On Thursday the Bank of England announced it would extend its bond-buying programme by £100 billion, in a bid to support the UK economy through the Coronavirus pandemic. The move sees a continuation of the bank’s quantitative easing, which began at £200 billion in 2009, and after today’s announcement stands at £745 billion.
It follows £200 billion-worth of bond purchases back in March, the (in this context) encouraging news that UK inflation was at a four-year low, and the ONS report which stated that the UK economy had contracted by 20.4% in April.
What’s the upshot of buying gilts?
The goal of this bond-buying will be to encourage spending, to support the economy. The first way this is done is by encouraging private spending.
By buying more government bonds from financial institutions, the demand for these instruments increases, and their yield (interest rate paid) – relative to their price – decreases. As the central bank buys more assets (in this case bonds), the financial institutions receive more funds.
As these institutions’ funds increase, they have more capital available to lend at a lower interest rate to businesses and individuals, which makes borrowing more inviting. With this in mind, businesses will borrow money to survive or expand their operations, and individuals will be more inclined to buy property, shares and even spend on leisure and recreation – at least, that’s the theory.
Secondly, it allows the government to spend more. As institutions and individuals see the Bank of England buying bonds, this encourages them to buy bonds from bodies such as the Debt Management Office, with some confidence that they will be able to sell them on.
This lessens the fear that they’ll be stuck holding an asset that nobody wants to buy, and should stabilise the market for UK government debt. Put simply, if people buy more UK government debt securities, the government will be able to spend more (hopefully on supporting British individuals and businesses).
So what’s wrong with it?
Well, while the outcomes listed above sound desirable, there are also negative externalities which have raised legitimate concerns. First, the Bank of England buying bonds is not just an issue of playing with demand, but effects supply.
The intended externality is an increase in the supply of money in the system. Once central banks ‘print new money’ (in actuality, buying bonds with virtual capital), they use this money to buy bonds, the money from that purchase then goes to banks (the bond vendor) and then gets filtered through the economy via bank services.
While the short-term effects of this are ostensibly desirable – in essence more readily available cash should mean more economic activity – there are also fears that bank bond purchases will trigger an inflation crisis. If the supply of money increases at such a rate that there is a tangible excess of cash, and this is reflected in indicators such as steep increases in the goods prices, then we face the implications of a debased currency, which would see peoples’ savings and earnings suddenly worth a lot less. Thankfully, these concerns seem not to have been raised with much severity during the current crisis, given both the current situation with inflation (as mentioned earlier) and because prophesies of an inflation spike a decade ago have yet to materialise.
Beyond the first order issues of money supply, however, we mustn’t be flippant about secondary concerns, such as what people spend their more readily available cash on. One area of salience is property. Before money even begins to be lent out, institutions receiving funds from bond selling will invest in other assets such as property and shares, which increases demand and in turn, the price of these assets. Then, once businesses and individuals get wind of cheap borrowing, those with the resources to put down deposits will start snapping up properties and reap the benefits of cheaper borrowing.
During this period of high activity, the demand for assets such as property increases. Notably, this demand is not spread out through the whole population. While some residential buyers might take advantage of low interest rates, those most likely to exploit the opportunity will be those who have the money at hand to put deposits down on multiple properties.
In turn an awkward feedback loop ensues, as those most able to buy properties do so, and push property prices further out of reach of many young and first-time buyers. Of course, demand won’t increase at such a rate that prices increase exponentially and in perpetuity, but certainly at such a rate that the way we understand property ownership has changed completely. If we look at what the ONS has to say about wages:
“For February 2020, average regular pay, before tax and other deductions, for employees in Great Britain was estimated at £511 per week in nominal terms. The figure in real terms (constant 2015 prices) is £471 per week, which is £2 (0.4%) less than the pre-2008 economic downturn peak of £473 per week for March 2008.”
We should then compare this to property prices, which increased by 43% between 2009 and 2019. Not only have they moved far ahead of wage increases – and made it far more difficult to buy property – but the entire landscape of social mobility has been changed. Buying property helps aspirational young families establish themselves and build their wealth off of a tangible asset; what happened instead was that rising property prices have made property ownership an increasingly coveted opportunity, and in turn an increasingly exclusive one.
While satisfying the economic balance sheet (and though far from being the only contributing factor), QE played a part making those who already ‘had’, wealthier, while punishing those who were trying to ‘have’.
Secondly, and far less sombre than the first dilemma, is that today’s QE may be the right idea at the wrong time. While the Bank of England cited strong borrowing activity during the second quarter, we’d definitely be right to question whether this is the right time to invite people to start investing and entering financial commitments.
Certainly, we should make it easier to spend money and keep livelihoods afloat, and perhaps greasing the wheels makes this process run more smoothly. However, if we can – for a moment – compare monetary policy to bullets, you’d be forgiven for thinking this bullet was fired prematurely. With a No-Deal Brexit appearing increasingly likely, a Coronavirus second wave looming and a recession of unknown proportions to come, it would be foolhardy for individuals to enter into significant financial arrangements, and perhaps irresponsible of financial institutions to encourage them to do so.
Theory aside, what is the significance of the Bank of England stimulus?
In reality, stimulus is both inevitable and likely necessary. Whether or not it is moral to encourage people to make big financial commitments at this stage is almost beside the point for institutions such as the Bank of England. They need to keep the wheels turning, and successfully doing so keeps businesses afloat and prevents a worse recession down the line.
The £100 billion commitment announced today is relatively moderate when compared to the Fed’s seemingly endless appetite for QE and the ECB’s negative interest rates, though Bank of England governor Andrew Bailey hasn’t ruled out more innovative measures (such as negative interest rates) going forwards. We can definitely expect more stimulus going forwards, and despite how it may sound, £100 billion appears like something of a top-up. The question going forwards will be – is perpetual QE viable?