There is no correlation either, in the long-term UK data, between long-term bond yields and levels of government debt. That’s not to say that QE has no effect on monetary conditions. At least for a time, and like a reduction in the policy rate, it helps to reduce the real cost of borrowing, for the private as well as the public sector. But it’s important to understand that policy is only one of many influences on those costs. A “model” of bond yields that has them responding only to public-sector debt issuance, with or without purchases by the central bank, performs very poorly in the data. One cannot conclude from a coincidence of higher government borrowing on the one hand and lower interest rates on the other (whether short or longer-term) that monetary policy is doing anything other than what it should do. As I said in the introduction, the acid test is ultimately the behaviour of inflation itself. Anyhow, let’s have a look at some of the numbers, starting with short-term policy changes. Charts 3a and 3b get across clearly the correlation with economic activity under inflation targeting. For the post-crisis period they both make some attempt to include shifts in QE, via a translation into the equivalent change in Bank Rate. The first plots changes in the resulting shadow rate (as developed by De Rezende and Ristiniemi (2020)) against the growth of GDP.
Third, and instead, what matters more – not just for inflation itself but the cost of government debt as well – is the prevailing regime for monetary policy. The two can clearly interact: the monetary regime was abandoned in those wars partly because of the pressures from higher spending, and it was that de-linking from gold that allowed prices to rise in the first place. Equally, it was precisely because of the visibility and prominence of that measure, and the belief that it was likely to be temporary, that both the subsequent inflation and the rise in the cost of new government borrowing were contained to the degree they were. Conclusion Aggressive monetary easing by central banks, occurring as it has alongside very large government deficits, has raised fears in some quarters about “monetary finance”. These are misplaced. Certainly there’s nothing about the coincidence of the two in time that, in and of itself, constitutes monetary finance. If the rise in government debt is caused by a weak economy, something that would otherwise depress inflation, easing policy is exactly what an independent, inflation-targeting monetary authority should be doing. Theory tells you that, to stabilise inflation, policy needs to lean against swings in demand and UK history bears that out. It’s true that, if only for a while, easier money policy reduces the real cost of borrowing, for public and private sectors alike. That’s how it’s meant to work. The reduction in the cost of borrowing for the private sector stimulates demand and inflation.