When taxpayers buy business debt
Can the Bank of England's autonomy over monetary policy, its independence from political interference, be sustained as the Bank Rate approaches zero?
At a time of painful recession, this question may sound of interest only to the clashing egos of central bankers and Treasury ministers.
But the answer probably does have implications for all of us, because it would have a bearing on the all-important credibility of the institutions that shape economic policy, especially that of the Bank of England.
This issue has arisen because the Bank of England is about to start using measures other than movements in its policy interest rate to influence the interest rates actually paid by businesses and households and to increase the stock of money in the economy.
These measures have been given the label "quantitative easing". But this seems a very unhelpful badge, since economists seem divided - in a theological kind of way - over precisely what it means.
Better then to describe what the Bank of England is about to start doing.
Within a few short weeks, it will start exchanging high quality Treasury bills for various forms of corporate debt, both bonds and commercial paper (the main difference between bonds and commercial paper is that bonds have a longer maturity and commercial paper is short-term debt).
We'll know a bit more about this tomorrow, when the chancellor and the governor of the Bank of England send letters to each other setting out the scope and operation of this scheme.
But this is what we know so far. The Bank of England will have about £50bn of Treasury bills to disburse and this fund will be underwritten by taxpayers. So any losses incurred by the Bank of England from its investments in companies' debts will ultimately be borne by all of us.
Now the reason why the Treasury and Bank of England have decided to set up what they call an "Asset Purchase Facility" is because they believe big companies are finding it too difficult and too expensive to borrow in the form of bonds and commercial paper.
The logic is that if the Bank of England were to buy these bonds and commercial paper, the market would become deeper and more liquid - which in turn could persuade other investors to buy these forms of corporate debt.
There's a hope on the part of the authorities that the price of bonds and commercial paper would rise (over time), which in turn would lead to a fall in the interest rates actually paid by companies. In other words, big companies would find it easier and cheaper to borrow.
Now the governor of the Bank of England insists that what's going on here does not represent formal monetary policy. But that's surely a nice distinction, because the Bank of England would be influencing both the supply and price of credit - which seems to me to have the distinctive quack of monetary policy.
However, Mervyn King feels able to describe this as something other than monetary policy because this debt is not being bought for cash but for interest-bearing Treasury bills, or government debt.
That said, those bills are highly liquid. The recipients of them would treat them as the equivalent of low-risk money.
Oh dear. I am in danger of slipping into the kind of obsessive theological economic debate that gives me the willies. So let's move on.
Perhaps the important point is that Mervyn King and the chancellor have both made clear that it won't be long before the Bank of England starts to use money, rather then Treasury bills, to buy corporate debt and other financial assets. At that point, even the governor would call that monetary policy.
It would be the moment when - for the purists - quantitative easing would begin (you knew I'd break my word not to use this ghastly expression). To reiterate, the Bank of England would start to buy financial assets - low-risk government bonds and higher risk corporate debt - from banks and for money.
There would be two reasons for doing this.
First, the stock of money in the banking system would increase. The hope would be that the banks would lend this out - though if they were still feeling very averse to risk, they might lend it only to the Exchequer, by purchasing more government bonds. In fact, if they were feeling really frightened about the world, they could just sit on the cash.
That is why it would make sense for the Bank of England to buy riskier business debt, corporate bonds, from banks: doing so would liberate precious capital for banks, under capital adequacy rules, and would give them an incentive to provide new loans to companies and to households.
You'll notice, of course, that what we're talking about here is taxpayers paying cash for corporate debt. In a way, we'd all be lending to companies.
And because we'd be lending to companies - which brings with it the risk of loss for the Exchequer and thus for us - the chancellor feels he can't stand idly by and give the Bank of England free rein to invest as much as it likes and in whatever way it likes.
So Alistair Darling will, I am told, set limits on how much the Bank of England could disburse when buying financial assets from banks. And he may also set guidelines on how much the Bank can spend on individual categories of debt that carry different kinds of risk (thus there'd be a maximum allocation set by the Treasury for purchasing corporate debt, another allocation for government bonds, and so on).
He feels unable to dodge doing this, because taxpayers' money would be on the line.
However, it would mean that he would be impinging on the operation of monetary policy, as and when it takes the form of purchases of financial assets (oh yes, the infamous quantitative easing again).
Many would see this as undermining the independence of the Bank of England - almost an abandonment of the economic reform upon which Gordon Brown built his early reputation for success as chancellor more than ten years ago.
Would that matter?
If this new form of monetary policy were to fail, blame would be shared with the Treasury - so perhaps the credibility of the Bank of England would be less damaged.
But it may represent a slippery slope back towards a muddying of how macroeconomic decisions are made. And some would say that the UK's mediocre economic performance through most of the post-war years stemmed from a failure to properly delineate the responsibilities of the Treasury and the Bank of England.
Or, to put it another way: when politicians were intimately involved in setting monetary policy, Britain was something of an economic loser.