My Lords, in 21 years in this House, this is the first time I have ever spoken in Grand Committee. That may be because I am attracted to controversial subjects. I would just like to say, not in any kind of disobliging way, that I am disappointed that a report of this importance to our country is not being debated on the Floor of the House, and even more disappointed that the debate on the Budget was not taken on the Floor of the House. I know we are restricted in what we can do in respect of the financial affairs of our country, but that does not mean that they should be relegated to this Committee, important as it is.
I would like to introduce the report from the Economic Affairs Committee: Quantitative Easing: A Dangerous Addiction?By the end of 2021, the Bank of England will own an eye-watering £875 billion of government bonds and another £20 billion in corporate bonds, which is equivalent to 40% of GDP. Given these sums, it is now difficult to remember that QE was intended to be a temporary measure, like income tax. The first round of QE in 2009 initially amounted to a mere £50 billion and was sanctioned when the economy was in danger of tanking in the aftermath of the global financial crisis. Over a decade later, the unconventional has become conventional, temporary appears to have become permanent, and £50 billion has become £895 billion.
It seems extraordinary to me that the bank has faced little scrutiny for a tool that could have enormous implications for inflation, wealth inequality and the public finances. Our report, which was agreed unanimously, was the first major parliamentary inquiry on any central bank QE programme and has attracted international attention as a result. It is a step forward in increasing the bank’s accountability to Parliament. “Trust us, the man in Threadneedle Street knows best” will no longer do.
Before I explain our conclusions, I thank the committee staff: Adrian Hitchins, Dr William Harvey and Mithula Parayoganathan, and the committee’s special adviser, Professor Rosa Lastra, who did a fantastic job for the committee.
Allow me to begin by tackling one of the most pressing issues facing the global economy: inflation. First, we were told as recently as May this year that inflation may rise temporarily above the Bank’s 2% target. Next, we were told that it may exceed 4%. Now we are told by the governor, amidst warnings from the Bank’s new chief economist, that inflation is likely to rise
“close to or even slightly above 5 per cent”
and that the bank “won’t bottle it” if interest rate rises are necessary to curb inflation.
We raised concerns that the ongoing round of quantitative easing could pour fuel on the fire as it coincides with a growing economy, substantial government spending, bottlenecks in supply and a recovery in demand. That was in July 2021. Since then, bottlenecks have got worse, shortages have increased, wages have risen and prices have rocketed. We asked the Bank to outline in greater detail why it thought inflation would prove to be transitory. It did so shortly after our report was published, but apparently not by way of response to the committee’s recommendations.
My Lords, the committee’s report was published in mid-July and I am pleased that the responses from the Bank of England and Her Majesty’s Treasury came fairly rapidly—coincidentally on the same day. I commend the Bank for the thoroughness of its response. However, the Treasury’s two-side letter is less comprehensive. I think that this reflects a desire to convey its message that quantitative easing is the business of the Bank and the MPC, not the Chancellor. That is all well and good but, as our report makes clear, the fact is that the Treasury is underwriting this process with huge potential swings; the fact is that QE could and does have far-reaching effects on the economy and people’s lives. This means that the Chancellor and the Government have a lot of skin in this game.
I echo the thanks that the chair gave to committee staff and all the witnesses, who did a fantastic job. I also congratulate the chair on his speech. This topic has a tendency to drift into the arcane, so this debate needs to address why on earth anyone but central bankers should care about quantitative easing. I hope that the noble Lord, Lord Forsyth, has started that process.
In my view, the central flaw in most of the analyses is that the data gathered during the response to the economic crisis in 2009, and some of the data in 2011 and 2012, are being conflated to refer to quantitative easing as it is now. By the Bank of England’s own reckoning, there were five distinct QE interventions, the last of which was the Covid one in 2020. As the noble Lord, Lord Forsyth, set out, this tranche totals £450 billion and exceeds the others combined. Given its scale and the different public policy backdrop, QE 5, as we can call it, is substantially different from what went before, yet the data that the Bank is using refers to the previous generations.
Even taking the data that it has, the Bank admits that it is not possible to measure the macroeconomic effects with any great precision—or, I would say, at all. Continuing the pharma vein taken by the noble Lord, Lord Forsyth, if QE were a new drug, it would not get approval based on the data that we have so far. The Bank’s central defence is consistently to deploy the counterfactual: the future without it would be worse. Given that we do not know what the future with QE is, I find this response very hubristic.
My Lords, quantitative easing is a very big deal. As the noble Lord, Lord Forsyth, said in a characteristically challenging speech, it represents 40% of the UK’s GDP—a huge figure. Yet if you were to ask the modern equivalent of the man on the Clapham omnibus—or to level up a bit, the woman or man on the Sheffield tram—what QE is, you would be almost certain to draw a blank. That would not just be on the Sheffield tram; it would be just about everywhere else. If truth be told, members of the Economic Affairs Committee, of which I am one—with some notable exceptions, particularly the noble Lord, Lord King of Lothbury—did not know too much about it until we embarked on this inquiry and it got well under way. In fact, for most of us, it was a voyage of discovery into what had been a murky corner of the UK’s economic policy—and to some extent still is.
We were very much helped by an excellent secretariat and a galaxy of star witnesses, as the noble Lord, Lord Fox, said, from this country and overseas, including from the US, the EU and Japan. Utilising Zoom to whizz around the world, we were able to hear from a much wider range of economists than would have been the case had we been relying on physical presence in Westminster, where we could not do that; we probably benefited from it in this case.
At the start of the inquiry, I for one read up about the disasters of the Weimar Republic in 1923. We all know what happened there: they opened up the printing presses, followed by hyperinflation—or was it the other way round? I am not sure which. I also looked at contemporary experience in Zimbabwe and Venezuela, where hyperinflation has accompanied a surge in the monetary supply. Could the same thing happen here? Would QE lead to, or risk, a surge in inflation? It did not, and our central conclusion has had to be that the Bank of England needs some congratulation on the success of QE so far—it may have got away with it. The inflationary effect that we are experiencing at present has not been down to QE.
My Lords, if my memory serves me correctly, I was a member of the committee when the decision was made to undertake this inquiry, although I was rotated off it before the inquiry began. We knew at the outset that it was going to be very complex and difficult, and I congratulate the committee and its chairman on producing a ground-breaking report. As has been said, a lot of us have learned a lot in that process.
I turn to the point that has been made about bringing together this remarkable group of people who gave evidence. The witness sessions are really worth reading in detail; so many really exceptionally good sessions were undertaken. What they highlighted for me was that there was a debate between two opposing views on recent developments with QE. That debate is important and has been going on in financial circles for some months.
The first approach argues that the Bank of England has been funding the Government’s borrowing requirement by expanding its balance sheet and avoiding upward pressure on longer-term interest rates that might otherwise have happened. Those who take this view highlight the consequences for the growth of money supply, the risks to inflation and the enormous puzzle of how to unwind this behaviour. They also worry that the episode might obscure and compromise the Bank of England’s independence.
The second view, including that of the Bank itself, is that the amount of QE was a direct result of implementing a policy of seeking to maintain inflation at 2%. They argue that, in the absence of scope to reduce short-term interest rates, which were regarded as already being at the lower band, this intervention was necessary to achieve the inflation objective and that, without QE, inflation would have been below target. They argue that the appearance that the Bank has been financing the Government’s borrowing is illusory and simply a by-product of targeting inflation and insist that the amount and profile of the asset purchases were not undertaken with an eye on the Government’s borrowing.
My Lords, it is a great pleasure to take part in this debate. It is an excellent report: it is well worth reading and the evidence is of very high quality. Some Members of your Lordships’ Committee may well feel that it is a very technical subject, all about the details of monetary policy and central banking. I believe that, as has been said by the noble Lord, Lord Monks, my noble friend Lord Forsyth and others, nothing could be further from the truth.
What we are discussing today is at the heart of the problem of controlling inflation and the effect that inflation is having on our economy and society. As has been mentioned already, it is also to do with the financing of government borrowing and the national debt. There is also the issue of perception. My noble friend Lord Forsyth is absolutely correct that the Bank of England is not challenged with blurring monetary and fiscal policy; the report says it is the perception of it that raises questions about its independence. The fact is that, after three decades of being anchored at 2%, inflation is now rising. The Bank of England expects it to rise, and I think it would be a very brave person who said that inflation will remain anchored at 2%.
I will raise two issues today. In raising them, I should say that the committee says it is sympathetic to the Bank because of the environment in which it has carried out its mandate: the path of Covid; the large swings in expectations—first of the worst recession since the 1700s and then of a tremendous recovery, which was unexpected; the fact that the Bank has more objectives placed on it from decade to decade; and, of course, the knock-on effects of Brexit.
The first question I put to the Minister is this: does he accept that the £450 billion of debt purchases by the Bank from the market over the last 18 months to two years has had little impact on rising inflation? As far as the Bank is concerned, QE seems to play little role in inflation. In the short term, the Bank explains inflation through a simple Phillips curve—if unemployment is reduced, inflation rises; if unemployment rises, inflation falls—but if you read the MPC reports, it explains inflation by way of energy costs, wage costs, supply-side shortages, input costs, tax changes and so on, but pays very little attention to what it does in its own back yard. As the noble Lord, Lord King of Lothbury, has pointed out, in the longer term the Bank has very little explanation of what leads to inflation. He said that
My Lords, I join other speakers in thanking the noble Lord, Lord Forsyth, for securing this debate and for his powerful introduction. The committee’s inquiry into QE reflects the noble Lord’s foresight and leadership, and its timely relevance owes much to him. I was privileged to be a member of the committee. I declare my interest, as disclosed in the register, as the paid chair of the Credit Services Association. I strongly endorse the report and its recommendations and, in the time available, will pick out a couple of points for more detailed comment.
When the inquiry was established, the committee agreed that, despite the exceptional economic expertise of at least some members, we would not seek a collective Nobel Prize by trying to come to definitive conclusions about the inflationary impact of QE here in the UK, let alone globally, but would focus on the implications for the Bank’s independence and governance and the transparency or not with which the programme has been pursued over the past 12 years. In light of the sharp increase in inflation in recent months already referred to, particularly in the US and UK, it would be wrong not to make some comment on this. Of course, issues of governance and transparency go to the heart of how the Bank of England is positioned to respond to that increase in inflation, particularly if it proves more than transitory.
The report is supportive of the principle and much of the practice of QE since its establishment in 2009. With that I also strongly concur. It is clear that the impact of QE, as the noble Lord, Lord Forsyth, said, is greatest at times of severe dislocation in the financial markets, so the periods from, say, 2009 to 2012 following the global financial crisis and then the early months of the pandemic of March to May 2020 were when the interventions were clearly most effective.
It is also clear that the contribution of QE to maintaining economic activity and hence achieving the target level of inflation is harder to judge. The contractionary fiscal policy of the coalition Government, from 2010 to 2015, left too much of a burden on monetary policy to generate growth during less stressed, but still challenging, conditions. The level of QE that has been pursued since mid-2020, even after the immediate crisis in the financial markets caused by the pandemic had been averted, is also questionable.
My Lords, I congratulate the Economic Affairs Committee on its excellent and highly insightful report, which, in my opinion, needs not just to be noted by the House but shouted about from the rooftops until someone at the Bank of England actually takes heed of its recommendations and takes action.
The Bank’s dismissive initial response suggests perhaps a degree of complacency or a tendency towards wishful thinking. Other equally concerning explanations are that the Bank may at this point be either too afraid by the extent of what it realises it does not know to take on the challenges or too dulled by its addiction to quantitative easing to act on the report’s very sensible and very practical recommendations. In particular, I highlight its recommendations that the Bank prioritises and shares its research into the effectiveness of QE’s transmission mechanisms into the real economy, and how its effects are distributed, and the impact of QE on the outlook for inflation, which is clearly rapidly changing.
Of course, as other noble Lords have said, the Bank needs to be much more transparent about the interactions between monetary and fiscal policy at this point. The connection between the level of rates and debt servicing costs and the need to finance deficit spending risk fiscal dominance and so threaten the Bank’s independence. That is not an accusation; it is just fact. There is a blatant contradiction between the Bank’s abrupt “This is incorrect” response to comments that the objective of the Bank’s asset purchases has been to ensure that financing conditions remain favourable for the Government and the governor’s own assertion in June last year:
“I think we would have a situation where in the worst element, the Government would have struggled to fund itself in the short run.”
We would all, I am sure, be sympathetic to the difficulties faced by the Bank—no one has all the answers here—but there is no merit at all in shutting down discussion or pretending that things are different from how they really are.
My Lords, we must thank the Economic Affairs Committee for its authoritative report on quantitative easing, and the noble Lord, Lord Forsyth, for securing this debate. It has been enlightening to hear the earlier speeches from noble Lords and the noble Baroness.
My remarks will refer to the impact of quantitative easing on pensions, an issue touched on in the report but not dealt with in any detail. That is odd, perhaps, because the explanation of quantitative easing in the introduction refers specifically to the important role played by pension funds in its operation. Initially, I was going to express some disappointment, but we cannot blame the committee, because there is a general lack of information. Those of us who have worked in pensions for the last 10 or 15 years will be aware that there has been a lot of discussion of quantitative easing and its effect on pension funds. We all have views; what we do not really have is any hard information or evidence, and that is inevitably reflected in the committee’s report.
I will not resolve that situation in today’s debate, but it suggests that there is a need for some harder studies on how quantitative easing has impacted on pension funds. You will hear the views but, when you seek the evidence, there is a conspicuous lack. However, I am never afraid to express views, even with a shortfall in evidence, and there are a couple of things that I would like to say.
The committee refers in a couple of places in its report to the impact that quantitative easing has on pension provision. There is a reference to the important evidence from the Pensions and Lifetime Savings Association. I very much agree with its statement that
“on balance … quantitative easing had benefitted pension funds due to the support it had provided to the economy, which it said helped businesses which sponsor and contribute to pension schemes”.
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We also expressed concern that the Bank has not explained why continuing its asset purchases until the end of 2021 is the right course of action. The MPC itself is increasingly divided, with three members voting to end the current asset purchase now at its most recent meeting. The Bank is yet to fully explain why QE is always the answer to the country’s economic ills, regardless of their cause. Its communications remain mismanaged, with only uncertainly left in its wake. If and when the governor’s delphic hints on rate rises materialise, there is a risk that the cost of servicing government debt could rise significantly.
QE makes the cost of serving government debt more vulnerable to increases in interest rates. Having chosen not to increase rates so far, when the Bank has to hit the brakes there could be a significant increase in the cost of servicing government debt. We heard that a 1% rise in interest rates could increase debt interest spending by £20.8 billion in 2025-26. To put this into perspective, the head of the OBR has said that just a 1% interest rate rise could easily wipe out the Chancellor’s headroom. In other words, a 1% rise would mean that the Treasury failed to meet its new fiscal rules.
We raised concern that if inflation continues to rise, the Bank may come under political pressure not to take the necessary action to maintain price stability. Given the current context, that concern seems to be at the forefront of most people’s minds. During the course of our inquiry, the committee found that the deed of indemnity—the contractual document between the Treasury and the Bank of England governing taxpayer liability for QE—had not been published. Despite assurances from the governor of the Bank that the document is benign, the Chancellor has still refused to make the document public, telling us that it contains some information that has operational sensitivity. There is no convincing argument for concealing this document from public and parliamentary scrutiny. It is astonishing that the document has not been published, and our report calls for the Chancellor to do so.
On the question of transparency and credibility, perhaps I could just take a moment to clarify the committee’s examination of allegations that the Bank has acquiesced in deficit financing. The committee did not, in contrast to the governor’s reported criticisms, conclude that the Bank used QE to engage in deficit financing. We took evidence on the perceptions that had developed during the pandemic and called for the Bank to explain the purpose of QE, including the publication of its assessment processes for calculating the amount of asset purchases needed to achieve a stated objective.
In monetary policy, perception is everything, and we raised our concerns that the Bank ran the risk of losing its credibility if its communication did not improve and it was unable to put these perceptions to bed once and for all. The strength of the Bank’s reputation rests on its ability to operate independently from political decision-making. We urged it to improve and clarify its communication to demonstrate its independence.
The Bank has now been using QE for over a decade and in a variety of situations, but we concluded that it had limited impact on growth and aggregate demand. It has been effective at stabilising financial markets during periods of economic turmoil, but its impact on the real economy has been negligible. There is little evidence to show that QE increased bank lending, investment or consumer spending by asset holders. We did, however, conclude that it has inflated asset prices artificially and exacerbated wealth inequalities.
In its response, the Bank said that
“what literature there is does not support”—
our conclusion that
“quantitative easing has had a limited impact on growth and aggregate demand”.
Yet, as we noted in our report, that is contested.
The fact that it is contested, and contested after a decade and £895 billion, makes it all the more remarkable that, faced with any problem or piece of bad news, the Bank’s default answer is to do more QE without sufficient justification or public engagement about its side-effects. During the inquiry, the committee thought that we might call it “monetary aspirin”, but we decided that that would be unfair to aspirin, but this is why the word “addiction” is included, with a question mark, in our title.
All this brings us to the question of whether the Bank will ever be able to unwind QE. No central bank has successfully managed to reverse QE over the medium to long term. At the time of our report, it was unclear whether, when the Bank decided to tighten monetary policy, it intended to raise interest rates or unwind QE first. We called for the Bank to expedite its review into the order in which policy is tightened and recommended that it publish a road map demonstrating how it intends to unwind QE under different economic scenarios. The Bank has since updated and published its policy, making clear that it intends first to raise interest rates, then begin to reduce its stock of purchased assets when the bank rate has reached 0.5%. We welcome the clarity that the Bank has provided but remain wary of the fact that the ratchet effect in which central banks engage in QE in response to adverse events, only to be unable to reverse the policy subsequently, exacerbates the challenges involved in unwinding QE.
Our response examines a policy that could have far-reaching implications for inflation, wealth inequality and the public finances. It is a crucial first step towards rectifying the lack of scrutiny that the Bank has faced on quantitative easing. I beg to move.
One of the dangers identified in the report is that QE is perceived to erode the independence of the Bank from government. This fear of co-dependence, as was just set out, is largely fuelled by evidence that money raised closely matches the money that the Government needed. The Bank asserts that this is not the case. It also deploys a curious technical response as to why this cannot be true. Seeking to refute the suggestion that the Monetary Policy Committee was seeking to lower the Government’s financing costs, it says in its response that, were this perception real,
“expectations of future inflation would … drift upwards, and inflation risk premia in sterling assets would increase causing gilt yields to rise.”
That was written in September and I find the response absolutely incredible. First, no scientist would choose these two parameters; they are both so open to a wide range of influences that they could prove any specific point. Secondly, at the time of writing, both parameters were moving in the opposite direction from that by which the Bank could prove its point. In the report, as we have heard, we highlight the Bank’s poor communication. I suggest that this is just another example of really poor communication—and, I would say, misplaced communication, because it is wrong.
Of course, inflation is subject to widespread upward pressure, as we heard from the noble Lord. In another communications master class, the Bank points to it being transitory. Do Her Majesty’s Government now have a settled view on what “transitory” means and how they believe inflation will move over the next years?
This is relevant because inflation is where monetary and fiscal policy meet. As we heard from the noble Lord, Lord Forsyth, with inflation rising, interest rates eventually may rise too, and this is the point at which Her Majesty’s Government and the Treasury will have to start to pay out money. As we also heard, the Chancellor will then rapidly lose any headroom that currently exists. This is the point at which the Chancellor should be more responsive to the concerns around QE and why I was surprised that the Treasury response was so light.
I will close on the point about inequality. In this respect, it seems that the committee and the Bank are more or less agreed: QE is making the poor relatively poorer and the asset-bearing rich relatively richer in terms of absolute cash—although the Bank deploys the phrase,
“the absolute impact will have been more varied.”
We know that, as inflation rises, the pressure on the poorest will be disproportionately worse and that QE offers little or nothing to help their cash position. We also know that, as inflation rises, we will see interest rates go up and that this will cost the Treasury big money —money that will not be available to mitigate the plight of the least well off. Does the Minister agree that this would make things very difficult for the Chancellor? Does he agree that we should all be concerned about the trajectory of the economy?
QE1 was deployed in response to the 2009 crisis. Thereafter, each tranche—from QE2 right up to the current QE5—has been justified by a different sort of necessity. Each justification has been different, yet the response has been exactly the same, except larger. As such, QE has become regarded as the go-to monetary response, or at least that is how it seems—an addiction, to use the parlance of our report. Yet we still do not know where we are heading and an exit, even from QE1, may be years in the future, if ever. The country is in grave danger of being ratcheted on to some monetary moving staircase designed by Maurits Escher; ahead of us, there are only rising steps, with no progress being made and no end in sight. We need a better idea of where we are going, backed up by a rigorous approach to data, and we need to know how this all ends.
The first tranche of QE, in 2009, helped stabilise the economy after the severe financial crisis at that time. The evidence is much less clear-cut in relation to the later and larger tranches of QE—first, in 2016, to cope with Brexit-related shocks, and, secondly, in 2021, to smooth the impacts of the pandemic. At minimum, QE did not lead to surges in inflation, and even though inflation is now rising—temporarily, we all hope—the root causes lie elsewhere, in fuel shortages, supply chain difficulties and so on. Yet, as our report points out, QE poses risks, problems and dangers.
I want first to comment briefly on the independence of the Bank of England. It strains credulity to say that there is no relation between the Government’s burgeoning fiscal deficit and the amount of QE that has been issued. The two amounts correspond almost exactly, fuelling suspicion that the Bank is financing the deficit. Such suspicion is widespread in the City; we did not share it too strongly in the end, but we know that it is a strongly held view that that is the case.
The Bank argues in a spirited response to our report that the current easing of monetary policy and increased debt issuance is
“entirely consistent with fiscal and monetary policymakers independently pursuing their objectives”.
Well, okay. While I again applaud the Bank and the Treasury for having worked closely and sensitively together, which is crucial in a crisis, the Bank needs to be very careful in guarding its independence in this relationship and project. So far, it just about gets the benefit of the doubt, but the next test is coming, as the noble Lord, Lord Forsyth, pointed out, if, as is forecast, it has to make a judgment shortly on raising interest rates, which we already know is supported by a minority on the Monetary Policy Committee. What will this do to the Government’s borrowing costs? How will the Treasury react? I will be very interested in the Minister’s response to that scenario. It is a big task that is coming, unless we get lucky and inflation subsides quickly.
The other issue that I want to address briefly is a question that was in the committee’s mind all the way through the inquiry. The figure of £875 billion has been, or is being, issued. We know where it came from, but where did it go? “Follow the money” is always a good principle in assessing financial matters. There is general agreement, as has been said, that an inflated asset price has benefited those who own property and shares—that is, the already wealthy. The Bank and the Treasury, in response, argue that QE, by providing money to the financial system, helps avoid economic shocks that would otherwise have hit jobs and living standards hard, so hitting disproportionately the poorer sections of society. Maybe that is so, but that itself raises other questions, particularly about the future of QE, if indeed it is to be used any further—if it is going to be used again after the current programme ends shortly.
The Chancellor has already included the transition of a net-zero economy in the Bank’s adjusted terms of reference. As our report points out, the Bank will presumably need to change its approach to buying corporate bonds, perhaps favouring those consistent with the net-zero objective and steering clear of sectors such as fossil fuels and some forms of mining—metal mining in particular. Our committee was, frankly, nervous about extending the Bank’s mandate, which risks it being given a more political role, perhaps forcing it to select bonds to purchase that were in line with the Government’s fiscal and other policy objectives.
We now have to consider the relationship of all this to the further use of QE. Will QE be targeted in future? Will there be government pressure to do that? If so, how would the confidence of financial markets be maintained? If it is deployed on the net-zero transition, will there be a temptation for Governments to use it on other vital subjects? That is a big question that needs to be thoroughly aired and debated before the Bank embarks on a further issuance of QE.
There is a great deal at stake and many questions still to be answered by the Treasury and the Bank. I look forward to the Minister’s responses on those questions.
There is a stark difference in these two views. Personally, I am reluctant to get into a debate about intentions and whether the Bank is sacrificing some of its hard-won independence by giving the Treasury an easy way out. In my experience, the Bank has never been easy to politicise on these matters, and surely that is even more the case with the MPC.
However, it must be faced that, whatever the motivation, what is agreed by both groups is that there has been a close alignment between the Government’s borrowing requirement and the Bank’s purchases of the gilts that were issued to fund it. The subsequent growth in money supply has received much less attention. Far from the MPC’s fear that inflation might fall below target, we now have a situation in which inflation is running well ahead of target. Of course, we cannot know what the counterfactual would have been in the absence of that amount of QE, but I must say that having to justify inflation well above target at a time when you are defending an action that was taken to prevent inflation falling below target must be, to say the least, a rather uncomfortable position for the MPC. Rather than debating the motivation, I am more concerned about the lessons that should be learned from this latest episode. I very much agree with the committee that, if the Bank is to be convincing in dismissing the charge of deficit financing, it will need to be much more explicit about the analysis that justifies the amount of QE that is undertaken.
In the world I remember, the Government’s ability to fund the deficit from the gilt market was an important constraint on government behaviour. I remember Eddie George saying on many occasions, “And if you do that, we will never sell another gilt.” It turned out that he was often exaggerating, but it was a threat that carried a good deal of resonance. Having that constraint was never popular with Governments, but it was always there as a reminder of the danger of going too far. It would be a matter of real concern if we gave the impression of having switched off this important control mechanism by making QE an everyday instrument of policy. There is still a lot of confidence that the MPC is working to meet its remit, but we need greater transparency about the decisions on QE and the analysis that lies behind its decisions if we are to reassure markets that this important control mechanism has not been switched off.
I agree with the committee’s concerns about the risks we face. The exit process faces several risks and hazards, which the report makes very clear. QE has had an important impact in shortening the age profile of government debt, and thus the Exchequer costs of higher short-term interest rates in future. I am also conscious of the impact on the value of the purchased assets if long-term interest rates return to a more normal level.
I also caution the Bank about using the defence that we have not been alone in using QE. The Bank’s response notes that QE has been deployed in other parts of the world. However, we are also seeing increases in inflation in other countries, particularly the US, one of the largest users of QE. This morning, the FT reports a warning from the head of the Bundesbank about the need for countermeasures against rising inflation. I must say that drawing attention to the use of QE elsewhere may not be that much of a reassuring message.
I know from bitter experience that unexpected outcomes are a regular challenge in setting monetary policy. During much of the pandemic, many economic commentators have worried that, in the process of returning to something closer to normal, we would face a significant problem of deficient demand. However, in reality, at present, around the world we are suffering from an acute problem of deficient supply. Following the pandemic, we have had a major supply-side shock: key transportation networks have been severely disrupted, ports are congested, and truck drivers are in short supply. In consequence, many production lines are in difficulty. For the moment, demand remains strong. It is supported by a catch-up of required maintenance in all walks of life, plus a desire to fulfil postponed purchases across a range of sectors. I believe we need to question the view that was evident to me in the early stages of this bout of QE—that, somehow or other, deficient demand is always around the corner and that measures to support demand are the automatic solution to that.
I have retired from the forecasting business and must emphasise that I have no wish to return to that activity; I do not wish to make comments about the future. After all, none of us knows when the supply problems will disappear or whether demand will stagnate once the catch-up effects of the pandemic work their way through. But given what we know now, it is likely that questions will continue to be asked about whether the scale of the Bank’s QE policy was excessive for too long and whether the correction has been too slow. However, I am confident that the Economic Affairs Committee will continue to ask those very questions. I look forward to seeing the answers it receives to those questions in time.
“Forecasts of inflation made by central banks always tend to revert to the target in the medium term … they assume rather than explain inflation in the long term”.
If you read the evidence to the committee and its report, it is clear that QE supported the economy following the financial crisis by avoiding deflation. Andy Haldane said that it was
“necessary to support the economy and hit the inflation target”—
that is, no deflation. Coppola said that it was
“an effective tool for arresting a deflationary collapse”
and Congdon said that QE in 2009 prevented a deflationary collapse and that money stock would have fallen “rapidly” without it. The Bank of England evidence said that QE has provided “monetary stimulus” to help the MPC to meet its inflation target. The committee concludes that QE
“prevented a recurrence of the Great Depression”.
I recognise the difficulties of disentangling the effects of QE, lower interest rates and fiscal policy in preventing the recurrence of deflation, but if QE has been effective in avoiding deflation, which I think everyone accepts, is it not also effective in creating inflation, when you are in an upswing instead of a downswing? I think that that is exactly the position we are in today. Businesses are finding it easy to pass on prices. We have a million unfilled vacancies in the UK—judged by the ratio of jobseekers to unfilled vacancies, that is the highest for 40 years. We already have strikes in places such as Weetabix and Clarks, and formerly in Glasgow as COP was starting. I would like the Minister to explain this contradiction. The noble Lord, Lord Burns, presented them as alternatives, but I see deflation and inflation as two sides of one coin.
The second issue that I would like to raise has been mentioned by the noble Lord, Lord Monks, and others: the implication of the perception of blurring monetary and fiscal policy. The Bank has been under great pressure since Covid to support overall government policy and to be seen as a team player. It has stated on many occasions that the time is not yet right to raise interest rates. After the 2008 crisis, the mandate of the Bank was not only expanded to much greater regulation, apart from controlling inflation, but extended to climate change. I do not think that the Bank would ever bow to explicit political pressure, but I am impressed by the views of three central bankers, two of whom I have known and one I have talked to but do not really know, namely Paul Volcker, Mervyn King and Otmar Issing. I worked for 15 years as an adviser to an investment bank and got to know Otmar Issing well. I was impressed with his evidence to the committee. He said:
“Exit from the zero interest rate policy will bring central banks into conflict with their Governments. It will be a very hard test for the central bank to withstand political pressure and I see a great risk that exit, once needed to”
wipe out
“inflationary development in the bud, might be delayed because central banks have come closer to political decisions during the financial crisis and now in the context of the pandemic.”
I close with my second question to the Minister: are we not imposing subtle but intolerable pressures on the Bank of England in giving it responsibilities and objectives that conflict with each other and undermine fundamentally its target of low and stable inflation?
For all that, I am not an advocate of immediate rises in interest rates or reversal of QE. The driving forces behind the current inflationary surge are primarily a combination, blended according to your Lordships’ individual tastes, of the pandemic aftermath, global supply chain friction, Brexit, stubbornly poor productivity growth, labour market failures and so on. The question that we should ask is: does the balance sheet position that the Bank of England now finds itself in, with nearly £1 trillion of predominantly government bonds, potentially inhibit it in honouring the “primacy of price stability”, as the Chancellor wrote in its mandate? In theory, at least, it should not, but so much hangs on how well the Bank of England’s independence is maintained and protected.
There was a widespread view in bond markets that it was more than a coincidence that QE amounts so closely followed the borrowing requirement at the time. There were unconfirmed reports of exceptional pressure on the Bank of England senior executives from the Treasury. When the governor gave evidence to us, he said, “Yes, I talked to the Chancellor daily”, in March and April 2020. “What did we talk about? Covid.” Yes, it was hard for any of us to talk about anything else at that time or subsequently, but the question is how much the Government’s pandemic-driven need to fund its deficit has been allowed to influence the Bank of England’s executives’ views and, hence, their positions within the MPC. We may not know for 30 years, if ever, but the independence of the Bank of England is not just a theoretical concern.
The noble Lord, Lord Forsyth, highlighted the challenge of unwinding QE and the potential accentuated impact of interest rate rises on future funding costs for the Government. Like the noble Lord, I deplore the refusal of the Chancellor to publish the deed of indemnity. This makes it hard to analyse some potential scenarios. For instance, in the Chancellor’s terse response to the report, he said:
“As it relates to the cash transfer part of that deed, there is sensitive information in there.”
Cash transfers? Under the terms of the deed of indemnity, the Bank of England has paid £112.5 billion to Her Majesty’s Treasury in the period between April 2013 and February 2021, with £13.7 billion in the last 12 months of that period.
The Government have been pursuing what the Chancellor, as a former hedge fund manager, would recognise as a giant carry trade and, so far, very profitably. Think how much worse the deficits would have looked without those transfers. However, every trade carries risk and there is the risk in QE not just of running losses when interest rates rise but the possibility of capital losses if the fair value of the bonds were to fall.
The Bank of England does not have to crystallise any of those losses, but it must not be inhibited from so doing if it believes that the control of inflation requires it. I believe that the deed of indemnity would protect the Bank from any loss, but the positive effect of QE on the Government’s accounts would be reversed. How relaxed would this or any future Chancellor be to see that happen? In giving evidence to the committee, the noble Lord, Lord Macpherson, suggested that any tensions in the relationship between the Treasury and the Bank of England so far will be as nothing when QE comes to be unwound.
The Chancellor wrote in his response to the report:
“Independent monetary policy has been successful in delivering low and stable inflation.”
This Government have shown themselves casual, to put it mildly, towards the independence of so many institutions. I urge them to defend and promote the Bank’s independence unequivocally and to do nothing to breach that principle.
It is becoming absolutely critical, not merely for the Bank of England’s credibility but more importantly for the economic prosperity of this country and its people, that the Bank changes its tune, and quickly, and that it takes the report’s points seriously and focuses its efforts on trying to better understand the implications of what has become, without question, the biggest monetary policy experiment of all time, both nationally and globally.
One explanation for possible complacency is that the first big round of QE—the £375 billion in response to the global financial crisis—did not appear to have any major adverse effects on inflation. Along with many others, however, including the noble Lord, Lord Fox, I think that it had a big impact on wealth inequality. But of course there were massive deflationary pressures in the 2010s: exploding supply; the rapid adoption of online shopping, making it much easier for consumers and businesses to compare prices; the offshoring of labour in an increasingly globalised economy driving down manufacturing costs; and heightened competition in many sectors that had previously been almost oligopolies—for example, between energy suppliers—benefiting end consumers.
That has all now changed, and changed suddenly, with a surge in demand following lockdowns, well-documented supply chain problems, more nationalistic policies—including over energy supplies—rising geopolitical tensions, increasing awareness on the part of consumers about the need for fair treatment of and fair pay for labour, and the mismatch of skill sets that businesses need with those who are unemployed. Demand may settle down but many of the other factors are not going to reverse any time soon, making it highly unlikely that inflationary pressures will indeed prove “transitory”.
In the space of less than two years, we have gone from a deflationary backdrop to an inflationary one, yet the Bank is still pursuing the same hyper-loose monetary policies; it is actually a doubled-down version, following the massive £450 billion—or £460 billion, if you include corporate bonds—QE in response to the economic threats caused by the pandemic. What is more, this is true throughout the western world, with the EAC reminding us in the report that central banks around the globe have expanded their balance sheets by some $5.5 trillion since the onset of the pandemic.
One of the key lessons that I learned from 15 years as a bond fund manager was the critical importance of actively looking out for inflexion points, watching for those moments when the past would not extrapolate into the future and there would be a sudden dislocation. This tended to happen when everyone was looking the other way—complacent, relaxed or just enjoying “dancing to the music”, as former CEO of Citibank, Chuck Prince, infamously said ahead of the financial crisis. Focusing my energies and analysis on deliberately looking for the next thing proved the making of my career when, having persuaded my colleagues early in 1997 that the risks of a Labour Government’s tax and spend policy were already in the price and we should buy the very longest-dated gilts, and as many as we could, the newly elected Labour Government’s first action was to make the Bank of England independent. Of course, I made a lot of less good calls in my time as a fund manager, but that one taught me so much about the need for courage and to stand back from the crowd and hold steady, even when everyone seemed to have a well-reasoned set of arguments on the other side.
In his leaving speech in June, entitled “Thirty years of hurt, never stopped me dreaming”, former Bank of England chief economist, Andy Haldane, put it more eloquently, when he said:
“This is the ‘dreaming’ bit—looking around corners to judge not only what is coming but how to reshape it, seeking out the biggest issues not just of today but tomorrow. It is the Wayne Gretzky”—
a famous Canadian ice hockey player—
“approach to public policy—skating to where the puck is going, not where it is … it is, for me, the essence of effective policymaking.”
Unfortunately, in its approach to policy and to this report, the Bank of England is not adopting Andy Haldane’s essential rule of policy-making. Its analysis, or at least what it shares with the rest of the world, is perfunctory; its representatives defensive and dismissive of challenge. Yet it and other central banks are increasingly out on a limb. As the report points out,
“central banks take a more positive view of quantitative easing than independent analysts.”
Today, market practitioners are truly worried that, first, the current spike in inflation may well not prove transitory; secondly, that central bankers, for whatever reason, may move too late to tighten policy, either through rate rises or unwinding QE; and, thirdly—though this terror is scarcely mentioned—that a loss of confidence in monetary policy catalyses an unaffordable spike in the cost of servicing vast government debts. In that situation, given the extremes of both fiscal and monetary policy today, policymakers run out of options.
It is not too late to do something to mitigate that risk, although it is getting urgent that action is taken. As noble Lords know, US CPI inflation hit 6.2% last week—the biggest inflation surge in more than 30 years. Even stripping out volatile, although rather essential, food and energy costs, the US inflation rate was still 4.6% last month—much higher than expected. The US 10-year bond yield has trebled since August last year, reflecting growing concerns. Here in the UK, the 10-year break-even rate between index-linked and conventional or fixed-rate gilts has topped 4%, a level last seen over a decade ago. That means that inflation needs to be more than 4% over 10 years for the inflation-linked bond to outperform, which is the highest break-even rate across the G7.
The market knows that we have reached a tipping point and that the policy response needs to change. Sadly, the Bank is way behind the curve, and seemingly refuses to listen. Let us keep shouting off the rooftops until it responds properly to the actions recommended in this report.
However, the association also mentioned the downside, which is that
“quantitative easing had resulted in ‘significant increases in deficits’—
that is, the deficits of pension funds—
“that have had to be filled through higher employer contributions or greater investment returns”.
While that provides a partial picture of the impact of quantitative easing on pension funds, it fails to explain what would have happened without quantitative easing. What is the counterfactual in a pensions world without quantitative easing? That is why the committee’s conclusion—that the use of quantitative easing in 2009
“in conjunction with expansionary fiscal policy, prevented a recurrence of the Great Depression”—
is so important. It would be wrong to point to the reduction in yields that has undoubtedly taken place without also considering what would have happened to investments in general had the policy not been introduced.
As Charlie Bean explained back in 2012, when he was Deputy Governor for monetary policy at the Bank of England, while the policy has led to an increase in deficits,
“the impact of QE is nevertheless small compared to the movement in the deficit associated with other factors, such as the collapse in equity prices as a result of the financial crisis and the recession”.
That conclusion has stood the test of time. He went on to say that higher equity yields were as much a purpose of the policy as lower fixed-interest yields.
The report also refers to the submission received from Professor Davis, who said that there is “some evidence” of pension funds engaging in a “search for yield” through investment in leveraged alternative assets, structured products, private equity and derivatives. Whatever we think of such investments, whether they are problematic depends on their scale and their suitability to match pension liabilities. There is no a priori reason to rule them out.
More generally, the search for yield is surely what pension funds need to do. They should look for investments to provide a decent return on the assets set aside to secure future pensions. The idea that the best, most secure and most appropriate investment for pension funds is government debt has been massively oversold and has led to a poor outcome for those funds.
Coincidentally, I would refer the Committee to the Financial Times and an article by Martin Wolf, the newspaper’s chief economic commentator, who refers to the need to have a sensibly invested pension fund, which he defines as one invested predominantly in equities. It is important to understand, therefore, that the greater the extent to which pension funds follow this sage advice, the less significant will be the adverse effects of quantitative easing.
Equity yields have not suffered from the same effect and, as argued by Charlie Bean, they have benefited from the policy compared to what would have happened in its absence. It is also important to question the extent to which the decline in yields—which has undoubtedly taken place, with the inevitable impact on pension fund liabilities—is due to quantitative easing as compared to other factors. I think that issue was considered by the committee.
Given this reduction in yield, I do not want to paint too rosy a picture of the effect of quantitative easing on pension funds, but the underlying problem is not quantitative easing itself but the utter failure of the Government to address the productivity crisis. Quantitative easing provided a respite during which we could have got to grips with these long-running economic issues. I am sure that we would have a variety of views about how the benefits of increased productivity might be used, but adequate pensions must be a leading candidate. I am sure we all agree that this is at the heart of the financial problems we face as a country—not quantitative easing but the failure to grow productivity.
I agree with the chair of the committee that the Bank has not been subject to sufficient scrutiny in pursuing this policy, but there is a greater question about what objectives the Bank should follow. The report correctly highlights the adverse distributional impact of quantitative easing. The right conclusion is that the Bank should take this more into account by understanding those effects.