This article was originally published in February 2021.
Standing at close to £759bn, the ‘stock’ of UK state debt acquired by the Bank of England on behalf of the state is not merely a considerable number but, to many, a monetary time-bomb. Indeed, I am often challenged with the question: when the Bank of England ‘deals’ with the debt it has landed itself with, what host of problems will this land the UK economy in? My answer to this has been stubbornly consistent: we needn’t be worried by what the BoE does with ‘our debt’. Before making a case for such a seemingly blithe answer, let me turn the clock back to why the Bank of England acted as it did over a decade ago.
The simple fact is that, after the unprecedented banking shocks by which the UK economy was suddenly and so dramatically hit from 2007, it needed a sizeable infusion of liquidity. Far more sizeable in fact than what could be achieved even with the dramatic and timely cuts to the base rate that were actioned.
Quite frankly, then, UK near-ZIRP/QE was the quick and effective way for the Bank of England to achieve the essential injection of money the UK economy most desperately needed, for reasons best explained by a very simple factor model.
Be in no doubt that the BoE is sitting on a very sizeable notional profit from its QE gilt programme
Stripped down to its skeleton, a ‘flowing’ economy depends on this factor: the STOCK OF MONEY multiplied by its VELOCITY OF CIRCULATION. The latter is simple enough to understand; we never choose to retain every pound we earn, but spend a portion of it. This portion goes on to become income elsewhere, a part of which is in turn spent and so on, such that £1 moving around at 90% velocity sums to total income of £10. When real interest rates are high and/or our confidence in the future is low, we are more inclined to slow the speed we CIRCULATE our MONEY. With this in mind, when the events of 2008 so dramatically struck, UK household and business confidence was so seriously undermined that the monetary policy committee immediately and very wisely stepped in and slashed interest rates in an effort to mitigate matters. So much, then, for much looser conventional monetary policy helping to restart the practically stalled VELOCITY OF CIRCULATION. The problem back in 2008 was that the STOCK OF MONEY too fell dramatically.
To understand what happened, one has to embrace how we consider our STOCK OF MONEY as not merely in terms of the notes and coins to which we have immediate access, but what we consider CLOSE MONEY.
Please reflect for a moment on how British homeowners seem incapable of passing an estate agency window without glancing in at it. This is not to look at our physical appearance but rather to check out our financial image, as reflected by our local property prices showing how much equity we have in ‘our’ (very often mortgage-laden) home. In the wake of the 2008 shock, the image we saw was bleak. The same image of negative equity had, as we sadly remembered, appeared in the past, most notably back in 1989. What differed so much in 2008, and so much for the better compared with 1989, was that the UK’s monetary policy had shifted out of amateurish and ‘handcuffed’ chancellorial hands, into extremely professional and agile Bank of England ones (we were so fortunate to have the likes of Professor Charlie Bean as chief economist and deputy governor all those difficult years ago).
