Few in Britain may want to hear it, but the financial crisis that rocked the country has a silver lining for the rest of the world. The dramatic intervention by the Bank of England reminds us that quantitative easing, the large-scale bond buying commonly associated with low inflation rather than today’s price surge, is not going away.
What looked like a one-off exercise rooted in the traumas of 2008, Europe’s debt crisis a few years later and post-bubble Japan, continues to be rolled out. The UK is unlikely to be its last resurrection. The potential for a breakdown in the trading of US Treasuries is troubling top officials; Treasury Secretary Janet Yellen went public with her concerns last week when she fretted about adequate liquidity. The worst market rout in decades is not helped by the Federal Reserve’s efforts to unload a portion of the bonds it acquired during its Covid stimulus.
Watching the BOE wade in and calm the market led me to recall a powerful message from Raghuram Rajan, a former Reserve Bank of India governor, at a conference a year ago. Inflation was beginning to build around the world and central banks were contemplating how to begin ever-so-gently unwinding the vast sums pumped into the financial system during the pandemic. Was QE slated to return to the archives? Rajan was sceptical and told a panel that asset purchases were like “a whirlpool”, easy to fall into but far harder to escape.
It seemed like an odd time to be flagging a short retirement. The Fed was starting to signal a tapering of bond purchases and would subsequently move faster than expected toward interest-rate hikes. The Reserve Bank of Australia was preparing to jettison efforts to suppress bond yields, the Bank of Korea and the Reserve Bank of New Zealand were already hiking and the BOE was preparing to do so. Deployed to prevent a public health crisis from morphing into an economic calamity, so-called unconventional policies were being blamed for exacerbating the uptick in inflation. QE looked like yesterday’s hero — and villain.
Rajan stands by his warning of October 2021. In theory, he says, the process is straightforward: During QE, central banks buy bonds and expand their balance sheets. When the economy has recovered and it is time to unwind stimulus, you simply do the reverse and release the bonds into the market. QE becomes quantitative tightening or QT. “That is the narrative that says it is very easy to get in and very easy to get out,” Rajan, a professor at the University of Chicago, told me recently. “The problem is that stuff happens along the way.” Providing liquidity in tough times makes perfect sense “but the private sector gets used to it and you keep having to go back in. It is a drug which is addictive. The private sector cannot withdraw from that addiction”.
Once considered a piece of Japan exotica, QE was unfurled by the Fed during the 2007–2009 Global Financial Crisis. It was also utilised by the BOE and during the European debt crisis that followed, by the European Central Bank. QE has become a legitimate tool that is always there and no central bank is likely to foreswear its future use, no matter how much it may be blamed in the current economic cycle for contributing to much higher levels of inflation. It is simply far too useful.
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Like battlefield weapons, that does not make their actual deployment free of hazard. Witness the BOE rowing into the market in recent weeks to mop up bonds after a reckless and unfunded government fiscal package spurred a run on the pound and an implosion in demand for UK debt. While billed as an exercise in restoring financial stability, the buying puts the BOE in a precarious position. The bank is committed to ratcheting up its benchmark rate to quell inflation and may do so dramatically at the next meeting of its Monetary Policy Committee. On the other hand, by engaging in QE — albeit of the emergency and short-lived variety — it pursued a policy linked to risks of deflation. And having stepped in once, who can doubt officials will return?
One of the defining characteristics of QE is not just about bond purchases, per se. It is about signalling, a way of saying that rates will remain low for quite a while. The punch is more powerful when twinned with forward guidance that commits to easy policy as much and as long as possible. That was the case after the collapse of Lehman Brothers Holdings Inc and during much of the pandemic. Just because the principle doesn’t apply right now — inflation well exceeds the Fed’s 2% target — does not mean the lesson has lost meaning.
Because of concerns about a “taper tantrum,” such as the one that occurred in 2013, officials waited too long to extricate themselves from Covid QE. The resulting rapid tightening, the fastest in decades, is creating enormous strains in the global economy. The economic dislocation will force many banks to cut rates in 2023, economists say.
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But with inflation now the highest in decades and officials scrambling to assert their hawkish credentials, surely the bar for QE will have been raised much higher? Not necessarily. The RBA last month released an autopsy of its QE programme. While finding some benefits in large-scale easing, the bank concluded that deploying unconventional policy is best “only in extreme circumstances”. Yet the circumstances in which it resorted to QE — the advent of the pandemic — were extreme. The conclusion might resemble a “sorry” note but is not really. In the same situation, RBA Governor Philip Lowe or his successors would probably do it again.
Even in the withdrawal of stimulus era, forms of QE are alive and well. Bank Indonesia is selling short-term notes to drive up yields and make its debt more attractive, while buying longer-dated bonds to lower borrowing costs for the government. The Reserve Bank of India has undertaken a similar programme.
QE is just too hard to say goodbye to, even when everyone wants to be seen as the next Paul Volcker, the slayer of inflation. — Bloomberg Opinion
