The Bank of England's attempt to support the economy with massive injections of newly created money has failed to achieve its main objectives, according to an independent assessment of the Bank's policy of quantitative easing (QE).
A report by the economic consultancy, CEBR, found that all households have lost out with pensioners the worst affected following Threadneedle Street's decision to pump funds into the City in an effort to support bank lending and persuade consumers to buy more goods.This finding is important because as Larry Elliott says in his Guardian column that quantitative easing is a quick fix that the world now depends on.
QE is designed to be a double-whammy. Firstly, the price of a bond moves inversely to the yield (interest rate) that it generates. Taking bonds out of the market reduces supply and pushes up the price. The interest rate comes down, making long-term borrowing cheaper for companies and householders with fixed-rate mortgages. Secondly, the institutions that hand over their bonds to the central banks get money in return, and they can use this to buy other assets such as shares. Rising equity prices help to restore business and consumer confidence.
In one important respect, QE did the trick, because without it there is no telling what would have happened to the global economy in the winter of 2008-09. By the summer of 2009 there was clear evidence that the decline in output had bottomed out. Fears of a Great Depression 2 were scotched.
And yet, QE was supposed to be a temporary measure, with the process reversed once the global economy returned to normal. Far from that happening, central banks kept on buying bonds. The Bank of England is on its fourth round of QE; the Fed is about to embark on its third. Despite an unprecedented stimulus, the global economy is losing momentum.
Some argue that the harmful side-effects of QE are partly to blame for this, since the money created by bond buying has led to speculation in commodity markets, driving up the price of food and fuel, and hence hitting the spending power of consumers. Others wonder whether QE is now bumping up against the law of diminishing returns, with each round of bond buying less effective than the last.The CEBR would argue that QE produces its own headwind to economic growth.
Ros Altmann, a pensions expert and the director general of Saga, said the Bank's policy had several unintended consequences that were undermining the recovery....
Altmann said a breakdown by age group showed that in the first years after the credit crunch younger families with mortgages and other debts benefited from lower interest rates at the expense of older people who rely on savings income. But recently, banks have increased the cost of mortgage loans while inflation has eaten away at the living standards of all age groups.
She said: "CEBR estimates that real incomes for the over-50s would have been 1.5% higher without QE. This group comprises 21 million people and represents more than half of UK households and nearly half of total domestic consumption." ...
"The effects of these factors are not confined to those pensioners directly affected because the impact of their spending spreads out through the economy through those who supply them with goods and services."The CEBR report establishes when the short-run benefits of QE give way to the long-run unintended consequences of QE.
It also highlights how monetary policy is not fit for the purpose of dealing with a bank solvency led financial crisis.