Big cash balances amassed by the Bank of England as a result of its electronic money-creation programme will be used to pay down the national debt by £35bn over the next 18 months, the Treasury has said.
The chancellor said it was economically inefficient for the Treasury to have to borrow money to pay the coupons (interest payments) on the £375bn of gilts accumulated by the Bank since it adopted the strategy of trying to boost the economy through a huge expansion of the money supply.
Sir Mervyn King, the Bank's governor, said the change to the arrangements made sense as the scheme was bigger and likely to last longer than anticipated.
The move will reduce the national debt in the short term and cut the interest payments the government makes on the money it has borrowed over the years. Osborne said transferring the cash would allow the government to manage its cash more effectively, and "should lead to debt-interest savings to the government in the short-term".
The chancellor said he wanted the £35bn that would have been accumulated by the end of the 2012-13 financial year to be paid in staggered payments. After that, he said, the Bank would have to transfer the balances quarterly, an indication that the government expects the scheme to be in operation for a considerable period.
The Treasury and the Bank anticipate the cash position of the scheme will deteriorate when Threadneedle Street starts to sell gilts, leading to higher debt levels in the long term, as future losses could not be offset against the coupon payments. The asset-purchase scheme involves the Bank buying gilts from the private sector in return for cash in the expectation that the newly created money percolates into the economy.
Until now the Bank has kept the coupon payments on the gilts in anticipation that the balances will be needed when the economy has recovered and the bonds are sold back to the private sector.
But, in an exchange of letters with the chancellor, King said: "As the scale and likely duration of the asset-purchase facility (APF) has increased significantly since its inception, I agree that it now makes sense to normalise the cash management arrangements for the APF."
The governor stressed, however, that the boost to the government's finances was likely to be short-lived. "While transferring the APF's net income to the exchequer will result initially in payments from the APF to the government, it is likely to lead to the need for reverse payments from the government to the APF in the future as bank rate increases and the APF's gilt holdings are unwound by the monetary policy committee (MPC).
"Indeed, under reasonable assumptions, it is likely that the majority of any transfer of funds to the government will eventually need to be reversed."
The MPC believes the move will lead to a small loosening of monetary conditions. King said that because the stock of government debt would be reduced, the private sector would hold fewer gilts and more money than would otherwise be the case.
Economists said the changes could have significant long-term implications. Marc Ostwald of Monument Securities said it showed "just how desperate Osborne was" to find funds, even though most of the money will probably be transferred back to the Bank when QE is unwound.
"It blurs the divide between fiscal and monetary policy even more, and some may well say that this is tantamount to monetising the deficit," he added.
Duncan Weldon, senior policy advisor at the TUC, believes the government is now more likely to hit one of its fiscal targets. "Until approximately 11.45am this morning my base case scenario, and that of most independent economists, was that the government was due to miss the second of its two fiscal rules at the autumn statement on December 5th … that government debt/GDP would be falling in 2015/16. This accounting change means that the government is now likely to hit the target," he said.
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