I have just posted this thread on Twitter:
The Bank of England has a supposed duty to control inflation in the UK, being required to ensure it runs at about 2% a year. The crash in the value of the pound this weekend makes that even more unlikely. What will the Bank do now? A short thread…..
The Bank of England has only three weapons to tackle inflation. One is that it can raise interest rates. It can do this to either take excess money that's fuelling demand in the UK economy out of circulation. But, bankers apart, no one has excess money in the UK right now.
Or it can also raise interest rates to protect the value of the pound because if that value falls the cost of imports goes up and that fuels inflation. We have the pound collapsing on financial markets right now.
The second thing the Bank can do is quantitative easing (QE). QE sounds complicated but in reality it is just a ruse to hide the fact that the Bank is lending the money to a government that needs to run a deficit without it having to borrow from the financial markets to do so.
In effect, QE disguises the fact that the government is really running an overdraft with the Bank of England.
The third thing the Bank can do is quantitative tightening (QT). This is the reverse of QE.
Instead of the government not borrowing from the financial markets when running a deficit, under QT the government does, via the Bank of England, in effect issue new bonds but not to fund a deficit but to, instead, control inflation.
QT controls inflation by taking private sector money out of circulation in the hope that this will reduce demand for goods and services and so reduce inflationary pressure.
This is all the Bank of England can do. It has no other powers. The question is in that case what it will do now?
My suspicion is that if Kwasi Kwarteng does nothing today to address the crisis we are facing the Bank will be having an emergency meeting of its monetary policy committee very soon.
The only purpose for that meeting would be to increase interest rates. They could go up dramatically: something well over 1% might be likely. Even 2% would be possible, I think. Nothing like this has happened since 1992.
The result would be a disaster. Millions of UK households will not be able to pay their mortgages if this happens. Rents will skyrocket too. Renters will feel the impact very quickly. We will face an unprecedented housing crisis if rates go up like that.
That could also lead to a banking crisis bigger than 2008. Only this time we would be the only country facing it.
I hope Kwarteng has the sense to stop this happening. Instead he could authorise the Bank of England to do more QE. The Treasury has to approve this before it can happen.
Even if it did there is no guarantee the Bank would do it. Only last week the Bank decided, quite bizarrely, to do £80 billion of QT instead. I have no idea if they could be persuaded to change their minds.
If they will not change tack them Kwarteng could suspend the Bank's powers. He can do so, in effect, using a 1998 Act of Parliament. This would spook markets, again, but it may be he would have to take that risk.
Then Kwarteng could demand the Bank do £250 billion of QE (which is less than it did for Covid) to provide him with the money he needs in the next year. That would work, just as it did in the 2008 crash and in 2020 and 2021.
In that case the markets would not be asked for new money. They would not need to be spooked to the extent that they are now. The pound could stabilise, and even rise a bit. Time would have been bought. That is vital when everyone is panicking.
However, the crisis would not be over. Kwarteng's budget still makes absolutely no sense, at all. Markets will know that, and will wonder how long QE could last. The answer is we don't know. But, I stress again, time would be available.
In that time Kwarteng would have to change policy. It would either be that, or the Tories would have to be rid of him and Truss and their madness.
That would still leave us in a horrible mess, with austerity very likely from the Tories (and Labour too, I am afraid). But the moment of madness we are now in could be deferred and some sanity could be restored.
My suspicion is that the Bank are going to force the issue on all this: they are going to either up rates, or want to do QE, or both and Kwarteng will crumble. But that does not mean the crisis is ended.
Kwarteng has revealed the weaknesses in economic management and politics that exist across the UK political spectrum right now. We are going to pay a price for that, and it is going to be massively uncomfortable. Kwarteng has created a mess. It will take many years to clear it up.
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What are the consequences of the QE route? It seems a simple solution which makes me think there must be a cost somewhere.
No, in a word
@ Jack,
Richard says it is possible to have QE and rising interest rates at the same time. I’m not sure about that but the BoE don’t seem to have any doubts. They say no. The vote at the BoE for the £80 billion of QT, which is just the opposite of QE, was unanimous. So there is no chance of the BoE going down the QE route any time soon in any case.
Are there any hidden costs to QE? If government can borrow from the BoE interest free they should certainly do that if they are only thinking about their own finances. However, MMT tells us that government economic policy should never be about those alone. The government has a duty to balance the wider economy rather than its own books.
I’m sure the BoE and Treasury economists will be thinking along these lines even though their actions will appear to be misguided by many MMT economists who would favour anchoring interest rates at 0%.
I am not sure I did say that: my goal is to re-establish low rates
@ Richard,
I wasn’t meaning you in particular. I agree that interest rates should be low but not necessarily always at 0%. Some adjustments may be necessary from time to time but they should be far less frequent than they are now. They should not the main lever for macroeconomic control of the economy.
We can agree then
Depressing as it is, I agree with your commentary Richard. I think a comment I noted in the Guardian this morning sums it up succinctly:
“Nouriel Roubini, the economist who predicted the 2008 financial crisis, warned bluntly that the UK was starting to be priced like an emerging market, and was heading back to the 1970s.
“Stagflation and eventually the need to go and beg for an IMF bailout … Truss and her cabinet are clueless,” he tweeted.” Couldn’t agree more.
That certainly looks to be the case, doesn’t it? One of the reasons Heath took us into the EC in the 1970’s was because we were the ‘sick man of Europe’, for various reasons, cultural, political and structural.
EU membership compensated to some extent, for the lack of investment by our hopelessly short termist business and government culture, which Thatcherism only made worse.
And now here we are again, the sick man of Europe having let the EU on disastrous terms and run by a government of staggering incompetence who are following an extreme right wing ideology that has been proven to fail time after time.
How did we get to this situation? Why do such dreadful, clueless people end up in charge of the UK?
I don’t understand why we should have to go to the IMF for a bailout if QE would do the job. Isn’t that a hangover from the belief that the UK had a finite amount of money?
I’m also unclear as to how rising interest rates protects the value of the pound. Are you able to explain it in words of one syllable, Richard?
There is no way on earth we need the IMF as we owe all our national debts in sterling
I would assume it works like this:
If the interest rates rise then this increases the demand for treasury bonds. Since these are bought in pounds, the demand for pounds increases thus protecting the pound’s value.
A justification for higher interest rates can be made in MMT terms. MMTers sometimes can’t agree on whether currency issuing Governments borrow money or simply create new money. It comes down to the same thing. As Stephanie Kelton often says: A Government’s deficit, or borrowing, is everyone else’s surplus, or saving. However, no causality can be assumed and it works the other way too. Everyone else’s surplus is the Government’s deficit.
This means that the Government can only run a higher deficit, which is its stated intent, if it can persuade everyone else to save more. At a time of high inflation, some increase in interest rates may therefore be necessary.
Your assumption that there is reversible logic in economics is not something I agree with
Hi Richard, have KK and Truss caused this instability, or have they just hastened or accentuated a vulnerability that already existed?
I am also interested in what the road to recovery looks like? To me austerity cannot be the answer; it’s just a grim holding position.
Thanks, Aggie
I will be writing more on that road to recovery, but not now I am afraid
Well, if you are going to count QE and QT as two separate options, then the BoE has at least one more option which is the opposite of interest rate rises – the BoE could cut interest rates.
Doesn’t the Bank of England also have a regulatory role? So perhaps there are other steps they could take, albeit without the immediate and obvious response that QE and interest rates would have.
The government could keep on doing QE but there must be consequences and they will depend on what the government does with the funding. It could use the funds to invest for the future, particularly in sectors with a high multiplier such as health care or which de-risk the future such as insulation and renewables, but it looks like it is going to throw the funds away. Would more QE further weaken sterling, and create yet more asset price inflation, for example?
Kwarteng evinces a “crisis what crisis” insouciance, which suggests either this disruption is deliberate, or he has no idea what he is doing or has done. This is what happens when dogmatic ideology meets the real world.
Other countries must think the UK has collectively gone slightly bonkers since 2016, lurching from smarmy overconfidence to brittle indecision to bluff and bluster to sixth form idiocy. Dear god, where are the adults in the room?
I entirely agree that a good outcome of QE depends on how funds are spent
On that score, Kwarteng would make bad use of the funds
And no, it seems there are no adults in the political sphere: Labour economics is little better and as riddled with dogma, guaranteeing austerity in their case
It’s hardly surprising that the markets are nervous about the worth of the GBP: they’re seeing what looks like individual elements of Government operating against each other:
1. The BoE raising interest rates at the same time as the Treasury announces tax cuts.
2. The BoE does £80bn of Quantitative Tightening while the Treasury is contemplating a new bout of QE to protect the profits of energy companies.
3. The PM calls for more migrants to fill job vacancies while her Home Office is committed to harsh expulsions of migrants attempting to come to UK.
4. Rumours abound that Letters of No Confidence in the PM, the Chancellor and the Cabinet are already being lodged. Whether there is any evidence that this is actually happening or not is largely immaterial, but it’s bound to destabilise the GBP in the markets.
It all smells strongly of headless chickens and none of it makes any sense until it’s viewed through the lens of the Disaster Capitalist. What are the odds on a re-run of Soros 1992?
I am slightly surprised when you say that the Bank of England might argue for QE. Their whole approach seems to have been so conventional. But extreme times call for radical action. Of the three options it is the only one that makes any sense.
If only Labour could do the same.
Richard,
A very good contribution from you on BBC Radio 5 live, Nicky Campbell (a valuable audience I suspect), if I may say so.
On the QE blog here, may I suggest the current problem with QE, it seems to me is that given the actual methodology used in its execution by the BofE (key dealers and elite institutions), this does not actually direct the resources where they are most needed. The proof of its past use is that it ends in asset bubbles, because it is managed by commercial banks and elite financial institutions in their own interests.
We have moved quite far towards a cashless society already; a cashless society is effectively the prisoner of commercial banks – it doesn’t deal in “cash” (notes and coins), but in credit; something quite different in a crisis, as we should know by now in the UK. In a cashless society the commercial banks are going to own our lives, and increasingly will have the power to ‘include’ or ‘exclude’ people from our functioning society, at will.
This comment is not intended as a criticism of the principle of QE in a crisis, but QE as it has been effected, and is likely to be executed in this cost of living crisis.
I agree with that – which is why I use QE as a metaphor for government money creation now, in reality
We do not need the bond shenanigans associated with it, at all
Good to see that others also see self-serving reasons that make the Banks so keen on a cashless society.
I also believe that it must be an offence against the human right to privacy that Banks will soon be able to track our every financial transaction.
However, so low is the ability of most of the public to smell a giant rat even when it is right under their nose that I do not expect much opposition.
Some years ago part of my teaching was to give a couple of lectures about Data confidentiality. Students were outraged that corporations would seek to invade their privacy.
A few years later they were all handing over their entire lives to Facebook.
I am now almost cashless
Mr Langston,
I completely agree. Permissionless innovation and the indifference of Law, lost in inertia as the digital world simply passes it by; has allowed Big Tech and Banking to effectively to use technology to take over the world, without anyone noticing or, frankly, caring. Consumer Convenience has seduced virtually everyone. Children grow up to accept it all as a box of goodies, and nobody provides the cultural, moral and rights framework to understanding. I am terrified by the prospect of Big Tech gobbling up the Banks.
What is to stop them? Politicians? That would be the equivalent of stopping a tank with puff pastry, if you allow me ….. scarcely any exaggeration.
I agree totally about Kwarteng and what he has done.
He seems to be trying to recreate the Thatcher boom (some sort of big bang) but has actually ended up up having the opposite effect because he is oblivious to the effects of 12 years of austerity, too many years of Neo-liberal bullshit (is there anything of any value left to flog and call ‘GDP’?) and perhaps, most importantly, that there is no North Sea Oil revenue to hide the harm he is doing as it did for Thatcher.
All I would add is that even now the Tories are working out where they can cut the public sector if only to be seen to addressing the balancing that people are expecting.
We’ve been told to expect the worst at work – there is a lot of panic in local authorities at the moment and it’s affecting everything we do.
Another scenario: what if this is all intended; a means to cause chaos and, specifically, to undermine the BoE? Disaster capitalism at its finest. I think key elements of this administration are simply not concerned about the next GE (and are focussed on enriching themselves and their backers); those that do are indeed clueless.
I tend to disagree: they think they are on a messianic mission and believe people will see the light very soon
You are right. Messianic is the word.
Once very intelligent people take on an ideology-and what they are doing is very ideological -they cease to be influenced by real world data, dismissing what doesn’t fit and exalting that which does.
…”he’s not the Messiah – he’s a very naughty boy”.
🙂
Kwarteng’s published an explicitly contractionary budget, with tax cuts that cast doubt on the long-term stability of our public sector and even our ability to service the national debt.
The markets’ reaction is entirely rational: the UK is now a less attractive place to invest .
The Bank of England may or may not recognise the trap in front of them: you’ve already pointed out that interest rate rises won’t suppress inflation caused by supply shocks in the labour market and price-gouging by the UK’s energy monopolists.
…But the Bank surely knows the trap of raising domestic interest rates to reverse a currency crisis by pulling-in ‘Hot money’ flows: it works, up to a point, and that point is where overseas investors decide “You can’t afford to pay that”. And the ‘You’ who can’t isn’t always the tax revenue servicing overseas debts: it might be the domestic property market, at risk of crashing if lending rates rise too high, triggering a stampede of foreign investors liquidating their UK property portfolios.
One wonders how much of this Kwarteng actually understands: he and his Prime Minister seem to have a lot of friends among Sterling short-sellers and ‘disaster capitalist’ vultures.
Such has been the ineptitude of Kwarteng’s policies, that I did seriously wonder if it was corruption in play with some sort of collusion with his mates in the hedge fund sector shorting the pound and government bonds to coin it in.
However, this seems a bit too far-fetched. Most likely explanation is that, having worked with Kwarteng in the past, they realise what an absolute pillock he is as regards his absolute dedication to the concept of trickle-down and, as soon as he found himself as Chancellor, there was some easy money to be made by simply betting against him.
Kwarteng’s ‘expansionism’ reminds of the nuclear bomb going off, with all attendant shock waves.
The data on the numbers who would be unable to pay their mortgages for a given rate of increase is on the CountriesWhereSocialismWorked web-site.
They’ve allowed for the benefit of inflation in reducing the real debt to mortgage payers even if wages are rising a few % below inflation. Also they have taken into account forbearance and obtained realistic estimates of the numbers of mortgage holders who do have some excess income or capital they can dip into. They’ve also used the figures on average mortgages rather than average house prices to do their calculations.
Worth a look if you can find it.
Might you provide a link?
There are some difficulties finding examples.
I don’t have the original source – I’m fairly sure it’s Neal Hudson’s work, but I can’t pin it down – but the most accessible account of it is Ed Conway’s analysis for Sky News.
A degree of caution is required when reading material from Sky. Nevertheless, Conway makes a clear point that the affordability of rate rises is far, far worse than forty years ago.
“Add all those things to the equation – debt burdens, incomes, mortgage terms and mortgage rates – you end up with a very different picture. [Nile: from the picture of mortgage affordability in 1980] – Here’s data from @resi_analyst who’s worked out the “equivalent” interest rate – eg the actual BURDEN of interest rates over time.”
https://twitter.com/EdConwaySky/status/1572975530722627584
The difficulty with Conway’s work, or limitation to be more fair, is that it doesn’t take into account forbearance which is far more widely available to borrowers compared to when interest rates were high in the past. And banks will be far more willing to accept the request as the real value of the debt is coming down so fast.
I’ve not been able to find support for the link you asked about
“Richard Murphy says:
September 7 2022 at 6:14 am
The average mortgage is £239,000”
Or have I misunderstood the question
Based on BoE data on mortgage debt and ONS debt on the number of households with mortgages
Based on BoE data on mortgage debt – that’s “£1,648.0 billion” according to
https://www.bankofengland.co.uk/statistics/mortgage-lenders-and-administrators/2022/2022-q2
Might you share a link for the number of mortgages?
Later…
What do you think it is?
It’s not really a matter of opinion this one.
BoE data shows mortgages taken out in the last 4 quarters of around £700bn.
Mortgage approvals in the last 4 quarters for house purchases are around 60-70,000 a month.
You don’t arrive at a £239k average current mortgage.
How does that logic work?
https://www.ons.gov.uk/peoplepopulationandcommunity/housing/articles/researchoutputssubnationaldwellingstockbytenureestimatesengland2012to2015/2020#:~:text=6.8%20million%20(28%25)%20were%20owned%20with%20a%20mortgage%20or%20a%20loan
ONS says 6.8 million households with mortgages
You do the maths allowing for rounding on the total mortgages
1 o’clock BBC News headlines downplaying serious nature of the £’s crisis, saying £’s fall is [only] ‘partially’ due to Tory “mini-budget”, and so the BBC is in damage limitation mode. People remember headlines rather than analysis. Daily Mail headlines – Largest Tax Cuts ever. BBC discussion following was more realistic, and alarming – “6% interest rates…”.
Truss/Kwarteng may get away with this shameless stunt in the ongoing Great British Heist, if the markets don’t punish them enough. They’ll slink in with a QE rescue.
Frances Coppola on O’Brien’s LBC slot this morning was too polite to slam the Tories. And Labour is too polite to be remembered and credible as it tries to appease Neoliberalism as a better alternative – come off it. If not now when – does the opposition speak. No wonder some of your detractors and trolls try to slam you, you are effective.
I worked for an American company in the 80’s and remember in 1981 enjoying a £1 rate of $2.50 when I visited the New Jersey office and then in 1985 the fall towards parity. A colleague of mine had sold his house in 1984/5 to move to the US office and he had to try to buy a US home when it’s was close 1:1 exchange.
this may be a stupid question…
could the government not legislate or intervene for a period so that existing mortgage rates have to be capped at X% despite the base rate going higher? would that be a compromise to allow rates to go higher to strengthen the pound internationally, but without crashing the banks as a result?
I suppose the banks would argue they are losing relative to inflation if they’re not getting base rate back on existing mortgages. But the other hand is they’ll lose a lot more if there are mass defaults on mortgages.
This could crash banks dependent on short term loan funding for their long term lending as Northern Rock did
I am not sure of the scale of this issue now
Capping rates on one particular type of instrument (mortgages) would cause choas (yes, even worse than it is already). However they could cap rates on all loans….. but buying gilts to keep mkt rates from rising….. it is called QE.
🙂
Interesting spat between you and James Medway on twitter.. basically calling you a liar in your assessment that John Mcdonnell agreed with balancing the books and austerity. A lot of venom in his rhetoric.
I imagine gilts could be offered at rates which are not directly tied to the bank base-rate.
It should also be borne in mind that bank loan business is often sold on to third parties in the form of mortgage-backed and loan-backed securities.
Gilts can be offered at any old price. The market buys at the price it wants to pay
” Only last week the Bank decided, quite bizarrely, to do £80 billion of QT instead…”
“My suspicion is that the Bank are going to force the issue on all this: they are going to either up rates, or want to do QE, or both…..”
Isn’t QE primarily a way of reducing interest rates? If so, QT is just the opposite. ie a way of raising them. So if, rightly or wrongly, the BoE wants higher rates there’s nothing bizarre about a round of QT. The bank can’t do QE and raise rates simultaneously according to what they say themselves. Or at least they don’t think they can – if I understand what they are saying correctly.
https://www.bankofengland.co.uk/quarterly-bulletin/2022/2022-q1/qe-at-the-bank-of-england-a-perspective-on-its-functioning-and-effectiveness
If it wants higher rates it can set them
QT is about reducing the size of its balance sheet
“QT is about reducing the size of its balance sheet”
Yes it is but QE/QT is really about influencing the term structure of interest rate. The base rate which they set is only short data, So the purpose of QT through gilt sakes is to raise medium and long term gilt yields. All commercial interest rates follow the gilt yield curve with an additional premium depending on credit risk.
“QT is about reducing the size of its balance sheet”
Yes it is but QE/QT is really about influencing the term structure of interest rate. The base rate which they set is only short dated. So the purpose of QT through gilt sakes is to raise medium and long term gilt yields. All commercial interest rates follow the gilt yield curve with an additional premium depending on credit risk.
I disagree. That’s BS in my opinion
QE is about alternative government funding now
As you said Richard, discussions about what they think they are doing is all part of the “shenanigans” in which the BofE and Treasury (deliberately?) shrouds their devious balance sheet activities. You seek it here, you seek it there …..
Don’t know how true this is:
https://www.independent.co.uk/news/uk/politics/liz-truss-pound-no-confidence-letters-b2175293.html
If it is…….
I quote Larry Summers: Britain is moving from emerging market status to submerging market status.
Won’t be long until BoE announces a halt to QT and maybe they bring forward a rate rise to bat the speculators away. Thus KK gets away with his stupidity and he should be grateful after chastising the BoE up to the election.
Now we have to make rate rises to support our currency we are forced to overtighten in relation to GDP. I have never liked inflation targeting for this reason, the war will not let inflation reach 2%, this is an imaginary number invented by the RBNZ decades ago.
James
If I were you, I wouldn’t quote Larry ‘Derivatives Boy’ Summers on anything.
I said this a few days ago on here but a different thread.
“Personally I think it is deliberate. A general election in a couple of years – this one might be the one to lose. Leave a mess. Then in five years time when things are beginning to look on the up blame Labour for the early mess. Unfortunately people will believe it.”
I believe it more so now – after three days.
Actually, this looks really bad, doesn’t it?
The Neo-libs will point to this being another example of how Government or the State is incapable of running the economy.
As ever with Neo-liberal Thatcherites they can turn their own disasters to their advantage and use them as an argument for their faulty doctrines.
It’s been a bad week for pro-Statists. It’s the reputation of the State that’s being hurt as well – just like how that reputation is also sullied by deliberately underfunding public services to make them look bad.
The cunning of unreason again.
I suspect Stephanie Kelton has it in a nutshell:
https://stephaniekelton.substack.com/p/the-oldest-trick-in-the-book?utm_source=substack&utm_medium=email
Her blog is the perfect companion to yours Richard. Often it’s US – oriented, though none the worse for that since US and UK economics are based on the same deceit. But here Stephanie refers directly to Kwarteng and draws the obvious and probably correct conclusion. After all the same dirty trick was pulled by Osborne in 2010 with disastrous consequences.
I agree – her blog is well worth reading
So, I’m keeping good company then if Ms Kelton is thinking what I am thinking. But there’s no need for celebration, intellectual or otherwise. The trouble is I’m also going to be at the sharp end of it too, working in the public sector.
Could this be the coup de grace at long last?
Wow – 12 year’s an austerity slave and then this…………………………….
I tend to agree, whilst not being one for conspiacy theories I think it very dangerous to dismiss Truss and Kwarteng as idiots or plain stupid……evil, punitive and destructive would be more appropriate. If people don’t acknowledge this then we have no way of countering them. Labour badly needs to name their game!!
I wish there were a group of highly qualified economic advisors – independently appointed – and Chancellors would be legally obliged to consult them before making decisions that could damage the economy. People who would not owe their positions to anyone in government, parliament or the BoE, who would have no links to hedge funds or banks – who would take an oath on taking office, that, to the best of their ability, their advice and opinions would be untainted by private interests, ideology, or abstract economic philosophies and would be pragmatic and based on here and now situations and possibilities.
And I would want the opinions that were given to be open to public scrutiny – published – so that people could have a clearer idea of the decision- making process. They could see if pragmatism produced better outcomes for them than policy based on ego-centric rodomontade