Select Committee on Economic Affairs
Corrected oral evidence: Quantitative Easing
Tuesday 9 February 2021
Watch the meeting: https://parliamentlive.tv/event/index/b886f44b-0e65-47bc-b506-d0e805c01f4b
Members present: Lord Forsyth of Drumlean (The Chair); Lord Bridges of Headley; Viscount Chandos; Lord Fox; Lord Haskel; Lord King of Lothbury; Baroness Kingsmill; Baroness Kramer; Lord Livingston of Parkhead; Lord Monks; Lord Skidelsky; Lord Stern of Brentford.
Evidence Session No. 3 Virtual Proceeding Questions 22 - 32
I: Fran Boait, Executive Director, Positive Money; Professor Tim Congdon CBE, Founder and Chairman, Institute of International Monetary Research; Liam Halligan, Senior Economics Commentator, The Telegraph Media Group.
USE OF THE TRANSCRIPT
Fran Boait, Professor Tim Congdon and Liam Halligan.
Q22 The Chair: Welcome to the Economic Affairs Committee. We have two panels today. The first panel is Fran Boait, executive director of Positive Money, and Tim Congdon, founder and chairman of the Institute of International Monetary Research.
Perhaps I could start with the first question to Tim Congdon. Have the objectives of the QE programme changed over time, and why?
Professor Tim Congdon: The original QE programme was back in early 2009 and was to combat the very deep recession that had taken hold at that point. There were various episodes of it, and it came to an end in 2013 or 2014. There was a little resumption in 2016 just after the Brexit vote—not very well advised in my view—and it has been present since Covid-19, beginning in March last year. In all cases, it is to anticipate or deal with a downturn in the economy. Does that help?
The Chair: Yes. Thank you.
I apologise to Liam Halligan. I did not introduce him as an economist, author and broadcaster, and the third member of our panel. Could I put the same question to you, Liam, and could you add whether you think the experience of QE has shown monetary policy to be ineffective in stimulating economic growth?
Liam Halligan: Thank you, Chair, Committee and staff for asking me to testify.
As Tim says, QE began in 2009 to stave off a banking collapse. I think that was part of the reason. It started as a £50 billion programme. By the time we went into lockdown in 2020, it was a £425 billion programme, so it was far bigger than originally envisaged. It became an exercise in the central bank buying government debt, not corporate debt.
Since the lockdown, QE has expanded even more. We are now at £875 billion, up from £425 billion this time last year. It is now almost entirely about buying government debt. The Bank tries to portray the idea that QE is about increasing inflation to stave off deflation, but no one in the market believes that. A very interesting, albeit belated, survey reported in the FT at the turn of the year showed that no serious bond buyer believed it was about inflation; it was about financing the government deficit now. The increases in the public sector net borrowing requirement by month since lockdown correlates almost one to one with increases in quantitative easing.
As for growth, we have had a massive and unprecedented expansion in the central bank’s balance sheet since 2009, yet the recovery from the post-2009 recession has been the slowest, most tepid and least convincing that we have had in 100 years of British history. It has been unconvincing despite massive QE. I agreed with QE when it began, to a degree. Tim and I had a few differences then, but I think we both agree that because it helped Governments avoid tough spending decisions, and because financial markets, above and beyond everything else, liked QE, it led to a massive expansion in both stock and bond prices. It was an enormous bubble, as Andy Haldane has said, and we stayed with it for far too long. We are now in a situation where monetary policy since lockdown has become extremely excessive, counterproductive and, in my view, dangerous.
The Chair: Are you saying that the Bank of England is not simply following its inflation objectives but is being lent on by the Treasury?
Liam Halligan: I think that it is plain to everybody. Even the Bank’s internal watchdog released a report earlier this year saying that the Bank did not have enough understanding of what it was doing. I paraphrase, but that is roughly what the report said. We should be honest about what is happening. This is no longer an exercise in controlling inflation and escaping from deflation, if it ever was; it is now an exercise in fiscal policy, and it has been for a very long time.
Fran Boait: On Liam’s last point, I would not say it has been an exercise in fiscal policy, because for a vast period of the last decade we have had fiscal and monetary policy pulling in opposite directions. We have had QE and, at the same time, austerity. If we are looking to stimulate economic growth, austerity is absolutely disastrous for that.
I agree that things have changed. The first round of QE, probably right up to the one in 2016, was about stimulating the economy. It did an incredibly poor job because it relies on trickle-down economics, the wealth effect, which is extremely poor at stimulating the economy. It relies on the wealthiest in society getting richer and spending some money. That simply does not work and turbocharges inequality, which is what we have seen. A lot of economists now agree that trickle-down economics does not work, but we still see that thinking in our economic institutions. It has very weak transmission mechanisms to stimulate both the wealth channel and the bank lending and portfolio rebalancing channel.
As many people have said, monetary policy is a bit like pushing on a string. In the past year, since Covid, things have changed, and QE expansion has been done at the same time as an increase in government spending. We welcome that co‑ordination. Positive Money has long called for greater transparency around monetary and fiscal co‑ordination. The transparency should be there. Other witnesses have pointed to the fact that the Bank has not been totally clear that it has expanded QE in order to allow for government spending to stem unemployment and the severe economic downturn in the past year.
Q23 Lord Bridges of Headley: I want to pick up some of the remarks that each of you has made and ask this simple question. Has QE been a counterproductive monetary policy tool not just for asset prices but in the zombification, to use a horrible word, of parts of our economy? I have in front of me an FT article from December about Europe’s corporate landscape; research claims that a fifth of Europe’s corporate landscape may now be zombified. Liam, can you put some flesh on the bones of what you were just saying and try to address some of the points I just made, and the extent to which QE might have been counterproductive?
Liam Halligan: I think it has been counterproductive. Fran and I look at it through different ends of the telescope, but we both agree that the original QE and since has driven inequality. The Bank of England’s own research department put out a paper in 2018 that said that QE had driven about a quarter of the increase in house prices in the last 10 years, and it has led to bubbles in both stock and bond markets.
I also think it has been counterproductive in that it has kept alive a lot of banks and in particular firms that suffer from very low productivity and can just about afford to service their debts—the classic definition of zombification—rather than channelling capital into growth. QE has kept an awful lot of firms going that should not be going, frankly. The resources should be reallocated.
Do not get me wrong: if we had not had at least some QE in 2009, we would have had a much worse situation. If money had stopped coming out of ATM machines, there would have been civic unrest, so I do not disagree entirely with QE. I just think it has gone much too far, and it had gone much too far even before lockdown. A lot of very powerful vested interests like QE; it boosts stock and bond markets. And there is a key difference between the first phase of QE and QE since lockdown – which perhaps we will come to.
Fran Boait: I agree with Liam’s point about inequalities. The richest 10% of households benefited by £350,000 during the first round of QE, which was more than 100 times the benefit for the poorest. It has had significant inequality effects.
I agree that in the immediate aftermath it may have been the best tool available in a hurry, but both the Bank of England and the Treasury have had a decade to think through the new economic situation we find ourselves in and a new framework or settlement for monetary and fiscal co‑ordination to make sure that the power to create money in the public interest benefits the whole of society, and helps efforts to overcome the challenges we have, whether that is high levels of private debt or wage stagnation. In the UK, we have seen the worst wage growth in the G7 over the last decade. Alternative tools need to be seriously investigated if we are to meet the challenges of the UK economy.
On “zombie” firms, I do not think that is always helpful terminology because we need to look at the weakness of a lot of businesses within the context of the wider economy. Businesses in the private sector and households have not been able to deleverage their debts since the crash, for the last decade. We have had weak economic conditions, in large part because of choices made in fiscal policy and the Bank of England’s policy. We need to think about what we should do to get businesses to thrive in our economy and provide quality employment, and not just about businesses with too much debt, which, if it was not for QE, would go bust. If we replaced them with other firms, the other firms would have the same challenges. We need to look at the different things we need to change to create an environment where businesses can do a lot better than in the current one.
Professor Tim Congdon: To be clear, both of the big QE exercises we have had in the last 15 years have been after very large falls in the stock market, with problems in banks, although not with banks in severe form the latest case. In the 2009 case, the housing market was very weak. There is no theory that says there is any effect on inequality in the long run from monetary policy. It is dangerous to suggest otherwise because it misleads. If we are concerned about inequality, and there is inequality in our country, it is education and things like that which really matter.
As far as zombie companies are concerned, the most important thing is to leave the decisions as far as possible to the managers of the businesses, banks and so on involved. The business may not recover the capital invested in it, but it may be employing people and covering labour costs. Closing down that business just destroys jobs. Leave it to the people on the ground; they know best. In the years while QE was going on, there were protests about the NatWest restructuring group. The banking industry was criticised both for supporting zombie companies and for being vultures in seizing the assets of businesses with too much debt.
Q24 Viscount Chandos: The primary or ostensible purpose of QE has been to get the rate of inflation up to the target range, but is there evidence that it could be creating inflationary pressures that will push future inflation to a level significantly higher than the top of the target range?
Professor Tim Congdon: Yes. I provided a written statement in which I said that all the answers were in the context of the theory of determination of the price level. If there is excessive monetary growth, you get inflation. What happened in the first episode of QE was that the quantity of money would have fallen very rapidly without QE. I was in favour of QE to stop deflation. But that is not what is going on at the moment. In the year to November or December, in the last money figures, the growth rate of money was 14%. The annual trend growth rate of the British economy in real terms, in terms of output, is not much more than 1%. There is a huge imbalance and it will come through in inflation.
Our situation is bad enough; America’s is even worse. In the year to June, it had 26% money growth, the highest since the Second World War. We are already getting rapid commodity price inflation. Oil prices are virtually back to where they were last February, while asset prices have been strong too. And asset price inflation typically precedes inflation in shops, factories, websites and so on. I think that what is happening at the moment in Britain, even more so in the United States, is very irresponsible, and for once I agree with Liam about QE and inflation, but it is all in the context of a theory in which we relate the price level to the quantity of money.
Fran Boait: I take a slightly different point of view. There is a huge connection between QE and asset price inflation, and that has been a big problem. There is a lot of evidence that that has driven wealth inequality, and I can talk more about that. There is less evidence to suggest a link between QE and consumer price inflation, or whether it is coming. In the UK, the outlook now appears more deflationary, if anything, with prices falling during the pandemic. There have been long-term trends as well of wages stagnating and falling severely in the UK economy.
We might need a more direct form of monetary financing, where Bank of England money, rather than going into financial markets, goes directly into the economy through government spending to get inflation up to the Bank’s target. We have seen knock-on effects in the UK from QE where assets such as housing continue to go up. We have seen stock markets reaching all-time highs in the last 10 years, at the same time as poverty and food bank use are steadily increasing. This tells us that our economy is extremely dysfunctional at a deep structural level, and QE, to an extent, is just adding to that by increasing asset prices and not doing anything to get money into the real productive economy and helping with wages where most people live and work.
Viscount Chandos: Liam Halligan, is there anything you want to add? Professor Congdon bracketed you with him in his answer.
Liam Halligan: There was some inflation post the first QE; it was above 5% at one point in 2011, but for the most part QE1 was an asset swap. The central bank bought financial assets, particularly gilts, from investors in the market, often banks. Those banks then redeposited the proceeds from those gilt sales at the central bank in order to shore up their reserve ratios and help the banks recapitalise themselves. That was what QE1 was. The money did not get into the broader economy; it stayed within the financial system and bloated stocks, bonds and some real estate, as we have discussed.
The key breakthrough that this inquiry must embrace and analyse is that the post-lockdown QE is very different. What is happening now is that QE is directly, or almost directly, funding government spending; effectively, the proceeds from QE are being deposited in the bank accounts of businesses with business grants and households with furloughing proceeds. There has been a £400 billion increase in QE since lockdown, and we will see a £400 billion increase, roughly, in government borrowing this year when Rishi Sunak announces his Budget on 3 March. That is why QE2, or post-lockdown QE, is inherently much more inflationary on the demand side, plus the fact that there are lots of pent-up savings and a post-lockdown economy that will struggle to respond on the supply side. For those reasons, plus the commodity price reasons that Tim mentioned and the broader measures of money that he has documented regularly in his monthly newsletters, I think post-lockdown QE is far more inflationary than pre‑lockdown QE.
The Chair: Tim Congdon, I think I am right in saying that you have put a number on where you think inflation might go in the United States. Are you able to do that for us?
Professor Tim Congdon: I would be surprised if US inflation is not over 3% by the middle of the year. I would expect it to be over 5% by the end of the year. I would not rule out the US getting double-digit inflation either. Those numbers seem extraordinary compared with what we have had in the last 20 years, but let us remember what I said.
The growth of money in the year to June 2020 in the United States was 26%, the highest since 1943. The Americans had 20% inflation in 1947. All this comes back to the stability of agents’ money-holding preferences—I am sorry to be a bit technical, but there are economists on your Committee. As far as I am concerned, the evidence for the stability of agents’ money-holding preferences is compelling. There are many problems in the short term, but over the medium term those relationships always come back. In my view, the Americans have been incredibly foolish in what they have done. What they did was understandable, but it was nevertheless out of order, quite honestly. What we are doing in terms of the quantities involved is not justified by what is happening in the economy.
The Chair: But you are not making a prediction about the effect on inflation in the UK.
Professor Tim Congdon: I would be surprised if we did not get inflation over 5% for some months. Let us remember what Liam just said. After the last QE, we had inflation for a period of over 5%. I wrote an article in the Sunday Telegraph in late 2006 that pointed out, way before the crisis really hit, that we had rather too high money growth then.
Liam Halligan: You did.
Professor Tim Congdon: I did indeed. These things take a long time to come through, but I am very confident that we will not get inflation back under control either on the other side of the Atlantic or this side of the Atlantic unless money growth comes back to about 5% a year.
Q25 Lord Fox: I think we have already started to establish that there are two sorts of QE. Liam seems to have acted as Tim Congdon’s spokesperson on this, but there is general agreement. What are the limits to QE?
Tim, going back to the Chair’s questions, you talk about inflation of 3% to 5%. For the sake of this inquiry, can you tell us what is wrong with inflation of 3% to 5%? Do you agree that QE has passed a limit that will create that level of inflation? If not, what level of QE will start to create those levels of inflation?
Professor Tim Congdon: As far as any inflation is concerned, if inflation is a tax, it is an unfair tax. It is the clever people and the richer people who exploit these situations. I am one of them, and I know I do. I can judge the situation and make money out of it, frankly. Inflation is not a good thing for any society to have; it is a deeply unfair way of organising any economy and I am totally opposed to it. I am sure that Lord Skidelsky will help us with quotes from Keynes and so on.
As for keeping it under control, the important point is to keep the growth of money at a level that is roughly in line with the trend growth rate of output. Figures like 10% and 15% for the growth of money are not consistent with low inflation and 1% or 2% growth of output. It simply cannot happen. I am afraid that the melancholy experience of Britain through the 1970s and 1980s was in part a demonstration of that.
As to limits, we could have the banking system lending only to the Government, and then the maximum of the state’s claims on the banking system, which increase because of QE, is the ratio of money to GDP. I would say that at a maximum in the UK it is about 100% to 125% of GDP. We do not want to go there, thank you very much. Once you have money growth running at 20% to 30%, you will get inflation of those kinds of numbers too.
Lord Fox: Fran Boait, I suspect that you might come at this from a different angle. What do you see as the limits of QE and the dangers of crossing those limits?
Fran Boait: The Bank has put a limit of 70% on stock of government bonds. We can look at the Bank of Japan to see that you can carry that on for a long time and still have a deflationary environment. We have to recognise that where the money is going matters for where inflation happens. We have seen massive asset price inflation, but at the same time that is not getting into the real economy, as I said before.
We have a banking system whereby 80% of bank lending, which creates new money, goes into property and financial markets; only 10% goes into the real economy, and a further 10% goes into high-cost credit. Those are approximations, but they have stayed the same for the last 10 years. The two things together mean that we have an economy that is driven towards an oversized finance sector, housing bubbles and high asset prices, and QE is fuelling that. If we want to rebalance the economy, we need to do things differently, or at least have other macroeconomic tools alongside QE.
For a long time, we have talked about not doing monetary financing through indirect private sector channels, which do not work. The wealth channel does not work; portfolio rebalancing just goes into the housing market, and the bank lending does not work. As I have said, most of our banks just lend to financial and property markets anyway, so we need fiscal policy to step up and start to rebalance things, alongside a much wider conversation about how we rebalance our economy. That would do a lot more to help us think about how we have fair and even inflation than would a conversation just on the limits of QE. We also need to be clear, if we want QE, about its purpose right now. As we have said, it has changed and has not always been clearly communicated through the Bank.
Lord Fox: I will let subsequent questioners interrogate that one.
The Chair: Fran, I am sorry to interrupt you, but we have quite a lot of questions to get through. If we can try to keep the answers reasonably short and focused on the question, that will help us to get through them. Liam Halligan, Lord Fox rather inelegantly described you as Tim Congdon’s spokesman. I am sure you are nobody’s spokesman. Do you want to pick up that question?
Liam Halligan: That is ironic on so many levels.
Professor Tim Congdon: I understood the irony.
Liam Halligan: Lord Fox, there is nothing wrong with 3% or 4% inflation for a while; it would be quite handy at the moment when we are amassing lots of public sector debt. The trouble is that history shows it is very hard to keep inflation at 3% or 4%, because once you get above 2%, the rope slips and inflationary expectations get into the system.
We grew up in the 1970s, when inflation expectations operated at labour market level, in collective bargaining. There is still quite a lot of collective bargaining in the state sector, which is 25% to 30% of the economy and growing. Those inflationary expectations work down supply chains in the private sector too, so it is hard to keep inflation at 3% or 4%. It very quickly spirals and escalates. When it gets to 7%, 8% or 9%, it starts hammering investment and people keep their money off the table because they are worried about not getting a real – that is, post-inflation – rate of return. I worry about the inflationary expectations of this new variant of QE, to coin a phrase. I think all of us testifying today agree that it is new.
In more general terms, in my job I talk to an awful lot of real-world investors, not people operating in the Square Mile or from their conservatories in Surrey, day trading shares or whatever. These are people deciding whether to build a new factory or expand their business and employ more people. An awful lot of non-financial real-world investors—I can give the Committee names if you want—are seriously spooked by the excessive monetary policy we now have. They worry that we are setting ourselves up for a collapse in the stock market or the bond market, or both.
We are looking at QE infinity. Quite a lot of very adept and articulate campaigners are pushing that idea here in the UK and in the US, such as some people around Joe Biden. It is already very fashionable. We have Alexandria Ocasio-Cortez promoting “Modern Monetary Theory” in Congress, Jacinda Arden, the New Zealand Prime Ministers and all the rest. Everyone thinks, “Let’s just print money for ever”, and, if you disagree, you are a bad person. That is not what history shows is the right thing to do, and we are in danger of running away with ourselves. In my view, inflation is just the first danger from QE infinity.
Q26 Lord Haskel: We have been hearing a lot about the growth of QE. Looking to the future, have the Bank of England and the Treasury become overdependent on QE? Liam Halligan, you said that it has gone too far. What are the implications?
Liam Halligan: The implications are that we have in this country at the moment effectively what János Kornai called soft budget constraints, and soft budget constraints lead to bad economic decision-making. I think the Chancellor is aware of this both privately and publicly; particularly in private he has stressed that there are limits to QE. I am in touch with most living former Chancellors, many of whom privately worry about the implications of QE. If you plot the monthly increase in the public sector net borrowing requirement with the Bank of England’s QE operations since March 2020, you see that it is axiomatically true that QE is being increased in order to meet that public sector net borrowing requirement. It is completely undeniable. When you have soft budget constraints and can just print money to meet your obligations, it leads to bad decision-making, to put it mildly.
Lord Haskel: Tim Congdon, you are obviously very concerned about inflation. With us having become overdependent on QE, do you think that will be the outcome?
Professor Tim Congdon: Yes, but one needs to put it within a framework of national income determination and the theory of determination of price level. That is why I have given a written statement about the link between money and prices. The key is to keep the rate of monetary growth down to, say, 5%. I guess that would be consistent more or less with the inflation targets we have.
The problem at the moment is that money growth is up at 14%. Also if there is a large budget deficit there is a temptation to finance it from the banking system. That creates money and so on. That is part of the problem. The budget deficit needs to be kept down to facilitate monetary control.
The banking system can either finance the state—government, budget deficit—or it can finance the private sector. It is very important that the private sector should have access to flexible, low-cost bank loans. If the state takes up much of the banking system balance sheet—in the extreme, it can take up all the banking system’s assets—there is no scope for companies or households to borrow from the banks, which in my view is a great shame.
Lord Haskel: Fran Boait, you speak about the need for more direct involvement with the real economy. Can that be a way of becoming less dependent on QE?
Fran Boait: Certainly. There are two mechanisms. We have a fiscal policy that recognises we need to spend in the economy. It is fine that QE has supported fiscal spending in the past year, whereas previously they had been pulling in opposite directions, but we need to be transparent about that and to have a framework around monetary and fiscal co‑ordination, recognising that it makes sense for our central bank and our Treasury to work in tandem for the macroeconomic outcomes we want, which include not allowing masses of unemployment because of Covid and the unforeseen fallout from the pandemic.
Apart from getting money in through public spending, the other way is to think about our banking sector, which does an incredibly poor job of getting money into the real economy. It simply is not fit for purpose. Despite economic textbooks saying that what banks do is take money from savers and lend it to businesses, in the UK they actually mostly create money to go into finance and property. We have not seen much change in the last decade, since the crash, despite having quite a wide public conversation about banks not being fit for purpose. Maybe we need to use the opportunity of Brexit to think about how we get our banking sector to serve our domestic economy for better jobs and employment in the real economy.
Q27 Lord King of Lothbury: As this is my first appearance, I declare my interests as shown in the register, in particular my position as Governor of the Bank from 2003 to 2013.
We have spoken a lot this afternoon about the level of QE and, to some extent, whether it is being driven by the Bank to meet its inflation target or by the Treasury to finance its budget deficit. Could I ask you all about the composition of the assets that the central bank buys when it creates more money? Some commentators have talked about the desirability of widening the set of assets that the Bank purchases, to make up a different approach to QE. What is your view about the benefits, costs or advisability of encouraging the Bank to purchase a wider set of assets than government debt? If so, should that come with a different mandate for the Bank?
Fran Boait: We definitely need to think big about alternative approaches to QE in its current form. I have spoken quite extensively about the fact that we see a real need for monetary and fiscal co‑ordination. The Bank of England is operationally independent, but its mandate is set by the Treasury or the Government. We need to make sure that changes are accountable and transparent. There are big challenges in, hopefully, coming out of Covid with a green and fair recovery, which will mean a lot more tools and levers in the macroeconomic policy framework. Thinking about how we can use the Bank of England’s power to create money in the public interest to meet some of those goals will be important.
Liam Halligan: Once the Bank starts buying corporate debt, it is making very political decisions. It will often be buying that debt in distressed circumstances, and the Bank will then be judge and jury on which companies should survive and which should not. I do not think that is what any central bank should be doing, least of all ours. Similarly, once the Bank starts investing in infrastructure bonds to level up the economy, or for whatever reason, these are very political decisions that should be taken by democratically elected Governments with the usual checks and balances.
The least troublesome kind of asset for the Bank to buy is government debt, and we are getting to a point where that is now excessive. On the Bank’s own estimates—it is not discussed very widely—the Bank has been buying gilts at twice the rate it was after the global financial crisis, and we are now headed for a situation where our central bank, in one of the most advanced economies and democracies the world has ever known, owns half of all outstanding gilts. In my view, there is no price exploration in the gilt market; it is not signalling the real cost of borrowing. Investors are accepting yields on gilts because they know the central bank is there basically as a buyer actively determining what those yields are.
Professor Tim Congdon: I agree entirely with what Liam has just said. There are two problems in buying corporate bonds. One is that the company may go bust, so the central bank has losses from the purchase and will immediately be put in front of parliamentary committees and asked why it has lost all this public money on buying private sector paper. On top of that, as Liam emphasised, there is the risk of favouritism and politicisation.
Then there is the whole business of whether the central bank should support a green recovery. It is not the job of a central bank to get involved in lending to companies involved in renewables. That is not what it knows how to do. As far as I am concerned, the assets in which QE operations should be conducted, together with quantitative tightening when it is necessary, are government paper.
Q28 Baroness Kingsmill: I wonder whether quantitative easing, like the poor, is always with us. The two are probably related in some respects. How will it get unwound, and when and to what extent? What are the risks associated with unwinding QE? It has been a very useful tool, but it is now becoming excessive and, therefore, perhaps needs to start unwinding. What would be the criteria and the risks?
Fran Boait: There are significant risks. Debt deflation can be really significant.
Baroness Kingsmill: I meant to get away from the inflationary and de‑inflationary risks.
Fran Boait: Unwinding QE is about debt deflation, mass unemployment and financial instability. That is why it does not look likely that the Bank of England will unwind QE. Indeed, financial markets do not seem to believe that it will be unwound any time soon. The Bank of England should be transparent about that. We should not have to say that it has to be paid back. Rushing to do so could be very dangerous for the economy, with the risks I have just outlined.
Liam Halligan: The trouble is that the more QE you do, the harder it is to retreat. We now have a generation of people in asset markets and financial markets who do not know anything other than QE. The fundamentals have gone out of the window. There is no proper bottom‑up value investing that Ben Graham would recognise; it is all about the momentum coming from central banks. It is an absurd situation, and we are setting ourselves up for another systemic collapse, which will be the third in two decades. It will not make capitalism and smart people like us, who are meant to know what is going on, look very clever, will it?
Look back to when Janet Yellen tried to take QE away a little bit. She did some quantitative tightening. She tried to be Volcker for a while, and she did some interest rate rises. With the best will in the world, there was a taper tantrum and the financial market showed that they ruled the roost, and that is the situation we are now in again. The first prerequisite of a proper retreat from QE to defuse the situation we are in is to admit what is happening and talk about it. Our central banks do not seem able to acknowledge what is happening. They are involved in deficit financing at a huge level. They are involved in a stock market, bond market Ponzi scheme, if you like. If we are to defuse it in a safe way, although the probability of doing that is receding all the time, we have to start to be honest about what is actually happening.
Professor Tim Congdon: To be clear, these things are soluble. The key is low and stable growth in the quantity of money, to refer to the banking system’s liabilities, and we need to match that on the other side of the balance sheet by appropriate growth of banking system assets. We had that for the so-called “nice” years, as Lord King described them. It is possible. We should try to get back there.
Your question is very pertinent because the banking system always holds claims on the state. That was not true for a brief period of two or three years about 15 years ago, but normally it holds claims on the state. At the end of the Second World War, the banking system’s assets in the UK were 85% claims on the state. We are not at that level yet. We can get the budget deficit down and keep it consistent with low growth in the quantity of money. The banking system can be helped to lend to the private sector at a rate consistent with that 5% or so growth of money, and then it will not be necessary to have committees like this and we can relax and enjoy ourselves.
The Chair: I am sure we would like to keep committees like this.
Q29 Baroness Kramer: After the first optimistic statement of the day, Tim, could you talk a little about the Bank’s 2% inflation target? Is it the right target? Is it now something that is acknowledged more in the breach? I think you suggested a tighter target than that as a better way forward for healthy growth in the economy. Can we have your comments on the target? Is there a role for forward guidance? Does that have much meaning?
Professor Tim Congdon: To go back to the 1970s and all the problems with rapid inflation, we brought inflation in Britain down from 27% to 2%, and kept it at 2% on a fairly sustained basis. That was a major achievement of public policy, so it can be done. Even 2% inflation means that the value of money falls dramatically; it is over 85% in 100 years, so even in a lifetime you have to worry about it. The ideal is that we take it that prices will always be as they are today, and that the rate of interest in nominal terms is the same in real terms. It is a much easier way of life. Zero may be taking some risks with deflation, which is a very bad thing and is worse than inflation, so I would say 1% inflation. I do not think most people in British public debate are awfully interested in this subject. If you got it down to 2%, it would be an amazing achievement compared with the 1970s. But there we are. I prefer 1%, which I think is perfectly feasible.
Baroness Kramer: Liam, do you have any comments?
Liam Halligan: It seems okay at the moment because 2020 inflation will be around 1%, but an awful lot of very credible people in mainstream economics are now talking about more inflation to come, so it does not do the authorities’ credibility much good if they start raising the inflation target when inflation is coming down the line. It smacks of moving goalposts and the time when Chancellors’ golden rules were for ever being tweaked in order to avoid them being breached. I think 2% is a reasonable target. To move it now when there are big inflationary dangers would undermine central bank credibility, at a time when questions are increasingly being raised about that credibility.
Baroness Kramer: Fran, do you want to come in?
Fran Boait: I am happy to come in on the question if that is helpful.
I definitely think we need to update the mandate. A 2% inflation target on its own is not enough to reflect the challenges of the day. The Fed has a dual mandate with employment. That could be a way to go, or it could at least be considered in the UK. You mentioned forward guidance. Part of that was looking at employment a few years ago. There are complications with employment because there is so much underemployment. Since the crash, we have seen the Bank having a dual mandate, with financial stability added.
When we speak to people at the Bank of England and the Treasury, we find that the wider problem is that they are very keen for the different mandates to be siloed, so monetary policy is about price stability, separate from financial stability and separate from fiscal and industrial, but we know that the economy is interconnected and all policies have knock-on effects on one another. If we stick to very narrow targets such as 2% inflation, they create blind spots in policy-making and do not allow for the sophisticated discussions we need to have about the challenges we face: private debt, financial instability, housing bubbles and increasing inequality. There are quite a lot. Rather than narrow targets, thinking about frameworks is a good way to go in ensuring that we do not have very siloed ways of doing policy between the different arms of the Bank’s dual mandate and the Treasury and industrial strategy.
Q30 Lord Livingston of Parkhead: Liam, you commented that, effectively, QE was funding government debt and that that link was undeniable. There are some who would deny it. Has the Bank been good enough in communicating its decisions? I do not mean what it is going to do, because that has been pretty clear, but why and how, particularly the linkage almost pound for pound between debt and QE?
Liam Halligan: It is very difficult. I think Alan Greenspan once said to Congress, “If you’ve understood what I’ve said, you’ve misunderstood me”. With all respect to Lord King, part of what central banking is about is looking both ways and trying to square policy circles.
It is easy for me as a teenage scribbler to write columns saying that we need to be more honest about what is happening, but I understand that, if the Bank of England is completely open and transparent, that could itself be counterproductive. There is a range of openness and transparency. At all times, the central bank has to remain credible. There are times when it has to acknowledge the obvious, and it is now completely obvious what is happening. That is why I may sound slightly disrespectful in saying this, although I do not mean to be for one moment. I think we have reached a point where the link between government borrowing at the margin and QE at the margin is now so obvious and clear to anybody with an internet link and an Excel spreadsheet to draw the graph that we need to start talking about the implications of that. The implications are not just financial and systemic; they are also democratic. I would worry about a dual mandate. The Fed has a dual mandate because it still has the world’s reserve currency—just about. We do not have a reserve currency. The central banking regime that we have is precious and was hard won through the tough years of the 1970s.
Lord Livingston of Parkhead: I think we are going into a different area. I meant just communication, but I get your point. Fran, do you think that the Bank has communicated adequately why it is doing things?
Fran Boait: We have said that it could do a lot better. We do our best to bring the general public into these conversations and translate what is going on for them. We have seen quite poor understanding in Parliament, which is there to hold the Bank of England to account, on some of these issues. There is not necessarily support from Parliament on QE. A poll in 2018 showed that only a third of MPs supported its further use, and only 15% polled in 2017 had an accurate understanding of money creation in the modern economy. There is work to be done.
Sometimes, the Bank has been quite poor at explaining the trade-offs openly and transparently, and it has tried to keep everything simple when we know that it is not. More recently, Andrew Bailey has at times implied that QE has been expanded in the last year to support fiscal spending, government spending, and at other times he has tried to deny that. That is an example of where things could be improved.
On the inequality front, it was quite disappointing when Mark Carney, in 2017 I think, went on the defensive around QE, saying that the poorest had gained the most from it and using very narrow data analysis to prove that point—
Lord Livingston of Parkhead: In summary, you are saying that the Bank could do a lot more about explaining the why and what it thinks the impacts are.
Fran Boait: Yes. There was a recent report by the Independent Evaluation Office of the Bank of England that made some suggestions, particularly on communicating the ways that QE should or does interact with fiscal policy, which is important, but there is a lot more we can do. Being honest about the difficulty of the challenges is important.
Q31 Lord Monks: I have a question for Tim Congdon. Others may want to add to it. We have had an independent central bank since 1997, so to whom is the Bank of England accountable for its monetary policy decisions? Is it accountable? We know that the Treasury has to approve in advance the issue of QE, but that does not change the basic constitutional relationship. Are the controls or the accountability mechanisms adequate? What can we do about that?
The Chair: Lord Skidelsky wants to ask a similar question. Lord Monks, would you mind if I asked him to put his question, and then we can deal with both answers together?
Lord Monks: By all means.
Q32 Lord Skidelsky: If the Bank of England has been acting as the agent of the Treasury, as Liam said, is the operational independence of the Bank a fiction? Is it not the fact that the operational control of inflation is the responsibility of the Treasury? Are we not perpetuating mystification by pretending otherwise?
The Chair: That is accountability and independence.
Professor Tim Congdon: The Government’s borrowing can be financed either from the banking system or from non-banks; it can be financed from abroad. The effects on the quantity of money and on the economy are very different. Those are properly decisions for monetary policymakers. In my view, monetary policymakers should talk to, interact with, be friendly with and co‑operate with the finance ministry. They should be doing that all the time. They should be grown-ups; they should not regard themselves as having particular bits of turf that are theirs. They have to work together.
Having said that, it is possible to combine budget deficits with low monetary growth, and these are things that have to be sorted out by public policymakers thinking together in the large. Decisions about the rate of interest appropriate to determining and influencing the rate of growth of credit to the private sector can, in my view, be left to an independent central bank, and ideally should be left to an independent central bank, with as little Government control and interference as possible.
Fran Boait: We have to remember that the Bank is operationally independent but its mandate is set by the Treasury, and therefore by the Government, so it makes sense that they would work together. One of the Bank of England’s secondary mandates is to serve the Government, so the idea that it has been totally separate since 1997 is not true. I also do not think it is a sensible idea. The Bank of England should be accountable to Parliament and the public, and we probably need greater communication if that is to be at an adequate level.
There has been a disconnect over the last decade, as things changed quite rapidly after the great financial crash and over the past year under Covid and the pandemic. In order for the Bank of England to be accountable to Parliament and the public, we need a full and accurate picture of what it is doing and why. We need to be clear about the different options. Rather than it being a choice between QE or nothing, a lot of other options are on the table. Moving towards a new framework, a new settlement that brings some aspects of central bank policy-making into the open, would be welcome. What is most important is that we have our economic institutions working together and complementing one another, not pulling in different directions.
Liam Halligan: Lord Monks is correct. Accountability is important, but independence is important too for a central bank to have credible policy. That is one of the key lessons of decades of economic history. There has always been blurriness about the independence of the central bank, and there always will be, as Tim intimated, but lockdown has blown any idea of independence completely out of the window, arguably for good reason. We are in an extreme situation. No one is trying to score points, but the independence and credibility of the central bank have been seriously dented during lockdown. That is why we need honest, open debate: not to make the central bank less independent and more part of the Treasury but for it to assert its independence—to make it more independent.
The Chair: I know we started late, and time is against us, but Lord Stern has a question.
Q33 Lord Stern of Brentford: I do not know whether we have time for three answers to my question. Essentially, would you see any difference between the second round of QE now, when it is part of an attempt to prevent the collapse of employment in the economy, and the use of QE and its effects at another time, when the counterfactual is not the potential collapse in employment? Do you see a difference between those two things and their effects?
Professor Tim Congdon: To be clear, in both 2009 and last year the concern was to keep up employment. What was going on in 2009 was a very severe recession, and the worry last year was what would be lost in travel, restaurants, hotels and so on. In my view, you should not use a general macroeconomic demand instrument or approach to deal with sectoral-specific issues, but we have not really touched on that in this session. There is no doubt that QE last year and at present is very different in its context from what was going on in 2009, but in both cases there is concern to make employment more than it otherwise would be.
Liam Halligan: I take my life into my hands quoting Keynes, given some of the people on this committee, but as Keynes wrote to FDR in 1933, thinking you can increase output by increasing the money supply is a bit like “trying to get fat by buying a larger belt”. At the heart of your question, Lord Stern, is that we are facing a lot of unemployment and clearly there will be huge political pressure to do something about it.
Personally, I do not think, and I do not think history would suggest otherwise, that the way to tackle unemployment is to expand the central bank’s balance sheet. The way to address unemployment is to make the economy more efficient, with supply side measures for the most part, to enhance business confidence. There may be some areas at the edges where state investment can enable private sector investment to come forward, which is what ultimately drives all sustainable growth. We are in danger of our politics lapsing into a very unanalytical situation where there is no hard budget constraint, where a consensus emerges that all we need to do is print money and anyone who disagrees with that is immoral. That is the wormhole we are in danger of disappearing down.
Lord Stern of Brentford: To ask an analytical question, do you think that the supply side measures you describe would have prevented an immediate collapse in employment as a result of the lockdown last year?
Liam Halligan: Just as in 2009, we were in a very extreme situation. In 2009, with no QE we would have had a banking collapse with all the civic unrest that that gives. I am about to broadcast a documentary on Channel 4 about regional degradation levels today. They are absolutely scary at the moment, as my programme will reveal. I am not completely against any kind of QE; it is all about degree. But I think economists have got themselves into a situation where, even outside extreme situations like 2009 and lockdown, they think the answer to any problem is to print lots of money: “Oh, the growth figures are not looking very good. Let’s print lots of money”. That has been the history of the last 10 years, and economists have to push back against that.
Fran Boait: We have to learn from the mistakes of the last decade, when QE coupled with fiscal austerity was a disaster for wage growth and employment in this country. We had an incredible amount of underemployment, and the fallout from Covid in the past year has meant that we are potentially on the brink of mass unemployment if the wrong decisions are made. It would be a mistake to say that we need to stop QE that is supporting government spending. We need fiscal and monetary co‑ordination.
On the point about the amount of money, we need to ask continually where the money is going. If the money is going into stock markets, financial markets and property, carrying on the status quo, that will not get us out of an employment crisis. We need to think longer term about linking together monetary, fiscal and an industrial strategy if we are to come out of Covid with a green and fair recovery, which seems to be what most politicians and the public want.
The Chair: On that note, we are out of time. Lord Haskel has had to depart to sit on the Woolsack. I thank our three witnesses for a really interesting session. It has been very helpful. You are very welcome to stay for panel 2.