Spot the odd-one-out in this Bank for International Settlements chart:
It is the UK’s very own Bank of England.
A quick explainer here. What the author, Peter Stella, is trying to do is examine the point at which a central bank’s finances would come under pressure — that is, the point at which their monetary policy, or ability to control inflation, might be jeopardised. The above chart, for those wondering, uses a hypothetical 35 per cent loss on total local currency assets (the purple bar) compared with sustainable losses (the red one).
And despite the BoE outlier, Stella is rather positive on central bank strength:
Even in this incredibly high-loss scenario, in only the case of the Bank of England (BoE) is there reason to be concerned with the macroeconomic level of losses. However, the BoE is largely indemnified by the UK Treasury for potential losses; thus, it is not plausible that it would have to assume losses of that magnitude. In presenting the data for the United Kingdom I have used an adjusted combined BoE balance sheet which excludes currency.9 As seigniorage from banknote issue is directly transferred to the Treasury, it cannot be considered as financing the Bank. Consequently, the BoE has the lowest currency plus capital within the sample, and sustainable losses are actually negative as calculated here (Figures 3 and 6). On the other hand, the UK Treasury explicitly indemnifies the BoE for its lender of last resort operations.10 During the current crisis, it has also indemnified other unconventional operations. From the financial standpoint, the BoE is essentially operating under a Treasury agency arrangement, and consequently need not hold capital against the imputed fiscal risks. The United Kingdom also explicitly sets an unremunerated reserve requirement held by eligible commercial banks in the form of cash ratio deposits (CRD) to generate the income necessary to fund BoE operations so that significant funding capital is not required. Adding the CRD (approximately GBP 2.5 billion in 2008) to the calculated BoE currency plus adjusted capital yields sustainable losses very close to zero.
In sum, it would seem that the central banks examined here are not in significant danger of witnessing losses that would prevent them from attaining their inflation targets. I will therefore turn to an examination of the other element of fiscal risk, which is perhaps more relevant.
We get it, we get it.
But the ‘indemnified by the UK Treasury’ point might not come as any comfort to the Bank of England . Thursday saw its head, Mervyn King, criticised by some Monetary Policy Committee members for crossing “the line of political impartiality in associating himself so closely with the government’s fiscal consolidation programme.”
The rest of the BIS paper, incidentally, goes on to discuss just that political governance subject. That would be the idea of monetary policy risk generated not by financial losses — but just by engaging in, say, unconventional policy or “straying into what would appear to be expenditures of a fiscal nature.”
Related links:
What’s left of central bank independence? – Willem Buiter’s Maverecon
‘Can’t the Fed just buy stocks?’ - FT Alphaville
Inflating the output gap at the BoE – FT Alphaville