QE must be accompanied by economic stimulus if it is ever to work

Last Friday the British Manufacturing Activity Index fell dramatically and unexpectedly from 50.5 to 47.9.

This fall represented a contraction in activity for manufacturing.

David Noble, the chief executive of the Chartered Institute of Purchasing & Supply (CIPS) who published the report made it clear the reasons for the fall: “The sector witnessed a fall in new orders…and a continued lack of demand”.

This was followed on Monday by the news that the UK banks, rather than being stimulated into lending more to businesses by the government Funding for Lending Scheme (FLS), lent £2.7 billion less, in part due to “lacklustre demand”.

Michael Saunders, chief UK economist at Citi, was blunt about the failures of the FLS:

“It is pretty clear that the FLS is not living up to expectations.” He continued that this “raises the likelihood of other forms of easing and additional credit easing in our view.”

This sentiment was echoed by chief economists across the banking sector that the falling Manufacturing Activity Index was “going to play a big role in the QE decision next week.”

QE has a very simple stimulus from a macro-economic basis for a country: by electronically printing all this money, the theory goes that banks become stable and cash rich.

With the government bonds that have just been bought back by the Bank of England providing little to no interest, this pushes the banks to go out and lend to businesses, and in the process boosts the economy.

This pumping cash into the system is needed to combat the shrinking of available money, caused by increased savings and the de-leveraging of the banks that happens in a recession.

The only problem is this stimulus hasn’t  happened and the logic behind why it hasn’t is very simple: for QE to work the cash stimulus for banks allowing them to lend must be accompanied by a stimulated demand for this money.

If this demand is not stimulated, then you have an economy that stumbles around for years with little to no growth, bumping from recession to recession.

In other words, our economy is a car stuck at the bottom of a hill; we can fill it with all the petrol of cheap borrowing we want, but if we are not prepared to press the accelerator of demand the car will just sit there at the bottom of the hill. The latest manufacturing Activity Index and FLS figures back this up.

We have to ask the question: why are city economists so willing to support QE but not a stimulus in demand? The rational that the  market will not let the UK borrow more to stimulate demand does not stand up to scrutiny – the UK is borrowing more year on year with no effects on its cost of borrowing, (another effect of QE).

There is a very cynical view, and it is that these same institutions that pay the economists’ wages have done very well from QE.

Another recognized effect of QE is its positive impact on the stock markets: the UK stock market recently reached a five year high and it was followed by the US stock market last Friday.

A well established effect of QE is that it will lead to a “sugar rush” of investment in the stock market. This has allowed the city investment houses, in such a turbulent year as 2012, to see record profitable days, and while the economies of the world were in crisis they saw their profits explode.

Even those of us with a less cynical disposition must ask the question of why these city economists are so ready to push QE, but not demand, when logically they are so closely binded together.

With evidence overwhelmingly pointing to the need for demand boosting measures to kick-start the economy, we need to ask City economists the same question that John Maynard Keynes asked when challenged about his change in economic policy to tackle the Great Depression in the 1930s:

“When my information changes, I alter my conclusions. What do you do, sir?”

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  • LB

    1. Tax cuts on employment.

    e.g Employer’s NI. If taxes on smoking, drinking, driving discourage those activities, cut taxes on employment.

    2. Taxes on investment – cut them.

    3. Allow losses against income tax. If you make an investment that goes wrong, then it helps you get back and make more.

    4. Stop QE.Of 375 bn pounds of QE, 375 billion pounds has been used to buy gits, and the government has spent it. No one else is willingly lending to the muppets in Westminster.

  • Newsbot9

    1. Will cut tax revenue. Nothing else. Paid for by the poor, of course, further reducing demand and lowering growth,
    2, Tax cuts for the rich, lowering revenue.
    3. Allowing the rich to never pay even income tax, lowering revenue.

    You’re after another tax cut and socialising your costs again.

  • Newsbot9

    QE *is* working as intended. It’s crushing pension returns. Growth? Not a government aim. They made no mistake when then described it as a threat to them!