt is bad, money only comes from private banks. The system is such that central banks tend to be run by private bankers taking time out from their normal day-job. The idea that governments could be funded directly by central banks is anathema, literally. In any case, such an approach would disintermediate private banks, a complicated way of saying they would lose money.
In both cases (energy market reform) and government funding, there is an interlocking “caste” which ensures that any changes are highly gradual and allow time for re-positioning (one sees the same wrt de-carb – Shell et al just want enough time to painlessly “re-position” themselves). The caste is self-selecting, outsiders are never (rarely?) welcome and following the party line (often called “loyalty”) is a key requirement.
Thanks
Offer more, if you wish….
Mr Parr,
In response to your acute supplementary comment, Sir Patrick Vallance, government Chief Scientific Advisor has struck back at the extreme right-libertarian, quasi-religious sect that now run the Government, the back-benches and the whole wretched intellectual and values void that is the Pangloss (aka “Conservative”) Party*. Vallance provided sound common sense in his remarks about the real role of science, which: “advances by overturning previous dogma and challenging accepted truths …. Encouraging a range of opinions, views and interpretation of data is all part of the process. No scientist would ever claim, in this fast-changing and unpredictable pandemic, to have a monopoly of wisdom on what happens next.”
For readers here these remarks fit perfectly application to neoliberal economics fatally flawed methods, its groundless belief in its inadequate theories, and its blind faith in its shallow, superficial ‘wisdom’, and its fundamental inability to grapple with the real world.
* “Tout est au mieux dans le meilleur des mondes possibles” (Voltaire, ‘Candide’; a sentiment repeated endlessly by the Leibniz acolyte, Pangloss); which my faltering French Anglicises with cavalier freedom to fit our present wretched condition: “Everything is for the best in this best of all British, Conservative-Pangloss worlds”.
Vallance seems very angry at the dismissal of SAGE advice
He chairs it
Well I hope that you are right.
We thought that they’d listened to the arguments about raising interests rates but they didn’t – they rose. And I realise that the interest raise did have some obvious beneficiaries (the lenders).
So the issue is also one of competence – is not just an empty threat. It could still happen. Because we also know that stupidity abounds in this Government and the cronies who run the various departments.
And I want to be totally wrong BTW.
Perhaps this report has a lot to do with it?
https://publications.parliament.uk/pa/ld5802/ldselect/ldeconaf/42/4202.htm
That is but a reflection or reiteration of it
I take Richard’s point on this, but some of the oral evidence by witnesses at the Select Committee on Economic Affairs, e.g. Charles Goodhart and especially Lord Skidelsky, are pertinent!
(and many of the comments by other “eminent” witnesses are just weird!)
e.g. from Lord Skidelsky –
“We have become terribly involved in people’s QE and helicopter money. That issue has been very extensively explored, so I want to phrase my question slightly differently. To what extent does the use of the Bank to finance government spending, which is really what has been happening, undermine the accountability of the central bank as an independent actor?
It seems to me that what has happened—I do not know whether the witnesses agree—is that Governments have been so scared of fiscal policy that when the crunch has come and they have needed to use it they have simply outsourced it to an institution supposedly independent of political pressure.
Lord Turner, perhaps you could start the answer to this. You have said that you want central banks to decide how much government spending they are prepared to finance by monetary policy and that Governments should then decide how to spend it, but is that not another way of simply passing the buck? Surely, you cannot do that if you have a Government who are accountable to Parliament for their spending. You cannot tell the Bank, “This is how much we are prepared to finance”. The Bank will have to finance whatever the Government want.”
And the discussion of “helicopter money” might raise a smile.
https://committees.parliament.uk/oralevidence/1920/html/
Skidelsky night be right
Funny who used the term created to describe a wholly different form of QE
Helicopter money is another issue