The UK economy is barely growing. To stimulate demand, should the Bank of England mail out a voucher worth fifty quid to every citizen of this fair land and tell them to go out and spend it on beer, fags and cheap Chinese electronics? It sounds like a mad idea, but is it any stranger than the Bank of England printing money to buy up goverment debt?
In a recent speech to the Council of Mortgage lenders - Charlie Bean, Deputy Governor for Monetary Policy, Bank of England - seriously discussed the voucher distribution idea:
"Several commentators have suggested that the effectiveness of quantitative easing could be enhanced by spending the newly created money on something other than government debt.
For instance, one idea that has been floated involves sending households a voucher, which could then be spent in the shops and redeemed for cash by the retailer. This may sound like a good idea, as it seems to get the money quickly into action in stimulating demand. Now, such a policy in effect combines an increase in borrowing to finance a temporary increase in income tax allowances with some conventional quantitative easing in which gilts are exchanged for claims on the Bank of England
But economic theory, as well as considerable evidence, suggests that such a temporary increase in disposable income would be likely to be very largely saved. Only households that wish to borrow, but presently cannot, would be likely to increase their spending materially. And making the voucher time-limited would do little to help, as households could always use the voucher instead of the cash they would have spent.
In sum, this hardly seems the most effective way to add additional stimulus."
Charlie thinks that if we received some free money, we wouldn't spend it; we would save it. On this point, he is right. However, Charlie is actually making a deep and fundamental point about fiscal policy and its ability to influence output. If it is true that we would save that spare note gifted from the BoE, it is also true that any temporary tax reduction would also be saved. In fact, any attempt to to use fiscal policy to stimulate the economy by temporarily boosting disposable income is a wasted effort.
Charlie's observation about fiscal policy has further implications. For the last four years, the UK government has issued huge amounts of debt. Since government debt has to be paid off in the future, we all know that taxes will also have to increase in the future. This means that our future disposable income will fall, and since we know we will be poorer, we are spend less now. So, running up large fiscal deficits actually depresses consumption. The conclusion is the same - fiscal stimulus doesn't work.
Mr. Bean doesn't believe in fiscal stimulus but what about quantitative easing? Printing new money doesn't create more output, it only increases the claims on a fixed amount of output. The inevitable consequence of more money will be more inflation, which is exactly what happened after the previous round of quantitative easing. Inflation went up, the economy barely grew, and unemployment remained constant.
Being a central banker Mr. Bean understands the inflationary implications of quantitative easing. Nevertheless, he still thinks borrowers will respond to quantitative easing and spend more. This is because inflation erodes the real value of debt. Inflation makes borrowers permanently better off. However, for those on fixed incomes, and savers with bank deposits, inflation makes them permanently poorer. So, quantitative easing is about robbing savers to placate debtors. This is hardly a strategy for sustained economic growth.
There is only one way that the UK can recover from this crisis. Tighten monetary policy to restore positive real interest rates. Balance the budget and pay off government debt. Reduce the size of the government and generate space for permanent reductions in taxes for working families. Reform the benefits system to create incentives for work rather than unemployment. Break up monopolies, and downsize and privatize state owned banks.
This is the only way forward for the UK economy. The question is how long will it take policy makers like Mr. Bean to realize it?