Wednesday, 4 April 2012

Quantitative Easing isn’t working

There is an economic crisis, yet those who advocate quantitative easing as a solution have misunderstood both the nature and the magnitude of it. This blog has consistently criticised Osborne's austerity programme and his evidence free belief that the public sector has been ‘crowding out’ the private sector.

Now I want to look at the Bank of England’s monetary policy: quantitative easing.

Quantitative easing (QE) is often referred to as ‘printing money’. In fact it is more accurately described as giving banks cheap credit (see BBC guide to QE). The use of QE is based on the assumption that our economic system is in crisis due to a lack of available credit (a credit crunch) and a lack of lending.

The same intellectual malaise is evident in the ‘soft Keynesians’ who advocated bailing out the banking system, but now reject an economic stimulus. Their unspoken slogan is ‘save the banks, fuck the people’.

These people failed to foresee the crisis, and now fail to offer viable solutions for resolving it – in fact (if one assumes their policies are advocated rationally) they seek to make it permanent by institutionalising declining real pay and hoping the private sector will magic some jobs soon (crowding out theory)

There are several collective nouns for this group: Chancellors, Treasury ministers, leading economists or business leaders.

Today the economy does not suffer from a lack of credit. It suffers from a lack of demand. Unemployment, underemployment and wage constraint have all produced a situation in which living standards are falling.

Separately, the government has massively cut its capital spending, sucking further billions out of the economy.

Vincent Cable whinges that the banks are not lending to small businesses yet why would they in a climate of falling demand, and wider financial uncertainty? Regular pay is increasing at only 1.1% per year, outstripped by inflation at over three times the rate. It is no surprise that retail sales volumes fell 0.8% in February 2012 (incorporating a 1.5% decline for non-food items).

Some, to make the case that QE is necessary, have pointed to statistics showing that the number of small business loans rejected by the banks has quadrupled since the crisis. This ignores two very salient factors:

  1. Businesses are now making more loan applications to cover (what they hope are temporary) shortfalls, rather than to invest
  2. Banks, whose reckless lending practices played a major role in causing the crisis, are now more rightly more cautious
  3. The same business plan in 2006/07 at a time of high employment and rising real wages was a lot more attractive to invest in than it is in 2012/13

The real need for the UK economy is not more credit, but more demand –and that means putting more not less money in people’s pockets. It would mean doing the exact opposite of what George Osborne is doing – redistributing £30bn from benefits and tax credits into the pockets of businesses via tax breaks. It would mean ending pay constraint and reversing the VAT hike (a tax on consumption). This could be funded by reinstituting the 50% rate and closing down on the loopholes used by the super-rich and big business to avoid their obligations.

Meanwhile the Bank of England’s now £325bn quantitative easing programme has clearly not been used to extend credit to meet any growing demand. Instead, the banks have used the extra liquidity to speculate in derivatives markets and to invest in safer foreign markets.

This is not to say quantitative easing is always a bad policy. It’s not, but in the current climate it has long outlived its utility. Part of the problem is the limited policy options open to the outsourced (independent) Bank of England and the lack of any coherent strategy from HM Treasury.

Instead of botched austerity, we need investment based around a new industrial policy to create jobs in sectors that meet people’s urgent needs, including housing, energy, and transport.


  1. Good, clear article Andrew. It is a real indictment of mass media economics journalists that Osbornomics has been allowed to propagate the myth of 'crowding out' for so long without ANY theoretical or empirical basis WHATSOEVER!

    I seem to recall that Keith Ewing points out that the need for demand stimulus from 1931 led the inter-war National and Tory governments under Stanley Baldwin to pass the Cotton Manufacturing Industry (Temporary Provisions) Act (1934) and the Road Haulage Wages Act (1938), which required employers to reach 'sector-wide' wage agreements. This had the effect of pushing up wages in a manner that was 'non-competitive' between different private firms in the sector and created Keynesian demand stimulus. Osbornomics is to the right of Tory 1930s laissez faire economics, which at least recognised reality, rather than propagating fictions such as 'crowding out'.

  2. Thanks Alex.

    You're right about the 1930s, but it took a few years until the economic situation became severe before they were forced to change course.

    In 1929 and 1930 there was mass opposition to the Labour government's economic policies - both internally from the likes of Mosley and Maxton, the ILP and affiliated unions.

    Austerity failed. Unemployment increased massively. The solution was even sharper cuts in 1931 and the forming of the national govt which slashed public spending and cut public sector pay.

    By late 1931 though the UK was forced to abandon the gold standard, devalue and slash interest rates. But real investment-based job-creating stimulus didn't occur until the mid-30s.

    Ultimately Osborne will be forced to change course. The question is how bad will it get first.