To: The Right Honorable Bank of England Governor Sir Mervyn King
From: Athinarayanan Sanjeevraja
Date: October 17, 2011
RE: QE
Suggestion: Identify and correct the fundamental factors that are behind low economic growth.
Good Morning Sir. The Bank of England has decided to undertake more QE. I agreed that during the financial crisis of 2007-2008 monetary policy was effective in re-establishing liquidity in the main developed economies especially US, UK and Europe. But current economic conditions in developed economies reveal problems whose solutions are far beyond the scope of monetary and fiscal policy. In my view that QE just postpones and magnifies the needed adjustment to the lower debt to GDP ratio. When that policy expires, sentiment falls unless there is a stable exit strategy. Presently, the BoE faces the challenge to exit the strategy in time to prevent inflationary pressures and minimize any possible negative impact on the UK economy. BoE needs to look for a novel solution to financial problems.
BoE plans to buy £75 billion of gilts over the next four months because you believe that inflation likely to fall back sharply next year 2012. In my opinion, commodity prices are expected to remain at elevated levels in future because persistent excess demand in major emerging market economies which are contributing to broader global inflationary pressure. MPC has spent the last two years insisting wrongly that inflation will fall in the medium term. I reality we all know that it has instead risen. Pumping money into the economy creates inflationary pressures. A bit of inflation would be a good thing; a lot would be disastrous especially if the economy fails to bounce back. A bit of inflation would also be helpful in reducing the costs of debts.
I appreciate that the BoE efforts have worked in as much as you have very probably pushed down yields on gilts below so that it has helped reduce the wider cost of borrowing. Did you realize that the fear in the market had already done the job for driving down yields? If you wanted to buy something you could have gone into the corporate bond market and found better value but there again perhaps you would have been worried about the effects of inflation on that asset. However the aim was also to get credit flowing again, to kick start spending. On that front success has been more limited. In my view money supply – the total amount of money in the UK economy is seen as the best measure of the success. I agreed that money supply has improved but only marginal. So I conclude that success has been more limited in QE Programme. The big concern is that banks and insurers rather than letting the freed up money flow in to the economy, prefer to stash it away to help improve their battered balance sheets and financial strength. As a result, there is a still danger of double dip recession.
As far as the fiscal stimulus programme is concerned, it aimed at raising the public expenditure and reducing taxes. This initiative faces a lack of credibility on future fiscal adjustment because today’s authorities do not want to deal with costs associated with any current austerity measures. In fact the fiscal adjustment needed to begin stabilizing the public debt would probably have a negative impact on UK economy in the short term.
I would like to recommend identifying and correcting the fundamental factors that are behind low economic growth. Greater government intervention and uncertainty on future economic policies could be leading to an adverse business environment. In my opinion lower CPI prices are the key to recovery. Consumer need to be able to buy products with their cash but not borrow back.
Thank you very much for your kind attention to these issues Mr. Governor.
Sincerely,
Athinarayanan Sanjeevraja.
Follow me on Twitter: @ Athinarayanan Advisory Authority
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