Chris Giles is continuing his obsession with interest rate increases in the FT today. In advance of the budget he has suggested that:
Th[e]remarkable increase in the sensitivity of the public finances to interest rates has occurred because the BoE has doubled the planned level of quantitative easing by the end of 2021 to £895bn.
He elaborates by suggesting that because the QE programme effectively replaces government bonds with cash balances held by the clearing banks with the Bank of England whilst the interest on the bonds is cancelled that due on the bank deposits is not. And so, with breathless excitement he anticipates an almost instant transmission mechanism between interest rate rises that the Bank might choose to make and increased cost for the government.
It's Giles' suggestion that this one fact, by itself, might increase interest cost by £9bn.
For reasons that are not apparent (and which do not exist) Giles assumes index linked borrowing costs would also increase by 1% if base rates increased by that same amount. For simply presuming the relationship he should pick up the ‘duffer of the year' award.
And third, Giles then assumes all other gilt costs would rise by 1% even though this is not true because most gilts are very long term and it can take 14 years for interest rate changes to work through into changes in government borrowing costs.
But, Giles wants to say that interest rate risers could cost the government £25bn, which he says represents a 5p basic rate tax increase (which is not true, either in quantum, or in fact because there is no direct link between government deficits and tax rates, meaning Giles should also get the runner up prize in the ‘duffer of the year' awards for thinking so).
And Chris Giles really does get this very wrong.
Firstly, that's because tax is paid on interest paid, of course. Not on all of it, I agree. Some is paid abroad. Some goes to pension funds. But maybe £4 billion of the increase would be recovered in tax.
Second, Giles ignores that if there was inflation of 1% then it is likely all other tax receipts would also rise. Throw in another £6 billion or so for that too.
And then there are two further issues. First, the Bank of England has to want to increase interest rates, and candidly it is very hard to see why it would want to do that at any time soon. There are about 9 million people not working in the UK right now. If there are grounds for an interest rate rise I would like to know what they are.
Second, Giles makes the mistake of presuming that what has been will be. It is true that the Bank of England has paid bank base rate on the central bank reserve accounts the commercial banks have held with it since 2009, before which they hardly existed. That is because it has been convenient for it to do so. But that does not mean it has to do so. It is entirely possible for it to pay a different rate on these accounts. As rates increase (if they do) then I think this likely. After all, differential rates are normal in banking. But Giles had not even considered the possibility.
To say that Giles gets his wished for monetarist dream wrong is to be kind to him. I am feeling kind this morning. Let's leave it at that.
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I struggled to find this article in the FT online….. until I switched from the international edition to the UK version – there is a message for us there, I suspect.
I am feeling kind, too. I think there might be some progress in Mr Giles’s thinking.
He seems to have accepted the case that the interest rate costs on the government’s gilts held in private hands is a very slow burn issue due to the long average life and turned his attention to Reserves held at the CB. In doing so he has, at least, understood that money, once created by government spending, will always end up as reserves held by clearing banks at the BoE (unless drained by tax/borrowing or a leak in the plumbing). That is progress and the next step is that he accepts your point that the rate paid on these reserves is in the gift of the BoE. We can pay different rates for different purposes. From there he might even get to understand what Recovery bonds are all about!
We can hope….