Thank you for visiting Is It Me!, which I am relaunching in the defence of Brexit. Anthony Royd
However, before I launch into that topic, I will address a series of current problems, starting with sustained high interest rates and the damage it is inflicting on the UK Economy.
My first article will focus on the UK Government’s Monetary Policy and the Bank of England’s (Bank) totally inadequate response to the increase in inflation, by increasing the Bank Rate, which I shall demonstrate is the wrong option, as they totally disregard the fact that the cause of inflation is the world economic problems and is not driven by domestic factors, other than uncertainty concerning the Governments monetary policy.
It is not surprising then that The Organisation for Economic Co-operation and Development (OECD) has recently released a warning that effectively says that The Bank of England’s maintenance of its high base rate, will continue until at least the end of 2025.
Alongside this first article I have published a monetary policy that addresses these failings and has the potential to reduce inflation and reduce mortgage interest levels to a sustainable level for home mortgages social housing and business loans.
Demonstrating that to reduce inflation, there is no need to destroy the lives, jobs and businesses of hardworking people, along with the lives of vulnerable groups, which is the impact of the current levels of high mortgage rates, rent increases and the high cost of business loans, as a direct result of the Government’s Monetary Policy.
The Royd Monetary Policy is a comprehensive proposal that attempts to balance economic growth with social well-being, using a thoughtful approach to monetary levers, housing market considerations, sectoral focus, and the adoption of alternative metrics like the TPI.
The monetary policy will reduce mortgage interest levels to a sustainable level, boost growth by funding economic growth, using Bank of England Discounted Rates, to Economic Sectors that are significant contributors to the UK economy. It will also boost the central bank reserves and improve it’s sovereign credit rating that will lower the interest rate on UK debt.
All that can be achieved, whilst focusing on sustainability, equality, and local conditions. The question is: “If I can see it, why can’t they?” or ‘Is It me! ‘
UK Government Monetary Policy
An analysis of the UK government’s monetary policy by Anthony Royd
Anthony Royd provides a thorough analysis of the UK government’s monetary policy, offering a critical perspective on its effectiveness and potential consequences and provides a thorough analysis of the factors contributing to high inflation and how the Bank’s actions have increased the overall UK debt burden.
HM Treasury & Bank of England Policy Relationship
The relationship between the UK’s HM Treasury (Treasury) and the Bank of England (Bank) when deciding monetary policy is a crucial aspect of the country’s economic governance. Both institutions play significant roles in shaping and implementing monetary policy, but they have distinct responsibilities and functions
Monetary Policy Committee
The Monetary Policy Committee (MPC) is responsible for making decisions on interest rates and other monetary policy measures and consists of nine members, five from the Bank and four external members.
While the Bank has operational independence in setting monetary policy, it works closely with the Treasury to align objectives and ensure consistency with broader economic policies.
The Chancellor of the Exchequer, who is a key member of the government’s Cabinet, oversees the Treasury and plays a crucial role in making decisions related to government borrowing and debt issuance.
The Treasury makes the decision to issue government securities, such as Gilts (government bonds), to raise the necessary funds, when the government needs to finance its budget deficit or fund specific projects.
However, the Bank may purchase or sell government securities in the secondary market as part of its monetary policy operations, but the initial decision to issue new securities rests with the Treasury.
The Chancellor’s role in appointing the external members to the MPC is to ensure a balance between internal expertise and external perspectives.
The Treasury also sets fiscal policy, which involves decisions on taxation, budgetary needs, and is also responsible for managing the government’s overall debt.
The Chancellor also provides guidance on how monetary policy should support the government’s broader economic policies, so the Treasury is responsible for overseeing macroeconomic stability, including inflation targeting and exchange rate policy.
Government Debt Management
In 2006 The Bank of England introduced Interest payments on Bank Reserves, then in 2009, it implemented Quantitative Easing (QE) measures.
In 2020 it used QE as part of its response to the economic challenges posed by the COVID-19 pandemic, by injecting liquidity into financial markets to support economic activity.
The October figures show that the Bank now holds around £248.9 billion of public sector debt, that have debt-servicing costs that are highly sensitive to even small changes in the Bank Rate. This puts a strain on the public finances, due to the high cost of servicing the debt.
Public sector net debt was £2,643.7 billion at the same time and was provisionally estimated at around 97.8% of the UK’s annual gross domestic product (GDP)
The cost of servicing central government debt in October 2023 was £7.5 billion.
Impact on Government Debt
While the Bank holds government securities, it represents a liability for the government. The government has issued these securities, and it will need to pay back the principal amount when they mature, plus any interest that may be due. So, even though the Bank holds the debt, it is still considered a part of the overall government debt.
However, if the Bank sells Gilts or allows existing financial assets to mature without reinvesting the proceeds, it will force inflation higher. This is also inevitable, because the Gilts will eventually mature, so the current UK Monetary Policy is compromised.
The MPC’s failure to control inflation
The MPC’s decisions on interest rates, money supply, and other policy tools have a significant impact on inflation levels.
It is important to consider various factors that contribute to inflationary pressures in an economy.
The high level of inflation in the UK can be attributed to a combination of fiscal pressures including excessive government spending, budget deficits, monetary policy actions, exchange rate fluctuations, wage growth, supply chain disruptions, inflation expectations, and external factors.
These significant factors that contribute to inflation are described as:
Demand-pull inflation (D-P)
This occurs when aggregate demand exceeds the available supply of goods and services
Cost-push inflation C-P
This type of inflation occurs when there is an increase in production costs and the increased cost of basic goods and materials due to global conditions.
Another pressure on inflation is Asset Appreciation, caused by the shortage of houses and increased demand for home ownership due to government incentives, inflating the price of homes, both for sale and for rent.
This in turn, is fuelling the Wage-Price Spiral, leading to the current high level of wage increases.
All this pressure, whilst productivity remains sluggishly low; meaning that in real terms, output or value added per hour is stubbornly low.
All of which, indicates that the main inflation driver is a Cost-Push inflation problem.
See: IMF eLibrary on The Price-Wage Spiral.
Exchange rate fluctuations (ERF)
Changes in exchange rates can impact the prices of imported goods and service and feed into the Wage-Price Spiral
However, the Exchange rate fluctuations against a range of currencies over the period from December 2019 to September 2023, were in a modest range, so ERF did not have a significant impact on inflation.
The ranges for example, GB to Euro, was between 1.06078 to 1.21523 and GBP to USD, had a range of 1.0727 to 1.42267.
Furthermore, both were in our favour, when importing goods and services, so would most likely have had a modest downward affect on inflation and the costs of production.
To resolve high levels of inflation, there are three economic leavers available to a Central Bank to control the economy, which are: Bank Base Interest Rate, Quantitative Easing/Tightening and Cash Ratio Deposit.
The Bank of England
Definition of Terms
Bank Base Interest Rate
This the interest rate that Bank charge UK banks to borrow money from them.
Low interest rates are intended to stimulate the economy, but may lead to an increase in inflation, by increasing money in circulation.
Macroeconomic Stability
Macroeconomic stability involves maintaining a balance in various economic indicators to promote sustainable and healthy economic growth.
Governments use a combination of fiscal, monetary, and regulatory policies to achieve these objectives and ensure the overall well-being of the economy and its citizens.
Gilts / Bonds and Cost of Debt
When the Treasury needs money, it issues Government securities such as Gilts (government bonds, that are essentially IOUs) that have specified terms and conditions. These include the interest rate, maturity date, and other features.
Investors receive periodic interest payments and the return of the principal amount when the securities mature.
When the Treasury issues Gilts, it auctions them on the open market and the Bank may need to buy a proportion to “help improve the functioning of the gilt market” (MPC’s words, not mine).
Chapter 3: QE and the COVID-19 pandemic [72]
In layman’s terms ‘the Government is printing money, which incurs debt, both in interest that needs to be paid and the refund of the money originally invested in the gilt’.
When the Bank of England trades in the open market, buying (QE), or selling (QT), the Treasury still has to maintain the Interest payments on the Gilts it has issued, which increases government’s debt (Cost of Debt).
Quantitative Easing / Tightening
Quantitative Easing (QE). The buying of Guilts to increase the money in circulation, facilitate lending, and encourage spending, investment.
Quantity Tightening (QT) is when the Bank sells Guilts or allows existing financial assets to mature without reinvesting the proceeds.
This reduces the money supply and puts upward pressure on interest rates for savings and loans.
The theory is that this will reduce inflation, but this depends on various factors such as economic conditions, velocity of money, and fiscal policy coordination.
Cash Ratio Deposit (CRD)
The Bank can require banks and building societies with eligible liabilities of more than £600 million, to place a proportion of their deposit base with the Bank, on a non-interest-bearing basis.
The Bank then invests these funds in interest bearing assets (i.e. very secure bonds) and the income generated is used to meet the costs of its monetary policy and financial stability functions.
Causes of High Inflation
The fiscal pressures that caused the UK’s high level of inflation, can be attributed to several factors: Government Spending, Budget Deficit, Wage Growth, Supply Chain Disruptions and External Factors – mainly conflicts and global warming.
Outdated Monetary Policies, without minimising undesirable side-effects of QT.
See 1.8 – BoE 1950’s Monetary Policy
Bank Base Interest Rate
The MPC voted in November to maintain Bank Rate at 5.25% and adopt a policy of High Interest Rate over an extended period to reduce inflation (Minutes: 20 to 24)
Higher interest rates mean borrowing costs more and savings gets a higher return, but only if the banks pass this on to savers.
The policy should lead to less demand (D-P) in the economy, to bring down the rate of inflation.
However, the current high cost of living is already reducing the actual value of money in circulation, so D-P is not the problem.
This policy is the equivalent to bleeding a patient, who is suffering from blood loss.
Quantitative Easing/Tightening
Quantitative Easing (QE)
One of the main objectives of QE is to lower interest rates, making borrowing cheaper for businesses and individuals.
However, according to the quantity theory of money, an increase in the money supply without a corresponding increase in goods and services can lead to increased inflation, so it is difficult to understand why they should use it during the Pandemic.
In 2020, the Bank of England conducted three rounds of quantitative easing raising the government debt from £425 billion to £875 billion
The Open Market sales were: March 2020, £200 billion of gilts were bought. June 2020, the Monetary Policy Committee voted to purchase an additional £100 billion of gilts. November 2020, an additional £100 billion of gilts.
Sir Paul Tucker, Research Fellow at Harvard Kennedy School and former Deputy Governor of the Bank of England, said he had questioned why the Bank of England wished to “stimulate aggregate demand just as aggregate supply is closing down” House of Lords, Parliamentary business, Publications & records: Chapter 3: QE and the COVID-19 pandemic [72 & 73]
Quantitative Tightening (QT)
This reduces the money supply and puts upward pressure on interest rates for savings and loans. The theory is that this will reduce inflation, but this depends on various factors such as economic conditions, velocity of money, and fiscal policy coordination, which the Bank does not appear to have sufficient understanding.
Written evidence submitted to a Parliamentary Committee, by Positive Money, a not-for-profit research and campaigning organisation, supports this view and Section 1 of their report clearly identifies that “significant net losses expected from the Bank of England’s gilt sales represent unjustifiably bad value for public money given that HM Treasury indemnifies the Asset Purchase Facility against any losses, ultimately leaving the public liable.”
In short: the Bank is selling Gilts below the purchase price and we the public will pay for the losses. House of Lords, Parliamentary business, Publications & records: Chapter 3: QE and the COVID-19 pandemic [72]
The details surrounding the guilt sale can be found in a written submission by Positive Money: Section 4.1 to a Parliamentary Committee: “In November 2022 HMT made a first transfer of £11bn to the Bank of England to cover losses on the Asset Purchase Facility. — As discussed in 1.2, the Bank of England’s current approach to monetary tightening will, if followed through, cost the government more than £230bn over the next decade, according to the most recent analysis the Bank has published”.
Cash Ratio Deposit (CRD)
The Bank can require banks and building societies with eligible liabilities of more than £600 million to place a proportion of their deposit base with the Bank, which was originally on a non-interest-bearing basis, but this was changed to an interest payment system in 2006.
In 2009, the Bank then invests these funds in interest bearing assets (i.e. Gilts that are very secure bonds). The income generated, less interest paid to depositors, is used to meet the costs of its monetary policy and financial stability functions.
However, the operation of the CRD scheme, established in 1998, has failed to make its targets and the QE scheme introduced in 2009 has also failed, as it is exposed to volatility of the market yields and in 2020/21, did not generate a dividend for the Treasury and the shortfall was funded from the Bank’s capital and reserves, reducing the Bank’s retained profits, as reported in an HMT 2021 Review of the cash ratio deposit Scheme.
The problem with the CRD scheme is that the level of interest-bearing deposits placed with the Bank was based on a flawed set of assumptions of return from gilt yields that was overestimated over the five years from 2018 to 2023.
On 1st March this year, the Bank replaced the Cash Ratio Deposit (CRD) scheme with a Bank Levy, as consequence of a 2021 Treasury consultation with banks and building societies on how to fund the Bank’s policy and financial stability functions. The financial institutions supported the proposal for a new Levy and so, the Financial Services and Markets Act 2023 made amendments to the Bank of England Act 1998, which allow the Bank to charge the Levy to eligible institutions.
While not directly a part of monetary policy, the Bank of England has a responsibility for maintaining financial stability. This involves monitoring and addressing risks to the financial system to ensure its smooth functioning.
While it’s understandable to feel sympathy for the Bank as a victim of the global economic contraction, it is crucial to acknowledge that they should have incorporated a mechanism within their scheme to promptly respond to evolving economic factors. Unfortunately, the three-year consultancy period aimed at finding a solution seems excessively prolonged and raises concerns about the Bank’s responsiveness. The Bank Levy, as discussed in the Conclusion below, falls significantly short of being deemed an acceptable solution, highlighting the need for more immediate and effective measures to address the challenges posed by the changing economic landscape.
To demonstrate a viable alternative, I have published ‘The Royd Monetary Policy’ “a policy for
Empowering Tomorrow’s Economies“ that proposes a radical and unconventional CRD use. The reliance on investing in guilts would be replaced by investing in the economy using the economic sectors that will boost the economy in conjunction with TPI’s primary focuses on sustainability, equality, and local conditions. This would be coupled with a scheme to incentivise the CRD payers to invest in the economic sectors that will boost the economy and to set a lower long-term mortgage interest rate for existing home, social housing mortgages and similar loans to small and medium businesses.
Conclusion
The Bank and Treasury strategy to rely on a combination of a high Bank Interest Rate, in conjunction with Quantity Tightening, which is intended to reduce the Demand-pull inflation on the basis that there is too much money in circulation, is demonstrably wrong and does not address the current need.
The Banks reliance on QT further aggravates the situation, because high inflation has already reduced the money supply, so that demand for money exceeds supply, which fuels the Wage-Price Spiral, increasing personal debt, when wages fail to keep astride with inflation.
Furthermore, QT combined with the Treasury’s tax increases (personal and business) and the freezing of personal allowances, is destroying lives and business confidence, leading to reduced investment in the UK.
The Bank has a further problem in that QE and monetary policies since 2019 have moved a substantial amount of government debt, from fixed-rate borrowing to higher-rated floating-rate borrowing. This has increased the debt-servicing costs that change with (their high) Bank Rate.
Moreover, there is a lack of coordination between the Bank’s monetary policy and the Treasury’s fiscal policy. Transitioning from the CRD to a Bank Levy potentially addressed the financial challenges faced by the Bank, resulting in a reduction of the disparity between the interest earned on bonds acquired through quantitative easing and the interest paid out by the Bank of England. It is worth noting that the responsibility for funding this gap lies with the Treasury.
The surge in excess reserves held by commercial banks [Internal Link to AR Current Challenges] has heightened the vulnerability of the Treasury’s guarantee deposit scheme. This scheme serves as a safeguard for the Financial Services Compensation Scheme (FSCS), ensuring coverage of up to £85,000 per account. Notably, for temporary deposits, this coverage could extend up to an impressive £1 million. The burgeoning excess reserves pose challenges to the stability and integrity of the deposit protection framework, warranting careful consideration and potential adjustments to mitigate associated risks.
Finally
The impact of the current UK Monetary Policy of restricting the money supply and the reliance on interest rate rises to reduce inflation, is having a significant negative impact on various groups in the UK, including working families, old age pensioners and vulnerable groups. All at risk of losing housing, affordable rented accommodation and other basic needs. Small and middle-size business are also at risk, while banks, major retailers, power companies make obscene profit levels and the wealthy get richer through Asset Appreciation.
