Sunday, 16 October 2011

QE design in the UK - where Fiscal and Monetary Policy collide

When is Fiscal Policy not Fiscal Policy? When the Bank of England decides to label it Monetary Policy by the look of it.

I've been looking into the accounts of the Bank of England Asset Purchase Facility Fund Ltd (BEAPFF), which is the vehicle by which the Bank of England is buying Government Gilts and Corporate Bonds so that it can be 'seen to be doing something' (as much it can see with ideological blinkers on). It's an interesting corporate setup as its effectively operates much like a trust fund.

The Bank of England is the nominal shareholder but has no financial stake in the profit or loss of the firm. As can be seen from the annual report:
...HM Treasury has indemnified the Company against any losses it may incur in connection with its operations. Any surplus from these operations after the deduction of fees, and any tax payable is due to HM Treasury...
...In view of the Indemnity from HM Treasury, the Company requires only nominal capital...
...The Company’s operations are fully indemnified for loss by HM Treasury, and any surplus for these operations after deduction of fees, operating costs and any tax payable are due to HM Treasury. As such, the Company is not exposed to financial risk, but manages credit risk and monitors market risk on HM Treasury’s behalf. The Company does not face liquidity risk...
The Bank supplies the personnel to run the company and charges fees for doing so. And the activities that it undertakes for monetary policy purposes (ie buying assets) are fully released as statistics under the 'Asset Purchase Facility' section of their site. And that is close to the previous £200bn limit (now £275bn).

Even the time series of the Gilts purchased are available. And what this tells you is that in the initial phase of QE (before they started buying again on the 10th October 2011), BEAPFF bought £177.735bn nominal of bonds for £198.275bn Sterling with an annual income of £8.676bn (2.3% of GDP, or half last year's growth).

Remember that gilt income paid to BEAPFF is government spending - fiscal policy at work. It's fairly simple to work out from the purchase spreadsheet that since QE1 started BEAPFF has (to date - 16th October 2011) received £19.850bn in gilt interest.

Theoretically the excess of that interest should be returned to HM Treasury. Otherwise, due to the matched funding nonsense, the Debt Management Office (who manage the cash stream for HM Treasury) will end up issuing more gilts than it needs to. That will draw down Bank Reserves and end up reversing the effects of the Asset Purchase operations (more gilt supply and the yields creep back up).

Yet when you look at the annual report of BEAPFF you see a very large cash balance and a very large indemnity owing to HM Treasury (£9.8 bn in February, or 2.6% of GDP). So I thought I'd ask them for the cash balance to date and what mechanism they had in place to return the surplus to HM Treasury. After all government spending and government funding is generally seen as Fiscal Policy. To which, after four weeks of waiting, I received this reply stating it was covered by the 'monetary policy' exemption the bank has to information requests.

So there you have it from the horse's mouth. The UK Fiscal Authority is issuing extra gilts draining the extra bank reserves put in place by the Bank of England so that it can give it back to the same bit of the Bank of England. HM Treasury is funding the Bank of England with the Bank's own money. Fiscal Policy as Monetary Policy. You couldn't make it up.

So the next time somebody whinges about the £140bn or so annual deficit, you can let them know that about 5% of that is down to the left hand not knowing what the right is doing. (Or is that the right not knowing what the left hand is doing...).

Of course this was all just confirmation. It's fairly easy to estimate what the value of the cash account is and the relentless decline in Bank Reserves on the face of the Bank of England balance sheet shows that HM Treasury hasn't received a windfall recently.

To 28 Feb 2011, BEAPFF had received £13,090.50 mn in Gilt interest and £52 mn in bank interest, whereas it has been charged £1,626.10 in bank interest on the loan and £9mn of expenses. That totals £11,507.70 mn which compares favourably to the £11,584 change in cash in the accounts (the difference attributable to the income from the corporate bond portfolio). So I reckon my estimation isn't far wrong.

To date I think there is about £18bn sat in the cash account at BEAPFF and it doesn't look like they're using it up for the next round of QE - as the balance sheet appears to be expanding again by the amount of the auctions. So what are they saving this money for? Are they legislatively barred from handing it back? Perhaps Uncle Merv is planning to dress up as Santa...

So why look into this. Well I wanted to know why Bank Reserves were falling over time. As we know this means they've been moved somewhere else on the Central Bank's balance sheet and I wanted to know where. Some can be explained by the commercial banks using bank reserves to offset their notes and coins allocation (where previously they'd used longer term repos), but some of it couldn't be clearly identified in the ever growing 'Other Liabilities' at the Bank of England.

This is what I've got so far. (Issue Dept is the one that issues notes and coins)
and that still leaves a bit missing - unidentified since QE1 completed at the end of Jan 2010. Any ideas what this could be? And what's that rise since March all about?