Andrew Lilico: Inflation is too high and switching from QE to outright money-printing ain't gonna help
The target measure of inflation, CPI, rose from 2.2% to 2.7% this month, well above the 2.4% expected. As recently as August the Bank of England's inflation report expected inflation at about 2% by now. Back in February the inflation report expected inflation by now to be well below 2%. With recent rises in energy and food prices, inflation is now expected to exceed 3% within months (3.5% by the middle of next year is being discussed), meaning Mervyn King's last few months as Governor will feature several more letter exchanges with the Chancellor. If growth were really to get going, 3.5% could be highly optimistic. We've seen over the past four years that whenever the UK economy isn't actually shrinking, inflation goes to 5% and rising. Think how much inflation we might get if GDP growth were to get to the 3% or so annual rate that would herald recovery. Barring some international shock, such as the euro collapsing, I would expect recent inflation highs to be tested or exceeded in the next couple of years.
Governments can often blame recessions on past governments or international events. They can say that spending cuts are a necessity rather than a joy. But voters tend to be less forgiving of rises in the cost of living. The short route to political unpopularity for a government is tax and inflation rises. Osborne will struggle to blame anyone else if inflation starts to race on his watch.
As regards the debt position, the Treasury's receipt of this money is relatively harmless provided there is consistency. It's clearly silly to say that it makes the government less indebted, since all it has done is to shift some money from what the Treasury describes as a "savings account" at the Bank of England to an account at the Treasury. There is no effect on the government's net worth as a consequence, any more than if you switched money from one of your bank accounts to another one you would be any richer. There is nothing per se improper about it, though. The Bank of England is a public institution on which the Treasury has the claim for its profits, and the Treasury automatically receives half those profits every six months anyway.
That's not a problem (yet - there is, though a different kind of problem as we'll see below). But there is a danger here, in that because the interest is passed automatically, so should be profits and losses on the gilts themselves. So when interest rates rise and gilts prices therefore drop, the BoE is going to make large (probably hundreds of billions) of losses on QE gilts. It might like to hold to maturity, and so realised losses only gradually (in the form of lost opportunity cost), but if it is going to take receipt of interest it really ought to mark QE gilt losses to market - i.e. accept losses as soon as they arise, with the Treasury indemnifying it. Otherwise it will be taking gains instantly but losses gradually - wanting to have its cake and eat it as well. I expect the ONS to mark losses to market (as with the banks), with the consequence that government debt including QE indemnifications will ultimately be about 13% of GDP higher than at present, and that some of that rise will occur between 2014 and 2015 - meaning Osborne's hopes of controlling debt are going to look absurd. (To put the matter more simply, doing things this way means the Treasury is formally taking less debt now in exchange for more debt in a couple of years' time. That's not going to make Osborne's task of meeting a 2015 debt target easier, but harder.)
The really problematic issue here isn't about the Treasury's debt. It's about money printing.
QE was supposed not to be money printing because it involved an automatic mechanism for withdrawing the liquidity - namely the coupons and bond redemptions. So over the long-run there was no net injection of money. Imagine the simple case in which the BoE prints £100bn of money to buy government bonds direct from the government. Then although there would be £100bn of extra money around at the start, that would leech out of the system as the bonds were redeemed, so once they were all paid up there would be £0 of extra money. That still wouldn't be neutral in its effects, however, as the money sat in the system for a while, much as if I borrowed £100 from you and paid back £100 in a years' time that would still involve a net transfer from you to me as I'd got to use the money for a year and you hadn't. But just as that "got to use" effect is neutralised in the case of my loan by my paying you interest, so the "sat around for a while" effect would be neutralised by the coupon payment. In other words, it's only by including interest payments on QE gilts in the money withdrawn that QE isn't really money-printing.
But if the government takes the coupon payment to itself, that means the automatic withdrawal is less than the money injected and QE really does entail money printing - just plain old Weimar-type money printing disguised by an accounting trick. Essentially by taking the interest, the government is essentially forgiving a portion of the real value of its own loans. There's a case for that - Lord Turner made it a few weeks' back. But if that's what's to be done it would be much better if it were done explicitly, by saying "We shall forgive £xbn" and arguing the case for it, not via accounting legerdemain.
Inflation has been far above target for a long time, and will go farther above. Moving from QE to outright money-printing at a point when inflation is well above target and cost of living increases are known to be politically toxic is one of the more, as Sir Humphrey might have said, courageous decisions this government has taken.