Treasury Committee

Oral evidence: The Effectiveness and Impact of Post‑2008 UK Monetary Policy, HC 1040

Wednesday 1 March 2017

Ordered by the House of Commons to be published on Wednesday 1 March 2017

Watch the meeting 

Members present: Mr Andrew Tyrie (Chair); Mr Steve Baker; Helen Goodman; Stephen Hammond; George Kerevan; Kit Malthouse; John Mann; Chris Philp; Mr Jacob Rees-Mogg; Rachel Reeves; Wes Streeting.

Questions 1‑84

Witnesses

I: Professor Sir Charles Bean, London School of Economics and Office for Budgetary Responsibility; Professor David Miles, Imperial College London; Detlev Schlichter, The Cobden Centre.

Examination of Witnesses

Witnesses: Professor Sir Charles Bean, Professor David Miles and Detlev Schlichter.

Q1                Chair: Thank you very much for coming to see us.  As you can see by looking in our direction, the whole Committee without exception is on parade to take evidence from you this afternoon, which is perhaps a reflection of the importance that the Committee attaches to this subject. 

Can I begin with a question of political economy, maybe to you, Sir Charles?  We created, on an emergency basis, a very unusual arrangement, whereby the Bank acquired on its balance sheet a huge stock of bonds, for which the Treasury, which is the taxpayer out there, our voters, has to bear an indemnity.  The Bank has virtual total control over what happens to that stock and may make errors costing a fortune, at some time in the future, adding to which, sitting alongside, you could argue outside the formal remit of the MPC, is the task of managing and then running off this stock.  Have we got the accountability arrangements right?  What are we going to do for the future?  Can we carry on like this indefinitely?

Professor Sir Charles Bean: You are right to raise this as an issue, and indeed it was something we were conscious of when the asset purchase facility was first set up back in 2009.  It is a vehicle that is owned by the Treasury; the Treasury has the financial interest obviously, so any gains or losses ultimately impinge on the taxpayer. 

There are two particular aspects that are worth drawing attention to.  First, it explains why every time the MPC wants to make additional asset purchases it has to get the consent of the Chancellor.  That was quite deliberately to try to tie the fiscal authorities into the decision, so you could not have a situation further down the road where people said the MPC bought x billion of gilts and has made so many billions of losses on it, and that this is all impinging on the taxpayer; who gave them the right to do that?  There will automatically be a shared responsibility with the Treasury.  The second thing I would say is that it also partly accounts for why the Bank has hitherto been very reluctant to go beyond predominantly buying gilts as the counterpart to the expansion.

Chair: That in turn has aggravated the distributional consequences and the distortive effects of the policy.

Professor Sir Charles Bean: Even if we had been buying other assets, there would still be distributional consequences, but it is worth saying that, to the extent that the MPC engages in buying a lot of private securities, corporate bonds, mortgage‑backed securities and equities—you could have a very big range of assets it might buy—there is obviously the potential for losses on those.  Also, if you are buying private credit instruments, inevitably you raise the question about which companies’ securities you are buying and if they should favour a particular part and so on.  That also has a significant political economy dimension.  For that reason, the Bank management always wanted to try to stick to plain vanilla quantitative easing, if you like, focusing very largely on gilts. 

Q2                Chair: That is explaining where we are, but that is not quite the question I was asking, which is where we go from here.  Can we carry on indefinitely with the management of this stock in this shape and with this line of accountability?  Is there a case for some other set of arrangements to be put in place, which involves Parliament more?  After all, you yourself said just a moment ago that it is really partly fiscal policy.  QE is not purely monetary policy.

Professor Sir Charles Bean: Indeed, and central banks have felt uncomfortable about the extent to which they have been pulled more and more into territory that is rightly the domain of politicians.  We would prefer to get back to a world of nice, simple, plain vanilla monetary policy, where you just manipulate the short‑term interest rate.  The one thing that is worth saying is that I think it is unlikely that the asset purchases that have been made hitherto will lead to a significant cost to the taxpayer—in fact quite the opposite—simply because, at the circumstances when the gilts were bought and the likely future evolution of Bank rate, it is very, very unlikely that there would be losses accrued to the taxpayer.  The expectation is that there will be a substantial profit in an accounting sense.

Chair: It should be noted that Sir Charles has entered the forecasting business.  Market conditions can change. 

Professor Sir Charles Bean: Circumstances can certainly change, but it would need a very big change in the future part of the underlying natural real interest rate of the world economy to invalidate what I have just said.

Q3                Chair: Do you have any suggestions to make on the accountability issue that I am raising here that we should consider as a group?

Professor Sir Charles Bean: It is a good question about what you might want to put in place to strengthen it.  Clearly you already hold the MPC to account, through the regular hearings after the inflation report and so forth, and that obviously accompanies the asset purchase.  The question is whether you need to bolster that in some way.  It is worth just noting that, although I pointed out that to expand the facility requires the formal consent of the Chancellor, running down the facility, as I hope will happen at some stage in the future, does not formally require the Chancellor.

Chair: That is an unusual asymmetry.

Professor Sir Charles Bean: Except that running down will be associated with putting upward pressure on longer‑term yields.  Most Chancellors will be happy to see lower yields, because they are reducing the cost of financing the deficit, but therefore will not like it so much when it goes into reverse. 

Q4                Chair: You have just touched on one of the moral hazard aspects of all this that requires some discipline to be imposed by Parliament on the Executive.  Could I ask you to take away the thought about how that bolstering might be accomplished, and maybe come back to us?  He may have some suggestions, but I would like your considered ones outside of this meeting.  Perhaps you could write to us on that. 

Professor Miles: I just wanted to offer a thought on the longer run. At some point, the degree to which you want monetary policy to be expansionary will diminish.  I hope we get there within my life and within a few years, hopefully.  At that point, it makes sense to start selling most of the assets that sit in the APF, but I do not think that that is the point at which the assets overall are sold by the Bank of England.  The reason is this: for the funding for the £400 billion or so of purchases so far, the counterpart on the liability side of the balance sheet is the reserves of the banking system.  Before the financial crisis, the reserves that commercial banks in the UK held at the Bank of England were miniscule, absolutely tiny.  In retrospect, they were ludicrously less than should have been held, given what we now know.

Q5                Chair: There is an argument for a larger balance sheet, but not this big.  We have got that point.  I am trying to move the discussion on to the point about what we are going to do about the stocks. 

Professor Miles: It is relevant to monitoring how the asset side is structured.  Supposing that the commercial banks want to continue holding as many reserves as they have at the moment.  For monetary policy purposes, the gilts will start to be sold, but they could essentially be bought by another bit of the Bank.  At that point, if that is what happens, most of the assets may not be sold.  They will sit in another part of the Bank, which will be the responsibility not of the Monetary Policy Committee but of the executives of the Bank that are in charge of the overall riskiness of the Bank of England’s balance sheet.  It will change and the criteria they may use will be different from the criteria that the Monetary Policy Committee uses to decide what kinds of assets they should be holding.

Q6                Chair: Can I ask you also to think about what you might drop us a line on in this field, for the longer term?  Mr Schlichter, you are new to the Committee.  These two are old hands, with one hat on or another.  In fact, Sir Charles has worn several hats over the years.  What do you think about this issue?

Detlev Schlichter: I agree with Sir Charles that, at first, the operation of QE is probably more profitable for the central bank.  That is certainly the case with all the central banks that are doing QE right now.  They are creating bank reserves, which are the deposits that the banks hold with the central bank.  Usually, in our environment, the Bank of England or other central banks pay the banks no interest on those reserves.  Obviously they buy interest‑bearing or dividend‑paying securities as part of their QE operations.  As long as this process goes on, it is more likely to be a profitable operation for the central bank. 

I am not familiar with the specifics of central bank accounting and what the arrangement is in this country, but I assume that in most countries central banks give the profits back to the Treasury and, in that sense, the Treasury pays coupons on Government bonds that are held by the central bank.  The central bank collects these coupons, they become part of central bank profits and they are handed back to the Treasury.  As long as this holds, I do not think there will be a big problem. 

The problem arises if we were to be in a situation where the central bank wants to offload these assets and do this in a market environment in which, suddenly, they realise much lower prices.  Maybe that could be the case in a highly inflationary environment, but I do not think that is very imminent.  I do not think the idea that the QE operation is a problem for the taxpayer in the immediate future is an issue. 

Chair: That is not really what I was asking.  If we made a profit, it might be a profit that could have been larger or it may be a profit that politicians, for various reasons, might have decided not to realise at the time, had they the control of the assets, so it is an accountability issue, rather than the idea that I was asking about.  Perhaps you would reflect on it as well.  I am going to move the questioning on, because we have already spent some time on this, and I know that Kit Malthouse has some follow‑up questions.

Q7                Kit Malthouse: I think you have broadly covered it, Chairman, but thank you.  I just wanted to ask you about some of the distortive effects of QE.  When we had the Governor here the last time before one, he denied that QE had pumped asset prices.  Do you think that that is correct or incorrect?  Has QE and an ultra‑low interest rate inflated asset prices?

Professor Sir Charles Bean: I am not familiar with exactly what he said.  It strikes me as strange to suggest that QE would have no effect on asset prices. 

Kit Malthouse: It was a kind of throwaway remark, as I remember.

Professor Sir Charles Bean: It is precisely the primary mechanism for how it is supposed to stimulate demand.  The Bank buys gilts and pays for it by issuing extra reserves.  People do something with those reserves that have been issued.  That pushes up asset prices in general—equity prices, corporate bond prices and so forth—lowers the yield on them and encourages investment and higher wealth, and also stimulates demand directly.  That is the classic transmission mechanism for QE and what is referred to as the portfolio rebalancing channel.  There are some other mechanisms, but on the MPC we always thought that that was the primary route through which QE operated. 

The empirical evidence, looking at so‑called event studies, which is where you look at the responses of market prices to announcements of QE programmes, suggests that, certainly in 2009 when we and the Fed first started buying assets, purchases worth about 10% of GDP lowered 10‑year bond yields by a little under 100 basis points.  That then had ripple effects through all asset prices in the economy.

Q8                Kit Malthouse: Are there particular asset classes where the effect has been marked, or has it been a general rise?

Professor Miles: At the point when asset purchases were being undertaken at their most rapid rate, in 2009, £200 billion of gilts were bought.  At that point, the corporate bond market was completely dysfunctional.  That was the point at which the asset purchases began.  A year later that market was operating a bit more smoothly.  Over that one‑year period, the reduction in corporate bond yields was enormous.  It was far, far larger than the reduction in gilt yields.  At the time, I took the view that the main beneficiary effect of asset purchases was to try to sort out ridiculously high yields in the corporate bond market.  The yield on high‑yield more risky corporate bonds fell by 20% over that year.  Gilt yields fell by 1%.  That was partly to do with QE, because we were buying gilts and the people who sold the gilts looked for an alternative asset that was a bit like gilts.  Sterling corporate bonds are that asset.  It had a big impact on the prices back then, but it has been much less since then.

Detlev Schlichter: There were various studies by the Bank of England.  Just looking at the website, they had the Quarterly Bulletin for the third quarter of 2011, “The United Kingdom’s quantitative easing policy: design, operation and impact”, and also the working paper by Mr Haldane from October last year.  All these studies find that quantitative easing did have an impact on lowering Government bond yields, compressing corporate bond spreads, potentially boosting equity prices and also weakening sterling.  I think Sir Charles is absolutely correct; this is by design.  This policy is intended to change market prices.  The question from my point of view is if that is advisable in the long run.  If the goal was to implement a policy that changes market prices, according to the study of the Bank of England, that has been achieved.

Q9                Kit Malthouse: Does that present an increased stability risk for the future?

Detlev Schlichter: We assume that without that policy, yields would have been higher.  I am just quoting the research from the Bank of England itself.  Without the policy, yields would be higher; corporate bond spreads would be wider; equity prices would be lower; maybe house prices would be lower.  The first thing we have to recognise with any of these policies is that, by definition, the policy creates winners and losers.  Part of the debate about quantitative easing that I find problematic is that it often talks about aggregates.  It has boosted aggregate GDP or increased the aggregate price level.  It will have done so by creating winners and losers, and by distributing.  Some companies win; some sectors win; others lose. 

The economy is not just performing at a higher level; it is a different economy.  You have changed the operation of the economy.  In my view that is a dangerous direction to take for the simple reason that we would assume in a market that, for example, corporate bond spreads or the yields on the Government bond yield curve would give us information about the preference of savers and of investors and reflect the true underlying risk of corporate issuers of corporate debt.  For the central bank to step into these markets and begin to change price behaviour, there is a fundamental problem.

Professor Sir Charles Bean: I have a slightly different perspective on it, although I certainly do not dismiss these concerns.  What is clearly true is that you have another significant actor in the market, which is clearly affecting relative rates of return.  It certainly has distributional effects, but it is worth recognising that monetary policy always has distributional effects, even when it is operated through the conventional short‑term policy rate. 

The significant difference here is that, with normal business cycles, people accept that sometimes the interest rate is a bit higher, sometimes it is a bit lower, sometimes unemployment goes up a bit and sometimes it goes down a bit.  It is swings and roundabouts.  What marks out the current episode is that it has just gone on for so long.  When we embarked on QE, I thought we would probably be reversing it in the course of two years, once the emergency was over, yet here we are.  It is almost a decade since the financial crisis started.  We still have a very large balance sheet and, in fact, the Bank is marginally adding to it, at the moment.  The Fed has just started to normalise policy.  When I left the MPC in 2014, I expected that, towards the end of that year, maybe the Bank would be starting to raise rates, but actually they have cut it since then.  The episode has gone on longer, which has made people much more conscious of the distributional consequences than would have been the case if this had been much more short‑lived. 

Chair: Do you want to come on to this in more depth?

Q10            Kit Malthouse: Yes, I will come on to it in more depth.  Professor Miles, did you have anything to add?  Because I know you have done some work in the area, I wanted to ask you specifically about the housing market.

Professor Miles: I suspect there is a bit of an impact of QE on the housing market.  I do not think it is the strongest impact of QE at all, but it probably brought down the price of some mortgages a bit, because most sold in the last 10 years have been short‑term fixed‑rate mortgages, the pricing of which is a bit sensitive to the position of the yield curve, not just the Bank of England Bank rate, so it probably made mortgages a bit cheaper than they otherwise would have been.  However, there are other, more long‑term fundamental factors behind rising house prices, which actually have very little to do with QE.

Q11            Kit Malthouse: There is one area I wanted to ask you about.  I have to declare an interest, Mr Chairman, as I own a business that operates in the commercial finance market.  It is whether you have looked at or considered the anti‑competitive impact of QE and the other measures that the Bank has taken, to the extent that the big players in the market have access to lots of liquidity at very low rates, which means that they are able to dominate over smaller players, in a way that they have not been able to do in the past, which is making the market distorted in that direction and very inefficient.  Has there been any look at how QE effectively gives an advantage to the bigger players in the market and creates a much more concentrated commercial lending market?

Professor Sir Charles Bean: I have to say that I am not aware of any work that has been done.  I certainly cannot remember anything that we have done at the Bank.  They may have done something subsequent to me leaving, of course, and there may have been work on the financial stability side that I was not aware of.  Equally, I am not aware of any analogous work in the academic world, unless David knows of anything.

Professor Miles: No, I do not.

Q12            Kit Malthouse: It is just really an interesting phenomenon market‑wise, where we have one large dominant player, RBS through Lombard, which does not operate under the same rules of moral hazard, shareholders, return on capital and all the rest of it, and also has access to this incredibly cheap funding and security from the central bank.  My impression is that it is distorting the commercial lending market.  I know others want to ask you about zombie companies in the future, but if nobody has looked at it, then obviously nobody is bothered about the effect on my business and me, but there we are.

Chair: I would not go that far.  Do you want to say anything in response?

Professor Miles: Just one thing: I think I am right in saying that there is a very large number of banks, including quite small banks, which can access the banking and lending facilities, the discount window facility, and the new Term Funding Scheme, which is kind of the successor to the Funding for Lending Scheme.  Those operations, which allow banks to borrow for relatively long periods at very low interest rates—Bank rate—are not just for the big banks.

Kit Malthouse: That is true: you have to have a banking licence and will also receive benefits if you can operate at scale.  The small challenger banks do not have the scale to cope.  They have to charge rates that allow them to cover their administration costs, which are disproportionate for them in any event. 

Q13            Chris Philp: Good afternoon.  Sir Charles, have you or the committee done any analysis of what might have happened without the QE programme that the Bank has pursued over the past eight years?

Professor Sir Charles Bean: In effect, yes.  The studies that have been carried out about the impact of QE are implicitly telling you how it would have looked if we had not done it.  I quoted the so‑called event studies for the UK and for other countries, which suggest, at least during the worst of the Great Recession, a 10% of GDP bullet of purchases would knock about 100 basis points off 10‑year yields.  The implication is that if we had not done that, yields would have been 100 basis points higher.  Where it becomes a bit more tenuous is the more interesting question about what the impact of that was on the real economy.

Q14            Chris Philp: That was my next question—specifically inflation and being behind the curve in asset prices.

Professor Sir Charles Bean: Certainly while I was there, the Bank did work trying to assess the impact of the consequent changes in rates and asset prices on the QE programme and how they might have impacted GDP and inflation.  I have forgotten the exact numbers, but my recollection is something like adding 1.5% to GDP.

Detlev Schlichter: I have the table here.  This is the 2011 Q3 report by the Bank of England.  They had three or four different methodologies and it came out that the peak impact of the first round of QE, which was £200 billion from March 2009 into 2010, was about 1.5% to 2% on GDP and about 0.75% to 1.5% on CPI. 

Professor Sir Charles Bean: That is the peak effect.  The key thing to say about those numbers is that they are not independent assessments of that monetary impulse.  The way they were calculated was essentially to take the interest rate responses you get from these event studies and then use standard multipliers from the past about how investment and consumption would be affected by a given change in interest rates.

Q15            Chris Philp: Is it possible that those assumed impacts actually understate the impact of QE in those years 2008‑09, those years of crisis?  I would imagine that, at that time, standard multipliers probably would not apply and in fact all the models did not predict what happened.  One might possibly say that QE staved off a sense of crisis and a general lack of money supply that might have had far worse consequences than those relatively modest numbers you just read out. 

Professor Sir Charles Bean: I certainly think that is possible.  My view is that the first round of QE in 2008‑09 was likely to have been particularly effective, not only because of these asset price effects that we have been talking about, but it also sent a signal that the authorities were really determined to put a floor under the collapse in demand and avoid the sorts of mistakes that were made during the Great Depression, when GDP collapsed 25% in the US.  That indirect confidence effect was important. 

Q16            Chris Philp: Are you suggesting that, but for QE, 2008, 2009 and 2010 might have resembled the Great Depression?

Professor Sir Charles Bean: No, it would have taken a lot more than that to have hit GDP by 25%.  There were a lot of big mistakes that the Fed and other actors made during the inter‑war period, but it helped to put a floor and stop demand continuing to contract after the initial hit to consumption and investment after the collapse of Lehman.

Q17            Chris Philp: You referred in an earlier answer to the fact that your initial expectation, when this was put in place, was that it might last for two or three years.  It has now been almost eight years.  In fact, the eighth anniversary is probably in a couple of weeks’ time.  What sort of conditions does each member of the panel think would have to apply before we start to unwind QE, and what might the consequences of that be when do?  Perhaps I could start with Professor Miles and then move across.

Professor Miles: It is when the economy looks like it is building up a bit more of a head of steam than we have seen over the last few years, and there is in inflation, which in the short term is going to go above the target level for sure, but looks like it is going to be hovering around the target level more sustainably.  We may reach that position relatively soon.  The first step would be to start increasing Bank rate off the floor and that would be a welcome day, actually.  That is not a bad day; that is a good day. 

Q18            Chris Philp: Why would you increase rates first rather than unwind QE first?

Professor Miles: I have two thoughts on that.  One is that I do think there are some unfortunate side effects of having Bank rate so very low, and they are probably more serious than the Bank holding £400 billion of gilts.  I would quite like to see that as the first step. 

Q19            Chris Philp: What are those consequences that concern you?

Professor Miles: It is squeezing margins within the banking sector.  We have probably got to a level where some banks are finding it pretty difficult to live with such a low level of Bank rate.  That problem is less bad than it was a little while ago, but it still has not gone entirely.  If you want to achieve a certain reduction in the expansiveness of policy, my own feeling is that it is a very good idea to do it on Bank rate first and the QE sales can come later.

Professor Sir Charles Bean: Can I just expand on that?  First of all on the squeeze on bank profit margins, it is worth saying that the reason we stopped at half back in early 2009, rather than going even lower, was precisely because of the potential adverse effects of squeezing bank profit margins even more.  First, that might have led to more of them falling over, which would have been bad for general confidence.  Secondly, the squeeze on bank margins could also potentially lead to a further impairment in the supply of credit.  Over the past year, the Bank has looked at that again and decided it could safely cut a bit more, to 0.25%, but like David I think there is at least an argument for wanting to try to reverse that when circumstances are appropriate.

The second thing I would say is that there is also a more pragmatic reason for wanting to get Bank rate clear of what you regard as its floor before you start actively selling the APF’s assets, and that is because you really have to set out a programme of asset sales.  You do not try to sell £100 billion one day; you say you will sell £25 billion over six months or whatever it might be.  You do it slowly to try to keep the markets reasonably orderly.  Now of course there is always the possibility that you may have an adverse shock during that period and, if you have Bank rate clear of the floor, you can subsequently cut it, so the Bank rate becomes the marginal policy instrument.  We certainly took the view, and I think it is the right view, that you really only want to start a programme of asset sales when you are reasonably confident that you are well clear of that floor and can do it in a methodical manner over a reasonable period.

Q20            Chris Philp: Mr Schlichter, do you concur with your colleagues on this question?

Detlev Schlichter: I do not quite.  I think your question was what the requirements are for us to move to a higher Bank rate and unwind QE.

Chris Philp: Yes, and which first: QE or rates?

Detlev Schlichter: For either of these things to happen, we would probably have to see a complete chance in the philosophy of the central banks to monetary policy.  As long as the central banks assume their responsibility to manage aggregate demand in the economy, they will not get out of this QE situation, in my view.  If you have a quick look at it globally, the first central bank to start QE was the Bank of Japan in 1999 to 2001.  None of the central banks have so far managed to reduce their balance sheets at all.  The furthest ahead in terms of normalising policy is obviously the Federal Reserve—they managed two rate hikes in two years, but they are still sat on the same balance sheet.  Looking internationally, all these central banks have moved themselves into the same position so far. 

I would take a step back and ask how all these central banks could move into this position.  We have to go back a little.  If I take the Bank of England, between 1997 and 2007, the bank reserves in this country grew on average by about 11% every year, which means M1 grew by about 11% every year, and M2 and M4 by about 8% and 6% every year.  That is phenomenal monetary growth over a 10‑year period, every year.  Why was this done?  The reason is simply that we were at a time of fairly low inflation, partially because of structural changes.  The Governor of the Bank of England explained to this Committee about effects like China entering global trade, the internet and whatever it was.  This was taken as an opportunity to run a bit more of a positive expansionary monetary policy, because inflation would have been lower than 2% if the central bank had not run a more expansionary policy. 

This policy has obviously affected other parts of the economy.  We have already discussed how it is always distortive.  It created housing bubbles.  It created a massive growth in bank balance sheets.  It created more credit accumulation.  You can see a massive growth in the pile of debt.  This all came to an end in 2007‑08 and this was a global phenomenon.  QE is now only the next logical step for the central bank, now that they have reached the lower bound.  All these central banks now have to buy assets to keep accommodative policy in place.  This policy is geared at the margin to keep the economy from contracting, but at the same time it also keeps the debt pile high up.  The global economy has not deleveraged.  The UK economy has seen the private sector deleveraging by about 15% of GDP since the crisis.  This is all made up by public sector re‑leveraging, so the total debt wealth has not changed in this country.  In the United States, private sector debt is now higher than it was in 2007, when the crisis first started.  There is obviously no deleveraging going on in Japan. 

Now that the central banks try to stimulate economies through monetary means, which have a very extensive debt allocation and they have not worked that off, monetary policy becomes ever less powerful on the margin.  It becomes ever more difficult to get that extra effect.  The diminishing return of monetary policy is massive and even documented by the Bank of England when talking about quantitative easing.  My prediction has to be that, over the next couple of years, we will see another economic downturn and then we are back to more QE for any or all of these economies.  Unless we see a fundamental change in what monetary policy is about, what it should do or should not do, we are digging a deeper hole.

Q21            Chris Philp: That was very interesting; you are predicting that QE is here to stay forever.  You mentioned earlier, Mr Schlichter, that there are winners and losers created by this policy.  Can you very briefly outline who you think those winners and losers are?

Chair: We are going to come on to the distributional issues in more detail, so you can be brief.

Detlev Schlichter: It is very difficult to say in the short run.  I could not even say that households lose or pensioners lose.  It is very complicated.  It will depend on what your financial position is.  Obviously people who had a big share of their portfolio, who had wealth and who had it allocated in financial assets, have obviously benefited recently.  The average household in the UK holds about £1,500 in bank deposits.  They have certainly lost.  People who have more financial assets have gained.  These tend to be wealthier people; they also tend to be older people, so there are inter‑generational aspects as well. 

It is obviously very difficult to disentangle all these effects, because the Bank of England has a point when they say, “Would there have been more job losses?”  There potentially would have been.  Would more companies have closed if these policies had not been done?  It is very difficult to weigh up all these impacts.  My biggest concern is simply that there is no way out of this policy.

Chair: A moment ago you said that unless there is a fundamental change in policy, there is no way out.  I think that is a good cue for Steve Baker to ask you a few questions.

Q22            Mr Baker: Good afternoon.  Before I start, I should just say that I am a trustee of the Cobden Centre, of which Detlev is a senior fellow, and I endorsed his excellent book.  Since it is peripherally relevant today, I should also say that I am a seed investor in Glint Pay, although that still falls below the declarable threshold for the House. 

With all of that out of the way, I think some of the things that I wanted to ask about have already been touched on, but I want to come on to ultra‑low interest rates.  For about eight years, we have had monetary policy and we have had interest rates at a level that the Governor described as extraordinary, if not an emergency.  I want to come back to this point about aggregate demand, because it seems to me that this approach of stimulating the economy is a fundamentally Keynesian one of wishing to produce aggregate demand through lower interest rates.  Detlev, I just want to give you this opportunity to talk about why it is that you think that that policy has not produced the effects that were expected, why it has taken longer, as has been explained, than was expected to get out of this position and where you think it leads.

Detlev Schlichter: It is part of what I referred to in the previous answer.  Sir Charles was correct when he said earlier that every kind of stimulatory monetary policy has distorting effects, even when we have conventional monetary policy.  Whenever monetary policy boosts aggregate demand, it does so by hugely lowering the interest rates.  I would call it artificially making credit cheaper and encouraging extra borrowing.  This certainly has a stimulatory effect in the short run.  I find it very interesting; if you look at the analysis the Bank of England has done about QE, from what I can see, I give them credit for correctly lowering borrowing costs, encouraging extra credit and therefore giving a stimulatory effect to the economy, in the short run. 

My question only is about what the long‑run effects of that kind of policy are?  Once that effect has played out, obviously the economy is more highly indebted and credit has been built up in the economy that would otherwise not be there.  Without going too much into the fields of economic modelling and economic theory, there is one line of thought that would say that the extent to which we can accumulate credit in the economy would ultimately depend on how much voluntary saving we have on the other side.  Interest rates are one important factor of price, or the relative price, that help us to allocate savings and determine to what extent the economy can build up and sustain a capital structure that only pays off in the long run, which means low interest rates, and that will build out a productive structure that only gives us return further down the road.  This is what low interest rates do. 

If they are artificially lowered, you have a higher build‑up of credit and more investment.  That sounds good at first, but it ultimately may not be supported by the voluntary decisions of the public.  It may not be supported by voluntary savings.  It is an artificial credit boom, if you like.  Central banks can do this.  In the short run, we see the effects of stronger growth; we see high employment and high inflation, and all the effects we had between 1997 and 2007, but they always come at the effect of distorting the economy and distorting capital allocation.  This will ultimately have to be corrected. 

In this theory, one way to think about recession is not as something that suddenly happens like an accident, where something suddenly goes wrong.  Something had gone wrong before the recession hit.  The recession is almost a process by which the economy forces itself to go back to some kind of equilibrium.  The focus on aggregate demand means that, yes, we can stimulate the economy in the short run, but we do so by always introducing distortions and imbalances that will come to haunt us later.

Q23            Mr Baker: As you know, I have bought into the same fundamental analysis, but Sir Charles explained a few minutes ago that he expected that we would be unwinding QE by now.  I think you said that, Sir Charles.

Professor Sir Charles Bean: That was only when we first went into it.

Q24            Mr Baker: Yes, I do not wish to be critical.  I just wish to try to seek the truth.  Detlev, could you try to articulate what you think is the fundamental analytical difference that meant that, when we went into QE, Sir Charles thought we would be unwinding it by now, whereas I think you have always thought we would never escape from QE until it reached its logical conclusion?  What is the fundamental difference in your analytical framework, which leads and has always led you to a fundamentally different conclusion?

Detlev Schlichter: Again, I want to avoid deeper discussions on theory.  Very simply put, if you use the word “stimulus” and take that example, the way the Bank of England and other central banks look at the word “stimulus”, it almost sounds like you give the economy an initial kick, which basically gets it going and then it moves by itself again.  It is almost like you start an engine and it keeps on running.  If you look in detail at the process that evolves if you interfere with the monetary process, if you inject more money into the economy and you artificially lower interest rates, you change the economy.  The fundamental point is that it is not a stimulus that simply gives ignition to the economy. 

If that had been the case, then certainly we should have been out by now.  We would have just given this impulse and the economy would have responded.  It is almost like you wake up the economy and it operates more normally again, but in fact the policy introduced a dislocation.  One of these dislocations is that it has maintained high debt levels.  These are certainly weighing on the economy now, which make it more difficult for inflation to pick up, make it more difficult for productivity to rise and make it more difficult for the economy to grow by itself, so the economy falls back and needs more medication.  In a way, the economy is overmedicated with monetary policy already.

Q25            Mr Baker: Sir Charles, if I was to put what Detlev has just explained in a phrase, it is that monetary policy has real effects on the economy and those real effects matter.  That explains, if I am summarising it correctly, the difference in the way the world has worked out compared to what you thought at the start of QE.  What is your answer to that analysis you have just heard?  If you have an analysis that suggests that Detlev is wrong in what he said, to what do you attribute the world turning out differently to what you all expected when you started?

Professor Sir Charles Bean: There are some extra ingredients that I think are important to bring into this.  It is very important to realise that interest rates are not low solely because of monetary policy decisions.  An absolutely key underlying real driver of where we are has been the remorseless decline in the underlying real interest rate that is consistent with the economy being in equilibrium.  Here I am talking about the world economy. 

There are several forces that have played into that: relatively high savings, partly associated with demographics, partly associated with the integration of China into the world economy; a falloff in investment, which may partly be associated with a shift in the nature of production away from needing physical capital to a greater reliance on human capital, as you do not have to invest so much in machines; and also slower population growth stays in there; and a change in preferences and availability of risky vis-à-vis safe assets.  There is a number of mechanisms, but it is important to realise that this trend dates back to starting in the late 1990s, so it is pre‑crisis, and it is actually part of the driver for what actually happened in the crisis, with the build‑up in debt.  I would not put all the blame on the monetary policy.  There are a number of things playing in.

There is certainly a significant part of what Detlev said that I would agree with.  Monetary policy certainly has real effects.  If it did not have real effects, there would not be much point in us doing it.  More to the point, monetary policy should only really be expected to fill in dips in demand.  You can use it transitorily, but you cannot permanently sustain a higher level of demand through running a looser monetary policy and bringing demand from the future to the present, essentially by borrowing, because you do end up building bigger and bigger debt stocks, and that creates problems further down the road.  There may be ways you can mitigate those risks, but that is ultimately not a world in which you want to be living, where the only way you can have demand that is high enough is by building up bigger and bigger debt stocks.  I am absolutely at one with Detlev’s concerns there.  There are more moving parts than he has suggested perhaps.

Q26            Mr Baker: We are probably all agreed that there are many moving parts.  If I may, what I am trying to drill into is that, given that Detlev’s analysis is about the detailed structural dislocations in the economy caused by monetary policy, why is it that you think the world has turned out differently?  Given your analysis as you have set out, why is it that, over the last eight years, the world has not turned out as you expected eight years ago?  I think Detlev would say that the world has turned out the way that it has.  Perhaps you will confirm this in a moment, Detlev.  It has turned out the way you would have expected, which is that we have not escaped low interest rates and QE, which is what your forecast suggests.  That is what you forecast: that we would not escape QE and low interest rates.

Professor Sir Charles Bean: My basic answer to your question is that it takes a lot longer to recover from a downturn that is associated with a banking crisis and an excessive build‑up of debt than it does from a normal cyclical recession.

Q27            Mr Baker: I am not wishing to aggravate, but why did you not foresee that at the time that we began QE?  What was missing from the analysis that meant you would have expected to have unwound QE by now or to have begun unwinding QE, but in fact the world did not turn out like that?  Why was it not possible to foresee it?

Professor Sir Charles Bean: One can make a legitimate argument that we should have been more aware of the historical evidence from previous financial downturns.  There is an important book by Reinhart and Rogoff that was published in 2009, I think, which collected a lot of this information together.  There was subsequent work that the IMF did that appeared in 2010 and 2011.  I can remember us having discussions on the MPC about the likely speed of recovery from the downturn.  I think it is fair to say that we really only became fully conscious of the likelihood of a very slow recovery during 2012.

Q28            Mr Baker: I am keen to bring in Professor Miles next, but could you just answer this?  Suppose Detlev is right and what monetary policy has done is to sow dislocations in the economy that have simply not yet been unwound.  They have not been allowed to unwind, because we have maintained extraordinary, if not emergency, monetary policy.  Could those dislocations explain why the economy has not in fact been kick‑started?

Professor Sir Charles Bean: I am sceptical of that, I must admit.  When you talk about dislocations, I am not really quite sure what you have in mind here.  Clearly what is true is that if interest rates are low, it encourages certain sorts of investment.  If those investments are mistakenly made on the basis that rates are going to stay low forever and then they do not, there will need to be a subsequent change.

Mr Baker: I must resist the temptation to give evidence myself, so I would like to bring in Professor Miles and then have Detlev answer that question.

Professor Miles: I would say two very brief things.  The first is that the reason why most people on the committee back in 2009 thought that we would be out of the woods by now, and no longer have interest rates as low as they are and be selling some of the assets, was that back then most of us did not think that the damage done by the banking crisis was as bad and as long‑lasting as it has turned out to be.  That is the answer to that one, and maybe we should have because, as you will know, the banking system came within a smidgen of just totally collapsing.  The damage that did was much more serious than I thought, even in 2009 into 2010.

If I may say one other thing, I think that the global decline in real interest rates, which has nothing to do with very low nominal interest rates since the crisis and asset purchases, is if anything even more powerful than Charlie suggested.  I would date the beginning of the decline in what you might call the global real interest rate a bit earlier than Charlie and put it in the 1980s.  We have a very good measure in the UK, which is the yield on long‑dated interest‑linked bonds. When long‑dated interest‑linked bonds were launched in the early 1980s, the yield was 4% or so.  It declined to about half that level by the mid‑2000s and it has carried on that trajectory since then.  It is now slightly negative.  The Bank of England has not bought any long‑dated interest‑linked bonds, so it is unlikely to be very strongly related to asset purchases.  Of course, what the Bank of England does is to set a short‑term nominal interest rate, whereas I am looking at a very long‑term real interest rate.  The scale of that decline is absolutely enormous.

Mr Baker: I am close to running out of time, but this extra damage to the banking systems speaks to the dislocations, Detlev.

Chair: You have run out of time.  Mr Schlichter is going to get a quick rejoinder then it will be Rachel Reeves. 

Q29            Mr Baker: What are these dislocations that concern you in the economy?

Detlev Schlichter: Why was monetary policy not as effective?  It is simply because the central bank lost the banking system.  The banking system had obviously been hugely expanded before the crisis.  Banks now look after their balance sheets, they are under heavier regulation and they have learned from the crisis, so they are simply not lending.  Earlier in the 1990s, bank reserves grew by 11% every year and broader monetary aggregates, by about 6% to 8%.  Over the last eight years of QE, the balance sheet of the Bank of England grew by more than 20% every year on average, but broad aggregates only grew by 2%, 3% or 4%, because the banking system does not transport that into the broader economy.  That is the reason why the recovery has been so weak and that was the reason why inflation has been so low.  The Bank of England and other central banks, despite having this very exuberant, flamboyant policy of quantitative easing, have had a much smaller impact.  My concern is that they are just pushing ever harder.

Q30            Rachel Reeves: In the latest range of QE, the Bank expanded the range of assets it is purchasing and is now purchasing corporate bonds as well.  The Bank said that those purchases are likely to provide a greater stimulus than that provided so far.  Sir Charles and Professor Miles, when you were on the MPC, those assets were not purchased.  Why was that?

Professor Sir Charles Bean: We did actually buy corporate bonds in 2009.  The purpose or mode of buying them was slightly different.  When the Asset Purchase Facility was originally set up, the first things it bought were corporate bonds.  That was essentially because of the illiquidity in the corporate bond market and we were acting as a market-maker of last resort.  Once the market started functioning properly again, we exited and we sold our holdings.  At the current juncture, it is more like a conventional monetary policy.  When I say “conventional”, it is a conventional unconventional monetary policy, QE, except instead of buying gilts it is buying a small amount of corporate bonds. 

The first thing to be said is that the corporate bond market in the UK is not huge.  The sort of scale of action that we judged was necessary back in 2009‑10, if we had said was going to be corporate bonds, would have bought the whole market.  It could only ever have been a relatively small fraction.  Certainly this issue that I alluded to in my opening response to the Chairman, with concerns about the political economy aspects of buying private securities, was an argument that I know weighed heavily with the then Governor, Mervyn King.  I agreed with him that I thought this was more questionable territory to get into.  If we were going to buy private securities, it really ought to be as an agent for the Treasury and the Chancellor.  If the Chancellor decided, “I want you to go and buy corporate bonds or some other private credit instruments,” that would be fine; the Bank would do it.  For the QE operation, we thought it was sensible to stick to plain vanilla gilts.

Certainly there are arguments that, pound for pound, it is more effective to buy corporate bonds than gilts, because you are directly affecting the price that might then have an effect on the real economy, but the response to that was that you just buy proportionally more gilts to get the same net effect at the end of the day.  That was the view that we adopted.

Q31            Rachel Reeves: Do you think the decisions in this round of QE were the right ones to expand the purchase into corporate bonds, or are you suggesting they are not?

Professor Sir Charles Bean: You can certainly have a debate about exactly what to buy, but I think that, by going into that territory, they have exposed themselves more to political economy questions.  I seem to remember one thing that came up at the time they announced it was that one of the investment‑grade bonds they were going to buy was Amazon, which was in the dispute about its tax burden at exactly that moment.  Of course there was adverse criticism of the Bank for buying Amazon bonds, so the Bank is treading into this difficult territory.  Personally, I think that if it is going to do that on any significant scale, that is where you have to start thinking more about the accountability framework that surrounds it.

Q32            Rachel Reeves: Professor Miles, what are your thoughts on this new strategy?

Professor Miles: When I was on the committee, I must admit I was pretty open‑minded about whether or not we should buy corporate bonds, but I took the view that, if you were having the kind of impact you wanted on the wider economy through buying gilts, it was much preferable to do it through gilts, because you do not have to get into the issue of “What exactly do we buy?  Is it that company?  Is it this company?  Are we favouring that bit of the economy rather than that bit?”  Particularly in 2009 and 2010, and to some extent again in 2012, we were having quite a significant impact in the corporate bond market indirectly, through buying gilts.  The impact that you have from buying gilts is greatest when there are financial dislocations.  It was clearly much bigger in 2009 than it was in 2012, and I am sure it is bigger in 2011‑12 than it is today.  As I say, my view was always that if you could have the impacts that you wanted through buying gilts, that was far preferable than buying corporate bonds.

Q33            Rachel Reeves: Is that for the same reasons that Sir Charles said in terms of the political economy point?  What about the efficacy of the policy?

Professor Miles: It was partly political economy.  It was partly that I did not feel that nine of us on the committee, who were not experts in the credit assessment of individual companies, could make very well informed decisions to buy that and not buy that.  I felt much more comfortable, particularly with the scale of purchases, buying gilts.

Q34            Rachel Reeves: This comes into the territory of what is the Bank’s responsibility and what is the Government’s responsibility.  It seems to me that one of the reasons why you have had to have such loose monetary policy, with both interest rates and QE over recent years, is because fiscal policy has been pulling in the other direction, with a very tight fiscal policy.  Do you think that there could have been a better balance between fiscal and monetary policy in the last few years, or do you think that it has been about right?  I am mindful of a comment that I think you made earlier, Sir Charles, that part of the impact of QE has been to keep rates at an incredibly low level and therefore bring forward borrowing, but that has not necessarily happened in terms of Government borrowing.

Professor Sir Charles Bean: It is worth saying that the issue here is obviously not just what has happened in the UK.  Clearly there are other countries that might have had more fiscal space to exploit than we did.  You can obviously think of countries like Germany here.  One should certainly recognise that, as far as the UK goes, in 2010, at the depth of the Great Recession, we had a budget deficit exceeding 10% of GDP.  That was not sustainable.  You can debate how you want to close it, but the degree of freedom for manoeuvre on fiscal policy was distinctly limited.  Where we are now of course, by virtue of the decisions that have been taken over recent years, the Chancellor has potentially more room to use fiscal policy should he feel he needs to use it.  That is just algebra, if you like.

The other thing I would say is that fiscal policy is not the answer to everything.  You also have structural policies.  Structural policies can potentially affect both the amount of saving in the economy and affect the amount of investment.  Again, in different parts of the world different policies might have been appropriate in that sphere, but greater use of those policies would enable you to get away from saying that it is always monetary policy that has to pick up the ball, at the end of the day.  Central banks have been the policymaker of last resort around the world, and that is not a good place for them to be in.

Q35            Rachel Reeves: I very much agree with you.  Professor Miles, do you have any thoughts on this?

Professor Miles: I think Charlie is right.  In 2009, there was a fiscal deficit of 10% and you cannot do that for very long.  In the stock of debt right now, net debt to GDP is getting pretty close to 90%, having been slightly under 40% before the financial crisis.  One could describe monetary policy, and people often do, as being “tight”.  Actually, it has allowed the stock of debt to rise enormously relative to GDP.  We keep pushing back the date, maybe very sensibly, at which the Government actually get back to balance and the stock of debt to GDP begins to level off.  I am slightly more reluctant to sign up to the language of “We’ve been running a tight fiscal policy”.  We have certainly been running a super‑expansionary monetary policy.

Q36            Rachel Reeves: There has at least been a difference between fiscal and monetary policy, but the monetary policy has done the work.

Professor Miles: Monetary policy has been uber‑expansionary.  Fiscal policy has allowed an enormous deficit to decline very slowly. 

Q37            Rachel Reeves: Do you have anything you want to add, Mr Schlichter?

Detlev Schlichter: I would obviously not suggest fiscal policy as an alternative here.  As I explained, my view is that, by about 2007‑08, a crisis and a recession was baked in the cake.  It was basically inevitable; the imbalances had accumulated.  One of these imbalances was excessive levels of debt.  My problem with monetary policy is that, since 2009, the policy was geared to keep debt levels high or even add to them, and an expansionary fiscal policy would have done the same or has done the same.  If you see the composition of debt in the UK, there has been private sector deleveraging, but public sector re‑leveraging.  In that sense, the same as with monetary policy, you can make your GDP numbers look a little bit better in the short term, but you always do that by adding to the imbalances that hold the economy in the long run, so I would not have suggested an expansionary fiscal policy.

Q38            George Kerevan: We have had asset purchasing for a decade.  In fact, just last year we increased it.  America has had it for a decade; Japan has had it for two decades.  I am interested in why it remains.  Is it because, to take the UK situation, the MPC is frit—there is a moral hazard and you are frightened to unwind it—or is there some deep‑seated implication for the economy in the short to medium term about what might happen to growth if you did unwind the asset purchases?

Professor Sir Charles Bean: The deep‑seated elements are firstly this decline in the underlying real interest rate that we have referred to, which is a two‑to‑three‑decade‑long phenomenon, which automatically means that you run out of room with the short rate sooner.  You have less room there, which means you have to resort to asset purchases. 

Now, there is the question about the point at which you feel sufficiently confident that you can start reversing things.  It is fair to say that probably most MPC members have tended to be somewhat cautious about the point at which you start moving rates back to normal, because there is an asymmetry.  If you move too late and inflation gets too high, you know how to stop that; you can tighten policy pretty easily.  On the other hand, if you tighten policy prematurely and put the economy into a significant tailspin, it is much harder to get out of it.  You have to do another big slug of QE and maybe other things, so there is a little bit of asymmetry, which is a consequence of the floor on effective interest rates.  If you did not have that floor, there would not be any sort of consequential asymmetry.  That is part of the story.

Q39            George Kerevan: Is there not a floor on the policy rate?  You can go negative.

Professor Sir Charles Bean: It is a question about the effective rate.  One can certainly argue that it is counterproductive to go any lower than we are.  If you go back to 2009, we thought further cuts below 0.5% might well have a negative effect on activity, rather than a positive effect.  I am not confident that going into negative territory, which some central banks have done, would actually be stimulatory in this country.

Q40            George Kerevan: To paraphrase, until the natural rate of interest rises sufficiently, manipulating the policy rate is not effective, which leaves you in monetary policy terms with asset purchases basically into the distant horizon. 

Professor Sir Charles Bean: That is as long as we are getting negative shocks, yes. 

Q41            George Kerevan: Was that your explanation of why you thought QE was here forever, Mr Schlichter?

Detlev Schlichter: Yes, because, given what I call the imbalances in the economy, one of those being the excess level of debt out there, it would be very difficult to get real rates up and therefore get policy rates meaningfully off the ground.  Whenever there are any disturbances in the economy, as long as monetary policymakers feel they have an obligation to manage aggregate demand, they would have to resort to more asset purchases.  I would also add one point to reducing the balance sheet: please remember that if a central bank reduces their balance sheet and sells assets, they basically reduce bank reserves at the same time, so they eliminate the very bank reserves they created in the process of quantitative easing, so the banks lose the rocket fuel for their balance sheet and for creating deposit money and extending credit.  That is obviously a policy tightening.  Reducing the balance sheet is the same as raising interest rates; it is tightening policy on the margin. Again, it is my view that it would be very difficult for any of these central banks to do this meaningfully over the coming years.

Q42            George Kerevan: If we leave aside the recent experience in the UK with the fall in the value of sterling, which has raised short‑term inflation, if we net that out and look at the medium term, until the natural rate of interest rises as some global phenomenon, here in the UK we have a policy rate that is zero‑bound and we cannot do very much with that.  We are therefore stuck with QE as the main monetary policy tool.  Does that not ultimately lead to changes in perceptions and expectations about inflation, and lead us into a deflationary cycle?

Professor Sir Charles Bean: That is a potential worry, yes.  I would certainly be very concerned if I saw medium‑to‑long‑term inflation expectations shifting down into negative territory or zero.  Fortunately in this country they are still reasonably well anchored around the target, but that would not necessarily continue to be so if there was a big negative disturbance to the economy.  Of course, in Japan inflation expectations were allowed to get embedded at a very low level, and that has made it much harder for the BoJ to get out of where it is.  For a time, it looked like the ECB might slip into that same area.  It is a reason, I believe, that if you do find yourself subject to a significant adverse shock, there is an argument for taking quite bold expansionary action straight away to try to nip it in the bud and not to keep your ammunition dry, which you sometimes hear as an argument.

Q43            George Kerevan: Would that be by using fiscal policy?

Professor Sir Charles Bean: It is ideally by using other policies.  I want to emphasise that people should not get fixated on fiscal policy as the only other game in town.  There are other policies you can have. 

Q44            George Kerevan: Such as what?

Professor Sir Charles Bean: There are a raft of structural policies.  This is going outside the UK but, to give you a very good example, the most powerful structural policy that could be implemented to boost investment globally would be enhancing the rule of law in many developing countries.  That is the one thing that would encourage investment.  Firms do not invest if they expect to be expropriated.  There are things like the design of the tax system and the way labour market policies operate.  There is a whole range of things that you might do.  The shift in countries away from unfunded pension schemes to funded pension schemes is actually something that goes exactly the wrong way in this environment, as it happens.  That is something that is a structural policy; it does not necessarily require fiscal change.  There is a raft of things that you could be considering, as well as conventional fiscal action, which may also have a role if you have fiscal space to do it.  Some countries obviously have more fiscal space than others. 

Q45            George Kerevan: Let me bring in Professor Miles, as I have left him out today.  When you left the MPC, one of your parting shots was to say that we should move reasonably quickly to raising the policy rate.  Are you still of that view?

Professor Miles: I am more optimistic than some of the discussion here, which seems to be that we are stuck in this trap, QE will never be unwound and interest rates will be at the floor for a long period of time.  I am more optimistic than that.  The inflation rate is pretty much at the target now and it will go above it.  That is partly to do with the exchange rate being temporary.  You should look through that but, even having looked through that, my guess is that it will settle at around 2% and maybe even slightly north of that. 

Unemployment is under 5%.  We should not be talking about the UK as if we are stuck in a depression, so I do feel that the point at which we begin the slow march to something more normal is on the horizon.  It could well be.  I must admit, I look at where the yield curve is right now, which is the market’s anticipation of where Bank rate might be, and I think it is too gloomy, in the sense that what is priced into the market is that Bank rate is still around 0.5% four or five years down the road.  That is not my best guess as to where we will be.  I think we will be at something a bit more normal by then. 

Q46            George Kerevan: What would that be?

Professor Miles: What is normal is a good question.  We used to think normal meant Bank rate at 5% or so.  I do not think that is normal anymore, partly because of the things Charlie was talking about.  Real interest rates keep coming down globally.  My guess is, looking down the road beyond super‑expansionary monetary policy, that normal might be a Bank rate nearer to 2.5% or 3%.  I think interest rates will be nearer that level than where they are now, even four or five years down the road, even though the markets do not see it that way.

Q47            George Kerevan: How will events in America, particularly in a fiscal expansion America, impact on interest rates?

Professor Miles: That is a really tough one to try to figure out, and it depends what happens to the deficit and it depends what happens to the fiscal plans, and whether Trump will really go ahead with the scale of expansion that the rhetoric suggests.  That is a very hard one to try to figure out. 

Chair: I am sure we are going to take a look at America and its effects on the global economy including ours in other sessions, but I do not think we will expand that now, because it is QE we are really concentrating on. 

Q48            John Mann: I have questions on three subjects.  The first one is to both Professor Miles and Professor Bean, as long‑term interlocutors with this Committee.  When it comes to monetary policy, is it your observation or not that there is significant groupthink in Parliament on monetary policy?

Professor Sir Charles Bean: Is that in Parliament rather than the MPC?

John Mann: In Parliament, yes.

Chair: Do you see a good row of groupthink here?

Professor Sir Charles Bean: I have to say your Committee seems to be a little bit of a counter‑example to that, but there may well be a question about whether you are representative of the whole of Parliament.

Chair: They should leave the whole job to us, do you not think?  We would be able to sort it out.  We do not need 650; 11 will do.

Q49            John Mann: I take that as a “not sure”.  I simply ask the question because I note that John McDonnell’s monetary and fiscal policy is actually identical to Philip Osborne—that is probably the right term: Philip Osborne or George Hammond.  That strikes me as more than a curiosity in terms of whether there is a hegemony in terms of monetary policy.  I throw that out because I find that intriguing.

Professor Sir Charles Bean: In some sense, I would not have a concern if there was a shared view about how monetary policy operates, because there is enough consensus about how it operates in general, in central banking, across economists and so forth.  We may have different views about precise quantitative magnitudes and some people will have more concern about the adverse consequences of monetary policy actions.  I am probably halfway between my colleagues either side there, so I certainly share some of Detlev’s concerns.  I think David is probably a bit more relaxed.  These are quantitative differences, rather than conceptual differences.

Q50            John Mann: Does it matter whether the Bank allows its holdings of QE bonds to expire without selling them back to the market? What would be the consequences if they simply sat on them and did nothing?

Professor Sir Charles Bean: That is the easiest way to run down the facility, just to let the bonds mature and not replace them.

Q51            John Mann: Is there anything that we should worry about if we do that, Mr Schlichter?

Detlev Schlichter: No.  Again, I say that it is unlikely to happen because by the time most of these bonds have matured, we would have had another crisis and the Bank of England would have bought something else, maybe equities.  No, running them off is not a problem. 

Chair: Furthermore, there is a chunk in the first five years that would make it quite lumpy.

Professor Miles: I do not think there need be a problem, as long as the Monetary Policy Committee took the view that the scale of tightening implied by just letting the things roll off happened to coincide with what they thought was the right monetary policy, which would be quite an unusual situation, because you could always move Bank rate to adjust it, so that simply letting them roll off gave you the right overall monetary policy.  As I was saying earlier, that will probably not happen, because the Bank of England’s own balance sheet, looking forward beyond the near term, will be much bigger than it was before.

Q52            Chair: Do you not think there might be some merit in that, though?  Is it not better to get rid of the stock, even if you have to adjust interest rates a bit?

Professor Sir Charles Bean: I have to say that I took the view on the Committee that the natural time to stop reinvesting was actually when you decided that you were on a path to raise rates.  You do not wait until you have hit 2%, say, before you stop reinvesting.  I would say to stop reinvesting when we had the first hike in Bank rate as well.  That was not a view that was shared across the rest of the committee.  The committee thought that it was more logically coherent to say that you keep on reinvesting maturing bonds until the 2% point, at which you might consider sales.  To me, it seemed natural to take the advantage of the natural runoff when it was safe to do so.  It just meant that you had to sell fewer bonds actively into the market further down the road.

Q53            John Mann: My observation of my own constituency over the last 16 years is that by far the single biggest stimulus to the local economy, without question, was the unexpected windfall that came, rightly so, morally and ethically, to former coalminers, who were relatively poor compared to everybody else in the country, suddenly getting a cheque for industrial injury.  Further, I noted that those who got the small or middle amounts spent a huge proportion of that in the local economy.  Those who got much bigger amounts would also tend quite rationally to have things like foreign holidays or even occasionally timeshares, if they got that much.  That suggests to me that helicopter money was dismissed too readily as a tool that would have had a huge and easy impact.  You talked to Mr Baker about dislocation; I noted that dislocation of real wages was never mentioned by anybody.  In your three views, is helicopter money a valid tool, and might it be a valid tool in the future?

Professor Sir Charles Bean: The first thing to be said about helicopter money is that it is formally equivalent to conventional bond finance fiscal policy, coupled with quantitative easing by the central bank, where the asset purchases are never reversed.  It is helpful to think about it that way, because then you can focus on the various elements.  As far as the fiscal bit goes, as I said earlier, I have no objection to it.  Conventional helicopter money is not necessarily the most sensible way to boost demand, because you would expect that, for a lot of people, if you just give them a lump sum in cash, a lot of it will be saved.  If you can focus it on people who might be relatively poor, credit‑constrained and things like that, they would have a higher propensity to spend, so it would make sense to try to focus any distribution like that.  There may be other fiscal actions that make even more sense—investment spending and things like that—but that fiscal policy is properly the domain of you guys.

On the monetary bit of it, the first key point to make is that the expansionary element is not as big as people often think.  The reason why people think helicopter money works is that it is basically giving people some wealth.  It is costless to produce, but the money is valuable to people, so they may be better off and they go out and spend.  It is very important to remember that the Bank reserves pay interest, so QE is essentially changing the duration structure of the state’s liabilities.  There are fewer gilts out there and there are more short‑term liabilities, which are being issued by the Bank, but the Bank is having to pay interest on them.  The net consequence of that in terms of a wealth injection is actually much smaller than people think. 

When you come to the question about this being a permanent monetary expansion, there is a fundamental question about how on earth you can make that credible, because it can always be reversed further down the road.  We cannot tie the hands of our successors; you cannot tie the hands of future policymakers.  They can always undo whatever you do now, so it is actually incredible to say that you are going to make sure that this injection is permanent, and it only applies to part of the money stock anyway.  I think it is a mistake to think there is some new policy weapon that has not been tried, but it is perfectly reasonable to make the argument that a well targeted fiscal intervention might well be something that we should consider at this juncture.  That is the sort of thing that you should have a debate about and indeed you do have debates about, but it is the role of Parliament, not the central bank.  I think it is very important that the central bank just does the monetary bit of this, not the fiscal bit.

John Mann: Plus it buys a few corporate bonds. 

Detlev Schlichter: Helicopter money is obviously at the very extreme end of monetary policy.  I already outed myself as a critic of monetary policy in general, so I am certainly not a fan of helicopter money, but it illustrates the point very well, I think.  The interesting thing is, if you give everybody in the economy extra money or the more widely you disburse the newly created money from the Bank of England among the population, the smaller the impact on the economy is going to be. 

The reason is simply this.  To take your example of the miners in your constituency, the only real benefit they have is that they have the money and not everybody else in the constituency does.  If everybody gets £10,000 in their bank account or let us assume that, whatever they have in money, they have another 10%, 15% or 20% more than what they have in their bank account today, everybody is richer.  Nobody’s relative position has changed.  To take one example, a US fund manager gave this example when discussing helicopter money.  He said, “Let’s assume that we all get $1 billion into our bank accounts tomorrow.  Would that not mean there would be huge queues outside the BMW dealership?  Obviously not, because the person who sells the BMW also got $1 billion in their account and the people who put together the BMW would also suddenly be richer.” 

I found it interesting that nobody is referring to this whole argument today.  It has already been discussed—by David Hume, in 1741.  He wrote an essay on interest.  He plays this thought experiment where he says, “Let’s assume that we all wake up tomorrow morning and we have double the money we had the night before.  What would happen to the economy?”  Obviously the answer is nothing, with one exception: all prices would go up, because the relative position of the individuals in the economy has not changed.  Everybody is suddenly richer by a certain amount.  The rational thing to do is that everybody who produces something, which is every one of us in some sort of capacity, to charge more for additional services.  Everybody who consumes, which is also each of us in another capacity, would be willing to pay higher prices. 

It illustrates that the impact of additional money in the economy, and what the Bank of England and any central bank does, only has an impact on growth, because you give the money to some people and not to others.  The money that is being printed today ends up with the banks.  The banks give it to the marginal borrower, who then does the marginal investment project that would not have been done if that money had not entered the economy.  This is what makes the economy develop into extra activity.  If you give everybody the same relative improvement in nominal money, the only thing that will change is inflation, and there will be no real economic gain.

Professor Miles: The crucial thing about helicopter drops is that there is a bit of problem with talking about helicopter drops.  Milton Friedman created the term and his idea was that you literally hand out notes to people from a helicopter and throw the notes out in the economy.  That is not how it could happen institutionally.  What would end up happening is that the money that is created through so‑called helicopter drops would end up as reserves at the Bank of England.  It would not be a massive expansion in the note issue.  If you think of it as reserves at the Bank of England, if the Bank of England continues its current strategy of paying interest on reserves, it is exactly equivalent to the UK Government simply financing some government expenditure by issuing some new bonds that pay Bank of England Bank rate.  It is equivalent.  As Charlie said, then the idea that this is super‑expansionary begins to evaporate in front of your eyes.  It is a mistake for people to think that the notes that might be created are like Milton Friedman’s literal bank notes.  It is not that kind of money. 

Q54            Chair: Why did Adair Turner not take this on board?

Professor Miles: I have spoken to him many times and I am not sure I understand the answer to that question yet.

Chair: I have three more colleagues who want to come in.  I am sorry this is a longer session than planned and we started a bit later, but there is a lot of interest around the table.

Q55            Wes Streeting: Some of John Mann’s questions lead very neatly on to the debate I wanted to get into, which is about the distributional impact of QE.  In your view, has QE disproportionately benefited wealthy households?  Could you say something about the impact of QE, not just on income inequality or wealth inequality, but also on inter‑generational inequality, if you think there is an impact on that?

Detlev Schlichter: As I said before, it is very difficult to disentangle all the effects of quantitative easing or any monetary policy.  It is very difficult to subdivide the population and the society into very different buckets, and say that this group has won and this group has lost.  We can identify certain tendencies.  What I would say—and there is even a paper by the Bank of England on this—is that it will, on the margin, benefit people who have financial assets.  Those certainly tend to be wealthier households, and then it depends on which form you hold assets.  Most poor or middle‑class households hold a lot of bank deposits.  Obviously they would be negatively affected, certainly by a zero interest rate policy and, in some countries, now a negative interest rate policy.  People who hold equity portfolios or hold long‑duration Government securities have certainly benefited and these tend to be wealthier households and they also tend to be older citizens.

One of the interesting studies—and I am not quite sure whether it was in one of the publications by the Bank of England or somebody else—showed that the part of the population that is 65 and above was the only part of the population that sustained positive consumer spending growth through the financial crisis, while other age groups had to cut back, particularly the younger people.  Another aspect is that we know that we had what I consider to be an artificial housing boom between 1997 and 2007.  Now there is this widespread idea that it is good if house prices stay up and high, but obviously people who would like to enter the housing market would look for lower prices.  I read with mixed emotions when the Bank of England says that their policy sustained or avoided a sharper drop in house prices.  Clearly there are many people who would not like their house price to drop, but there are certainly people who would benefit from it. 

This comes to the old point that policy will always benefit some and disadvantage others.  That also happens in a market economy.  If consumer tastes change, it will also affect certain industries and others.  If consumer demand shift, there will be industries that decline and have to make layoffs, while other industries grow.  However, that is a disinterested process that is driven by society at large, by all of us as consumers.  Now you have a Government entity like the Bank or an agency like the Bank of England that has to make these calls.  That is the major problem with quantitative easing.

Professor Sir Charles Bean: I agree with quite a lot there, but I would like to add one or two extra glosses.  The first thing to recall is that we have said that an important underlying reason for lower interest rates is these tectonic forces in the world economy.  It is not just monetary policy that has had these distributional effects.  A significant driver of higher house prices has been that decline in long‑term interest rates, which is driven by these real factors.  You have been having big distributional shifts that would have taken place anyway. 

At the margin, because it is designed to stimulate demand through pushing up asset prices, QE is going to benefit the asset‑rich, to the cost of those who do not have assets but want to acquire them.  In that sense, there is certainly an inter‑generational angle.  However—and this is the complicating factor—because it has indirect effects on the level of activity, those people who are disadvantaged because of the asset price movements, younger people, are more likely to be in work.  They may have higher wages and so forth, so there is something that goes in the other direction.  It is not clear, a priori, which way the net effect on them goes.  It would be different for different individuals at different stages of their life cycle and so forth. 

Q56            Wes Streeting: What about thinking about the long‑term impacts on younger people?  You mentioned a potential impact on wages and so on but, in the long term, one of the consequences of where we find ourselves at the moment is that the working‑age population is having to pay a great deal towards the retired population to maintain pension costs, particularly because of defined benefits, which are defined by definition, in spite of what else is going on in the economy.  In the longer term, in terms of the investments in pensions for example, it may be that this younger generation not only pay for their predecessors, but pay more for a lower‑valued pension in the longer term.  Actually, there is a longer‑term impact on the people who are currently young, compared to the elderly and retired population, whose incomes have gone up.

Professor Sir Charles Bean: There are certainly lasting effects.  These big inter‑generational shifts are one of the big stories of the last 10 or 20 years.  As I say, monetary policy is a marginal player in this, compared to these big, deeper, tectonic forces.  Increased longevity also plays in there as well, but this is very much the territory of Parliament and fiscal authorities, not the central bank.

Professor Miles: I must admit that I think the inter‑generational things are formidably difficult to work out.  I am not even sure which direction they go in.  For example, if you were about to buy an annuity at the point at which gilt yields come down, partly because of QE and partly because of longer‑term trends anyway, you are worse off.  If you are a 30‑year‑old who was taking out a mortgage to buy your first property, you might find that the interest rate you get on a five‑year fixed‑rate mortgage is quite a bit lower, because the Bank of England has managed to push five‑year gilt yields lower.  You can tell stories where the inter‑generational stuff is moving money from the old to the young, and there are some other people who are young who will be worse off than the old.  The net impact of all this is formidably difficult to work out, and it is just not obvious to me that it is clear that the older are better off and the younger are worse off.  I do not think it is like that. 

Q57            Wes Streeting: Before Steve comes in with his rejoinder, Sir Charles, you made the point quite rightly that there are many things that Government could do through fiscal policy to mitigate some of the consequences of what you describe as the marginal impacts of monetary policy on wealth and income inequality, and inter‑generational inequality.  I am curious to hear the view of all of you before handing back to the Chair; should this issue solely be the preserve of fiscal policy or are there appropriate monetary policy responses that should be considered as well, in terms of mitigating against inequality, either wealth/income or inter‑generational inequality?

Professor Sir Charles Bean: It is not obvious to me what instruments you have in mind.  If they are monetary instruments, they are probably operating pretty indirectly, so they would not be well targeted, but I would be very worried about pulling the central bank into having obligations to worry about distributional consequences or to be given a distributional mandate, because that really is territory that is for politicians and Parliament to decide.  We have already seen a degree of mission creep happened with central banks.  The central banks themselves do not want it and they are being pulled more into territory that is genuinely that which should be inhabited by political actors.  Taking the step of actually giving the MPC, say, a specific distributional element to its monetary policy remit would be extremely dangerous territory.  If you are concerned about the distributional consequences, the right response would be for Parliament to decide to do things that address them appropriately.  If that requires doing something in conjunction with the Bank, that can be set up.  The Bank acts as the Treasury agent and so forth, but it should not really be the Bank executives or the MPC actively taking decisions that have specific distributional effects.  That is certainly my view. 

Detlev Schlichter: It is obviously a complicated topic.  I certainly do not think that monetary policy should be dragged into the equality debate.  Again, monetary policy is already doing way too much.  My general view is that a functioning market economy is the best tool for the standard of living to rise throughout society.  Does that mean equality?  It obviously does not, but I think we all know this; the outcome will not be equal.  Is there any reason to believe that it will lead to rising inequality?  I do not see that.  I do not think a functioning market economy leads to a constant widening of an economy.  Quite the opposite: I think one of the phenomena of capitalism is a middle class.  The middle class did not exist in pre‑capitalist times. 

If we see this globally, now that the world economy has opened up more, global trade has risen with the exception of the last 10 years.  Over the last 40 or 50 years, inequality has actually declined on a global scale.  If fiscal policy or monetary policy is geared towards just giving us a functioning market economy, I do not think we have a major equality problem to begin with.

Professor Miles: I tend to agree with Charlie that it is problematic to tell the Bank of England that, as well as having an inflation target for financial stability, and a relatively limited range and tools, you also have an inequality target, of either income or wealth, to try to hit as well.  That would be problematic even if you could reliably work out what the distributional impacts of monetary policy are.  As I mentioned earlier, there is also an issue where it is far from obvious what those distributional impacts generally are.

Chair: Steve Baker had a burning question, if you could be quick. 

Q58            Mr Baker: This very point about it being practically impossible to work out the distributional impacts points to the problems with what Sir Charles indicated, which is where the Government are.  Government should do something to redress the injustice of the redistribution, but we are really not sure how it works.  Is this not indicative of two categorically different kinds of society: a market economy, where the distribution of wealth and income depends on your ability to adjust what you do to best meet the needs of other people, as entrepreneurs do, versus a society in which there is a very high degree to which your wealth and your income are determined by unknown consequences of decisions by authority?  I am just putting it to you that that is a categorically different kind of society to a market society, and you are nodding, Sir Charles.

Professor Sir Charles Bean: Absolutely, and in fact I gave a lecture on exactly this to the first‑years at LSE last week.  I think you are absolutely right, but there is no guarantee that the distribution of income that comes out of a well functioning market economy, as Detlev says, is one that we find socially acceptable.  To the extent that you do find it unacceptable, the best way to deal with that is through redistributive taxation, rather than direct intervention in a market economy.  You lose the benefits of the market economy. 

Chair: We are going to stay in the same field and a slightly different angle with Helen Goodman.

Q59            Helen Goodman: I just want to ask one question about low interest rates first, and I am not going to go down the theoretical line that Steve went down, but to ask a really practical question.  Of course, we can all understand and imagine that, if we cut interest rates from 8% to 5%, then all sorts of investment projects around the economy become economic, and so people borrow some money from the bank, go ahead and the economy whizzes off.  Do you really think that cutting interest rates from 0.5% to 0.25% is going to have a significant impact on the number of investment projects that are profitable?  I will go to Professor Miles first, because he is laughing.

Professor Miles: No.

Chair: We would like quick answers.

Professor Sir Charles Bean: No.

Detlev Schlichter: No.

Q60            Helen Goodman: What was the point of doing it?

Professor Sir Charles Bean: It may have some small effect at the margin, but I really do not take the view that the policy package that was announced after the referendum, including the other elements as well, is likely to have had that powerful an effect on the economy.

Q61            Helen Goodman: Do you think that there becomes some level below which it impacts to say that the policy lower bound is not 0%; it is 1%, or something else?

Professor Sir Charles Bean: In 2009, we took the view that the effective lower bound was 0.5%.  Even though we could have gone lower in principle, we thought that going lower would have been counter‑productive.  Obviously as you are approach there it gets less and less effective.  I would agree with you that, in the territory that we are in, rates are so low already that the degree of traction you get from rate cuts is probably pretty low.

Q62            Chair: Before we move on, can I just ask Charlie Bean?  If these measures did not have much impact on the economy, the Governor must be wrong when he tells us that the reason everything is going swimmingly is because there was a stitch in time to save nine and he took the requisite measures that kept the economy on course.

Professor Sir Charles Bean: My personal view is that that may have had a marginal element, but I do not think it is the primary reason why growth has surprised us to the upside in the second half of last year.  I do not want to say any more than that, if you do not mind, for reasons that you understand.

Chair: You have been so helpful to us so far and we want more material from you after this meeting, so I suppose we will have to settle for that.

Professor Sir Charles Bean: Can I suggest we come back to this when I reappear in front of you in two weeks’ time?

Chair: Yes. 

Q63            Helen Goodman: I want to come back to this point about the distribution impact of QE.  I think my colleagues are getting bored of hearing me say this, but the fact is that the Bank of England published a paper in 2012 that showed that the wealthiest 5% of households gained £185,000, which is an absolute fortune by most people’s standards.  My first question is: do you think we should ask the Bank to update that piece of work, because that is now five years ago?  Do you think that would be a good idea?

Professor Sir Charles Bean: The first thing I would say is to remember that that is the marginal effect of QE.

Q64            Helen Goodman: What do you mean by the marginal effect?

Professor Sir Charles Bean: It is the effect of just QE.  If you actually think about what has happened to wealth, those people took a big hit to their wealth as a result of the collapse in asset prices that occurred during the Great Recession and the financial crisis.

Helen Goodman: So it was right for the Bank of England to restore it to them.

Professor Sir Charles Bean: No, but I am just saying that, when you put it in isolation, it makes it sound like those people have done very well, whereas you want to set it against the fact that those people got hit.  Basically, wealth and income inequality have not changed hugely.

Q65            Helen Goodman: We were told that this earlier week by the new deputy governor, but I am sorry, Sir Charles: that is not true either.  Income inequality has fallen since 2007, but wealth inequality has increased.  This is obviously part of it, even if it is not the major part of it.  When you say that you think it is wrong to give the Bank some kind of target or aspiration on distribution, why is it wrong for them to be concerned to make the world less unequal, but absolutely fine to make the world more unequal?

Professor Sir Charles Bean: Let us be clear: the Bank did not undertake QE with the object of having some distributional consequence.  It is a by‑product.

Helen Goodman: Of course I understand that. 

Professor Sir Charles Bean: What I said earlier this afternoon was that you are going down a very slippery slope if you are actually going to delegate direct decisions over distribution and say, “We are giving you an objective to try to achieve,” to the MPC or the Bank of England.  A much better way to approach this is to say that if there are distributional by‑products of monetary policy actions, then Parliament should implement appropriate offsetting fiscal policies, or whatever other policies may be appropriate.

Helen Goodman: I know, Sir Charles, and we have heard that from the Bank as well.

Professor Sir Charles Bean: That is my view.

Q66            Helen Goodman: The problem is that it is not really in the realm of the politically feasible, as I am sure you know.  No Chancellor of the Exchequer is going to stand up and announce a tax rise on capital.  We do not have any capital taxes at the moment.  No Chancellor of the Exchequer is going to stand up in the Chamber and announce a tax rise on capital of £185,000 for the wealthiest people, is he?  We will have tinkering at the edges, £3,000 here.  Do you think that is a likely upshot?

Professor Sir Charles Bean: As I say, if you are concerned about the implications, there have been huge wealth consequences, inter‑generational wealth consequences, which swamp the QE impact as a result of this decline in global real interest rates.  There have been huge inter‑generational distributional shifts, a lot of it intermediated through the housing market.

Q67            Helen Goodman: I know that.  I understand that.  I agree that the housing market is not in a good state in this country, but we are having an inquiry about QE and one of the drawbacks of QE is the impact on wealth distribution.  People in the Bank of England and the top 5% of the population may not think that £185,000 is a lot of money, but my constituents do think it is a lot of money, and so I want to consider whether there is a way that the Bank could do the QE that would not have such serious distributional impacts.  Do you think that there might be?

Professor Sir Charles Bean: I think the answer to that is probably no, actually, just because of the nature of the way that QE operates.  I do not think you can avoid those distributional consequences.  I should say that I am concerned about the distributional consequences, but the right way out of this is to get the economy into a situation where you do to have to rely on QE and we can get back to conventional short‑term monetary policy measures and so forth.  That is the ideal.  As we said earlier, we looked on QE as an emergency weapon, so this is not somewhere where we would want to be, but I do not think that there is a version of QE that can have the effect that you want it to have on the general level of demand and avoids distributional by‑products.  You may be able to design it in a way that attenuates some of them with a different mix of asset purchases, but it would be a second order.  That would be my guess.  Others may disagree.

Q68            Helen Goodman: That was exactly what I was going to ask you about, because the ECB buys different assets than the Bank of England.  They have been buying assets in infrastructure banks in France and Germany, which we do not have, and they also have a strand of purchases that goes towards banks that support SMEs.  I was wondering, instead of this rather scattergun approach that the Bank has, if we had a more directed approach it might have different distributional impacts.

Professor Sir Charles Bean: The first thing to be said is that there will be general effects on asset prices, even from those asset purchases that are focused on different assets.  The way QE works is it ripples out across the economy.  As I have said earlier, I have no objection at all to buying other assets, but it should essentially be a decision for the Treasury, with the Bank acting as its agent.

Q69            Helen Goodman: Of course, and I think that that is completely sensible and reasonable.  The Treasury could say, “We are interested in investigating in these things, because we think they are good for the economy and, by the way, we think the distributional implications would be better.  Please, oh Bank of England, do it in this way.”  You would be perfectly happy with that. 

Professor Sir Charles Bean: I am entirely happy with that.  I do not see any problem with that.  What worries me is the Bank doing it off its own bat.

Professor Miles: I have just one observation.  It seems to me that what QE did when it was at its most effective, which I think was 2009 with the first £200 billion of gilt purchases, is it tried to bring the price of a range of assets—equities and corporate bonds—back to where they might have been or closer to where they might have been without the financial crash.  The financial crash happens.  There is a collapse in equity prices and corporate bond yields go through the roof.  That is of course a big loss of wealth, predominantly to the people who own them—the better off.  The first big slug of QE tries to bring those asset prices back up closer towards where they might have been, because the collapse in those values was not helping anybody. 

If you just look at the second bit, a bit like as Charlie was saying earlier, if you just look at the action in isolation, you might say, “This just helped rich people,” because what it was doing was trying to offset, imperfectly and only to some extent, an enormous loss that was having a damaging effect on the economy.  It was not, “Here is an action that has unambiguously redistributed wealth to the better-off.”  There is also the point about things like annuity yields, which, because gilts have fallen in yield after the crisis, partly as a result of asset purchases, actually make people who have a big pot of money and are about to buy an annuity worse off.  The inter‑generational stuff and the wealth inequality stuff is actually pretty murky and not quite as clear‑cut as some would suggest.  Incidentally, I thought the 2012 report from the Bank did not quite bring this out in the way that it should, so people jump on this £185,000 number in a way that I think is a bit misleading. 

Q70            Helen Goodman: Do you not think that there is a difference between undertaking a programme of QE in a crisis and discovering that it has this effect, and carrying on with it in the knowledge that it does tend to have these effects?  The economy is not going as one would wish, but no one would say that we are in a crisis.  That would be a false description.

Professor Miles: First, I think the impacts of the asset purchases after that first round have been much, much smaller.  Whatever you think about all these issues, they are much less significant after that first period than in that first period.  Secondly, I remain of the view that it is actually very difficult to be clear on what the distributional impacts of low interest rates and asset purchases actually are.

Q71            Chair: I am going to move the questioning on to Jacob, but before I do, I want to ask Charles Bean one question that is related to something that you have done quite a bit of work on, which you touched on earlier, which is this long‑term pressure to lower interest rates globally, which predated QE.  You gave a list of these pressures and I have noted them down roughly.  The question I wanted to ask you about them is the extent to which these are going to bottom out.  At that point, the underlying inflationary effects of QE that Mr Schlichter has identified might then start to become much more apparent.  I am looking at them now.  You said China; the move away from physical to a knowledge‑based capital; slower population growth that might carry on downwards; the flight to save assets, and there must be a limit to that; aging may carry on, but will it carry on at the same rate?  Can I ask you to comment on that?

Professor Sir Charles Bean: Some of those forces are still potentially going to continue, so the shift in the nature of production away from physical capital towards more human capital and knowledge‑based production, so all the internet stuff, would be one example.  There are a couple of particular things that you might think are going to reverse.  First, headwinds from the financial crisis should be abating.  We talked earlier about how quickly they abate.  There is a particular aspect of the demographics that is reversing.  A lot of people have focused on increased longevity, which has not been matched by higher retirement ages, which means you have to save more to cover your retirement years. 

There is another factor that is potentially important, which has not had so much attention, which is the relative size of different age groups in the population.  Broadly speaking, the young spend what they get; the middle‑aged save for their retirement; and then the old dis‑save.  We have just gone through, and here I am talking globally and not about the UK.  It is particularly pronounced in China, but it is in the other countries as well.  We have had a bulk of the middle‑aged, the 40‑to‑65 age group, who of course will be doing a lot of asset accumulation ahead of their retirement.  Over the last 20 years, the difference between the population share of the middle‑aged to the old has been going up.  We have just reached the point where that has peaked and it is now going into reverse, as we pass the bulge of post‑war baby boomers who are passing through into retirement.  You should expect relatively more dis‑saving going forward and that will put upward pressure on global real interest rates. 

David said he thought that the US fiscal policy was unclear.  I would also expect that to put some upward pressure on global real interest rates as well, so there are reasons for expecting some recovery in the underlying natural real rate of interest going forward.  It may be relatively slow; I am not saying that it is going to bounce back up in the next two or three years, but this demographic force will be something that is kicking in ever more strongly over the next decade.

Q72            Mr Rees-Mogg: As we are coming to the end of the session, it is time to talk about zombies, which I thought might be useful as we get later in the day, as there may be some emerging in the Palace of Westminster.  In particular, there is a report by the OECD on zombie companies and the effect that very low interest rates have had on productivity.  Potentially by keeping more companies around, the misallocation of capital is having negative economic effects.  To broaden it out from zombie companies, very low rates leading to the misallocation of capital generally have more negative than positive economic effects.  I would just like to get the views of the panel on that. Sir Charles, why don’t you start?

Professor Sir Charles Bean: Yes, there is potentially an element there.  One of the arguments for why productivity growth has been low in this country since the crisis is, in part, that the process of creative destruction operates less effectively when interest rates are low and also when the banking system is impaired, because the banks are reluctant to declare loans that have gone bad, because they immediately have to repair their balance sheets and so forth.  There is almost certainly an element of that.  It is difficult to know how big it is and the key thing during the depth of a downturn is that you do not want to end up killing companies that have a perfectly viable long‑term solution, so getting the timing right for any exit is important, but it is almost certainly the case that there will be some businesses that, when interest rates start to rise, find that their business models are no longer viable and that capital will be reallocated.

Q73            Mr Rees-Mogg: Is your point not that you do not want to destroy viable businesses at the depths of the crisis.  The depths of the crisis was nine years ago now and continuing these very low interest rates is just extending and delaying a solution to the problem, but it gets worse than that.  Mr Schlichter, you said that banks lend to the marginal borrower—that idea that would not otherwise happen if money was not going through the banking system.  If they still have their money tied up with companies that are not any good, they do not have the capital to lend to that marginal new company and so you delay the economic development that you would otherwise get.  Is that right or is that too simplistic? 

Detlev Schlichter: No, it is not too simplistic; I think it is absolutely correct.  Just to pick up on the phrase that Sir Charles used, creative destruction, without destruction there is no creation.  You need companies to fall by the wayside.  Bankruptcy is part of capitalism, as death is part of life.  You need to make room for new companies.  It again shows that part of the generally termed stimulus policies in a crisis are that the crisis or the recession also has a cleansing effect.  We should not engineer a recession in order to do cleansing, but as I said before, the recession is clearly a response to a preceding boom that went too far.  Stopping the forces of the recession in this cleansing or liquidation process must, by definition, mean that you keep businesses through the recession that should have been weeded out and gone by the wayside.

Q74            Mr Rees-Mogg: If I can push a little bit further, it seemed to me that, at the time QE started, it was absolutely the right thing to do.  The response to a credit crunch was to ensure that money was made as available as possible and that you did not crunch everybody at once.  Now people have had super‑low interest rates for an extended period, they have had every opportunity to readjust their affairs to meet the new reality.  The failure to begin to increase interest rates to begin to normalise the price of money is simply delaying any prospect of a proper recovery, and it has gone beyond the point at which it is helping to the point at which it is beginning to harm.

Detlev Schlichter: I fully agree.  Part of the problem here is that the objective of quantitative easing has kind of shifted, although maybe not so much within the Bank of England.  My two co-witnesses are better judges of that.  If you look at the United States, for example, clearly the first QE, right after the Lehman collapse, was targeted at trying to avoid a seizing‑up of the inter‑bank market.  The objective was to take assets from the bank balance sheets on to the central bank, replace them with bank reserves and over‑supply the system with bank reserves, so it will not rely on lending excess reserves to one another and would therefore keep banks from collapsing.  Very quickly, then, certainly by 2010, the policy objective had changed from one of using quantitative easing to stimulate the economy to further help the economy grow.  That is a form of mission creep that is unhealthy. 

Q75            Mr Rees-Mogg: Sir Charles and Professor Miles, you were both hinting at this in your concerns over the reduction in rates from 0.5% to 0.25%.  We actually need our banks to be making money, so that they can lend to good companies and to the good mortgage prospects that need it.  At 0.25% and 0.5%, and indeed negative interest rates in some countries, the bank margins are so low that it is very difficult for them to recover from other past mistakes, it is very hard for them to acknowledge genuine bad debts, as they want to keep them going and it is very hard for them to attract deposits.  Why on earth would you deposit your money with a bank?  This is all having a perverse effect now and it is damaging the banking system, rather than helping it.  Initially, it was essential to maintaining the banking system. 

Professor Sir Charles Bean: I have some sympathy with that.  As I said some time ago, when I left the committee I thought the time was approaching.  The economy was getting back to something like a normal level of operation.  Unemployment is now about what you would probably think is the natural rate of unemployment.  Underlying inflation—and I stress “underlying” here, because obviously the exchange rate depreciation would lead to some short‑term movements—looks reasonably okay.  You would be thinking that now is the time that perhaps we ought to be starting to remove some of the extraordinary monetary stimulus.

Q76            Mr Rees-Mogg: That was hinted at, was it not, with the forward guidance that indicated by late 2014.  Professor Miles, I do not know what you think, but that seemed about the right point to start normalising.

Professor Miles: I certainly very much agree with you that having interest rates at extremely low levels and certainly negative interest rates is something to be avoided.  Negative interest rates for the UK would be extremely unhelpful.  I cannot see any strong arguments for doing that at all.  Also, the less time that we can spend with interest rates as low as they are at the moment, the better, so I do not think we should delay what you might call a gradual normalisation of monetary policy at all.  As I said earlier, my own view is that we are actually much nearer that point—that welcome point when we can start that journey—than the financial market seems to think, and I hope we start it pretty soon.

Q77            Mr Rees-Mogg: How would you start it if it were up to you?  You would not put interest rates up to 2% tomorrow, would you?  What pathway would you follow, if you were still on the MPC or if you were on the MPC for the first time?

Professor Sir Charles Bean: This is certainly something that we talked about collectively as a committee.  We were very aware that, when the time did come to start tightening policy, you would need to communicate pretty carefully, so that you do not get over‑reaction by the markets.  My general approach, in part because you do not know what the impact is going to be after such a long period of very low rates, is that you probably want to do it fairly slowly if you can, which in itself tells you to start early.  Given that you have to increase by a certain amount, start early and go slowly.

Professor Miles: Start early, be gradual and stress that this is not bad news at all, quite the opposite.

Q78            Mr Rees-Mogg: Do all three of you agree—or would this be taking it too far—that quantitative easing has now passed the point at which it is beneficial and that keeping it going beyond that point actually becomes more harmful than normalising interest rates?

Detlev Schlichter: I think it has been harmful all along.  I could see at the depth of the crisis, given that part of the institution of a central bank is as a lender of last resort, it has led to this kind of perverse effect that we obviously encourage banks to take more risk.  We tell the public that banks are basically safe; they have backing from the central bank.  In a way, that is already a key violation of the principles of a market economy, so in that sense I would be against any central bank and against any form of QE.  Obviously that was the institutional arrangement.  It led to massive growth in bank balance sheets, so the depth of the crisis would probably have been the wrong moment to remove the safety net, but ultimately the safety net will have to be removed.  We have to come to the point when we remove the central bank as this lender of last resort.  That is my view and it is a radical view.  It is not compatible with a functioning market economy.  You constantly dis‑incentivise extra credit creation, which leads to all the problems we discussed here.

To the question, the marginal impact of QE, whether beneficial or otherwise, is clearly diminishing very, very rapidly.  That is certainly happening.  If you put me on the board of the MPC, I would probably think the best course would be just not to do anything.  Raising interest rates, as long as we live in such an over‑leveraged economy where the natural rate of interest is so low, would be a very dangerous policy.  It will probably be tried at some point, then it will kick off another recession, at which point we will go to an even more aggressive monetary policy. 

The one thing that you can clearly ascertain here is that where all these economies are at now is at the point where expansionary monetary policy has very little impact on the economy, but any form of tightening is potentially very disastrous, because we are living in an economy that is still clearly over‑levered.  The position that the central bank is in is a very dangerous one.  They know that they want to move back from this expansionary policy, for all the distortions on bank profitability, on distribution of income and wealth, having big balance sheets and all these factors.  Everybody is uncomfortable, but it is very difficult to move away, because as long as we do not allow the imbalances to clear out, which would probably require an even worse recession than in 2008, it is not wanted politically, so that puts the central bank in this extraordinarily difficult position. 

The best they can do is to basically tell the market and the system that this is it: here is the level of bank reserves we have, which are plenty.  They are going to last us for the next 50 years and we are not going to do anything.  The price of these bank reserves, how they are going to be used and what banks are going to pay for them we leave to the market.  We are not setting interest rate policy; this is it.  We have become passive.  To me that would potentially be the best outcome.  Would that mean 2% inflation?  It would certainly not.  It would probably mean something lower like zero inflation.  We may have years of ‑1%, we may have years of +1% or +2%—I do not know; we will see.  Ultimately that would be a better outcome than again and again trying to use monetary policy means to get the economy growing at a rate that it cannot sustain.

Professor Sir Charles Bean: I certainly think the marginal benefit of a given quantum of asset purchases is less now than it was at the depths of the crisis, for the reasons we have talked about earlier, and the costs in some of these unwanted side effects and the distributional consequences that we have talked about have come more to the fore, so the calculus is certainly much less favourable.  This is why, if stimulus is required, we really ought to be looking in other directions.

Q79            Mr Rees-Mogg: Is that fiscal rather than monetary?

Professor Sir Charles Bean: It could be fiscal or structural, I keep on saying.

Mr Rees-Mogg: I agree with you on structural and supply‑side reforms. 

Q80            Chair: How do you feel about pretty much scrapping the Bank—a passive Bank or a passive policy, as we were told by Mr Schlichter?

Professor Sir Charles Bean: I would not be worried about the reserves gradually being shrunk, because the banks essentially have excess reserves.  I do not think there is a direct linkage from the size of their reserve holdings to the sizes of their balance sheets, at the moment. 

Professor Miles: I also believe that the impact of changing the stock is much lower than it was in the past, particularly 2009‑10.  Partly because of that, there is no great reason to feel a great urgency in bringing the stock down, just because the marginal way, one way or another, is just that, on the margin.

Q81            Mr Rees-Mogg: We get no impression that the MPC thinks along these lines.  They still seem to think that monetary policy is working splendidly and they have lots more firepower.  Is this because if you are on the MPC, particularly as two of you were on the MPC, you have to believe your own propaganda?  Is it because they have groupthink?  Do you have any insight, or is this an unfair question and how could you possibly know now you have left it?

Professor Sir Charles Bean: I do not know what the views are on the committee.  It is quite difficult for a central bank to say, “We are totally powerless”, because of the adverse effect on confidence from doing that.  There is an element of bluff or a confidence game in this.  Even if you actually think that the policy action might not have that much traction itself, actually doing something at key moments may be quite important in reinforcing confidence.  Of course, we discussed what happened in early 2009.  The mere fact of the action added something over and above the technical aspects of the monetary intervention.  That is part of the story.  I would not go so far as to say that the Bank is completely out of ammunition, but they are in a much less favourably placed situation than we were even in 2009, when we were just embarking on QE.  They are boxed in more. 

Chair: We have had a very interesting session.  It has ranged very widely.  Kit, you wanted to come in, did you not?  I am very sorry, Kit; you had one quick rejoinder. 

Q82            Kit Malthouse: I just wanted to ask you a bit more and press you a little bit further on helicopter money.  There is a bit of evidence that we unwittingly used helicopter money during the recession, as almost 10% of QE was turned into free money thorough PPI repayments.  Getting on for £40 billion was effectively injected into consumers’ bank accounts over a period. 

Professor Sir Charles Bean: That goes back to something that Detlev was alluding to, because there is actually somebody on the other side of that transaction.  The people who paid up were the shareholders of the banks concerned and so forth, so it is essentially a redistribution.

Q83            Kit Malthouse: That was supported by an inflated asset base that the Bank of England created for them.  They were able to pay it with less consequence than they otherwise would because of QE and the transmission process was through the Bank.

Professor Sir Charles Bean: It certainly will have affected the marginal response of the Bank’s shareholders. 

Chair: They got a free ride.  They picked up free money again.

Professor Sir Charles Bean: In that sense there is an offset.  Things like PPI and what John Mann was referring to when he introduced his question about the payments to coalminers—that was actually a transfer.  It may have been expansionary

Q84            Kit Malthouse: I understand, but PPI was a quasi‑transfer.  If PPI is being paid by a publicly owned bank like RBS, underpinned by the taxpayer, subject to QE, Funding for Lending and all the rest of it, you are effectively giving people a tax rebate.  In Australia, this is what they have done a couple of times.  They have this tax bonus where they give some money back. 

Professor Sir Charles Bean: It is not helicopter money.  It is a redistributive tax policy, which is a net expansionary demand effect.  It may be perfectly sensible to do, but it is distinct from helicopter money.

Kit Malthouse: There needs to be another word for it then. 

Chair: I am now going to wind up this session.  We are very much looking forward to receiving the few points that I asked for at the beginning.

Professor Sir Charles Bean: I will have to think about that, Mr Chairman.

Chair: They require quite a lot of thought.  It is one of those cases where we do not know the answer, so we thought we would try asking someone else.  We are very grateful for the evidence we have had.  It has been extremely stimulating, as you can tell from the questions we have been posing.  Thank you very much for coming.  We look forward to seeing you in a fortnight.