Jeremy Corbyn started his Labour leadership campaign with a relatively cautious proposition. His government (from 2020) would match its current expenditure with tax revenues, but continue to borrow for capital expenditure – to invest in public infrastructure and institutions. This a clear but hardly radical challenge to what had become the conventional wisdom of austerity. Taking loans for investment is normal business practice, and when governments fund appropriate projects with their deficits they can speed up private sector growth.
But Corbyn upped the ante by introducing the idea of “people’s quantitative easing”. This is a much bolder proposition. Instead of financing investment through taxation or conventional borrowing, he instead proposes allowing the Bank of England to simply “print” the money that would be used “to invest in new large-scale housing, energy, transport and digital projects”.
Quantitative easing (QE) was an unconventional monetary policy when the Bank of England embarked on it in 2009. A closer inspection of Corbyn’s “QE for the people” shows how radical an idea it is, but also explains his rivals doubts on whether it could really work in the public interest.
The QE prototype
In its original guise, QE involves the central bank buying existing government debt while the government issues more of it. QE works, according to advocates, by putting more money in investors’ pockets, and pushing down the yield on financial assets to ensure they invest it in real production, or consume real goods and services. The commercial banks, whose debt is bought, can strengthen their balance sheets and lend more. And the government can finance its wide fiscal deficit without pushing interest rates up. Although the Bank of England acknowledges that QE could push prices up, it can justify this because inflation is well below the medium-term target of 2%.
QE has worked to the extent that government has been able to spend more without, in effect, either taxing or borrowing more. While it issues new debt, an equivalent amount of old debt is called in, accumulating on the central bank’s balance sheet. QE in the UK and US has thus confirmed a key proposition of “modern money theory”(MMT): that governments with a sovereign currency can spend any amount that their central banks are willing to create electronically.
But this doesn’t mean the Bank of England will be easily persuaded into further rounds of QE, outside the crisis conditions that confronted it in late 2008. Technically the Treasury must still eventually repay, or at least roll-over, the £375 billion of debt that’s been bought under the programme. This makes central banks wary of the way financial markets judge such large- scale money creation. They must convince domestic investors that inflation won’t surge above the target rate, and foreign investors that the currency won’t suddenly fall in value.
The credibility challenge
The injection of MMT – so new that most economists are still struggling to come to terms with it – lets Corbyn refute rivals’ accusations that he is peddling outmoded solutions to yesterday’s problems. But MMT still attracts some powerful criticisms, focused on the way it fuses the accounts of governments and their central banks.
More orthodox theory suggests that, in reality, the new money is a liability for the central bank that issues it. Inflation and currency depreciation are major risks. So if Corbyn tries to widen the Bank of England’s mission to include the financing of a public investment drive, this could put its other (primary) roles – subduing inflation and keeping the financial system stable – under threat.
The risk that future deficits would be paid for by an “inflation tax” and a severely weakened currency has been the focus of attacks by Labour opponents including shadow chancellor Chris Leslie. They also point to the risk that QE raises inequality by inflating prices of assets held by the very rich. And that the unexpectedly long time for which central banks around the world have already been practising QE has brought a new fragility to the global financial system, which could be exposed when interest rates start rising again before 2020.
Corbyn’s economic advisers – including tax expert Richard Murphy – are confident these fears are unfounded. After seven years of QE and record low interest rates, inflation is still virtually zero, and the pound recently hit a seven-year high against the euro.
Could it work for the people?
Former London mayor Ken Livingstone puts the case for people’s QE with a rhetorical question: “If we can get the Bank of England to fund the banking system, why don’t we get them to build us a proper broadband system as modern and efficient as you’ve got in many of our competitors?”
But many who believe QE helped to rescue the banks don’t view it as a safe or effective way to finance public investment. Central banks have found it very difficult to get QE funds to flow beyond the banking system, into productive investment. The way the extra money got trapped in a bank vault may be the only reason the threatened surge of inflation and devaluation hasn’t come to pass.
This has been made clear by the hard-headed assessments professional investors who watched QE swell the already full pockets of financial houses like Goldman Sachs, who poured it almost exclusively into new financial investments. Central banks’ hope that it would eventually promote real investment, as financial asset yields slumped, has been largely unfulfilled. Bank lending to UK small businesses has not been perceptibly boosted by QE either, even when supplemented by explicit Treasury schemes such as Funding-for-Lending.
The problem of boosting the wrong sort of spending has long been understood by classical economists too, who argue that QE channels funds into a financial circuit that’s not directly connected to the real circuit of goods and non-financial services production. On that basis, QE doesn’t give any stimulus to inflation or real production and is essentially no help in bringing economies back to growth.
The Corbyn camp will therefore remain under pressure to argue how its democratised money creation could have positive real effects, without an inflationary backlash. QE for the bankers hasn’t worked in a way that makes QE for the people easy to sell.