“The final word on quantitative easing will have to wait for historians,” wrote Ambrose Evans-Pritchard last week. Now the US Federal Reserve has apparently ended QE, I’d like to take a cue from my esteemed Telegraph colleague by suggesting what future historians might say.
Last Wednesday, the Fed terminated QE3 – the latest incarnation of its money-creation programme. The American version of this highly unorthodox policy began in late 2008, with the Fed creating virtual balances ex nihilo and purchasing assets such as government debt and mortgage-backed securities, often from bombed-out banks.
The US authorities originally billed QE as a $600bn exercise. By unlocking frozen interbank markets, it was supposed to spur growth, breaking the credit crunch. As meaningful recovery remained elusive, though, QE2 was launched in 2010, with its successor two years later.
In sum, the world’s most important central bank has fired $3,700bn from its monetary bazooka. America’s QE has been six times bigger than envisaged. The Fed’s balance sheet has grew more than three-fold in just over half a decade – an unprecedented monetary expansion. And it’s not just America, of course.
QE – IT’S NO JOKE
A Western central banker is ordering a pizza over the telephone.
“Should I cut your pizza cut into six slices or eight slices, sir?” asks the youthful restaurant staffer.
The central banker pauses and scratches his chin. “Hmmm, now let me see,” he says slowly, weighing every word.
“I’m feeling hungry tonight … so cut my pizza into eight slices, please”.
The central banker then pauses again, asks for a moment and then gives his final instruction.
“Actually, I really am quite famished. Could you slice it into ten?”
As far as most observers are concerned, Mark Carney’s speech at the Mansion House last Thursday boiled down to a single half sentence. The first rise in interest rates since July 2007 “could happen sooner than markets currently expect”, the Bank of England Governor uttered, to assembled City grandees and the wider world beyond. This sparked a frenzy of speculation that rates could start rising from their historic low of 0.5pc, where they’ve been since March 2009, sooner rather than later.
Before Thursday, the consensus expressed in bond and currency markets was that the first rate increase in almost seven years would happen early in the second quarter of 2015. Carney’s after-dinner bombshell changed that, with economists scrambling to update their forecasts.
The Bank of England is increasingly optimistic about the UK growth outlook. Britain remains on course to expand by a very punchy 3.4pc this year, Governor Mark Carney revealed last Wednesday, presenting the latest quarterly Inflation Report. Our economy, then, is now growing at its fastest pace since 2007, prior to the financial crisis. The Bank’s Monetary Policy Committee further upgraded its 2015 growth forecast, from 2.7pc to 2.9pc.
Over the next 2 and a bit years (9 quarters), UK GDP is set to rise at an annual average of no less than 3.1pc. This latest Inflation Report is among the most bullish the MPC has published since it was established 17 years ago. Britain is now moving “from a recovery supported by household spending to an expansion sustained by business investment”, according to Carney. “The economy has started to head back towards normal”.
UK inflation was apparently just 1.6pc during the year to March. That’s a four-year low. The Consumer Price Index has now fallen for six consecutive months – the first time that’s happened since the CPI inflation measure was introduced in 1997.
For more than five years, stubbornly high inflation has coincided with job market weakness and a related fall in earnings. As a result, average real wages have plunged by around 10pc, the most severe squeeze on post-inflation pay in this country for more than half a century.
That’s why there’s much excitement in political circles that rock-bottom inflation is now coinciding with faster nominal wage growth. After increasing by 1.4pc and 1.5pc in 2012 and 2013 respectively, average earnings rose by 2pc year-on-year during the three months to February.
Last Friday, the debate on UK bank reform burst into life, after Ed Miliband boomed that British banks have been “an incredibly poor servant of the real economy”. Labour, the party’s youthful leader told us, will “turn the tide”.
The UK’s five largest banks are “too powerful” and should be forced to give up “significant numbers” of branches, said Mililand. He’s right, given that the big-five still hold 85pc of personal accounts. “On day one” of the next Labour government, Miliband promised, steps would be taken to create two new “Challenger” banks to take on the existing “big five” and boost competition on the High Street.
UK inflation just hit a four-year low. Hurrah! The Bank of England will now be under much less pressure to raise interest rates – which is good news for the UK’s highly indebted households.
Inflation is now so subdued we don’t need to worry about it anymore. The real danger is that Britain contracts a nasty dose of deflation – the Japanese-style disease of falling prices, stalled demand in expectation of a further price slide and curtailed investment. So be reassured that our central bank, having already created £375bn of virtual money, could yet unleash even more quantitative easing.
The above two paragraphs represent, more or less, the conventional wisdom on UK inflation. I find myself, yet again, disagreeing with almost every word – except for the very first sentence. UK inflation is indeed at a four-year low, according to the Office for National Statistics. In November, the Consumer Price Index was 2.1pc higher than the same month in 2012.
Economists aren’t very popular. Dismal scientists, after all, are the kind of experts who don’t know what they’re talking about but make you feel as if that’s your fault. Such bamboozling is often deliberate, especially when it comes to forecasting. Projections and prejudices take on the air of unchallengeable truths when expressed in faux-scientific language and garnished with mathematical hocus-pocus.
As an economist myself, I’d say that one of the few positives from this ghastly sub-prime crisis is that the profession is becoming more humble. Since the credit crunch, the use by economists of ever more complex models, and the increasingly inane assumptions that go with them, has partly reversed. Good.
George Osborne waited until the depths of winter to deliver his fourth Autumn Statement. Yet the Chancellor was still on the front foot. Buoyed by upbeat new growth forecasts, Osborne presented fiscal numbers much improved on those in his March budget. This UK recovery, though, is extremely fragile and may not be sustained. And our country remains deep in the fiscal mire.
Thursday’s Commons set-piece was a political triumph for Osborne. This was inevitable, given the better economic backdrop. The Office for Budget Responsibility more than doubled its 2013 GDP growth forecast to 1.4pc, up from 0.6pc in March. Next year’s prediction accelerates to 2.4pc, said the OBR, up from 1.8pc nine months ago.
Early last week, the financial headlines were dominated by the trials and tribulations of a man called Paul Flowers. Later, the news flow switched, as the Bank of England and Treasury modified the controversial Funding for Lending scheme. The story of Flowers, the former Chairman of the Co-op bank, could have some bearing on the future of the UK banking industry. The government’s move to cool the UK’s rocketing mortgage market is also pretty important.
Yet, when it comes to this country’s future trajectory, both episodes pale into insignificance when compared to a little-noticed debate in the House of Lords. The government’s banking bill, debated by peers last week, is this country’s main response to the sub-prime crisis. Whether or not we avoid another cataclysmic financial collapse, with all the related economic fall-out and human misery, depends largely on the measures in that bill.