Josh Ryan-Collins is senior researcher on monetary reform at the New Economics Foundation
If you read articles on the topic in the media, you will see statements like “the Bank is ‘printing’ money” or the Bank will “pump a further £50 billion in to the economy”. Both these statements are misleading.
QE actually involves the Bank of England buying financial assets – usually government bonds – belonging to institutional investors and sitting in Banks. The Bank buys these assets with newly created central bank reserves. These reserves can only be held by banks – they do not and cannot go to businesses the real economy.
As explained in nef’s Where Does Money Come From?, central bank reserves are used by commercial banks to settle payments with each other.
By ‘pumping’ more reserves in to the intra-bank clearing system the idea is that banks will feel more confident about making loans to the real economy because they will know that other banks are in a stronger position to settle with them.
In addition, by buying up ultra-safe government bonds in vast quantities and thus pushing down the yield (the interest received on holding) on these assets, the central bank hopes to encourage investors to buy higher yielding corporate bonds – which again provides money for real businesses.
QE may reduce long-term interest rates, but there is little evidence it has stimulated commercial banks to start lending more to businesses, in particular small businesses, or soften the conditions banks are attaching to loans.
In fact the most recent figures published by the Bank show that net lending – the amount of loans minus the amount repaid – to small businesses has contracted by six per cent in the year to November 2011. And this despite the banks being given small business lending targets by the government through ‘Project Merlin’. Not much wizardry there then.
The hard truth is that commercial banks are still in a process of ‘de-leveraging’, more keen on getting their loans repaid and building up their capital base than making new loans to productive businesses in what is perceived to be a risky real economy.
Evidence suggests the additional funds provided by QE are more likely to be used by banks to create more speculative credit, not least commodity speculation, that provides shorter term returns. As a result, the money supply in the real economy is contracting just at the point where new investment is most needed.
But there are alternatives. The central bank, working with the government, could find ways of channelling newly created central bank money more directly in to the economy.
In a pamphlet released today, economist Richard Werner, who coined the term quantitative easing whilst commentating on the Japanese economy in the 1990s, and Green Party leader Caroline Lucas, argue that the Bank of England needs to rethink its strategy.
They suggest a massive ‘green quantitative easing’ program, involving the creation of a new entity – or a beefed up green investment bank perhaps – that could issue corporate equity or bonds purchased by the Bank of England and then use the funds to embark on a £70 billion green QE program for solar PV and energy efficiency in homes.
According to the calculations in the report, this would create 200,000 jobs and save households up to £250 per annum in reduced electricity bills. On top of this, green QE could finance the £16 billion green deal energy efficiency program for homes the government is planning, creating 65,000 jobs in insulation and construction by 2015.
If the Bank of England objected to buying corporate instead of government assets, the Treasury could guarantee them much as Obama’s administration guaranteed green loans in the United States to help kick-start the economy following the financial crisis.
Pension funds should also be happy to buy up such assets given the long term (25 year) secure returns generated through the Feed-in-Tariff and household repayment of energy efficiency loans by households met through the savings on heating bills.
The government and Bank of England needs to accept the fact that our banking system is not currently longer fit for purpose – assuming the purpose is getting money in to the real, productive economy. It could take decades to restructure our banks so that they become functional again.
In the meantime, we should abandon ‘orthodox’ QE and find better ways of exploiting the Bank of England’s power of money creation. Creating hundreds of thousands of jobs, tackling climate change and fuel poverty and improving energy security seems like a reasonable place to start.
• We’re all economists now, part one – Ben Mitchell, February 4th 2012
• Will quantitative easing work this time? – George Irvin, October 9th 2011
• Quantitative easing: The latest windfall from us all to “country London” – Ranjit Sidhu, October 8th 2011
• Could earnings-based rent-control replace quantitative easing? – Peter Morgan, September 26th 2011
• Osborne set to U-turn on QE – so why not on Plan B? – Shamik Das, September 12th 2011