The effectiveness of quantitative easing is difficult to judge, but Mervyn King was certainly right to keep interest rates down for the last 12 months
Mervyn King never misses an opportunity to remind people just how dire the world looked this time last year: financial markets were in freefall, house prices were plunging and business confidence had fallen off a cliff. The D-word – for Depression – was being bandied about for the first time in a generation.
Against this stormy backdrop, the Bank decided to let rip with every weapon it had. At its March meeting, it slashed rates to 0.5%, at the same time announcing a programme of quantitative easing – electronically creating money, which it would spend on buying up government bonds.
In the event, the apocalypse never quite materialised. Last year was the weakest since the war, and the 18-month-long recession saw 6.2% wiped off economic output; but most economists believe it could have been much worse, and King and his colleagues can take at least some of the credit.
But what's still likely to be argued about for many years to come is the question of how much credit the Bank can take – and how important QE, a policy most economists thought had been relegated to the history books, has really been.
The impact of cutting rates to their lowest level since the Bank was founded in 1694 is easy to see, because we know exactly how the long-trusted medicine of a rate cut helps economies to recover.
Borrowers see their repayments fall; businesses are able to refinance their debts at cheaper rates; and with a bit of luck, everyone – except the poor old savers, of course – feels a wee bit more confident.
Few economists doubt that rock-bottom rates have helped to cushion the blow of the worst recession since the war. Falling mortgage costs for those homeowners not stranded on fixed-rate deals, and smaller loan repayments for the 60% of businesses whose borrowing is linked to market interest rates, have helped them to bear the pain of the downturn more easily. "Those that have seen their hours cut have at least seen their outgoings cut as well," said Karen Ward, chief UK economist at HSBC. "It's helped the housing market; it's helped corporate cashflow — it's put in place all the foundations that will bring us growth this year."
The benefits of quantitative easing are much harder to measure. Right from the outset, the Bank was open about the fact that QE might work through several different channels, and it wasn't sure which would prove most important, or how best to measure their success.
Today, it tends to point to the rapid improvements in financial markets over the past year, with share prices rising rapidly and scores of companies managing to launch big-money bond issues, as the clearest indication that the measure has worked.
But the supply of money in the economy has continued to decline, suggesting the £200bn of electronically created cash is not finding its way through to the pockets of ordinary families and firms – partly, no doubt, because the clapped-out banks are hanging on to every pound they can get hold of.
"Every time I hear the Bank trying to explain how successful QE has been, I hear the sound of goal posts being moved heavily across the pitch," said Peter Dixon, of Commerzbank.
Vicky Redwood, of Capital Economics, reckons output could have been 2% to 3% weaker without the Bank's intervention, putting us perilously close to the usual rule-of-thumb definition of a depression — a 10% decline. But the jury's very much still out.
The Bank's unprecedented spending spree might also have been better directed. Mervyn King himself has been talking in recent weeks about the need to "bypass" the banking sector, and set up alternative sources of funding for struggling businesses. Yet when it came to QE, the Bank spent almost all its funds on buying up government bonds from financial institutions, leaving them to do the rest. In fact, some – including Dixon – argue that it's effectively been a back-door recapitalistion of the banks.
But given the doomsday scenario that was looming over us all this time last year – and the fact that many were already blaming the Bank for failing to grasp the seriousness of the downturn and slash rates earlier – it's hardly surprising if it erred on the side of overkill.
Last year was still by far the worst for the British economy since the Great Depression; but it could have been a whole lot worse.
Copyright Speakers Corner 2016