Reform roundtable seminar introduced by Dr Adam Posen, member of the Bank of England’s Monetary Policy Committee, on Thursday 29 March.
By Lauren Thorpe
Long-time students of central banks are often surprised at the degree of interest, and strength of feeling, that this topic currently generates. But this should be no surprise. Since the Bank of England started its Quantitative Easing (QE) programme in March 2009, it has pumped £325 billion into the UK economy. Any intervention on this scale will have major economic effects.
To provide an insight into thinking on QE and its likely economic effects, Reform held a round table seminar on Thursday 30 March with Dr Adam Posen, member of the Bank of England’s Monetary Policy Committee. This event was held under the Chatham House Rule. Some of the key points raised included:
- 1. Impact on pensions of QE. The National Association of Pension Funds (NAPF) recently published an estimate that the latest £50 billion asset purchase added £45 billion to the deficit of UK companies’ final salary pension schemes. The challenge is to assess whether any gain to the economy from QE exceeds these losses to pensions (there are no easy answers to this). To understand the full implications of QE it is also important to consider the counter-factual. What would the UK economy (and thus pensions) look like if QE had not have taken place?
- 2. Regulatory impact on pensions. There was concern that the effects of QE on pensions may have been increased by a lack of response from the regulator. Pension schemes report receiving inconsistent messages from the authorities, with pressure to transfer their investments into riskier assets while at the same time being encouraged to de-risk. Finding the right approach to regulation will become more important when the Bank of England needs to unwind its position and return gilts to the market.
- 3. Role of bank lending. An asset purchase programme should increase the amount of money in the economy and encourage bank lending. Yet there is a concern that banks have used much of the money to shore up their own balance sheets, rather than injecting cash into the real economy. This highlights two issues. First, is credit allocation by UK banks good enough? One view is that institutions in the US do a better job of this than our capital markets, given the larger reliance on bank lending in the UK and lower levels of competition in the sector. Second, QE should cause an increase in asset prices by allowing corporates to raise debt more cheaply, in turn generating wealth creation as consumption increases. While this has happened, evidence suggests that the impact is much smaller in the UK than in the US.
- 4. Circumventing the banking system. It has been suggested that the Bank of England could issue money closer to the market, by-passing the banks. In the US this can happen more readily given the existence of government backed organisations such as Fannie Mae and Freddie Mac. Yet there are two challenges to going in this direction. The first is scale – to match the tranches of QE already completed the Bank of England would need to buy a significant majority of the UK corporate bond market. The second is political. It would require “picking winners” which has well-known challenges.
These discussions aside, there is also a wider concern over the potential impact of QE on expectations. Will it increase moral hazard in markets? If QE is successful, are we likely to behave differently in the knowledge that the Bank of England can prop up the economy in this way? It is perhaps these dimensions of QE that will have the longest long-term effect.
Reform roundtable seminar on "why is UK growth so slow?" on Monday 2 July2012. Introduced by Richard Jeffrey, Chief Investment Officer, Cazenove Capital Management.
By Lauren Thorpe
Earlier this week Richard Jeffrey, Chief Investment Officer at Cazenove Capital Management, introduced the first of three austerity debates hosted by Reform. This debate was on the topic of “why is UK growth so slow” and was held under the Chatham House Rule.
The answer to the question was straightforward but politically tough – over recent “boom years” the economy had accumulated debt at a rate faster than could be matched by income growth. The wealth that was being consumed had not yet been earned, and after the party the UK found itself burdened with onerous amounts of public and private debt. This increase in debt reflects failures in fiscal and monetary policy. Interest rates were too low for too long and spending increased too quickly.
Looking forward as well as back the messages are just as hard. The UK needs to reduce its historically high levels of debt. Domestic demand needs to grow at a lower rate than GDP and fiscal policy must rebalance. Importantly, expectations for growth will need to be more realistic. The economy will be doing well to have a real rate of growth of two per cent, prolonging a recessionary feel. In short, austerity will be the new normal.
So what does this imply for government policy? A key implication is that the task of delivering growth is not just for the Government. Indeed, the best thing the Government could do for growth is to create the conditions for the private sector to expand. This should come from supply side reform. Efforts to prop up demand would either be too small to have a material impact or would need to be so large as to damage overall fiscal credibility. Curbing the overreach of the Government will also help reduce the degree to which it crowds out private activity (evidence of this crowding out can be seen through lower capital investment).
There are a number of supply side reforms that the Government could look to. The four main pillars that affect investment and growth in the private sector are: access to skills, the tax environment, regulatory burdens, and the quality of infrastructure. On skills, standards in schools must be raised so that employers do not have their productivity stifled. On tax the emphasis must be on creating an environment that is stable and consistent. Rather than increasing regulatory burdens, the Government should try to reduce them, particularly for small businesses. And finally, it is necessary to find a way to encourage private sector investment in infrastructure projects in the UK.
The picture for growth in the UK has changed. The UK is likely to experience shorter economic cycles where inflation plays an important role in shaping the real rate of growth. The next few years will require a prolonged and severe period of deleveraging. In simple terms, people need to spend less than they are earning. This may sound straightforward but following a decade of overspending, it will feel tough.
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