Why quantitative easing isn't the answer

June 23, 2015 10:58 AM

A while ago we wrote about about why the TaxPayers' Alliance are worried about the current state of government debt and why you should be as well. More than one person pointed out that we can inflate away or use quantitative easing to magic (at least part of) the debt away. So here's a post about why we can't rely on those options.

To start, let's talk about the Bank of England because they're the ones who would have to perform any monetary trickery, not the government.

The Bank of England (BoE) is the independent bank of the United Kingdom. It was granted operational independence in 1997 which means that the government sets the Bank's target but how this target is achieved is down to the Bank itself. This is to stop successive governments playing havoc with the economy (especially before an election) knowing that the BoE will bail it out. The Bank target is 2% inflation, the government's economic objectives are secondary to this.

  1. Inflation
    If the government wanted to inflate away the debt it could increase the BoE's inflation target. In practice it is very unlikely to do so because high inflation means rising prices. The result is a very unhappy electorate that can't afford food and will most likely vote you out of office. It's 2% for a reason.

  2. Printing more money / quantitative easing (QE)
    The BoE doesn't print money, it 'credits' its own account without debiting the money from another account. Using this money the BoE buys assets from investment funds, buying almost exclusively government bonds.

    As any GCSE economics student will tell you, increased demand = increased price. However bonds are a bit special because an increased price means a lower bond yield (the payout of the bond, similar to a dividend on a share).

    As government bonds are the baseline by which other bonds are measured this distributional impact of a lower bond yield would be immense, especially on anyone who relies on bond yields for income. And especially those who can't afford to put their money in risky assets.

    Like pensioners.  The age group most likely to vote in elections, not a group the government wants to upset. Even if nobody who drew a state pension were allowed to vote, the children of those pensioners would have to care for their parents when bond yields collapse.

And another thing:

So that's why it's very unlikely that inflation is going to be used to solve all our woes. But maybe you don't really care about pensioners? Maybe they should take one for the team? Well, it's not just pensioners that would suffer. 

Inflation would mean our goods are more expensive, people can't predict the value of their money so pay bargaining becomes difficult, people are less likely to take risks like starting a business, take on new employees or move home. Savers will see the value of their savings eroded and you'll soon find your personal allowance doesn't buy you very much.

There's also the effect on our currency. Massive quantitative easing would devalue the pound making it more expensive for us to go abroad but also cause foreign investors to dump the pound in exchange for something more stable which has further implications for our credibility, economic equilibrium and rate of inflation.

In summary:

Quantitative easing and inflation are not bad things, they are necessary tools in the arsenal of the Bank of England to create a stable economy. But there are consequences to using these tools and it would be short-sighted for the Bank of England to ignore these in order to deal with a pile of government debt that they are under no obligation to care about.

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