Osborne Sees Free Lunch, Eats It
Osborne has eaten a free lunch. As long advocated by Simon Ward, the Bank of England will start returning to HM Treasury the interest income on the large portfolio of UK government bonds accumulated under the QE programme.
The status quo ante saw the government simultaneously (on a consolidated view of the public sector balance sheet):
a) printing money and buying back its own long term debt to stimulate nominal spending
b) issuing long term debt and hoarding part of the money received
These are effectively bets in opposite directions; (b) only profits if (a) loses, and vice versa. If the government thought the expected losses from (a) were genuinely a problem it could simply do less QE. But that would be silly, because the effect on government income (tax revenue) from higher nominal spending dwarfs potential losses.
Meanwhile, the reduction in the government’s interest burden from doing (a) is a free lunch. So the Chancellor should eat it. If you think that’s wrong, try telling Barack Obama that he should be borrowing more money and hoarding the cash, just in case the US economy has a huge boom, interest rates have to go up faster than expected, and he needs to recapitalise the Fed. Good luck with that!
The most interesting part of all this is the exchange of letters between the Chancellor and the Governor (here and here); it seems to be the case that this decision had a material impact on the MPC’s November decision, when they decided not to extend the QE program:
During its meeting of 7-8 November I briefed the MPC on the agreement we have reached. The Committee was content that its ability to set the appropriate stance of monetary policy would not be affected by this action. But the Committee noted that its policy setting would need to take account of the effect of this action, which amounts to a small loosening of monetary conditions. This is because, as the Committee noted, your intention is to use any funds transferred to the Exchequer to reduce the stock of outstanding government debt. As a result the private sector will hold fewer gilts and more money than otherwise. That implies an easing in monetary conditions relative to the present position in which the coupon payments are held on deposit by the APF. The Committee therefore views the use of coupon income to reduce the stock of outstanding gilts as having an effect similar to the MPC purchasing gilts of the same value.
HM Treasury announced they would be doing some QE today. The MPC decided not to extend their QE programme in the policy meeting this week in full knowledge of HM Treasury’s announcement. There is a test of the Sumner Critique here. It would be fascinating to see if there is any hint in the MPC minutes – absent this decision by HMT would the Bank have extended QE?