To QE or not to QE…

The Bank of England’s MPC decided today to leave the stock of quantitative easing at its current level of £325bn.

Gavyn Davies attributes their decision to a recognition that the supply side of the UK economy has underperfomed – suggested by the troubling fact that inflation expectations for 2012 have risen even as growth expectations have worsened:

A few thoughts on this:

1) The inflation-vs-growth chart is compelling, but I don’t fully buy the argument that we’re near the limits of what demand can do. The 2008-09 crisis may have had hysteresis effect on potential output, plus  pre-crisis growth rates may have reflected the bubble economy rather than being sustainable – but do we genuinely think all this is enough to leave real GDP today almost 13% lower than it would have been had growth continued on its pre-crisis trend? (Perhaps the answer is yes; but what’s the evidence?)

2) Even if you’re concerned that supply-side weaknesses could lead to more inflation – are the MPC really worried that QE is inflationary? Remember, the Bank of England’s asset purchases involving buying UK gilts – highly-liquid AAA-rated government bonds – or exactly the type of security that the shadow banking sector considers to be part of its (unmeasured) ‘reserves’ on the Singh/Stella basis. CPI inflation may be currently above the 2% target, but it’s hard to argue this a result of monetary factors. Indeed, broader measures of the money supply are falling in the UK: M4 growth in March 2012 was -4.5% yoy.

3) Finally, whilst it’s strictly outside the MPC’s mandate – could the UK not chose to tolerate a bit more inflation over the next few years than we were accustomed to pre-crisis? At least some above-trend nominal GDP growth seems to be a necessary condition for smoothing the process of public- and private-sector deleveraging over the next few years.

Overall then, a disappointing decision. We probably don’t just need more QE, but also purchases of a much wider range of assets by the central bank.

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