by Adam S. Posen, Peterson Institute for International Economics
Op-ed in the Guardian
July 1, 2013
© The Guardian
The impact of monetary policy depends on what a central bank buys, and what institutions it transacts with. The Federal Reserve is demonstrating this fact with the huge impact on US residential construction of its purchases of mortgage-backed securities over the last year; the Bank of Japan is putting this principle into action by buying long-duration Japanese government bonds as opposed to cash, purchases of which previously failed to counter deflation. It is time for the monetary policy committee (MPC) with its new governor to observe the examples around them, and listen to the longstanding arguments of current and past committee members for buying something other than gilts.
The Bank of England should be buying securitized bundles of small, medium, and new enterprise debt, as I first proposed in September 2011. The more different from cash the asset that the MPC buys is, the bigger the impact its purchases will have on the economy; the more the MPC concentrates its purchases on where British financial markets are dysfunctional, the bigger the impact as well. Both these factors direct the banks towards SME lending. The highly concentrated British banking system, dominated by four big banks and one big mutual society, has largely forgotten about high-street lending, at least to businesses. The funding for lending scheme (FLS), while clever and well-intentioned, was intended to go through that existing banking system rather than around it, and thus was ineffective.
Governor Carney and the MPC will be tempted instead, for several reasons, to stick with some form of announcement by August that rates will not rise until certain targets are met. There are MPC members who think further quantitative easing (QE) is ineffective or harmful; there are those who think the UK economy is turning around; there are those who want to keep the Bank from taking on credit risk. Every one of these reasons, however, is misguided: Credit easing will be more effective than QE or FLS while addressing a structural problem; the UK economy is still a huge way from overheating, let alone full employment or accelerating inflation; and central banks, including the Bank of England, have bought and sold private assets throughout history. Stopping at cheap talk will not be enough, and the time for giving credit where it's overdue has come.