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  1. Politics
17 June 2024

The government can’t rob the Bank of England

The Treasury should uphold its side of the quantitative easing deal.

By Will Dunn

Late Summer, 2024: three shiny black cars speed along Threadneedle Street and screech to a halt outside the Bank of England. Cut to inside the Bank: the doors fly open and Rachel Reeves strides in, flanked by a team of burly special advisers and maybe some doves. All wear sunglasses and trench coats. Analysts and econometricians scatter as Reeves and her crew stride upstairs to the governor’s office, where she kicks the door from its hinges.

Andrew Bailey’s chair is turned towards the window: slowly it revolves to display the impassive governor, his gloved hands stroking an ermine.

“Ah, Mrs Reeves. I presume you’ve come to rob us?” Bailey feeds the ermine a quail’s egg and laughs softly. “You realise, of course, that I cannot allow that to happen. The vault is already locked down. You can threaten me… but you’d need an army to get in there.”

Reeves takes off her sunglasses and sits down opposite Bailey. “I’m here to rob you, Andrew, but I don’t need to get into the vault.” 

They lock eyes for a moment and Bailey gasps. The ermine hisses, baring needle-like teeth.

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“No!” cries Bailey. “You wouldn’t –”

“– I have. I’ve introduced tiered interest on the reserves held by commercial banks.”

Reeves fights her way out of the Bank through wave after wave of highly trained policy advisors, before returning to her lair to congratulate herself on perhaps the greatest bank robbery of all time: not the measly £30,000 that the average armed robber gets away with, but a million times that amount – £30 billion – every year.

Could this happen? Obviously, the door-kicking and the ermine are believable, but what about the economics: could a future government change an obscure rule and save tens of billions?

This idea has recently gained traction among all sorts of people, from left-wing economists to right-wing politicians. Here’s how it works: in 2009 the government asked the Bank of England to print tens of billions of new money and use it to buy bonds. The Bank had already reduced its interest rate almost to zero, but the bond-buying reduced borrowing costs even further; this was quantitative easing, or QE. It had many side effects, but the one that’s important here is this: QE involved buying bonds from commercial banks using central bank reserves, and part of the deal was that the Bank would pay interest (at base rate) on those reserves. This represented a risk for the Bank, so to get it to take the risk, the Treasury agreed to pay the Bank back for the losses it made from paying this interest.

Bank rate has gone up 14 times since December 2021, meaning the Bank has had to pay a lot more interest to commercial banks and the Treasury has to cover these costs. A recent article in the Financial Times estimated the loss at about £23bn a year, which the author, Chris Giles, described as “a needless banking subsidy”.

There are various ideas about how to fix the problem. Economists such as the New Economics Foundation suggest that introducing “tiered” interest on reserves – or, paying no interest on one part of the reserves (as many other central banks do) – could save the Treasury up to £11.5bn a year. Blokes in pubs, like Nigel Farage, say the government should just stop paying any of the interest, creating a magic money tree for Reform policies. In fact, Reform’s manifesto – released just this afternoon – claims such a mechanism could save the government £35bn.

This has been done elsewhere, and it didn’t go well: Sweden’s government told its central bank, the Riksbank, to take on the risk of QE for itself, and last year its QE losses became so acute that the world’s oldest central bank became insolvent and the Swedish government had to bail it out anyway.

But the real problem is that this magic money tree has already been picked clean by George Osborne. The deal between the Bank and the Treasury goes both ways, and while the Bank held interest rates close to zero – which it was compelled to do, in order to keep the economy alive during austerity – the Bank actually made a profit from QE. By the end of September 2022, the Bank had transferred a cumulative £123.8bn to the Treasury, which made Osborne’s policies look less disastrous than they really were and deferred the cost to his successors. By February 2023, this had become a cumulative loss of £72.3bn.

To renege on the deal would represent “bad faith”, says Stephen Millard, deputy director of the National Institute of Economic and Social Research. QE also squeezed the interest margins of the commercial banks (they couldn’t charge you as much interest on your mortgage), and it seems unfair to change the rules now that interest rates have changed in their favour.

Most of us would reach for our very smallest violin at the thought of banks’ profit margins being squeezed, but Millard, who worked at the Bank of England for more than 25 years, explains that they do need to be offered a reasonable deal. If commercial banks weren’t paid interest on their reserves, they would look for another way to make a profit: “They would have to be paid more money to be persuaded to sell their gilts”. Any future QE would be much more expensive. The sight of a government reneging on its commitments to financial institutions might also be enough to raise the overall cost of government borrowing.

This is probably why the real Rachel Reeves told the New Statesman’s George Eaton last week that she had “no plans” to tinker with the cost of QE: because while it might be possible to defray the cost the costs of yesterday’s policy, you need to play by the rules if you think you might ever need to use QE again, and in an uncertain world it is probably best to keep that option open.  

[See also: The petit bourgeois insurrection]

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