Several posts last year and early this year (e.g. here
) argued that the Treasury should book the net interest income of the Bank of England’s asset purchase facility (APF) as a receipt when calculating the targeted measure of the fiscal deficit. The rationale was that this would accord with international practice (i.e. failing to recognise the income risked creating an unduly pessimistic impression of the UK’s relative fiscal position) and could provide scope for modest stimulus measures (i.e. tax cuts or investment initiatives) within existing consolidation plans.
The Treasury announced on 9 November that excess cash held at the APF, mostly due to its net interest income, will henceforth be transferred to the Exchequer. The Office for National Statistics (ONS) has yet to determine whether these transfers will reduce the targeted borrowing and debt measures (i.e. public sector net borrowing and net debt excluding the temporary effects of financial interventions) but the Office for Budget Responsibility (OBR) forecasts that both will be lowered*. The Treasury could legitimately bypass the ONS determination by redefining the measures subject to the government’s fiscal mandate and supplementary debt target to include the APF’s net income / cash. (The total net borrowing definition used historically in fiscal planning includes the APF surplus.)
The Treasury’s move has attracted widespread criticism. One line of argument is that the APF is likely ultimately to be loss-making – net interest income will turn negative if Bank rate rises above about 4% and may cumulatively fall short of capital depreciation caused by a combination of some gilts being sold in less favourable market conditions when the MPC decides to unwind QE and others being held to maturity but having a redemption value below their purchase price. The cash surplus, on this view, should be retained as a provision against these future losses.
Such a practice, however, would be out-of-line with the treatment of other future government liabilities**, some of which are likely to dwarf any APF loss (e.g. public sector pensions, PFI commitments, nuclear decommissioning costs). Would critics of the APF transfer advocate that these liabilities should be similarly pre-funded by issuing additional debt in order to accumulate a cash provision?
More pragmatically, any APF loss will depend on a future rise in Bank rate but a large increase is likely to occur only in a scenario involving significantly stronger economic growth, in which case the value of the government’s stakes in the Royal Bank of Scotland and Lloyds Banking Group could appreciate significantly. “Financial interventions”, therefore, could break even or turn a profit even if the APF is ultimately loss-making.
Critics also claim that the Treasury’s manoeuvre represents an attack on the Bank of England’s monetary policy independence, since the transfer of APF cash has similar monetary effects to more QE. The Treasury, however, already has a significant impact on monetary conditions via its debt management policies – in particular, the decision about whether to issue short- or long-term securities to meet financing needs. Treasury bill issuance, for example, amounts to quasi QE, since bills are likely to be purchased by banks – resulting in a direct boost to the money supply – or else held by non-banks as a money substitute. The MPC should take account of such effects when calibrating its policy stance; the APF transfer raises no new issue of principle.
The Bank of England’s credibility and independence are under threat not from Treasury actions affecting monetary conditions but rather its serial failure to adhere to its inflation-targeting remit, defended on the invalid grounds that to have done so would have inflicted unnecessary economic pain***. The Governor will have been relieved that journalists used last week’s Inflation Report press conference to tackle him on the APF transfer non-issue rather than the inadequacies exposed by the recent reviews of the Bank’s performance and another big upward revision to its inflation forecasts.
*The OBR expects future APF net interest income to reduce both borrowing and debt but that only debt will be lowered by the transfer of cash accumulated to date.
**The transfer of the Royal Mail pension plan to the government in April 2012 similarly lowered borrowing and debt while creating a future liability.
***The defence is invalid because the claim is unproven and the Bank is not at liberty to ignore the remit.