RAPID responses

Unbreakable bonds

[Re: We need an open contest to decide who will run the Bank, Thursday]
Allister Heath argues that the £300bn plus held by the Bank of England in government bonds should be cancelled to reduce the government’s debt and interest bill. Cancelling the bonds would undermine the credibility and independence of the Bank and leave a huge hole in its balance sheet. It would leave the Bank technically insolvent because it would no longer hold assets to match the substantial sum of money (about 20 per cent of GDP) created under the quantitative easing (QE) programme. And it would leave the Bank without a means of reversing QE if it needed to do so to keep inflation in check. Any saving in interest would be purely artificial. The Treasury benefits from profits made by the Bank and has to underwrite its losses. So any interest received by the Bank of England over and above the cost of operating QE is returned to the Treasury anyway. Cancelling the Bank's bonds would reveal that QE had been all about printing money to finance the government's deficit – the kind of policy which led to rampant inflation in the Weimar Republic and Zimbabwe. The resulting collapse in financial confidence and the value of the pound would be catastrophic for the British economy.

Andrew Sentance, former member of the Bank of England Monetary Policy Committee and senior economic adviser at PwC.


Old Lady’s losses

Allister Heath’s plan is problematic. The Bank of England holding these bonds, instead of forgiving them, has three key effects. First, as the government pays interest on the bonds and redeems them as they fall due, the monetary injection provided via QE automatically leaks away. If the Bank forgives the debt, no such mechanism is in place, and consequently the implied increase in the money supply from QE is much more sustained (and hence greater). In an already inflationary environment, this is dangerous and would be even more so in a recovery. Second, by holding these bonds the Bank of England has a straightforward and very powerful mechanism to unwind QE to reduce money supply growth. If it forgives the bonds, it will find it much more difficult to limit money supply growth if it needs to. Its main option would be to use a large interest rate spike, which could have serious unintended consequences for those in variable interest contracts. Third, by forgiving the bonds, the Bank would make huge balance sheet losses, placing its solvency in question. That is best avoided – your central bank going bust can ruin your day.

Now, the Bank is indemnified by the Treasury against losses on these bonds. But that is a rather different matter from losses induced by forgiveness. The Bank would either have to recapitalise itself from seigniorage (inducing inflation by printing even more money) or be recapitalised by the Treasury.

On the other hand, the Treasury guarantee against losses means that if (as will surely happen in due course) interest rates rise above the level at which the Bank bought the bonds, the (potentially huge) losses the Bank then makes will be made up by the Treasury. That creates a close connection between monetary and fiscal policy – making rather a mockery of the (perhaps now obsolete) concept of “central bank independence.”

Andrew Lilico, director of Europe Economics and member of the Shadow MPC


Managed money

While monetisation of QE has occurred, it is not permanent; it can be reversed. However, if one cancels the gilts, that monetisation will become permanent and remain in an increased money supply. When the economy picks up, this increased money supply is likely to lead to inflation.

If the gilts were not cancelled, their sale would reduce the money supply introduced by QE. This sale can be calibrated to control economic activity, in the place of using base rates. The reduction of money will reduce the amount of economic activity it can generate. It will increase real interest rates but not at inflationary rates if managed properly.

Kumar Devadasan


Accounting fiction

The idea that one department of HM Treasury owes another department of HM Treasury £350bn is an accounting fiction. We might as well cancel the gilts owned by the Bank and recognise the commercial banks' loans to the BoE as government debt instead. Still, the taxpayer isn’t paying interest to the Bank, another department of the Treasury (the Debt Management Office) is. The accounting fiction nets off to precisely nil. The Treasury is not only paying interest to itself, it is receiving interest from itself, it is a zero-sum game.

Mark Wadsworth


Tax by design

[Re: Government wrong to demonise generous philanthropists, Friday]
We have a democratic system where an elected government decides where tax money is needed. Philanthropists want to be able to take money and say where they want it spent instead.

I may not want my taxes spent on some things the government does, but I shouldn't have the choice, other than through the parliamentary system, to reduce my contribution and instead fund my favourite hobby horses.

Nick Reid


This charity furore is just another example of how unsuited to office our politicians are.

It’s sad. The charity income tax cap is just another of the catalogue of 2012 policy errors. Like a football team headed inexorably towards relegation.

The Greens haven’t received 4 per cent of the vote since the 2000 mayoral elections, and yet Jenny Jones gets a platform.

'Everybody wants to save the earth; nobody wants to help Mom do the dishes.' So said
P J O'Rourke. @danhannanMEP