Quantitative Easing Failing?
A few months back, in a post that became something of a magnum opus I wrote that:
I suspect, given my views on credit, that the bank lending channel is one of the more important ways that monetary policy effects the economy. I also suspect that the bank lending channel is currently blocked. If I am right, QE will see an extra £75bn pumped into the economy (as gilts are taken out and cash put in through central bank purchases) and, probably, a £75bn rise in the money supply. The worry is that this will have little effect on the actual economy.
So, should we try QE? Of course. Either it works and provides a stimulus that prevents, or lessens, a slide into deflation or it doesn’t and nothing happens.
I’m starting to fear that I am correct. Despite an enlarged QE programme yesterday’s monetary data release from the BOE made for grim reading.
Figures from the Bank of England show that outstanding loans to companies and individuals declined at a record pace in July, in a worrying sign for the prospects of economic recovery. Moreover, private non-financial corporations – which form the backbone of the nation’s economy – paid down £8.4bn of debt during the month. That represented a 1.7 per cent overall drop in their bank credit and the largest decline since records began in 1997
Households showed no more propensity to spend; net lending to individuals fell by £600m to just over £1,450bn, the first net repayment of consumer loans since records started in 1993. The weak level of lending came as loans secured against property and consumer credit both declined by record amounts.
As the FT notes:
A brighter message emerged from a key measure of the money supply, seen as a gauge of the success of the Bank’s efforts to boost supply through so-called quantitative easing.
The underlying M4 money supply, which includes notes, coins and deposits at banks but excludes volatile deposits from within some parts of the financial sector, grew by 0.6 per cent in July, and at an annualised 5.3 per cent pace over the three months to July, data from the Bank showed on Tuesday. That is a faster growth rate than earlier this year.
To which I’m inclined to say… so what? Back in April I wrote that:
I’d argue further that money supply in and of itself is not the crucial variable – the crucial variable is credit, i.e. lending. It is lending that drives economic activity not money. Economists have focused on money for a long time. For decades this was reasonable. As most credit came from banks, money growth was a decent proxy for credit growth. As deposits (money) grew, and the liability side of the banks’ balance sheets expanded, credit also grew (the asset side of the banks’ balance sheets).
This cozy relationship though may no longer hold. The growth of ‘other credit providers’ – specialist mortgage lenders, credit card companies, car finance, store cards, the shadow banking system, etc – might have caused this relationship to break down. So money supply might soar with little impact on inflation or activity. Or banks might want to reduce their loan to deposit ratio from 130% to 100% (or even 90%) – again money supply (deposits) could soar with no growth in lending and hence little impact on activity. Mechanical monetarism doesn’t work.
This is what we are now seeing. QE is succeeding in driving the money supply higher but having little impact on credit. And it’s credit that is the vital variable.
With the banking system still broken, the transmission mechanism of monetary policy is still impaired. Fiscal policy must come to the fore.