There is much debate over the reason behind the failed recovery plan set by Chancellor George Osborne. The assumption the Chancellor made anticipated an increase in private sector output, when cuts were made to the public sector. Unfortunately this did not occur, or at least not quickly enough to appease the governments pressure groups, resulting in a U-turn on their thinking. A new programme of Quantitative Easing (QE) was introduced to ‘stimulate’ the economy, with the intention it will lead to growth.
I personally do not think that QE will lead to anything other than inflation, later on in the business cycle. I certainly do not think it will create any constant reliable growth. At best it may maintain a short period of artificial or ‘false’ growth, which many economists would call money illusion. I believe the government has not correctly addressed the problem which prevents growth. Some economists are saying the expectation of future economic difficulty is frightening consumers into saving, slowing spending.
I don’t believe this is true. When people save more, the money saved is lent to people who use that money to enable business or to consume. In short money is always doing something. There may be a lag in the time between saving and lending, which could reduce consumption. However this would generally be compensated for. People who borrow money have a higher propensity to consume than those who lend and will spend it faster. This is proven by the borrower being prepared to pay the premium of interest to consume now, rather than later.
However, banks are not lending the money they have. This is partly due to the increase in the required assets they have to hold to cover depositor’s withdrawals, as a result of the financial crisis (capital ratio). But it is mainly as a result of the banks fear of the risk in the market. This fear has prevented growth by stopping the natural transition of money from savers to consumers through the saving mechanism. Therefore, the real reason for the lack of growth in the economy is the increase, or at least the fear of an increase, in risk.
No amount of QE will reduce the risk. In fact it may make it worse. QE is a desperate action by a government in a dire situation. The implementation of such a policy will deter consumers from increasing their consumption, as it is a suggestion that their fears of economic woe are well placed. That is not to mention the fear it will put into foreign investors, who will be deterred from putting their money where they think a greater risk is.
If the government found an alternative way of reducing risk, it could restore the lending and borrowing mechanism enabling the private sector to grow again without trying things like QE. However current policy suggests potential disaster based on fear and expectations, which have originated from the messages the government is sending out. Reducing taxes and regulation will reduce risk, and deliver the growth we all want.