BOE’s King ‘Groping in the Dark’ as U.K. Expands Money Supply
By Brian Swint and Jennifer Ryan
Bank of England Governor Mervyn King, criticized for his initial response to the credit crisis, is now embarking on one of the biggest risks in British economic history.
The central bank yesterday won authority to print as much as 150 billion pounds ($212 billion) and pump it into an economy facing its worst recession since World War II, after cutting interest rates close to zero. With markets clogged and economic activity shriveling, King can’t be sure the gamble will work.
“We’re groping in the dark,” said Willem Buiter, a former Bank of England policy maker and now a professor at the London School of Economics. “Ultimately, we’ll know it works if the economy turns around, and that we won’t know for a couple of years.”
The risk for King is that the strategy fails, forcing him to create yet more money, or it backfires and fuels inflation. While U.K. officials are at pains to deny similarities with the economic policies of Robert Mugabe’s Zimbabwe, where printing money has fueled hyperinflation, some economists argue that the Bank of England hasn’t much of a choice left.
“You have to ask what it would be like if they weren’t doing anything and I suspect a lot worse,” said Amit Kara, an economist at UBS AG in London. “But the whole banking system has yet to be fixed, the economy has yet to deliver and credit is not available. It’s all a shot in the dark.”
Bank Run
King drew criticism from bankers and economists for waiting a month to extend an emergency funding program following the collapse of Lehman Brothers Holdings Inc. last year. Before Northern Rock Plc faced the first run on a British bank in more than a century in 2007, he told cash-strapped banks that lending them extra funds risked sowing the seeds of the next crisis.
Yesterday’s move now puts King ahead of European Central Bank President Jean-Claude Trichet in devising new tools to tackle the economic crisis. Trichet said in Frankfurt yesterday that the ECB still hasn’t decided whether to step up its response and buy securities in the market.
“We don’t know whether quantitative easing works or not, but it’s a good thing to try,” said Christopher Allsopp, a former U.K. policy maker. “The amount looks serious, and it needs to be to make sure it has a chance of working. They’re doing what they can.”
Gilt Purchases
The bank’s purchases may lower long-term gilt yields, reducing benchmark corporate borrowing costs in the process. U.K. 10-year government bond yields fell the most in at least at least 17 years yesterday on the bank’s announcement.
Still, Buiter said that the bank’s focus on buying government bonds with outstanding maturities of five to 25 years won’t help and may raise costs for pension funds, which depend on buying long-term securities.
“This is really quite pointless and in some ways counterproductive,” Buiter said. “They could indeed end up hurting pension funds more than helping anything.”
Policy makers may also have to come up with further measures, said Lena Komileva, an economist at Tullett Prebon in London. “I don’t think it will work,” she said.
Printing money has become linked with economic mismanagement. In the 1920s, the German government fueled inflation to fund World War I loan repayments and reparations, eroding the authority of the Weimar Republic. Mugabe’s monetary policy has left Zimbabwe with the world’s fastest inflation, last estimated at 231 million percent in July 2008.
‘Lost Decade’
Quantitative easing was also tried in Japan in the 1990s, where authorities struggled to stimulate the economy in what became known as the country’s “Lost Decade.”
King himself has noted how it’s all too easy for central bankers to let prices slip out of control once they start printing money.
“Zimbabwe has determined very clearly that if you want a higher inflation rate you could have it,” he told reporters in August 2007.
With the U.K. slipping deeper into recession, some economists nevertheless say the Bank of England’s policies are bold enough to help turns things around.
“Ultimately it has to have an effect,” said Matthew Sharratt, an economist at Bank of America Corp. in London. “It’s going to bring an extraordinary amount of stimulus into the pipeline along with all the other measures that have already been taken.”
source :Blommberg
