Monday, 22 October 2012

Fun Online Polls: Party conferences and QE

The result in last week's Fun Online Poll was as follows:

What was the stupidest idea from this year's party conferences?
Lib Dems: Use your pension fund as a mortgage deposit - 42%

Tories: Any suggestion that the leadership is in any way EU-sceptic - 31%
Labour: Spend 4G licence money on propping up house prices - 27%


So a pretty close run thing there.
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There were howls of outrage from the usual suspects when Adair Turner pointed out that the IOUs which one department of HM Treasury has issued and which are now held by another department of HM Treaury are effectively null and void and that to all intents and purposes it would make no difference to the outside world if these were cancelled. Golden rule: you cannot owe money to yourself.

The very real debts which the government has post-QE is the £366 billion-odd which the Bank of England now owes the commercial banks, i.e. the amount 'paid' for the UK gilts which the commercial banks have left on deposit with the self same Bank of England. But seeing as the banks can't withdraw this (or at least, they haven't done so far), no new money has been 'printed' or 'created' by QE and very little QE money has actually gone 'into the economy'. It's the deficit spending which creates 'money', the method and mechanics of the actual financing of that debt is a separate and secondary issue.

Just to see if anybody at all has been paying the slightest bit of attention, that's the topic of this week's Fun Online Poll.

Please vote using the widget in the sidebar.

7 comments:

Richard W said...

You are quite right in some respects and wrong to conclude that it makes no difference. Obviously around a quarter of the Treasury interest budget that politicians like scaring people with stories of how it is bigger that budget XYZ currently goes to the BoE and back to the Treasury.

You are right to say that the Treasury could extinguish its liability to the BoE by just cancelling the issued gilts currently on the BoE balance sheet. However, to say it would make no difference is quite wrong. The difference it would make is to change long-dated Treasury liabilities to effectively one-day Treasury bills that are remunerated at Bank rate.

The Treasury liability does not disappear because the bank reserves created from buying the gilts is still there. Why any government would want to shorten the maturity of their stock of debt in the current environment is a mystery. When interest rates are high good debt management is to issue short debt and lengthen the maturity when they are low.

So how are you ever going to be able to reduce the current elevated monetary base if the gilts that can be repoed for base money are cancelled? You can't so it would make a big difference.

So if we say that we will just accept a permanently higher monetary base is the same as saying we will abandon current monetary policy that targets 2% CPI. You can't cancel the BoE gilts and at the same time ask them to fulfill their 2% remit. The former would make the latter unachievable. An announcement by the government that it was cancelling the gilts on the BoE balance sheet would immediately raise inflation expectations in the gilts market. The interest rates charged to the government would rise and so would all other interest rates that use the government rate as a benchmark.

I am not saying that would not be desirable. Lots of people do believe the 2% target should be raised or completely abandoned. However, raising the 2% target is what you would be doing and you can't say it would make no difference.

" But seeing as the banks can't withdraw this (or at least, they haven't done so far), "

Bank reserves are never ' withdrawn '. They are used to settle interbank accounts and can never leave the banking system. The only body that can reduce them is the body the body that created them, the BoE. However, in a normalised economy banks will seek to reduce the ratio of reserves to assets and liabilities on their balance sheets, they can only do that by expanding their balance sheets unless the BoE reduces the reserves. So the BoE needs some instrument like government debt to repo with the banks in exchange for reserves.

Mark Wadsworth said...

RW, you are jumbling up topics again and not comparing like with like.

"the Treasury could extinguish its liability to the BoE" The treasury has no liability to the BoE it OWNS the BoE. Basic bookkeeping.

You say it would make a difference, you are wrong. Imagine this scenario - the BoE holds the gilts to maturity..? What happens then..?

Richard W said...

Mark,

All the topics are related because that is how the central bank conducts monetary policy. The BoE did not just start purchasing assets further out the yield curve than normal just for the sake of it. Short-term interest rates could not go any lower so to meet their remit required the unconventional measures of buying longer-dated securities. To say you can then just cancel the assets they bought and it would make no difference is just silly.

When you are looking at the transactions you are only thinking in terms of two arms of the same government, the BoE and the Treasury. However, there are three parties in the transaction, the Treasury, BoE and the private sector. Sure you can say the Treasury liability to the BoE and the BoE assets offset and they are both the government. However, the private sector have claims on the BoE for the exact same amount as the assets. Cancelling gilts does not make the claims go away, but you would remove the BoE assets that they would use to reduce those claims.

Yes the Treasury own the BoE. However, the Bank set up a company wholly owned by themselves, Bank of England Asset Purchase Facility Fund Limited to purchase the gilts. Here is their latest balance sheet.

http://www.bankofengland.co.uk/publications/Documents/other/markets/apf/boeapfannualreport1207.pdf

Even though the company are owned by an arm of government they are still bound by company law. You will know better than me if accountancy reporting standards would allow the the BoE to legally just cancel the loan they have extended to the company in return for the Treasury cancelling the assets on the APFF Ltd balance sheet. So the both things would offset. However, what would happen with that is the BoE assets would be reduced by the amount of gilts that you have cancelled but their liabilities to the private sector would remain the same.

" Imagine this scenario - the BoE holds the gilts to maturity..? What happens then..? "

What happens is quite simple. The BoE assets go down by the same amount as the maturing debt and their liabilities would remain the same. So there is a mismatch between assets and liabilities on the BoE balance sheet. To stop that happening the Debt Management Office would need to issue new debt that has the effect of reducing reserves in the banking system and balancing the BoE balance sheet. So debt is not being redeemed or maturing, it is being rolled over.

Maybe other than a big hole on their balance sheet it does matter if the BoE sterling liabilities exceed their sterling assets. And there is absolutely nothing to technically stop all the purchased gilts being cancelled. In fact, there is nothing to stop the BoE buying up the entire stock of the national debt and cancelling it. I don't dispute that they can do those things. However, they can't cancel them and fulfill their monetary policy remit at the same time because the price level would become indeterminate with no assets to reduce reserves. That is the main point that I am trying to get across.

Mark Wadsworth said...

RW: "you can say the Treasury liability to the BoE and the BoE assets offset and they are both the government."

I can say that because it is true and they are.

"However, the private sector have claims on the BoE for the exact same amount as the assets."

Oh for sure, the £366 bn which the BoE now owes the banks stands in the shoes of the £366 bn which the DMO had previously owed the banks, or bondholders generally.

The money which the BoE owes the banks (commercial bank deposits with the BoE) are very real debts indeed, the same as the gilts were previously.

It's like the DMO issuing £10 notes and the BoE buying back the £10 notes with 50p pieces. The 50p pieces now in circulation are real money and the £10 notes in the BoE vault are just so much waste paper.

"The BoE assets go down by the same amount as the maturing debt and their liabilities would remain the same."


Aaargh! Think! If the debts mature then the BoE's assets are reduced by the same amount as the DMO's liabilities to the BoE are reduced. The transaction will always cancel out and net off to precisely zero.

And of course, the £366 bn liabilities which the government owes the private sector stay the same, when did I ever say they would change?

It's like the 50p pieces are still valid coinage, even if the BoE burns all the £10 notes it bought back.

Mark Wadsworth said...

RW: " In fact, there is nothing to stop the BoE buying up the entire stock of the national debt and cancelling it. I don't dispute that they can do those things. However, they can't cancel them and fulfill their monetary policy remit at the same time because the price level would become indeterminate with no assets to reduce reserves. That is the main point that I am trying to get across."

So you are still missing the point.

Taking HM Govt, HM Treasury, the BoE and the DMO it is all the same thing.

The govt is perfectly entitled to choose between issuing 10 year bonds, or 1 year bonds or taking overnight deposits, they are interchangeable and it is always the taxpayer who ultimately has to repay them, or the saver has to pay them indirectly by suffering inflation.

So they could replace 10 years with 1 years, or replace 1 years with overnights, the total liabilities of the government towards the private sector do not change (the interest bill does, separate topic).

And yes, of course the government itself will always end up with net liabilities because it started off with net liabilities, it's called 'the national debt'. That's been run up in the past and is just there. Quite simple, ''the government' (or the taxpayer) owes the money to the private sector, and quite whether the DMO records that as 10 year or 1 year, or wether the BoE records that as overnight deposits is neither here nor there.

Richard W said...


" Aaargh! Think! If the debts mature then the BoE's assets are reduced by the same amount as the DMO's liabilities to the BoE are reduced. The transaction will always cancel out and net off to precisely zero. "

But I am not speaking about DMO liabilities to the BoE. The relevant liabilities are BoE liabilities to the banking system and they remain the same even if you shred the asset that created the liabilities. The assets on the BoE balance sheet consist of government securities and their liabilities are bank reserves. They create liabilities when they purchase government debt from the private sector and reduce their liabilities by shrinking their balance sheet by selling back the government debt.

" Taking HM Govt, HM Treasury, the BoE and the DMO it is all the same thing. "

We are not disagreeing.


" The govt is perfectly entitled to choose between issuing 10 year bonds, or 1 year bonds or taking overnight deposits, they are interchangeable and it is always the taxpayer who ultimately has to repay them, or the saver has to pay them indirectly by suffering inflation. "

This is where I think we are speaking at cross purposes because I don't disagree with you. Could I be a slight cheeky pedant to point out that if the security had only a one-year duration it would be a treasury bill and not a bond.

" So they could replace 10 years with 1 years, or replace 1 years with overnights, the total liabilities of the government towards the private sector do not change (the interest bill does, separate topic). "

Of course they could do that. But you started by claiming it would make no difference if they cancelled purchased gilts. My point is of course it makes a difference because long-term debt would be turned into short-term debt.

The UK debt stock has one of the highest average maturities in the world. I think it is something like around 13 years. A high average maturity is good although it cost slightly more. Cancelling issued gilts would be nuts because it would turn the liability into short-dated debt that constantly needs to be rolled over in the market.

" And yes, of course the government itself will always end up with net liabilities because it started off with net liabilities, it's called 'the national debt'. That's been run up in the past and is just there. Quite simple, ''the government' (or the taxpayer) owes the money to the private sector, and quite whether the DMO records that as 10 year or 1 year, or wether the BoE records that as overnight deposits is neither here nor there. "

Well we are in agreement but that was not what you were suggesting. We could just announce that the gilts purchased by the BoE were not going to be sold back and that is the same effect as cancelling them. The flip side of that is just accepting a higher monetary base. However, that is the same for monetary policy terms as raising the CPI inflation target. Much more sensible and explicit just to raise the target if that is what we want.

Mark Wadsworth said...

RW: "The relevant liabilities are BoE liabilities to the banking system and they remain the same even if you shred the asset that created the liabilities."

That is absolutely correct and exactly what I said in the original post.

"But you started by claiming it would make no difference if they cancelled purchased gilts..."

That is quite correct and does not in any way contradict my subsequent statement about the £366 bn BoE liabilities being very real liabilities.

"... My point is of course it makes a difference because long-term debt would be turned into short-term debt"

Wrong again - the long term debts HAVE ALREADY BEEN turned into short term debts (via QE), that has already happened.

"The flip side of that is just accepting a higher monetary base."

No it's not. Money doesn't really exist, it is not a thing in itself and is merely a unit of measurement and all 'money' always nets off to precisely zero.

The 'monetary base' is a highly artificial concept - you can only arrive at it by excluding some other assets or liabilities on an arbitrary basis - and would be unaffected by cancelling UK gilts owned by BoE.