Quantitative Easing (Economic Affairs Committee Report)

Lord Desai Excerpts

Monday 15th November 2021 Grand Committee

[Lord Desai (Non-Afl)]

My Lords, this is an excellent report, excellently introduced by the chairman, the noble Lord, Lord Forsyth. At this late hour and with little time, let me revert to being a teacher—which is about all I can do. Quantitative easing is not new. It used to be called open market operations when I was young. The scale was rather small, and it was used mainly to stabilise the market, rather than fundamentally affect the level of interest rates.

Around the time this report came out in July, I was in Delhi. I had not read the report. I was having a shower and suddenly had a lightning flash—a revelation, or at least a question. There are asset markets and goods markets. In asset markets we love inflation, but in goods markets we hate inflation. QE more or less operates on the asset markets. The question I conjectured was this: does money put into the asset market roll over into the goods market? The noble Lord, Lord Monks, asked: where did all the money go? I conjectured that the money that the central bank puts into the asset market stays in the asset market; people just buy other assets. They sell their bonds or whatever it is, interest rates come down, then they take that money and buy equity—so equities are happy, and so on. I conjectured that very little of that money flows into the goods market to cause inflation.

It was never argued that the 2009 quantitative easing caused any inflation. It was meant to compensate for the collapse of equity prices—not to do anything about the interest rate but just to revive equity prices and avoid large-scale bankruptcy. The 2008-09 quantitative easing succeeded in reviving the equity markets, and then the economy did or did not revive, depending on what happened with fiscal policy—but we shall leave that aside.

Remember that quantitative easing comes from Milton Friedman’s work. The man who fought inflation all his life said that the great depression had happened because the Federal Reserve had not expanded money supply. It was necessary to expand monetary supply to avoid the great depression, and nobody did. Ben Bernanke, who did a PhD on that, used that example to launch quantitative easing, which is supposed to act on the asset markets and to revive asset prices. No wonder inequality goes up—because people who hold these assets get richer. Interest rates fall and, as I said, equity is revived.

How did I test this? Basically, I did a very crude test, comparing asset price increases and goods prices. It turned out that they were not cointegrated, to put it technically: there was no correlation between asset prices and goods prices. It is unlikely that quantitative easing by itself causes inflation, unless you add some other things. At least until about September, almost October, there had been no inflation in the market. Now, of course, it is still possible to say that supply-side shocks are causing the inflation and not so much the quantitative easing, which has been going on for a while. We have borrowed 40% of GDP or whatever it is, and in November inflation starts. I am too old to take 4% inflation seriously—I have lived through a time when it was 22% and the Labour Government had frozen academic salaries, and can tell you that that hurt.

We need to make a proper distinction between what the Bank does in the asset markets when it is intervening with quantitative easing and when it is financing the government deficit. These are two different operations and, as many noble Lords have said, they have different effects.

The 2020 quantitative easing was qualitatively different from that in 2008, because the economy had suffered a much bigger shock from the pandemic—a shock that we have never seen before, in which both aggregate demand and aggregate supply collapsed simultaneously. It was not a Keynesian crisis, in which aggregate demand collapses and people are unemployed but ready to go to factories—people could not go to factories as suppliers and consumers could not go to restaurants. That had some strange monetary effects because savings went up for people who had jobs.

Quantitative easing and the parallel fiscal policy interventions, such as furloughs and so on, had very different effects. Normally, we say that, when the Government print money, it goes into the market and causes an inflationary shock. We need—maybe the Economic Affairs Committee could do this—a proper study of exactly what happened during the pandemic around the demand and supply shocks, how we survived them and how we recovered.

On the narrow question of quantitative easing, we should welcome it as a new weapon for economic policy which works much faster than fiscal policy. In the old days, we used to teach that fiscal policy is effective and fast and monetary policy is slow—you cannot push on a string or whatever it is. A central bank can act quickly because markets are deep and it can go and buy billions of dollars of bonds. That is fine, but it will affect interest rates and exacerbate inequalities.

One thing I take away from this excellent report is that real work needs to be done on precisely what happened with quantitative easing and how it is an effective instrument of policy, provided the timing is right and the thinking is subtle.