It is often said that armies train to fight the last war rather than prepare for the next conflict. By the same token, governments are usually seen tackling the previous financial crisis, rather than the most likely sources of future instability. For much of the 1980s and 90s, governments considered 1970s-style inflation to be the biggest threat to financial stability and were quick to use interest rates as a break on economic overheating.
So was the Bank of England (BoE) right to launch a second round of quantitative easing (QE) on 6 October, just as other governments have sought to blow the embers of economic activity by boosting money supply? Well, as so often in such cases, it is easy to argue both in favour and against. Yes, because stagflation is currently a bigger threat than inflation; but no, because there is too little concrete evidence to show whether and how QE actually works.
The popular press like to depict the strategy as something akin to the inflationary money-printing of Germany in the 1920s and Zimbabwe in the 2000s. There are a variety of differences but the key point is that QE has not resulted in dangerous levels of inflation. Without such a downside, the BoE’s approach seems worth a try and in this case it could be fighting the right battle at the right time. It is entirely possible that the stagflation that paralysed the Japanese economy for over a decade could be heading Europe’s way, if urgent action is not taken.
As in mainland Europe, North America and much of the rest of the world, the British government is reining in expenditure – in the long term at least – in order to reduce public debt. Yet depressing demand could throttle the lifeblood out of the nascent recovery, so pumping more money into the economy is surely a sensible move. With interest rates at 0.5% there is little scope for a rate cut, so the BoE had few other weapons at its disposal if it was to be seen doing something.
A further £75 billion will be injected into the British economy by the BoE, following an earlier commitment of £200 billion. Without some kind of controlled experiment, it is difficult to assess the impact of phase one of this operation but it has certainly not caused the British economy to overheat. Growth in the UK economy during the second quarter of this year has just been revised down to 0.1%. Such sluggish progress may have prompted the Bank’s decision and Westminster too seems to prefer QE to Keynesian-style public works in order to generate more economic activity, although it will not on its own provide the solution.
From an objective point of view, QE highlights one of the biggest absurdities of the capitalist system. The BoE will use much of the money to buy UK government bonds, so the British establishment will seek to boost growth by buying its own debt. This arrangement is far from rare, as the Federal Reserve is well known as the biggest holder of US government debt. Once again, this supports the truism that capitalism is far from an ideal system but it is the least bad system thus far devised by humankind.