Bank of England The verdict on 10 years of quantitative easing
In March 2009 the Bank of England began to slash interest and buy bonds – has it worked?
Ten years ago this week, Threadneedle Street dropped borrowing costs down to the lowest level in the Banks 324 years of existence and embarked on the bond buying programme of QE, never before tested in Britain.
The decision has been credited with preventing the recession from turning into the second Great Depression, but its side-effects have meant rising inequality. The policy of government austerity, also imposed now for almost a decade, has damaged living standards and paved the way for the Brexit vote.
With interest rates still close to rock bottom and the money printing machine still running, Britain also lacks adequate firepower to fight the next downturn, despite economists warning it could be on the immediate horizon.
What did the Bank of England do in the crisis?
The bad news had been flooding into Threadneedle Street for several months by 5 March 2009. Financial markets around the world were in a tailspin and Britain’s banks had caught a cold from the US mortgage market, infecting the real economy, as credit dried up for ordinary households and businesses.
Faced with these risks, the Bank’s monetary policy committee (MPC) decided to cut interest rates to 0.5%, the sixth rate reduction in as many months, down from as high as 5% in October 2008.
Threadneedle Street had known since November that setting the cost of borrowing at 0.5% wasn’t enough alone. Emergency meetings with the then chancellor, Alistair Darling, under the code name “Crunch Co”, drafted the use of a new idea: quantitative easing, with an initial bond buying round worth £75bn.
First used in Japan during the early 2000s and deployed by a few years later across the Pacific by the then US Federal Reserve chair, Ben Bernanke, after Lehman Brothers collapsed, the tool worked via central banks creating money to buy government bonds from banks, giving them cash to lend to the real economy. Driving up demand for gilts raised their price, causing the yield, or interest rate, to fall – which had the effect of slashing borrowing costs for the government, businesses and households.
David Blanchflower, who was among the MPC members to make the call to unleash QE in 2009, said: “It was the equivalent of 10,000 Warren Buffets showing up.
“Two people saved the world. Bernanke saved the world on the monetary front and Gordon Brown on the fiscal front [by raising government spending to stimulate the economy].”
The total spent on buying government debt under QE has been repeatedly expanded over the past decade to £435bn, with the latest round coming straight after the EU referendum in 2016. Interest rates were cut from 0.5% to 0.25%, although they have since gradually been raised again to 0.75%.
Has it worked?
The measures were designed for an emergency, yet still remain in place today, with the proceeds from any maturing bonds immediately used to fund more QE purchases. However, the fact that it has not been stopped – and that rates remain close to zero – indicate that the policy has not worked emphatically.
Andrew Sentance, an economist who was on the MPC and also helped draw up the plan, said financial markets in March 2009 pointed to rates returning to 3% by 2011. “I don’t think anybody on the MPC deferred from the view that this was an emergency step. I certainly didn’t,” he said.
“The real problem we have with the economy is that it hasn’t turned out to be an emergency measure, it’s turned out to be the status quo.”
Still, on several measures, the policy worked wonders. Britain enjoyed a jobs-rich recovery from the 2008 crash and has had the longest unbroken quarterly growth streak of any G7 nation. UK unemployment peaked at 8.5%, versus 10% in the US and 12.1% in the eurozone, and has since dropped to 4%, the lowest since the mid 1970s.
But that isn’t the full story.
What were the side-effects?
While helping keep borrowing costs low, low rates and QE drove up asset prices. As well as the anniversary of the rate cut, this week also marks 10 years since the FTSE 100 hit its post-financial crisis nadir of 3,512, before going on one of the biggest bull runs in history, doubling to more than 7,000.
Wealth inequality has soared. The least wealthy 10% of households saw their real wealth rise by £3,000 between 2006-08 and 2012-14, versus £350,000 in gains for the wealthiest 10%. However, the Bank argues that QE has had little impact, as it helped keep people in work, while inequality was already high.
Savers with cash assets got a raw deal from low rates on bank deposits, but families with mortgages had cheaper costs, enabling them to keep spending – helping fuel the economic recovery. Cheap borrowing costs have, however, allowed debts to build up. Borrowing on credit cards, personal loans and car finance has soared above levels seen before 2008.
Blanchflower, who will publish a book this summer, Where Have All the Good Jobs Gone?, on the cost of the policy reaction to the crash, said: “It made people think: ‘Those bastards, they got rescued.’ The banks raised asset prices and the stocks that fell suddenly came back up. If I don’t have assets, what’s happened is I’m pissed off.”
He added: “Brexit and populism is like this: these people aren’t hurting, so I’m going to mess with them so they’re hurting as well.”
Why have interest rates not risen?
Rock-bottom rates and QE stimulated the economy, but the election of the Conservative-led coalition government in 2010 led to austerity, ostensibly to curb the ballooning deficit in the public finances that came as the economy plunged.
Monetary policy fuelled growth but austerity pulled in the opposite direction, making it harder to raise rates when growth was weak.
“Through 2009 the economy was recovering at escape velocity and then the buffoons found austerity and that killed off growth,” said Blanchflower.
Mark Carney, the Bank’s present governor, had talked about raising rates in 2014, during the strongest years of economic growth since the 2008 crash, although he was likened to an “unreliable boyfriend” for leaving them on hold.
“We missed the boat in 2014 and 2015 when the UK economy was performing very strongly. You have to act ahead of the curve, you can’t wait and see if developments unfold in your favour or not,” said Sentance.
Inflation generated by the weak pound since the Brexit vote and record employment levels and rising pay growth have since led the Bank to lift interest rates twice to 0.75% by last year. The threat of a disorderly Brexit has, however, kept rates on hold at levels that are still equivalent to the economy remaining on life support.
Are we adequately equipped to fight the next crisis?
With recessions typically occurring once every decade, a downturn is overdue. A no-deal Brexit could be one such trigger, with the Bank trotting out the worst-case scenario of a recession deeper than the downturn after the financial crisis.
Most mainstream economists believe interest rates would need to be slashed again in the event of a damaging no-deal Brexit, while QE would be expanded.
Blanchflower said negative rates could be used, meaning central banks would charge commercial banks to deposit money, encouraging them to use it to lend. QE could be expanded to buy more corporate bonds, rather than just gilts, as well as other assets.
However, many economists believe QE has lost some of its potency and warn a fresh round could further exacerbate wealth inequality. Carys Roberts, chief economist at the IPPR thinktank, said rates were also usually cut by as much as 5% during recessions – more than the UK can currently handle.
“We simply can’t do that now. We’re in a very weak position to fight the next recession. There’s a one in four chance of the next recession within a year, so this is really quite an urgent question,” she said.
With the Bank lacking firepower, economists say the Treasury would be required to step in with fiscal stimulus, cutting taxes and raising public spending, to fight the next downturn.
Sentance said: “Monetary policy is going to be fairly impotent, so fiscal policy is going to have to deal with any future downturn.
“The danger is today that people don’t see policymakers in government taking action, they seem impervious about what’s happening in the real economy. What encouraged the real economy in 2009 was policymakers doing what they could. Today it’s policymakers generating the instability.”
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