Tuesday, September 14, 2010

Quantitative Easing - Werner, Voutsinas, Biggs, Chancellor & Brittan

Quantitative easing (QE) is being bandied about as the cure-all for the ongoing economic crisis but what does the term signify? The Bank of Japan first used the QE phrase in March 2001 to describe an apparently new departure in its economic policy.  Richard Werner in a new paper 'New Evidence on the Effectiveness of 'Quantitative Easing' in Japan' written with Konstantinos Voutsinas has made a study of just what the authorities  in Japan did at that time and what effect it had. Werner himself coined the phrase QE in Japan in 1994 to signify a specific policy he recommended that a central bank should follow to stimulate the economy: 'the central bank directly target the quantity of credit creation by the banking system....In order to emphasise the quantitative nature of this policy tool, whilst explicitly differentiating it from the traditional monetarist (bank reserves or money supply) policy,...  a new expression, namely 'quantitative easing'.  Voutsinas & Werner show that what the Bank of Japan called 'Quantitative Easing' in 2001 as they embarked on a new policy was not in fact what Werner meant by QE, that is: credit creation. Their  paper concludes that from the Bank of Japan's 'QE': 'no statistical evidence of a significant change in the relationship between potential monetary policy tools or intermediary targets and nominal GDP [gross domestic product] occurred'.

An article in the Financial Times (13 Sept 2010) by Edward Chancellor A Japanese lecture for bond investors points out (quoting Michael Biggs of Deutsche Bank) that the lack of flow of credit in Japan in recent decades meant that deflation took hold and he suggests that this was a deliberate policy to protect an aging population who had most of their savings in Japanese bonds. Protection for this large group against the wealth-wasting effects of inflation had the effect of dampening down more general wealth-enhancing effects if a policy of credit creation had been in place. 

All this points to the need to be sure just what is meant when politicians and central bankers speak of QE. Also the importance of a clear debate as to the side effects of a new policy.
Was there a debate in Japan about the pros and cons of deflation and inflation? In the UK the big issue at the moment  is the cuts in government spending that are to be implemented. But where is the debate about the new credit creation that is so vital to the  production of new economic activity? As Voutsinas and Werner point out credit creation can come from various sources: central bank, government, commercial bank and trade credit. It is within the power of central bank and government to create credit.

Sam Brittan (The secret of Osborne's popularity) Financial Times (9 Sept 2010) suggests the establishment of a 'stabilisation fund that would inject purchasing power when depression threatens and remove it during periods of inflationary pressure....  There is no reason to confine such a fund to public works. It could cover any type of spending or, for that matter, provisional tax cuts. .... It would be best to finance such a fund from Bank of England advances, as this would be a respectable form of Ben Bernanke’s much-mocked helicopter money drop'.

posted by Charles Bazlinton


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