THE BLOG
05/07/2013 07:44 BST | Updated 03/09/2013 06:12 BST

Carney Leaves Rates on Hold, But the Catch 22 of Easy Money Persists

Having blamed a significant part of the financial crisis on too much easy money fueling an unsustainable credit bubble, it may seem a touch odd that our policy prescription to date has been to continually facilitate cheap lending in the name of growth. How can the cure and the disease be one and the same? Stranger still, we have implored banks to pump credit around the economy with greater freedom whilst simultaneously mandating that they keep greater levels of capital in reserve accounts.

Such are the conflicting impulses of how we now approach monetary policy. We are ever vigilant of creeping inflation whilst demanding growth led by consumer spending. We abhor debt whilst asking business to take on more of it. And we want banks, once considered overly reckless with their lending, to help them do so. Nobody ever said treading these lines would be easy, and by extension neither is the job of recently appointed Bank of England governor Mark Carney. Today, in his inaugural decision, Carney's Monetary Policy Committee maintained the Bank's quantitative easing program at £375bn, keeping its benchmark interest rate at a record low of half a percent.

It's fair to say that this judgment marks the continuation of double-edged economic sword that is easy money. As much as it oils the levers of enterprise, the kind of bubble that emerges partly as a result of policies designed to free up capital is now found in the bond markets. With yields rising across the board in recent weeks, raking up the interest already heavily indebted governments have to pay to finance their deficits, it is becoming increasingly hard to justify huge volumes of quantitative easing by appealing to a politically motivated drive for growth at all costs.

If we were seeing significant growth as a tangible product of low interest rates and Bank asset purchasing, perhaps this would be sufficient evidence that credit easing is working. Unfortunately, unless the underlying demand is there in the economy - which it just isn't at present - increasing the amount of finance available to small businesses, say, is worth very little in terms of growth. They still have scant incentive to invest in new projects or to take on new workers. It is for this reason that uptake on the coalition's flagship taxpayer subsidised SME credit easing schemes has been pretty poor.

Nor is the problem that businesses don't have enough cash to start with; UK corporates are currently sitting on a pile of unused cash worth at least £318bn. Anyway, while credit conditions are favourable, what additional finance companies are gaining access to may more likely be used to pay down preexisting debt than to send themselves further into the red by increasing spending. And with savings rates so low, it really says something about the state of economic pessimism within the business community that companies are still willing to hold so much credit on their balance sheets.

Therein lie the limits of monetary stimulus, yet investors still fear that the tap of easy credit may be turned off before an economic recovery is firmly established. Worries that the Federal Reserve and other central banks will roll back their quantitative easing programs have seemingly been reflected in both bond markets and stock indexes. The Dow broke the 15,000 barrier for the first time in its history in May, but when chairman Ben Bernanke last month indicated that the Fed must eventually stop printing new dollars to the tune of £56.2bn a month, yields on US Treasuries climbed. The FTSE 100, having hit a five and half year peak in the same month, has since slumped nearly 10 per cent as jittery investors express concern that borrowing costs could soon rise.

This erratic behavior may be just a knee jerk which readjusts in time, but it does reflect a far larger problem with making credit so abundant: once you flood the economy with cheap money, how do you begin to scale it back? Key interest rates impact upon financial products owned by pretty much everyone, and a jump in repayments on loans for everything from entrepreneurial ventures to consumer goods is simply asking for the number of defaults on them to rise in line, no matter how gradual the move.

While Carney's first decision is a safe, steady one, holding both interest rates and asset purchases does suggest that we still can't quite seem to make up our minds as to whether the virtues of credit easing outweigh these vices it leaves us in. Few think the exact level of monetary stimulus has been spot on; some monetarists insist that £375 bn worth of quantitative easing doesn't go nearly far enough, while inflation conscious deficit hawks are adamant that growing the money supply at will is sheer folly. If nothing else, Carney's course will give some much needed consistency to the Bank's policy of bisecting these two extremes, signalling to the markets that, much like his predecessor, he is not willing to turn the tap off on a whim.

It will be interesting to see how the markets react in the near future now Carney has shown his hand. When the easy credit is finally reigned in, as long as growth doesn't tank, they should hold up just fine. Everyone knows it has to happen some day, its just a matter of time as to when. In his next public manoeuvres, Carney should prepare everyone for this eventuality so that the consequences of restricting credit are at least mitigated to some degree.