We must print more money, says Bank

Governor appeals for urgent action to salvage Britain’s shrinking economy
Sean Farrell
The Independent, UK
Thursday, 19 February 2009

The Bank of England is to start ‘printing’ new money for the first time in 30 years as it runs out of options to kick-start the economy. The Governor of the Bank of England will write to the Chancellor within days to get permission for the unprecedented action.

The Bank will create the money by buying government and corporate bonds from financial institutions for new supplies of sterling. Termed “quantitative easing”, it is the modern equivalent of printing money. It is designed to put more cash into the economy, creating more money for companies to spend and for banks to lend.

The move marks the most dramatic step taken yet by the Bank as it tries to stop the deepening recession turning into a slump. One of the main reasons for the financial crisis has been the unwillingness of banks to lend money after the sub-prime losses in the US.

Critics have branded the action irresponsible and said it could stoke inflation and spark a run on the pound but the severity of the recession has driven the usually conservative central bank to throw caution to the wind.

The minutes of this month’s Monetary Policy Committee meeting, released yesterday, showed a unanimous vote to request the go-ahead from the Chancellor. Alistair Darling is expected to reply immediately to the Governor’s letter in an exchange that will cap urgent work at the Bank and the Treasury to allow purchases to start as soon as possible.

Andrew Goodwin, a senior economic adviser to the Ernst & Young ITEM Club, said: “It is crucial that the Bank be allowed to swiftly and boldly implement this policy. The lack of supply of credit is the biggest problem facing the UK economy and increasing the supply of central bank money via purchases of government securities should help to loosen these restrictions,” Mr Goodwin said.

Under measures announced last month, the Bank is already authorised to buy up to £50bn of assets to help unblock frozen markets but without increasing the supply of money to the economy. The Bank’s rapid move to the extreme option of creating new money in exchange for the bonds underlines the increasing sense of crisis.

The Bank’s nightmare is a sustained period of deflation – general falling prices – which would prolong and deepen the recession by encouraging consumers and businesses to delay spending. A short period of falling prices is expected later this year, driven by dropping energy costs, but with inflation falling and the economy contracting quicker than forecast, the Bank wants to act to prevent a downward spiral.

The results of a CBI survey released yesterday showed manufacturers’ order books shrinking at their fastest rate since 1992 and companies expecting to cut output at a pace not seen for nearly 30 years. The measure of export orders slumped to its lowest since November 2001, quashing hopes that sterling’s recent sharp fall would boost overseas sales for British businesses.

The Bank has never taken such a radical step to boost the money supply before but similar measures were used by Japan in the early 1990s and during the 1970s when the supply of sterling was increased. Critics argue that creating new money did not prevent Japan’s “lost decade” of stagnation.

The Bank has started a softening-up exercise to rebuff accusations that quantitative easing amounts to recklessly turning on the printing presses in a way that has driven countries such as Zimbabwe into hyperinflation.

Charles Bean, the deputy governor for monetary policy, said on Monday the aim was to boost the supply of money and credit to achieve the Bank’s 2 per cent inflation target and not to finance a government budget deficit as happens in corrupt regimes.

With the economy “undergoing a significant and sustained adjustment” and inflation heading for negative territory, the Monetary Policy Committee decided it would need more than rate cuts to limit the recession and keep inflation close to its 2 per cent target in the medium term. The minutes showed doubts growing about the impact of further interest-rate cuts as the committee agreed to slash borrowing costs to a record low of 1 per cent.

It voted 8-1 in favour of the half-point reduction. David Blanchflower called for a one-point fall but the majority rebuffed his call for a bigger cut because it could deter banks from lending.

“There was a great deal of uncertainty about what would happen to banks’ and building societies’ ability and willingness to lend at low levels of interest rates,” the minutes said. “There might even be a point where further cuts in bank rate could have an adverse impact on the economy.” Mr Blanchflower said past errors were due to cutting too late and not too soon.