John Redwood has written a characteristically insightful piece this morning, as a follow-up to his Today interview (which can be accessed via here). I had some comments on what he says, which may be of interest and I reproduce below.
Quantitative easing will eventually have a significant effect, but past experience suggests that this will come only after either or both of the following: balance sheets are rebuilt (in which case conventional interest rate cuts would have an effect, also); inflationary expectations become properly anchored at a positive, zero, or low deflationary level of inflation. If people both need to rebuild their balance sheets (need to cut their debts) and expect deflation - the current situation in the UK - quantitative easing will have little impact until the exit path (i.e. what happens after deflation ends), when it will drive significant inflation.
This is, of course, why the US is now considering the introduction of an average inflation target (a price-level path target). This is intended to manage inflationary expectations (in the way I described in Lilico (2002), which Fed governors have read) so as to try to re-establish the link between the amount of money printed and the amount of lending that goes on in the economy. In the UK, with the collapse of the inflation target, we will find it very difficult to create positive inflation expectations until so much money is printed that it would have the effect, in equilibrium, of inflating away private debts (so that people would no longer need to de-lever). That would imply a significant rise in inflation on the exit path.
Much better would be for us to introduce a price-level target now (price-level targeting also has a number of other good properties, not the least of which is that it is not subject to the asset price bubble creation flaw of inflation targeting) and use that to determine the optimal level of money printing. This would allow much lower inflation rises on the exit path.
Incidentally, as I have argued before on CentreRight, I believe that Redwood is quite correct in his remarks about the perversity of capital requirements. As I have argued before, in my view, all formulaic regulatory capital requirements should be suspended (i.e. we should [suspend] Basel II/the CRD), prudential supervision should become entirely a Bank of England responsibility, and prudential supervision should become fully integrated with the lender of last resort function of the Bank of England (i.e. prudential requirements should become simply those that the Bank of England advises commercial banks are the minimum conditions necessary for the Bank of England to be prepared to lend the commercial bank funds at a pinch).
