Tuesday, 24 June 2014

Interest rate rise instead of unwinding QE

Quantitative Easing, that was a good topic for a long time here and in the UK generally. The magic money tree come to save us from a dearth of credit. It is hard in any meaningful way to say it has work, clearly there are reports from the Bank of England saying it has added over 1% to GDP growth, but they are not really an independent source.

Now though, with the economy growing strongly, the time approaches when interest rates will have to rise and Mark Carney is going to speak today with a view to saying they may indeed start to rise this year.

What is interesting is that there is no discussion of unwinding of QE first. After all, the net effect of QE is to reduce interest rates below zero - therefore surely this emergency source of monetary funding should be the first to be unwound?

Interestingly, the Bank of England and its fellow travellers say not. They say that QE is not inflationary as it has not provided direct capital to Banks after all - they can still create their own reserves to book against loans as needed. As such, raising rates will have a larger impact than reducing QE.

This is all very well and all very technical. But as you raise interest rates, then the price of Bonds will fall. This means the Bank will be losing money on its investments, the more rates rise the worse it gets.

So what? Well if you are not going to reduce QE then perhaps you monetise the debt? or Perhaps the losses do not matter as no one knows who owns the Bank of England and its debts anyway?

But this is too clever by half in my view, people in the Country will see that money is being created and destroyed at will and it undermines the concept of fiat money altogether which would be a bad thing.

Worse is to leave QE and experience the high losses, as any taking of these losses were they ever to sit with Government would cause a huge political problem for the Government of the day.

I can't see how keeping QE is good in the medium term, it should be unwound before the Bank starts to raise interest rates.


MyUsualName said...

QE should never have been instigated in the first place.

It welfare for arseholes who cannot manage their own finances.

The real interest rates in the real economy are about 17% (standard car finance rates) up to 400% (payday lenders).

hovis said...

"It welfare for arseholes who cannot manage their own finances"

You mean the banks.

Blue Eyes said...

Kaletsky says that QE may have simply created money that was actually needed, i.e. that it is possible that the crash caused a step change in the need for cash in the economy.

I agree that it surely makes sense to slowly unwind the bond purchases instead of raising rates. I am still not convinced we are ready for tightening, though. The economy is not booming. Wages are still stagnant and prices for manufactures goods, food etc. are not rising. The only reason people are talking about rate rises is the London property market, and that is not going to be affected by a per cent or so on the base rate.

Rates should be held down until there is a genuine risk of inflation. The London property market should be looked at in context. If it's too hot (lots say it has already peaked) then look at the causes. I doubt it is too cheap money.

CityUnslicker said...

BE - Fair points, normalising the economy to rates around 5% has to happen though. Over a long period, but the long-term effect of cheap money are devastating - its how we got to 2008 in the first place.

Blue Eyes said...

I don't disagree, but whacking rates up prematurely will just push us into Eurozone-style depression. Getting out of a depression is much harder than not getting into one in the first place.

If anything the government should be setting a higher inflation target, say 4% on the old RPI measure.

hovis said...

CU I'd agree that cheap money leads to misallocation, but essentially it didnt cause the crisis of itself. Banks runs are a feature, not a bug of FR banking surely? The inherent lack of trust given the the securitization of debt, saw risk couldn't be quantified, prices nosedive and panic ensue, prices asset valuations nosedive, Mark to Matrket rules and more banks [should've] gone under. Blame securtization, blame Black-Scholes, blame central banks, blame non enforcement of regulation, not just cheap money ...

As an aside most commercial lending has been at normal rates as banks have used the cheap mopney they can get their hands on to re-build tgheur balance sheets. Any rate raise will be passed on, any "cheap money" has only been for those withs special access (Crony Capitalism anyone?)hence the asset price bubbble in equities.

Whilst it might seem contradiactory I'd agree with BE the London bubble isnt driven by cheap money, but a confluence of other factors, including the lest dirty shirt in the laundry basket rather than inherent value or attractiveness of London.

Nick Drew said...

please don't blame Black-Scholes !

it's just a calculation, & it's not rocket science

oh hang on, actually, it is rocket science ...

Blue Eyes said...

Hovis and I agree on something!

There are similar property booms happening in the desirable bits of Canada, Australia, New Zealand and so on. Not all of those places have had low bank rates and QE.

Steven_L said...

But as you raise interest rates, then the price of Bonds will fall

Bollocks. Long term US bonds stayed yielding pretty much the same during the last phase of rising US rates in the mid naughties.

Folk blame the global savings glut. What's the bet Cameron and co are trying to flog the Chinese gilts as we speak?

As for all this mumbo jumbo about undermining the concept of money etc, pull the other one. Money, and the economy in general, is more centrally planned now than it has been in my lifetime. I heard on the radio today that a public sector bank is setting up a $1bn fund to 'invest' in windmills, presumably collecting the government mandated feedin tarriff or one of these cfd's ND was on about a few months back.

andrew said...

If you actually do have interest rates of 0.0 or less, weird things start to happen.

QE sort of dodged that bullet and from what i have read, is less bad than negative rates.

After all of the purpose of a bank (in social terms) is to efficiently allocate resource from savers to debtors, lending £100 with the promise of returning £96 in a years time works, but serves no purpose.

i.e. when interest rates really are significantly negative, it actually means for all purposes they are 0.0 for you and me as we will just get cash, and as a by-product there is not much need for a bank - unless it is for secure storage of your cash.

Some may say that that is what banks are really for and they should go back to that.

Being a v.v.v. small time participant in the funding circle, i was fascinated to see that they are hooking up with santander to offer small business loans in a wide scale.

the flip side of the QE or not QE issue is the general 'what is it being spent on' question.

On page 33 of 'why nations fail'.
The basic thesis (and I may well be wrong as only on page 33 of 460 odd) seems to be that if a country's institutions are set so that any increase in that country's wealth is passed on to the majority of its citizens, that country tends to succeed. It the fruits of progress are kept to a too - small group, the country 'fails' - becomes relatively poorer over time.

The question I sort of have is given you think this is correct (I think it is), and more and more money is passed to a wide group of people (although QE could be said to be doing the precise opposite), what then?

When every flat has a big tele and an xbox and a wardrobe full of knock-off armani from the last hol in turkey (for that is where I am), even if the rewards of progress are 'fairly' shared by some definition of 'fair', what then?

In previous generations, increasing income bought freedom (from serfdom), land, political freedoms, security, plumbing, electricity, cars (freedom of movement).

What non-substitutable thing do people not have now that they are willing to struggle for?

This may be a reason why income inequality looks to be rising - because there is nothing to buy with a small amount of extra money.

But there are things that can be bought with lots of money (a ticket to orbit).

Apologies for running somewhat o/t

Bill Quango MP said...

I have why nations fail on my shelf.
But I've still 200 odd pages of 1974-1979 to go.

But it's next on the list. After a lighter novel. Stephen king or a Derek Robinson.

hovis said...

Andrew: I think that the number and type baubles on offer are increasing and enough people are getting them for the moment, but in trend terms i.e. how far are they spread, that is pointing towards increasing polarisation.
Your point at what then, implies you are questioning infinite growth?

Personally I also think politically we are in bread and circuses territory, with a political system that is taking away freedoms and trying to use the baubles as a distraction.

Nick: I agree Black Scholes is merely a formula, I was being opaque and thinking more of the aim of people like McQuown, Kealhoffer and Vasicek who took it further wanted to liberate the debt market and make it as liquid and tradeable as equities. Now I'm not blaming them, or that per se it's a bad idea, the execution however (especially some securitisations) introduced risks that were not understood and/or ignored.

CityUnslicker said...

Greenspan caused the the securitisation bubble by holding rates low - financialisation was the way the bansk went to generate returns and that led to your problems Hovis. The original sin was cheap money and the imported deflation from China.

As for rates - I am not strongly in favour of them going up yet as BE and Hovis righly point out the London bubble is equity driven, so borrowing costs are immaterial.

However, no one has chellenged the tenet that you should unwind the QE first before you raise rates.

SL - Bond prices have to fall as rates rise as the return increases. Whether the short or medium term markets reflect his is not the point. It's basic maths to calculate a yield curve.

Blue Eyes said...

CU Carney explained the strategy in his speech yesterday. He said that QE will be unwound, but only when Bank Rate has risen so that if the unwinding goes wrong Bank Rate can be cut again.

CityUnslicker said...

But that never makes any sense, it is an excuse to not unwind QE in the event that it can be monetised in the next crash....US GDP -2.9% for example..

Steven_L said...

Bond prices have to fall as rates rise as the return increases. Whether the short or medium term markets reflect his is not the point. It's basic maths to calculate a yield curve

But you were saying if bank rate goes up bond prices will fall. What zero-risk overnight bonds are you talking about?

You might find that the yield curve simply changes shape a bit and other interest rates stay largely the same. Further, as consumers can't open reserve accounts at the BofE, who is to say banks will start paying more for deposits? Current accounts still paid 0.1% when bank rate was 5%. If gilt prices don't change much then neither will the yield on one, two or five year deposits surely?

Blue Eyes said...

CU I don't disagree but that is what Carney said.

We should also be talking about fiscal tightening first, before monetary. Osborne would argue that the Plan already includes hefty fiscal tightening, but I want him to go much further before the monetary brakes are put on.

Electro-Kevin said...

The cause of the London house boom might not be cheap money - and it's not a high average wage causing it either.

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Helen F said...

We should also be talking about fiscal tightening first, before monetary. Osborne would argue that the Plan already includes hefty fiscal tightening, but I want him to go much further before the monetary brakes are put on.
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