The government’s economic recovery policy consisted of two tracks: one, a vastly expensive “fiscal stimulus“, involved ramping up spending at a time when tax revenues were falling by borrowing at unprecedented levels. Even Alistair Darling expects borrowing to reach £175 billion this financial year, around 12% of GDP, leading to a possible downgrading of the UK’s credit rating from AAA. Others think borrowing might be even higher. Yet the effectiveness of fiscal stimulus was largely dismissed for two decades prior to the recent crisis, during which time it also failed to lift Japan out of the mire despite massive public works projects during the 1990s.
Thank heavens, then, for quantitative easing (QE), the other track of the government’s policy. This, at least, was broadly supported by most mainstream economists: both neo-liberal and Keynesian. Milton Friedman built his reputation on A Monetary History of the United States, 1867-1960, where he argued (along with Anna Schwartz) that the Great Depression was caused because the Federal Reserve contracted the money supply at a time of deflation, whereas it should have flooded the economy with money to ensure that prices remained stable. This argument has become fundamental to macro-economic thinking.
So it is rather a surprise to discover evidence that suggests quantitative easing is not working as planned. According to the Bank of England, its £200bn programme of QE has been accompanied by a decline in broad money (M4) of 5.3% over the past three months; not the annualised growth of 6 to 9% that Mervyn King was looking for. Lending to business has also declined (by 3% over the same period). What seems to have been achieved is a roaring housing market and a stock market up over a quarter in a single year.
This seems to question mainstream economic theory, though it corresponds nicely with Murray Rothbard’s suggestion that, during the Great Depression, the Federal Reserve actually did expand those monetary levers over which it had control, but that the market nonetheless shrank the money supply because government could not fully control broad money.
Whatever the truth about the economic history, the economic practice in 2009 has arguably been disastrous. It seems £200bn has flooded into the money markets to achieve little but asset bubbles in the midst of a recession; and £175bn has been added to the public debt on the basis of dubious Keynesian theory. The twin tracks of the government’s economic recovery plan appear to have failed.