Wednesday, July 11, 2012

Bank of England tries to explain QE.

Just in case you thought central banks know what they are doing, this Bank of England (BoE) article will disabuse you.

The article claims quantitative easing was implemented primarily to keep inflation up to the 2% target: a strange objective (see 2nd para of “Introduction”, p.200).

Personally I think that maximising GDP within environmental constraints and providing jobs for those who want them is a more fundamental and important economic objective.

Their reasoning becomes SLIGHTLY clearer a few paragraphs later in a sentence that is not 100% clear: it says that a below target rate “could have led to inflation expectations, which would have pushed up on real interest rates, even with nominal rates kept at very low levels and reduced spending in the economy”. Presumably they meant “pushed up” rather than “pushed up on”. Also they don’t actually mention NEGATIVE rates of inflation, but I assume they had that in mind.

Now this reasoning is bizarre. The only circumstance in which inflation is likely to drop to zero or below is where there is a serious collapse in demand and unemployment reaches the worst levels experienced in the 1930s. AND THAT’S THE REAL PROBLEM: the collapse in demand and the unemployment.

That a zero or negative rate of inflation adds to the problem because it causes a rise in REAL interest rates is a possible CONTRIBUTORY FACTOR – that’s all. It’s a bit of a technicality.

Might, can, could and may.

Anyway, moving on . . . on page 201 they say “there are a number of potential channels through which asset purchases might affect spending and inflation..”.

“Might”? That fills me with confidence about the whole QE idea.

A couple of sentences later they say, “Asset purchases may also have a stimulatory impact through their broader effects on expectations..”

“may also have”? My confidence that the BoE knows what it is doing grows by the minute.

Still on page 201 and under the heading “Portfolio balance effects”, they say, “Unless money is a perfect substitute for the assets sold, the sellers may attempt to rebalance their portfolios by buying other assets that are better substitutes…”

“may”? I’m even more convinced.

Next, (p.202) under the heading “Liquidity Premia Effects” they say, “When financial markets are dysfunctional, central bank asset purchases can improve market functioning by increasing liquidity through actively encouraging trading. Asset prices may therefore increase through lower premia for illiquidity.”

There’s a “can” AND A “may” in that passage. Two uncertainties for the price of one!

Next, under the heading “Confidence effects”, they say, “Asset purchases may have broader confidence effects..”

“may have”? Now this is getting silly.

Then under the heading “Bank Lending Effects” they say “A higher level of liquid assets could then encourage banks to extend more new loans..”

“Could”!! Well that makes a change from “may” and “might”. No – it’s worse than that: the idea that banks lend out reserves or that they are encouraged to lend when reserves are boosted is an idea that has attracted widespread criticism. E.g. see about one minute into this video clip:

We plebs and peasants always knew QE wouldn’t work.

I pointed out on this blog when QE was first mooted about two years ago that it wouldn’t have much effect. And for a more professional demolition of the whole idea, see here.

So what does work?

Well fantastic as it might seem, if consumers are given more money, guess what they do with it? Yep: they spend a significant proportion of it!!!!

Amazing that, isn’t it? The average mentally retarded six year old probably knows that. But there seem to be no end of academic economists and central bankers who can’t work that one out.

To be more exact, when the average consumer comes by an increase in income or a windfall, they spend anything between about a third and two thirds of it within about six months, plus they save between about a third and two thirds (depending on the exact nature of the windfall).

That’s what the empirical evidence shows. See here, here, here, or here.

No “maybes”, “mights”, “coulds” etc. The empirical evidence is quite clear.
But as I pointed out here, many academic economists are not too interested in reality.

And finally, I owe a hat tip to Neil Wilson for drawing my attention to the above BoE article.


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