Belfast Telegraph

Tuesday 23 September 2014

Printing money could save us from European turmoil

Growth may not happen for a few years yet

Just print the money! One of the things that a central bank can do and do without limit is to flood the markets with liquidity.

To give you an order of magnitude, this latest £75bn of quantitative easing is equivalent to 5% of GDP - maybe not quite a flood of money but a decent wodge none the less.

The European Central Bank similarly announced that it would buy €40bn of bonds and take other measures to put liquidity into the system.

The headline number is more modest than the UK, particularly with reference to the economies concerned, but the market judgment is that the two central banks are following broadly similar strategies. Expect a rate cut from the ECB, reversing the two increases this year, soon.

So what should we make of this? Well, there is a genuine debate as to whether the money that the central banks have created goes principally into increasing output or principally into increasing inflation. In extreme situations, such as Germany in 1923 or Zimbabwe in 2008, the money generates hyper-inflation. But in normal times, while you would expect some inflationary impact you, would also expect some increase in output.

The Bank of England reckons that its previous action on QE added 1.5-2% to growth and 0.75-1.5% to inflation. But the trouble is we don't really know what would have happened had they done nothing and it is at least possible that the relationship was the other way round: the policy added more to inflation than growth.

But why is the Bank of England - and the ECB - now doing another bout? The obvious answer is that both are really worried about the global slowdown in general and the sovereign debt crisis in Europe in particular.

From a narrow British perspective it is certainly true that any slowdown in Europe comes at a bad time, for the recovery has undoubtedly been disappointing.

But the trouble is, we still don't fully understand why this should be so. The data does not seem to fit what intuitively seems to have been happening.

Citigroup makes an interest-ing comment on this: "The UK's boom-bust cycle was even bigger than thought previously. In turn, that upward revision to spending in the boom - probably leaving real GDP even further above potential - may (along with the weak pound) have contributed to the persistent stickiness of inflation (including services inflation) in recent years."

So maybe we should not be blaming QE for the present surge in inflation - maybe the roots of the problem go back to the unsustainable nature of the Brown boom.

If you want to think of the bottle as half empty, that may mean that there is less spare capacity in the economy than currently thought. The loss of output cannot quickly be recovered because the previous peak in output was way above the sustainable trend.

If, on the other hand, you want to see the bottle as half full, the actual level of GDP now is somewhat higher than previously estimated because the base from which we started was higher than we thought.

My own "takeaway" from all this is that one should be extremely suspicious of initial estimates of GDP. If the statisticians have got the figures in the past so massively wrong, why should we trust them now? That is not to get at the people doing the job - it is simply a common sense reaction to these huge errors in the past. Let's remember too that even these revisions may still need to be further adjusted in the future.

My guess is still that the GDP data for last year will be revised upwards but that there is indeed a pause taking place now. That pause may become more prolonged if continental Europe fails to get a grip on its problems. However, while some European economies may indeed slip back into recession, the UK should manage to grow slowly. We will be protected in part by this new bout of QE.

However ambivalent we feel about this (and the objection that this just creates more inflation is very real), it may be useful insurance ahead of a European sovereign debt crisis that may become quite nasty.

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