THE NEWS that Britain’s sovereign debt has been downgraded comes as no surprise to those of us who have followed the Bank of England’s monetary policies over recent years with growing bewilderment.
The job of a Central Bank is to maintain monetary stability. It is not to print money. It is not to manipulate the exchange rate. It is not, above all, to stoke up inflation or debauch the currency.
The Bank of England has been culpable of all three. And incredibly three members of the Monetary Policy Committee, including Mervyn King himself, are now reported to have voted for yet more money printing at their most recent meeting.
Let us seek to be scrupulously fair to them. Back in March 2009, with the world economy reeling after the collapse of Lehman Brothers, and the British Government battling against a credit meltdown following the collapse of Northern Rock, RBS, HBOS and several smaller financial institutions, a case could be made for the Bank of England’s announcement that it would try to revive the economy through Quantitative Easing. Against such a desperate backdrop, taking this leap into the unknown was defensible.
But now experience has told us that, not only does QE not work, it is seriously hampering economic recovery.
Half a century ago, in a classic essay on “The Methodology of Positive Economics” (1953), Milton Friedman wrote that “the only relevant test of the validity of an hypothesis is comparison of its prediction with experience.”
The Bank of England made the following predictions about the impact of QE:
1. It would kick-start economic recovery – the Bank forecast that the UK economy would grow by 1.7% in 2010, 3.4% in 2011, and 3.5% in 2012. It didn’t – UK GDP has stagnated.
2. It would boost bank lending to business and stimulate business investment. This has also not occurred.
3. It would ease consumer credit and drive retail sales upwards. That hasn’t happened. Retail sales remain flat with a succession of insolvencies among high street retailers.
4. QE would also ease the flow of mortgage finance and stimulate the revival of the housing market. This hasn’t happened either. House prices remain flat, mortgages are difficult and expensive to secure, especially for first time buyers, and there seems little prospect of a significant revival in the housing market in the foreseeable future.
5. These positive effects would be felt against a backdrop of low and falling inflation. Again, the Bank of England’s forecasts have been consistently wrong on this count, and inflation has continued to run well ahead of the Bank’s 2% target.
The reasons for the failure of QE were set out in my comment on “Quantative Strangling: Why QE is hurting the economy not saving it” here on August 14th 2012.
My own predictions of the likely impact of QE have been fully vindicated by experience.
So on the Friedman test, the Bank of England’s hypothesis – that QE works – has been shown to be invalid. My alternative hypothesis – that, not only does QE not work, but it has hampered economic growth and driven the UK into a stagflationary recession – has been fully validated.
Experience has revealed the consequences of QE only too clearly. It has driven down the real incomes of small savers, pensioners, the low-paid and those on fixed salaries. As a result, it has driven down consumer expenditure and harmed the retail sector. It has increased the unfunded pension liabilities of the corporate sector, forcing companies to divert their resources away from new investment that would have generated growth and jobs. In some cases, these liabilities have driven otherwise sound companies into insolvency, resulting in a rise in bad debts. It has choked off bank lending to new enterprise.
As all these effects became increasingly evident, hopes rose last year that the Bank of England would call a final halt to their failed policy and consign QE to the dustbin of history. The news that three members of the MPC voted for more quantitative easing in January threw this into doubt, causing turmoil on the financial markets, sending the value of Sterling tumbling, and resulting, last Friday, in a downgrade of Britain’s sovereign debt.
And so, in a final, cruel irony, a policy designed to drive down the cost of UK government borrowing has instead resulted in a debt downgrade that will cause gilt yields to rise.
It is to be earnestly hoped that the majority of the Bank’s Monetary Policy Committee will resist the folly of more quantitative easing being urged upon them by an irresponsible minority led by Sir Mervyn King.
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