If there has been one area of party political consensus since the Crash, it is that an interventionist monetary policy is a good thing. Osborne and Balls may differ on the fiscal path but they both agree that the Bank of England has done the right thing by slashing the base rate and pumping money into the economy by buying up financial assets. And if things don’t get much better (as it looks like they won’t for quite some time) then both parties expect the Governor to start the printing presses rolling once again.
Now a heavyweight paper from a senior central banker might have opened up a small crack in this cosy consensus. The paper’s author, William White is a former senior official at the central banks' central bank - the Bank for International Settlements – and is now something big at the OECD. I’ll let White’s paper do the talking here:
Ultra easy monetary policies have a wide variety of undesirable medium term effects ‐ the unintended consequences. They create malinvestments in the real economy, threaten the health of financial institutions and the functioning of financial markets, constrain the “independent “ pursuit of price stability by central banks, encourage governments to refrain from confronting sovereign debt problems in a timely way, and redistribute income and wealth in a highly regressive fashion. While each medium term effect on its own might be questioned, considered all together they support strongly the proposition that aggressive monetary easing in economic downturns is not “a free lunch".
Unsurprisingly, the paper has already caused something of a stir on the financial pages. But what is remarkable about the paper is that it is only now that such concerns are getting an airing in Britain. How can it be that such a major policy intervention - effectively pouring trillions of Dollars, Pounds and Euros into the global economy - has enjoyed such a tame, uncritical reception in the UK? (The wisdom of monetary policy activism is more disputed in the US and the Eurozone, of course.)
I think there are five reasons.
Firstly, QE is techy, difficult to understand and the impacts are uncertain. Cuts are different. Everyone can have a view on less money being spent on services, jobs being lost and welfare payments being reduced.
Secondly, QE provides a great alibi for politicians having to implement cuts and facing difficult questions about the likely negative impacts of those cuts on economic recovery. They can say, as Osborne regularly does, that monetary policy needs to do the heavy lifting on promoting growth and preventing depression while he gets on with sorting out the deficit.
Thirdly, we are living through an era of what might be called ‘macro-economic hubris’. As it has become clear that the private sector is stuck in a trough, the onus has passed increasingly to policy-makers to create economic health and growth. One result is that a huge amount of faith has been placed in the capacity of the discipline of macro-economics to formulate policy that can bring about a substantive change in our situation.
However, I, for one, have had my own faith severely shaken in the last two or so years as the powerlessness of policy-makers in the face of vast economic trends and developments has been exposed. I think if QE really does start to generate problems then this doubt may become more common.
Fourth, despite all the rhetoric about moving away from the short-termism of the financial sector that supposedly got us into the mess, the debate about the policy response to the economic crisis has itself been increasingly short-termist. For example, political credibility rises or falls precipitously now not just with the quarterly GDP estimates but even with the revisions of those estimates which used to go entirely unnoticed outside the City of London.
The short-termism can also be seen in the morbid over-use of the phrase "in the long run, we're all dead". This was a comment by Keynes that is now employed in all sorts of contexts to justify ignoring any longer-term effects of major interventions designed to kick-start growth.
As a result, the very great majority of the debate on QE has focused on how much money should be injected, when and in what way. Wider debate about the effect QE might have in the longer run has been much more sotto voce.
So if evidence begins to emerge that QE is doing as much or more harm than good, it could be a turning-point not just in the current terms of the debate over the deficit but also in the wider faith placed in macro-economic analysis and policy.
What might be put in the place of QE and faith in macro-economic policy is hard to say. I am increasingly convinced that we need to get back to an understanding of the economy as fundamentally a spontaneous, chaotic but effective generator of value and wealth in which all do their bit to create that value. From this perspective, the capacity of great puppet-masters in the form of Chancellors or Governors to nurse the economy back to health is probably far more limited than the current consensus suggests.
What this might mean in practice I am not sure but it is a theme I hope to return to in future blogs. The spirit of that outlook has also informed an RSA pamphlet I have written due to be published in the second week of September. I'll be blogging about that as well.