The Bank’s gambler plays double or quits
Is the Bank of England governor being run by a wily banker or a fanatical economist going for broke? Mervyn King’s attempt to increase the quantitative easing programme to £200bn looks like a losing gambler doubling his stakes.
Having cut interest rates to a record low of a half per cent in January without halting the slide into recession the Bank looked for another tool and took the unprecedented step of quantitative easing – QE – whereby it “prints money” to buy in assets such as gilt-edged stocks from banks, freeing them to lend more.
The untested QE was seen as an interesting experiment by the academic monetarist who heads the Bank. The monetary policy committee agreed a programme of upto £125bn in March 2009 with a first phase of £75bn over the three months to June.
With no clear evidence that this boost was working the MPC kept the taps running until the full quota was used. And still with no solid signs of success, it was persuaded at its August meeting to increase the programme rather than wait and see. King wanted a £75bn increase to £200bn; the majority of the committee, including his two deputies, voted against him but conceded a £50bn rise.
It looks like the desperate move of a poker player who, having lost his initial stake, borrows more in a hope of winning back his losses. And now we know the governor’s wishes we must assume a further increase will be on the agenda for future meetings.
However, if it is not clear that QE is working it is not clear either that it is doing any harm. So perhaps we should allow King to complete his game?
But look at the size of the stakes he is playing with. The £200bn programme he wanted is more that a third of the country’s annual public spending. It is more than half the conventional gilts market – which is why the Bank has had to add commercial paper to the class of stocks it will buy. It is only imaginary money however: the Bank doesn’t actually print it but it creates it from nowhere: it is not drawn from any existing reserves.
The worry is that at some point the QE programme must be unwound. The Bank must sell the vast portfolio of stocks it has purchased, and if it has pushed up prices and lowered yields by buying it could cause bond prices to fall and interest rates to rise by selling.
The fact that the Bank is still increasing its programme suggests the day it unwinds the portfolio is getting further away. But the more it buys the more it must ultimately sell. And if it pushes down prices it risks losing real money on its purchases made with imaginary money. Selling at just 5 per cent below purchase prices would now mean a £10bn loss that the taxpayer must bear.
It is not healthy for a central bank governor to be overruled by his own board. King may well be right – on previous occasions he was outvoted he was vindicated later – but this is a big gamble with big money in a game that few understand.
