“Quantitative easing (QE)” is an important task: the need to make monetary policy effective when interest rates are close to zero. The world’s leading central banks, including the Bank of England, have taken such actions. But is UK policy working? Yes, but not quite enough.

The argument about quantitative easing is polarised: some critics wail about inflationary “money printing”; others complain that too little attention is paid to the flow of credit. Of the two camps, the latter is the more persuasive.

At its simplest, as Charles Bean, the Bank’s deputy governor, has explained, the Bank uses newly created money to purchase assets. Hitherto, the UK’s QE has amounted to £200bn ($274bn), mainly used to purchase government bonds. The new money, in turn, ends up as bank reserves at the Bank.

Monetarists like the policy because of its effects on the money supply. Non-monetarists stress its impact on asset markets. In a recent speech, David Miles, an external member of the monetary policy committee, pointed to the effects on liquidity, on prices of government bonds, corporate bonds and other assets, and on issuance of bonds and equities. It is impossible to relate effects to causes precisely. But all these desirable things have happened.

The hysterics fear the policy will work too well: bank lending will explode and inflation expectations soar. As Adam Posen, another member of the MPC, has pointed out, the right response is: if only. Should anything like this occur, it would be simple (and desirable) for the Bank to reverse the policy.

More to the point, as both Posen and Giles Wilkes* of CentreForum argue, is the fact that QE does not reach the most damaged parts of the credit system: in the year to January 2010, “M4 lending” to the private non-financial sector shrank by 2.7 per cent. Posen and Wilkes suggest paying direct attention to this damaged channel. Any such “credit easing” carries some credit risks. For that reason, it should be regarded as fiscal, more than monetary, policy. But a future government may well need to consider such new measures, to promote the credit flow.

As Wilkes also argues, in today’s exceptional circumstances, the Bank could usefully buttress its inflation target with a medium-term objective for nominal demand. Then, if QE has to be restarted, the Bank could use such a framework to explain why.

Desperate times need desperate measures. The times are not over. Nor, therefore, are the measures.

Source: Financial Times

* Also see Wilkes, G., Credit where it’s due: making QE work for the real economy, March 2010, CentreForum