The European Union (EU), the US, Japan and the UK have all been able to borrow unprecedented sums at ultra-low rates of interest. The money has been needed to offset some of the large downturn caused by shutting so many sectors and businesses to limit the spread of the virus, and to provide benefits and loans to people and businesses damaged by the pandemic response.
All the leading central banks have created a lot of money or central-bank reserves over the last year and have used this new money, in the main, to buy very large quantities of government bonds. All have been at pains to point out they do not create money to give to their governments to spend. Government is responsible for borrowing new money to add to its spending to offset the recessionary effects of the pandemic.
The central banks are managing monetary policy. They create more money and buy more bonds to keep interest rates down and to ensure there is sufficient money in the banking system to allow plenty of credit to help individuals and companies short of cash. In practice, the creation of new central-bank reserves, and the purchase of government bonds held by others, makes it much easier for their governments to borrow large sums at low rates of interest.
The UK stresses the distinct responsibilities and policies of Bank of England and the Treasury. The Bank creates money to lend to a separate body, the Asset Purchase Facility. This benefits from a Treasury guarantee against losses on the bonds it buys should interest rates rise lowering the value of the bonds bought.
The Bank is the manager of the fund and lender to it but not the owner. The Treasury has agreed that, quarterly, it will receive any net profits the Asset Purchase Facility has made from the transactions and holdings. So far it has proved profitable, as the bonds owned provided a larger income than the borrowing costs which are at the overnight Bank rate of just 0.1%.
The Office of Budget responsibility has commented on this in its March Report. It said: “While the government’s debt stock has become more affordable in recent years, thanks in part to the ‘refinancing’ effect of quantitative easing by the Bank of England, this has come at the cost of much greater sensitivity to changes in interest rates. Since 2009 the Bank has acquired through its Asset Purchase Facility (APF) around one-third of the total stock of UK government bonds (gilts) with a median maturity of eight years and average interest rate of 2.1%. It has financed these purchases by creating its own liabilities in the form of central bank reserves which, in essence, carry an overnight rate of interest, Bank Rate, which is currently 0.1 per cent. The net result has been an interest rate saving to the public sector as a whole of £17.8bn in 2021-22 from the difference between rates on gilts and Bank Rate. But these savings have also come at the expense of a significant reduction in the median maturity of the outstanding gilt stock from 11 years (before netting off APF holding) to less than four years (after netting off APF holdings).”
The wish to protect the independence of central banks is understandable. It is also important to recognise that the pandemic crisis has led to much closer working between central banks and governments. We have been living through a remarkable period when central banks decided they needed to expand money and buy bonds on a large scale, and governments decided they needed to borrow and spend on a huge scale in response to a common crisis.
Phasing out special measures
In practice, the central banks other than the ECB are owned by a single government and state. Whilst the formalities will be observed in Banks having control of monetary policy and governments of fiscal policy, they will continue to work together over how to move on from this massive stimulus. Both have an interest is keeping confidence in the system and moving smoothly when possible to less support for economies weakened by the pandemic. All the time there are lockdowns and social distancing hitting material parts of their economies they will feel the need to continue some support.
Markets are nervous about the pace at which these stimulus measures might be phased out, and about possible increases in interest rates. The central banks forecast no return to unacceptable levels of inflation which would force a rethink of policy. They all assume some uptick in inflation this year as economies get back to work after lockdowns, but do not think this will follow through to wages and a price/wage spiral. Most of the central banks are still struggling to get inflation up to nearer their 2% targets. Against this background, low short-term rates are here to stay. Nevertheless, bond markets will test out central bank resolve over their continuing support from time to time.
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