Quantitative Easing, Austrians, Ron Paul and the Bank of England – Telegraph Blogs

Quantitative Easing, Austrians, Ron Paul and the Bank of England – Telegraph Blogs

Quantitative Easing, Austrians, Ron Paul and the Bank of England

By Jeremy Warner Economics Last updated: March 8th, 2012
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Ron Paul: We're all Austrians (Photo: Reuters)

I've been writing a column all day on Vince Cable's suggestion that Royal Bank of Scotland be turned into a British Business Bank – I'm sceptical – so I'm a bit late in commenting on the unchanged policy announcements from both the Bank of England and the European Central Bank. If they've done nothing, what's there to write about, you might ask, but it's part of my job to make something out of nothing, so here goes.
The ECB did nothing because it is being pulled both ways. The immediate financial crisis of a few months back has abated a bit, but in other respects, the outlook has clouded further. The ECB has both reduced its growth forecast and increased its inflation forecast. Inflation is now predicted to be quite a bit higher than the ECB is comfortable with for the remainder of this year as a result of higher energy costs and rises in indirect taxes. Both these factors will also push down on growth, so the ECB is stuck in the middle.
It's a not dissimilar picture at the Bank of England. Policy is in a state of paralysis. But that hasn't stopped the National Association of Pension Funds from complaining bitterly about the ongoing damage QE is doing to UK pension funds. According to the NAPF, QE has added £90bn to deficits.
I have to say that I find these complaints a bit odd. As David Miles, an external member of the Bank of England's Monetary Policy Committee, has pointed out, it's true that the very low long-term interest rates generated by QE is bad for savers, but taking into account the increase in asset values – both bonds and shares – brought about by QE, the overall impact is very probably neutral.
The problem occurs because funded pension schemes use the risk free rate of return – that is the yield on government bonds – to price the notional value of their liabilities. If this rate of return falls, then it costs more to fund the same pension promise, ergo the size of the liability increases and so does the deficit, which companies are then forced to provide for, further crimping earnings that might otherwise be available for investment and job creation.
This is all of course perfectly true, but to the extent that it makes a real difference, it says more about the absurdities of pension fund accounting than it does about QE. Most pension fund liabilities are very long term, and once interest rates rise again, as one day they will, then so will the liabilities shrink. The pensions regulator simply needs to be flexible enough to allow trustees to look through these temporary anomalies.
None the less, critics of QE have a point. QE has succeeded in generating a bizarrely negative real rate of interest, which is plainly very bad for savers and has been going on for some time now. The effect is to bring about a net transfer of wealth from savers to borrowers, or from the thrifty to the profligate. Morally, this is hard to justify.
Yet this isn't just an unwanted side effect of QE; it's the whole point of it. Think of an economy as like a balance sheet, with savers on one side and borrowers on the other roughly matched. When the debtors borrow more than they can afford, which is essentially what happened during the credit bubble, they must eventually retrench. So they stop spending and investing, leading to a collapse in previous levels of demand. If policymakers wish to avoid a slump, they have to find some way of persuading those who still retain balance sheet strength, the savers, to step into the breach and spend in the stead of the once profligate debtors.
So when people say that QE is unfair, yes it is, but that unfortunately is the intention. Or as Paul Tucker, deputy Governor of the Bank of England, put it to the Commons Treasury Select Committee last week, if the Monetary Policy Committee were to start worrying about the effect of policy on every interest group, it would never do anything.
I doubt his audience had any idea what he was talking about when Ron Paul, the US presidential hopeful, declared that "we are all Austrians now", but you have to be a true believer in that particular school of economics to think that doing nothing at all might actually have some merit. Would the world be any worse off without central banks? Well, they don't seem to have done too well in recent years. They seem to be like the grand old Duke of York, marching things up to the top of the hill only to march them down again. Why not just stay in the same place?
It's an amusing thought, but the history of money before the advent of modern central banking is not reassuring.