The Bank of England (BoE) may not be selling bonds fast enough to get inflation under control, a former member of the bank’s Monetary Policy Committee (MPC) told members of Parliament on April 18.
There is a case for going “a bit faster” to help “reinforce the impact of interest rates on inflation and on the economy,” Andrew Sentance, senior advisor at Cambridge Econometrics and former MPC member, told MPs on the Treasury Committee. “But that doesn’t seem to feed into the strategy.”
Since the global financial crisis in 2008, the BoE used Quantitative Easing (QE), colloquially known as printing money, four times to lower interest rates, buying a total of £875 billion in government bonds and £20 billion in corporate bonds.
In the last QE alone, it injected £450 billion into the UK’s economy during the COVID-19 pandemic.
The bank began to unwind the policy late last year, but Sentance said the Quantitative Tightening has been at “quite a modest level” compared to QE levels.
The banks are selling “just over six and a half billion [worth of bonds] a month,” while the MPC was “buying bonds at a rate of 25 billion a month” during his time, Sentance said.
“So there’s a degree of asymmetry there between the pace at which the bank is unwinding its bond portfolio and the pace at which it was built up at various points between 2009 and last year.”
Economists on the panel broadly agreed that the three rounds of pandemic QEs contributed to the double-digit inflation seen in the past months and that the tool has been used too much and for too long in the past years.
Sentance suggested that the BoE has become too trigger-happy with QE in the years following the 2002 financial crisis, although “it’s not always the right thing to do.”
Balance Act
Jagjit S. Chadha, director of the National Institute of Economic and Social Research (NIESR), quibbled with the word “tightening” in QT, saying it should be called “Quantitative Normalisation.”But he also said, “in a world of uncertainty, you’re not quite sure what the impact is going to be, it’s entirely sensible to start with a relatively small amount,” arguing that there is a balance to be struck on how fast the normalisation should go.
“By moving too quickly, you might be asking bond markets to do something that would lead to further problems, disruptions in bond markets, and lead to tighter monetary and financial conditions than you might want,” he said.
But by moving too slowly, “you might find yourself with too large a debt stock still held by the Bank of England, too large a balance sheet some years down the line.”
Gerard Lyons, chief economic strategist at Netwealth, said the “fragile state of the economy plus the huge amount of debt that is evident both here in the UK and globally means that we clearly need to exit in the gradual and predictable way,” but QT is “untried ... untested, and therefore one cannot be convinced that it will just be the mirror image of the QE process itself.”
He said it’s “important to bear in mind that two wrongs don’t make a right.”
“The Bank of England was wrong to have eased a couple of years ago. The other wrong would be to try it and overcompensate now by tightening too much at a time when previous monetary policy tightening—not just the QT already happened, but rate increases themselves—are still feeding through, the economy is flat, and inflation has peaked,” he said.
“Therefore, the speed, the scale, and sensitivity of the exit from QE and rate hikes need to be very sensitive to the mood of the economy.”
Commenting on the QEs, Lyons called them “the good, the unnecessary, and the bad.” He argued that the first QE after the 2008 financial crisis was well, but the QEs that followed were unnecessary.
Lyons said the policy embedded cheap money, led to asset price inflation, companies not pricing for risks, and a misallocation of capital, creating “the environment in which inflation took hold.”
Asked whether the benefit of QEs outweighed the side effects, Sentance said he hadn’t done a detailed calculation but believes “the fiscal cost is much more neutral than some of the figures that are being bandied around at the moment.”
Lyons said monetary policymakers should learn to “think about the longer term consequences if that policy almost goes on autopilot,” as “no one” when QE was first used would have thought it’s a sensible approach to have the bank end up holding a third of the national debt.
