In this paper, Jan Toporowski (Professor of Economics and Finance, SOAS) and Jo Michell (Associate Professor of Economics, University of the West of England) examine where the Bank of England goes after the quantitative easing that was supposed to overcome the effects of the 2008 financial crisis. They argue that there can be no going back to the pre-crisis orthodoxy of inflation-targeting and that this orthodoxy was incorrectly credited for a period of macroeconomic stability that was subsequently shown to be illusory. As a result of QE, the Bank of England now has a balance sheet whose running down would deflate the financial system.
Instead they argue that the Bank should be given an enhanced financial stability mandate in the form of a target to conduct open market operations to keep the yield curve stable. The history of the Bank shows that these operations in the capital market were conducted through most of that history. This mandate will require more explicit coordination with the Treasury, but need not eliminate the independence of the Bank.
The main finding in the paper is that, whereas the ability of the Bank to control inflation is itself questionable, the effectiveness of the Bank’s open market operations in regulating the liquidity of the banking and financial system is demonstrated by Quantitative Easing. Given the limitations to the Bank’s power, they caution against more fundamental reforms that involve extending the responsibilities of the Bank without increasing its capacity to deliver the outcomes implied by those additional responsibilities. However, they note that some recent suggestions, such as higher inflation targets and ECB-style targeted refinancing operations have merit.
