Where did all the money go?


Amidst all the talk about when and how to end or reverse quantitative easing (QE), one question is hardly ever discussed: why the massive doses of bond purchases by central banks in Europe and states United since 2009 have they had so little effect on the price level?

Between 2009 and 2019, the Bank of England injected £ 425 billion ($ 588 billion) – around 22.5% of the UK’s GDP in 2012 – into the UK economy. This was aimed at pushing inflation up to the BOE’s medium-term target of 2%, down from just 1.1% in 2009. But after 10 years of quantitative easing, inflation was below its level. of 2009, despite the fact that real estate and equities – market prices were booming and GDP growth had not recovered to its pre-crisis rate.

Since the start of the Covid-19 pandemic in March 2020, the BOE has purchased an additional £ 450bn of UK government bonds, bringing the total to £ 875bn, or 40% of current GDP. The effects on inflation and production of this 2nd round of QE are not yet being felt, but asset prices have again risen sharply.

A plausible generalization is that increasing the quantity of money through QE gives a temporary strong boost to house and financial security prices, thus greatly benefiting the holders of these assets. A small proportion of this increased wealth spills over into the real economy, but most of it simply flows through the financial system.

The standard Keynesian argument, derived from the general theory of John Maynard Keynes, is that any economic collapse, regardless of the cause, results in a sharp increase in hoarding. Money flows into reserves and savings increase, while spending decreases. This is why Keynes argued that economic recovery after a collapse should be driven by fiscal policy rather than monetary policy. The government must be the “last resort” to ensure that the new money is used for production rather than being accumulated.

But in his Treatise on Money, Keynes provided a more realistic account based on “speculative demand for money.” During a severe economic recession, he argued, money is not necessarily hoarded, but passes from “industrial” circulation to “financial” circulation. Money in industrial circulation supports normal production processes, but in financial circulation it is used for “the business of holding and trading existing securities of wealth, including stock and money transactions.” A depression is marked by a transfer of money from industrial circulation to financial circulation – from investment to speculation.

Thus, the reason why QE had virtually no effect on the general price level may be that a large part of the new money fueled asset speculation, thus creating financial bubbles, while the price and production as a whole remained stable.

One implication of this is that QE generates its own boom and bust cycles. Unlike orthodox Keynesians, who believed that crises were caused by an external shock, economist Hyman Minsky believed that the economic system could generate shocks through its own internal dynamics. Bank lending, Minsky argued, goes through 3 degenerative stages, which he dubbed hedging, speculation and Ponzi. As a first step, the borrower’s income must be sufficient to repay both the principal and the interest on a loan. Then it must be high enough to cover only the interest payments. And in the final stage, finance simply becomes a bet that asset prices will rise enough to cover loans. When the inevitable reversal in asset prices produces a crash, the increase in paper wealth vanishes, dragging the real economy in its wake.

Minsky would thus regard QE as an example of state-created financial instability. Today there are already clear signs of excess in the mortgage market. UK house prices rose 10.2% through March 2021, the highest growth rate since August 2007, while indices of overvaluation in the US housing market “flash bright red”. An econometric study (unpublished to date) by Sandhya Krishnan of the Desai Academy of Economics in Mumbai shows no relationship between asset prices and property prices in the UK and US between 2000 and 2016.

It is therefore not surprising that in its forecast for February 2021, the BOE’s Monetary Policy Committee estimated that there was a 1/3 chance that UK inflation would fall below 0% or exceed 4%. % over the next few years. This relatively wide range partly reflects uncertainty about the future course of the pandemic, but also more fundamental uncertainty about the effects of QE itself.

In Margaret Atwood’s futuristic 2003 novel Oryx and Crake, HelthWyzer, a drug development center that makes premium brand vitamin pills, inserts a random virus into their pills, hoping to profit from selling the pills and the antidote he developed for the virus. The best type of disease “from a commercial standpoint,” explains Crake, a mad scientist, “would be those that cause persistent disease. […] the patient would heal or die just before all his money was used up. It’s a good calculation. “

Robert Skidelsky, member of the British House of Lords, is professor emeritus of political economy at the University of Warwick.

Disclaimer: This article first appeared on Project Syndicate and is published under a Special Syndication Agreement.


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