MNI INTERVIEW2: Cut BOE Capital Losses From Goals - Saunders
Former BOE MPC member Michael Saunders talks to MNI about the BOE's gilt run-off and fiscal space.
Excluding Bank of England capital losses from calculations used to measure progress against fiscal targets would ease pressure on both the government’s budget balance and on the BOE as it pursues monetary policy, former two-time Monetary Policy Committee member Michael Saunders told MNI.
With the BOE currently running down its stock of gilts accumulated during quantitative easing by GBP100 billion a year, sales of bonds which have decreased in value are calculated as a capital loss, adding to debt and making it harder for the government to achieve its aim of reducing Public Sector Net Debt as a proportion of GDP within five years.
One way of addressing this problem, which the Resolution Foundation think tank sees as likely to be adopted by an incoming Labour government, would be for the BOE’s balance sheet to be reincorporated into PSND calculations. But this would become problematic were the Bank to provide a new round of cheap funding for banks, with Saunders recommending instead the exclusion of part of the Bank’s Asset Purchase Facility operations from public finances. (See MNI INTERVIEW: UK Likely To Restore BOE To Debt Calculation)
"One version is to exclude all the APF losses, including the interest losses, the other version is just to exclude the APF capital losses. I think the case for the latter is stronger, because the capital losses are chiefly determined by the pace of QT, whereas the interest losses, ... QE does have a genuine effect of shortening the maturity of government debt, and we do count those interest losses in the deficit," Saunders, now at Oxford Economics, said an interview.
"So I can see a case of still scoring those in the deficit and debt measure, but just not the capital losses,” he said, “That allows the MPC to do whatever pace of QT rundown they think is appropriate. It has no effect on fiscal policy.” (See MNI INTERVIEW: BOE Could Spark QT Woes Before Banks Expect)
WORST OF BOTH WORLDS
The present arrangement puts the BOE in an uncomfortable situation with its decisions on running down its balance sheet taking a direct toll on the government’s finances, he noted.
"The current system puts them in the firing line, because the pace of QT has an immediate and direct effect on fiscal policy, which is completely unintentional, and the MPC don't take it into account, but it's having a very large effect," Saunders said.
“Fiscal space shouldn't be constrained by whether the pace of APF run down is 50 billion or 100 billion or 200. That's to me, it's kind of crazy that we've ended up in a system in which the MPC are having a big influence on fiscal space.”
The BOE’s choice of a GBP100-billion-a-year gilt rundown may also be particularly unfortunate, Saunders said.
"What they've achieved with GBP100 billion is, from the fiscal policy point of view, the most painful path, because it's big enough to matter. Capital losses add substantially to debt, and it's low enough that they'll still be doing it in five years time ...It's almost as if they designed the system to cause the greatest inconvenience for fiscal policy," he said.
"If the MPC were to aim for GBP200 billion rundown, then rundown would be finished in three and a half years .. Conversely, if they were to do 50 billion a year of rundown, you'd have much greater fiscal space at year five as well, because there would fewer capital losses.”