Is Another Bout of QE a Good Thing?

19/06/2012 15:30 BST | Updated 19/08/2012 10:12 BST

In the last few days the Chancellor George Osborne announced a £140 billion 'kick start' to the British economy in an attempt to get the country out of stagnant growth. The plan is to provide high street banks with up to £80 billion of funds to lend to businesses and potential homeowners, with the intention of creating jobs and sustainable growth throughout the economy. The idea is a switchback on the general conservative approach to economics, which claims intervention in the economy in the short term will inevitably create inflation later on in the business cycle. I find it difficult to contest that argument however it is not my main concern with the Chancellor's new plan.

My issue with the idea is it prevents market correction, which is the reduction of prices created by falling income which is seen in a recession. If incomes fall it is not possible to maintain demand for goods making prices fall relatively. This mechanism creates a natural compensation during a recession. People may earn less but the prices they have to pay to buy goods fall in tangent. There is a relative price correlation between income and earnings that in a normal recession (without government intervention) allows for a reduction in the cost of living which falls at a similar rate to income.

All of the methods of intervention prevent market correction and this natural compensation. The mechanisms used to artificially stimulate the economy will see one sector of society benefit at the expense of the rest of the country. Maintaining artificial prices of certain goods within an economy prevents the opportunity for new buyers to enter the market and maintains the control of those assets within certain sectors of society.

House prices in particular are kept high through artificial mechanisms. The low interest rate and increased lending to mortgage borrowers will push the demand for housing up (or at least remain the same) and in turn prices will rise or remain high. This in my opinion is unfair on potential homeowners who are either priced out of the market or have to borrow larger amounts of money to buy a property. In addition to this factor the cost of renting is also related to house prices and will remain high as a result of the Chancellor's plan. I have written about the real consequences of debt orientated intervention in a recent article at the Adam Smith Institute (ASI), if you are interested in reading that you can here.

I therefore find it difficult to support the new plans for economic growth. I have two very large reservations about the plans. The first is the plans seem to benefit one sector of society over everyone else. People who already own a house and existing businesses have been allocated an advantage over the rest of the country through the low interest rates and ability to get cheap credit. I don't think this is fair and I don't think it is helping. There is evidence to suggest these plans are detrimental to certain sectors of society (especially the young), which I addressed in my article at the ASI. The second problem I have with the plans is the increase in debt could create problems further down the line than just an increase in inflation.

Just assume that the plans fail. The price that was paid for the mortgages on the houses bought during the implementation of the plan would be artificially high. That means it is unlikely the price can be sustained in normal market conditions, which will occur as soon as the stimulus stops. Whoever bought a house during that time would have negative equity and would have to pay back a mortgage greater than the value of the house after market correction. Therefore the plans, although perhaps well intentioned, may well create more problems than a short term fix to the economy justifies. I can appreciate the concept of stimulus and the desire to get the economy growing again. However I believe there are better ways of doing it. I would personally use the new funds created through QE to pay for a reduction in tax, in particular VAT and National Insurance Contributions.

A cut in VAT would lead to an increase in consumption and generate greater demand in the retail sector. I believe a decrease in National Insurance Contributions would lead to an increase in employment due to the lower hiring costs it enables. These supply side techniques would conform more to the traditional conservative economic perspective than the plans suggested by the Chancellor and would also pose less of a threat to the economy later on in the business cycle, either through the prevention of inflation or negative equity.

In addition to the domestic consequences of the suggested plan I think it is poignant to include the international ramifications. Foreign investors will look at the plans negatively because the market has not been made more open. The options the Chancellor has chosen will create a greater debt ratio or currency devaluation, which will deter foreign interest in the UK. The tax reduction strategies I suggested would be appealing for foreign investors and direct funds from abroad because they offer the potential for long term growth and an increase in the private sector market, this would be desirable for foreign investors as it offers the greater potential for a good return.

Finally I have an issue with the overriding concept of the plan, which assumes an increase in growth is needed to remedy the economic problems seen in the UK. The idea that growth will make things better is in my opinion a false promise. The economy may grow but that does not mean the standard of living improves. Where the money is spent through further QE will determine who will see a better living standard in the country. The best method of creating an improvement in living standards for everyone would be to allow market correction that sees the price of goods fall back in line with earnings. That way the cost of living will become lower for everyone not just the lucky few who manage to push some QE funds in their direction.