The Great Debate UK

from MacroScope:

There be feudin’ at the BoE

The once-good relationship between Bank of England Governor Mervyn King and his most likely successor, Deputy Governor Paul Tucker, is coming  under increasing strain, according to a new book by former Daily Telegraph journalist Dan Conaghan.  It  alleges   King’s management style and and alleged disdain for the financial markets is to blame.

While the Bank of England’s Monetary Policy Committee remains reasonably collegiate, on other matters King more than lives up to the description from former chancellor Alistair Darling that he is ‘incredibly stubborn’, says Conaghan, who now worksas an asset manager.

“The governor can be particularly dogmatic,” he told Reuters. “One of the key things … is the attitude to the capital markets. One of my sources described Sir

Mervyn’s attitude as one of disdain. I’ve heard that repeatedly. Paul is much more pragmatic.”

One tangible upshot of this came at the launch of the Bank’s quantitative easing programme in March 2009, which Conaghan said led to an upsurge in failed trades on the British government bond market, until the central bank found a mechanism to lend back some of the gilts it had bought.

More broadly, Conaghan’s book The Bank: Inside the Bank of England describes something approaching a feud growing out of a philosophical split between King – who champions a purist, economics-driven approach – and Tucker, who is closer to financial market participants.

“It is widely acknowledged within the Bank’s upper echelons and elsewhere that the relationship between King and Paul Tucker … has deteriorated over the past few years. One very senior figure at the Bank describes it as being, at times, ‘a battle-ground,’ where the battles over policy, direction and structure are common. Another senior official at the Treasury concedes that they ‘do not get on, to put it mildly’.”

The QE billions should go direct to consumers

By Mark Hillary. The opinions expressed are his own.

In 1998, the Japanese government was ridiculed for giving away almost $6bn (at 1998 value) of shopping vouchers. The plan was that consumers would spend more of this ‘free money’ and help lift Japan out of the seemingly endless malaise it suffered in the nineties – as many other developed economies were enjoying a roaring decade.

One of the major faults in the Japanese plan was that the vouchers could easily replace the need to spend actual money. If my groceries cost me $100 then why would I still spend $100 of cash on groceries and buy a nice meal in a restaurant with my voucher, when I could just use the voucher for those groceries?

But the Japanese may have been onto something by focusing on demand rather than monetary supply, contrary to most received wisdom at present.

The Bank of England’s Monetary Policy Committee has restarted quantitative easing (QE) in the past week, much to the surprise of the markets and leading some commentators to ask what they might know that the media and financial analysts don’t.

Former MPC member David Blanchflower even used his column in the Guardian to say: “The MPC argued that tensions in the world economy ‘threaten’ the UK recovery. I am unaware of the MPC ever using this word before. Given that a lot of care goes into the exact wording of such a statement all nine members would have had to sign off on this, then things must be pretty bad.”

Perhaps I am over-simplifying the complexity of the British economy, but if the man on the street senses that the economy is not improving then he will reduce spending, luxuries are forsaken, and unsecured credit is paid down.

Does the world need more QE from the Fed?

- Kathleen Brooks is research director at forex.com. The opinions expressed are her own -

The minutes from the Federal Reserve’s September meeting seems to suggest that more quantitative easing is a done deal for November. So far, the argument has centred on whether or not the U.S. economy needs another shot in the arm from the Fed to boost growth. The Fed certainly thinks it does. According to the minutes “many” members felt that the status quo – sluggish growth, inflation grinding lower  and no sign of a recovery  in the jobs market – was enough to justify more easing in policy.

These are pretty compelling reasons for more QE to stimulate the flagging U.S. economy, but what about the rest of the world? Any action by the Fed has huge implications for the global economy. Usually, when the Fed shifts its stance from easing to tightening or vice versa it starts a global chain reaction.

But now that we are in unusual times, the Fed’s actions are even more important. Turning on the printing presses will have three main consequences. Firstly, it may not have the desired effect on the U.S. economy. If it doesn’t make companies hire more staff, and corporations continue to sit on huge cash piles, then the liquidity generated by the Fed will start to seep out of the US economy.

If you can borrow cheaply but don’t want to expand your business, perhaps because you don’t have strong enough faith in U.S. householders who are busy retrenching and paying off debt rather than spending, then you’ll chase returns elsewhere. This will create liquidity bubbles. The immediate beneficiaries will be stocks and commodities. We have already seen gold reach new highs, and equities are looking like they are popping up. It’s great if you are at the receiving end of the liquidity, however if you are not, then you’ll be left out in the cold.

If the U.S. doesn’t boost demand with more QE, then domestic retailers will soon feel the chill of prolonged high unemployment. Likewise, if the money chases investments in high-growth economies, then it will leak to emerging markets, by-passing the sluggish, debt-laden west.

Capital inflows to emerging markets is what is fuelling the so-called “currency war”. While capital flows will put upward pressure on local currencies across emerging economies, the market hasn’t been focusing on the real problem – the prospect of Fed money fuelling the next financial bubble. In this sense, authorities including Brazil and Thailand who have imposed capital rules to try and stem the flow of money into their asset markets, have done not only to keep their export markets competitive, but also to prevent unsustainable asset price bubbles.

Monetary policy: QE2 or the Titanic?

“Those whom the gods would destroy, they first drive mad.” – the words of a wise Roman thinker (or was it a Greek central banker?). At any rate, the gods certainly seem to have no benevolent intentions with regard to this country, judging by the statements coming from the Bank of England, in particular the calls for another round of quantitative easing from one member of the Monetary Policy Committee and the cry of “Spend, spend, spend” from another.

The view emerging from the Bank and the Monetary Policy Committee is that the country is in the grip of a slow-growth recession, facing the threat of Japanese-style deflation and a double-dip recession, and that this grim situation requires near-zero interest rates, supported by QE2 if necessary, in order to restore consumption and lending (including mortgages) to pre-crisis levels.

As soon as anyone compares the UK and Japanese economies and finds similarities, I start to worry about their sanity. Leaving aside the massive differences in labour market flexibility, the key difference is that Japan got itself into a mess single-handedly in the late 1980’s, largely because of its unsustainably high levels of saving and investment. Indeed, for the last 20 years its massive stock of accumulated savings have largely insulated it from any sense of urgency. Its fiscal policy consists of running enormous Government budget deficits which are funded out of this stock of private sector assets, so that its expansionary fiscal policy simply serves to offset the excessive thrift of its overprudent households – hence, Japan’s ability to borrow well over twice its GDP without generating any sign of market nervousness about its ability to repay and with a buoyant Yen exchange rate.

Somehow, this does not sound to me like Britain’s current predicament. If we face years of stagnation, it is because of a debt overhang, the absolute opposite of Japan. Yet the Bank – no doubt in line with the majority of the UK economics profession – is convinced that Japanese-style demand weakness is our problem.

Take the deflation threat first. For all the worries, Britain’s inflation rate fails to follow the script. Not only does it repeatedly exceed the Bank of England’s own forecasts, but at over 3% it is still well above – not below – the inflation rates of every other major economy and double the Eurozone average rate. In particular, Germany’s inflation rate is only 1% and the USA’s is 2%.

What about unemployment? Again, it is far from obvious that the UK is in any way out of line with the rest of the industrialised world, given that our unemployment rate is still only 7.8% compared to 6.9% in Germany, 10% in France, and 9.5% in America (and 5.2% in Japan).

As far as household saving and consumption are concerned, the conclusion again depends on what yardstick you use. At 7.7% of disposable income, the UK saving rate is higher than it has been for a few years – it was barely 2% in 2008 – but this is still extremely low compared to well over 13% in the Eurozone and over 15% in France and Germany, not to mention 30%-plus in the Asian tigers. Only the USA has similarly low savings rates.

Part-paid gilts should return

– Neil Collins is a Reuters columnist. The opinions expressed are his own –

LONDON, April 23 (Reuters) – The UK Government needs to raise four billion pounds a week, every week, in the financial year to next April, to bridge the gap between its tax income and its spending.

Bank of England faces dilemma on QE extension

– John Kemp is a Reuters columnist. The views expressed are his own –

LONDON, April 9 (Reuters) – The Bank of England’s terse press statement announcing it will maintain overnight rates at 0.5 percent and continue the existing 75 billion pound quantitative easing (QE) programme gives no clue about whether the Bank intends to extend the programme when the first tranche of asset purchases are completed in June. But officials will have to make a decision soon: unless they signal a commitment to extend QE, gilt yields will rise even further in anticipation that the major buyer in the market will withdraw. The QE programme is dogged by ambiguity about its objectives (which a cynical observer might conclude is deliberate). Officially, the aim is to prevent inflation falling below target by accelerating money supply growth, not manipulate the yield curve for government and corporate debt. In this, the Bank’s avowed strategy is more conventional than the Fed’s ambitious efforts to determine the cost of credit for borrowers throughout the economy. It is a straightforward quantitative easing patterned on the Bank of Japan, rather than a credit easing patterned on the Fed. If true, the measure of success is how much the money supply has been boosted at the end of the three month period; the Bank should be indifferent about whether ending QE causes yields and borrowing costs to rise. So long as money supply has risen consistent with the inflation target, and the Bank can discern some green shoots of stabilisation if not recovery, officials can declare victory, end the programme, and keep the other 75 billion pounds of asset purchases authorised by the chancellor in reserve. Yields can be left to find their natural level. But many suspect the Bank’s real objective is yield control — in which case it will have to announce another round of buy backs of gilts and corporate bonds in good time, well before the current programme is completed, to shape market expectations. The results of the existing round have been unimpressive. After falling initially, gilt yields are almost back up to the level they were at before the Bank’s foray into unconventional monetary policy. The snag is that if the Bank stops buying, other investors will struggle to absorb all the new government paper on offer without a major increase in yield — pushing up borrowing costs for everyone, precisely what the Bank has sought to avoid. The Bank’s dilemma is whether to push on (heightening fears about inflation) or call a halt (risking a spike in yields all the same). Either way, the Bank needs to give the market, as well as the Treasury and the Debt Management Office, plenty of warning about its intentions. (Editing by Richard Hubbard)

Quantitative easing a last resort

-Alan Clarke is UK economist at BNP Paribas. The opinions expressed are his own-

As expected, the Bank of England left the Bank Rate unchanged at 0.5 percent at the April meeting, the first unchanged decision since September 2008.

The accompanying statement was short and sweet. The Bank has accumulated 26 billion pounds of asset purchases and will take a further two months to complete the planned 75 billion pounds of purchases – see you next month!

It is disappointing that gilt yields haven’t remained low – partly because of firmer economic data, but also because the market is wary of the exit strategy. Hence the statement was a bit of a missed opportunity. The Bank has run out of interest rate ammunition and hence is having to use alternative measures including quantitative easing. Some form of verbal intervention, voicing a desire to get gilt yields lower could have been a cheap and easy way to loosen conditions in the economy.

Ultimately we expect the scale and duration of quantitative easing to be more than most expect. Our models suggest that if the Bank Rate could fall below zero, interest rates “should” be -4 percent. That shows the magnitude of the stimulus that is required from unconventional policy. Given this, we expect Bank purchases of assets to amount to as much as double the 150 billion pound that the Bank is currently authorised to spend.

Quantitative easing is called unconventional policy for a reason. It is the last resort. We don’t know if it will work; if it does work we don’t know how well it will work or how quickly it will work; we don’t know how big any side effects will be. If it was so fast and effective then it wouldn’t be unconventional – we wouldn’t bother moving the Bank Rate, we would use QE instead.

The point is, it is going to take a long while before we discover if QE has worked. The typical lead time between interest rates and the economy is 12 to 18 months. Hence as a starting point, that is the horizon over which we should be able to conclude whether the programme of asset purchases has worked.