An incredible way to maintain credibility: Today’s QE news
Today the Treasury and the Bank of England have agreed what sounds like an arcane accounting treatment change but which may have profound political consequences.
The Bank of England has purchased £375bn of gilts (Government debt) as part of its extraordinary monetary policy to support the economy. The purpose of this was to lower interest rates, not to fund government spending.
At present we have the somewhat odd situation whereby the Government is borrowing money to pay interest due to the Bank of England own the gilt’s it owns. This situation does not exist in the US or Japan where the fed and the BOJ simply transfer any interest received back to the Treasury/Finance Ministry.
In an announcement today (accompanied by an exchange of letters between the Chancellor and the Governor) we have been informed that the UK is adopting this approach.
As a result the Bank will now hand back around £35bn of accumulated cash to the Treasury by March next year and the Treasury will effectively pay no interest on the £375bn of government debt (around one third of the total) held by the BOE as long as QE is in operation.
Now this impact will only be temporary, eventually the BOE will (or at least currently plans to) sell its gilts back to the private sector at which point the Government will have to resume paying interest on them.
Today’s decision should not in itself have a significant impact on the eventual aggregate net profit or loss to the Exchequer from QE.
In the medium to long term this will have no real impact on the government finances.
However the decision may have significant political impacts. Until approximately 11.45am this morning may base case scenario, and that of most independent economists, was that the Government was due to miss the second of its two fiscal rules at the Autumn Statement on December 5th. I.e. the OBR would say that government debt/GDP would not be falling in 2015/16.
This accounting change means that the Government is now likely to hit the target.
This raises several issues. Firstly, and of actual economic significance, the OBR note that this change means the Government will issue fewer gilts now and more at a later date. But presuming that the economy gradually recovers, interest rates should rise in the years ahead. By issuing fewer gilts now and more later the treasury will have to pay higher interest costs. This accounting change may well mean the Government hits a short term target but at a higher longer cost to the taxpayer.
Secondly, to account for these change the OBR says it will now have to make a forecast of longer than its usual 5 years. We may be in the very surreal situation of the OBR now saying that the Government will hit both of its fiscal targets but that government debt/GDP will then start to rise after they have been hit. To me this is proof that both rules are badly designed.
I think a third issue, and one I expect journalists to pursue (possibly without much luck!), is the question of where this initiative came from? I.e. the Treasury or the Bank? When was it agreed and by whom? (We know from the Governor’s letter that the MPC were informed of the decision at their meeting this week).
We now have a situation where the Government is sticking to austerity plans as it claims it has to maintain its ‘hard won credibility’. I just don’t see how hitting fiscal targets through accounting treatment changes that may cost more in the long run is anything but incredible.