Wednesday, 19 August 2009

Somebody stop me

The FT reports that Mervyn King had to be constrained during the last MPC meeting. The Governor wanted to print a further £75 billion. However, the rest of the committee held him back and finally settled on an additional £50 billion.

The extraordinary thing about UK monetary policy today is how close it is shadowing fiscal policy. This year, the Bank of England printing presses will produce roughly the same amount of new money as this year's fiscal deficit. Or to put it more bluntly, the private sector have, on a net basis, stopped lending money to the government. The Bank of England have stepped into the breech and filled the gap.

Here we come to a question that no one in Westminister or Threadneedle Street dare ask. What would happen if the Bank of England suddenly stopped printing cash?

Although it is an unforgivable question to ask, the answer is straightforward. If the Bank of England would stop funding the deficit, the government would either have to stop running up such large deficits or it would have to convince the private sector to lend sufficient funds to cover any government expenditures over revenues.

There is only one way that the National Debt Office could convince the private sector to lend more - higher interest rates. It is as simple and as complicated as that. Those rates would, of course, put an end to any nascent recovery in the UK economy.

This explains Mr. King's desire to keep the printing presses running. If he stops funding the government, rates would rise and the Bank of England would lose control of rates.

The poor man is trapped. He is working on that old adage "in for a penny, in for a pound". If the Bank of England are in the business of printing cash, then what does it matter if it prints £5o billion or £75 billion?


sobers said...

QE is a slippery slope, and we are beginning to get to the point of no return. If it gets extended again after this tranche of £50bn, I think thats it. It will be interesting - this lot will run out about the end of the year I reckon, leaving a gap of up to 6 months to the election. If they stop QE at end '09, that could cause a run on the pound/funding crisis in the middle of an election.

My guess is Labour will put the pressure on to keep QE going until mid 2010, so the sh1t doesn't hit the fan on their watch. They can then blame the Tories for everything that happens subsequently (funding crisis, devalued pound, tax rises, spending cuts, inflation).

What a way to run a country.....

Ed t said...

Vindication- but you knew this anyway, Alice.

Liam Halligan has been the best prognosticator, imo.