Sunday 3 March 2013

Economic Myths: Negative interest rates put money into the economy

From the BBC:

Bank of England deputy governor Paul Tucker has said negative interest rates should be considered. A negative interest rate would mean the central bank charges banks to hold their money and could encourage them to lend out more of their funds.

Firstly, how much of the banks' "money" does the Bank of England hold?

As at the balance sheet published on page 54 of their 29 February 2012 annual report it was £218 billion. The £286 billion shown on that balance sheet is the net value of the UK gilts the BoE repurchased under QE, to muddy the waters a bit, you then have to refer to page 5 the Bank of England Asset Purchase Facility Fund Limited's 29 February 2012 Annual Report to reconcile the missing figures. This figure seems to reconcile with the commercial banks' accounts say. Barclays 2012 accounts say that have £86 billion deposited with central banks, Lloyds 2012 accounts say they have £80 billion. I can't be bothered adding up and reconciling the rest.

What is not clear is how much that £218 billion actually belongs to the banks and how much is held by banks on behalf of gilt investors (mainly pension funds and annuity providers) who chose to cash in under QE. By all accounts, this is the bulk of it.

Those gilt investors have to invest in gilts or similar, those are the rules. So the bulk of that money has to stay where it is.

We also know:
- the BoE is currently paying 0.5% interest on those £218 billion deposits (or whatever larger figure it is now).
- the government invented a whizz bang new scheme last year to prop up banks and house prices, called the Funding for Lending Scheme, whereby, basically, commercial banks get up to £80 billion in low-interest loans.
- the interest rate charged on FLS loans, politely referred to as "fee" is only 0.5% per annum (flat fee 0.25% plus variable fee 0.25%) as long as the borrowing bank does its bit for house prices (see last page of this)
- if a commercial bank is naughty and takes the FLS money but just uses it to replace more expensive sources of funding (which is what they have done and why savings interest rates have plummeted), there's no penalty, it's only if a bank is extra naughty and reduces its total lending by 5% that the interest rate charged rises gradually to a savage... 1.75% per annum.

We conclude that there is a temptation there for banks to be naughty. Even if those public spirited bankers nobly resist this temptation, it's 0.5% in either direction. As a result of QE, the BoE is paying commercial banks 0.5% on money they deposit with (i.e. lend to) the BoE. As a result of FLS, the BoE is charging commercial banks 0.5% for money it lends to them.

So if it were true that the banks can merrily withdraw the £218 billion which they have deposited with (lent to) the BoE, there would be no need for the FLS, would there? Or alternatively, we can deduct the £80 billion FLS loans in one direction from the £218 QE deposits in the other direction and call it £138 billion, which we know all belongs to gilt investors, not the banks.

The FLS only makes sense (even in their warped world view) if banks can lend out money and earn more than 0.5% in interest. But if banks could earn more than 0.5%, they would have withdrawn the £218 billion anyway, wouldn't they?
----------------------------------------
Conclusion: the banks do not have any money with the BoE to withdraw and lend to the real economy anyway, whatever the base rate is, positive, zero or negative.

And even if they did, then so what?

Let's imagine that the BoE prints up £218 billion in new notes, dumps them in the safe and rings up the commercial banks and tells them to come and get it, and to the extent that they leave it in the safe, they will be charged 0.5%? The first thing they'd do is go and collect that money and transport it back into their own safes (assuming their physical storage costs are less than 0.5%).

How does that do the economy any good, unless you are in the safe-manufacturing or security business?

Even if the banks lend it out, it will not and cannot go into actual lending for investment into productive assets, because productive assets finance themselves. The income which people can generate in one year from putting productive assets to use is, broadly speaking, the same as the cost/value of those assets. That doesn't mean that the return on capital is 100% per annum, because the bulk of the income goes to the human beings who operate them, but there is plenty of cash there to pay the interest.

If you want to buy a new car but don't have the cash, you don't need a bank. The motor companies are all happy to let you have one under an HP or finance lease, you pay a small deposit, monthly instalments for three years and then you can normally buy the car for fairly cheap at the end, which is worth doing unless you know it has been driven by a complete idiot for the last three years.

The car manufacturer is not actually too fussed whether he sells a million cars a year for £30,000 cash, or whether he sells them on three-year HP deals, in the long run, the number of cars he makes and the amount of cash he collects each year levels out at the same.

Summa summarum, FLS and negative interest rates are all just part of the "They own land, give them money" programme.

9 comments:

JJ said...

Off topic, but here is an absurd critique of LVT for you to peruse

http://speaklibertynow.com/2013/02/08/critique-georgism/

Bayard said...

"If you want to buy a new car but don't have the cash, you don't need a bank."

I was trying to make this point this evening, how the general feeling has changed from, say, the fifties, when people avoided, if at all possible, getting into debt and, as you say bought things on HP, where the worst that could happen was that the thing was repossessed to now, when getting into debt for the most mundane of things is not only normal but desireable, all to the huge benefit of the banks, but I got roundly shouted down.

Mark Wadsworth said...

B, exactly. I have also been roundly shouted down by the hard left that "all interest payments are evil" (which has Islamic or Nazi undertones).

To my mind, if you buy a new item (be it a toaster, a telly or a car) from the manufacturer to be paid off in instalments over three years, and the total price you pay is slightly higher than the cash price, then the extra is not really interest at all. It is just a user charge for "early enjoyment" and to compensate for seller's risk of non-payment.

Anonymous said...

When you say: "Even if the banks lend it out, it will not and cannot go into actual lending for investment into productive assets, because productive assets finance themselves."
I'm being thick here but I just don't get this point. I know that many larger companies can more easily finance investments out of retained earnings but surely those who do not possess such luxuries [S&M's]would have little choice but to borrow provided they believed there would be demand for their products or services?

Mark Wadsworth said...

P156, banks don't really lend to small businesses. They only lend to small businesses if the loan can be secured on land and guaranteed by the directors.

Anonymous said...

You're right generally in this post of course but you're not right about motor vehicle finance. Some motor manufacturers use banks to provide their finance deals. Others have their own financing operations, which are set up as banks. Either way, the manufacturer gets the full price for the car when it is sold. There is no difference between getting a bank loan for a car and financing it on HP.

Bayard said...

"There is no difference between getting a bank loan for a car and financing it on HP."

There most certainly is if the loan is secured on your house and not the car. There is also the difference that the bank is a third party, so there are two contracts, one between you and the bank for the loan and one between you and the business selling the car for the purchase of the car, whereas with HP there is only one contract.

There are some things where paying by instalments is normal and paying in a lump sum up front gets you a discount e.g. telephone line rental. How is this different from HP, where paying in instalments costs you more than paying a lump sum?

Bayard said...

Mark, personally, I think the Muslims have the right idea about interest. It was, after all, Christian doctrine, too for centuries. I didn't know the Nazis were against interest or were you just being Godwinned?

Anonymous said...

Bayard, about the HP. The car manufacturer sells the car to the finance company. The finance co then sells you the car. Your contract is with the finance co (which may be a bank or a finance arm of the car maker which would be set up as a bank with separate financing and balance sheet). General Motors is a good example. Their finance arm is GMAC, which is set up as a bank. It even provides mortgages.

From your point of view as a customer, HP is different. From an economic point of view, it is the same. The bank advances the money which goes to the car maker. It is the bank that holds the car as an asset until the HP is paid off, not the car maker.