QE WILL GIVE US MORE INFLATION, NOT GROWTH / THE FINANCIAL TIMES MARKETS INSIGHT ( A MUST READ )

Markets Insight

September 26, 2011 2:53 pm

QE will give us more inflation, not growth

By Andrew Sentance


It is sometimes said that bad news comes in threes. That certainly applies to global financial markets over the summer.


In late July, the US budget deficit crisis erupted, followed by the downgrade of US sovereign debt by S&P in early August. That helped to reignite the most recent phase of financial market anxiety about high deficits and debts in the euro area. Most recently we have had gloomy statements about world growth by global financial leaders.


There is a common theme behind this trio of harbingers of bad economic news. It is a failure of leadership. In the US, policymakers showed themselves incapable of devising a credible deficit reduction plan. A similar impasse seems to exist in the euro area.


Yet global economic forecasts are not excessively downbeat. The latest International Monetary Fund forecasts point to 4 per cent global growth in 2011 and 2012 – in line with the healthy economic growth rate we saw before the financial crisis. However, the gloomy prognostications of world leaders have fuelled suspicions in markets that something dark and nasty is lurking in the woodshed.

So what is the way out of this impasse? The first step to get out of a hole is to stop digging. If world leaders and policymakers have nothing positive to say about the current economic environment, then they should say nothing.


The second step is to build a positive agenda for action at the G20 summit in early November. However, the policy action we now need is not a repeat of 2008/9, when the main focus was on stimulatory policies to halt a downward spiral in world demand and output. Instead, we need a focus on the policies which will help build recovery.


That requires a recognition that in the world economy of the 21st century, it is the Asia-Pacific region – supported by other emerging market economies – which will be the strongest engine of world growth. Europe and the US need to adjust to economic growth of about 2 per cent over the medium term (if they can achieve it), and focus on maintaining relatively high levels of employment.
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The policy agenda for the western economies now should not be about demand expansion, but structural adjustment: ensuring labour markets are flexible; the business climate is not encumbered by excessive regulation; tax rates are as low as they can be; and tax structures are efficient and reward enterprise and innovation.


The third ingredient needed is for central banks to stop pretending they can remedy all the deficiencies of the economic system by providing unending amounts of stimulus whenever growth appears weak in the short-term. Historical experience suggests that continual injection of demand stimulus to counter weak growth leads to persistent inflation and financial instability.


Central banks acted boldly – and rightly – in 2008/9 to stabilise economic conditions in the face of sharply falling demand and output. But they should now be focusing on a more conventional interpretation of their mandates. That means responding to upside risks to inflation by tightening policy when appropriate, as well as being prepared to relax policy in response to downside risks.


In the UK, we missed the opportunity in the second half of last year to start to rein in monetary stimulus. And the US embarked on its QE2 programme. These policies have not boosted growth. Rather, they have led to relatively high inflation. More stimulus is likely to result in more of the same, while doing little if anything to support growth.


What western economies now need is not further stimulus, but an opportunity to adjust to the new post-financial crisis reality. And they need stronger and more confident signals from policymakers that they are committed to pursuing sound economic policies in the medium-term.


We are in a tough period of economic policymaking, both for governments and central banks. But if policymakers duck difficult decisions in the current climate, they will find life even more challenging in the future. The experience of recent months has highlighted that very clearly.
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Andrew Sentance is a former member of the Bank of England’s monetary policy committee
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Copyright The Financial Times Limited 2011.