-Right Monetary Policy Moving Further In Expansionary Direction

LONDON (MNI) – Quantitative easing is effective, and it is right
the Bank of England Monetary Policy Committee is moving policy further
in an expansionary direction, but a Bank Rate cut would likely have
perverse effects, MPC member David Miles says.

Miles’ comments, in a speech in Edinburgh, underscore his support
for further stimulus but add to the raft of comments from MPC members
making the case against lowering Bank Rate. He also says that when the
MPC does finally decide to tighten policy, it should do so by raising
Bank Rate before unwinding QE.

“Monetary policy in the UK has been set to its most expansionary
setting in history and I believe it is right that it is still being
moved further in that direction,” he said.

He says that with all this stimulus inflation has not soared, and
it is wrong to believe it will, and economic activity has not collapsed.

“I do not consider this a great success. Perhaps the most one
could say is that the boat has not capsized even though the steering
wheel has been turned exceptionally hard in one direction,” Miles said.

Miles voted to extend QE in July but voted for unchanged policy in
August and his September vote is not yet known.

He appears very unlikely, however, to vote for a Bank Rate cut any
time soon. The MPC cut Bank Rate to 0.5% in March 2009 and has left it
there ever since, declining to bring it even closer to the zero bound.

The benefits of lowering Bank Rate may have been slight, as it may
not have substantially eased credit supply at the longer maturities that
matter for consumption and investment, Miles said.

The costs to the banking sector of a rate cut, however, could have
been high.

“It may have adversely affected the stability of a number of banks
and building societies whose profit margins were already squeezed,” he
said.

Miles believes the arguments for and against taking Bank Rate below
0.5% may well have changed little since 2009.

“There were reasons to believe that the benefits of cutting Bank
Rate further were, at best, likely to be small and the effects could
well be perverse. I see no obvious reason to think things are much
different today,” Miles says.

While Bank Rate is not the right tool to provide more stimulus, it
will be the chosen tool when the MPC finally starts tightening policy.

“A rapid return to more normal policy is not imminent,” Miles says,
but he argues it is essential to think through how tightening will
eventually be done.

Miles comes out strongly in favour of hiking Bank Rate before
selling any of the vast quantity of gilts the MPC has acquired through
QE.

If Bank Rate is hiked “the costs of reversing any premature
tightening would appear to be lower,” he said.

If the MPC chose to unwind QE first and then realised it had
tightened too early and policy had to be reversed the cost would be
higher than that associated with raising and lowering Bank Rate as it
“would create unnecessary volatility in the market for gilts.”

Also, just as a Bank Rate cut could undermine the stability of
banks and building societies a rate hike “may have advantages for
financial stability because some banks and building societies have
indexed a substantial proportion of their lending to Bank Rate.”

Miles argues the BOE should only start selling gilts once it sees
only a remote probability of having to cut Bank Rate back to near
zero.

In his speech at the RBS Scottish Economic Society Annual Lecture,
Miles insisted that QE had been undertaken because of the MPC’s 2%
inflation target and not despite it.

The MPC has been criticised for repeatedly increasingly stimulus
with inflation running above the 2% target.

Miles, however, says that although there has been an inevitable
“blurring” of fiscal and monetary policy with Bank Rate so close to
zero, policy “is still being conducted with an inflation target as the
guiding light.”

He said the MPC has sanctioned more QE to offset the risk of
inflation eventually falling below its 2.0% target. He rejected the view
that the inflation target has been unhelpful or that alternative
stimulus policies to QE, such as helicopter drops of money, should have
been conducted.

“Rather than the focus on inflation being an unhelpful constraint
on policy it is the natural means by which one judges how expansionary
monetary policy should be,” he said.

His speech also contained the remarks he made in an op-ed piece in
the Evening Standard earlier Tuesday.

He noted in that op-ed piece that some people have argued the
weakness of UK output is proof that monetary policy, and specifically
QE, is no longer effective.

“This ignores the factors which have restrained demand – and which
might have caused output to fall significantly had not an increasingly
expansionary monetary policy been pushing back in the opposite
direction,” he said.

-London newsroom; +44 20 7862 7491; email:drobinson@marketnews.com

[TOPICS: M$$BE$]