After the Lehman failure in September 2008 the view here was that central banks should embark on "quantitative easing", in the sense of direct purchases of assets, ideally from the non-bank private sector, in order to boost the broad money supply and reliquefy frozen credit markets. A severe shortage of money was developing, threatening economic freefall, as bank credit creation stalled and investors attempted to rebalance portfolios in favour of cash – put differently, increased money demand was depressing the velocity of circulation. Large-scale Federal Reserve securities purchases from late 2008, emulated belatedly by the Bank of England from March 2009, succeeded in alleviating the monetary imbalance both by expanding the money supply and stabilising markets, thereby slowing the "dash for cash". Faster growth of G7 broad and, particularly, narrow money, M1, from late 2008 confirmed that monetary conditions were improving, laying the foundations for a solid recovery in global economic activity starting in the spring of 2009.

With global momentum slowing recently, and fears growing about the impact of coming fiscal tightening, there are calls for central banks to engage in a further burst of "QE". In contrast to late 2008, however, there is little evidence that the global economy is being constrained by a shortage of liquidity. Broad money, admittedly, has been sluggish over the last year, with US M2 and UK M4 (on the Bank of England's preferred definition) rising by 2.0% and 1.2% respectively in the 12 months to July. The demand to hold money, however, has been reduced by negative real short-term interest rates and a revival of risk appetite. Velocity, in other words, has recovered – by 2.1% and 4.7% in the US and UK in the year to the second quarter (calculating velocity as nominal GDP divided by M2 or M4). Reflecting reinvestment of "safe-haven" cash, inflows to US and UK mutual funds have been strong, amounting to 4.7% and 2.5% of respective broad money stocks in the 12 months to July. (The latest UK figures, released today, show a £2.2 billion retail inflow in July alone, the largest since November – see chart.) Broad money, moreover, has reaccelerated over the latest three months, with US M2 growing by 5.4% annualised and UK M4 by 5.6%. Narrow money has also picked up, suggesting that economic momentum will revive in late 2010 (see second chart in Wednesday's post).

QE proponents argue that, even if there is no current monetary shortage, further action is warranted as insurance against the "tail risk" of a second recession leading to Japan-style deflation. An additional monetary boost, however, would involve its own risks and costs. One probable side-effect would be a further surge in commodity prices – "QE1" contributed to a 66% rise in industrial raw material costs during 2009. This would raise G7 inflation and lower real income expansion, thereby offsetting the direct boost to demand from monetary stimulus. Higher material prices had limited dampening impact on global growth in 2009 because they allowed commodity-producing countries to increase spending. This is much less likely now, since many of these commodity producers are in danger of "overheating" and will be forced to tighten monetary policies in the event of further stimulus from rising export prices. Even if central banks could be sure that more QE would provide a net boost to global growth, the wisdom of attempting to "fine tune" normal cyclical fluctuations is questionable: stimulus might arrive in early 2011 just as the economy is naturally regaining momentum, leading to excessive expansion and pressure for an abrupt policy reversal.