Thursday, 7 May 2009

The Asset Purchase Scheme reaches for the sky

"The Bank of England’s Monetary Policy Committee today voted to maintain the official Bank Rate paid on commercial bank reserves at 0.5%. The Committee also voted to continue with its programme of asset purchases financed by the issuance of central bank reserves and to increase its size by £50 billion to a total of £125 billion"

MPC press statement today

So, it seems that £75 billion was not enough. The Bank of England now needs to increase the Asset Purchase Scheme to £125 billion, an increase of £50 billion. It needs authorization to buy up to 10 percent of GDP in government assets to save the UK economy from the consequences of the financial crisis.

The funny thing is that so far the Bank of England has purchased £21 billion; they had plenty of room under the existing arrangement, but still felt that they needed more purchasing power. Why did they feel the need to increase the scheme? The answer? Forget deflation; think fiscal.

The MPC claim that quantitative easing is about avoiding deflation. Yet, it had to acknowledge today that this justification does not sit easily with recent inflation data. As the press release said: "CPI inflation was 2.9 percent in March, significantly higher than the 2 percent inflation target.”

The deflation justification looks even more dubious when we look at recent press reports, which suggest that the economy has reached a bottom and a recovery will soon be underway. On the one hand, monetary policy is being conducted as if we face a catastrophic collapse in consumer prices. On the other hand, the economy is through the worst and growth will soon resume.

If the latter is true, then the quantitative easing is not necessary. In fact, if the economy is about to recover then these asset purchases will inject a huge amount of cash into the economy, which will inevitably lead to a surge in inflation.

How can we make sense of this contradiction? It is to recognize that the Bank of England is not being honest about the true purpose of this scheme. The asset purchase scheme is not about avoiding deflation. It is about about filling the fiscal gap. It's about generating cash for a government that is likely to be shut out of debt markets and has allowed expenditure is to run out of control while at the same time cutting taxes.

Quantitative easing is about fiscal policy. Having lost its independence, the Bank of England is working with New Labour. Together, they are trying to delay the inevitable reckoning that comes from the macroeconomic mess that Brown and Darling have inflicted upon the UK economy.


AntiCitizenOne said...

I tend to favour incompetence.

"We must do something!!!!"

"This is something!!!"

"Therefore lets do this!!"

Seems to be the logic behind it.

Financial 'Hair of the Dog' for a debt hangover.

Anonymous said...

Perhaps we need a new law which only allows QE if the money is equally divided between each and every citizen.

£50bn that's nearly £1000 each that should provide a fiscal stimulus :)

sobers said...

Something stinks at the moment: the BoE is ploughing shedloads of cash into the economy, the govt is borrowing money left right and centre with no idea how it will finance it, unemployment is rising, house prices falling, economy still contracting and inflation proving stubbornly high, but the stock market is booming, the pound is rising and 'green shoots' are being seen everywhere. Nothing makes sense.

John East said...

I think the additional £50b might be to cover next years MP's expenses claims.

Phill Tomlinson said...

Simple sobers, we are under a monetary system with no restraint. That is the moral hazzard. Governments can inflate at will with no limit. This is how it will all be financed.

Either they carry on to try and keep the bubble going, with the eventual destruction of the currency. Or they abandon the inflationist policies, let the previous credit bubble deflate and move on. I hope one day we will come to our senses and do the latter, but for the time being we are pursuing the former.

boiling frog said...

Really they want to borrow money and to do so they have to sell govt bonds, so QE is a way of trying to keep the interest rate that the govt has to pay low.
Bernanke is also doing the QE bit, but it didn't go too well for him to day with a failed 30yr auction and the 10 year swinging up to nearly 3.30pct without any consideration for resistance levels.

Ullrakesh said...

We all have an interest in economics and we can all see that what they are doing is wrong.

This disaster is compounded however by the fact that because the UK economy is deteriorating at a slower rate this month, every bit of broadcast or published media is reporting this as a victory for the government, and a recovery is on the way.

I truly feel sorry for anyone stupid enough to think that this recovery is genuine. They might buy a house, get an ERL or even buy into the stock market now asset prices have supposedly reached bottom. They will be the latest victims of government lies and BOE deception.

When they find out that Stephanie Flanders (of BBC fame) comments on the reduced LIBOR rate are a false dawn, and they will feel cheated.

The fact that her and everyone else in the media are still saying 'I don't know' & 'It's to early to tell' when asked about QE's success, is truly a disgrace.

They should at least show us the successful examples of this policy in the past, weighted against the examples of failures from printing money.

As a nation we would take the keys off the BOE to the Royal Mint's printing presses, to prevent this madness from going any further.