QE III, Anyone?

As I sat down to lunch last Sunday, the problems of the global economy were, for once, not on my mind. Opposite me were a nurse from a local hospital, and my cousin, who is currently studying for a PhD in Economics at Columbia.

Somehow the conversation turned to the local hospital which has just recently installed an air-ambulance service. It transpired that part of the benefit of this was that the good people of the Channel Islands would now be able to get the needy to the hospital more efficiently. At this my, until then docile and semi-concious, mind perked up. But how, I asked could that be right? The Channel Islands pay no tax to the coffers of the UK, so how can they possibly use our health service?

At this point, my cousin chimed in. “But why does that matter?” she asked. “The NHS is not funded out of tax revenue, it's funded out of debt...”

By now I was fully awake. What on earth could she mean? She explained that there is no line item on your pay-packet that says NHS so it's paid for out of debt. I was struggling with her logic by now - I explained that yes, she was right that there was no hypothecated tax related to the NHS, but that tax revenue and debt issuance were effectively fungible. If tax revenues were insufficient, then you had to raise debt (if you can). By now emotions were running high. So she went the patronising route. “David”, she said, “your thinking is out-of-date - yours is a neo-classical perspective. The world has moved on. Debt is no bad thing. You can just monetise it. It's a far easier way to run your economy than taxing people.”

At this point I exploded.

Unsustainable Behaviour

The diatribe that I then went on basically accused her, and the policymakers that she was so adamantly supporting, of behaving totally unacceptably - the US is completely abusing its position as the world's reserve currency and is continuing on a completely unsustainable path, etc. Not only that, but it is explicitly borrowing money, with the intention of never repaying it (which is what effectively you do when you debase your currency). Anyway, I said to her, surely this should lead to inflation and does the Federal Reserve not have a price stability mandate? She looked non-plussed - well, she said, growth comes first and as for inflation, there's no explicit target.

As the US economy slows once again as QE II and the fiscal stimulus wears off, who would bet against QE III? And then afterwards QE IV, and so on? And you know what I learnt? That some in the US think this is reasonable. They see no issue with this course of action.

The issue for the Bank of England is that it has an explicit inflation target. And maybe it's ethically even more unsound, but they're pretending they're trying to hit it, when they know blatantly well that if they were to try and do so, the economy would judder to a halt. Or maybe they think all the factors are 'temporary' (how remarkably convenient) even though he's just written his sixth letter in succession explaining why he's off-target. So either Mervyn is lying or he's incompetent. Not a great place to be.