Monday, January 16, 2012
Is there too much money in the economy?
This could, of course, be one of John Rentoul's famous Questions to which the Answer is No (link). Indeed, one of the redeeming features which partially prevents this is that I am not, and have neither a desire nor an intention to be, a writer for the Daily Mail.However, this striking idea is suggested by the fact that the Treasury recently auctioned £700mn of fixed-rate bonds at a real interest rate of -0.116% (src).
Of course this should be heavily caveated: not least, there is an assumption that inflation doesn't come down from its current level over the lifetime of the 35-year bond. If it does stay significantly lower for a prolonged period, then the interest rate will turn out to be positive in real terms, and it is quite possible that people in the bond markets are expecting inflation to come down eventually. [EDIT: I should have known better than to trust financial journalists. This was an index-linked bond.]However, it does suggest that the Government's current economic strategy needs some fine-tuning. This bond issue of £700mn is several hundred times smaller than the Bank of England's total quantitative easing, which stands currently at £275bn. But it is beginning to look even more as though the Government is borrowing money on the markets and then putting the money back into the hands of its lenders, only to borrow it once more. It would be silly to do this and have to pay interest for the privilege: but it must be madness for the Government to get paid.Yet this is the effect of policy: money gets put into the bond markets, but it doesn't even leave those markets. Instead, traders are now just queuing up to put the money back with the Government. So we return to the original question: is there too much money in the economy? Perhaps not; but may there be too much in the bond markets?If this is true, then it suggests that the central bankers need to look at the structure of policy, rather than putting blind faith in the aggregates. Already there have been murmurings about a small-scale 'consumer stimulus' which might be achieved from redeeming the War Loan: this is mostly held by retail investors, who would be more likely to take some of the windfall and spend it. The money would not sit in the bond markets but would go out and do something different. Quantitative easing was the weapon of choice when interest rates had hit the zero bound. To push rates any lower would have been, in the central bankers' phrase, 'pushing on a string'. But could it be beginning to look as though QE, too, has hit its buffers and the central bankers are once again pushing on a piece of string? I'm not altogether convinced by this story, though I can see where it's coming from. However, I am convinced that the structure of policy is at least as important as the aggregates. One of the things which has frustrated me about QE is that central bankers seem to assume monetary velocity is effectively infinite, when we know full well it is not.