In his recent blog piece Mainly Macro, top economist Professor Simon Wren-Lewis reported that quantitative easing (or QE) is predicted by the Office for Budget Responsibility to eventually cost the government £100bn.
A government can do an awful lot with £100bn. Think of the backlog of building repairs in the NHS and state schools. Or they could invest in building new houses – and insulating the older housing stock. Funding social care for the elderly is another priority.
What is QE and how has this massive shortfall arisen?
QE is an unconventional tool in the monetary policy toolkit. In normal times the Bank of England steers the UK economy by adjusting interest rates (up if treading on the economic brakes, down if on the accelerator). But for a long period prior to 2022, interest rates were stuck at unusually low rates so that at times, when there was a need for stimulus, there was very little scope to reduce them further.
On four occasions QE was used as an emergency measure: in 2009 (in response to the global financial crisis), 2012 (Eurozone debt crisis), 2016 (post-Brexit referendum result – another crisis), and 2020 (when Covid struck the economy – financing furlough).
The way QE works is that the government issues bonds that the Bank of England (as lender of last resort) is required to purchase – at least, if no other institution does. The Bank has the capacity to ‘print more money’ (these days this is done electronically) and so always has the means to buy government bonds. The commercial banks hold many of these bonds as part of their reserves at the Bank, and the Bank pays interest on them. These interest payments are leaving the commercial banks as the big winners in this exercise.
By 2020 the total value of government bonds purchased by the Bank of England had risen to £895bn.
Interest rates, bond pricing, and profits (or losses)
The world of finance is awash with fluctuations. There are short-term interest rates and long-term interest rates and sometimes one is above the other – and sometimes vice versa. Government bonds carry a fixed rate of interest and changes in the long-term rate of interest (or expectations of change) will cause the second-hand price of the bonds to change. As the price of bonds changes so the Bank stands to make a profit – or maybe a loss – on its original investment.
In the early years of QE the structure of interest rates was favourable to the Bank’s position and the Bank was making a profit out of QE. In the last two years short-term interest rates have risen, and that has been to the Bank’s disadvantage. Even worse, the rise in interest rates has had a depressing effect on the second-hand price of bonds. Since those in charge of monetary policy see that now is the time to unwind QE (start to pay it off) the Bank of England finds itself making a whole series of capital losses on its bond sales. The various crises required QE to be undertaken on a huge scale – so there is scope for losses to be huge, perhaps as much as £100bn.
The government indemnifies the Bank for any losses that it might make, and so that £100bn loss comes back to the government (the public purse). Wren-Lewis believes that the risks of QE were known to George Osborne in 2010, but were pushed to one side. He writes:
“I suspect the politicians at the time ignored any potential future costs from QE because these costs were uncertain and, more importantly, would happen after the next election.”
This is pretty consistent with Conservative short-termism.
Massive profits for commercial banks – at the expense of the public purse
If the public purse takes the hit for a £100bn loss, who has profited out of this? The obvious winners are the commercial banks. In recent years the interest rate differential mentioned above has moved in their favour. Various economists have seen this as inequitable and have urged remedies, including a tax on commercial bank QE windfall gains.
A second series of unhelpful distributional effects arises with the impact of QE on asset values. Cash being more readily available pushed up asset prices – to the advantage of the already wealthy. In the first eighteen months of the Covid pandemic the number of billionaires in the UK rose from 147 to 171. At the same time, house prices rose, making it more difficult for people in their thirties to get on the property ladder. A side effect of QE has been to add to inter-generational inequality.
Could things have been done differently – and better?
Wren-Lewis makes a powerful case that conventional Keynesian fiscal policy (tax and spend) would have been a far better tool to deal with the 2009 global financial crisis – and, for that matter, the various subsequent crises. However, by 2010 the coalition was in government, with the so-called ‘quad’ (David Cameron, George Osborne, Nick Clegg and Danny Alexander) doggedly in favour of austerity. John Maynard Keynes never got a look-in.
Let me leave the last words to Wren-Lewis:
“Who is to blame for these losses? Jo Michell put it nicely when he wrote that ‘the original sin of QE was austerity’. We had QE on the scale we did because in 2010 the government reversed Labour’s fiscal expansion. As an expansionary tool QE is undoubtedly inferior to fiscal expansion, which is why austerity was so costly in macroeconomic terms.”
