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.