Finding the UK government’s ￡22 billion is easy but requires a change in the relationship between the Treasury and the Bank of England (BoE)

I have written much about the relationship between monetary policy, government “debt/spending” and fiscal policies in the UK, and the implications excessive Quantitative Easing (QE) has had on structural inflation and the cost of borrowing. The articles below provide for some background reading on this:

1)??????? On QE and Inflation : https://www.dhirubhai.net/posts/jensgemmel_people-in-the-uk-need-to-accept-that-they-activity-7071994457897725953-MgsN?utm_source=share&utm_medium=member_desktop

2)??????? On Government Debt and Reverse Repos: https://www.dhirubhai.net/posts/jensgemmel_why-quantitative-easing-qe-is-here-to-stay-activity-7104578969949073408-u43V?utm_source=share&utm_medium=member_desktop

As there is much debate about those “missing ￡22 billion” in the UK’s budget, I thought it to be useful to provide for further thinking on how to eliminate what Labour calls “unfunded spending” or “budget hole”.

When the government spends money into the economy, or when it receives money from the economy, those flows of funds go through commercial banks to the Bank of England into the BoE’s central bank reserve account. Essentially, this is when the real economy repays that government money through tax payments, or by depositing funds in government bonds or national savings and investments (so, money flows out from the government via the central bank reserve account and we pay back that money through the central bank reserve account).

What happened during the period from 2008 until 2021 was that the central bank reserve account increased from around ￡20 billion to about ￡1 trillion, a direct result of QE (printing money). The BoE started tightening it’s QE programme following last year’s inflation spikes but this has had only marginal effects on the overall balance.

Commercial banks have some ￡750bn in reserves deposited with the BoE, and just like a regular deposit where the bank will pay you interest for having your money with them, the central bank pays interest on that amount. That means that the BoE is paying 5% to commercial banks just to hold their money, which comes in at about ￡40bn a year.

Ultimately, UK taxpayers foot this bill as the government is liable for the BoE costs via the Treasury. The Treasury is responsible for funding any gap between the interest the BoE receives on bonds bought via?QE and the interest it pays out, along with any losses the Bank makes from active sales.

The net loss to the BoE is, however, less than the ￡40bn as the central bank generates interest on the ￡730bn of government bonds it owns. The Treasury will pay out over ￡150bn to the Bank of England to fund its payments to the banking sector by 2028 - this is on top of the ￡30bn already paid out in 2023.

Now, it is said by the City of London, and by some economists, that it is essential that the government pays interest at this rate, because this transmits the decision on official interest rates into the rest of the economy, and therefore requires that everybody else use that rate.

I disagree and argue that UK government could stop paying interest on most of the central bank reserves?balances that are held by our commercial banks with the BoE.

Last September, the European Central Bank (ECB) decided to stop remunerating banks' minimum reserves to contain the amount it pays in interest and the losses it is likely to make. It also debated raising banks' obligatory reserves – to 2% from 1% of deposits to increase cash from the banking system. It will save the EU about €136bn in interest to banks just for holding their money.

The Swiss National Bank also stopped paying for the money lenders must hold at the institution as a minimum reserve as of December in a move that that will save the country 300 million francs (￡269m).

Now, I'm not saying that no interest should be paid and any policy changes would need to account for some interest payments to achieve the monetary policy goal of transmitting the BoE’s interest rate into the economy - I would argue that a level set at 25% which equates to approx. ￡10bn would be sufficient. However, the remaining balance of that money (￡30bn) was created by the government through its QE programme following the 2008/09 financial crash and the 2020/21 Pandemic. It is this balance which could be cancelled in terms of interest payments. Accounting for losses on taxes from those receipts (about ￡10bn or 33%), the net benefit for the government may be a bit over ￡20 billion a year.

Perhaps it’s time for monetary policy to return back to the Treasury where it belongs and which would make these changes a simple matter of policy rather than a counselling session for a marriage gone wrong and where the entire village knows that one was cheating all along.