This is hard to explain, which is why the article is in the FT and not in other papers. The people who read the FT understand how the Bank of England sets interest rates and can work out that right now they do so in a very expensive way which is costing the Treasury a fortune and is limiting the nation’s capacity to afford things like a properly funded NHS.
Here is my explanation, which tries to say what Chris Giles says much better. The click through may run out – if so mail henry@agewage.com as I have several free-links to give away.
The Bank of England (BOE) sets interest rates (currently 5.25%) by paying the stated rate on all the money it owes for the gilts it created for 13 years after 2008 (QE) . The cost of this is £23bn a year (after the BOE gets back its 2% from the bonds themselves).
In other countries, only part of the Government’s debt requires interest to be paid. The banks who lent the money to Government get nothing on a large part of the debt and though the banks don’t like it, they put up with it. The BOE likes to think they are whiter than white in paying interest on the whole amount owed, but it has the means to pay interest on only a part of the money held by commercial banks and there’s nothing these banks can do about it.
The commercial banks who get paid the full whack at present aren’t exactly short of a few bob and though they’d whinge like crazy if a tier of the money they were owed did not get interest paid on it, they’d survive.
Helpfully the FT includes a chart from the London Stock Exchange showing that these banks are doing very nicely for senior managers and their shareholders
The point here is that the banks are now getting pay-back for the years of QE, the question is whether the pay back is so generous, the nation is going to wrack and ruin because of it.
If there is one positive from all the mud-slinging in this election, it is that we still are a very well respected player in financial markets and that may be a lot to do with Andrew Bailey, the Governor of the Bank of England being extremely kind to fellow bankers. Other countries and the European Central Bank – are not so kind, asking the bank to chip in to help out.
This complicated stuff could be made a lot simpler if we put this idea to the general public in the way I’m trying to do here.
The trouble is that the Treasury can’t be seen to be tweaking the BOE’s tail, so we are all being very nice about this.
Chris Giles thinks that the Governor could be given a nudge by Rachel Reeves inserting into the BOE’s monetary policy’s remit a requirement it
“have regard for the public finances – so long as it can effectively implement monetary policy”.
The billions that could be saved by dialling down interest payments to our big banks is real money, (not the usual accounting fiddle). “Tiering” reserves would mean a rather less cosey relationship between the commercial banks and the Central Bank, it might lose a little prestige for the British banking system, but can we really afford to keep our banks in clover when so many of our citizens are deep in bother.
I hope we can have a proper discussion on this after the publication of the Labour Party Manifesto.
The commercial bank deposits at the Bank of England (known as reserves) are very high, largely as a result of QE. They are far in excess of anything needed for systemically sound banking activity. Paying interest on reserves is far from universal among central banks and some will pay interest only on the statutory reserves needed for sound banking.
The Bank could certainly stop paying interest on some or all of these reserve deposits. This would eliminate an interest cost to the Bank and ultimately HMT – £23 billion. The question then is what would the banks and their customer depositors do with this money, these reserves once the interest received on it has been cut or eliminated. If spent, clearly it would have inflationary consequences for consumer prices.
Thanks Con,
This is like Truss/Kwarteng all over again.
When times are good we let banks rip and generate lots of private wealth for the few and government scoop up the crumbs, too afraid to take profits and be blamed for cooling their runaway economic success.
When times are bad we try punish this exuberance and ultimately the bill falls at society as a whole, as banks will “pass this on” by simply lowering deposit interest rates, or sacking loads of people, or raising mortgage costs.
Then government blame the greedy banks.
I think government need to grow up, I expect this level of excuse/reasoning from a naive child.
Adults who’ve lived through a handful of boom/bust cycles should be beyond this simplistic view, never mind professional in the sector and elected representatives.
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