Yesterday I looked at the arguments on the way UK fiscal policy should be deployed. The alternative short-term policy is to use monetary policy.
Usually monetary policy is about adjusting interest rates. This affects saving, borrowing and so consumption and investment behaviour. In short it pushes Aggregate Demand (the total amount of demand in the economy) up or down and so influences the level of economic activity.
The economic data suggests that the UK could slip into another recession. A more expansionary fiscal policy is ruled out (see yesterdays post) and so monetary policy might be an option. The problem is interest rates are already just 0.5% and so can't be lowered. The alternative is to simply print money.
Printing money in this context is called Quantitative Easing. The money supply rises, people have more money to spend and so consumption rises and firms have an incentive to invest. Easy really.
The problem is that printing money could be inflationary. That is unlikely, the money supply has not grown in the recession and the effect will likely go into demand. But another problem is that confidence among households and firms is so low that the extra money will simply be saved and have no impact on output.
The Monetary Policy Committee of the Bank of England meets today and will leave interest rates where they are. Some want them to do more Quantitative Easing (QE2). It probably wouldn't do any harm, but would confirm that the Bank fears the worst.
More and more rounds of QE is not sustainable and eventually it will help drive inflation up when inflation is already well above the 2% target adopted by the bank of England.
ReplyDeleteThe current economic climate is one where there is little consumer confidence and little general confidence in the economy at all. This means that although printing more money and therefore feeding more money into the economy should encourage more spending and therefore more growth people will be reluctant to spend. This is because a lot of people believe that the world economy is on the verge of a double-dip recession and spending more money now will mean that people will be in a much worse off position later if we all fall back into recession.
The main point is that we can't rush into more rounds of QE and that we must make sure that we do not over estimate the amount of QE that must take place or we risk doing a lot of long term damage to the economy.
All policy decisions have to be weighed carefully of course. However the call is not for more 'rounds' of QE, but one more round.
ReplyDeleteInflationary pressure is currently not demand side pressure and so a further round of QE is unlikely to be inflationary. However in the event that it is the process is reversible through normal 'Open Market Operations'.
The point of giving the financial system more liquidity is that it will allow banks the room to lend and recapitalise thier balance sheets, adding to both stability of the financial system and the pace of recovery.