After more than a decade of expanding its balance sheet, the Bank of England now has £ 739 billion in gilts, or 35% of the UK’s national debt. The BoE’s current buyout program will take it to £ 875 billion.
There are occasional calls to write off this debt, but it would be harder than it is worth. The BoE would be insolvent and it would be more difficult to control the level of reserves and the interest paid on them. This was discussed in more technical detail in the September 2014 OMFIF Bulletin by former BoE staff member Tim Young.
The real question is how the BoE should handle its record-sized balance sheet in an environment of high public debt.
The BoE’s liabilities are almost entirely made up of reserves held by banks and a few financial institutions. If he does manage to reduce the level of reserves one day, he does not expect to do so to pre-2008 levels due to higher demand from reserve holders; Basel III requires banks to hold a number of “high quality liquid assets”.
The most recent from the BoE estimates place the appropriate level of UK reserves over the medium term within a range of £ 150 billion to £ 250 billion, calling this range “the preferred minimum reserve requirement”. This is just above what the BoE thinks the shortage will enter, with the hope that such a level will keep markets functioning well.
Governor of the BoE Andrew Bailey said last year that the bank would maintain its current policy of paying interest on reserves to make rates effective.
When it comes to its assets, the BoE has given no indication of how it plans to manage its large holdings of gilts, other than the fact that it will continue to reinvest mature gilts and that profits and losses will flow. to the Treasury.
These plans raise several related issues. When the BoE initiated asset purchases in 2009, it expected its balance sheet to be permanently larger, but always looked for a return to a corridor system that has supported exchanges on the interbank market. Instead, we have a new monetary system in which the supply of reserves has been separated from their price.
If the BoE plans to hold a significant volume of assets, it will need principles to manage their composition and will need to review its coordination with the Debt Management Office. The DMO and the BoE now control the composition of UK government debt and the shape of the yield curve, and any crossover between mandates will be more evident when national debt and the central bank’s balance sheet are significant.
Bill Allen of the National Institute for Economic and Social Research has analysis the relationship between monetary policy and debt management since World War I. His work shows that they have often been integrated, but also that the relationship depends on the regulatory framework. If certain public liabilities are considered to contribute to banks’ capital and liquidity ratios, then the composition of the issue affects bank loans. Basel III and any changes made after the UK leaves the European Union will also need to be seen in this context.
Since 2009, significant changes in the way the BoE manages its balance sheet have come about through a simple exchange of letters between the British Chancellor and the BoE Governor. What is needed now is a more formal examination of the new monetary system as well as the links between monetary policy, debt management and financial regulation.
About once in every generation, senior UK economic officials meet to plan how the macroeconomic framework works. The National Debt Inquiry in 1945 and the Radcliffe Committee in 1959 both concluded that debt management and monetary policy were closely linked. The 1995 Debt Management Review downplayed the importance of debt management. Again, debt had fallen to about 30% of gross domestic product by this time. Maybe another thought is needed.
Hans Blommestein of the Organization for Economic Co-operation and Development and Philip Turner of the Bank for International Settlements urged policymakers in a 2012 paper to re-examine the links between debt management, fiscal policy and monetary policy in the light of post-2008 developments. However, they warned, “It won’t be easy. A major policy barrier is simply the absence of a generally accepted macroeconomic theory of public debt management. Macroeconomists have debated this subject for decades ”.
Chris Papadopoullos is an economist at OMFIF. He can be contacted at [email protected]