QE, Asset Prices & Investment Levels: A Proposal
I’ve droned on about quantitative easing for so long now, that I’ve started to bore myself. Giles, at least, still seems interested…
In the comments to a post on Monday I said the following:
Where QE might be helping:
(i) Keeping sterling low
(ii) As you say, supporting fiscal policy through funding the deficit
(iii) Actual lending – who knows how bad it would be in the absence of QE
(iv) Inflation expectations – QE may keep them high.
(v) Corporate bond market. Very heavy issuance this year at decent interest rates, it could that QE is responsible through both lowering gilt yields (and indirectly therefore corporate bond yields) and providing the cash for institutions to buy with.
(vi) Supporting equity rights issuance. Been a load in the UK this year, QE cash might be helping.
This is why I still support QE.
The last two points are both decent examples of how supporting asset prices can be helpful to the real economy.
By complete coincidence BOE Deputy Governor made a speech that afternoon which pretty much agreed with my final two points.
He noted that:
Now obviously we would prefer that the money circulates more rapidly and that this is done through increased bank lending and deposit taking. In other words, we would like to see a further expansion of credit and broad money. Since the banks collectively are now awash with reserves, they should not be prevented from making additional loans because of any liquidity concerns. Banks are, though, constrained by a lack of capital and are looking to reduce leverage rather than increase it. (My emphasis).
Similar to my pre-QE post from March:
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.
He then noted:
Fortunately, increased bank lending is not necessary for Quantitative Easing to work. Indeed, it was precisely because the Monetary Policy Committee expected the additional monetary injection not to stimulate bank lending directly at the current juncture, that the Asset Purchase Facility’s purchases were targeted at assets held primarily by the non-bank private sector1. So if the Asset Purchase Facility buys gilts from pension funds or asset managers, they will then have to look for another home for their money. As it is not very rewarding just to hold it on deposit, they are likely to look to put their money into other assets, including equities and corporate bonds. Thus not only does the price of gilts rise as a consequence of the Asset Purchase Facility’s initial purchases, but also the prices of a whole spectrum of other assets. That in turn lowers the cost of non-bank finance and encourages increased corporate issuance. Also the rise in asset prices increases wealth and improves balance sheets. In this way, Quantitative Easing helps to work around the blockage created by a banking system that is still undergoing a process of balance sheet repair..
Let’s be clear about what’s happening here. The original intention of QE was to increase the amount of money circulating in the economy and bank lending. This isn’t really working (with the important caveat that things would probably be even worse without QE). So now QE is aiming to prop up the economy via the mechanism of raising asset prices.
This allows corporates to issue bonds cheaper (in effect borrowing money whilst side stepping the banks). It also allows companies to re-capitalise themselves by issuing fresh equity cheaper. Both of these effects are helpful.
But a deliberate central bank policy to raise asset prices also poses questions. What are the distributional effects of this policy? Again let’s be clear, the policy of the Bank is to raise the raise the price of assets – this necessarily favours the wealthy over the poor and increases inequality.
For how long can asset prices be artificially supported? Do we risk a new bubble?
Economically how does this policy help the economy re-balance, how does it help small and medium sized businesses that can’t access the equity or corporate bond markets?
One solution, that I’d offer, is the newly proposed National Investment Corporation. I’ve been a big advocate of this for months. As ‘Director of Finance’ magazine has said:
…it looks very like the old ICFC, the Industrial & Commercial Finance Corporation set up by the Labour government in 1945 to provide finance for small firms. It was funded by the newly-nationalised Bank of England and the main clearing banks, which had their arms twisted by ministers. In the days before private-equity, ICFC was the largest provider of venture capital to British companies.
There was a sister organisation for larger companies – Finance Corporation for Industry – and the two merged in 1983 and became Investors In Industry, now known as 3i and still a major provider of capital to small companies despite its own stock market flotation.
The 1970s government also created the National Enterprise Board to direct finance to firms that could not find it elsewhere. And even this current Labour administration has set up a £1bn innovation fund to direct finance to small firms.
The new NIC is an old idea reworked therefore, but there’s nothing wrong with that if history showed the idea worked previously. And there is clearly demand for small-firms finance: if the privately-owned banks won’t provide it and the publicly-owned banks wont either, then direct government funding will be welcomed by business.
We can use such an organisation to help increase investment levels, to rebalance the economy, to support green business and new technologies. Any serious industrial policy costs money. The mooted size of the NIC is £3bn. Good, but it could be better.
So why not call it £10bn? Or £20bn? Let’s see how much demand for financing there is out there and meet it. And let’s pay for it with QE. That way the BOE can (indirectly via the NIC) lend directly to the real economy, for useful purposes. I’d be far happier with a policy aimed at fostering investment and new technologies than I am with a policy aimed at raising ‘asset prices’.