Several questions have been asked about whether or not People's Quantitative Easing funding imposes a cost on the Bank of England because it is paid for with newly created Bank of England money. My argument was it does not because the Bank of England is not an entity separate from the Treasury and so all the interest flows are within the government sector.
It's a point Paul Krugman, in a sense, made in 2012 when he said:
David Beckworth has a good piece on a point I've also tried to make: the irrelevance of “helicopter money”, and in particular the irrelevance of the decision to finance budget deficits by printing money as opposed to selling bonds.
Why is this an issue? Because a fair number of people have in fact argued that we can get extra bang for the stimulus buck if we pay for infrastructure investment and so on through the printing press rather than conventional finance. Now, the truth is that this would do no harm – but it would also do no good.
It doesn't take fancy analysis to make this point – just an acknowledgement that in financial terms, at least, the central bank is part of the government. The Fed, for example, remits the interest it earns on government debt to the government proper, keeping only that amount it needs for operations. So for the purpose of our analysis right now, we can use the term “the government” to include the central bank.
I added the italics.
First this piece makes my point: that the Bank of England should just be though of as part of the government and so, first of all PQE does not create debt per se, and does not create an interest cost per se on the debts created by a National Investment Bank (as Jeremy Corbyn would use for this purpose). But it does create an interest charge on reserves, which I accept, except that as the Bank of England has recently said in an email to a person who asked what the impact of this was, and which was shared with me:
Thank you for your email of 10 August. You are correct that the APF owes interest on the loan from the Bank of England at the prevailing Bank Rate, as well as any administrative costs.
To understand the flow of funds related to the interest payments on the loans made to the APF, we need to consider the impact of APF transactions on the Bank's balance sheet. When asset purchases are made through the APF, a corresponding liability is created on the Bank's balance sheet in the form of central bank reserves. Under the current sterling monetary framework, the Bank remunerates all reserves held at Bank Rate. As a result, interest payments by the APF to the Bank are broadly offset by interest payments made by the Bank to reserve account holders.
Thank you once again for writing to the Bank of England.
Yours sincerely
Jasbinder Kaur
Public Enquiries Group
Bank of England|Threadneedle St|London EC2R 8AH|+44 (0)20 7601 4878
To elaborate that, the APF owns the £375 billion of current QE assets. And the interest it pays is (plus or minus) born out of interest paid by the government on the bonds the APF owns. Except that as gilt rate is above bank rate right now (roughly 2% compared to 0.5%) there is a guaranteed imbalance: the government has profited from QE by markedly reducing its interest costs as a result. That is why a substantial return has been made by the Bank of England to the Treasury. That would only change, of course, if the effective fixed rate on the QE funds rose above bank rate. I am not seriously expecting bank rate above 2% for a long time to come. In other words, QE and so in turn PQE is, right now, the cheapest form of money the government can lay its hands on, and certainly cheaper than gilts. Krugman was not quite right on neutrality as a result. The trade off is some increased long term risk. The consequential incentive created is, however, for the government to keep interest rates low, which I would argue an essential feature of any economic policy the UK needs for decades to come, so there is nothing wrong with that.
But for those who want to take this issue a little further, can I recommend a 2012 response to Krugman from Prof Stephanie Kelton? This is important. Because some may not be able to access it I have turned it into a PDF, with Stephanie's permission. As Stephanie argues in the first instance:
Some, however, still question [Krugman's] idea because they wrongly believe the Fed and the Treasury to be two separate entities. While this may be the case on paper, in reality they represent more of a married couple with a joint account than two separate entities.
And as she then says:
To help explain, we've done some balance sheet exercises to show how it is that the ultimate outcome of bond-funded spending, whether QE supported or pure money printing, is the same.
In other words: printing money is neutral from an economic perspective. And it makes not a jot of difference to a central bank, because in fact it does not change that central banks overall position. In the process Stephanie also shows that the ban on central banks lending direct to central treasuries is also absurd.
This though, is not the end of it. First, the difference can matter if broader issues are considered. All Krugman sought to show was that the Treasury / Central Bank split was just a facade, which it so obviously is. When that is accepted it is Modern Monetary Theory explains why there is a real choice to be amde between bonds and any form of QE. As Stephanie puts it, the question is:
When institutional formalities are removed and we look at the real mechanics of what's going on when the “the government” buys back its Treasury bills, it is as if it had never issued it in the first place.
Consequently, the fact that the government funds itself through bond sales serves a different purpose than one of pure financing.
I have, of course, shown that the net effect of QE in UK consolidation is cancellation. This confirms Stephanie's first point. So, the second is important. What are the reasons for bonds, or PQE come to that? Stephanie says (and I have anglicised, a bit):
[Any] deficit creates reserves and deposits. Obviously this is an option available to a currency issuer without issuing debt first, whether via consolidation or via overdraft for the government's Treasury to the government's central bank if the government so allows.
But without [bank base rate] set at the targeted interbank rate, adding reserve balances causes the interbank rate to fall below the target rate, all the way to zero. The only alternative is to drain the reserve balances through sale of (in this case) [gilts] if the government (or central bank if we aren't consolidating) desires a positive interbank target rate. Thus, as Abba Lerner put it, the purpose of bond sales for a currency issuer isn't “financing” but rather a desire that the public should hold bonds rather than reserve balances earning interest [at bank base rate].
To put it another way: this is about controlling rates, but has nothing to do with funding, which a government with its own currency can always do anyway, and at what will usually be lower rates than those set is gilts are issued. As Stephanie then concludes:
Of course, none of this means that a currency-issuing government should run large deficits, or that it always has an interest to do so. What it shows is that it can do so without worrying about bond vigilantes because the interest rate on the national debt for a currency-issuing government is either [bak base rate] –a policy rate–or the [gilt] rate, which arbitrages with the policy rate. Splitting up the central bank and Treasury doesn't change this, and neither does the self-imposed requirement that the Fed not provide the Treasury with overdrafts–which simply means that the Treasury can issue debt at roughly the Fed's target rate via [gilts].
But it does mean that co-ordination on these issues is vital, making a mockery of a supposedly independent central bank, as I have long argued.
So where does this leave PQE and interest cost? It leaves it in the mix as an option of choice. It is, effectively, a bank overdraft for the state rather than a gilt at the end of the day. And the choice as to which to use depends upon either target interest rates and other, non-financial, targets.
But the argument that PQE both works, and does not impose additional cost, and might usually be cheaper when there are long term very low bank base rates happily survives the analysis. As I always thought it would.
After which why political economic choices might suggest PQE is the proper choice becomes the question to consider, but that is for another blog.
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Article 123 of EU’s Lisbon Treaty prevents central banks from printing money to finance government spending. How will PQE succeed if this is the case?
Because across the EU it is being treated as legal
Mark Carney and Mario Draghi both agree
So stop wasting my time: the question has been answered
The MMT view is you just set interest rates at zero permanently and use fiscal policy.
Treasury rums an overdraft at BoE (Ways and Means Account)
And on the Consolidated Balance Sheet this doesn’t exist.
Essentially the UK is “MMT ready” already but ideology stops access to central bank money being used.
I think you somewhat simplify the MMT view
But it does certainly think fiscal policy has priority – and so do I
Another blog is forthcoming drawing many strands together, maybe tonight: if not, tomorrow morning
There’s a glaring flaw in PQE which I’ve pointed out before on this blog. It’s as follows. Having the state print money and spend it is stimulatory. But in some years little or no stimulus is needed. Ergo in those years the amount spent on infrastructure projects would decline dramatically or even grind to a halt. Not very clever. Is that difficult to understand?
But that’s not to rule out having the state print money and spend it. Indeed the submission to Vickers by Prof Richard Werner and co-authors advocated just that. Their system for doing that was much better thought out than PQE. See bottom of p.10 to top of p.12 here:
http://b.3cdn.net/nefoundation/3a4f0c195967cb202b_p2m6beqpy.pdf
In particular, under the latter system, government would not CONCENTRATE new money on just one or two areas like infrastructure: it would spread it fairly widely: even spend some of it on tax cuts rather than more public spending.
Moreover, the fact that there has to be coordination between central bank and Treasury under “print and spend” does not “make a mockery of central bank independence” as claimed by Richard Murphy above. Under Werner & Co’s system, the central bank (or some similar committee of independent economists) has complete independence when it comes to deciding the AMOUNT OF new money to be printed, but no independence whatever when it comes to strictly political decisions, like what that money is spent on.
I hear all that
The only slight problem is that this system effectively requires the abolition of banking as we know it
And I really do not see that happening
Any more than I see an end to state infrastructure spending
I am sorry: I simply do not agree in other words
First, the arguments for and against full reserve banking are entirely separate from the “print and spend” question. I.e. you can have PQE or “print and spend” without full reserve.
Second, the fact of abolishing X, Y, or Z as we know it, i.e. the the fact of arguing for a root and branch reform of X, Y or Z is not an argument against that reform. I might as well argue that Corbyn’s PQE is totally different to anything that’s gone before, ergo it mustn’t be allowed.
Third, parts of the existing bank system, specifically National Savings and Investments would fit into a full reserve system as if nothing had happened.
Sanjay
Let’s get real: right now full reserve banking is not on the cards
And I deal with the possible
Richard
Just a few comments on your post.
Firstly, one of the problems of Western economies in allowing NeoLiberal thinking on money creation to gain such a hegemonic hold on its citizens’ minds is that it discourages the necessary effort of looking at the effects of consolidation of both sovereign government (consolidated Treasury and central bank) and private bank creation of money from nothing in particular the effects of private bank loans when spent into an economy being subject to taxation as the loan money circulates from pocket to pocket. “Corbynomics” is nothing if not a return (according to your view on Keynes) or fresh thinking on the importance of consolidated thinking on money creation.
Secondly, Geoff Tily in his book “Keynes Betrayed” argued that central to Keynes’s thought was that it made sense for a (consolidated) sovereign government to keep base rate (or reserves rate) as low as possible because the higher private bank loan rates were the more riskier the investments simply because the profit margin had to be higher to compensate for the higher bank loan rate. Stephanie Kelton’s MMT perspective outlined in her FT article whilst correct and in favour of sovereign governments targetting a low reserve rate rather than the use of bond issuance I think neglects the point that Jeffrey Lau and John Smithin make in their 2002 paper “The Role of Money in Capitalism” that money forms part of the social contract for the purposes of social stability. Aiming for really low interest rates can undermine that social stability because “A particular problem would exist if real interest rates become negative, as then the real value of financial resources would be eroding over time.” Of course, English landed gentry in the 18th century liked low rates because it made their estates more valuable from the point of view that low interest loan rates made their purchase cost more “affordable.” Clearly though there is an issue here that MMT needs to better address. Perhaps they have but I am not aware of it.
http://cs.marlboro.edu/courses/spring2013/adams_tutorials/Munoz/Role_of_Money_in_Capitalism.pdf
Quote from pages 16 and 17.
Much in your second para I agree with
I know and like Geoff – and his book is brilliant – heartily recommended
I agree with Geoff re low rates: I think they are vital. PQE would provide very strong incentive to achieve that for reasons noted
I see no reason to create significantly positive rates: they simply redistribute wealth upward. Negative rates indicate another malaise: in between there is zero real rate. It, or there abouts, is a compromise with some virtue to it
I think that to say QE as so far conducted is not a cost to the state is not fully clear.
First, the APF bought gilts at a higher cost than their final redemption cost, which means that some of the extra interest they receive will have to be used to cover this shorfall.
Second, the Bank of England will be paying interest on the central bank reserves created under QE, for which they might not get back the full value in the future.
And who gets the Bank of England’s losses? Well as ever they become profits to the private banks.
But this does not have to be the case under quantitative easing, and only happens because in the past QE has been conducted through the private banks. Under people’s QE any profits would go direct to the people!
You rightly point out QE flaws
But not PQE ones
Central banks don’t make “losses”.
Interesting point: they can and do suffer movements in their own reserves
Richard
Don’t think you’ve covered this but forgive me if you have.
If the operational reality of bond issues is to control the target rate by draining reserves, consider the effect of paying interest on reserves whch the bank has done since 2009. It achieves exactly the same effect without the need to issue ‘debt’.
If it offers interest to banks at the target rate then those banks will not lend to other banks below that rate. The reserves are neutralised and the target rate achieved. There is no need to issue bonds at a higher rate.
Also if you check out the consolidated government accounts issued by the treasury each year you will see that they net out the QE assets and liabilities. Stephanie is right. The debt is gone. You know it. I know it. The Bank of England knows it. Even the treasury knows it. Yet an accounting trick that would be prohibited in any set of group accounts has been engineered for political expediency. Can you imagine just as the austerity agenda was being introduced what the effect of saying ‘Oh and by the way we’ve just destroyed a third of the national debt” would have been ? They expected to be able to resell the debt into the secondary market I guess. The only way that is going to happen is if the Bank of England buys another big chunk of it. Presumably from itself.
Agreed
See here http://www.taxresearch.org.uk/Blog/2015/08/05/qe-does-cancel-government-debt-its-own-accounts-prove-the-point/
And incidentally, the rate on reserves is lower than gilt rate: PQE saves money. Osborne knows this. Its one reason why QE has helped him reduce the deficit. But no one will say it
So if Osborne knew that a 3rd of the national debt was gone, why the hell was and still is advocating for austerity to reduce the national debt?? What is going on here?!
Lies, damned lies and national accounting
WOW!! 0_0! Cant a case be put in the courts then on the grounds that the prime minister knowingly lied to the general public about the need for austerity and in turn caused unnecessary damage to the UK society? In my personal opinion, this is A REALLY FLIPPING SERIOUS ACT!
Hi Richard,
Thanks for the post.
A very basic question has risen in my mind from reading this.
If the central bank and treasury come under the government, why do they loan the money to the government at interest? Why not loan it interest free? If the central banks can create and issue the government’s money why the need to loan it out at interest? They wouldn’t have a profit motive would they, because what would be the point of it?
In effect it is interest free when done internally
But they play a game that the central bank is independent
More lies, damned lies and national accounting
Pff! So the interest ends up just adding to the confusion rather than doing anything worth the added confusion?
Also, can you please recommend a good place to start about understanding the ACTUAL macroeconomic workings of the government for students new to this?
Try this?
http://www.3spoken.co.uk/2010/04/primer-on-modern-monetary-theory-mmt.html
Neil comments here regulalrly
Right! Thanks! And about the interest part of my question? Is there any use for it?
Can’t remember the question
So Government produced money IS cheaper but by pretending it isn’t means that the private banking systems (and their ‘investors’) get to make huge amounts of money out of issuing money as debt?
Damned lies indeed. I was about to ask how ‘they’ get away with it but we already know don’t we?
Pff! So the interest ends up just adding to the confusion rather than doing anything worth the added confusion?
Also, can you please recommend a good place to start about understanding the ACTUAL macroeconomic workings of the government for students new to this?
Lastly, if I understand correctly, the aim of MMT is to show that the main constraint for a government to carry out its objectives is resources, not money. So, do you know if Jeremy Corbyn(and his supporters in the party) have analysed whether the UK actually has the physical resources to do what they want? I suppose my larger question is that, if the government of a country doesn’t have to worry about money, how does it actually analyse/calculate whether it has the resources for its plans and whether its a good idea to use those resources at that particular time?
As I have made clear: the OBR think the capacity to invest at the scale I suggest is available without inflation
I do not think business will do it
So I suggest government could
I think that’s fair
It was a question to your reply –
You – In effect it is interest free when done internally
But they play a game that the central bank is independent
More lies, damned lies and national accounting
Me – So the interest ends up just adding to the confusion rather than doing anything worth the added confusion?
Effectively, yes
But you have to accept the accounting on a consolidated basis to agree that
Right.
So I reckon if economists do accept the consolidation of treasury and central bank, then a lot of the mainstream macroeconomics would come under question, and I suppose their intellectual legitimacy too.
By the way, can you please program your blog so the reply button comes on the comment I would like to reply to instead of the main comment. For some reason, the reply button does show up on every other comment that others have made and you have replied to, but not on the your replies to mine.
Thanks!
Sorry: way beyond me to program that
Agreed on economists
Richard,
I expect you’ve covered it previously, but how do you deal with the apparent prohibition of “monetary financing” in the Treaty for the Functioning of the EU (TFEU) – unless there is an ’emergency situation’ and the country whose bonds are being purchased is receiving (or will receive) formal support from the ESM and/or is or will be in a Troika support programme? I accept a lot of this is an alleged “rules-based” fiction to keep Germany (and others in its orbit) happy – although the Court of Justice of the EU (CJEU) has told the German Constitutional Court to butt out when it queried the legality of Outright Monetray Transactions (OMTs). The threat of OMTs provided the big bazooka Mario Draghi needed when he promised to do what it takes to save the Euro and to put some manners on the disaster merchants in the sovereign bond market.
I suppose where I’m a little confused is in terms of do you see PQE being wheeled out only when the wheels start to come off George’s cunning political, but economic illiterate, strategy, or would it have role from the get go as a means of financing infrastucture investment? I realise all of this is hypothetical with fixed term parliaments – unless there’s almost total economic and political chaos, but if it’s the former there is no TFEU issue. The latter may be more problematic.
I am very confident Osborne will not deliver
I am also quite confident the EU will have done so much near equivalent QE by 2020 that there will not be a hope of legal challenge to what I propose
Which is why Carney and Draghi have already said it is OK
Thank you, Richard. I suspect the real benefit of PQE, similarly to that of OMTs on bond market participants, might be the threat it poses to the companies and individuals sitting on mountains of cash. They can invest it at an appropriate risk-related rate of return or see its value erode as PQE does what they should be doing and introduces some economy-benefitting inflation.
On another slightly different, but related, tack, I find it interesting that the Competition and Markets Authortity (CMA) has published only a handful of the responses to its proposed energy market remedies. The deadline for submissions was extended from 31 July to 5 August, but there have no updates since 31 July. I expect there was almost total rejection of its main remedy to prevent ‘inactive’ consumers being gouged – this ‘regulated safeguard tariff’. I remain convinced that, for a variety of reasons, renationalisation is not the answer. But a ‘regulated safeguard tariff’ isn’t either. More on this if or when my response appears on the CMA’s website.