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FT editor Roula Khalaf selects her favorite stories in this weekly newsletter.
The writer is a contributing editor to the FT.
When decisions made a decade ago cause a political storm, you know you’re in a bad place.
For almost ten years, the Bank of England sent quarterly payments to the Treasury: fiscal dividends from quantitative easing. Together these amounted to almost £125 billion. Few hairs stood on end. But since October 2022 the flow has reversed. Last year, the Treasury sent the Bank of England £44 billion to cover both the funding shortfall of its QE portfolio and losses made on its bond sales. This was more than the UK government spent on long-term care. The Bank of England estimates that the lifetime drawdown of the QE program on public sector accounts is likely to eclipse £100 billion.
Furthermore, there is now a direct line between the Bank of England’s Monetary Policy Committee’s decision on the pace of balance sheet reduction (so-called quantitative tightening or QT) and the Chancellor’s ability to tax and spend. Halting active bond sales would give the chancellor up to £10bn a year of fiscal space, according to analysis by the Bank of England. That the MPC’s decisions define fiscal space so directly cannot be right. With huge losses and MPC decisions influencing fiscal space, it is no surprise that a number of Conservative MPs have been angrily calling for a review of the Bank of England’s independence.
The Bank of England and the Office for Budget Responsibility have rightly argued that the fiscal implications of QE and QT cannot be captured by an account of cash flows. The Bank of England argues that the economy would be smaller in a world without QE. But bank officials’ performative indifference to QT’s drain on public accounts has not helped calm tensions. Bank officials are public officials, whose mission is to achieve financial and price stability, not to commercialize profits. The indifference to the quarter’s losses appears designed to shore up market confidence in the Bank of England’s independence. But it risks undermining that independence as cross-party support declines.
If the political heat fueling attacks on the Bank of England’s independence comes from the impact on public accounts, it is worth remembering that things do not have to be this way. Firstly, changing the pace at which the Bank of England reduces its balance sheet will not change much the magnitude of total lifetime cash costs. It will simply load them from the front or from the back. That the Bank of England’s choice as to the timing of its balance sheet operations has any impact on the calculation of Britain’s fiscal rules shows how bad these rules are. Secondly, the UK’s choice to deal with QE losses is not the international norm. Until 2012, bond coupons purchased by the Bank of England were gathering dust on Threadneedle Street. George Osborne rightly changed practice to follow the Fed and pass on the benefits of QE to the Treasury. But he chose not to follow its standards for dealing with central bank losses, committing the Treasury to reversing cash flows if interest rates normalized or the Bank of England incurred losses on bonds bought.
The Federal Reserve, whose accounting losses from QE dwarf those of the Bank of England, is not asking Congress for cash. This despite distributing profits when times are good. Instead, losses create a deferred asset that can be repaid through seigniorage profits. Until it expires, the Federal Reserve system essentially operates with negative equity.
The United States is far from alone in this approach. A report by the Bank for International Settlements found that of 32 central banks in emerging markets or small open economies examined between 2001 and 2022, ten had had negative equity positions during the period. Furthermore, the report considers that this practice does not affect either financial or price stability. A recent Bank of England working paper cataloged the practice of 70 central banks around the world. They found that while the UK’s approach was not unique, it was one of a small minority of countries that took such a strict approach to central bank losses.
One way forward would be for the UK to adopt US practices. It is true that this would risk generating an aura of perfidy. But doing so may be the lesser of two evils. In fact, the IMF recommends re-examining the treatment of QE/QT gains and losses.
The current framework produces politically corrosive results that undermine central bank independence. Furthermore, it cannot be right that the Chancellor’s room for maneuver under the fiscal rules depends on when the Bank of England crystallises losses. The upcoming general election is likely to divert pressure from the Bank of England. But once the source of the problem is identified, the best the next government can do is solve it.