Did QE fail or Did It Only Do What It Was Meant To Do But We Didn’t Realise What That Was?

(Updated 18th July 2015)

If you are not familiar with the reasoning behind increasing money supply, it’s worth having a quick read of the Capitol Hill Baby Sitting Coop parable.

Then have a look at the latest blog from the Bank of England.

Worryingly, the two seem to be pointing at quite different things. The Baby Sitting Coop tells of the need to increase liquidity in order to allow spending to recover. According to the BoE blog, the consequence of QE  seems to have been to allow banks to rebalance their inner workings.

At the time, and since the £375 bn QE programme, it was widely accepted that QE was meant to be similar to the release of extra vouchers into the Baby Sitting Coop. But the BoE blog seems to indicate that it wasn’t quite so.

The public interpretation was that QE would release money into institutions which would then be able to loan more confidently, and also QE would strengthen asset values so their owners would spend more and the trickle down effect would kick in. Both effects would release money into the rest of the economy.

The BoE blog seems to assert that the former failed and the latter worked.

Aside from the dubious credentials of trickle down, this is strange way to go about things. As I said last year, QE would have been a much better envigorator of the economy if money supply was introduced in areas where there was little likelihood that the money would be withheld – ie introduced to people and businesses who would spend and not save the money. But then my priority would be aggregate demand, rather than credit flow, asset prices or inflation. A rise in aggregate demand would have positive effects on the other areas. The rebalancing of the over-leveraged banks is a separate goal that could and should have been done in a more appropriately titled way.

But the BoE blog also states that the banks themselves did not receive the programme funds, they merely enabled the purchase of financial assets owned by other companies. And yet, right at the start the authors say, that the “resulting churn in banks’ deposit funding stopped any such [portfolio rebalancing] channel from operating.”

The beautiful innuendo of “portfolio balancing” means changing the proportion of high risk / low risk assets. It doesn’t infer any particular desired outcome or direction. But I will naively assume that portfolio rebalancing in this case was meant to be the decrease in risky assets and increase in more secure assets. (I might well be wrong.)

The authors state:

“… while gilt purchases were to be made from non-banks, these transactions took place via banks that are eligible to transact in the Bank’s QE operations”

They continue with an “however”:

“The non-banks sell their gilts and in return gain deposits at the bank they transact through… these deposits offer cheaper financing than other sources of funding.  We also show that if deposits are very ‘flighty’ (i.e. if they move quickly from one bank to another) then banks are less likely to increase their lending.”

It is technical stuff, but it does seem to show that the banks were absorbing the QE rather than acting as a channel for it. The tubes were not greased, but lined with sponge.

At the end of the blog, the authors say that in their analysis they:

“… dispel the myth that money created by QE lay idly on banks’ balance sheets. Instead deposits and reserves moved more rapidly around the banking system.”

To a bank economist this may be a technical truth. But to a lay person, if the money isn’t getting out in the form of loans, then to all intents and purposes it is still stuck in the banking system, regardless of how much it is getting churned. (I am sure there is a useful metaphor involving fluid milk turning to sticky cheese here, but I can’t put my finger on it.)

As to whether QE failed to heat up the economy is a different matter. There certainly seems to have been a positive effect in the US and UK compared with the EU which has only recently begun its QE programme.

One could infer an admission that QE has failed to do little other than “increase[s] the net wealth of asset holders, which encourages them to consume more”. If that were true, we’re back to Reagonomics in the UK – hoping that by securing the wealth of the wealthy, the benefits with trickle down to the the rest of the population. Of course, there is plenty of evidence that trickle down is a fallacy. And the argument for trickle down in a stagnant economy is even less convincing as wealth holders are nervous about letting go of their money. I remember being delighted when, at the end of a Newsnight discussion a few years ago, Mariana Mazzucato suggested this as likely. Her comment was met with amusement, but as it turns out, it was no joke.

Overall then, the blog seems to say something that is ever present with political economics: when you are trying to achieve more than one goal with one solution, the measurable effects are fudged. This is good news for politicians who can use the results to “prove” many things, but bad news for the social “science” of economics.

Maybe one day we will be able to measure the flow of money by tagging it as scientists follow the movement of migrating birds.

So was QE a policy which masqueraded as expansionary / inflationary but has only ended up putting more money into a hesitant and mistrusted financial sector?

Or was it exactly what is was meant to be. And we all got the wrong end of the stick as media commentators struggled to explain QE to the public?

Either way, this latest BoE blog shows that QE was not what most people thought, and absolutely has not done what the majority of people and commentators had hoped it would do.

Update: Simon Wren-Lewis has written a lot about Helicopter Money. This is a particularly useful blog of his.

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