WWhen Labor made the Bank of England independent in 1997, the idea was that the Bank would set interest rates and the Treasury would tax and spend the funds. Monetary policy was carried out in Threadneedle Street, fiscal policy in Whitehall. But in August the Bank of England quietly let it slip that its key policies could cost the Treasury £120 billion. This policy – quantitative tightening (QT) – clearly needs to be rethought, and the Treasury’s policy of compensating the Bank for its losses is over. Last year, ministers paid the Bank £17 billion to cover these possibly contingent losses – a sum significantly greater than the budget of the Ministry of Justice, which is battling a real prison crisis.
Bank independence was designed for a world in which monetary policy decisions had predictable and indirect financial consequences. The financial crisis, Covid, war and difficult trade disputes have contributed to the destruction of this world. The bank bought government bonds to support the economy through its quantitative easing (QE) program. But the constitutional settlement—where an independent central bank decides what to do with those bonds—did not work. The game is surely over when former Deputy Governor of the Bank Charlie Bean admits that independence cannot justify effectively giving power to an unelected Monetary Policy Committee (MPC) over decisions with big implications for public spending.
The Treasury is responsible for losses – and gains – on bonds bought during quantitative easing and held in a Bank of England subsidiary called the Asset Purchase Fund. Losses are produced in three ways. First, the Bank sells these securities at current market prices. Since their yield is higher than during QE, the securities are worth less than the NPF paid for them. Secondly, the NPF is losing money because the £500 billion worth of bonds on its balance sheet are earning less than the base rate payments on the “loan” that was used to buy them. Third, securities purchased above their value are counted as a loss at maturity.
Labor created compensation after the 2009 crash. But it was George Osborne who turned it into a quarterly ATM in 2012. When rates were low, the Treasury made a profit of £124 billion. Once rates rose, the same mechanism was reversed – and since this recovery is without limit, even when the windfall has been repaid, the Treasury continues to pay the Bank.
Ministers must end this arrangement. No other major central bank behaves this way. Whatever you think of the losses, the Treasury’s demand to settle them immediately turns monetary policy into fiscal intervention. A report this week said the Bank and Treasury are developing changes to QT to ease pressure on rising interest rates. Independence appears to have been abandoned in favor of quiet coordination. The MPC’s decisions cannot be taken for granted.
Andrew Bailey, the Bank’s governor, calls the overall value of QT “neutral” – but, as economist Patricia Pino points out, only when measured over six decades. In fact, billions of dollars in cash demands are coming to parliament. Governments have not set budgets, voted in elections or run public services for 60 years. It is unsustainable for the Bank to make decisions and force ministers to face political consequences to voters.
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