There is much debate about whether Labour is really short of money, and if it is, why it did not know it was going to be. I was on LBC radio discussing this yesterday.
In this video, I argue that if Labour says it is really short of money it need not be so. I suggest that they just stop paying maybe £30 billion of interest to our commercial banks each year that they have done nothing to earn and then see what they can do with it to change the well-being of people in this country.
The audit version is:
The transcript is:
Three weeks or so after a general election, and there's one thing that is now very clear. Labour is short of money.
There's no great surprise about that.
I said it would be way before the election happened.
Every other commentator said that the forecasts prepared by the Office for Budget Responsibility for the outgoing Chancellor, Jeremy Hunt, which Rachel Reeves has accepted as if they are gospel truth, would result in there being a shortage of government funding for essential programmes.
And now the truth is very apparent. The crisis has come, of course, over the two-child benefit cap, but there are many more such issues to come from now on. The government is massively underfunded to meet its obligations. It needs more money. How does it get it?
Well, I keep on talking in these videos about the fact that it could tax wealth more, and that's true.
But that's not the only way in which the government could get more money. Let's raise another obvious change that the government could make, which was talked about by Reform during the course of this general election, but which I have been talking about for a very long time, before it ever got came into existence, let alone came to think about it as a policy.
And that is, the government could stop paying interest on all the central bank reserve account balances that are held by our commercial banks with the Bank of England.
There's a lot of jargon in that last sentence, so let me explain what I mean.
When the government spends money into the economy, or when it receives money from the economy, those flows of funds go through commercial banks to the Bank of England. And, the commercial banks hold a very particular type of bank account with the Bank of England, which, by the way, only has about 300 odd customers. That account is called a central bank reserve account. It effectively is the point where government money is transferred into the real economy, and the real economy repays that government money by way of, for example, making payment of tax, or by depositing funds in government bonds or national savings and investments.
So, money flows out from the government through a central bank reserve account. We pay money back through a central bank reserve account, either as tax or as money that we want to save with the government.
That's the essence of what these accounts do.
But what happened during the period from 2008 until 2021 was that these central bank reserve accounts went up in value from around £20 billion to almost £1 trillion, or £1,000 billion.
Now they've fallen a bit since then because the government has been reversing what is called quantitative easing and so they're now under £900bn, but they're not going to fall in a big way any time soon.
The problem is that the government has since 2006 paid interest on the central bank reserve account balances at what is called Bank of England official base rate, which is at the present point of time five and a quarter per cent.
Now when the balances in question were only £20 billion, who cared what the interest rate was? The total impact upon government finances was neither here nor there.
But now, if you're going to be paying five and a quarter per cent on coming on for a trillion pounds, you're going to be paying, well, something like £40 billion a year at present on these accounts.
Now, it is said by the City of London, and by some economists, that it is essential that the government pays interest at this rate, because this transmits the decision on official interest rates into the rest of the economy, and therefore requires that everybody else use that rate.
The only trouble with that theory is that the European Central Bank successfully transmits its interest rate into European economies without paying interest on all the central bank reserve accounts that banks throughout Europe have with the European Central Bank. And the Bank of Japan, which is the equivalent of the Bank of England, does not pay interest on all the central bank reserve account balances that it holds for commercial banks in Japan.
So, the Bank of England is a bit of an outlier here. It's paying vast amounts of interest that it appears do not need to be paid.
Now I'm not disputing that some needs to be paid. I think that's true. I think that £10 billion, meaning, therefore, that roughly one-quarter of all the central bank reserve account balances might be subject to interest payment, would be reasonable. I think that would achieve the monetary policy goal of transmitting the Bank of England's chosen interest rate into the economy.
But the rest? Look, the rest was created by the government as new money injected into the economy to keep it going in the aftermath of the 2008 financial crisis and during the COVID crisis and there is no reason why our commercial banks should be enriched by those funds.
Up to £30 billion a year could maybe be cancelled in terms of interest payments. Although, I should add that if that's the case, the banks would not, as a consequence, pay tax on those receipts. And so the net benefit for the government may be a bit over £20 billion a year.
Well, £20 billion, would that make a difference? I think so.
It would end child poverty.
It would allow us to pay the whole of the backlog of pay due to junior doctors and restore their confidence in the NHS so they wouldn't all be leaving to go to Canada or Australia and somewhere else.
It would allow us to pay for the special educational needs of every young person at school, primary or secondary in the whole of the UK.
It would end the bedroom tax.
It would restore most of the payments due to those with disabilities. that had been lost during the period of the Tory government.
It could restore the services supplied by local government.
It could improve social care, and a bit might go into the NHS.
It's that big. £20 billion can make a real change to the way in which our economy is run and services are supplied.
And right now, it's all going to banks. That makes no sense at all. Should they be enriched at cost to the people of this country who need essential government services, or who require government support to be able to enjoy a full life as part of their community? I don't think so.
I don't think banks deserve that money.
I think other people do.
This needs to be looked at. Just because Reform picked up this idea does not mean that it should now be treated as out of bounds, not to be considered. It was always a terrible idea that interest was paid at this rate on that money. And it remains so, whether they supported it or not.
We need this change. The Labour Party needs to make this change. And it's one of those things that I really hope to see when Rachel Reeves stands up and delivers her first budget sometime this autumn.
Thanks for reading this post.
You can share this post on social media of your choice by clicking these icons:
There are links to this blog's glossary in the above post that explain technical terms used in it. Follow them for more explanations.
You can subscribe to this blog's daily email here.
And if you would like to support this blog you can, here:
Buy me a coffee!
Do we have to wait for the budget?
It would be reassuring if someone close to the directors of the BofE (recently retired maybe) were to confirm that Richard is right or (unlikely) make the case for why he is wrong.
Richard’s Taxing Wealth Report 2024 was published long enough ago. It makes serious claims. Is there somebody with an impressive reputation willing to tell us that, ‘Yes, it is fundamentally right’ (It seems so to me, an interested amateur) or if not, why not?
At some stage the issue of why government has to make up market capitalism’s failings by creating and spending money needs to be addressed. Clearly some businesses are highly efficient and people working in those companies receive good incomes enabling them to be much less dependent on government welfare. It makes sense that the less efficient companies should be weeded out and this in turn will help reduce taxes on the more efficient companies and those who work for them. Britain has been poor in regulating market capitalism for many years!
Bill Mitchell keeps is simpler IMO and closer to his MMT roots
“Politicians invariably claim that the situation they inherit when they take office following an election is untenable and that the ‘public finances’ are worse than they had initially thought.
Of course, the idea that ‘public finances’ can be good or bad or somewhere in between is a misnomer and just reflects the ignorance of the fiscal capacity that governments have (that is, currency-issuing governments).
There is no such thing as a deteriorating public finance situation.
So when Rachel Reeves got up after being elected the new Chancellor of the UK she was just posturing and telling the British people that they should not expect much better than what the Tories delivered.”
Versus,
“It needs more money. How does it get it?”
Surprisingly the Observer is waking up to the hole Starmer has dug for himself!
https://www.theguardian.com/commentisfree/article/2024/jul/28/the-observer-view-sticking-to-fiscal-rule-will-imperil-labours-future
It’s still very timid
Hi Richard,
Is the base rate mentioned, the one that the MPC decides and we are informed as “interest rate changes”? If so, then the government could instruct the BofE to reduce that rate, also providing more money?
Regards
It could…
That is not suggested
I totally agree with your post but I am against any interest being charged on the CBRA at all.
It is just a win win for the banks who after all are having their dodgy deals under written by the government.
This might be OK when the government is also looking after its people, but clearly is not OK since 2010 – or before. The CBRA is fluffed up; the state sector shrunk. Disgusting.
Cannot the Government find another way to influence interest rates on what is after all its own money? Even that issued under license? As you say, Japan and the EU do things differently.
I agree.
This occurred to me too. Unlike the EU and Japan, Richard says he accepts we should pay some interest but doesn’t explain why
As a transmission mechanism to enforce monetary policy, as I said
It is now being claimed that Reeves is going to legislate to give the OBR special powers of scrutiny over government. The problem here is that the OBR are proven poor forecasters. They also seem to be drawn from the same pool of ill-informed, weakly educated ‘disciplines’ of economics and banking that we know are deeply flawed. furthermore, the failure of regulators in Britain is notorious. Regulators in Britain endemically fail and have to be extinguished. The reason for that is the British political system is incapable of setting up an effective, efficient and independent regulatory regime. we know that from the gross failures over:
water, energy, banking, railways, Post Office (non-existent, and combined with the abandonment of responsibility by Parliament and Government), building regulations (Grenfell); need I go on? Non of these problems has even been fixed. and let me add to all that the long history of “Enquiries” in Britain. created by government – and always followed, twenty years later that the recommendations were never implemented – by anybody. These are the facts. Any apologetics by politicians or Press for this scandal – is guff.
This is all a long-drawn out, brazen and shameless political scam.
Much to agree with
Agreed, it does not look promising.
What do we think?
A precursor to more timidity or courageousness?
So no incentive for the BoE to cut interest rates if all this lovely money is going to their mates in the commercial banks?
Agreed
Spot on
This something that should be done.
It IS quite technical and there are some good reasons why some interest has to be paid on Reserve Account Balances. However, we have a BoE that is more interested in protecting banks’ income rather than reducing government’s interest costs; that needs to change.
Now, it may not be the perfect set up but the ECB is probably a decent place to start when looking at how to do this.
First, they pay no interest on minimum Reserves. They require every bank to hold a minimum amount (actually, it’s a minimum average amount but let’s not get too bogged down in detail) in their account with them. One can think of this as the money required to “oil the wheels” of the payments system, ensure banks are sufficiently liquid etc.
Second, they they do pay interest on reserves held above this amount at their “Deposit Rate” – currently 3.75%. They also conduct open market operations to try and keep market rates close to what they want at the Refi rate – currently 4.25%. Finally, they will lend (against collateral) at 4.5%.
In contrast, the BoE pays 5.25% on everything and will lend at 5.25% (against collateral). This is extraordinarily generous.
The critical question is what should that minimum be and how should it ne apportioned among banks? The BoE’s own estimate of Preferred Minimum Range of Reserves is somewhere between £345bn and £490bn
So, my proposal is
1) Pay no interest on minimum reserves from today. (I am not sure what that number is at present but each bank will have “a number” given to it by the BoE)
2) gradually increase this amount over the course of a year to £350bn. (Maybe £400bn…. but this should be done slowly to prevent unforeseen accidents and allow banks time to adjust their behaviour)
2) (assuming current (too high!) policy rates) pay a deposit rate of 4.75% on excess reserves, lend at 5.50% and conduct open market ops at 5.25%.
I am no fan of the ECB but I do think the BoE could learn from them
Footnote: lost in the mists of time I did give evidence to the ESCB (the fore-runner to the ECB) as to how the ECB should be set up and operate (conduct of open market operations etc..). Can’t remember what I said – or what they did.
Thanks
So, we head in the same direction, and we both help Reeves and save billions.
Thank you Clive and Nigel – very interesting and I trust your judgement about a different way it could be done and how the government could be more discerning – as for private banking, talking about having your cake AND eating it whilst kids go hungry?
Totally unjustifiable in my book.
Agreed
Clive: at last! A clear exposition of a potential solution.
1) How is the minimum for each bank actually (not theoretically) determined. Is it, for example in part by perceived risk? There is a lot going on here.
2) I am unclear about the relationship between your ‘range of reserves’ figures, and the trend outlined in 2).
3) What core margins do you assume between borrowing, open-market and lending on reserves. Your opening observation is the telling one: “we have a BoE that is more interested in protecting banks’ income rather than reducing government’s interest costs”. What this has cost us since 2008 is unimaginable; and unacceptable (and of course we have no idea of the quantum).
Having said all that; your comment is, to me a real, positive, usable advance on what we have. This idea needs widely circulated!
1) I don’t know how. The main reason to hold reserves is to ensure you don’t go overdrawn on an intra day basis as money transfers are made. If I transfer to you it’s instant but the CBRA transfer is not.
I will try to find out.
2) Nobody knows. I guess this BoE number assumes reserves remuneration at the base rate. It must hinge on the rate differential between Reserves and gilts; if reserves are unremunerated banks will hold the minimum as reserves with the balance in gilts. Underestimating this number led to the ‘taper tantrum’ in the US in 2018.
3) margins? Open market ops at the policy rate; LOLR lending +25bp; deposit interest -50bp.
Clive. My understanding is that CBRA transfers are instant if using Real Time Gross Settlement, otherwise the term is a misnomer, but I’d be happy to be put right if that isn’t the case. I have a paper from the BoE that explains how RTGS works but I’m not sure I can spend the time and effort rereading it. Or the inclination for that matter.
To be honest, I don’t know much about RTGS in the UK – I am more familiar with the Eurozone. Even here I am out of date. However, it certainly used to be the case that transactions were cleared periodically (hours, maybe minutes) but not instantly.
Even if it is instant I guess Reserves will still need to be held to cover the risk of operational failure etc.. Like you, I did see a report on this but lost the will to live after a page or two!
Not sure if anyone will spot this reply after such a long break…
… but spoke to a man that was responsible for all this stuff at a UK bank.
There is NO minimum balance required in your Reserve account, if you are short the BoE is quite happy to lend to you. He said there are “reputational issues” about borrowing too often but the BoE is keen to say that it is not a reputational issue, merely part of ordinary operations. In any case, with excess reserves in the system and interest paid at Base Rate there is no incentive to skimp.
What the BoE DOES require is a large portfolio of High Quality Liquid Assets (HQLAs) (of which balances at the BoE is a part along with gilt repo, short gilts and other stuff – although some with a hair cut).
Now, the size of the HQLA portfolio is dependent on what you business looks like but for his bank it is about 10% of the total balance sheet size.
So, under the current regime, if you paid no interest on Reserves, all those balances would go into the gilt Repo market; this would depress rates in this sector and lead the BoE to operate to keep rates up….. so, even if you stop paying on Reserve Balances you pay in gilt Repo.
In short, a method to force banks to hold Reserve Balances is required.
Regulation then…
As always, it’s regulation.
In the Eurozone the MRR (Minimum required Reserves is currently EUR 164bn. Scaled for size and FX this might be about GBP 30bn.
In addition there is about EUR 3 trn on deposit with the ECB. Again scaling for size/FX and being a tad conservative due to the less fragmented UK banking system this might imply GBP 200bn on deposit.
So, if we adopted the ECB approach one would save 5.25% on 30bn and 0.5% on 200bn …. or about £2.5bn
Now, that is not the end point… but it is a start. It works for the ECB, why not for us??
It’s a start
Can I mention, that the central bank accounts that are now, since 2006, called “Reserve Accounts” were originally “Exchange Settlement Accounts” (ESA) where the BoE acted as a “Clearing House” through which commercial banks settled their intraday balances.
Clearing Houses were first proposed in 1636 by Philip Burlamachi, financier to Charles I of England. During the course of any day, banks transfer liabilities (ie money) between each other as their customers pay each other. At the end of the day some banks finish up with more liabilities and others finish up with less, so before Clearing Houses they actually sent couriers across London with boxes full of securities (such as gilts) to settle the difference. Clearing Houses were set up to hold those securities on behalf of the banks who would then have Exchange Settlement Accounts credited with the amount as securities held. So at the end of the day, rather than exchange actual securities wih each other, they would have the House transfer the ESA balance from one bank to another. The Bank of England is one (but by no means the only) of those Clearing Houses.
When the government pays someone it is empowered by legislation to instruct the BoE to increase ex nihilo the ESA of the bank at which the target recipient has an account, which allows the bank, because it has that added asset, to credit their customer’s demand (or current) account with the amount.
So it is reasonable that the BoE should pay interest on the securities it holds on behalf of the banks. In effect, because the BoE is owned by the government, the latter is ultimately responsible for that promise to pay.
However, the problem is that QE works by the government using that process to credit the ESAs of the banks, which has resulted in the banking system being awash with reserves against which the BoE holds no securities. It is therefore not reasonable for interest to be paid on those.
So they shouldn’t be paying interests on reserves per se, only on securities held.
A bit long that and it is all in your writings, but I thought I would try to summarise it. Please feel free to delete it.
A beat distinction. Thanks, Nigel.
However, having thought about it afterwards, as one does, I am not sure who gets to recieve the coupon payments on gilts held by the BoE as security against the ESA balances.
Because the BoE holds them….
So all the more reason for the BoE to pay interest on securities it holds but not reserves. It would be a very good getout for Reeves to announce that the BoE will not in future pay interest on reserves whilst not necessarily mentioning that it would pay interest on securities held. Oh, but hold on. The BoE is independent isn’t it?
Where gilts are posted as collateral all the “economics” (interest and capital gain/loss) lie with the original owner.
Thanks
Mr Hargreaves,
A well made series of points. Mr Parry’s invaluable suggestions, have – I think – a weakness you have opened to examination. My problem with QE in the Reserves was always that it was not commercial bank assets, it is government assets. The drawing back of QT is proof this is government, not bank sourced. The commercial banks should be paying for it, not being paid for collateral they didn’t supply. Worse, QE was supposed to reboot the economy, and encourage growth, and not just save thew banks from themselves. It never happened. The commercial; banks funded an asset bubble instead.
I said, i think rightly that Mr Parry had offered an interesting proposal, but the problem is; it appears to treat banks assets in Reserves as equalt in all. respects to QE. There needs to be an exemption, or at least lower interest rates to be paid to commercial banks for QE.
You can’t tell where a bank’s reserves come from. Yes, in aggregate, we know the increase in reserves is through the purchase of gilts… but who did they buy from? From investors of all sorts.
Of course, all these investors have bank accounts so for every £ in a bank’s reserve account they owe a £ to a customer.
“You can’t tell”.
“You” being the BoE. That may be acceptable if there is no QE. The Reserves are all the same. QE surely changed everything. Shouldn’t the system provide an audit trail? it is not as if it is small numbers.
Clive is right: we can only do aggregates here
But I guarantee you appriximations could be done
That’s why I am advocating paying interest on securities because they for sure have records of that with a suitable audit trail.
Richard and Clive,
I have no doubt that the system does not currently allow sufficient refinement of analysis (in a digital world of developing AI; ho, hum); I take the point. But, frankly it does look like the system began with the answer most convenient to the principal parties involved, and worked out what would deliver it without anyone even being able to deconstruct the result, ex-post.
Is this the best we can do? £800Bn+ of aggregates we have no way of disaggregating? It is just too difficult? This is not complex real phenomena (like a cloud of gas) requiring statistical mechanics to decipher it, or identify the particles in movement. All of these monetary entities has no existence, save formally as basic binary digits. Already in a computer.
That’s it? in the 21st century? The best money and wit can buy in banking and economics?
Mr Hargreaves,
“That’s why I am advocating paying interest on securities because they for sure have records of that with a suitable audit trail.”
I may be losing the thread of a now long, tenuous argument of comments here and taken a misstep, but if the securities (gilts presumably) are collateral, and the owner receives the interest, doesn’t that mean you and/or Clive are saying the owners (the commercial banks) receive the interest on both the security as owner, and then is paid again interest as beneficial owner of the collateral?
.
JSW. Richard intimated somewhere in the thread that the BoE is the holder of the gilts so it gets the coupon payment. I agree. I think that’s the logical answer. So it’s reasonable that it passes that interest on to the original owner. There is, BTW, a whole range of securities the BoE accepts as collateral in exchange for reserves. However, I suspect it may not hold that many these days now the banks are awash with reserves because of QE.
Are we then saying interest is paid on QE simply because it can’t be disaggregated from other reserves (and in spite of the fact QE looms so large in total reserves)?
Right now that looks like a good excuse….
All these technicalities are way beyond me, but I have the impression that Rachel Reeves isn’t considering them. Surely she should? I don’t know whether she’s poorly advised, or being less than honest with the public, or simply not up to the job. It doesn’t matter which – what is important is how we make the govt engage with the issues urgently.
Reeves is a politician with domain knowledge from private sector banking as far as I can tell.
There is such a low bar for modern politicians these days to be in charge of anything.
Why it is we have the most under-qualified, under-informed people in charge is less of a mystery when you consider the way in which the party system is funded and how many politicos go on to make a killing afterwards.
The Establishment wants Knights that are compliant and support the status quo.
‘Corrupt’ does not even begin to describe it.
Maybe, but that still doesn’t tell me how we make them engage with the issues. Too many politicians keep on trotting out their favourite prepared lines and famous-name interviewers rarely point out the nonsense. Could we urge Lib Dem MPs to ask awkward questions? Refusing to cooperate with govt demands is likely only to hurt people.