FactCheck Q&A: Magic QE trick that may help Osborne hit borrowing targets
When Gordon Brown was Chancellor he had a “golden rule”: only borrow to invest, and pay for current spending out of current taxation.
By 2006 he was widely accused of manipulating the rule by moving the time frame of the economic cycle – shifting the goalposts to cover up the fact that he was spending too much.
That was, at any rate, the accusation from his Conservative opposite number George Osborne, who said: “Instead of fixing his spending to meet his golden rule, he fixed his golden rule to meet his spending.”
Now Mr Osborne holds the reins of public finance, and he is being accused of similar sleight-of-hand with the news that tens of billions are to be shifted from the coffers of the Bank of England to the Treasury.
The accounting change will mean that the initial gains from quantitative easing can be used to help pay down Britain’s debt.
This could save Mr Osborne from an embarrassing admission of failure. His golden rule, set out in 2010 emergency budget, was “to ensure that debt is falling as a share of GDP by 2015-16″.
But borrowing has remained stubbornly high and independent analysts have been queuing up to predict that the chancellor would be forced to drop that key target in the autumn statement next month.
Today’s strategy could be a lifeline for a government keen to avoid further U-turns. How does it work?
What is quantitative easing?
It’s 2009, we’re in the depths of the financial crisis, and the Bank of England is desperate to stimulate the economy. But its usual tactic of cutting interest rates isn’t working.
Enter quantitative easing, or QE. The Bank creates money electronically out of thin air (a hefty £375bn to date) and uses it to buy assets – mostly government bonds – from the financial sector.
This does three things. It gives the banks more cash, it pushes up the cost of gilt-edged government bonds – encouraging investors to switch to stock market shares instead – and it reduces interest yields on bonds, lowering the cost of borrowing for business.
The net result is more money in the economy, more consumer spending and higher growth – or that’s the theory.
Some economists don’t believe QE works at all and the Bank of England’s enthusiasm seems to be cooling, despite their estimate that the initial £200bn pumped into the economy in 2009 and 2010 boosted GDP by 1.5-2 per cent.
So where does all this extra cash come from?
This is where things get weird. The Treasury says there will be an £35bn in the coffers of the Bank of England by the end of the financial year thanks to QE.
This is because the issuer of a bond promises to pay the buyer interest, usually in the form of two dividends paid twice a year.
In this case the issuer of most of the bonds is the government…and the buyer is the government too. But the government still has to fulfill its obligation to pay the dividend…to itself.
When QE started the interest just built up in a Bank of England account. Now it will be transferred to the exchequer and will help reduce the stock of government debt.
Is that such a bad idea?
Not necessarily, according the experts we’ve spoken to. It makes economic sense to do it this way because as things stand, the government has to borrow money to pay the interest on the bonds.
That’s right. The government creates imaginary money to buy bonds, then has to borrow more money to pay the interest on the bonds back to itself. It’s pretty mind-bending, but it is apparently true that today’s change could save the taxpayer money.
Handing the money straight to the government brings us into line with what’s done in Japan and the US – the other big QE pioneers – and reflects the way things are managed in other parts of the public finances.
What’s the catch?
We’ll probably lose money eventually.
The long-term strategy is to reverse Quantitative Easing after it’s achieved its purpose.
Paul Johnson, director of the Institute of Fiscal Studies (IFS), told us: “It is a clearly-stated policy that these gilts would always be redeemed. The Bank has created money to buy gilts and at some point in the future it will sell them. Having printed the money, you then burn the money.”
We’ve never done this before so it’s difficult to say when this will happen and what the effects might be, but in principle, the assets will be sold or redeemed, and the overwhelming likelihood is that the proceeds will be lower than the price we paid.
As the independent Office for Budget Responsibility puts it: “Public sector net borrowing will be lower in the near term than it otherwise would have been…net borrowing is then likely to be higher in future years.”
But all of this would have been the case without today’s change. The government promised to indemnify the Bank of England for losses if the value of the debt goes down, so we would have ended up paying for QE one way or the other.
By absorbing the surplus or deficit every quarter instead of letting it mount up there we avoid having to pay off a potentially huge debt at the end.
So will Mr Osborne hit the golden target?
The short-term “windfall” will be pretty small in the great scheme of things – an extra £11bn for the Treasury in 2012/13 and an additional £23.8bn next year.
But then Mr Osborne may not be on course to miss the borrowing target by much – perhaps £22bn, according to the National Institute of Economic and Social Research (NIESR). So every little helps.
Few economists are saying that today’s change is a bad move in itself, although many are questioning the timing.
The announcement which comes immediately after the Bank rejected another dose of QE, which suggests that Bank economists see this sudden injection of money into the government’s finances as a QE-like measure in itself.
It also comes after the Financial Times, the European Commission, NIESR and the International Monetary Fund all agreed that the target of getting debt on a downward trend by the end of this parliament is looking increasingly unlikely.
Both NIESR and the IFS have called upon Mr Osborne to rethink the usefulness of the golden rule rather than move heaven and earth to try to keep his word.
Mr Johnson of the IFS told us: “It’s not a ridiculous thing to do. It isn’t an out-and-out fiddle. But nothing has really changed. It will make the numbers look better but it will change nothing in reality.
“The target never made a lot of sense in the first place. Whether debt is falling in 2015 is neither here nor there. The appropriate thing is to change the target.”
NIESR’s director Jonathan Portes said: “On a technical level I think what the Treasury are doing is quite sensible.
“But this is an accountancy change between the Bank of England and the Treasury. Both of them are by definition wholly owned by the taxpayer and any idea that taxpayers are more or less indebted as a result of this is clearly wrong.
“It could make it significantly easier for the government to hit their fiscal targets, but if you are only meeting your target by changing something in accounting terms, that does indicate that the target has lost credibility.”
By Patrick Worrall