Quantitative Easing (Economic Affairs Committee Report)

Lord Burns Excerpts

Monday 15th November 2021 Grand Committee

[Lord Burns (CB)]

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.

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.