The Bank of England does not understand its own flagship quantitative easing programme, the central bank’s internal independent watchdog concluded on Wednesday.
QE, which operates by the central bank creating money and buying government bonds in financial markets, aims to provide monetary support for the economy during the coronavirus pandemic, primarily by seeking to keep inflation close to the central bank’s 2 per cent target.
The BoE’s programme has worked operationally but caused controversy because the central bank’s “important knowledge gaps” hinder its ability to build “public understanding and trust in QE,” the review by the Independent Evaluation Office said.
The BoE says its £895bn QE programme also helped soothe disorderly financial markets last spring.
But over the past year, investment managers have become convinced that the programme is aimed at reducing the cost of government borrowing to pay for the Covid-19 crisis by becoming the market’s main buyer of government debt.
The findings were uncomfortable for senior BoE officials who plan to increase the amount of money printed in 2021 to an equivalent of about £13,000 for each individual in the UK. The conclusions have nevertheless been accepted by senior management.
In a response to the review, the BoE said it “welcomed the recommendations” and would work on “advancing and applying its technical understanding of QE, ensuring that the governance and implementation of QE remain fit for the future and building public understanding and trust in QE”.
Since becoming BoE governor last March, Andrew Bailey has been open about the limits of the central bank’s understanding of QE, which has been its main response to the 2008-09 financial crisis, the 2016 EU referendum and the coronavirus pandemic
He told the Lords’ Economics Affairs Committee in October that he agreed with former Federal Reserve chairman Ben Bernanke that QE “works in practice but not in theory,” noting that, “even over a decade on, there is still a lot of debate about it”.
The monetary policy committee’s inability to explain how QE works resulted in the BoE’s most senior officials being unable to say in November why they chose to print another £150bn of money to address the pandemic rather than a different quantity.
The bank’s evaluation office recommended that this change in future with more research dedicated to understanding the effect of QE, especially as the policy “should no longer be seen as a transient, ‘unconventional’ crisis response”.
“At times over the past decade, and accepting the considerable demand on its resources, the Bank arguably underprioritised such investment work and lacked a structured plan for delivering it,” the watchdog said.
It added the BoE should give more evidence to explain is choices when it designed the programme, such as the total amount of assets it has chosen to buy, the pace of purchases, the reinvestment strategy and the types of assets bought with the newly minted cash.
The evaluation office said that the BoE had conducted QE operations with efficiency and “excelled” at delivering the policy at pace and often in crisis situations.
It said the BoE’s lack of understanding had hampered effective communication of QE, resulting in the policy being “a poorly understood monetary policy tool for much of the public” and was “contentious” for some people, especially around the effect it has had in raising asset prices and potentially widening wealth gaps in the UK.