Quantitative Easing (Economic Affairs Committee Report)

Lord Forsyth of Drumlean Excerpts

Monday 15th November 2021 Grand Committee

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[Lord Forsyth of Drumlean]

That this House takes note of the Report from the Economic Affairs Committee Quantitative easing: a dangerous addiction? (1st Report, HL Paper 42).

[Lord Forsyth of Drumlean (Con)]

My Lords, in 21 years in this House, this is the first time I have ever spoken in Grand Committee. That may be because I am attracted to controversial subjects. I would just like to say, not in any kind of disobliging way, that I am disappointed that a report of this importance to our country is not being debated on the Floor of the House, and even more disappointed that the debate on the Budget was not taken on the Floor of the House. I know we are restricted in what we can do in respect of the financial affairs of our country, but that does not mean that they should be relegated to this Committee, important as it is.

I would like to introduce the report from the Economic Affairs Committee: Quantitative Easing: A Dangerous Addiction? By the end of 2021, the Bank of England will own an eye-watering £875 billion of government bonds and another £20 billion in corporate bonds, which is equivalent to 40% of GDP. Given these sums, it is now difficult to remember that QE was intended to be a temporary measure, like income tax. The first round of QE in 2009 initially amounted to a mere £50 billion and was sanctioned when the economy was in danger of tanking in the aftermath of the global financial crisis. Over a decade later, the unconventional has become conventional, temporary appears to have become permanent, and £50 billion has become £895 billion.

It seems extraordinary to me that the bank has faced little scrutiny for a tool that could have enormous implications for inflation, wealth inequality and the public finances. Our report, which was agreed unanimously, was the first major parliamentary inquiry on any central bank QE programme and has attracted international attention as a result. It is a step forward in increasing the bank’s accountability to Parliament. “Trust us, the man in Threadneedle Street knows best” will no longer do.

Before I explain our conclusions, I thank the committee staff: Adrian Hitchins, Dr William Harvey and Mithula Parayoganathan, and the committee’s special adviser, Professor Rosa Lastra, who did a fantastic job for the committee.

Allow me to begin by tackling one of the most pressing issues facing the global economy: inflation. First, we were told as recently as May this year that inflation may rise temporarily above the Bank’s 2% target. Next, we were told that it may exceed 4%. Now we are told by the governor, amidst warnings from the Bank’s new chief economist, that inflation is likely to rise

“close to or even slightly above 5 per cent”

and that the bank “won’t bottle it” if interest rate rises are necessary to curb inflation.

We raised concerns that the ongoing round of quantitative easing could pour fuel on the fire as it coincides with a growing economy, substantial government spending, bottlenecks in supply and a recovery in demand. That was in July 2021. Since then, bottlenecks have got worse, shortages have increased, wages have risen and prices have rocketed. We asked the Bank to outline in greater detail why it thought inflation would prove to be transitory. It did so shortly after our report was published, but apparently not by way of response to the committee’s recommendations.

We also expressed concern that the Bank has not explained why continuing its asset purchases until the end of 2021 is the right course of action. The MPC itself is increasingly divided, with three members voting to end the current asset purchase now at its most recent meeting. The Bank is yet to fully explain why QE is always the answer to the country’s economic ills, regardless of their cause. Its communications remain mismanaged, with only uncertainly left in its wake. If and when the governor’s delphic hints on rate rises materialise, there is a risk that the cost of servicing government debt could rise significantly.

QE makes the cost of serving government debt more vulnerable to increases in interest rates. Having chosen not to increase rates so far, when the Bank has to hit the brakes there could be a significant increase in the cost of servicing government debt. We heard that a 1% rise in interest rates could increase debt interest spending by £20.8 billion in 2025-26. To put this into perspective, the head of the OBR has said that just a 1% interest rate rise could easily wipe out the Chancellor’s headroom. In other words, a 1% rise would mean that the Treasury failed to meet its new fiscal rules.

We raised concern that if inflation continues to rise, the Bank may come under political pressure not to take the necessary action to maintain price stability. Given the current context, that concern seems to be at the forefront of most people’s minds. During the course of our inquiry, the committee found that the deed of indemnity—the contractual document between the Treasury and the Bank of England governing taxpayer liability for QE—had not been published. Despite assurances from the governor of the Bank that the document is benign, the Chancellor has still refused to make the document public, telling us that it contains some information that has operational sensitivity. There is no convincing argument for concealing this document from public and parliamentary scrutiny. It is astonishing that the document has not been published, and our report calls for the Chancellor to do so.

On the question of transparency and credibility, perhaps I could just take a moment to clarify the committee’s examination of allegations that the Bank has acquiesced in deficit financing. The committee did not, in contrast to the governor’s reported criticisms, conclude that the Bank used QE to engage in deficit financing. We took evidence on the perceptions that had developed during the pandemic and called for the Bank to explain the purpose of QE, including the publication of its assessment processes for calculating the amount of asset purchases needed to achieve a stated objective.

In monetary policy, perception is everything, and we raised our concerns that the Bank ran the risk of losing its credibility if its communication did not improve and it was unable to put these perceptions to bed once and for all. The strength of the Bank’s reputation rests on its ability to operate independently from political decision-making. We urged it to improve and clarify its communication to demonstrate its independence.

The Bank has now been using QE for over a decade and in a variety of situations, but we concluded that it had limited impact on growth and aggregate demand. It has been effective at stabilising financial markets during periods of economic turmoil, but its impact on the real economy has been negligible. There is little evidence to show that QE increased bank lending, investment or consumer spending by asset holders. We did, however, conclude that it has inflated asset prices artificially and exacerbated wealth inequalities.

In its response, the Bank said that

“what literature there is does not support”—

our conclusion that

“quantitative easing has had a limited impact on growth and aggregate demand”.

Yet, as we noted in our report, that is contested.

The fact that it is contested, and contested after a decade and £895 billion, makes it all the more remarkable that, faced with any problem or piece of bad news, the Bank’s default answer is to do more QE without sufficient justification or public engagement about its side-effects. During the inquiry, the committee thought that we might call it “monetary aspirin”, but we decided that that would be unfair to aspirin, but this is why the word “addiction” is included, with a question mark, in our title.

All this brings us to the question of whether the Bank will ever be able to unwind QE. No central bank has successfully managed to reverse QE over the medium to long term. At the time of our report, it was unclear whether, when the Bank decided to tighten monetary policy, it intended to raise interest rates or unwind QE first. We called for the Bank to expedite its review into the order in which policy is tightened and recommended that it publish a road map demonstrating how it intends to unwind QE under different economic scenarios. The Bank has since updated and published its policy, making clear that it intends first to raise interest rates, then begin to reduce its stock of purchased assets when the bank rate has reached 0.5%. We welcome the clarity that the Bank has provided but remain wary of the fact that the ratchet effect in which central banks engage in QE in response to adverse events, only to be unable to reverse the policy subsequently, exacerbates the challenges involved in unwinding QE.

Our response examines a policy that could have far-reaching implications for inflation, wealth inequality and the public finances. It is a crucial first step towards rectifying the lack of scrutiny that the Bank has faced on quantitative easing. I beg to move.

--- Later in debate ---

[Lord Forsyth of Drumlean (Con)]

My Lords, I am conscious of time. There is a message here. Over the weekend and today, I have been reading various comments from the likes of Andrew Neil, Mr Paxman and others about what a useless organisation the House of Lords is. I hope they listened to this debate and to the expertise that was apparent throughout.

I am grateful to everyone who participated, particularly to the Minister for having to read out that speech from the Treasury, in these circumstances, and also for being asked to say that a meeting of the Treasury Select Committee this afternoon showed accountability. Clearly, the messages that come from this report are about accountability, complacency and the risks that there are to inflation and to the Bank’s independence. I hope that my noble friend answers some of the specific questions that were raised during the debate, rather than telling us what we already know, in writing to members of the committee subsequently. But I am grateful to him for drawing the short straw, and to other members of the committee.

One point I should make is that every member of the committee declared their interests. I perhaps should have declared mine as the chairman of a rather small, quoted bank. These interests are declared and, with them, comes a degree of knowledge. I will single out one member of the committee, my noble friend Lady Morrissey, who explained what she thought after 15 years as a bond fund manager. If I were a Minister listening to this, I would go back and say to my officials, “We really have to do better than this”.

Motion agreed.