Federal Reserve governor Ben Bernanke and Bank of England governor Mervyn King both used to be teachers. I’m glad I wasn’t a student in their classes.
Teachers are supposed to make complex things simple. But these two guys are about as clear as mud, as they dance around monetary policy jargon like drunken nightclubbers.
I’ll get to Merv in a minute, since he had more dire things to say about the state of Britain’s economy this morning [11 February]. First up, though, let’s wrestle with Mr. Bernanke’s latest explanation of current monetary policy…
What’s in a name? a lot if you listen to these guys.
Let’s get one thing straight, folks… don’t call it quantitative easing,” okay? It’s “credit easing.” Get it wrong and you’ll find yourself in detention with the guv’nors.
“Credit easing” is the term Bernanke uses to describe the Fed’s monetary policy, now that interest rates are practically at zero.
In “normal” times, banks use conventional methods like adjusting interest rates to control the flow of money into an economy. Low rates encourage consumers to buy more and financial institutions to lend more money. High rates are supposed to slow consumer buying and lending.
But these aren’t “normal” times. Simply put, there’s only so far you can go to make money cheap. And with rates cut just about as far as they can go, both the Fed and Bank of England have pretty much exhausted their traditional monetary policy tool.
That’s when more drastic measures need to be considered. Entering stage right… “quantitative easing.” Or not. If you listen to Messrs. Bernanke and King, they’re foxtrotting their way around the issue to avoid describing it this way.
Desperate times call for quantitative measures
Quantitative easing can include targeting the cash that commercial banks have with the central bank. But instead of using an interest rate, it sets a target on the balance that the banks have with the central bank. The central bank can then meet that target by purchasing the banks’ assets which means cranking up the printing press and using new money to pay.
In theory, this boosts the amount of money that commercial banks have, who are then supposed to release it into the broader economy through increased lending, etc.
Trouble is… when that doesn’t happen, the policy is essentially a waste of time as Japan discovered earlier this decade when the banks just kept the cash.
In a recent speech, Bernanke noted that the Fed’s current policy is “conceptually distinct” from quantitative easing. It’s called “credit easing” and involves not just buying assets like bonds from commercial banks, but from several markets.
This adds to the Fed’s own holdings and also boosts the overall liquidity flow, but despite Bernanke’s unnecessary semantics, the end goal is the same: To put more money into the financial system through quantitative measures.
Britain braced to go deep in 2009
In Britain, Mervyn King is almost at the end of the monetary policy line, too.
After a series of heavy cuts, interest rates are now at 1% (down from 5% in October), and given the governor’s latest assessment of the economy, it won’t be long before the Bank of England takes further action.
Warning that “the economy is in a deep recession,” with a 4% annual GDP contraction projected for the second quarter, King said the BoE will continue to use the “full range of instruments at its disposal” to tackle the situation. But he also said that the length and depth of the recession would hinge “to a significant extent” on the rest of the world (there’s that “globalisation” thing gone awry again) and whether the coordinated measures to increase credit and spending are successful.
Despite having the power to boost the monetary base (and one option is through the quantitative easing mentioned above), there are uncertainties about whether it will work. Nevertheless, with King and his fellow bankers believing that the recent interest rate cuts are having less impact, they’re giving these extra measures a shot.
On the agenda: Buying assets to boost corporate spending, plus increasing the money supply. Loosely translated… “Crank up the printing presses, mate.”
But it also means, in King’s words, “unconventional policies,” too. Specifically, that means making purchases through the BoE’s Asset Purchase Facility, which means the money spent on assets will be matched by an equivalent amount of Treasury bills sold. Not so much quantitative easing, but matching. Nevertheless, these quantitative easing measures still exist. The BBC says the Bank of England’s additional stimulus efforts over the second half of 2008 increased its balance sheet by 160% and swelled the monetary base by 35%.
No matter what the governors call it, additional efforts like this to stimulate the US and UK economies are still designed to “ease” more money into the financial system. They’re just printing it in a different, less well-known way.
But with interest rates at practically zero, we’re getting down to last resort-type measures here. If it doesn’t work, they’re going to have to work on some really flashy dance moves.
• This article was written by Martin Denholm, Managing Editor of the
Smart Profits Report
, on Wednesday 11 February 2009