The governor of the Bank of England has rejected claims that his institution is violating its independence and directly financing government spending.
Andrew Bailey told a virtual event on Friday there was no “merit” to claims the central bank was backstopping the Treasury.
“I sometimes hear it said that the Bank of England has flouted the rules and thereby damaged its independence by purchasing government debt and lowering the government’s cost of borrowing,” Bailey told the London School of Economics’ German Symposium on Friday.
“I’m very glad that central bank independence is being vigilantly scrutinised. But I’m also sorry to have to be blunt but I don’t think these arguments have any merit.”
The Bank of England has vastly expanded its balance sheet during the COVID-19 pandemic, increasing the size of its government bond buying programme — known as quantitative easing — to a total of £875bn ($1.2trn). At the same time, the UK government has been forced to borrow record sums to finance its response to the pandemic. The Office for Budget Responsibility estimates the government is on track to borrow around £400bn this year alone.
The Bank of England buys UK government bonds, known as gilts, on the secondary market. The government first sells gilts to institutional investors, such as pension funds and asset managers, and then the Bank of England buys them from private institutions.
The aim of this policy, which was first introduced in the wake of the 2008 financial crisis, is to inject liquidity into the financial system and keep money flowing easily and cheaply through the economy.
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However, coordinated action between the Bank of England and the Treasury in the early stages of the pandemic — combined with the extraordinary sums borrowed by the UK government since last March — have led to accusation that Threadneedle Street is indirectly financing the government. This suggests the central bank had lost its independence and risks international investors losing confidence in the UK.
“To be independent doesn’t mean being disorganised,” Bailey said on Friday. “Independent pursuit of an inflation target doesn’t mean monetary policy is uncorrelated with other macro policies, including fiscal policy. Indeed, in the current circumstances there are mutually reinforcing effects from monetary and fiscal expansions. It doesn’t mean independence has been abandoned.”
He said the expansion of the Bank of England’s government bond buying programme was a policy arrived at in pursuit of the central bank’s 2% inflation target — not at the behest of government. Bailey pointed out that coordination between central banks and government had been praised by the International Monetary Foundation.
“QE does involve purchasing assets and for all of us, the predominant asset is the risk free asset that we purchase which is government debt,” Bailey said. “But it’s important to say that we’re not purchasing government debt to finance the government and we are not undertaking what you might call fiscal repression, in other words the government is not telling us to do it.”
Bailey said the bank’s independence would become clearer when it begins to tighten monetary policy in the recovery stage. A failure to act independently at this point would lead to a swift rebuke from politicians and financial markets, he said.
The last decade has seen the rise in popularity of an alternative branch of economics known as “modern monetary theory”. The theory argues that the financial firepower of a governments is determined by its willingness to spend, rather than the tax base. In this scenario, central banks control liquidity in the economy by buying and selling government bonds using money it creates.
Bailey said there was a “critical difference” between the current situation and modern monetary theory.
“Our decisions on QE... are not motivated by: what level of money does the government need to raise in the next period? We’d better finance it,” he said.
“Far from it. Indeed, let me make this point during this pandemic, the pattern of the pandemic and therefore of fiscal policy and therefore of government debt raising has been so unpredictable. We would have had to have had remarkable foresight to predict it, given that we were taking decisions on the quantum of QE purchases in advance of those events unfolding often.”
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