Limits of QE
Chris Giles in the FT calls, reasonably, for more quantitative easing. This poses the question: aren't we approaching the limit of what QE can do?
Take as my starting point the Bank's own estimates (pdf) for what the first £200bn of QE achieved. It reckons it reduced gilt yields by 100 basis points, raised inflation by 0.75-1.5 percentage points, and boosted GDP by 1.75-2%.
This implies that if we wanted to raise GDP by 4%, returning it to its pre-recession level, we'd need another £400bn+ of QE.This, though, runs into at least two problems:
1.To achieve this, gilt yields would have to fall by 200bp, which would take 10 year yields down to under 0.2%. This, though, is infeasible. Just as there's a zero bound to short rates, so there is for long ones. This is partly because gilt investors would expect short rates to rise over the long-term, and also perhaps because they might anticipate negative QE (the Bank selling gilts) as the economy normalizes. Japan's post-1990 experience suggests the lower bound for long-term interest rates is around 0.5%; this was the low-point they hit in early 2003.
2. In 2009, QE helped boost the economy not just by reducing gilt yields but by reducing tail risk - the small risk of economic catastrophe - which improved business confidence and reduced credit spreads. It's not obvious that this mechanism would operate this time.
I therefore doubt that QE could raise GDP by as much as 4%. And even this would be no huge achievement. If employment were to rise by 4%, we'd create just under 1.2m jobs which, given that some would be filled by the "inactive", wouldn't get unemployment much below two million.
QE, then, is not enough. So, what else could be done?
There's plenty the Bank could do to force long yields down. It could emulate the Fed and pledge to keep short rates low, thus reducing rate expectations. It could commit to cancelling gilts, thus closing off the prospect of negative QE. Or it could do an "operation twist". All these, though, merely get us to the zeroish bound on gilts.
This leaves unconventional QE. The Bank could buy corporate debt, thus reducing credit spreads which would hopefully stimulate invenstment.However, the Bank has so far been loath to embark upon what would, in effect, be a partial and selective nationalization of companies; even Adam Posen has been leery of the idea, given the thinness of UK corporate bonds markets. And anyway, it's not clear how far lower borrowing costs would boost investment;if firms' £300bn cash pile (table A57 of this pdf) isn't encouraging them to invest, why should a slightly lower cost of borrowing?
Alternatively, the Bank could try an outright helicopter drop. But this runs into several problems such as how to administer it to the sheer uncertainty of its effects.
There is, of course, a simple solution to these difficulties - to use fiscal policy. There are good reasons to suspect it might be unusually helpful now.
My point here is simple. We often think of fiscal policy as being constrained, either by bond markets or by administrative problems. But there are constraints on monetary policy too. And these might be more more binding than the constraints on fiscal policy.