Economics Weekly - Is it too soon to start withdrawing QE? Weekly economic data preview - Pre-Budget Report to dominate a particularly busy week for UK data
Economics Weekly - 7 December 2009
Is it too soon to start
Quantitative Easing (QE), the purchase of
private and public sector debt by the central bank financed by an expansion of
its balance sheet, has been in place in the UK since March. Similar policies are also
in place in other countries. There appears to be a difference of opinion about
whether QE is working or not. Most agree that it has been essential in preventing
a financial collapse in early 2009, and in the immediate aftermath of the
failure of Lehman Brothers on 16 September 2008. This is not just true for the UK, however. Injections of liquidity (cash)
into financial markets by central banks in many other countries were also
essential in staving off a global financial calamity.
Now that financial markets have staged a
recovery and economic conditions have strengthened, there are those who argue
that QE and liquidity injections generally should be withdrawn to avoid another
asset price bubble and because they have succeeded in boosting economic growth.
Comments from some members of the UK Monetary Policy Committee (MPC) seem to
suggest that there is support for this thesis. But is it true that QE has succeeded
on all fronts, boosting money supply and kick-starting a sustainable economic
recovery? We look at some of the issues in assessing whether QE has succeeded.
Taking the UK as an example, QE started in March 2009,
when liquidity appeared to be drying up in the financial markets and policy
interest rates were cut to record lows. Businesses in the financial, corporate
and personal sectors could not get hold of money at almost any price. This led
the central bank to take the decision to directly inject money into the
financial sector by buying up gilts and other private sector bonds so that
market participants and hence their customers did not fall short of the liquidity
required to keep operating. Chart a shows that since then gilts yields have
stabilised and equities have recovered. In this sense, QE seems to have worked.
It has stabilised financial markets and sparked a recovery in asset prices.
Corporate spreads have narrowed sharply; money market interest rates and
spreads have also come down substantially. In the absence of QE, company insolvencies
would have been higher, debt defaults greater, and personal debt, bankruptcy
and unemployment much more than otherwise.
As chart a confirms ,financial markets
have recovered since QE started and appear firmly on the mend. Money from
central banksâ€™ purchases has found its way into corporate bonds, the stock
market, commodities and a range of financial market assets. This improvement in
markets has helped companies to refinance themselves at cheaper costs than otherwise,
as rising prices for bonds and equities lower the cost of capital. Chart b
shows the extent to which companies in the UK have been using capital markets for
finance. Since March, there has been a pronounced use of equity and bond
issuance to raise finance. Also, continued low interest rates mean that households
have more money in their pockets to spend and that has helped to maintain
consumer spending and retail sales. This means that global economic growth has
turned and recovery is underway. True, the UK economic recovery is lagging that in
some other countries, with the US, eurozone and Japan already out of the recession. Emerging market
countries have recovered fastest of all. But UK economic recovery now appears likely in
Q4. On this thesis, QE has done its job. The path to economic recovery may not
be smooth but it should be unstoppable. Hence, QE should be withdrawn before it
There are a couple of important problems
with this argument, however. One is that the quantity of money is still falling
sharply. And not just in the UK, but in the US and euro area as well. Charts c and d show
nominal (inflation plus volume) economic growth alongside money supply growth.
If QE was working so successfully, why is money supply contracting? It begs the
question of whether there can be a sustainable economic recovery when money
supply is shrinking in this way. Many would argue that it is not possible. Not
all would agree, however, as the economy may simply settle at a lower level of
activity and growth still occur. But if money supply is still contracting in
February 2010 when the current allocation of QE is used up, will the MPC really
stop purchasing securities from the private sector?
A second major issue is that households
and companies are severely cutting back on borrowing or are repaying debt
outright. This means that economic growth from investment and household consumption
will remain weak, perhaps threatening economic recovery. The next series of
charts, e, f and g show this trend occurring in the US, UK and eurozone economies, posing a
challenge to policy makers in these countries. Do they withdraw the extraordinary
policy measures put in place to inject liquidity into the economy, and keep
down the costs of borrowing and servicing debt, when economic growth appears
so fragile? At present, this still seems a delicately poised decision. It is
not one that leads to the certainty that policy loosening will be withdrawn in
short order. Signs of economic recovery currently being seen might start to
wither if monetary policy tightened too
Trevor Williams, Chief Economist,
Editorial comments to:
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Weekly economic data
preview - 7 December 2009
Pre-Budget Report to
dominate a particularly busy week for UK data
ô€‚„ This week sees a particularly busy
calendar in the UK, featuring the Chancellorâ€™s Pre-Budget
Report (PBR) and the latest Monetary Policy Committee (MPC) meeting. We look
for Bank Rate to remain on hold at 0.5% while the MPC continues with its Â£200bn
programme of asset purchases. The PBR, meanwhile, will be closely-watched as
markets focus on government efforts to consolidate the public finances.
Elsewhere, there is no shortage of economic data and events taking place in the
US. Here, the main highlights include October
trade data, latest weekly jobless claims figures, November retail sales and
Decemberâ€™s preliminary Michigan consumer confidence survey. Following
last weekâ€™s ECB monetary policy deliberations, the euro-zone sees a somewhat
quieter week in terms of economic data. With little in the way of aggregate
euro-zone data scheduled for release, attention this week turns instead to German,
French and Italian industrial production figures.
ô€‚„ With UK monetary policy decisions
currently being made on the basis of fiscal policy formulated back in Aprilâ€™s
Budget, this weekâ€™s PBR will be among the most closely watched in years. If the
Treasuryâ€™s PSNB projection for 2009/10 of Â£175bn looked bad in April, recent
monthly data on the public sector finances suggest it could look even worse
come Wednesday. Clearly, the bigger picture is how to achieve the goal embodied
in the recent Fiscal Responsibility Bill â€“ of halving the fiscal deficit within
four years. On the revenue side, much of the build-up to the PBR has centred on
a prospective increase in taxation for high earners. Possibilities include a
widening in the scope of the new 50p top rate of income tax, increasing
National Insurance contributions for top rate taxpayers and also various
measures to boost revenue via the Inheritance Tax system. In terms of spending,
numerous government departments are likely to see budgets pared back
significantly compared with the growth seen in previous years. While the PBR is
likely to dominate events in the UK this week Decemberâ€™s MPC meeting will, as
ever, be carefully watched by financial markets. We look for Bank Rate to
remain on hold at 0.5% while the Â£200bn programme of asset purchases â€“ aimed at
boosting nominal economic activity in the economy - continues. Importantly,
October UK industrial production data are released this week, where we look for
a 0.4% month-on-month increase. But the figures take on added significance,
since the October data will provide a guide to Q4 gdp.
ô€‚„ In the US, ahead of the next FOMC meeting
on 16 December, this week features a wave of important economic data including
trade, retail sales, initial jobless claims and Decemberâ€™s preliminary University of Michigan consumer confidence survey. We look for
the US trade deficit to narrow to $32bn in
October, in part reflecting US dollar weakness. Meanwhile, last weekâ€™s
better-than-expected non farm payrolls figures have prompted a more optimistic
mood in terms of labour market prospects. We think that this Thursdayâ€™s (less high-profile)
data on initial jobless claims will show a small (7k) decline, so keeping the four-week
moving average on the downward path seen since March. Retail sales figures for
November are published on Friday, where we look for a 0.5% m/m rise in the
exautos measure. If realised, this would be the fourth consecutive month-on-month
increase. But household balance sheet adjustment, continuing job losses and the
recent expiry of the so-called â€˜cash-for-clunkersâ€™ incentive scheme does not
augur particularly well for consumer activity heading into 2010.
ô€‚„ There are relatively few euro-zone economic
statistics scheduled for publication this week, so attention will shift to
various national indicators. Industrial production figures for Germany, France and Italy are all due for release. In Germany, we
look for industrial production to rise by 1.2% in October, with robust demand
for investment goods as global economic recovery continues, led by emerging
Asia. In France and Italy, we also envisage significant month-on-month
rebounds in industrial output, of 0.6% and 1.7%, respectively.
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