BOE Paper: Unwind QE Before Hike; Permanent QE Not Beneficial

By David Robinson

     LONDON (MNI) - A Bank of England Working Paper published Friday concludes

that it is not beneficial for a central bank to maintain "permanent quantitative

easing" and that QE unwind should start before hiking the policy rate.

     The paper is by Richard Harrison, Senior Advisor, Monetary Assessment and

Strategy Division, at the Bank, who has been a leading light in the BOE's

research into QE. His conclusions are, at face value, at odds with the Monetary

Policy Committee's current approach of only starting QE unwind when Bank Rate is

raised from its current level of 0.25% to around 2%.

     Harrison found that while QE works, as it creates welfare gains when the

policy rate hits the effective zero lower bound, it is not beneficial

maintaining it indefinitely.

     "Despite the presence of portfolio adjustment costs, a policy of 'permanent

QE' in which the central bank holds a constant stock of long-term bonds does not

improve welfare," Harrison stated.

     In running permanent QE a central bank loses the ability to influence

expectations through asset purchases.

     "The results from my model suggest that it is optimal to start reducing the

stock of QE before the short-term policy rate has been increased from the zero

lower bound," Harrison stated.

     He said that one reason for the apparent difference between his findings

and policy setting by the MPC was that his model focussed on the fraction of the

stock of long-term government bonds held by the central bank as a proportion of

the total debt stock, rather than the absolute size of the debt stock.

     If the MPC holds its stg435 billion of gilt purchases steady and debt

rises, then the BOE's stock of long-term debt as a fraction of UK long-term debt

would fall as long as total debt grows.

     "Actual policy behaviour is indeed broadly consistent with the model's

predictions: a fixed central bank asset stock when government debt is rising

constitutes a reduction in q (the QE policy variable). In the model, because

government debt is assumed to be fixed, q can only be reduced by active sales of

assets," Harrison stated.

     Nevertheless, if and when the UK's total debt stock stops growing, the MPC

will no longer have the get out clause of being able to claim it is tightening

by holding QE steady.

--MNI London Bureau; tel: +44 203-586-2223; email: david.robinson@marketnews.com

[TOPICS: M$B$$$,M$E$$$,M$$BE$]