On sound monetarist principles I thought that quantitative easing – the Bank of England’s euphemism for printing money – was a sensible policy. There was such a huge output gap – a growing number of unemployed people and a greater stock of underemployed productive capacity – that any new money would first go into boosting employment and productivity. Only when things had stabilized did we need to worry about the new money driving up prices.
There were, I thought, two possible dangers. One was that confidence would return as rapidly as it had disappeared, meaning that money would reappear from under people’s mattresses and come back into the productive economy. With the Bank creating even more, that could over- egg the pudding and produce an inflation mess instead. The other was that, even if the new money worked as the Bank intended, and gradually stabilized the economy, it might not rein back in again quickly enough. After all, central bankers rather enjoy booms, and so do their political masters. So that would be another pudding over-egged, with similar results.
Since then, the economic situation has changed, and there now every danger that the Bank’s (recently boosted) quantitative easing will indeed produce inflation. First, monetary aggregates are expanding, and prices haven’t exactly fallen much, so the deflation dragon seems to be more of a gekko. Second, the output gap is big, but it has not grown as much as expected. The OECD says we’ve bottomed out, even George Soros says so. The reason, of course, is that we have borrowed so hard to stave off a collapse. Borrowing may stoke up future problems, but we seem to have bought our way out of a complete meltdown. We’ve been high on the drug of cheap credit for years, and instead of going cold turkey, we have bought ourselves a rehab course. It takes a lot longer, it might not be so effective, and the methadone of borrowing might have its own unpleasant effects, but at least we’re not quivering and sweating on the floor.
You can argue whether that’s the right policy – and I’d argue that it’s highly dangerous – but the implications for quantitative easing must be clear. If this was largely a crisis of confidence, and confidence is now returning and the economy is reviving under its own steam, there is no point in stoking up the boiler yet further with new money. It can only lead to an explosion of inflation.