Covid-19 and the victory of quantitative easing

26 October 2020

7:22 PM

26 October 2020

7:22 PM

Crises often lead to new paradigms. The politicians of the day try to repair the damage, learn lessons and prevent recurrence. Frequently, they start by strengthening international institutions, or creating new ones. That has not happened over Covid. The international body which should have been most closely involved, the World Health Organisation, has been feeble. When he laid into the WHO, Donald Trump was criticised. For once, that was unfair. Even Mr Trump is not always wrong. That said, he is the most prominent example of the political-health epidemic which currently afflicts the West: weak leadership. None of the major Western countries has an effective head of government. This is depressing, and dangerous.

But in the UK, one thing has gone right. Over the past dozen years, the world economy has been hit by two powerful torpedoes: both of them the worst shocks since the Great Crash and the Great Depression. Millions of people have suffered. Businesses have been destroyed and livelihoods lost. This has inevitably given rise to political instability. Even so, it could have been far worse. The post-1929 slump killed off the Weimar Republic, helped to discredit liberal democracy and brought the world to the edge of catastrophe. By those standards, our present woes seem almost trivial. We British are doing better than we might have been, and so are other countries with the same policies, because of a new economic paradigm, a synthesis of Keynesianism and monetarism. Its principal manifestation is quantitative easing, a Keynesian remedy which is being cautiously applauded by most thoughtful monetarists.

When it thrust its way into British political debate, monetarism often had a bad press. This was partly due to the quasi-religious fervour with which some of its adherents proclaimed the new cult. Ian Gilmour, a critic, said that a monetarist was like a driver who paid no attention to what was happening on the road: merely to the indicators on the dashboard. Denis Healey had fun teasing the Thatcher government about sado-monetarism. But even if there were some excesses, there were also two points in the monetarists’ favour. First, by 1979 the inflation virus had become endemic in Britain, and there was no equivalent of herd immunity. It had to be brought under control, and that could never have been painless. Second, monetarism is not some arcane doctrine. At its core is a common-sense proposition. Money is a commodity as well as a store of value. If the supply of money increases relative to the supply of other goods, it will lose value: inflation.

Although that may sound simple in theory, it is not easy in practice. In a sophisticated modern economy, measuring and controlling monetary growth is a complex business. The partisans of Margaret Thatcher and Nigel Lawson were still arguing about which of them was right in their dispute over monetary policy at the end of the Eighties. Some rigid monetarists used to talk as if any growth in the money supply would be inflationary. That, of course, is nonsense. The money supply needs to grow in order to accommodate economic growth. It is also sensible to allow for a small amount of inflation, up to 2 per cent, to ensure that growth is not interrupted. But the price of monetary continence is eternal vigilance by central bankers.

The monetarist versus Keynesian debate often seemed to be a matter of temperament as much as intellect. Stern and unbending monetarists were the sort of characters who had predicted six of the last two recessions. The phrase ‘no good will come of this’ was never far from their lips. There was also a tendency, sotto voce, and especially in the US, to conflate Keynes’s economic views with his Bloomsbury lifestyle. The Bloomsburies were well-known for living in squares and making love in triangles. So it seemed all too probable that a man with loose morals would also favour loose fiscal policies.

The Keynesians had a formidable retort. They pointed out that Keynes had been right about German reparations and right about the Gold Standard, while Keynesian measures might have prevented the political disasters of the 1930s. They had a point, and their master had a huge influence on post-war policy. Although German war guilt was vastly greater than it had been in 1918, there was no attempt to thwart economic recovery, at least in West Germany. The Keynesians also found receptive audiences when they argued that full employment was essential for social and political stability. Yet the disciples went too far. Keynes was a practical economist, not a dogmatist. He would never have insisted that every government in all circumstances should merely increase borrowing. By the later 1960s and into the Seventies, it had become clear that the problem of unemployment did not arise from a deficiency of demand, but from weaknesses on the supply side: in particular, trade union power. When governments tried to spend their way out of that, the result was hyper-inflation.

But we are now back to demand-side weakness. There has been a slump in Britain’s productive capacity and unless the Government had in effect distributed helicopter money on a huge scale, this would have led to widespread poverty and, almost certainly, social unrest. Instead, we have three quarters of a trillion’s worth of quantitative easing. The Government sells bonds. The Bank of England buys them and puts them in a back drawer. The Government ends up with a debt to itself. There is no reason why this should ever be repaid.

So has the Government discovered the philosopher’s stone? Or is it stoking up the mother of all hyper-inflations? I have come to a conclusion, which readers might find exciting, or alarming. Nobody knows. Obviously, this cannot go on for ever. Quantitative easing is a euphemism. It used to be known as ‘printing money’ and we all know what Margaret Thatcher would have thought about that. Yet up to now, there is no sign of inflation. Nor are the markets reluctant to buy UK gilts, though admittedly, a lot of them are inflation-linked.

There may be a further tentative conclusion. As long as QE goes into jobs and output, the risks can be contained. A loose fiscal policy is justified in order to rebuild productive capacity.

Eventually, there will have to be a return to normal. That means an annual budget deficit lower than the growth rate and, if possible, diminishing further. George Osborne always talked about the need to fix the roof while the sun is shining. That day will come again, especially if the Government refuses to destroy the economy in order to control the virus. During the transition, there could indeed be a spike in inflation, but there is no reason why that should be more than temporary.

According to the smoke signals from Whitehall, the Chancellor is pressing his colleagues to pay more attention to the economic damage of the virus, which also has consequences for health. Stoicism is required, and also that ringing phrase from FDR’s early days. ‘We have nothing to fear except fear itself.’

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