A proposal I have long made has won a surprising supporter in the form of Chris Giles of the FT.
The proposal is to cut the interest paid on the central bank reserve account balances notionally held by the UK's commercial banks with the Bank of England, but which actually represent the money created by the Bank of England as a consequence of quantitive easing policies, which sums ended up being described as a new bank deposits held by those commercial banks with our central bank, but which were actually nothing of the sort. The balances in question were, effectively, gifted to those commercial banks by the government when. creating new money to keep the economy going during g periods of crisis.
I, along with a few others, like the New Economics Foundation, have been arguing for a long time that the payment of interest on most of these balances was quite unnecessary.
The transmission of Bank of England interest rate policy into the larger economy does not require that interest be paid on the vast majority of these sums, in my opinion.
Before 2006 no interest was paid on any touch balances, although they were insignificant at the time.
When interest payments were first introduced, no one argued that the balances have to amount to hundreds of billions of pounds to be effective, and evidence from other central banks, such as the European Central Bank, has shown that interest need not be paid on all such sums.
So, why has such interest been paid? That is because two exceptionally powerful lobbies have argued for those payments.
One of those lobbies has been the commercial banks, who have profited considerably as a result. Even now I would argue that they are profiting by more than £35 billion a year as a consequence. At one point that gain exceeded £40 billion a year.
The other powerful lobby has been the Bank of England who, I think, see their interests as being aligned with those of the commercial banks.
The case for reducing these payments is very obvious. Those payments have unjustly and wholly inappropriately enriched the banks at a cost to society at large, grossly inflating the interest costs due by the government. This means that they have entirely inappropriately induced an environment of austerity within the government's culture. The wrongheadedness of this has always been obvious.
Now, enter Chris Giles of the FT into the fray, rather unexpectedly. He has said that this matter could be resolved by changing the Bank of England's mandate. He suggests that six words be added. They are that it should “have regard for the public finances” so long as it can effectively implement monetary policy.
I agree with Chris, that would be useful. I would add a specific obligation to deliver full employment and sustainability as well: as usual, he does not go far enough.
But he then developed his argument by saying:
At present the BoE pays 5.25 per cent interest overnight on the money it created to buy government bonds under multiple waves of quantitative easing since 2009. It still holds roughly £700bn of bonds that were purchased and they earn a return of about 2 per cent. Netted off, the annual interest rate loss is around £23bn a year, a little shy of 1 per cent of GDP.
Chris gets his numbers wrong. There is no reason to offset interest received on bonds notionally owned by the government against interest paid: they are unrelated issues. So the cost is the gross sum, which is over £35 billion, as I have noted.
But the key thing is that he thinks that he thinks interest should not be paid "in the interests of the public finances". And to this extent, he is absolutely right. There is no reason for most of this interest to be paid.
How much does this release for public funds? Maybe £30 billion a year.
And will the banks suffer as a result? Yes, of course. So, too, will savers. But, c'est la vie: this is the age-old trade-off between appeasing the well-off and meeting needs, and those in need should win.
As for interest rate policy implications, the Bank might just realise that high interest rates really are not good for the economy after all. That would be an extra win.
But whatever happens, Labour will need to address this issue.
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The fact this is now getting traction in the FT is important.
First, Richard is right to suggest that the interest received on the portfolio of gilts is not relevant here – the interest received by the BoE is paid by HMT… so is a net zero trade for the Government. So, it IS £35bn “in play”.
Second, not all of that £35bn can be “saved”. There needs to be interest paid at the base rate on some reserves… otherwise there will be no transmission of policy to the real economy. But even if it is “only” £10 or £20bn it is worth it.
Third, Chris Giles suggests this can all be changed by altering the BoE mandate to “have regard to Public Finances”…. which suggests that the BoE currently has NO regard for public finances… which is rather shocking when put this way.
Fourth, there is lots of whining below the line of the Chris Giles article about “higher rates for borrowers/lower rates for savers”… but this all assumes banks maintain their profits… and they won’t.
So, just raise (unremunerated) reserve requirements incrementally starting now until we start to see a problem.
Thanks
And I agree maybe £5 billion would need to be paid
Nobody (least of all the BoE) knows how much needs to be paid in order to run monetary policy efficiently. It is impossible to know in advance what the commercial banks’ desire to hold reserves will be under a new remuneration regime.
But we just need to get on with cutting the amount paid now…. and see where we get to.
They don’t ultimately get the choice about holding reserves: they as a collective have to. They can only squabble between themselves.
Probably true in practice….. but not for certain.
If banks pay zero on savers’ accounts those savers might switch to NS&I which would reduce aggregate reserve balances. Equally, if the BoE sell gilts via QT it reduces aggregate reserve balances.
Now, neither of these things is necessarily bad – it all depends at what rate it happens and I would rather savers get the interest via NS&I than have the banks trouser it. Indeed, if this flow became significant it might move us towards a new NS&I that does a lot more.
In short, there are a lot of moving parts in this process and the risk of “unintended consequences” is high. So, move now, move incrementally, be flexible and think of this process as just part of a broader reform of banking and monetary policy
I saw Farage and Tice present this as official Reform Party policy this morning. I think I am right that it used to be that banks kept their central bank reserve account balances as low as possible based on their own projected liquidity and settlement requirements and central bank minimums with any remaining liquidity invested in bonds precisely because the CB reserve rate was zero. QE offered them an easy money making arb. Even the interest payments have to be digitally printed!
CBRAs were created by QE ( in effect, although it was more complicated than that). The banks had no choice but accept them. They can only be reduced at government choice. The banks can swap them between them, but there is strong evidence they need the liquidity they provide.
@Clive Parry
I don’t think it is true to say “There needs to be interest paid at the base rate on some reserves… otherwise there will be no transmission of policy to the real economy”, though I do understand the logic.
Firstly, do we really want the transmission of [interest rate] policy to the economy? It’s a very blunt instrument that has manifestly failed over the past couple of years.
But let’s assume, for the sake of argument, that we did want to control interest rates. Then we could do that through government sales and purchases of bonds (as Japan has done very successfully). Then, the argument goes, you lose control of your exchange rate (witness Japan’s low exchange rate, though that also helps their manufacturers). But now there is a logical fallacy. On the one hand wanting to control the interest rate, on the other saying that we cannot do it in a particular way because that affects the exchange rate. What this means is that we’d be trying to control two variables, inflation and the exchange rate, via one control, interest rates. That’s logically impossible (unless the two variables are very closely coupled, which they aren’t).
What this means is that the BoE cannot both control inflation and the exchange rate. More controls are needed, which can only be provided by government.
I agree that it would be wise to reduce the amount of reserves on which interest rates are paid slowly. It’s not wise to introduce sudden shocks into a large complex system like the economy. But I see no reason why the amount of interest paid on reserves should not, eventually be reduced to zero.
I look forward to Clive’s reply….
I have long advocated (on this blog) a larger “tool kit” for policy makers – in particular, credit controls. Historically, we have used interest rates, credit controls, reserve requirements, special deposits, FX controls as well as non-monetary measures (eg. Wage and Price controls) to manage inflation and the economy in general. Not all of these make sense today in the current Capital/Liquidity regulation framework
I have also argued that QE/QT was wrong in that purchases were at “any price” and gilt yields got to absurdly low levels that had no benefit for the real economy but stored up problems elsewhere. I have always believed that yield curve control via sales/purchases of gilts would have been better.
So, I fully agree with you that one tool can never “do it all” and that a complete overhaul of policy tools and policy making is well overdue.
I agree with you Clive
Well said Tim – As to zero rates on reserves and thus a low interest regime for public finance – Richard quoted Keynes on interest, “Indeed, the transformation of society which I preferably envisage may require a reduction in the rate of interest towards vanishing point within the next 30 years.”
@Clive Parry
A good discussion thanks. Some interesting points. 🙂
Thanks for that interest ling post. I’m pleased that at least some people are noticing that interest paid on reserves is ridiculous.
The discussion highlights the ridiculous position of the BoE and why it should not be independent. I agree that they should “have regard for the public finances”, and also “to deliver full employment and sustainability as well”. Added to the current mandate to control inflation, that makes 4 objectives. It is impossible to control 4 objectives using only one control (interest rates). Even if you add in QE/QT there are not enough variables to control the economy. It needs the flexibility and taxation powers of government to do that. An independent BoE is, therefore, nonsense.
What would happen if the BoE paid no interest on any reserves? Obviously the banks would scream, but I’m not concerned about that. The BoE would claim that it couldn’t transmit monetary policy (interest rates) to the economy. That might be no bad thing but, anyway, is not true. Interest rates could still be controlled by bond sales and purchases. Banks might stop paying interest on deposits. It seems to me they have little reason to encourage deposits if they cannot arbitrage interest payments on reserves. And it might be a good thing not to pay interest on bank deposits. Firstly it might encourage people to understand how the economy really works; there is no God given right to interest on savings, you always have the option of spending. It might also turn them towards saving via government bonds, which might be a good thing. It also might encourage savings to be applied to real investment (not the stock exchange Ponzi scheme).
So, yes, the BoE should not be paying interest on reserves.
You reach the obvious conclusion, by implication. Central banks should not be managing economies.
“…. there is no God given right to interest on savings, you always have the option of spending. It might also turn them towards saving via government bonds, which might be a good thing”.
Actually there requires to be somewhere to invest with security (safe asset theory). You have merely transferred the need from banks, exclusively to direct investment in government saving. The issue is how you fit in the private sector, but with security and very low risk for depositors, and without the private sector following its natural instincts, and opportunistically ripping everyone off; as surely, eventually they will – or they cause a major financial crisis; as inevitably they will, because they do, time after time. There is also a reminder in the blood scandal, Post Office, Grenfell (etc, etc); you cannot always trust government.
@ John S Warren
Well, I’m sure people would like a safe asset, and I believe it is a good, highly desirable, thing for the government to offer safe savings in the form of bonds, but, again, there is no God given right to safe savings. Historically definitions of money have included a “store of value”. But ultimately, in absolute terms, there is no safe store of value. After all, a planet killer meteor will destroy all stored value.
Of course we should be mistrustful of government, especially in the light the blood scandal, Post Office, Grenfell (etc, etc). But, even allowing for reasonable scepticism, I think government bonds are as safe as it gets. The world is a scary and unsafe place. People are fooling themselves if they think they can engineer complete security.
Sorry Tim, but this is absurd
Let’s assume we will have government
Then its provision of a safe place for savings is essential – and with8n known tolerances they can do it best. Shall we ignore the rest?
Let me put this another way. The “God given right to safe saving” is actually just an important part of the Sovereign Government’s basic necessity for survival (the mirror image of what secures soverignty for the sovereign); the issue of a currency all its people trusts implicitly and without hesitation, sufficient to encourage them to secure their savings in it safely at the lowest risk they can conceive. This is one important element of the foundation for the creation of a money people will trust without further reflection, and induce them to pay the taxes the government commands.
In the digital age, and a post ‘cash’ world, the security of saving outside the small number who buy gilts, is more, not less critical to government, because government is losing its direct money contact with its own people; it is moving ‘out of touch’. This sense of trust by people, must be universal within the whole community, and if not direct, still requires to be absolutely rock solid; not merely Northern Rock solid.
I was trying to say government bonds are a good way of savings. Highly desirable. I agree government should provide.
I wouldn’t exclude other types of savings, but bonds seem safest to me.
And then I was merely saying that nothing is absolutely safe, even governments though they are probably the best we can do.
My apologies if my phrasing was confusing.
I think we are more or less in agreement?
A little caution on over centralising… the safe deposits with NS&I could be via the private banks eg in France each major bank offers a Livret A which is a hypothecated investment which helps finance public housing, the Livret de développement durable et solidaire for renewable development, etc. There should be a return to central bank “window guidance” on lending a percentage of bank loans for real GDP, not the parasitic finance sector (FIRE Finance, Insurance, Real Estate). But this would be helped by decentralisation of banking with the creation of thousands of small local not for profit banks lending to local business’s, the power houses of Chinese, German, Japanese, and Korean economies. Note over regulation is currently damaging this small bank sector, much better local bank examiners who can spot upcoming problems guide the banks rather than Basle III for this sector. Housing loans only available from non-profit cooperative housing societies (no bank created money) ?
Nice idea.
Unfortunately, the infrastructure disappeared a long time ago.
Well said again Tim! … But I have a question. Wouldn’t selling bonds be deflationary and raise rates?
Someone buys them….
Richard – to your – someone buys them response. True, but when CBs sell bonds or the banks do it, we have QT. the money supply shrinks.
This fine paper states that selling bonds destroys money, just like repaying loans.
https://www.bankofengland.co.uk/-/media/boe/files/quarterly-bulletin/2014/money-creation-in-the-modern-economy.pdf
That I agree….but I did not pick that up from your comment
Selling bonds tends to increase rates. There’s more supply, the price tends to go down, so the yield tends to increase. And vice versa.
Whether it’s inflationary or deflationary depends on a host of other factors.
There is no pure market here….
Please do whatever you can to make sure this gets to Starmer and Reeves. Also James O’Brien on LBC would be a great advocate . This has always been a criminal waste of public money.
Starmer and Reeves know this
And James O’Brien has to ask me on – and that is rare
How did they ever get away with it? Revolving doors: banks – BoE – civil service? ‘We’re mates and understand one another and our decisions do not need to be justified?’ ‘And nobody really looks when there is so much else going on?’ ‘It will do for now. We can look again later. … Oh, it isn’t convenient yet. … Let’s just alter interest rates instead’?
How much more of it is there?
What if Richard Murphy took off his kid gloves? And more financial journalists showed the courage of Chris Giles?
I fully understand the point made that commercial banks love free money – who wouldn’t? Where my understanding falls to pieces is : “The other powerful lobby has been the Bank of England who, I think, see their interests as being aligned with those of the commercial banks.”
Umm, the gov owns the BoE. Why would the BoE & by extension the government think that their interests align with commercial banks? and in turn, why is GIVING circa £35bn to commercial banks “a good thing”.
It all smacks of commercial capture of a state function (in this case commercial capture of the state function that can and does print money).
Moving into fantasy land: imagine a committee of randomly selected citizens that had BoE oversight. “Ok so we see that you gave £35bn to commercial banks for holding money given to them by you… why”. I guarantee – if broadcast it would beat the ratings of Corrie. Especially if they were supported by a KC that did the forensic questioning.
If only…
The BoE are aligned with the commercial banks and dealers, on whom they rely to execute important elements of their monetary policy. The public only has direct contact with the BoE if it buys gilts, or uses ‘cash’ (almost nobody does now*).
NB. *I am due payment (a refund) from a company. They asked for my bank details to pay me. I declined to provide them, because it was a one-off transaction, and I do not care to have confidence in Big Tech, security, or indeed banking systems. I asked for a cheque. They have now told me that they can’t do this, they no longer do this; and it is all too expensive. I have been offered a BACS payment, because they found they had my bank details from some time in the past. Cash is being driven out of the system, and save for gilts, the government, that issues our currency is de-coupling itself from the people. the private sector is hustling in to make sure it all works, principally for their profit interest. all this cannot end well.
The Bank of England was originally both a private bank dealing in its own interest, and the Government’s bank. This ended so badly (most notably in the worst banking crisis in history, other than 1929 and 2007 – and in some ways even closer to total banking system collapse; and followed by several banking crises in the 1830s), because the BoE faced ruin before it effectively acted in the market as lender of last resort in the 1825 crisis; but without recognising that it had an over-riding duty to act as lender of last resort, until faced with disaster. This problem was not fully recognised (even in the tardy Banking Act, 1844), and the concomitant risks and inconsistencies in policy finally removed, when the BoE was taken over by Government in 1946.
I submit that what has happened in the modern City, is that the banks and dealers have been gifted special access to and privileges with the BoE, in the operation of monetary policy, including over reserves and QE; and have simply replaced that ‘private interest operation in financial policy execution’, acting for the BoE and acting in their own interest simultaneously, and simply re-creating the 19th century arrangements, risks and inconsistencies; but now at one remove from the BoE. And nobody has noticed.
“Chris gets his numbers wrong. There is no reason to offset interest received on bonds notionally owned by the government against interest paid: they are unrelated issues. So the cost is the gross sum, which is over £35 billion, as I have noted”.
1) Richard, if you have the time, could you tease out exactly what you mean by this?
2) “…have regard for the public finances”. Yes, this makes the general point; however, It is not usable, at least as it stands. It completely lacks rigour. Turning it into something usable is far more difficult.
3) Nobody seems to have mentioned tiered reserves.
Time feels like a very scarce commodity today….
(1) The netting off of interest paid on reserves with income received on the resultant gilt portfolio suggests that the income is in some way dependent on the creation of reserves. Yes, the additional reserves created were as a result of gilt purchases but that time is past – we now have a gilt portfolio that pays interest and that is fixed (give or take some reinvestment). Besides, interest on gilts owned by the BoE is a “net zero” transaction between two arms of government. So, the only “moving part” here is a transfer of cash from the State to commercial banks (who may or may not “pass it on” to savers)…. and it is that “moving part” which is £35bn and can be altered.
(2) I agree, definition is required…. but Chris Giles HAS started a debate on the issue.
(3) Tiered reserves are certainly one route to reduce payments…. and should be considered. I guess “zero” is an extreme form of tiering
Thanks Clive, that is very clear, concise and useful.
3) The point of tiered reserves is that we do not have to reinvent the wheel. It has already been done. we have the starting point. And the idea of this BoE inventing anything fills me only with dread. The only too recent LDI-Pension fiasco, from its lack of attention to a) regulation, b) detail c) learning the lessons from 2007; are all just too recent, and too depressing.
The point about “…. ‘zero’ is an extreme form of tiering” was not just witty, but shows that it seems that tiering covers the bases fairly comprehensively.
I’m flabbergasted !
When someone provides money to another entity, it is the loanee who pays the interest NOT the lender !
We bail out the banks and pay the interest on the money we gave them – you couldn’t make it up
If we’ve provided them working capital, as I assume that this is effectively what this is, then the banks should be paying the interest, as would another other normal business
Or is this a ‘premium’ we are unknowingly paying to keep London the Financial capital of the world (allegedly)
I would like to know who agreed to this and hold them to account via a proper inquiry , ala Post Office scandal
I suspect it was discussed and agreed via informal discussions between BoE, banks and Conservative Party in a cosy gentlemen’s club
Any idea what the cumulative cost to date has been ?
Also how long is this expected to go on – in perpetuity ?!!!
I debit a while ago, but not up to date
It has only mattered since 2021
Think of this. Why are all these big reserves there? mostly QE derived, built in because the banks broke the system, and were bailed out. They are being paid for the public providing them huge amounts of public money; and demanding reserves; why? Because you just can’t trust them, without the reserves.
This is a paradigm definition of irony. A little deeper? The irony is a reminder that this is a bad system; and they have no idea how to produce a better regulated system. and that is another paradigm irony.
Yes, many have asked why this interest is being paid. Following the massive increases in living costs, many households are defaulting on credit card debts. While the banks have created these loans electronically at no cost to them they have lost the interest payments.These loans are often sold on as loan-backed securities to third parties and they will also have incurred losses.. The same will apply to those who have defaulted on mortgage payments, car loan agreements etc. Can they all be taken to court? It would swamp the system and people would still default on fines and the prisons are full.
I suspect this is the government’s way of compensating the banks for this mess.
Why should the government compensate the banks for their own mess?
And, I don’t think this has anything at all to do with this, for the record.
I agree with you, Richard but there is no more reason why the banks should be paid interest on these deposits.
I have tried to find the real reason why this has been set up and my suggestion above is a point which has not been discussed openly – probably just the way my cynical mind works after years in the financial world.
I think the real rason is ‘they say it should be so’
Sometimes the simple answers are the best
“I suspect this is the government’s way of compensating the banks for this mess”.
Mr Palmer, you appear to be saying that because the banks created this mess, there is no way out; save to subsidise them at the cost of everyone else’s living standards, and drain the economy of value, for the sake of making them easy profit, for ever and ever: because nobody can figure out how to fix it any other way; or have the least idea how to replace the post-crash (2007/8) fudge, that was hastily thrown together in a panic; and are simply too terrified by their own inadequacy and poor foresight to change much at all.
It isn’t much of a sales pitch, still less a credible prospectus. It is striking to me , and I confess quite unexpected; the sheer scale of the public traction Sunak leaving the Normandy beaches early has had (especially among Conservatives), and it is a telling insight into the sense people have of the mess we are in, the failure of our current age, and the deep nostalgia that still resonates for a time, and for a sense of determination and purpose that has moved out of reach, and very soon, even of living memory. A resonance felt even by generations with no viable direct memory of the time they revere.
All those who are most upset will have tomorrow …. is the mess we have made since, and will leave behind for other generations to clear up as best they may (they will have reasons to memorialise our generations); because clearly we have already amply demonstrated by what we have done, or failed to do; it is all quite beyond us.
“they will have reasons not to memorialise our generations”.
Now i think of it, perhaps future generations will be sufficiently sceptical to memorialise our generations with an anti-memorial.
Richard – Great column
I. I would everyone to reread Richard’s 2023 column which was superb
https://www.taxresearch.org.uk/Blog/2023/08/10/the-uk-governments-bung-to-our-commerical-banks-additional-data/
2. Perhaps you need to dedicate another column to the mechanics of controlling interest rates without using rates on reserves. Clearly the central bank can buy bonds to lower rates, but selling bonds is a deflationary measure – raising rates and reducing the money supply.
If I get time…yes
If I have time I will try and set out how monetary policy operates now, how yield curve control could supercede QE/QT and what the possibilities and problems are for not paying interest on reserves.
But not this weekend.
Send it my way..