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The outcome of quantitative easing on real incomes - summary note

Hector McNeill1

NOTE: This is a re-issue of this note at the request of several readers who had difficulty in understanding my garbled initial version - apologies.

Since 1975, the Real Incomes Approach has explained that the Aggregate Demand Model of the macroeconomy used as the basis for Keynesian, Monetarism and Supply Side Economics (KMS) constantly drain the purchasing power of the currency. The short term impact is instability which manifests itself in winners, losers and those who apparently remain unaffected by policy. But the long term impacts are increasingly apparent in the erosion in purchasing power.

This effect is most marked in the case of lower middle incomes and low income families, thereby exacerbating inequality.

With the operation of quantitative easing since the 2008 crisis, vast amounts of money have been poured into the economy but the evidence shows that a significant proportion has not been channeled into investment for product and service industries but, rather, the funds have ended up in the FICRESS sector which has drained funds from investment and the cash flow (incomes) of lower middle income and low income segments.

With the advent of BREXIT it is regrettable that the government has not seen fit to order the discussion on options to point out the real dangers of some options such as the so-called "no deal option".

The chart on the right shows negative impact of Quantitative Easing (lower interest rates and increased money volumes,
Interest rates
through bank issued debt1 which has resulted in the migration of money to FICRESS2 assets (blue line) leading to a starvation of real investment and returns and in particular real incomes of lower income segments (green line). Stock prices have been driven up by own share buy-backs as ooposed to having anything to do with corporate prospects.

Without quantitative easing and the conventional monopoly imposition of higher interest rates (orange line) bank deposits tend to rise to gain interest payment as returns. However, the interest rates become prohibitive for real sector investment and consumer credit.

In the case of the natural interest rates3 and the application of the real incomes Price Performance Policy (PPP). The real incomes response curve to price performance declines results in higher investment and returns to investment and rises in real income levels, in particular, reducing the precariousness of the lower income segments. Therefore moving away from quantitative easing and stopping centralised policy intervention of arbitrary higher interest rates the real incomes response curve is the PPP curve (red line).

This significant gain in real incomes and returns on investment is also accompanied by a performance/efficiency-based reduction in inflation4, and a recovery of higher returns on savings. This can reverse the asset bubbles by the draining of speculative FICRESS activity and encourages banks to advance loans at rational5 rates for investments in the real economy.

The impact of QE is to accelerate the demise of fixed incomes from savings leading to banks raising money purely based on debt. This has a medium to long term effect of increasing the reliance of economic growth on bank debt and an acceleration in the decline in monetary purchasing power. An article on this specific negative consequence of bank operational interests and government policy will be released soon.

1  The increase in money volumes arises from bank issuance of debt as explained by Bank of England brief: "Money creation in the modern economy"; for further explanation return to home page click on the link, lower down, "The monetary paradox").
2  FICRESS is Finance, Insurance, Commodities, Real Estate and Stocks and Shares (for further information on FICRESS return to home page and click on the link, lower down, "The monetary paradox")
3  Natural interest rates are freely established as a discount on actual returns on investment. Natural interest rates are not subject to monopoly market intervention by the state, imposing arbitrary rates which distort the free market (current basis for monetary policy). This concept was developed and explained by the economist Johan Gustaf Knut Wicksell (for further information on natural interest rates return to home page and click on the link, lower down, "The monetary paradox").
4  PPP secures a strong incentive for inflation reduction through the use of the Price Performance Levy where rebates are gained to the extend that unit price inflation is reduced (for further information on this process return to home page and click on the links, lower down, "The Price Performance Ratio" and "The Price Performance Levy").
5  Under a natural interest rate regimes a "rational" interest rate is located within the spread between normal returns on investment and normal returns on lent (saved) money. It is considered to be rational because both saver and lender benefit (a good example is building society spreads)
Real Incomes Programme  SEEL-Systems Engineering Economics Lab