A mistaken estimate of what QE can do: letter to FT 30/3/2015

Peru 039The first point they make is that “QE is an unreliable tool for boosting GDP or employment”. This is of course correct because despite inflated claims QE can only ever have a secondary and tenuous effect on these variables. The primary task of QE is to achieve target inflation in its given currency. The hope is then that stabilising the economy at target inflation will cause confidence to return and set the economy on a growth path. The 19 economists follow this point by saying that traditional “monetary policy no longer works”. Here I agree because it was never originally designed to work on output and employment, but disagree over its impact on inflation, where in the UK and USA it was designed to avoid deflation, which it did, and in the Eurozone to recover from a period of deflation, which it will do if the ECB have got their sums right.

The 19 economists then go on to refer to Bank of England research that shows that QE “benefits the well-off, who gain from increasing asset prices, much more than the poorest” Again this is not correct as QE tends to have a small impact (perhaps up to 100 basis points) on interest rates, which is only temporary while the QE is on-going. However the sustained impact on asset values is the impact of artificially low interest rates which have the continuing and distorting effect that has produced current asset bubbles. These bubbles benefit certain groups in the economy such as investors and debtors and damage savers.

The main thrust of their letter is that QE is misdirected into financial markets whereas it could have been used to “finance government spending” or used to make gratis payments “to each Eurozone citizen” My point is that QE is not injected, as they state, “into the financial markets”. Rather it is injected into the economy through financial markets to manage inflation. In this way it is more likely to be used efficiently as it spreads through the economy than if it is being controlled by well-meaning groups of civil servants or economists.

In conclusion the letter is unsound, mistaken in its estimate of what QE can do, and confuses QE with badly managed interest rate policy, when it refers to asset prices. I remind you that the points I make refer to all currencies where the successful use of QE can manage inflation, but will only have a limited and secondary impact on growth and employment.

Yours faithfully,

John Hearn

Senior Lecturer,

ifs University College,

London EC3


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