Models Of Central Banking And The Organization Of The Bank Of England

Models Of Central Banking And The Organization Of The Bank Of England Presented by: William A. Allen (NIESR) Date: 17th April 2023 Summary of Argument - The 1997 structure of the Bank of England was based on certain assumptions. - The assumptions were overtaken by events, and the structure was amended in 2013 (bank supervision, FPC). - Some post-crisis and post-2013 decisions might have been different if the structure had been different (4 instances). - The existing structure, even as amended post-crisis, isn't well- adapted to dealing with likely future developments. - Proposal for new structure. Events, 2007 - 2021 1. Northern Rock. Tripartite committee didn't work  Stalemate over LOLR.  Run on NR: overture to financial crisis. 2. Old connections between monetary policy and financial stability reappeared:  Financial condition of commercial banks became precarious and important for monetary policy.  Liquidity of gilt-edged market evaporated on two occasions - threat to monetary policy and financial stability objectives. 3. Macro-prudential policies.  Financial Policy Committee of B of E (2013).  Potentially affect monetary policy objectives. 4. Quantitative easing.  Introduced in emergency in 2009.  Not a natural monetary policy instrument since not high-frequency.  Shortened maturity of government debt – turbines que policy.  Debt management objectives (cost, risk) subordinated to monetary policy objectives, since 2009. 5. MPC needed balance sheet instruments as well as short-term interest rates but had to choose from a menu selected for it by B of E executive, likewise FPC ('concordats'). Contrast with Federal Open Market Committee which issues directives to the NY Fed. 6. These events undermined the assumptions of the late 20th century model. Post-Crisis Support For Bank Liquidity - Inevitable post-crisis regulation (Basel 3) included liquidity regulation, - Minimum Liquidity Coverage Ratio (LCR) requires bank to hold enough - high-quality liquid assets (HQLA) to survive a hypothetical month in which it loses funds as quickly as is deemed plausible. - HQLA are mainly reserve balances in central banks and government securities. - In the first few years after the crisis British banks had to get LCRs up a long way to achieve minimum of 100%. They got there by the end of 2015. While they were increasing their liquidity ratios they had to restrict lending. - QE didn't relieve LCR pressure because it merely exchanged one HQLA for another, leaving the total unchanged. - Other schemes did help, notably the Special Liquidity Scheme: 1) provided Treasury bills ( = HQLA) in exchange for commercial loans. 2) Introduced in 2008, terminated in 2012. 3) MPC wasn't consulted about either the introduction or the withdrawal of the SLS. 4) If the MPC had been consulted, the SLS might have continued for longer and bank lending might have been stronger. The Goodfriend Doctrine - Securities purchased in QE programs were nearly all government securities (not quite all). - Application of 'Goodfriend doctrine' (2009), namely that central banks should hold no assets other than government securities, except for limited amounts in exceptional circumstances. Otherwise the central bank is committing an act of fiscal policy, for which it lacks legitimacy. - I don't want to discuss the merits of the Goodfriend doctrine. - The MPC wasn't consulted on whether to adopt the Goodfriend doctrine: it was decided by the B of E executive, as provided for (afterwards) in the 'concordat'. - The B of E might not have embraced the Goodfriend doctrine if the MPC had made the decision. Gilt Maturities And Financial Risk  Financial profit or loss from QE = difference between yield on gilts bought and cost financing them at floating interest rate.  Risk was borne by Treasury (indemnity, subordination of debt management objectives).  In practice, the MPC doesn't seem to have discussed maturities (or financial risk) much, but they have consistently avoided very short maturities (< 3 years): short gilts were 'more likely to be held by banks and overseas central banks' Suggests concern with money supply.  Maturities bought have extended to 50 years. Buying long maturity bonds unhedged implies a view about short-term interest rates in the distant future, but the MPC is no better placed than anyone else to have such a view.  Financial risk would be less if maturities were confined to the period during which the MPC expects to keep short-term interest rates low. Could be argued that MPC should buy only bonds maturing within its own time horizon.  Lifetime mark to market loss of QE programs = £67 bn as at October 2022 (my calculation, not including Truss/Kwarteng operation). DV01 ~ £½ bn. Lots of risk.  QE programs has to be evaluated on both macro-economic effects and financial costs, and in principle compared with other possible policies. But it seems likely to turn out very expensive.  Nobody seems to have felt responsible for managing the risks or weighing them against the benefits. Treasury approved all requests from MPC for QE indemnity.  NB the same thing happened in the Fed and the ECB, both of which have made heavy losses. Last-Resort Market Making - - Gilt market liquidity evaporated on two occasions:  March 2020 - Covid.  September 2022 - Truss/Kwarteng 'fiscal event'. March 2020 - emergency meeting of MPC decided on more QE (£200bn, followed by a further £250bn), to restore market functioning and pursue the inflation target. FPC was in the background. - September 2022 - emergency meeting of FPC noted market dysfunction and urged B of E to implement MMLR operation. B of E purchased £19bn and reversed purchases promptly and profitably. - Both market breakdowns threatened both monetary policy and financial stability objectives. And both MMLR operations served both monetary policy and financial stability objectives. - Who decides which committee should take decisions? Clarity is necessary: having to make procedural decisions in an emergency can be a dangerous distraction.