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When the sky rains money: What happens after QE?

QE

Parmenion’s Chief Investment Strategist, Simon Brett considers the impact of Quantitative Easing (QE). Has it worked? What effect will it have in the future? And what happens in a post QE world?

Quantitative easing has resumed in Europe and interest rates are on their way down again in the United States. In the UK, rates may also be heading south, depending on the type of BREXIT (if any) we experience. So what happens next?

Let’s begin by taking a look back. It is now over 10 years since the Great Financial Crisis (GFC) of 2007-08. As it fades into memory, it is easy to forget the seriousness of the crisis. Queues of anxious and angry savers outside Northern Rock…the rescuing of the high street banks Lloyds and RBS. The UK government resorted to QE to save the banks and pump money into the economy. The Bank of England bought government bonds from the insurance companies and pension funds which, in turn, deposited the proceeds with the banks. That gave the banks money on their balance sheet to lend to companies and keep growth going. The demand for bonds drove their prices up and yield down. Interest rates reached an outstanding low of 0.25%, a 324 year record.

Did it work? A qualified yes. The world did not sink into depression, nor did deflation take hold. Lower interest rates and, as a result, lower mortgage payments, kept the consumer in money. This maintained growth in the economy and kept unemployment from rising.

Some feared all the printing of money would lead to inflation taking off. That has not happened. However, much of the money was invested in financial assets like the stock market which has enjoyed a 10 year bull run. With yields so low, savers looked to company shares to provide income. Those who had assets before the GFC have done exceptionally well, unlike those without. Record employment levels have not led to wage growth, something many commentators find difficult to explain.

With interest rates so low, what can central banks do come the next recession, now they have lost their traditional rate-cutting remedy? There are several options, some of which are quite radical.

Perhaps the easiest option is carrying on regardless. This is what European Central Bank has done with its resumption of QE.

Alternatively, as in Japan, central banks may widen their purchases to include buying company shares. With its purchase of ETFs, the Japanese Central Bank is now a major investor in many companies in the Nikkei 225 index – a bizarre outcome.

Another option is raising the minimum wage. Higher labour costs may raise prices low earners have a greater propensity to spend, thereby helping the economy.

Or, very topically given the promises being made in the current General Election campaign, the buck could pass to governments to spend more money. In particular, investment in infrastructure might improve the long run potential of the economy.

Finally, if all else fails, ‘helicopter’ money may work. In this scenario, all individual bank accounts are credited with some money from the central bank. Like QE, money is credited direct to accounts, bypassing the financial sector. The theory is that such a windfall is spent and generates demand.

The last 10 or so years have been a great monetary experiment, the long-term results of which are yet to be determined. If and when the next slowdown appears, QE as we know it may have less potency and it might be time for some of those other options – including money falling from the sky, straight into our bank accounts.



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