What are the Treasury and the Bank of England up to?


What are the Treasury and the Bank of England up to?

First posted on November 10, 2012 by 

There was an interesting announcement yesterday by the Chancellor saying that excess cash held by the Bank of England’s Asset Purchase Facility will be transferred to the Exchequer.

It’s widely known that the BoE has been purchasing UK government bonds on the secondary markets via QE. To date it has bought £375bn worth. What is less known is that the Government has been paying the Bank of England interest on these bonds – around £35bn so far. Blogger Neil Wilson has written about this previously here, which Think Left drew attention to here.

These interest payments will now be returned to the Treasury on a quarterly basis, so in effect, the bonds held by the Bank of England will now be interest-free. Previously, we have been issuing more debt than we needed to in order to pay interest to the Bank of England, which was actually money the Treasury was entitled to. If it sounds crazy, it is.

George Osborne argues this change just brings the UK into line with the practice in Japan and the US. This is true in that the US Treasury regularly ‘sweeps’ the accounts of the Federal Reserve to return any profits it makes to the Treasury, but it represents something of a volte face and the timing is interesting. A while ago, I put a question to the Treasury about this via my MP and was told that profits from QE would not be returned to the Treasury until QE was ‘wound-up’. They were not able to say when they expected this to be. I had suspected Osborne was saving this up for some pre-election tax cuts, but desperation seems to have set in.

So what does this mean in practical terms? The timing is interesting, coming as it does just a couple of weeks before the Autumn statement, when the OBR was expected to announce that Osborne would miss his debt and deficit targets. As Duncan Weldon argues, this change could mean that Osborne could now remain on course. The payments from the BoE will mean the deficit will be lower than it otherwise would, and it looks like Osborne will not use this money to increase spending, but instead to reduce the amount he borrows externally. This appears to be a purely political move though, as good economics would say this money would be better spent on capital projects, direct job creation, or tax cuts for low earners.

There is a complicating factor here however, in that the Treasury ‘indemnifies’ the Asset Purchase Facility, meaning that if the BoE makes any losses when unwinding QE (if it sells bonds back to the markets for less than it paid for them), then the Treasury would have to cover the losses. So while this may be a short term (political) benefit to Osborne, in the longer term, it may actually end up costing the Treasury more. In reality though, I think it unlikely that QE will be unwound any time soon (in the next five years at least).

If all this sounds confusing, don’t worry, it is. Making the Bank of England a separate entity from the government means that it looks like the debt is a lot higher than it actually is. Officially, the national debt is over £1 trillion, but if the Bank of England consolidated its balance sheet with HM Treasury under the rules in IFRS-10 (h/t Neil Wilsonagain), the debt goes down to around £700m.

A lot of commentators reacted to the news quite hysterically by announcing that the Government had finally lost the plot and resorted to ‘printing money’ again. Jeremy Warner in the Telegraph was one of the first here (although he later rowed back somewhat). This is not what is happening though, and we are just bringing ourselves into line with the US and Japan, although as I said, the timing is interesting.

I’ve argued before that a lot of the hysteria about government debt is irrational. As the government issues sterling, it can never run out of money, neither does it need to tax or borrow in order to finance it’s spending. This latest announcement is just another reminder that much of ‘the debt’ is not really debt at all and certainly isn’t a burden on future generations.

Will our Grandchildren be grateful to the Tory/LDs?


Somebody Think of the Children

First posted on October 27, 2012 by 

‘I think we have a moral duty to the next generation, to our children and our grandchildren, to wipe the slate clean for them. We set out a plan, it lasts for about six or seven years, to wipe the slate clean. To rid people of that sort of dead weight of debt that has been built up over time… We owe it to the youngsters of today to lift that dead weight of debt off their shoulders.’

Nick Clegg, May 2012

Of all the justifications for austerity, the one which says we owe it to our grandchildren to deal with the debt is probably the most emotive. The national debt currently stands at £1 trillion and despite what Nick Clegg says (in the quote above he confuses the debt and the deficit), it’s set to rise year on year. Right wing commentators (such as Fraser Nelson) love to remind us this is £20,000 per person which will need to be paid off through higher taxation in the future. Now it’s true £1 trillion is certainly a lot of money, but is it true that our grandkids will suffer if we don’t deal with this now?

I would argue that the exact opposite is true. What we leave to our grandkids should be measured in real things. Will there be enough housing? Will our roads and railways be adequate? Are our schools good enough? Have we invested enough in the decarbonisation of our economy? In looking to cut now, I believe the Government are on the way to ensuring the answer to all these questions is no. That will be the real legacy we leave to our grandkids. By failing to invest for the future today we will bequeath a less prosperous economy, and a huge debt pile because at the moment austerity is failing to reduce the deficit.

But is this huge debt pile a problem? If it’s been built up investing for the future, it will be less of a problem than if it’s been built up by paying people not to work, but in both cases though, it’s a distributional issue rather than a funding issue. Every £ of government debt is an asset to someone else. The question is who holds these assets? If it is mainly those at the very top, that may be a bad thing. If it’s going mainly to support the retirement income of pensioners, maybe that’s not as bad. We could rectify this distributional issue through the tax system.

So who holds the national debt at the moment?

This data come from the Treasury and is up to date as of Sept 2012. You can see that following QE, the Bank of England now holds over a quarter of government debt. Any interest the government pays to the Bank of England must be returned to the Treasury as profit. So this portion of the debt is no burden on anyone. More QE is likely, so this proportion could rise.

About a quarter is held by the insurance sector. This includes pensions. Most pension funds hold government bonds as part of their porfolios as a way of generating low risk returns, and debt interest payments go towards pensioners income.

The other sector with large holdings of UK debt is the foreign sector. This includes foreign governments and corporations. Just over 30% of UK debt is owed to foreigners. A lot of people may be surprised it’s not higher and are worried about what might happen if foreigners stop buying our debt. The UK is seen as a safe haven at the moment due to the turmoil in the Eurozone, but if there did come a time when the rest of the world stopped buying our debt, this would not mean the government would cease to be able to fund its spending.

It’s possible to view government debt issuance not as a source of funding, but instead as a way of controlling interest rates. The government could actually turn that 25% of debt held by the Bank of England onto 100% and stop issuing debt externally altogether. Some Modern Monetary Theorists such as Bill Mitchell view government debt as “corporate welfare” and think the practice should be stopped altogether.

In summary then, it’s right to think about the longer term and worry about what life will be like for future generations, but in promoting austerity as a way of reducing the debt burden for our grandchildren, what we are actually doing is ensuring they will be less wealthy than if we invested now in infrastructure, education and decarbonisation. I don’t think they will thank us for that, so we need to invest for the future  now to ensure they will be better off than we are today. In Mr Clegg’s words, “we owe it to our youngsters”.

The fundamental deceit of ‘There’s No Money Left’


There’s No Money Left?  by alittleecon

http://alittleecon.wordpress.com/2012/09/24/the-british/ First posted 24.09.12

“The British Government has run out of money because all the money was spent in the good years,”

George Osborne, Feb 2012

“…in the years of plenty they put nothing aside. They didn’t fix the roof when the sun was shining”.

David Cameron, March 2008

“There’s no money left”

Letter left by Liam Byrne, May 2010

For the last 4 years you will have seen or heard quotes like this in the media. How we were on the brink of bankruptcy and how “there is no money left”.  Those advocating a “Keynesian” response to the current crisis are rebuffed with the argument that we cannot increase borrowing now because we didn’t run budget surpluses in the years before the crisis – “Gordon Brown spent all the money”. Keynesianism has now been reduced to “surpluses in the good times, deficits in the bad”.

Liam Byrne’s famous note left as Labour left office was particularly heinous and the Coalition never miss an opportunity to use it as a stick with which to beat Labour. It may surprise you to hear this, but Liam Byrne is not an expert on the economy (or anything else), and should be ignored on all matters economic.

The Government say Labour want to increase borrowing by £200bn, and this would be disastrous as, if the ‘markets’ thought we were increasing borrowing, they would start to worry that we would be unable to repay our debt (or “pay our way in the world” as David Cameron is fond of saying), and interest rates would start to rise. This is basically what has happened in some of the states in the Eurozone, and Coalition ministers have not been shy in pointing this out (repeatedly and at length). Currently, Labour have no coherent response to this.

But is there any truth to this narrative? Is there an alternative path?

Perhaps surprisingly considering they have provided the intellectual cover for austerity, economists have long known that the idea of balancing budgets over the cycle is a bit like a fairy story we tell to frighten the kids. Here’s Paul Samuelson, “father of modern economics” and Nobel Prize winner, being interviewed in 1995:

“I think there is an element of truth in the view that the superstition that the budget must be balanced at all times [is necessary]. Once it is debunked [that] takes away one of the bulwarks that every society must have against expenditure out of control. There must be discipline in the allocation of resources or you will have anarchistic chaos and inefficiency. And one of the functions of old fashioned religion was to scare people by sometimes what might be regarded as myths into behaving in a way that the long-run civilized life requires. We have taken away a belief in the intrinsic necessity of balancing the budget if not in every year, [then] in every short period of time. If Prime Minister Gladstone came back to life he would say ‘uh, oh what you have done’ and James Buchanan argues in those terms. I have to say that I see merit in that view.”

So the idea that budgets must be balanced is a myth. Samuelson believed this myth was necessary to place a leash of governments who might be tempted to spend, spend, spend, but a myth it is never the less. But why is it a myth? Aren’t governments limited in their spending by what they can raise in taxation plus the amount the private sector is willing to lend them?

Categorically no! A country like the UK which issues its own floating currency, does not depend on anyone else for money. It can issue more currency at will and without limit. Therefore, it can never go run out of money and can always afford to purchase anything for sale in its own currency. This is a very simple (and perhaps obvious) point, but one that is generally ignored in all discussions about government finances. When it is discussed, it is discussed in somewhat hysterical terms: “PRINTING MONEY!! HYPERINFLATION!!” etc. etc. More sensible people realise that government creation of money is no more inflationary than bank creation of money. Creation of new money could be inflationary, but only at the point where output is unable to expand any more in response to new demand.

But if a government doesn’t need to collect taxes or borrow from the markets in order to spend, why does it do these things? In a country like the UK, taxes serve a number of purposes. Firstly, tax ensures there is a demand for the government’s currency. We must all pay taxes in pounds (some more than others), so we accept pounds as payment for goods and services so we can pay our taxes. Secondly, taxes make room for government spending. If the government just spent without taxing, very quickly we would reach maximum output and start to experience accelerating inflation. Taxation helps keep a lid on inflation. Finally, taxation is used to meet social aims. These may be to redistribute wealth or to discourage harmful activities, like polluting or smoking.

Why does the government sell bonds? It does this primarily to maintain its target rate of interest. If the government wanted, it could stop selling bonds altogether. This would mean the overnight interest rate would fall to 0%. Bonds also serve as a risk free asset which institutions like pension funds like to hold as part of their portfolios, so they serve a purpose in that way also.

So armed with this knowledge about government finances, what should government do?

  1. The do nothing approach. Like Paul Samuelson says, we can accept the truth about government finances, but also be concerned about letting governments spend without constraint, and so continue to tie our hands with regards to policy options. Taking this approach means we are in for a prolonged slump and a very slow recovery. We could still borrow more from the markets for investment, but this adds no new money to the system, just brings old money back into use.
  2. Use the knowledge that a government is not constrained by revenue and borrowing to actively pursue policies which would restore full employment and raise living standards. One possible approach would be to adopt an idea devised by the economist Abba Lerner (a contemporary of Keynes), known as functional finance. Lerner set out three rules for fiscal policy under functional finance:
    1. The government should ensure there is sufficient aggregate demand to ensure there is full employment. It should do this by lowering taxes and/or raising spending. If inflation beckons, government should do the opposite.
    2. Government should borrow money when it wishes to raise the interest rate and repay debt when it wishes to lower it.
    3. The government press shall print any money that may be needed to carry out rules 1 and 2.

I prefer option 2 as clearly it offers the shortest path back to prosperity. There are issues around how our political system would cope with functional finance, but this is a political problem, not an economic one. If the general public were fully aware of the realities of our monetary system, and the policy options that presented, we could all have a much more grown up debate about which course we should take.

For a full discussion of the nature of modern money, I recommend this video of a presentation given recently by Michael Hudson and L. Randall Wray. It’s a bit long, but well worth the effort:


Further Reading

The following are a few blogs I find useful for helping to understand economics: