William A. Allen worked for the Bank of England from 1972 to 2004, and is now a visitor at the National Institute for Economic and Social Research. He is the author of ‘International Liquidity and the Financial Crisis’, ‘Monetary Policy and Financial Repression in Britain, 1951–1959,’ and ‘The Bank of England and the Government Debt: Operations in the Gilt-Edged Market, 1928–1972’.
By the time the Bank of England’s quantitative tightening programme is completed, quantitative easing will have cost British taxpayers £100bn, according to the latest forecasts from the Office for Budget Responsibility .
That is a dreadfully large amount of money. The final figure won’t be known until the vehicle in which the assets bought in the programme — the Bank of England Asset Purchase Facility Fund (APF) — is wound up many years from now, but it’s hard to see how it won’t be big and negative. It will be a constant drag upon the UK’s economy .
But, like it or not , the losses are there and have got to be paid. Perhaps the most important thing, right now, is to try to understand how we got here. It’s a sound principle of public finance that somebody identifiable should be responsible when debts are incurred. In this case, accountability for the losses is obscure.
In launching quantitative easing, the powers that be (or, rather, were), took a risk. Initially, QE provided a positive tailwind to the public finances; now, it is backfiring.
So the fundamental question is one of risk management — whose responsibility was it?
In an August 2016 letter from then-Governor Mark Carney to then-Chancellor Philip Hammond , the former said that role lay with the Bank, which “[a]lthough indemnified . . . risk manages the APF on behalf of HMT”.
So, on paper, it was Threadneedle Street’s job. But this framing never made real sense. Whatever Carney said, the Treasury’s indemnity is, and was, the practical expression of the Treasury’s acceptance of responsibility for the risks.
The nature of the risks depends on the nature of the assets. The Bank of England Governor and executive managers decided early on that the APF would confine its purchases as far as possible to gilts, and the Treasury did not demur. The decision implied a lot of interest rate risk. For the Bank, it was a matter of doctrine, not financial risk management. The Monetary Policy Committee was allowed no say in the matter.
For its part, the MPC ignores profit and loss in its deliberations, seemingly also as a matter of principle. Here’s deputy governor Sir Dave Ramsden discussing its approach last year:
The MPC must focus on the overall impact on money stability, on achieving the inflation target, and on getting inflation down from the current 10% back to the 2% inflation target. The MPC is aware of the cash flow consequences, but the MPC is thinking about its objective, which is for monetary stability for hitting the inflation target.
This is a bad principle, and a bad approach. The losses from QE cannot be seen as separate from monetary policy: they are so large as to significantly increase the risk of the public finances becoming unsustainable and of fiscal dominance of monetary policy. That would undermine the MPC’s objective, and the MPC should be concerned about it.
But this is all theoretical — what about the actual monitoring of risk? Initially, senior bank staff apparently didn’t understand the interest rate risk, or even realise that there was any risk, based on the findings of the House of Commons Treasury select committee’s January report on quantitative tightening .
Much lower down the hierarchy, risks were carefully quantified and reported throughout — but nobody did anything about them. Perhaps this was understandable in the early days, when QE was an emergency measure, but — as it metamorphosed into the main instrument of monetary policy — a reassessment was badly needed.
Was it essential that QE be carried out exactly as it was? Was there no other, less financially-risky policy that could have achieved the same macroeconomic result?
Actually, maybe there was. Purchases of privately-issued assets (or loans against such assets) might have achieved the same result — or probably better, because they would have made it easier for banks to meet new regulatory liquidity requirements, and thus to extend more credit after the crisis. And they would almost certainly have been much less costly.
Unfortunately, once QE as we know it was in train, none of the people who really mattered — Treasury officials and the executive managers of the Bank — seem to have thought very hard about the alternatives. The doctrine of concentrating on gilts prevailed without much recorded debate or explanation.
If you can’t see where responsibility lies, then the management structure isn’t working — and needs to be redesigned. The Treasury obviously needs to pay closer attention to the risks against which it has issued indemnities. Yes, it should not have taken the temporary cash flow surplus from the APF and frittered it away — thanks, George Osborne — but, moreover, in over-respecting the Bank of England’s independence it surrendered its own objectives for debt management.
The Bank, meanwhile, needs to stop ignoring the side-effects of its decisions. A good start would be to consolidate its decision-making committees into a single executive board, which in setting policy would consider its effect on all of the Bank’s objectives. And the Bank should get closer to the Debt Management Office.
To be fair, the Bank has evidently recognised that there are problems with its structure, and has, for example, revised the ‘concordat’ that prevented the MPC from expressing a view about what assets the Bank should buy in QE. But even if it wanted to, the Bank couldn’t make the necessary comprehensive reform without new legislation. The QE episode shows how expensive malfunctioning structures can be.
This is not a proposal to weaken the independence of the Bank of England or modify its objectives. Its purpose is to recognise the fact that actions taken in pursuit of one objective can prejudice other objectives. Refusal to face that fact is the real threat to the Bank’s independence.