Jeremy Corbyn, the newly elected leader of the Labour Party, is proposing a number of radical economic policies. One that has attracted considerable attention is for a new form of QE, which has been dubbed ‘people’s quantitative easing’.
This would involve newly created money by the Bank of England being directly used to fund spending on large-scale housing, energy, transport and digital projects. Rather than the new money being used to purchase assets, as has been the case up to now, with the effect filtering only indirectly into aggregate demand and even more indirectly into aggregate supply, under the proposed scheme, both aggregate demand and aggregate supply would be directly boosted.
Although ‘conventional’ QE has worked to some extent, the effects have been uneven. Asset holders and those with large debts, such as mortgages, have made large gains from higher asset prices and lower interest rates. By contrast, savers in bank and building society accounts have seen the income from their savings decline dramatically. What is more, the indirect nature of the effects has meant time lags and uncertainty over the magnitude of the effects.
But despite the obvious attractiveness of the proposals, they have attracted considerable criticism. Some of these are from a political perspective, with commentators from the right arguing against an expansion of the state. Other criticisms focus on the operation and magnitude of the proposals
One is that it would change the relationship between the Bank of England and the government. If the Bank of England created money to fund government projects, that would reduce or even eliminate the independence of the Bank. Independence has generally been seen as desirable to prevent manipulation of the central bank by the government for short-term political gain. Those in favour of people’s QE argue that the money would be directed into a National Investment Bank, which would then make the investment allocation decisions. The central bank would still be independent in deciding the amount of QE.
This leads to the second criticism and that is about whether further QE is necessary at the current time. Critics argue that while QE of whatever type was justified when the economy was in recession and struggling to recover, now would be the wrong time for further stimulus. Indeed, it could be highly inflationary. The economy is currently expanding. If banks respond by increasing credit, the velocity of circulation of narrow money could rise and broad money supply grow, providing enough money to underpin a growing economy.
Many advocates of people’s QE accept this second point and see it as a contingency plan in case the economy fails to recover and further monetary stimulus is deemed necessary. If further QE is not felt necessary by the Bank of England, then the National Investment Bank could fund investment through conventional borrowing.
The following articles examine people’s QE and look at its merits and dangers. Given the proposal’s political context, several of the articles approach the issue from a very specific political perspective. Try to separate the economic analysis in the articles from their political bias.
Jeremy Corbyn’s proposal
The Economy in 2020 Jeremy Corbyn (22/7/15)
Articles
People’s quantitative easing — no magic Financial Times, Chris Giles (13/8/15)
How Green Infrastructure Quantitative Easing would work Tax Research UK, Richard Murphy (12/3/15)
What is QE for the people? Money Week, Simon Wilson (22/8/15)
QE or not QE? A slippery slope to breaking the Bank EconomicsUK.com, David Smith (23/8/15)
We don’t need “People’s QE”, basic economic literacy is enough Red Box, Jonathan Portes (13/8/15)
Is Jeremy Corbyn’s policy of ‘quantitative easing for people’ feasible? The Guardian, Larry Elliott (14/8/15)
Corbynomics: Quantitative Easing for People (PQE) Huffington Post, Adnan Al-Daini (7/9/15)
Corbyn’s “People’s QE” could actually be a decent idea FT Alphaville, Matthew C. Klein (6/8/15)
Jeremy Corbyn’s ‘People’s QE’ would force Britain into three-year battle with the EU The Telegraph, Peter Spence (15/8/15)
Would Corbyn’s ‘QE for people’ float or sink Britain? BBC News, Robert Peston (12/8/15)
Strategic Quantitative Easing – public money for public benefit New Economics Foundation blog, Josh Ryan-Collins (12/8/15)
People’s QE and Corbyn’s QE Mainly Macro blog, Simon Wren-Lewis
You can print money, so long as it’s not for the people The Guardian, Zoe Williams (4/10/15)
Questions
- What is meant by ‘helicopter money’? How does it differ from quantitative easing as practised up to now?
- Is people’s QE the same as helicopter money?
- Can people’s QE take place alongside an independent Bank of England?
- What is meant by the velocity of circulation of money? What happened to the velocity of circulation following the financial crisis?
- How does conventional QE feed through into aggregate demand?
- Under what circumstances would people’s QE be inflationary?
China has a key role in the global economy. Recording double digit growth for a number of years and posting impressive export figures, China’s has been an economy on an upward trajectory. But its growth has been slowing and this might spell trouble for the global economy, as was discussed in the following blog. For many, China is the pendulum and the direction it moves in will have a big influence on many other countries.
There are some suggestions that China’s rapid growth has been somewhat artificial, in particular following the financial crisis, where we saw massive investment by state-owner enterprises, banks and local government. This has led to a severe imbalance within the Chinese economy, with high levels of debt. One of the key factors that has enabled China to grow so quickly has been strong exports. China has typically had a large current account surplus, often balanced by large current account deficits in many Western countries.
The exchange rate is a key component in keeping strong export growth and the devaluation of the Chinese currency in August (see What a devalued yuan means to the rest of the world) is perhaps a suggestion that export growth in China is lower than desired. Devaluing the currency will boost the competitiveness of Chinese exports and this in turn may lead to a growth in the current account surplus, which had fallen quite significantly from around 10% to 2%.
The problem is that China is currently imbalanced and this is likely to create problems around the world. With globalisation, the free movement of capital and people, deflation in the West and falling world asset prices, the situation in China is crucial. Although you will find many articles about China and blogs on this site about its devaluation, its growth and policy, the BBC News article below considers the conflicts that exist between three key economic objectives:
1. currency stability
2. the free movement of capital
3. independent monetary policy
and the need for some international co-operation and co-ordination to enable China’s economy to return to internal and external balance.
China’s impossible trinity BBC News, Duncan Weldon (8/9/15)
Questions
- What is meant by internal balance?
- What is external balance?
- Would you suggest that China is suffering from an imbalanced economy? If so, which type of imbalance and why is this a problem for China and for the world economy?
- The article refers to the trilemma. Why can an country not achieve all 3 parts of the trilemma? You should explain why each combination of 2 aspects is possible, but why the third is problematic.
- Use a diagram to explain why a fall in the exchange rate will boost the competitiveness of exports and why this can create economic growth.
- Why is a devalued Chinese currency bad news for the rest of the world?
- How could international co-operation and co-ordination help China?
The mood has changed in international markets. Investors are becoming more pessimistic about recovery in the world economy and of the likely direction of share prices. Concern has centred on the Chinese economy. Forecasts are for slower Chinese growth (but still around 5 to 7 per cent) and worries centre on the impact of this on the demand for other countries’ exports.
The Chinese stock market has been undergoing turmoil over the past few weeks, and this has added to jitters on other stock markets around the world. Between the 5th and 24th of August, the FTSE 100 fell by 12.6%, from 6752 to 5898; the German DAX fell by 17.1% from 11,636 to 9648 and the US DOW Jones by 10.7% from 17,546 to 15,666. Although markets have recovered somewhat since, they are very volatile and well below their peaks earlier this year.
But are investors right to be worried? Will a ‘contagion’ spread from China to the rest of the world, and especially to its major suppliers of raw materials, such as Australia, and manufactured exports, such as the USA and Germany? Will other south-east Asian countries continue to slow? Will worries lead to continued falls in stock markets as pessimism becomes more entrenched? Will this then impact on the real economy and lead then to even further falls in share prices and further falls in aggregate demand?
Or will the mood of pessimism evaporate as the Chinese economy continues to grow, albeit at a slightly slower rate? Indeed, will the Chinese authorities introduce further stimulus measures (see the News items What a devalued yuan means to the rest of the world and The Shanghai Stock Exchange: a burst bubble?), such as significant quantitative easing (QE)? Has the current slowing in China been caused, at least in part, by a lack of expansion of the monetary base – an issue that the Chinese central bank may well address?
Will other central banks, such as the Fed and the Bank of England, delay interest rate rises? Will the huge QE programme by the ECB, which is scheduled to continue at €60 billion until at least September 2016, give a significant boost to recovery in Europe and beyond?
The following articles explore these questions.
Articles
The Guardian view on China’s meltdown: the end of a flawed globalisation The Guardian, Editorial (1/9/15)
Central banks can do nothing more to insulate us from the Asian winter The Guardian, Business leader (6/9/15)
Where are Asia’s economies heading BBC News, Karishma Vaswani (4/9/15)
How China’s cash injections add up to quantitative squeezing The Economist (7/9/14)
Nouriel Roubini dismisses China scare as false alarm, stuns with optimism The Telegraph, Ambrose Evans-Pritchard (4/9/15)
Markets Are Too Pessimistic About Chinese Growth Bloomberg, Nouriel Roubini (4/9/15)
Data
World Economic Outlook databases IMF: see, for example, data on China, including GDP growth forecasts.
Market Data Yahoo: see, for example, FTSE 100 data.
Questions
- How do open-market operations work? Why may QE be described as an extreme form of open-market operations?
- Examine whether or not the Chinese authorities have been engaging in monetary expansion or monetary tightening.
- Is an expansion of the monetary base necessary for there to be a growth in broad money?
- Why might the process of globalisation over the past 20 or so years be described a ‘flawed’?
- Why have Chinese stock markets been so volatile in recent weeks? How seriously should investors elsewhere take the large falls in share prices on the Chinese markets?
- Would it be fair to describe the Chinese economy as ‘unstable, unbalanced, uncoordinated and unsustainable’?
- What is the outlook over the next couple of years for Asian economies? Explain.
- For what reasons might stock markets have overshot in a downward direction?
With worries about Greek exit from the eurozone, with the unlikelihood of further quantitative easing in the USA and the UK, with interest rates likely to rise in the medium term, and with Chinese growth predicted to be more moderate, many market analysts are forecasting that stock markets are likely to fall in the near future. Indeed, markets are already down over the past few weeks. Since late April/early May, the FTSE is down 4.5%; the German DAX index is down 7.0%; the French CAC40 index is down 6.9%; and the US Dow Jones index is down 2.3%. But does this give us an indication of what is likely to happen over the coming months?
If stock markets were perfectly efficient, then all possible information about the future will already have been taken into account and will all be reflected in current share prices. It would be impossible to ‘get ahead of the game’.
It is only if market participants have imperfect information and if you have better information than other people that you can are likely to predict correctly what will happen. Even then, the markets might be buffeted by random and hence unpredictable shocks.
Some people correctly predicted things in the past: such as crashes or booms. But in many cases, this was luck and their subsequent predictions have proved to be wrong. When financial advisers or newspaper columnists give advice, they are often wrong. If they were reliably right, then people would follow their advice and markets would rapidly adjust to their predictions.
If Greece were definitely to exit the euro, if interest rates were definitely to rise in the near future, if it became generally believed that stock markets were overvalued, then stock markets would probably fall. But these things may not happen. After all, people have been predicting a rise in interest rates from their ultra-low levels for many months – and it hasn’t happened yet, and may not happen for some time to come – but it may!
If you want to buy shares, you might just as well buy them at random – or randomly sell any you already have. As Tetlock says, quoted in the Nasdaq article:
“Even the most astute observers will fail to outperform random prediction generators – the functional equivalent of dart-throwing chimps.”
And yet, people do believe that they can predict what is going to happen to stock markets – if not precisely, then at least roughly. Are they deluded, or can looking calmly at likely political and economic events put them one step ahead of other people who perhaps behave more reactively and emotionally?
Bond rout spells disaster for stock markets as global credit kraken awakens The Telegraph, John Ficenec (14/6/15)
Comment: Many imponderables for markets The Scotsman, Bill Jamieson (14/6/15)
How Ignoring Stock Market Forecasts Will make you a better investor Forbes, Ky Trang Ho (6/6/15)
The Predictions Racket Nasdaq, AdviceIQ, Jason Lina (21/5/15)
Questions
- Why may a return of rising interest rates lead to a ‘meltdown in equity prices’? Why might it not?
- Why have bond yields fallen dramatically since 2008?
- Why are bond yields rising again now and what significance might this have (or have had) for equity markets?
- Why may following the crowd often lead to buying high and selling low?
- Is there an asymmetry between buying and selling behaviour in stock markets?
- Will ignoring stock market forecasts make people better investors?
- “The stock market prices suggest that investors believe both the Federal Reserve and the Bank of England are bluffing about raising interest rates. That may be so, but it is an extremely risky game of chicken for investors to play.” Explain and discuss.
In the late 2000s, Zimbabwe experienced hyperinflation. As a post on this site in January 2009 said, two estimates of the inflation rate were made: one of 5 sextillion per cent (5 and 21 zeros); the other of 6.5 quindecillion novemdecillion per cent (65 and 107 zeros). In January 2009, in a last attempt to save the Zimbabwean currency, a new series of banknotes was issued, including a Z$100 trillion note.
Prices were typically being adjusted at least twice a day and people had to carry large bags of money around even to buy a couple of simple items. The currency was virtually worthless. As the Guardian article below states:
Hyperinflation in Zimbabwe left pensions, wages and investments worthless and spread poverty as everyday items became unaffordable. It also caused severe cash shortages, because the government could not afford to print bank notes to keep pace with inflation.
The solution was to allow other currencies, mainly the US dollar and the South African rand, to be used alongside the local currency. Although the Zimbabwean currency was still legal tender, it effectively went out of use. Prices stabilised and since then inflation has been in single figures.
But many people still have stocks of the virtually worthless old currency, either in cash or in savings accounts. The Zimbabwean government has now said that it will exchange Zimbabwean dollar notes for US dollars at the rate of US$1 = Z$250tn (250,000,000,000). People have until September to do so. Up to now, they have mainly been used to sell as souvenirs to tourists! For people with Zimbabwean dollars in their bank accounts, they will get a minimum of US$5. For amounts beyond Z$175,000tn they will get an additional US dollar for each Z$35,000tn.
Historical examples of hyperinflation
As case study 15.5 in Economics 9e’s MyEconLab points out, several countries experienced hyperinflation after the First World War. In Austria and Hungary prices were several thousand times their pre-war level. In Poland they were over 2 million times higher, and in the USSR several billion times higher.
Germany in the 1920s
But even these staggering rates of inflation seem insignificant beside those of Germany. Following the chaos of the war, the German government resorted to printing money, not only to meet its domestic spending requirements in rebuilding a war-ravaged economy, but also to finance the crippling war reparations imposed on it by the allies in the Treaty of Versailles.
From mid 1921 the rate of monetary increase soared and inflation soared with it. By autumn 1923 the annual rate of inflation had reached a mind-boggling 7,000,000,000,000 per cent! As price increases accelerated, people became reluctant to accept money: before they knew it, the money would be worthless. People thus rushed to spend their money as quickly as possible. But this in turn further drove up prices. (The note shown above is in old billions, where a billion was a million million. So the note was for 50,000,000,000,000 marks.)
For many Germans the effect was devastating. People’s life savings were wiped out. Others whose wages were not quickly adjusted found their real incomes plummeting. Many were thrown out of work as businesses, especially those with money assets, went bankrupt. Poverty and destitution were widespread.
By the end of 1923 the German currency was literally worthless. In 1924, therefore, it was replaced by a new currency – one whose supply was kept tightly controlled by the government.
Serbia and Montenegro 1993–5
After the break-up of Yugoslavia in 1992, the economy of the remaining part of Yugoslavia (Serbia and Montenegro) collapsed. The government relied more and more on printing money to finance public expenditure. Prices soared.
The government attempted to control the inflation by imposing price controls. But these simply made production unprofitable and output fell further. The economy nosedived. Unemployment exceeded 30 per cent.
In October 1993, the government created a new currency, the new dinar, worth one million old dinars. In other words, six zeros were knocked off the currency. But this did not solve the problem. Between October 1993 and January 1994, prices rose by 5 quadrillion per cent (5 and fifteen zeros). Normal life could not function. Shops ran out of produce; savings were wiped out; barter replaced normal market activity.
At the beginning of January 1994 a ‘new new dinar’ was introduced, worth 1 billion new dinars. On 24 January this was replaced by a ‘novi dinar’ pegged 1 to 1 against the Deutsche Mark. This was worth approximately 13 million new new dinars. The novi dinar remained pegged to the Deutsche Mark and inflation was quickly eliminated.
Articles
Zimbabweans get chance to swap ‘quadrillions’ for a few US dollars The Guardian (13/6/15)
175 Quadrillion Zimbabwean Dollars Are Now Worth $5 Bloomberg, Godfrey Marawanyika and Paul Wallace (11/6/15)
Zimbabwe is paying people $5 for 175 quadrillion Zimbabwe dollars Washington Post, Matt O’Brien (12/6/15)
Zimbabwe dollars phased out BBC News Africa (12/6/15)
Zimbabwe ditches its all but worthless currency Financial Times (12/6/15)
Zeroing in Thomson Reuters, Breaking News, Edward Hadas (12/6/15)
Old articles
Could inflation fell Mugabe? BBC News (28/7/08)
ZIMBABWE: Inflation at 6.5 quindecillion novemdecillion percent IRIN (21/1/09)
The Worst Episode of Hyperinflation in History: Yugoslavia 1993-94 Roger Sherman Society, Thayer Watkins (31/7/08)
Questions
- Why have several governments in the past been prepared to allow hyperinflation to develop?
- Itemise the types of cost imposed on people by hyperinflation.
- Does anyone gain from hyperinflation?
- What are the solutions to hyperinflation?
- What difficulties are there in eliminating hyperinflation? What costs are imposed on people in the process?
- Why might the causes of hyperinflation be described as always political?
One is that it would change the relationship between the Bank of England and the government. If the Bank of England created money to fund government projects, that would reduce or even eliminate the independence of the Bank. Independence has generally been seen as desirable to prevent manipulation of the central bank by the government for short-term political gain. Those in favour of people’s QE argue that the money would be directed into a National Investment Bank, which would then make the investment allocation decisions. The central bank would still be independent in deciding the amount of QE.
