The Institute for Fiscal Studies, in its commentary on the so-called Reform Party manifesto for this election, says of that party's plan to save £35 billion by cutting the payment of interest on central bank reserve accounts:
The cost-saving measures would save less than set out. There is a respectable argument for changing the extent to which the Bank of England pays interest to commercial banks, and indeed some other central banks don't pay interest on all the reserves they hold. But whether a good idea or not, it would raise a lot less than £35 billion per year.
I note the phrase:
There is a respectable argument for changing the extent to which the Bank of England pays interest to commercial banks.
It is an argument that I have made here, often. It is welcome that the issue is now out in the open, on the national agenda, even if it is a great shame that it took Reform to put it there.
Would it raise £35 billion? Let me split that into two parts.
The first is, will it? The answer is no. That's because I am persuaded that maybe one-quarter of the reserves might need interest paid on them to support monetary policy. That means roughly £9 billion must be paid. Then the rest, or £26 billion, will have tax paid at 28% on them, or roughly £7 billion. That tax will not be paid if the interest is not. So, the net saving might be around £19 billion, which is a better estimate than I suggest just about anyone else is coming up with.
The second is whether the savings should be £19 billion. The answer is that, of course, it should not be. Bank base interest rates should be much lower than 5.25%, meaning that the interest cost should be nothing like £35 billion.
This glaringly obvious point seems to have been missed by almost everyone. But, of course if interest rates were cut - as is essential - the cost to government of its whole debt would fall by much more than £19 billion.
Why did no one talk about that, I wonder? What is this taboo that debate on interest rates is not for discussion in this election all about? It is deeply dangerous and an abandonment of democratic control of the economy that it is not.
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Am i right in thinking you were the first economist to say this? If do well done!
Amongst the first
Don’t tell Farage but he is just copying the EU.
The ECB stopped paying interest on required reserves from July last year. https://www.ecb.europa.eu/press/pr/date/2023/html/ecb.pr230727~7206e9aa48.en.html
Andrew good catch!! …
Richard – I am not sure what it means though. Isn’t there a massive surplus of reserves? What happens to the interest on them?
Thanks
I retest is paid on all central bank reserve accounts
Would you mind explaining the 9bn of interest paid on monetary policy?? TIA
It’s interest paid at current rates on a quarter of the reserves, which should be enough to transmit BoE monetary policy.
£35Bn-£19Bn = £16Bn, less the difference in interest rates.
We are still paying a penalty for holding up a badly conceived system designed to shore-up a system that collapsed because we know that, unless tightly controlled we can’t trust commercial banks not to ruin us. We are effectively controlling them by bribing them not to rip us off, or let us down. That, I submit is the reality.
Agreed
Meanwhile, there is continuing child poverty
Mr Warren: ” We are effectively controlling them by bribing them not to rip us off, or let us down.”
Why?
I fail to understand in the least why the BoE should pay a brass tack of interest to UK banks for “holding reserves”.
My understanding is that these “reserves” were given to them by the BoE?
Or perhaps they are reserves required to be held to cover their banking activities? If the latter why should the gov/BoE pay interest on them?
(and also I understand that the Basel III reforms required loans vs assets (= partly reserves?) to be circa 10:1 or better.)
I’m sure I’m missing something but I’m puzzled why banks need BoE subsidies to function – whilst at the same time – “screwing” (a technical term) their vicitms aka “customers”.
We seem to have moved away from the idea of banks as, you know, “commercial” institutions and towards gov as a wholly owned subsidiary of banks.
Power
It is always power
Time for a bank of Britain for all public sector finance. Pensions and education and hospitals and social care are wasting billions of pounds in bank charges and fees and interest. the banks are always making money. The bank of England makes the money?
As I understand it, before 2006 all government payments were debited directly from the Exchequer’s Consolidated Fund, the bookkeeping for which is handled by the BoE. But I was told by Andy Haldane, when he was Chief economist at the BoE, that they felt it was not right for them to compete with the commercial banks, so all government payments were outsourced to two banks who successfully tendered for the contract – NatWest and Citi Group (plus Barclays for HMRC accounts). I am presuming that these banks get paid fees by the government to handle these accounts. In the US all government payments come directly from the Federal Reserve.
All of which is totally absurd…
So, the BoE asked the commercial banks if they wanted to do a bit of clerical work for guaranteed profit? They didn’t even have to ask for the business, just put in a decent bid!
I’m guessing this is just an extension of the neoliberal mantra that only the private sector can do anything efficiently, so we must get everything off the government’s books. I wonder how many staff at the BoE were laid off after this needless transfer of work to the private sector? Or perhaps they just moved jobs to work for the commercial banks doing exactly the same job!
Thank you.
Across the channel, the Bank of France operates in the provinces and acts as local authority banker, including collecting fines for speeding incurred by drivers based abroad.
I can’t believe any form of US government would hire a foreign bank as banker or be allowed to.
During the crisis, UK banks, via their trade body / my employer, got the government to make sure NS&I did not offer superior rates.
“All of which is totally absurd…”
The USA, The UK or both??? LOL! LOL!
Invaluable observation. This takes me back to my point about the BoE using private sector intermediaries to process Government payments into the public money system. Private sector intermediaries (banks and dealers) will always act in their own interest. They do not automatically place their only priority with a public duty, when their obligations are ambiguous and clearly create a conflict of interest.
The BoE was itself a private Bank, and it was only after persistent banking crises in the 1820s-30s particularly, where the BoE struggled to understand the urgent need for it to act as lender of last resort; that led – eventually, and it took far too long – to the nationalisation of the Central Bank. In short the operation of the execution of money policy is deeply unsatisfactory; but again, insiders fail to recognise the weakness. They have done so, for 300 years and it is a perverse recurring problem that is left to the insiders themselves, and never fixed. That persistent fact really should tell us something quite stark about the obsolete nature of our central banking culture.
Farage is mistaken here, possibly due to his treatment by NatWest in attempting to de-bank him and also disclosing data protected information about him as a customer. He would like to poke some hot metal into their house and see them scared. Revenge will be his.
By the way, the letters from the major banks to the Treasury Select Committee are here
https://committees.parliament.uk/committee/158/treasury-committee/publications/3/correspondence/?page=2
The details of the interest paid on reserve accounts are around 3/4 the way through the letters. They are interesting reading partly because some of them are making testable predictions that the amounts paid are already falling.
Richard,
Have you thought of offering an alternative manifesto:
1. Cut interest rates
2. Devalue the currency
3. increase spending on public services
4.Divert savings into social investments and national infrastructure
5. promote equality
6. restore national ownership to strategic industries
its a chore but someone has to do it.
No
Richard< you claimed that “This glaringly obvious point seems to have been missed by almost everyone. But, of course if interest rates were cut – as is essential – the cost to government of its whole debt would fall by much more than £19 billion”.
Surprisingly no-one else has comments on this, but the vast majority of the government debt is fixed rate – changes in interest rates may change the value of the debt for investors but won’t change the interest paid by the government by one penny.
Surely this massively undermines your argument?
More than half is variable rate – this element plus variable rate index linked bonds
With low inflation and low interest rates government borrowing costs could tumble
Richard, this is simply wrong.
75% or thereabouts is fixed rate, and the majority of the remainder is inflation linked. Floating rate (T-bills) are a very small proportion.
And inflation is not expected to fall if interest rates are cut.
So your claim is highly misleading.
Oh dear….that assumes the debt owned by the government is real debt and the alternative cost of central bank accounts should be ignored
Shall we discuss the real world?
My claim reflects the real world
Richard,
This article from the National Audit Office’ confirms that only 25% of the debt is index-linked and a negligible proportion is floating rate.
https://www.nao.org.uk/press-releases/managing-government-borrowing/#:~:text=Around%2025%25%20of%20government%20gilts,to%20lenders%20rise%20with%20inflation.
Perhaps you might like to reconsider your claims on this!
Oh dear….that assumes the debt owned by the government is real debt and the alternative cost of central bank accounts should be ignored
Shall we discuss the real world?
Richard,
Ok, let’s discuss the real world.
Where are your ‘real world’ figures for the current debt outstanding, split between floating rate, fixed rate and inflation linked?
25% roughly is index linked
30% is CbrA interest
So a minority is fixed rate
That’s the fact
Richard
Excellent post which generated many interesting responses.
We need an alternative scheme to control interest rates. You raised one – fewer reserves would qualify for interest. That has been the case in the past.
Perhaps you or others of your capable regular contributors have suggestions.