The policy differences between the UK’s political parties are wider than they have been for decades, but on one issue they are resolutely united: their support for the Bank of England’s “funny money” policy of ultra-low interest rates and the buying-in of government debt with newly printed money. Given the increasingly evident long-term damage that this policy is inflicting on the UK economy, this consensus should be highly controversial.
Quantitative easing (QE), as funny money is officially known, had some justification in the aftermath of the financial crisis when lending by banks dried up. To offset a contraction in the money supply, the Bank of England stepped in, lowering interest rates drastically and injecting newly created money into the economy. It was hoped that this policy would benefit the economy by encouraging investment, making house purchases affordable, reducing the cost of the national debt and weakening the sterling exchange rate to the benefit of trade. The risk was that irresponsible governments would replace irresponsible banks as they became addicted to a limitless supply of easy money. Such has proved to be the case.
The fall in sterling last year is now being recognised as the most ineffective devaluation in history. The consequent rise in inflation, to 2.7% in April on the consumer price-index measure, has squeezed disposable income and slowed the economy. Low interest rates have pushed up house prices, benefiting existing borrowers at the expense of first-time buyers. And far from encouraging productive investment, low rates have led to the purchase of existing assets using leverage – resulting in great wealth for the few, but the stagnation of real wages for the many.
Low bond yields have increased pension fund deficits and lowered annuity rates, as Ros Altmann, the former pensions minister, tirelessly points out. Companies have to divert cash flow from investment into their pension funds. In the case of British Steel, this imperilled the viability of the whole business. Trustees try (but fail) to play catch-up by switching from equities to bonds: equity weightings in pension funds have halved since 2009.
The dangers of this are twofold. First, the search for risk-free return ends up with the reality of return-free risk. Second, it diminishes the supply of capital for investment. The recipe for sustained long-term economic growth is no mystery: the key is an abundance of domestically financed private-sector investment.
So it is no surprise that productivity growth in the UK and in all the other countries that have adopted funny money has dwindled, lowering the sustainable rate of economic growth. Immigration, not investment, sustains the UK’s respectable growth rate, but the quality of the resulting growth is poor.
The chief beneficiary of funny money has been the government, which can borrow at will, safe in the knowledge that the Bank of England will buy back the debt with printed money. The façade of spending promises being “fully costed” is maintained, while the definition of “investment” is stretched well beyond the normal requirement to produce a visible financial return. The target of a balanced budget has been all but abandoned by the Conservatives, while Labour would significantly increase the deficit.
An end to funny money means that the central bank must raise interest rates and stop buying government debt. It means encouraging saving by giving a fair return on bank deposits, and broadening the availability of credit but charging a proper price for it. There will be short-term losers, but many more long-term winners. The alternative is a continuing descent into financial irresponsibility by all political parties. By the next election, Conservative policies will be as extravagant as the Labour ones are now, while Labour will be following in the footsteps of Mugabe and Chávez.