Although this uses UK events as a spur, the point about QE is universal
Labour leadership candidate Jeremy Corbyn has shown some flexibility on his idea of People’s QE. That is perhaps a good sign for the future (if he wins), in terms of responding to informed criticism. As I have written before, the original proposal took two perfectly good ideas (we can do better than current QE, and the need for a National Investment Bank) and combined them in an unfortunate way. I was annoyed that this proposal had been made public with so little consultation, and that as a result it might discredit both of the two good ideas. Perhaps more optimistically it will instead spark a debate on each individually.
Here I want to talk about Quantitative Easing (QE). The basic idea behind QE is that by buying long term assets at a time when their price is high (interest rates are low) to make their price even higher (interest rates even lower) in the short term, and selling them back later when asset prices are lower (and interest rates higher), you could stimulate additional demand. At first sight it seems not too dissimilar to a central bank’s normal activities in changing short rates. There are however two major differences. The first, which in principle does not matter too much, is that the amount of money you create to ensure short term interest rates fall is modest. The amount of money you have to create to have any significant impact on long rates is much greater.
The second more important point is predictability. The central bank can have a large and fairly predictable influence on short term rates in the market. The impact of any amount of QE on long rates is much more uncertain, both in theory and in practice. Worse still, because its impact depends on certain institutionally specific market segmentation, or some very time specific signalling, and may also be quite non-linear, there is no reason to believe that any knowledge gained this time round will still be relevant the next time the instrument is used. In short, it is a lousy instrument.
That should mean that everyone is looking around for a better way of doing things when short rates hit their lower bound. Fiscal stimulus is the obvious candidate, but we know the political problems there. If you want to be kind, you can say that they illustrate the difficulties of apparently delegating stabilisation policy to a central bank, and then telling politicians that just when stabilisation is most needed they have to do it themselves. For that reason helicopter money is not just fiscal stimulus by the back door (and if the central bank is always underwritten by the fiscal authority, that could be all it is), but a means of giving the central bank the tools to do its job effectively whatever the size and sign of shock.
In the absence of an appropriate government fiscal policy, I find the logic for helicopter money compelling and the arguments against it pretty weak. But just as with fiscal policy, just because something makes good macroeconomic sense does not mean it will happen. I have always been reluctant to pay too much attention to the distributional impact of monetary policy, because it seemed like one of those occasions when even well meaning attention to distribution can mess up good policy. Yet in terms of the political economy of replacing QE, perhaps we should.
It is more likely than not that QE will lead to central bank losses. By this I mean that the central bank will have less money than if they had not undertaken the policy: whether they actually have to be recapitalised by the government is not the key issue here. After all, they are buying high, and selling low. That is integral to the policy. Who gains from these losses. Where does the money permanently created because of these losses go? To the financial sector, and the owners of financial assets (who are selling to the central bank high, and buying back low). In that sense, likely losses on QE will involve a transfer from the public to the financial sector.
If QE was the only means of stabilising the economy in a liquidity trap, because fiscal policy was out of bounds for political reasons, then so be it. The social benefits would far outweigh any distributional costs, even if the latter could not be undone elsewhere. But if QE is a highly ineffective instrument, and there are better instruments available, you have to ask in whose interest is it that we stick with QE?