Dear Mark

April 15, 2013

–Laurence Copeland is a professor of finance at Cardiff University Business School. The opinions expressed are his own.–

Dear Mark Carney,

As you arrive in your new office, you will not be short of free advice, least of all from economists. Nonetheless, like a supporter of the away team valiantly trying to make himself heard above the roar of the home crowd, this is my feeble attempt to compete against the chorus of voices calling for ever more, ever larger doses of QE, ever lower interest rates and even more devaluation of the Pound.

Just say no!

What, after all, has QE achieved?

We can never know for sure what might have happened without it – my colleagues are still arguing about the effects of economic policy in the nineteen-thirties, so we can’t wait for a definitive answer about 2008 and its aftermath – but the evidence in its favour is far from overwhelming, whereas the damage it is doing is plain for all to see, especially in two areas.

First, the distortion to interest rates is equivalent to a massive redistribution from savers to borrowers, a forced loan amounting to hundreds of billions of pounds. The subsidy takes many forms, most obviously the negative real interest rate paid to bank depositors and, perhaps even more damagingly, the cripplingly low annuity rates and unsustainable burden on pension funds.

To a great extent, this is an intergenerational transfer. Now we didn’t need David Willets to tell us that we baby-boomers have never had it so good and our good fortune is to some extent at the expense of the young, who have to pay for our index-linked state pensions and all the benefits in kind we enjoy. But it is also because my generation was brought up to believe that security came from saving, whereas the young are far more inclined to borrow – hence Britain’s disastrously-low saving rate, far below that of almost any of our competitors. Throughout the post-war period Britons have seen their savings expropriated by the authorities by a combination of raids on pension funds, more taxation and high inflation. Unsurprisingly, they have responded by over-investing in housing, the only asset available to ordinary folk that seemed to be sheltered from the vagaries of economics and the greed of politicians –– which brings me to the second area where QE is doing a lot of damage.

Too many people, including those who ought to know better, talk as if re-inflating the housing bubble should now be the Holy Grail of monetary policy. For them, it’s a no-brainer: print money and you can be sure that much of it will be used to buy houses.

So why hasn’t that happened already?

We’ve been printing money like crazy since 2008, so why hasn’t it generated the mother-and-father of all housing booms? Trillions of pounds have been created, but little of that money is reaching households, nor the SME’s who are just as desperate for it. The dirty little secret at the heart of QE is that it is being used to recapitalise the banks.

The record gap between borrowing and lending rates and even the 3%+ difference between long and short gilt yields should be added to the bill for cleaning up the mess left by Fred Goodwin and co. Essentially, QE means the banks can borrow for nothing and lend at rates barely changed from the boom years – my credit card offers me cash at 27%. (By the way, these high rates cannot be explained away by default risk, because bad debts have barely increased in the last few years).

Of course, being able to trumpet the world-beating reserve requirements imposed on Britain’s banks has become a point of competitive honour for our regulators, so bankers can to some extent claim force majeure as a defence. But if anyone asks why we need such sky-high reserve ratios, it is because of the appalling track record of our banks, because systemic risk is greater than ever, given that we have chosen to merge banks rather than break them up, and because we still insist on basing our economy on financial services instead of taking the opportunity to wean ourselves off this dangerous dependence.

I know that much of this is beyond your control, given the international context, in particular, the currency war unleashed by the Fed in 2008.  The Bank of England has led us into the battle with enthusiasm and success. The Pound has been by some way the weakest major currency in the last few years, falling by 25% against the dollar, 35% against the yen and even by 6% against the euro – sovereign debt crisis notwithstanding. But what benefit have we derived from these hollow victories? Our export performance has remained feeble, while our inflation rate has long been far higher than any of our major competitors.

Now I am not asking for a policy of unilateral disarmament, but I think you could at least use your reputation and the prestige of your office to press your opposite numbers in the world’s central banks for an end to this madness before it is too late. It is time to get back to sound money, and to bury once and for all the myth that monetary policy can generate real growth.

For all the talk of bubbles past and present, the most damaging bubble of all has been in the market for central bankers. The first real superstar was Alan Greenspan, and his bubble burst spectacularly. Yet here we go again, expecting Bernanke and Draghi and Kuroda to save the world economy by wrecking its money.

Now you arrive in London trailing clouds of glory, revered as the world’s best central banker. The first thing you should do is make it plain to everyone – politicians, markets and the public at large – that you are not an adherent of the central-banker-as-superman philosophy and that you take what we must now call the minimalist view that characterised the pre-crash orthodoxy, with one critical modification. The job of a central banker, or rather of the MPC, ought to be to keep broadly-defined inflation under control – that is to say, the pre-2008 terms of reference need to be broadened, but not to cover the level or growth rate of real or nominal GDP. Instead, it should be widened to require you to keep an eye on asset prices. The notion that we cannot identify bubbles is simply an excuse for neglect. True, in any given case we cannot say with 100% certainty what is irrational exuberance rather than rational confidence in the future, but, as you well know, most macroeconomic decisions have to be based on unreliable estimates of things like the growth of capacity, the supply of labour and the demand for money.

You arrive in London at the top of the league of central bankers. Bear in mind that there is only one way your reputation can go from here.


Laurence Copeland

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