From the TUC

An incredible way to maintain credibility: Today’s QE news

09 Nov 2012, by Guest in Economics

Today the Treasury and the Bank of England have agreed what sounds like an arcane accounting treatment change but which may have profound political consequences.

The Bank of England has purchased £375bn of gilts (Government debt) as part of its extraordinary monetary policy to support the economy. The purpose of this was to lower interest rates, not to fund government spending.

At present we have the somewhat odd situation whereby the Government is borrowing money to pay interest due to the Bank of England own the gilt’s it owns. This situation does not exist in the US or Japan where the fed and the BOJ simply transfer any interest received back to the Treasury/Finance Ministry.

In an announcement today (accompanied by an exchange of letters between the Chancellor and the Governor) we have been informed that the UK is adopting this approach.

As a result the Bank will now hand back around £35bn of accumulated cash to the Treasury by March next year and  the Treasury will effectively pay no interest on the £375bn of government debt (around one third of the total) held by the BOE as long as QE is in operation.

Now this impact will only be temporary, eventually the BOE will (or at least currently plans to) sell its gilts back to the private sector at which point the Government will have to resume paying interest on them.

As the OBR has argued today:

Today’s decision should not in itself have a significant impact on the eventual aggregate net profit or loss to the Exchequer from QE.

In the medium to long term this will have no real impact on the government finances.

However the decision may have significant political impacts. Until approximately 11.45am this morning may base case scenario, and that of most independent economists, was that the Government was due to miss the second of its two fiscal rules at the Autumn Statement on December 5th. I.e. the OBR would say that government debt/GDP would not be falling in 2015/16.

This accounting change means that the Government is now likely to hit the target.

This raises several issues. Firstly, and of actual economic significance, the OBR note that this change means the Government will issue fewer gilts now and more at a later date. But presuming that the economy gradually recovers, interest rates should rise in the years ahead. By issuing fewer gilts now and more later the treasury will have to pay higher interest costs.  This accounting change may well mean the Government hits a short term target but at a higher longer cost to the taxpayer.

Secondly, to account for these change the OBR says it will now have to make a forecast of longer than its usual 5 years. We may be in the very surreal situation of the OBR now saying that the Government will hit both of its fiscal targets but that government debt/GDP will then start to rise after they have been hit. To me this is proof that both rules are badly designed.

I think a third issue, and one I expect journalists to pursue (possibly without much luck!), is the question of where this initiative came from? I.e. the Treasury or the Bank? When was it agreed and by whom? (We know from the Governor’s letter that the MPC were informed of the decision at their meeting this week).

We now have a situation where the Government is sticking to austerity plans as it claims it has to maintain its ‘hard won credibility’. I just don’t see how hitting fiscal targets through accounting treatment changes that may cost more in the long run is anything but incredible.  


11 Responses to An incredible way to maintain credibility: Today’s QE news

  1. gastro george
    Nov 9th 2012, 2:34 pm

    But who creates both money and bonds in the first place? The state or one of it’s agencies. This is a nothing story. The idea that one branch of the state should pay interest to another branch, and to think that this is meaningful, is farcical.

  2. Romford Dave
    Nov 9th 2012, 3:44 pm

    It is indeed farcical, so why change it?

    It may remove the farce of paying interest to oneself, but not lessen the farce of lending oneself money in the first place.

    Has it now reduced the farcical position or increased it?

    In times like these I’m oft reminded of Bruce Lee’s art of fighting without fighting, being based more around what you think you hear as against what you actually see.

    Here we see a target met with a sleight of hand, it will be interesting to hear what the slate watchers have to say.

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  5. william
    Nov 9th 2012, 5:24 pm

    Since QE for ever is ,thankfully impossible(think hyperinflation),and base rate at 0.5 percent against published inflation of 5 percent has distorted the money and gilts market,the return of reality will be painful.Base at 3 meets inflation at 3.The Bank makes an enormous loss on its gilts.Future gilt issues come at a hefty cost.The unwinding of QE will also reduce propery prices across the board(more insolvency for the banks).Mervyn King has been as disastrous as Gordon Brown: first time house buyers will be rewarded,if they are patient.

  6. gastro george
    Nov 9th 2012, 5:42 pm

    Oh no, the hyperinflation bogey …

  7. Frances Coppola
    Nov 9th 2012, 10:54 pm

    The accounting is a wash. There is no net profit or loss to the Exchequer or the BoE from coupon payments on QE. The BoE is wholly owned by the Treasury, so any holdings of cash by the BoE arising from payments by the Treasury will disappear in the consolidated accounts anyway – as will any debt issued in order to make those payments.

    The pricing is a wash, too. Basically the Government has now redefined all gilts held by the Bank of England under the APF as zero-coupon, whereas the price the Bank paid for them would have included expectation of coupon payments. The Bank must therefore suffer an immediate (unrealised) capital loss. The question is whether that capital loss will actually be realised at a future point. Mervyn thinks it will, and expects that the Treasury will have to make good that loss by paying back the interest remitted by the BoE. But that’s nonsense. The BoE will sell the gilts back to the private sector at the coupon-inclusive price. As I said, it’s a wash.

    The only question remaining is whether the market price of gilts would have dropped by the time they are sold – which is likely, as unwinding QE would be done in a growing economy in which interest rates would be at a more normal level. But an economy in better shape would have better tax revenues. Any loss incurred by the BoE would be offset to an unknown extent by increased Government income. So the Treasury might not have to issue debt to compensate the BoE for trading losses on its gilts portfolio. It could be yet another wash.

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  9. gastro george
    Nov 10th 2012, 1:32 pm

    There is an important part of Duncan’s post – which is that this is an accounting charade that the Tories will seek to profit from politically, while the actual accounting is meaningless.

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