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 Article written by Stephanie Flanders Stephanie Flanders Former economics editor

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  • rate this

    Comment number 130.

    So it is OK for people to loose their savings when Banks go bust!
    How did they get their savings.?
    Well: work hard at school/college/university; study for qualifications; get and work hard at a good job; continue to study and maintain relevance in a changing world.
    Not everyone gets mega bonuses.
    Most people with savings to lose have worked, earned and saved!

  • rate this

    Comment number 129.

    Great, but eventually these are all essentially vacuous monetary ''statements'' based on the vacuous monetary instruments that the vacuous monetary establishment have concocted. There is no real money in any of it. Debts are virtual, borrowings virtual, so standings and status are virtual. Write it all off. Start again. Those who will lose most had too much to loose, but how did they get too much?

  • rate this

    Comment number 128.

    A combination of cynical overpromise by our politicians and loss of business to cheaper economies means we shall continue to suffer price pressures in staples and energy while remaining uncompetitive.

    Skilling-up and boosting investment in technology seems the only option if we don't all want to end up on Mumbai callcentre wages.

  • rate this

    Comment number 127.

    Printing lots of money rewards those who over-borrowed recklessly and penalises savers and investors. A further £35bn of financial fiddling just postpones sorting the real economy out.

    The B of E is a big part of the UK economic problem and bears heavy responsibility for keeping economic failures going - listen to http://www.bbc.co.uk/iplayer/episode/b01ntfwh/File_on_4_The_Zombie_Effect/

  • rate this

    Comment number 126.

    £35 bln is 2% of GDP going back to HMG.
    Next step is to allow wage inflation to raise living standards and government tax takes and reduce the annual deficit.
    We need a few strikers to do this: we have all been too compliant with austerity.
    Why do we let producers and suppliers to up costs but we do not let workers say , oi jimmy, we need 25%?

  • rate this

    Comment number 125.


    spending = income eventually
    I do so wish that were true.

    My experiments have thus far proved that spending = no money.

  • rate this

    Comment number 124.


    spending = income eventually, but on what will spending be spent - home production or imports. You also the spreading out effect of saving. You also ignore the rapidity of spending - the multiplier effect. And the reverse multiplier of cutting spending. The speed of circulation is important. You also ignore the effect of spending on inflating the price of existing assets!

  • rate this

    Comment number 123.

    like it or not no,market price discovery, fix it or rig that is the question,we have been sold short naked

  • rate this

    Comment number 122.

    @118 LKC
    Agree it would be helpful to know ...

    ... please see my post @31 and join in the lobbying!


  • rate this

    Comment number 121.

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

    Ha ha ha. No seriously... my eyes nearly rolled right out of my head when I read that. Pathetic.

  • rate this

    Comment number 120.

    Unless this transfer of funds ends up in the pockets of the average person then the econemy is still going to be stuck. Basic maths; if I have £100 then I can spend it if I don't I can't.

    Very simple process.

  • rate this

    Comment number 119.

    LKC: The banks have been redistributing several billion back to the general population via ppi repayments as it is now apparent that adults are no longer responsible for their consumer actions and can sign forms with impunity.
    Nick Clegg mis-sold my son on tuition fees, he is still waiting for his compensation.

  • rate this

    Comment number 118.

    Errata. A rephrase of my earlier comment.
    Last week the hullabaloo was about £32 billion being returned to the Treasury. Now, inflation. Such alarmist reports detract from a clear headed discussion about QE.
    The question that we should be asking is, "Is the QE money doing its job?" I think the answer will become clearer once we know what the banks has been doing with the QE money.

  • rate this

    Comment number 117.

    Tuition fees in the calculation of inflation? How does that work? Relates to a minority of the population and will probably never be paid off in full. Makes a nonsense of the basis of these inflation figures, that the Bof E their policy on!

  • rate this

    Comment number 116.

    Aircraft 115: It could be they are ALL idiots and THEY don't know. Their track record since 2005 would suggest this is the case.

  • rate this

    Comment number 115.

    Either they are ALL idiots OR there is something that we don't know. You choose.

  • rate this

    Comment number 114.

    The BoE is an utterly clueless organisation led by a buffoon knighted for his incompetence in overseeing the worse banking crisis in decades followed by an abysmal record on controlling inflation, further rewarded by a £250k annual pension..
    Why should anybody listen to what he says, his forecasting powers are worse than a well trained chimp and a lot less entertaining.

  • rate this

    Comment number 113.

    #95 You may not have seen it but unemployment is down - the story is tucked away on the lower left of the business page -

    Seems BBC prefers to talk about doom in europe and bad news in general rather than push out the positive news stories.
    Nothing to do with which side of the political divide your on - just think we need to focus on positives more and not just pander to doom and gloom!.

  • rate this

    Comment number 112.


    But you need to ask this question
    QE is now 1/3rd of Govt. debt. What happens when this crutch is removed?

    My advise.
    live within your means
    stay in a job - if you have one

  • rate this

    Comment number 111.

    #110 hang on most QE was done under Brown, yo umean its save browns skin for a while just enoug hto get a hung parliament otherwise we would have been like greece ?


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