The Bank of England should expand its toolkit to include interest-rate cuts on reserves and consider steps to aid banks such as buying their bonds or injecting equity into them, said former policy maker Charles Goodhart.
“Although quantitative easing was originally successful, it’s now largely a spent force,” Goodhart said in an interview in London today. “The problem is that it’s not answering the correct problem, and the correct problem is nothing to do with a shortage of liquidity.” The main obstacle is the “spread between the funding costs of the private sector, particularly banks, and the public sector” which “QE does nothing directly to affect.”
Some Bank of England policy makers have voiced concern that their bond-purchase plan may be becoming less effective ahead of next week’s decision about whether to expand stimulus. Deputy Governor Charles Bean said earlier this week that consumers’ and businesses’ concerns about the outlook may undermine the impact of QE, while Deputy Governor Paul Tucker said in September that it doesn’t have the “same bite.”
Goodhart said the central bank should cut the interest rate it pays on excess commercial-bank reserves it holds to encourage lenders to buy public debt and lower the government’s borrowing costs. While this “would complement and extend QE,” it isn’t a “game changer” because it doesn’t tackle the willingness of banks to extend credit to businesses and households, he said.
In this regard, the Bank of England’s Funding for Lending Scheme, which aims to provide banks with cheap finance to boost credit, has been “potentially quite successful,” Goodhart said. Officials should be prepared to support the plan with other measures, he said, including buying banks’ bonds and even injecting equity into lenders that are failing to expand credit.
“If there’s a real euro crisis, and you can’t rule that out, then you’d go straight back to QE,” Goodhart said. However, “if the U.K. economy remains weak, perhaps because of this fiscal tightening, and if the FLS doesn’t work out and if the euro zone remains stable, then I would like them to do these additional things.”
Goodhart served as a founding member of the central bank’s Monetary Policy Committee from 1997 to 2000 and is now a professor at the London School of Economics.