Friday, November 09, 2012

An Interesting Little Experiment

The Bank of England has said that it will be giving the interest it receives from the debt it holds as a result of quantitative easing back to the treasury. In one way we can regard this as giving George Osborne a way of wriggling out of his deficit targets, in another way though it can be regarded as the first step on a path towards some very interesting monetary policy.

 So..a bit of quick fag packet maths: debt interest currently costs around 3% of GDP, the bank owns about 1/3rd of government debt so this amount in total is about 1% of GDP, this 1% of GDP gives a tiny bit of extra wiggle room to the treasury. An awful lot then depends on how the treasury uses that wiggle room. Assuming the treasury uses this wiggle room as an excuse to reverse a few cuts and undertake a few minor stimulus measures, the policy essentially amounts to a very minor, controlled form of helicopter money.

 My take on this is that this intervention is an attempt by the Bank and the Treasury to experiment with monetary transmission mechanisms. Both will be watching various economic indicators to see how this little experiment plays out in terms of GDP growth, inflation and long term expectations and will use the results as a basis for future policy.

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