Giving evidence to the House of Lords’ Economic Affairs Committee, Positive Money’s Fran Boait told members that since the financial crash, the Bank of England’s money creation programme has “turbocharged” inequality, by propping up stock markets at the expense of the real economy.
We were delighted to be invited to give oral evidence to the House of Lords’ Economic Affairs Committee last week, as part of their inquiry on Quantitative Easing (QE). The group is one of only five permanent investigative committees in the House of Lords and includes illustrious figures like former Bank of England governor Mervyn King and climate economist Nicholas Stern.
QE is the monetary policy introduced by central banks to respond to the last financial crisis. It involves central banks creating hundreds of billions of pounds of new money to buy financial assets, typically government debt.
Answering questions on everything from inequality and austerity, to the structural flaws of our banking sector, Fran dispelled five pervasive myths about QE and its effects on our lives, livelihoods, and wider economy.
Myth 1 – QE stimulates the whole economy
The popular misconception about QE is that it involves the Bank of England creating money and lending it to banks so that they will in turn increase their lending into the real economy. But, as Fran told the committee, that’s not really how it works.
Instead, the money created through QE is used to buy bonds (mostly government bonds) from private financial actors, such as pension funds and insurance companies. This means the newly created money goes directly into financial markets, boosting bond and stock markets.
In the years after the 2008 crash, hundreds of billions in new money was being created and funnelled into financial markets, whilst at the same time deep austerity cuts were inflicted on UK public services. Monetary and fiscal policy were pulling in opposite directions.
As Fran told the committee, these first rounds of QE were about “stimulating the economy and it did an incredibly poor job because it relies essentially on trickle down economics, the wealth effect, which is extremely poor at stimulating the economy”.
Without government spending doing any heavy lifting to help our economy recover, QE relied instead on the ‘trickle down’ effect, whereby wealth accumulated by the rich ‘trickles down’ to everyone else. The first £375 billion of QE only led to £23-28 billion of growth. In other words, every £1 of QE only added 8p to the real economy.
Myth 2 – QE leads to inflation
There are often worries that QE leads to price inflation by increasing the money supply. But these fears are misplaced – after a decade of QE, inflation remains well below target and most economists now agree we face a higher risk of deflation.
However, QE does lead to a different kind of inflation – asset price inflation. That is a deliberate effect of QE, based on the hope we outlined above, that the increased wealth of asset owners will ‘trickle down’.
In practice, rather than spending it into the economy, the asset-wealthy invest even more money in fixed, safe assets like property. UK house prices have increased by nearly 40% since the first rounds of QE ten years ago, and have doubled in places like London, where the average house price exceeded more than £500,000 for the first time ever, just last month.
Myth 3 – QE benefits everyone equally
By boosting asset prices, QE has made the rich richer, whilst ordinary people have been forced to face insecure employment, lower incomes and lower living standards. As Fran told the committee, “we’ve seen stock markets reaching all time highs… At the same time as seeing poverty steadily increasing, food bank use steadily increasing. This tells us that our economy is extremely dysfunctional at quite a deep structural level”.
Myth 4 – The banking sector is effective at supporting the UK economy
QE has also shown up deeper, more structural issues in our money and banking system. Currently 80% of lending in the UK goes towards property and financial markets, and only 10% into the real economy. As Fran highlighted, “despite economic textbooks saying what banks do is take money from savers and lend towards businesses, they actually create money and they create most of it to go into finance and property in the UK”.
This heavy skew towards an oversized financial sector, acts as a parasite on the rest of our economy. To rebalance things we need new macroeconomic tools, and a genuinely purpose-driven banking system that supports the real economy rather than extracting value from it.
Myth 5 – ‘There is no alternative’ to QE
Lastly, Fran emphasised that this kind of QE is not our only option. There are alternative macroeconomic tools available to the Bank of England to help us avoid the mistakes of 2010, and build back better after this crisis. But to make the most of the tools available, we need a new settlement between the Treasury and the Bank of England to allow for better monetary-fiscal coordination. That means fairer taxation, and for government borrowing and money creation to all work together to achieve our social goals – like a fair, green recovery from Covid-19.
One proposal is for the Bank of England to give money directly to the Treasury to spend into the real economy, rather than funnelling it into financial markets. The avenue for doing so already exists via the government’s pre-existing overdraft at the Bank of England, known as the Ways & Means Facility, which the Bank offered to increase last year. In fact, estimates suggest that £50 billion of this “direct monetary financing” may have been more effective than £500 billion of conventional QE. For a deeper dive into the problems and potential solutions for quantitative easing, read our recent blog here.
Finally, the Bank of England will be better able to support the whole economy with a new and improved mandate to address one of the major crises of our time – climate breakdown. We hope Rishi Sunak will make this change happen before the Budget in just a few weeks’ time. It’s vital that any change to the mandate is as ambitious as possible, to enable our central bank to do all it can to align our financial system with the government’s climate targets, add your name to petition here.
It was a privilege to present this evidence to members of the House of Lords, and promising to see decision makers listening to civil society voices on this issue. This speaks to a growing recognition that we need fresh approaches to economic policymaking, and we look forward to seeing how the inquiry shapes the Bank of England’s approach to QE in the next phase of the Covid-19 recovery.