Simon Jenkins has written a piece for the Guardian called ‘We should cash-bomb the people – not the banks’. In it, he makes an argument I hear quite a lot. It goes, basically, like this: Quantitative Easing was all about dumping money on the banks and hoping that they would lend it out to stimulate the economy. What we should do is dump the money on ordinary people. As Jenkins puts it: ‘The money must go straight to households, not to banks. Banks have had their day and miserably failed to spend. From now on they get nothing.’ Or again:
The commentator Anatole Kaletsky points out that if the £375bn of QE had gone to private bank accounts rather than to buying bonds from banks, it would have meant £24,000 per British family.
I agree with the sentiment, but neither the analysis nor the recommendation make any sense.
Start with the analysis. QE did not involve ‘cash-bombing’ the banks. It didn’t involve the banks at all. Rather, it was an attempt to circumvent the banks, who weren’t lending despite rock-bottom interest rates. The idea was to get non-bank entities – pension funds and the like – to lend instead. (From the Bank of England‘s own report: ‘Overall, there are several ways in which QE may have indirectly affected bank lending. But . . . these channels were not expected to be key parts of its transmission mechanism.’)
Moreover, QE didn’t ‘cash-bomb’ anyone. Indeed, nobody became any richer as a result of it.
How, then, was it supposed to work? The Bank of England effectively took a lot of liabilities off the Treasury’s balance sheet and put them onto its own balance sheet. Pension funds held assets just as before, but now the assets were effectively reserve balances at the BoE (intermediated by bank deposits) rather than Treasury gilts. The idea was that the pension funds wouldn’t want to just sit on what is effectively cash, so that they would invest more in companies and thus stimulate the economy.
There were many flaws with the plan, but here are two big ones.
- First, there’s no lending without borrowing. Even if the pension funds wanted to lend out their cash, they’d have to find firms willing to borrow it. Unfortunately, after a big financial crash nobody wants to borrow again, for the same reason nobody wants to get back on a bus that just crashed. If there were investment opportunities out there then there’s no reason the pension funds couldn’t have exploited them when they held gilts rather than cash.
- Second, there’s no reason to expect that the pension funds would even want to invest as a result of QE. People make their spending and investment decisions on the basis of how rich they feel. If people are going to invest more, they have to feel richer first. But QE, as I said, didn’t make anybody richer. The pension funds lost one financial asset – the Treasury gilts – and gained another – a lump of cash of equivalent value. They didn’t get any richer, so why would they invest more? Indeed, it’s possible to argue that QE had a contractionary effect, since financial institutions that used to hold interest-bearing gilts now held zero bonds (or near-zero bonds) instead.
Now the proposal. Imagine that the BoE wanted to credit ordinary bank accounts rather than simply switching the assets backing the deposits of pension funds. It could create new reserves to back these deposits, but what would it purchase to get the reserves into the banking system? In QE, it bought Treasury gilts. But ordinary people don’t have gilts to sell, nor any other liquid assets. ‘QE for the People’ just doesn’t make any sense – not, at least, as a central bank policy.
The last qualification is important. The Treasury could dump a bunch of money into people’s bank accounts. In principle, the Treasury doesn’t have to worry about it’s balance sheet, because it has no solvency constraints. As A. Mitchell Innes explained long ago, it can settle final payments with its own ‘liabilities’ because it demands back those same ‘liabilities’ in taxes. Current legislation, of course, makes it look as if it the government has to worry about its balance sheet, requiring it to issue new gilts and other bonds to offset all new spending. But these newly-issued bonds would be bought by private citizens. So people, as a whole, would be richer. The recipients of newly-issued money would have the money. The holders of bonds would have the bonds. The whole public sector balance sheet would expand. That really is a ‘cash bomb’. Since, again, people spend and invest more when they feel richer, there’s every reason to expect that this would help a recovery.
It’s also, however, just straightforward fiscal policy: a classic Keynesian stimulus. It has nothing at all to do with Quantitative Easing. First, it’s a Treasury policy, not a central bank policy. Second, it’s an expansionary policy. QE isn’t: it’s just an asset swap orchestrated by a central bank.
Incidentally, every single major party in the UK seems to be opposed to the idea of Keynesian stimulus (even the Greens don’t want fiscal expansion; they just want the tax burden of austerity to fall on the rich). But it’s foolish to suppose that such people will be happy to accept it if we just pretend it’s some variant on QE. That seems to be what Jenkins is trying to pull off in his piece. If we want to advocate Keynesian stimulus, I think we should just advocate it, rather than try to draw a bad analogy between it and a very different policy.
Why? Well one major reason is that once you admit that stimulus is what you want, we can discuss the best way to do it. I don’t think just handing out cash to people is likely to be the best way. It may not help employment very much, which should be the goal. You’d get better results in terms of employment by investing in infrastructure, improving public services, hiring more staff for schools, hospitals, libraries, aged care, parks and recreation, etc.
Moreover, once you look at the actual mechanics of fiscal policy, and stop getting confused by a false analogy with QE, you can ask important questions. For example, why should the government issue bonds every time it increases its spending (unless it raises taxes)? The bonds aren’t like corporate bonds; they’re really just like National Savings accounts. Issuing bonds has two bad effects. First, it guarantees that every time an ordinary person benefits from government spending, some bond-trader also has to get a freebie from the government. Second, it invites people in the media to go crazy about ‘unsustainable government debt’ – as though the bonds represent genuine debts rather than mere securities accounts no different from reserve accounts except in the interest they pay and the cultural associations.
There are lots of debates to be had about which kind of stimulus is best and how the mechanics of fiscal policy should actually work. But you shut them all down if you try to pretend that what you’re really after is some populist version of QE.