http://blogs.telegraph.co.uk/edmund_...ailed_in_japan
Why on earth will Britain succeed where Japan failed? It is the big question which no-one in the Bank of England - or for that matter the Federal Reserve, or other central banks around the world that have pledged to embark on policies of overt money creation - is particularly comfortable answering.
There is nothing new about what the Bank has announced it will do. Japan tried very similar tactics around a decade ago after most of its other deflation-aversion tactics failed. As we all know, it failed to pull Japan out of the rut it still lies in (though the hyperinflationists among you may be reassured that neither did it spark a Weimar Germany style rise in prices).
So what have we got on our side that Japan hasn't? Here are the big differences.
1. Time. Japanese policymakers took a good few years to get round to Quantitative Easing (let's call it QE from hereon). The old adage in monetary policy is that the sooner you act the more effect it will have, and the Bank definitely has this on its side, having reduced interest rates all the way down from 5pc to 0.5pc in barely more than a year, and now getting on with QE pretty much instantly. On the other hand, the size and immediacy of the economic slowdown we're facing is far greater.
2. Size. The Japanese (and for that matter the Americans) spent around 5pc of their GDP on QE, printing money to buy up assets. The Bank of England, on the other hand, has committed to spending just over 10pc of GDP. This is a hell of a lot of money. A terrifying amount. To put it into context, the total size of the 5 year to 25 year government bond market in the UK is around £250bn; the amount the Bank is proposing to spend on these government bonds through magicked-up money is around £100bn (the remaining £50bn will go on corporate bonds, the market for which is even smaller). Anyway, with QE, the bigger, so they say, is better.
3. Savings culture. Quantitative easing is designed to encourage people to save less and spend more. The Japanese, however, had a 15pc or more (I forget) savings ratio at the start of their recession. As a result they had a massive bed of savings to eat into (rather than borrowing) over the years. We have little or no savings ratio and a culture of high borrowing and spending. In the long run that needs to change, but it may mean the switch to frugality may be slightly less fast and aggressive than it was there.
4. Application. This is important but mildly technical. The Japanese may have pumped this newly-created money into the wrong bit of the financial system. They did a very similar thing to what the Bank is planning, printing money (electronically) and using it to buy up government debt. This will certainly mechanically increase the amount of cash floating around the system. It will also push down the yields on government debt, which should in turn reduce the cost of borrowing throughout the economy. However, this is only one half of the objective for QE. The other is to try to encourage companies and investors to get out there and spend more.
The Japanese tended to buy most of these assets off banks. Unfortunately, the banks then hoarded the cash, because their balance sheets had been so damaged by the financial crisis. The Bank, on the other hand, intends to buy most of the gilts off institutional investors - pension funds, insurers and the like. The theory - or hope - is that they will be less keen to hoard the cash and will spend it elsewhere.
This will, so the theory goes, set off a snowball effect whereby they buy extra stuff, which in turn encourages other sellers to go out and buy, and which eventually causes the economy to start growing again. So the £150bn that is poured into the economy eventually generates two or three or four times that in economic output and in money growth. We hope.
***
The problem, as you'll have guessed, is that although all of these arguments seem very rational, we have no idea whether they will work in practice. Sure, the Japanese made mistakes, but there could easily by another mistake we'll make. Likewise, even if we fulfil all the preconditions necessary, will this actually have the desired effect of bringing economic growth back up to trend? And if it does, how will we ensure we don't then generate a tidal wave of inflation which creates another dangerous bubble five years hence?
No-one knows, of course. All of which is why this new topsy-turvy world is so terrifying. However, the one counterfactual I am pretty sure about is this: for all that it is disturbing for savers now to see interest rates down at absolute zero, the economy would be in a far, far worse state if interest rates had been any higher over the past year. Then we truly would have been staring economic armageddon in the face.
In the meantime, we must try to get to grips with the remoulded economic and monetary landscape thrown up by quantitative easing. Many thanks for all your comments and questions in my last blog. Please keep them coming (either at the bottom here or by twitter) and I'll try to address them tomorrow and thereafter. I'm going home now to watch trashy television and briefly expunge words like quantitative easing from my brain.
Why on earth will Britain succeed where Japan failed? It is the big question which no-one in the Bank of England - or for that matter the Federal Reserve, or other central banks around the world that have pledged to embark on policies of overt money creation - is particularly comfortable answering.
There is nothing new about what the Bank has announced it will do. Japan tried very similar tactics around a decade ago after most of its other deflation-aversion tactics failed. As we all know, it failed to pull Japan out of the rut it still lies in (though the hyperinflationists among you may be reassured that neither did it spark a Weimar Germany style rise in prices).
So what have we got on our side that Japan hasn't? Here are the big differences.
1. Time. Japanese policymakers took a good few years to get round to Quantitative Easing (let's call it QE from hereon). The old adage in monetary policy is that the sooner you act the more effect it will have, and the Bank definitely has this on its side, having reduced interest rates all the way down from 5pc to 0.5pc in barely more than a year, and now getting on with QE pretty much instantly. On the other hand, the size and immediacy of the economic slowdown we're facing is far greater.
2. Size. The Japanese (and for that matter the Americans) spent around 5pc of their GDP on QE, printing money to buy up assets. The Bank of England, on the other hand, has committed to spending just over 10pc of GDP. This is a hell of a lot of money. A terrifying amount. To put it into context, the total size of the 5 year to 25 year government bond market in the UK is around £250bn; the amount the Bank is proposing to spend on these government bonds through magicked-up money is around £100bn (the remaining £50bn will go on corporate bonds, the market for which is even smaller). Anyway, with QE, the bigger, so they say, is better.
3. Savings culture. Quantitative easing is designed to encourage people to save less and spend more. The Japanese, however, had a 15pc or more (I forget) savings ratio at the start of their recession. As a result they had a massive bed of savings to eat into (rather than borrowing) over the years. We have little or no savings ratio and a culture of high borrowing and spending. In the long run that needs to change, but it may mean the switch to frugality may be slightly less fast and aggressive than it was there.
4. Application. This is important but mildly technical. The Japanese may have pumped this newly-created money into the wrong bit of the financial system. They did a very similar thing to what the Bank is planning, printing money (electronically) and using it to buy up government debt. This will certainly mechanically increase the amount of cash floating around the system. It will also push down the yields on government debt, which should in turn reduce the cost of borrowing throughout the economy. However, this is only one half of the objective for QE. The other is to try to encourage companies and investors to get out there and spend more.
The Japanese tended to buy most of these assets off banks. Unfortunately, the banks then hoarded the cash, because their balance sheets had been so damaged by the financial crisis. The Bank, on the other hand, intends to buy most of the gilts off institutional investors - pension funds, insurers and the like. The theory - or hope - is that they will be less keen to hoard the cash and will spend it elsewhere.
This will, so the theory goes, set off a snowball effect whereby they buy extra stuff, which in turn encourages other sellers to go out and buy, and which eventually causes the economy to start growing again. So the £150bn that is poured into the economy eventually generates two or three or four times that in economic output and in money growth. We hope.
***
The problem, as you'll have guessed, is that although all of these arguments seem very rational, we have no idea whether they will work in practice. Sure, the Japanese made mistakes, but there could easily by another mistake we'll make. Likewise, even if we fulfil all the preconditions necessary, will this actually have the desired effect of bringing economic growth back up to trend? And if it does, how will we ensure we don't then generate a tidal wave of inflation which creates another dangerous bubble five years hence?
No-one knows, of course. All of which is why this new topsy-turvy world is so terrifying. However, the one counterfactual I am pretty sure about is this: for all that it is disturbing for savers now to see interest rates down at absolute zero, the economy would be in a far, far worse state if interest rates had been any higher over the past year. Then we truly would have been staring economic armageddon in the face.
In the meantime, we must try to get to grips with the remoulded economic and monetary landscape thrown up by quantitative easing. Many thanks for all your comments and questions in my last blog. Please keep them coming (either at the bottom here or by twitter) and I'll try to address them tomorrow and thereafter. I'm going home now to watch trashy television and briefly expunge words like quantitative easing from my brain.
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