Why the Bank held off spending

Bank of England When fiscal and monetary policy start to merge, who is in charge? The Bank or the chancellor?

When the Bank of England decided last week not to create more money to support the recovery, some of us wondered why they didn't offer an explanation.

Now we know they had at least two reasons to hold back, which they couldn't have put in the press release: the coming spike in inflation for October, and the Treasury's decision to relieve the Bank of the billions it has made so far from creating money to buy government bonds.

The sharp rise in inflation to 2.7% is more than most in the City expected, partly because the large rise in university tuition fees has made a much bigger difference than people thought. That factor alone raised the Consumer Price Index for October by just under one third of a percentage point.

Only a small proportion of the population is affected by these tuition fees, and even they don't actually have to pay them up front. So that part of the bump up in inflation might not affect consumer confidence and growth as much as other price rises.


But everyone is affected by the increases in food and energy prices that are coming down the track, many of which have still to feed into measured inflation.

So, at best, members of the MPC last week knew they were looking at a bumpy few months for inflation. Some even think it could go back to 3% by the end of 2013, before heading back down again - meaning another exchange of letters between the governor and George Osborne.

Inflation would then have been above 2% for more than 36 consecutive months and most of the past six years.

Of course, it's the longer term picture for inflation that ought to guide policy - not the prospects for the next few months. Tomorrow we'll find out the Bank's new forecasts for growth and inflation, which the members of the MPC also had to guide their decision last week.

It's possible that these will show inflation remaining higher than previously expected, for longer, partly as a result of the stickiness in energy and food inflation that we are starting to see now.

Or the Bank might think the prospects for the recovery next year are slightly weaker than in August, meaning that inflation is still in danger of falling below target in a year or two.

But there too, the members of the MPC had a piece of insider information last week that we did not have at the time: They knew that the Treasury was about to do some quantitative easing of its own.

Crafty or sensible?

By and large, most economists I speak to think the Chancellor's decision to take hold of that big cash surplus sitting in the Bank of England's quantitative easing account is perfectly sensible.

It's an issue that has been debated by academics for a while, though many wish Mr Osborne or his predecessor had sorted it out a long time ago, when the move didn't look quite so convenient.

It was always a bit silly for the Treasury to acquire more debt, solely in order to pay interest to another part of government (the Bank).

The move also brings the UK into line with the way that quantitative easing is handled elsewhere. The US Treasury pays the Federal Reserve interest on the US Treasury bonds that the central bank has bought on the open market as part of its quantitative easing, but the Fed always sends that money right back again.

Crafty, or sensible, we can say for sure that the change in policy represents a small easing in monetary policy, which will act much like another dose of quantitative easing over the coming months.

In the 1980s they would have called this "under-funding": There will be spending of £35bn this year which the Treasury was expecting to have to raise in the financial markets, which instead it will be getting free from the Bank, as three-years-worth of accumulated interest payments are transferred back to the Treasury.

Depending on how long quantitative easing continues, and what the Bank decides to do about its government bonds when they come up for redemption, there will be another £11bn or £12bn a year in free money for the Treasury after that.

The transfers will continue until the Bank has raised its own cost of borrowing above the level of interest it is receiving on its gilts, or starts to make losses selling them back to the market, probably for less than they bought them for.

Then the money would start to flow the other way. But in the meantime the Treasury would still have benefited from not having to pay all that interest.

That is why I would expect the Office for Budget Responsibility to tell us in the Autumn Statement that the Bank's policy of quantitative easing is going to save the government money overall, even if the Treasury does have to send some money back to the Bank.

Presumably they've checked with the lawyers to make sure that this does not violate the Maastricht Treaty, which forbids governments from using the central bank to finance any of their deficits.

Small beer

Not for the first time, we're reminded that these extraordinary times have made the dividing line between Bank's "independent monetary policy" and the government's budget plans rather murky.

Sir Mervyn King said the other day it would be wrong for the Bank to write off the government debt it had bought as part of its quantitative easing policy, because that would be an act of fiscal policy - and an irresponsible one, at that.

But if that's true, you might ask whether Sir Mervyn or his successor would really be in a position to stop a chancellor who decided to engage in a stimulus programme, funded by QE, any more than he could stop George Osborne loosening UK monetary policy slightly last week.

Bank officials will say it's all a matter of appearance - and degree. In the grand scheme of things, a £35bn loosening of monetary conditions over several months is pretty small beer.

Still, when monetary and fiscal policy start to merge, the lesson of last week is that the chancellor is still in charge.

Stephanie Flanders, Economics editor Article written by Stephanie Flanders Stephanie Flanders Former economics editor

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  • rate this

    Comment number 50.

    Anyone with a single brain cell knows that QE is nothing more than devaluation. But don't tell Osbourne he thinks it helps the economy, it doesn't. It actually increases the cost of everything in real terms as we pay more with devalued £'s sensible people recognise this as inflation. No big surprise with the inflation figures, just night following day.Please leave George your out of your depth.

  • rate this

    Comment number 49.

    "Still, when monetary and fiscal policy start to merge, the lesson of last week is that the chancellor is still in charge."

    Agreed, the whole idea that monetary policy was distinct from fiscal policy was always just an illusion. Monetary policy has always just been a type of fiscal policy. Also the idea of an independent central bank is just a device to constrain good government.

  • rate this

    Comment number 48.

    don't worry about it. You can still get obese on 1500 calories a day if you do not exercise much.

  • rate this

    Comment number 47.

    As well as QE, the £80bn Funding For Lending scheme has hammered savings rates. Institutions simply don't need savers at present. All that seems to be happening is that inflation is stoked and inflated property prices supported. And still not enough lending to SMES despite "Project Merlin" etc. Policies of the madhouse.

  • rate this

    Comment number 46.

    I'm glad all sensible economists agree about the QE interest. Kept the conversation quiet though. Perhaps you could let us all in on sensible economists' view about retiring the QE bonds.

  • rate this

    Comment number 45.

    @39 onothimagen
    Previous QE: yes. Not so the February tranche, IIRC.

    I'll leave you to check Steffie's Blog as she covered it at the time. I think they said it was specifically targeted at good quality businesses that were having trouble obtaining loans.

    Seem also to recall that there was talk of setting up a bank or a specific bank network to handle it.

  • rate this

    Comment number 44.

    If you ever lent anything to anyone you know that's the last time you will see it kiss it goodbye and don't act surprised I don't think there is a problem really and I am sticking to that story. Everything is normal. It's just new if you are inexperienced. Even the nicest people will run away with your comics and toys and flog them on ebay. I know it's hard to accept the truth.

  • rate this

    Comment number 43.

    The Bank of Enland should lend directly to the businesses that need credit - Banks won't lend it out. Form a new link with the real economy and let the banks go bust one by one. We could all get paid our salaries in cash, pay bills when our meters get read, pay for everything in cash.

    I will be dancing in the streets when the banks go bust and invite you to join me!

  • rate this

    Comment number 42.

    "these extraordinary times have made the dividing line between Bank's "independent monetary policy" and the government's budget plans rather murky."

    The Bank has never been independent! it serves the Banks and the Government.

  • rate this

    Comment number 41.

    who wants a loan with rates like that? The idea that money makes money isn't 100% foolproof. Just because a lot of people borrow money to finance risky initiatives doesn't mean it's the right thing to do since it is obvious you will have a crisis if it falls through but not borrowing doesn't mean you can't get in trouble either. It all depends on what you individually are up for.

  • rate this

    Comment number 40.

    Funny thing about Sept infl was that it appeared to overlook blip in road fuels prices. In my neck of woods those started to go down in Oct yet ONS man was saying they were the third cause of incr after tuition fees&food. Another funny thing, I've been seeing lots of BOGOFs & price reductions in supermarkets in October ...

    ... the ONS doesn't half cause some head-scratching here!

  • rate this

    Comment number 39.

    QE is not supposed to go anywhere near customers.
    QE is an asset swap between long term investments & cash in banks reserves, banks don't lend reserves. The idea is that cash rich reserves would encourage banks to lend other money (it doesn't) & lower interest rates at the longer end of the yield curve (it does)

  • rate this

    Comment number 38.

    Strange isn't it? QE started off as an emergency measure but now it has become part of regular policy. This can only be construed as failure.

    The banks are bust, the state indebted and the public increasingly unable to pay. The zombies are running the show which is why there is no recovery.

    This position is not sustainable.

    Let's put on the kettle and have a nice cup of hot water......

  • rate this

    Comment number 37.

    All just "Wooden Dollars" really so it is a good job we have no gold standard. How much poorer we will be in 2015 compared to 2010 ? Dare any member of the coalition to predict that one.

  • rate this

    Comment number 36.

    I think it's long overdue that we stop pretending that printing money to keep an overspending government spending and broken banks limping along is anything but that. It does nothing for the real economy. Lending to credit worthy businesses and individuals is still seriously broken and real inflation such as energy and food is high as a consequence as is the disgraceful erosion of savers wealth

  • rate this

    Comment number 35.

    like the last paragraph entitled 'small beer'
    it is indeed rather murky that dividing line.
    and warning of 'the tsunami of regulation from Europe' (quote from J Warner)
    and very cynical of the ONS to raise inflation by 0.5% in October when most pension funds and HMRC use the 2.2% September rate.
    looking forward to your comments on the Autumn Statement on Dec 5th.

  • rate this

    Comment number 34.

    31.Up2snuff " let alone the customers it was designed to help?"

    I don't think it was EVER really designed to help anyone except the banks and then only fraudulently!.

    Here is a billion or so for nothing so lend it back to be at a couple of percent - Oh look you are now making a profit and you can rebuild your capital base - except the banks don't - they pay huge bonuses!

  • rate this

    Comment number 33.

    cut your energy bills and spend it on food it's cheaper. If you drive a car you have to move 2000kg plus your body weight that is millions of joules but if you walk you can go 65km on a mars bar. If you try and go faster the laws of physics say it will cost you more energy so if money is a problem we think slow down.

  • rate this

    Comment number 32.

    24.Batty précis: Why don't we just write off the debt.

    If you lent money to HMG you would want your money back wouldn't you? Perhaps you wouldn't? Maybe we should confiscate your personal pension savings? Or re-nationalise the privatised industries and sell them off again!

    We have to repay it one way or another if at all possible. Or the UK will be paying pay-day-loan rates to borrow.

  • rate this

    Comment number 31.

    Steffie, your Blogs are getting like London buses: nothing for ages then two come along together. And, like London buses, they're a welcome sight!

    Could it be the BoE is tight-lipped on QE because the February tranche, was it labelled QE3, has not even reached the banks let alone the customers it was designed to help?

    Please could you investigate this for us?


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