Keeping a straight face

As far as anyone could tell, Bank of England Governor Mervyn King neither smirked nor blushed when he announced a further £75 billion of quantitative easing (QE) yesterday, though of course he may have had his fingers crossed under the desk. The move is needed, says King, to make sure inflation does not fall below the Bank's 2% target. Here's part of The Independent's report:

The Bank, which left interest rates at a historic low of 0.5 per cent yesterday, dismissed the argument that asset purchases will stoke inflation, which at the moment runs at more than double the Bank's official target.

On the contrary, the Bank's Monetary Policy Committee said, price pressures throughout the economy are receding as the economy weakens and QE is needed to help Britain avoid a deflationary slump. "The deterioration in outlook has made it more likely that inflation will undershoot the 2 per cent target in the medium term," it said. "In the light of that shift in the balance of risks... the Committee judged that it was necessary to inject further monetary stimulus into the economy."

Well, if the goal of QE is to boost inflation, it's certainly been a roaring success -- and the latest producer price figures, released today, strongly suggest there's more of the same to come, despite King's assertion that the peak is nigh. However, if the goal is to boost growth, the evidence is rather more mixed. Although it's impossible to test the counterfactual (what if there had never been any QE?), even the Bank's own claims for QE -- that it has added 1.5-2.0% to growth -- are modest enough to be not much more than a rounding error.

It's hard to be surprised by this. If Mervyn King were to listen to the vox pop, he'd find that most people say they are cutting back on spending because they are being hit hard by inflation. Sure, unemployment is severe problem for some, but joblessness has risen much less than anyone feared, and well over 90% of the workforce are still employed. In contrast, inflation and the fear of worse to come affects just about everyone. QE2 can hardly fail to ratchet up inflation fears even further, and hence must be rated as most unlikely to do anything significant to boost real growth.

The Bank of England now seems to have completely lost touch with one of the key tenets of inflation targeting: you have to take divergences from the target equally seriously whether they are to the high side or the low side. The Bank has been warning of the risks of below-target inflation for month after month, and did so again in announcing QE2, even while watching with insouciance as the actual inflation rate has risen relentlessly to more than twice its 2% target. The credibility of the entire targeting approach may well have been blown to smithereens -- maybe it's no wonder Mervyn wasn't smiling yesterday.