Monetary Policy

Questions over quantitative easing


From a monetarist perspective, a strong case can be made in support of the Bank of England’s decision to engage in quantitative easing. A severe deflationary shock would cause big problems for an economy adapted to moderate inflation. Moreover, given that the effect of further interest rate cuts is likely to be limited, quantitative easing may be the only mechanism by which the Bank can hit its inflation target. In a situation in which we are very uncertain about the way in which money supply will respond to interest rate changes, it makes sense to use the quantity of money as the control variable.

But there are risks. In the medium term, as the velocity of money recovers, it may be necessary for the Bank to slam the brakes on hard to prevent its expansion of the money supply causing inflation. Getting the timing right will clearly be difficult. An interest-rate spike could delay recovery and lead to calls for greater political intervention in monetary policy. Nothing that the Bank of England has done either in the boom period or the following bust gives any indication that they understand the role of money in the inflationary process. They may therefore be slow to mop up liquidity.

Austrian economists might also argue that quantitative easing will hamper the economic adjustment process by which boom-time malinvestments are liquidated – the depth of the recession may be reduced but at the expense of a longer period of slower growth.

The risks associated with easing could perhaps be mitigated if the government adjusted the Bank’s inflation target. As explained in the IEA monograph, Less Than Zero, mild deflation is perfectly consistent with sustained economic growth in a period of rising productivity. If the 2% target was changed to an upper limit rather than a fixed target, or cut to say zero, then the rationale for the Bank to engage in easing would be correspondingly reduced.

Deputy Research Director & Head of Transport

Richard Wellings was formerly Deputy Research Director at the Institute of Economic Affairs. He was educated at Oxford and the London School of Economics, completing a PhD on transport and environmental policy at the latter in 2004. He joined the Institute in 2006 as Deputy Editorial Director. Richard is the author, co-author or editor of several papers, books and reports, including Towards Better Transport (Policy Exchange, 2008), A Beginner’s Guide to Liberty (Adam Smith Institute, 2009), High Speed 2: The Next Government Project Disaster? (IEA , 2011) and Which Road Ahead - Government or Market? (IEA, 2012). He is a Senior Fellow of the Cobden Centre and the Economic Policy Centre.


8 thoughts on “Questions over quantitative easing”

  1. Posted 13/02/2009 at 13:03 | Permalink

    I dont think Quantitive Easing (QE) will reduce the depth of the recession.

    The recent monetary boom resulted in investment of resources on a massive scale in areas of the economy unjustified by underlying spending/saving ratios. To try to perpetuate those investments thru artifical credit expansion – be it interest rate manipulation or QE – will simply take us down a blind alley, putting off the necessary recession.

    What is needed is a severe, decisive market correction: for asset prices to correct themselves thru the interplay of supply and demand. Yes it will be painful. But the sooner the market is allowed to enforce its corrective medicine the better. Obama/Brown take note.

  2. Posted 13/02/2009 at 13:03 | Permalink

    I dont think Quantitive Easing (QE) will reduce the depth of the recession.

    The recent monetary boom resulted in investment of resources on a massive scale in areas of the economy unjustified by underlying spending/saving ratios. To try to perpetuate those investments thru artifical credit expansion – be it interest rate manipulation or QE – will simply take us down a blind alley, putting off the necessary recession.

    What is needed is a severe, decisive market correction: for asset prices to correct themselves thru the interplay of supply and demand. Yes it will be painful. But the sooner the market is allowed to enforce its corrective medicine the better. Obama/Brown take note.

  3. Posted 15/02/2009 at 22:50 | Permalink

    Hi,

    I agree with the first poster.

    I think economist’s, who have not been branded socialist, but are in the mainstream, have been either bought or bullied into agreement by the free-market capitalist structure.

    QE would not solve much, when the assets were over priced in the first instance.

    Best,

    Yourihttp://globalviewtoday.blogspot.com/

  4. Posted 15/02/2009 at 22:50 | Permalink

    Hi,

    I agree with the first poster.

    I think economist’s, who have not been branded socialist, but are in the mainstream, have been either bought or bullied into agreement by the free-market capitalist structure.

    QE would not solve much, when the assets were over priced in the first instance.

    Best,

    Yourihttp://globalviewtoday.blogspot.com/

  5. Posted 25/02/2009 at 16:10 | Permalink

    The zero-interest rate/quantitative easing approach carries with it the potential for calamity.

    The current depression is the inevitable result of spiralling monetary inflation (the money supply has been expanding by between 10% and 15% since 2003), which had to lead either to hyperinflation or – as occurred – a run on the banks.

    To try to prevent this correction with a further dose of inflation will simply mask the signals that investors need to realise that many of their investments are not actually profitable.

    Unfortunately, this realisation is not politically palatable for our political masters so they would rather pour taxpayers money into unsustainable businesses.

  6. Posted 25/02/2009 at 16:10 | Permalink

    The zero-interest rate/quantitative easing approach carries with it the potential for calamity.

    The current depression is the inevitable result of spiralling monetary inflation (the money supply has been expanding by between 10% and 15% since 2003), which had to lead either to hyperinflation or – as occurred – a run on the banks.

    To try to prevent this correction with a further dose of inflation will simply mask the signals that investors need to realise that many of their investments are not actually profitable.

    Unfortunately, this realisation is not politically palatable for our political masters so they would rather pour taxpayers money into unsustainable businesses.

  7. Posted 05/03/2009 at 19:09 | Permalink

    The perfect vehicle for the distribution of QE will be BERR and HMRC.
    SME’s need to shrink to match falling order books, but are leveraged to suit growth. Reducing their workforce to suit income through redundancy destroys cashflow. Long serving employees have long notices to work, and higher redundancy payments. 15 weeks to see the benefits of reduced payroll in cashflow.
    SME’s need shorterm funding, interest free loans to tide over that period. The banks won’t loan to support redundancies. Please support the petition below:-http://petitions.number10.gov.uk/QuickQE/
    This will put QE where it will be used, not held on a balance sheet

  8. Posted 05/03/2009 at 19:09 | Permalink

    The perfect vehicle for the distribution of QE will be BERR and HMRC.
    SME’s need to shrink to match falling order books, but are leveraged to suit growth. Reducing their workforce to suit income through redundancy destroys cashflow. Long serving employees have long notices to work, and higher redundancy payments. 15 weeks to see the benefits of reduced payroll in cashflow.
    SME’s need shorterm funding, interest free loans to tide over that period. The banks won’t loan to support redundancies. Please support the petition below:-http://petitions.number10.gov.uk/QuickQE/
    This will put QE where it will be used, not held on a balance sheet

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