No QED for QE
Called Quantitative Easing, or QE, an Asset Purchase Facility was announced by the Bank of England in March 2009 with a target level of asset purchases equivalent to about 12% of GDP. Six months later, we ask whether the recovery demonstrates the policy was successful.
The size, 12% of GDP, was roughly the sum at that point of the target nominal growth rate of GDP consistent with the Bank’s inflation target and the actual loss of GDP caused by the rapid onset of recession. The stated intention was to boost asset prices by buying gilts and commercial paper from non-bank financial institutions. There were three conditions the Bank was hoping would hold:
Fund managers would raise their risk tolerance and reinvest in riskier assets
They would buy newly-issued securities that could replace bank lending as a source of capital
By bidding up asset prices they would help reawaken ‘animal spirits’ amongst a fearful investing public.
If we think back to what was happening at that stage, risky asset prices were still falling, six months after the shock of major bank rescues around the world. The British had adopted an insurance-based approach to helping banking balance sheets: using taxpayers’ money to put a cap on banks’ losses on damaged banking assets, at the same time as recapitalising most of the banks. But whatever politicians said publicly, there was not a snowball’s chance in hell that this would translate into increased bank lending. It was consistent with that realism that QE was aimed at the non-bank sector.
This made the whole initiative even more indeterminate than earlier examples when central banks had inflated money supply by buying up banks’ holdings of government bonds to reduce their liquidity and promote lending. This we could just about get our heads around. But the idea that professional money managers could be led to alter their risk appetite just because the Bank of England was going to run reverse auctions in gilts,however mind-boggling the sums, was, to this money manager, absurd. It presumed all sorts of things about portfolio choices in long-term investing institutions that did not look very credible.
Aside from that, the assumption that the additional bank balances initially created by QE would end up credited to firms or individuals who would buy real, non-financial goods and services, was speculative. It essentially required the reopening of a vigorous new issue market in either debt or equity. This did not hang on gilt yields.
As for the trickle down effect on the real economy of reviving animal spirits in the stock market, that too was more hope than demonstrable economics.
Six months after QE was announced, and even less in terms of actual money flows, the FTSE All Share index is 50% up, corporate bond spreads have narrowed, interbank deposit rates are back to pre-crisis levels and economic activity has by all accounts started to recover. Does this mean QE has done its stuff?
If it does, investors fear that, when the exceptional liquidity is withdrawn, asset prices across the board will relapse. But if QE has very little to do with it, then by implication the only concern is that the gilt market will fall, this being the asset directly manipulated by QE.
Looking at the timing of the recovery, its extent and its global reach, I think it is ludicrous to ascribe much significance to the UK’s QE initiative. As a firm, we are also glad it has not had much impact on index linked gilt yields, which matter a lot to us as our risk free asset, and very relieved we do not hold any conventional gilts.
Will we ever know what the actual effects were? No. That includes whether any inflationary or deflationary tendencies that emerge in future years were the fault of introducing QE or withdrawing it too soon or too late. Other causes are likely to be more important but equally unpredictable in advance.