Treasury Committee
Oral evidence: Quantitative tightening, HC 1116
Thursday 18 May 2023
Ordered by the House of Commons to be published on 18 May 2023.
Members present: Harriett Baldwin (Chair); Mr John Baron; Danny Kruger; Dame Andrea Leadsom.
Questions 56-128
Witnesses
I: Andrew Bailey, Governor, Bank of England, Dr Ben Broadbent, Deputy Governor, Monetary Policy, Bank of England, and Sir Dave Ramsden, Deputy Governor, Markets and Banking, Bank of England.
Witnesses: Andrew Bailey, Dr Ben Broadbent and Sir Dave Ramsden.
Q56 Chair: Welcome to this session on the Treasury Committee’s inquiry into quantitative tightening. I start by asking our panel to introduce themselves for the record.
Andrew Bailey: I am Andrew Bailey, Governor of the Bank of England.
Dr Broadbent: My name is Dr Ben Broadbent, Deputy Governor for monetary policy.
Sir Dave Ramsden: My name is Sir Dave Ramsden, Deputy Governor for markets and banking.
Q57 Chair: Thank you very much. We are here at the Bank of England this morning, taking evidence for our inquiry into quantitative tightening. Governor, we are seeing you again on Tuesday next week when we will be talking about monetary policy matters. We will separate our questions into those two themes.
Can you start by reminding the public why the Bank decided to embark on this course of quantitative tightening and reducing your balance sheet last September?
Andrew Bailey: Yes. I think it is worth going back a little bit and saying that really for some time—certainly, I think from around 2014-15—the Bank had been indicating that it would envisage running off the stock of assets that had been bought as part of the quantitative easing process. We reached that decision, as you said, in the middle of 2021 to 2022.
My own view on this is that it is important looking forwards that the Bank’s balance sheet adjusts so that it has headroom to do whatever we might need to do in the future. I think it is important that we do not envisage running in steady state with the balance sheet as big as it is and that we do adjust it downwards.
That was very much in my mind in terms of why, at the right time, we would embark on the process of reducing the size of it. That is important. It is not because I am envisaging that we do anything of that nature in the near future; it is really about being able to use the balance sheet should we need to. As has been the case in recent months, we have had to do that also for financial stability purposes, so having the scope to act and not having the balance sheet get bigger every time we do that is very important.
I will make one final point, if you don’t mind. Again, looking at this from the point of view of the balance sheet, I have said a number of times that I do not envisage the balance sheet returning to what it was before quantitative easing started in the financial crisis. The reason for that is that, of course, what sits of the liability side of our balance sheet is the stock of reserves; in other words, the deposits that banks make with us and those are the reserve balances. In many ways, that is the highest form of bank liquidity. It is the best quality bank liquidity because it is cash, effectively, for the banks.
There is no question—the UK is not alone in this—that the need for banks to hold larger cash reserves, from a prudential point of view and from a financial stability point of view, than where we were pre-financial crisis is important. Later, we may draw the distinction between the balance sheet and the APF, but in balance sheet terms, I do not envisage that we will go back to where we were before.
Q58 Chair: What I am hearing, Governor, is that, for you, this is purely a technical decision to reduce the size of the balance sheet and it is not something you are using to tackle the UK’s challenges at the moment with inflation.
Andrew Bailey: That is a very important point, so let’s come on to it. Ben and Dave may want to come in on this. We have been very clear that quantitative tightening is not our active monetary policy instrument. Of course, it will have effects and we can talk about what we think those effects may be. We do not think they will be very large and we can come on to why we have also sought to minimise the impact of those effects by the way we do it. But it is very important so the way we look at it is that, when we come to take decisions on the active monetary policy tool, which is the Bank rate—the interest rate setting—we take everything into consideration in terms of financial conditions, including any impact from quantitative tightening.
Sir Dave Ramsden: May I just add a little bit? I was very struck, Chair, by the way you framed this inquiry. You talked about our going into uncharted territory, but I think that what we have tried to do is to set out the signs on the route maps.
So, when we announced in August 2021 our strategy on quantitative tightening, we had three principles. One, as Andrew has just said, was that the Bank rate would be the active instrument; that would be how we would adjust the degree of tightening. Two, we would go about quantitative tightening, whether through not reinvesting assets in the portfolio or active sales, in a gradual and predictable way. And the third principle—these are the MPC principles; it is very clearly the MPC owning these principles—was that we would not disrupt the functioning of markets.
Therefore, when it came to the decision last autumn, the MPC said in September that we are going to embark on a programme reducing the APF by £80 billion. That was based on an analysis that was consistent with those principles—gradual and predictable, and not doing anything that would disrupt markets. We can come on to the details of how we arrived at that £80 billion figure. However, that was very much seen as being a background effect.
Interestingly, our survey of market participants before the MPC made those decisions—they had thought that we would probably go for a figure around about that. Andrew had announced in Mansion House a range of £50 billion to £100 billion, so we had prepared the market, as it were. That means that the market will have taken account of that kind of pace within its market pricing.
I think we all believe that there is some effect from quantitative tightening, but it’s relatively small, given those principles, and it is already going to be priced into markets. That then enables Bank rate to be the active instrument changing the degree of tightening.
Q59 Chair: It is uncharted territory, but you have told the passengers where you’re taking them is really what you’re saying there.
Sir Dave Ramsden: We have tried to do it at every stage—
Q60 Chair: But you do accept also that you are flying blind into that uncharted territory because you don’t know what the impact will be on monetary tightening.
Sir Dave Ramsden: Ben will want to come on to some analysis we have done; because of the principles we’ve set, we know that the impact will be relatively small, certainly compared to some of the episodes of quantitative easing. That is given the principles we’ve set—that we will only do it when markets are functioning well, and that it will be gradual and predictable. We are reasonably confident that those impacts will be small, so I don’t think it’s fair to say that we are flying blind, no.
Q61 Chair: Flying slowly, then, because you’re not 100% clear-sighted on things. You announced the flight take-off and then almost immediately had to land the plane.
Andrew Bailey: No—actually we hadn’t taken off, to use your analogy. We delayed the take-off. That was entirely consistent with the fact that, as Dave said, we had made it clear that we would not conduct quantitative tightening operations in disturbed market conditions. We judged those conditions to be disturbed, so I think it was entirely consistent. My judgment of the market reaction was that they said, “Yes”. I mean, they would have been worried if we had done anything else, probably.
Q62 Chair: But the obvious follow-up is, “Did your actions actually disturb the market?”
Andrew Bailey: No, I don’t—no.
Q63 Chair: One of the factors disturbing the market?
Andrew Bailey: No.
Q64 Chair: So nothing to do with you, Governor?
Andrew Bailey: No. Every day we monitor the markets, and we have a dashboard that our markets directorate uses to monitor market conditions, particularly with this in mind. So this is looking at pricing, liquidity and spreads—and no, we did not see a reaction to our own announcements.
Q65 Chair: Okay. Ben, you were going to tell us, I think, about the £80 billion and why you came up with that figure as well.
Dr Broadbent: Well, the £80 billion itself was chosen as the number that we thought we could reasonably do precisely without having these kinds of liquidity effects on markets or disturbing them unduly. So we did quite a lot of work before in the markets division.
We tried to think about what would be a reasonable pace that would not disturb market conditions. That was where the range of £50 billion to £100 billion came from, which the Governor gave in the Mansion House speech a year or so ago. We have not seen any move in yields on the days we have done these auctions.
I just wanted to reiterate one point that Dave made, which is that if you have announced the pace well in advance, as long as you are not doing it in disturbed conditions, you would not expect to see much of a move on the day you are—
Q66 Chair: But why £80 billion, though?
Dr Broadbent: Well, it has to be a number, and only one number, from that range. We thought that active sales of around £10 billion a quarter, on top of the natural expiry of a further £10 billion a quarter, would be about right. It was more or less in the middle of that range. That is not to say that it will be £80 billion every year, but our markets people advised that anything more than £100 billion might risk disturbing market liquidity, so we wanted to be slightly within that. That was more or less the rationale.
But the point that Dave made—whatever number you choose and announce being priced in already—is quite important. This is not a surprise, because we said we were going to do it. Therefore unless you are selling in very disturbed market conditions—and we have said explicitly that we will not be doing that—you would expect whatever you have announced to be there in the price and nothing actually to happen when you conduct the sale. That is exactly what we have seen: on the days of the auctions themselves, there has been no detectable move in yields.
Q67 Chair: Haven’t you just now ruled out, though, changing the course of the flight after your review this summer?
Andrew Bailey: No.
Dr Broadbent: There are two things to say. One is that we will always have these same guiding principles. We would not want to stick to that meaning precisely £100 billion or precisely the mix that we had this year.
Q68 Chair: But you are going to do a review this summer.
Andrew Bailey: Yes.
Dr Broadbent: What we envisage at this stage is that every year we will announce, over the following year, what we intend to do. That will more or less be the process. We announced last September what the active sales programme would be over the following year, and I would expect something similar this coming September.
Q69 Chair: So what would have to happen for the review this summer to mean that you change any of these parameters?
Sir Dave Ramsden: May I come back in on that? We obviously take account of the maturity profile of our portfolio. We have a longer average maturity, certainly, than the ECB and the Fed. In the first year of our programme, there were only £35 billion of gilts in the portfolio maturing, so that gives you your natural passive run-off, as it were. That goes up in the second year of the programme to £50 billion, so you have to take that into account.
I am not going to anticipate what the MPC will say. I wouldn’t want you to be left with the impression that we are definitely going to go for £80 billion again, because that would imply a slower amount of active sales. If you have £50 billion that is maturing, that would leave only a bit under £30 billion of active sales.
So there is the potential for us to go up a little bit; I do not see us going down, given the experience of the first year. This is me speaking on behalf of what I imagine the staff advice will be; it is very important that, although we are talking to you as three members of the Bank executive, this is an MPC decision on pace that will be framed by Bank analysis.
Andrew Bailey: It is worth also adding that—I think I am right in saying—in 2025, if we stuck to £80 billion, we would do very few active sales.
Sir Dave Ramsden: Because the maturity really begins to pick up.
Q70 Chair: Your framing is very much as a technical balance sheet exercise.
Andrew Bailey: Yes.
Q71 Chair: And you are framing it such that it would take something pretty major for you to change the generally stated direction that you have outlined. Are you still of the opinion that this is not having any impact in terms of the real world and banking sector balance sheets? We have had a bank failure since you have started.
Are you still of the view that this is not having any impact in terms of inflationary or deflationary pressures in the United Kingdom? Talk us through how you are thinking about all those other side effects that could be occurring.
Andrew Bailey: Let’s take that in two parts. As you said, there is a financial sector part of that question, and then there is an economy and inflation part. I will start with the financial sector, and I might ask Ben to come in on inflation.
I do not think there is any connection between quantitative tightening effects and any of the events in the banking system that we have seen in recent months, not least because the UK banking system has not experienced stress in recent months. As we discussed at the hearing, Silicon Valley Bank UK was a very idiosyncratic issue to do with the fact that it was a subsidiary of a bank that failed in the US. I don’t think there is any connection between market and credit conditions in the UK, the stress and quantitative tightening.
As a broader point, I mentioned earlier that banks hold reserves, which exist for monetary policy purposes. That is the way that we set the interest rate, effectively. We decide what the Bank rate should be, and that is implemented into the system, because that is the rate paid on reserve accounts at the Bank of England, so there is a monetary policy angle. There is also, importantly, a financial stability angle: those are the highest-quality liquid assets that banks can hold.
To give you a sense of that, the major UK banks’ collective high-quality liquid asset stock is about £1.5 trillion today—that is the stock that they hold. Of that, about £900 billion is reserves here at the Bank of England. All things being equal, quantitative tightening will reduce that reserve stock somewhat, so there will be a substitution effect. Banks will hold other high-quality liquid assets instead of that, so over time I expect that there will be some rebalancing of that in the financial system.
Just how far that goes comes back to the point that I made earlier. At some point, we will hit a point of resistance at which the balance sheet will not come down. We are ready for that, by the way, because at the point that we did our first quantitative tightening auction, we did a short-term repo facility, so any day that we see pressure, we can go into the market and put liquidity in. That change will happen—there will be some adjustment—but that is entirely manageable and entirely natural.
Q72 Chair: And then the impact on inflation, Ben?
Dr Broadbent: I will make a couple of points. One is about what it might be, based on prior estimates, and one is about how we go about taking that into account. I will maybe take the second first.
Precisely because we have said that this will be gradual and predictable, as we discussed earlier, we think this path is already in the price; it is already in the yield curve. Markets fully expect the rest of this £80 billion to be done. They may have some expectations for next year that won’t be a million miles from that number. When we do a forecast, it is based on those very same asset prices.
We are already taking into account in the forecast and in the setting of the Bank rate whatever effect QT is having on the economy, because that effect comes via gilt yields and asset prices more generally, and we base our forecasts on those same things. Precisely because it is gradual and predictable, and therefore priced in, we cannot say exactly what effect this is having, based on multipliers from earlier episodes and using the reaction of yields in episodes when there was not illiquidity in markets, and when the effects are generally smaller. Our best guess is that it is having a pretty modest impact anyway—probably less than 10 basis points on a 10-year gilt yield, and probably less than 0.1 percentage point on inflation. It is those sorts of numbers—say, £80 billion over a year, relative to doing nothing. So I don’t think they are likely to be big, partly because we avoid selling in periods of acute illiquidity. By design, almost—by construction, certainly—we can’t tell exactly what it is doing precisely because we have already announced it.
All the estimates that we have of the effects of QE come from our decisions being different from prior market expectations. We look at what the surprise does to gilt yields; that is how we infer the effect of QE. If you announce everything in advance and there is no surprise, you wouldn’t expect to see any movements in yields, and that is precisely what is happening. As I said, on days that we have done these auctions, they don’t move. The numbers I have given you—these 0.1s—are based on earlier ones, and they are sort of symmetrical. They are the opposite of the effects of QE, but they are quite small. Importantly, when we take decisions on the Bank rate, we think we are taking into account any such effects.
Q73 Chair: In our previous session, when we had expert witnesses talking to us about quantitative tightening from outside the Bank, Professor Chadha referred to what you are doing as decommissioning the quantitative easing. To use the analogy of a nuclear submarine, you are decommissioning that extremely carefully and cautiously, because the potential for things to go wrong is enormous. Do you accept that analogy?
Dr Broadbent: As we said earlier, the core principle of avoiding selling into liquid markets, doing this not just predictably but very gradually, and of being well within the number that the staff said might have any such risk, are all important features of the programme, yes.
Q74 Chair: So you are concerned that it could potentially go wrong?
Dr Broadbent: No, precisely because we think we have taken those risks into account and are well within the numbers. As you said, right at the start—even before we had started active sales—we had a decision precisely of this nature, with the LDI episode last October. We delayed the start for that reason. It is not the case that on any of the days that we have sold these gilts there has been any sign of disruption. Of course, we watch for those things very closely.
Sir Dave Ramsden: Where I think the decommissioning metaphor does not really work is, as Andrew was saying in response to an earlier question, we still want QE to be a monetary policy tool. We are not taking it out of commission, which is what the decommissioning metaphor would imply. I was in the Treasury back in 2009 when the then Governor and the MPC got in touch to say that they wanted to commission that tool. It was always seen that QE would not go on forever—there would be some QT—but you want to have the tool in the toolkit in case you need to use it again. I was thinking of another metaphor, but I won’t introduce it.
Q75 Chair: Oh, go on! Please.
Sir Dave Ramsden: It is always a risk, but I will try. I think of it more like this: with the APF, we have got to the top of a mountain, but you have to be careful going back down the other side, because you want to be in a position where you can climb another mountain after that if you have to. You always have to be very careful on the descent; a lot of accidents happen when descending mountains. We have not seen that in this case so far, but our principles are clearly designed to ensure that we don’t have any of those accidents.
Q76 Chair: Or start any avalanches.
Sir Dave Ramsden: See, it is already working as a metaphor. To go back to Andrew’s point, at the pace we are going—or anything around that pace—we have got some time until we get to the point where reserves reach the minimum that banks want to hold. We put out an estimate last year. We survey banks occasionally on this, and the last time we surveyed them I think reserves were at about £950 billion. They said that they wanted to go to somewhat less than half of that. At the pace that we are selling back into the market, and therefore using up reserves, we have several years to go, so we have time.
Obviously, however, the reserves demand will change. It is determined by such things as liquidity regulations, and how the market is looking. At the moment there is quite a lot of demand for liquidity, given recent events. We can track this; we track it day to day, but we also survey the banks. From the prudential side, we have all the intelligence on what sort of liquidity they want.
Andrew Bailey: For context, that number was £30 billion before the financial crisis, and that was prudentially unsound.
Chair: Thank you. I should point out that some of our Committee members weren’t able to leave Parliament today because they are in the Finance Bill Committee, so each Committee member will take a few more questions than they might normally. I will bring in John next.
Q77 Mr Baron: Thanks, Chair, and good morning. If you don’t mind, I would like to question the link between the QE that was carried out during the pandemic, especially the last tranche, and the subsequent outbreak of double-digit inflation, given the Bank’s 2% inflation remit. We don’t want to go over previous ground from previous submissions to the inquiry. We have heard loud and clear that the Bank doesn’t think there is a strong connection between QE and inflation. We have had the outgoing Monetary Policy Committee member Silvana Tenreyro saying that QE does not represent money printing, but rather a like-for-like asset swap, and that there is “no separate ‘money’ channel that can unleash inflation”. You yourself, Ben, have said that perceptions that QE leads to rapid growth in the money supply and excessive inflation are “not well supported by the evidence”.
I think the last tranche of gilt purchases was announced in November 2020. We are talking about quite a sizeable increase, as you well know. The pandemic QE issuance or buying of gilts was twice that—double the amount of QE—as you know, but this was significant. When the last tranche of gilt purchases was announced in November 2020, the inflation rate was 0.3%. By the time that last tranche was finished in December ’21, just over a year later, the inflation rate was 5.4%. Was that simply a coincidence?
Andrew Bailey: Can I say two things? I am sure that Ben will want to come in, because he has given a speech recently on this subject, as you said. I will start by reiterating something that Ben said in his speech, and I have said a number of times. We have had a series of very big shocks happening to the economy, which in my view have created inflation, unfortunately. We have had some very big external shocks, and those shocks are not connected to QE in that sense. They have a different source. Because they have changed the terms of trade for the United Kingdom, they have created inflation. The price of the things that we import has risen much more rapidly than the price of things that we produce domestically.
Q78 Mr Baron: Presumably you are talking about Ukraine.
Andrew Bailey: Yes, but I would start with the so-called supply chain shock coming out of covid, which was a global shock. That has now pretty much entirely worn its way through. That was the services to goods shock. Then Ukraine comes along. There are two parts to Ukraine: the energy part and the food part. There are some other aspects to food as well. Perhaps I could look at it through another lens, which is the lens through which the MPC was looking at it at the time. It goes directly to your point about QE and money. I will use the whole of the covid era QE to illustrate this, if you don’t mind, and then we will come on to the precise question. Certainly, we saw an increase in the broad money aggregate. That is the case. What we did not see, and we had not seen anything like it certainly in the preceding 40 years, was the so-called M4 lending measure—credit creation in the economy—moving in the same way. In fact, it actually decreased. That had a lot to do with covid, and a lot to do with household and corporate behaviour.
How do you reconcile those two things? What we saw was a build-up of cash balances, both in households and in companies; this was not just a household thing. We talked about this a lot at the time. The MPC was left with this question. You can interpret what was going to happen as a result of that in one of two ways. One was that this was precautionary saving, particularly among households, and particularly among households with a low propensity to consume, because it is not evenly distributed in the economy. It is more concentrated in the better-off sections of the population. They have a low propensity to consume. That is one way you can interpret it. The other way is that this is a very big overhang of money, which will come into the economy, create demand and fuel inflation. That is a perfectly reasonable story.
I might hand over to Ben on this point in a moment, because Ben set this out in his speech, but what we did not see in the covid era or the post-covid era—and still have not seen—is a strong recovery of demand in the economy. The level of demand in the economy today is no higher than it was pre-covid, three and a half years later. We were surprised by that. I mean, demand was the recovery. I am not talking about the initial bounce back in summer 2020—that didn’t take us anywhere near back to the level—I am talking about the stagnation that we saw, really, thereafter. We just did not see this demand effect come through.
In terms of the stock of money and monetary aggregates, that is what the MPC was coming to terms with. Because we have not seen demand come through, I do not think that the “QE to demand to inflation” story really does hold up in this case; these external shocks are the cause. I might hand over to—
Q79 Mr Baron: Before that, if you don’t mind, Ben, may I just pick up on something that you said, Andrew? That story about the lack of demand begs even more questions as to why inflation subsequently rose to reach double-digit figures. There is often much talk about external shocks, but the simple fact is that before Russia went into Ukraine, inflation was running at 6%.
Andrew Bailey: Yes.
Mr Baron: In other words, we were already on a steep trajectory. I know that we are talking about not just Ukraine, but the supply side. However, there was a steep trajectory—
Andrew Bailey: Yes.
Mr Baron: And interest rates were still at 0.5%.
Andrew Bailey: Yes, you are right, and the judgment that we were making then—I know this word is now a term of slight abuse, but we will use the word—was the question of whether you would use the term “transitory” or “transient” for that post-covid supply shock. That is the supply chain shock. Was it going to be a transitory shock that would work its way through or not? That is important for monetary policy setting because, if we thought that that was going to be a transitory supply shock that would not persist, we would look through it. If we thought that it was going to persist, then, of course, we shouldn’t. That was the judgment that we had to make.
If the only shock that the world had experienced was that one, I think the evidence now suggests that it would have had a limited time period. Unfortunately, of course, Ukraine came along, and there was no gap between those shocks. The shocks have, in a sense, piled on top of one another and extended the length of this thing. That is why I would accept that the word “transitory” is not one that we can use to describe these things. That is the problem that we have had, I would say. I agree with you on what was happening in 2021, but the judgment that we were having to make was on how persistent that shock was going to be.
Mr Baron: Okay. Ben?
Dr Broadbent: I will say a few things in support of what Andrew just said about the pandemic, how that happened and the judgments that were being made at the time. However, I just want to step back and talk a little bit about QE and inflation. Rather than saying, “Is it a coincidence?”, as if it couldn’t be, I would put it the other way around and say, “If one wants to establish the claim of a very clear and strong link, then let’s look at the past.”
We had 10 years of QE without anything close to double-digit inflation. We had 10 years of QE well beyond these shores, in the US and the euro area, and indeed, they have had below-target inflation throughout the period. As I said in the talk that Andrew referred to, that period was also characterised by relatively weak—not strong—money growth.
The money that really matters in the economy is not the reserve deposits that commercial banks hold here, but the deposits that you and I, businesses and households throughout the country hold at commercial banks, called broad money. That was “created” at a far faster rate before QE than it has been since. Those were the points that I was trying to make in the speech. Inflation was 2%, on average, during the 10 years that we did QE between 2009 and 2019, and it was 2%, on average, before that.
Q80 Mr Baron: Without going into too much detail, because I have a series of questions here, I would retort that the first round of QE largely did not reach the real economy, because it was restoring bank balance sheets, to a certain extent. Therefore, it is the effect on inflation of the subsequent rounds that we are particularly interested in. Essentially, what you are saying is what I suggested in the question to Andrew: you do not see a strong connection between QE and inflation.
Dr Broadbent: Well, there is some. I mean—
Mr Baron: Yes, but not a strong one?
Dr Broadbent: We hit the lower bound in 2009. There is an effect. That is why we employed that tool. Our target is inflation. We are certainly doing it because the MPC throughout believed there was some impact on inflation. It is certainly nothing remotely close to 10 percentage points. Dave, why don’t you come in? Then I will come back.
Sir Dave Ramsden: If you look at those three rounds of QE in 2020, all of them—I remember lots of discussion with the Committee over this period—we were very worried that the initial shock of the pandemic was going to have permanent scarring effects, and that those would impact very significantly on the labour market. Obviously, the Government introduced the furlough scheme. We learned over time about the supply effect, but in the first round of QE, we were clearly trying to respond to what we saw as a disinflationary shock at that point. We did think that, by doing QE, it would boost demand relative to what would have otherwise happened in inflation. I think Ben has done some thinking on this.
The subsequent rounds of QE were in June and then November. We did £150 billion in November. It was over the following year, so it was a much slower pace of QE than we had done initially. I think Andrew used the phrase “big and fast” to describe the initial QE that we did. When you think about where the economy was—we did it a few days before we went into the initial lockdown—there was massive uncertainty around what was going to happen with the pandemic. Even in November, though, when we did the last QE, the vaccination programme had not started and the economy was just going back into lockdown. We were managing very significant uncertainties around health and economic outcomes. We would still imagine that the final phase of QE had some effect on inflation, but it was a lot less, I suspect, than the first.
Q81 Mr Baron: While I’m with Sir Dave—I will come back to you, Ben—we want to really focus on the final tranche of QE and the subsequent increase in inflation to double digits. But as a matter of interest, you were one, Sir Dave, among the minority who voted for an early end to the final round of QE. Can you explain your thinking at the time and how an earlier end might have changed the subsequent level of inflation? Why did you do it?
Sir Dave Ramsden: Because we were engaging in a policy easing through that final QE programme. By the summer of 2021, I was becoming more worried about inflationary risks than disinflationary risks. I was not the only one; I think Andy Haldane, in his final vote, voted to end the QE programme in August—to stop it at £100 billion, rather than go to £150 billion. Michael Saunders did the same. I joined Michael in September. I have said that my risk assessment was that I had more concern about inflationary risks at that point, but I was not thinking that ending QE early was going to have a very significant effect—I was very clear on that when I appeared in front of the Committee a year ago with Andrew. However, at the margin, since we were engaged in a QE programme, I thought there would be some effect. It actually comes back to something that Ben said earlier.
Also, if we had stopped the QE programme, it would have been a surprise, so I also had that in mind. We know that surprises in QE or QT might have a magnified effect. I voted to end it in September. Actually, the majority wanted to complete the programme. I understood the rationale for that: there were still a million people on the furlough scheme. I think the majority of the committee were more uneasy about the labour market than I was, but that was a question of judgment. But as I said to you last May, I never thought it would have a significant effect. Compared with the inflation we have subsequently seen, I think it might have taken 0.2% or 0.3% off inflation to do £30 billion—which is what I was voting for—less. Against the backdrop of the shocks that have led to the inflation we have seen, it would have been a very marginal effect.
Mr Baron: Ben, I cut you off.
Dr Broadbent: We do a lot of work thinking about the effects of these things. We have the evidence, such as it is, on what these things do to gilt yields and activity and inflation. If you add up June and November and use these standard multipliers—derived from the previous 10 years of experience—maybe you get to half a point on inflation, just about. Ending it early might mean, as Dave said, that maybe it would be a quarter of a percentage point lower, but the idea that this is the cause of double digits is not well supported.
Q82 Mr Baron: Okay, but can you very briefly just explain or quantify the extent to which that £450 billion of QE did affect inflation? Can you attribute any—
Dr Broadbent: Well, I have just tried to give you a number for June and November. I think the March thing is very distinct. The March thing, essentially, is meeting a huge surge in the demand for central bank money—the demand for liquidity. In the very early days of the pandemic, this was a global phenomenon. A lot of the non-financial sector, largely firms, were caught up by huge moves in asset prices. They had to make suddenly huge cash calls on derivative positions. They started selling lots of assets, including safe assets—Government bonds—and central banks around the world came to meet this demand to liquidity.
March is rather different in nature. I think you can think of March as an action that prevented a big rise in yields, rather than actively—
Mr Baron: Okay. Can I then—
Dr Broadbent: Hang on. For June and November, as I say, with standard estimates, maybe you get to half a percentage point on inflation.
Q83 Mr Baron: In that case, we are still left with a dilemma, aren’t we? We are trying to ascertain the role of QE, particularly in the final large tranche, and inflation. I get the message from across the table that you think it is marginal. You have quantified it—thank you—but we are still left with this double-digit inflation. What I would therefore suggest is to what extent, relative to QE, do you think that monetary policy, in the form of low interest rates, has been a cause? I think Dr Andrew Sentance made the point that, actually, he felt that there was a strong reason we had double-digit inflation—because interest rates had been too low for too long.
Dr Broadbent: Can I phrase it—
Mr Baron: May I finish my question? If I may be slightly provocative on this, there was a long period when there was clear evidence that inflation was rising. The message we got—not just from the Bank of England, but for central banks generally—was that it was not an issue. When it became clear that it was an issue, it was going to be transitory. When it became clear that it was not going to be transitory, it was going to fall away very steeply—we still have an OBR forecast of 2.9% by the end of the year.
Now, I note that the Bank of England, only a couple of weeks ago—or certainly last week—raised its forecast from 3.9% to over 5%. I get it—the Bank of England is there—but still, central banks and the Bank of England have been behind the curve. Is that not, given the evidence—a month before Ukraine, inflation was on a very sharp trajectory, as we have discussed, at 6%. Interest rates were still 0.5%. May I be provocative and suggest that that is a woeful neglect of duty?
Dr Broadbent: Can I draw a really important distinction here, because I think your question is absolutely, hugely important? It is one that we think a lot about—
Mr Baron: The reason I ask, if I may, is that this is terribly important when it comes to people. It is not just the language from the Bank of England; it is the fact that people are struggling now, out there, with trying to catch up with inflation, whereas if the Bank had been—not just the Bank of England, but central banks generally—more proactive, there might be less pain out there for people. That is what we want to understand.
Dr Broadbent: I understand. There are lots of questions in there, and I would like to address them, if you will allow me to take the time.
Mr Baron: I don’t have a lot of time left.
Dr Broadbent: I understand, but it requires time. There is a distinction between saying, “Were you late in responding to the events that have caused inflation?”—that is a not just legitimate, but hugely important question—and saying, “You caused the inflation.” Those are two slightly different questions.
Interest rates were low, as you say, for 10 years, without this inflation. They are insufficient on their own to explain inflation. I think these shocks—the pandemic shock, the war—are hugely important and enormous. I will come back to sizing quite how big they are in terms of real income shocks in a moment, because I think it is important to grasp how big they have been.
It is very legitimate to ask, “Could central banks have responded to these shocks earlier?” “Could you have come to a different decision in 2021 specifically about the nature of the pandemic shock and how long it would go on for?” and “Did you cause it?” Those are not quite the same questions. I don’t think the cause has reasonable empirical support, as I say, because you can go back in time and say that we had the same conditions for a decade without this happening. Something else must have happened in 2021-22. We know what the something else is. The question then becomes: could central banks have picked up on these things earlier? Dave referred to some of the judgments. The key judgments for me were how long would this pandemic shock last, and how large would the second-round effects of these huge rises in import prices be on domestic inflation. Those are the two key judgments.
Q84 Mr Baron: If I may say, Ben, I accept your distinction between the questions, but there is a correlation at the same time. When it is quite clear that money supply is on the up, and there is clear evidence in the economy that inflation is on a steep upward trajectory—my apologies, I keep coming back to this, but a month before Russia went into Ukraine, inflation was running at 6% and interest rates were still at 0.5%. I accept that you cannot predict shocks—they happen—but you have to respond appropriately. When inflation is running at 6% on a sharp trajectory upwards, and you feel that it is going to go higher for the very reasons you have expanded on—supply-side shocks—why were interest rates sitting at 0.5%?
Dr Broadbent: Allow me a little time and I will answer the question. The crucial decision you have to make in ’21 is how long this goes on for. Imagine you get a big jump in the price of oil, or indeed a big fall. Depending on the size, that will have an immediate impact on inflation. The orthodox of monetary policy in such a scenario is to look through this, because the time for policy to take effect might be a period of, say, two years, and if we take a decision now, its peak effect on inflation is 18 months to two-and-a-half years. We are always trying to think, “Will it be there in two years?”
The inflation in 2021 was a result of two things caused by the pandemic. I am sorry to take my time, but I really want to get this across. One was a huge shift globally away from demand for services and toward demand for goods. We noticed this in 2020 even, and in early 2021 it was a global phenomenon. Secondly, as Andrew said, was a disruption of the supply of goods. You saw all around the world steep rises in prices of tradeable goods—not energy and not food, but things like computer chips and cars and so on—and the key question was how long it would go on for. Yes, it had pushed up inflation very strongly. The judgment the committee and other monetary authorities came to was that if these things were caused by the pandemic—a shift in demand and disruption to supply—then the cure for the pandemic would also make them go away. Actually, as Andrew has said, that was not a terrible judgment. If you look at what has happened to the price of shipping, computer chips and lumber and so on, they have come down. Then we got the war.
If I look back myself and ask what the collection of things are that I might have made different decisions about, or what the key decisions were where things could have turned out or not turned out, it was the strength of the second-round effects of these shocks on wages, and secondly maybe the duration of the pandemic shock—because lockdown went on a lot longer than we thought it would in China. But it is not as simple as saying, “Inflation is here, and interest rates should always be where inflation is,” because you always have to look forward and ask yourself, “How long will this continue?”
Q85 Mr Baron: I accept that, but having said that there was such a gap and the trajectory was so sharp. It was quite evident that inflation, even before Ukraine, was not going to fall away significantly.
Dr Broadbent: If I look at the consensus forecasts—
Mr Baron: Ah, consensus forecasts.
Dr Broadbent: Indeed, there are 30 forecasts out there. Those people spend their life doing this. They found precisely that inflation would come down.
Q86 Mr Baron: All right. A final question for you, then I must make way for others. You rightly say that interest rate policy has a lag effect. To bring the argument up to the present very briefly, we have official inflation forecasts of 2.9% from the OBR and 5%, recently upgraded—last week, in fact—from the Bank of England for year-end forecasts of inflation. Yet, given that interest rates take at least six to nine months—you mentioned an 18-month lag—if you believe those forecasts, why are you still raising interest rates?
Dr Broadbent: That is a question that we spend hours discussing.
Mr Baron: It does not make sense, because it goes back on yourself.
Dr Broadbent: Quite so. You are absolutely right that we are having to look forward further than the end of the year, because an interest rate decision today really does very little to inflation at the end of 2023. The key judgment in the latest forecasts is how persistent—I used the phrase “second-round effects”, which feels a bit technical—domestic inflation in domestic prices and wages will be. There is a range of views. You are absolutely right.
Q87 Mr Baron: I do not particularly think that that is going to be the case. I think inflation is going to be stickier, higher and more volatile, for a whole host of reasons, including the shortening supply line and onshoring, but your own forecasts suggest that it is going to fall away steeply, and here you are raising interest rates and, if I may suggest, causing more pain to a lot of people out there.
Dr Broadbent: The mean forecast is 2% in two years, and that is conditional on interest rates in the market.
Q88 Mr Baron: And you have just said that there is an 18-month lag, so why are you raising interest rates?
Dr Broadbent: No, it is conditional on interest rates. The forecast that we make depends on the path of interest rates priced into the market. If we cut interest rates now, that forecast would be higher than 2%.
Chair: And on Tuesday we have a whole session on monetary policy, so we will come back to these sorts of themes.
Andrew Bailey: Can I make one very brief point? There could be more agreement between us here than you possibly think, for the reason that our central forecast, which is more model driven but not entirely, brings inflation down much more quickly, but we rather share your view that there is a risk of more persistence. That is what Ben has described as the mean. That is the risk. What is distinctive here is that we have set policy more with that risk in view than we might in normal circumstances. There is a little more common ground between us than it might seem.
Mr Baron: Very briefly, I wondered whether you knew something that we didn’t with your current interest rate policy, but let’s wait and see.
Chair: We will definitely come back to this on Tuesday.
Andrew Bailey: We will pick this up next week.
Chair: I will revert to quantitative tightening, and bring in Andrea.
Q89 Dame Andrea Leadsom: Thank you, Chair. Good morning, and thanks for having us here. I fully agree with John that there are very grave concerns about monetary policy and its impact on the real economy. In my view, it really demonstrates how much forecasting is crystal ball gazing, and how very dangerous group-think and consensus can be. As you just said, Governor, you are now raising interest rates on the risk of inflation being stickier. That has such huge consequences for people in the real economy.
I want to get on to inequalities and the impact of quantitative tightening specifically, but first I would like to challenge you a bit on the policy and the process for quantitative tightening. You are all confidently saying that it is not a monetary policy tool, it is not going to do much, it is small amounts anyway, and it is all priced in. You have talked a lot about how it is the surprises that the markets do not like, and as long as you do not create surprises it is all priced in and you will not feel a thing, but of course that is not the reality on the ground, because whatever you do in terms of unwinding quantitative easing will have an impact.
I will start by reading out the OBR’s comment in its “Economic and fiscal outlook” from March ‘23: “The volume of government debt that private sector holders will need to absorb in the coming years is likely to reach the levels last seen during the financial crisis…But, with the APF now running down…the private sector needs to absorb 6.5 per cent of GDP in additional gilts each year over the next five years, the highest sustained levels this century.” Fitch is forecasting that the combination of debt sales from the UK Government and the Bank of England will be equivalent to 9% of GDP this year, whereas in the Eurozone the equivalent figure is just under 5%. So it is very hard to say that QT is not having an impact on bond yields, at least on bond spreads relative to other advanced economies.
I just want to challenge you again on whether QT really is as “you won’t feel a thing” as you say it is, notwithstanding the market trading lack of shocks by setting out transparently what you are going to do. Underlying that, we are seeing bond spreads growing between gilts and German bunds, and changes in our ability in long-term yields etc. that have profound impacts on the economy. That is an assertion from me that QT is not as painless as you say it is, so I would be grateful for your response to that.
Andrew Bailey: Let me start—Dave might want to come in as well, as he is responsible for our markets operations. I think a lot of what moves the long-term bond rate is not QT; it is obviously expectations of interest rates. We should come back to that. You quoted Germany, but the movement between gilts and US Treasuries in recent months has really been because of the move in US Treasuries, which reflects the impact of the banking situation in the US and credit conditions. So I add that caveat.
Secondly—I go back to something I said earlier—Silvana Tenreyro said that QE is an asset swap and QT reverses that. I want to come back to the point about the banking system. You are right that, of course, the gilts have to be purchased, but in maintaining those liquidity buffers, the banking system will have to substitute assets for the cash reserves that they hold at the Bank of England, which we expect to come down. So I would make it clear that there are some natural offsetting mechanisms going on in this process that we are very aware of and take into account when deciding how the process will work its way through. So I caution against a rather stark interpretation of what we are doing.
My final point, before Dave comes in, is to reiterate and spell out an earlier point a bit more. When we say that the Bank rate is the active monetary policy tool, what we are saying is that everything that goes on in the financial world in determining financial conditions, we take into account when we determine what the appropriate setting of Bank rate is. That will include any impact from QT. Any impact from QT is taken into account because it will be evident in asset prices.
Dame Andrea Leadsom: That is very simplistic.
Andrew Bailey: I don’t think so.
Q90 Dame Andrea Leadsom: Well, you have not commented on the rise in spreads between gilts and bunds. Also, to say that you are taking into account any impact through monetary policy is too simplistic because what you are seeing is that that reversal of QE, which you say is not a monetary policy, requires the markets to absorb much greater levels of gilts—as the OBR said, levels not seen since the financial crisis. Although you say that that is all absorbed by changes at the Bank, it nevertheless has an impact on people’s activities. If you are going to insist that it all comes out in the wash, why not let the Debt Management Office determine the QT policy, rather than the Bank of England?
Andrew Bailey: Because, if you don’t mind my saying so, we are independent as the Bank of England, and it is our responsibility to conduct these operations and manage our balance sheets. However, we liaise a lot with the Debt Management Office. We do not run these programmes without talking to each other. That is important.
You mentioned the points about Germany. Again, I will come back to the point that there will be a view on relative interest rate expectations. Also, the relative movement of gilt yields and German bund yields is much less than between gilt yields and US Treasury yields. That movement has not been anything like the same.
Q91 Dame Andrea Leadsom: But you have just given an example of why that is the case.
Andrew Bailey: Because I think relative interest rate expectations have shifted much less between the ECB and ourselves than they have between the Federal Reserve and ourselves and between the Federal Reserve and the ECB. That is because of the problems that the US has experienced.
Can I make one final point before Dave comes in? All this discussion is around gilt yields. A second thing that does not get picked up in any of this commentary, but is very important, is that QT has had a very beneficial effect in markets. When you look at the secured markets and the repo markets, it has increased the supply of collateral into those markets, and it has normalised spreads in those markets in a very helpful way.
Sir Dave Ramsden: Your challenge to us was that we were somehow saying that QT is not having any impact. We have not said that at all. What we have said, though, is that that impact, given the way that we are going about conducting QT, will be anticipated by markets. It will be in the price; it will therefore be in the yield. So the way you played back to us what we said is not accurate. We accept it is in the yield.
Q92 Dame Andrea Leadsom: Okay. So if it is having an impact—you are now saying it is having an impact—
Sir Dave Ramsden: I never said that it did not have an impact, but it is in the background in monetary policy terms.
Q93 Dame Andrea Leadsom: What does “in the background” mean? From a central bank’s point of view, how can something simply be in the background?
Sir Dave Ramsden: In the background means we announced last September an £80 billion programme, which built on not reinvesting the maturing assets, which started last March—
Dame Andrea Leadsom: Yes, I understand the process.
Sir Dave Ramsden: And then the active sales. That, therefore, is in the background for the next year. Meanwhile, since last September and we announced it, we have put up Bank rate at every one of our meetings. So that is the active foreground instrument and QT is in the background. I am sorry if this phrasing—
Q94 Dame Andrea Leadsom: That actually makes a huge amount of sense because, in effect, what you are saying is that QT is creating an effect on the economy and you are trying to offset that effect by raising interest rates. Is that what you are saying?
Sir Dave Ramsden: No, they are both working in the same direction.
Dame Andrea Leadsom: They are both working in the same direction—exactly.
Sir Dave Ramsden: If I can come back, Ben has given you some estimates of the impact, just looking through the simple lens of yield, on what that effect is. I want to come back to how you framed your question.
We know that yields and yield differentials are driven by a much greater range of factors. Monetary policy is a key factor. Andrew has emphasised that we currently have 10-year yields that are higher than US Treasuries and that is because expectations of US monetary policy have changed. In the US, there is more concern about the banking system and there is an expectation among markets that maybe the Fed will have to start cutting rates. You see that in the pricing of the yield curve for the US, whereas in the UK—to go back to the questions that John Baron was asking—there is less concern about the banking sector. We do not have the issues in mid-tiers that the US clearly has, plus my take on this is that there is more of a concern about persistence of inflation and therefore an expectation that our short-term rates, set by us, will be higher. That feeds through into yields, so that is one key driver.
Another driver is the fiscal position of the UK. You quoted the OBR. The amount of issuance that the DMO is doing this year is £243 billion, up from £125 billion last year. The Government are now—I remember this from my 10 years as chief economist at the Treasury—having to raise the debt to deal with the fiscal challenges from the fiscal interventions that were taken from the pandemic. That is another factor.
A third factor—if I can just finish—which may explain some of those yield differentials, is that there may be a bit of a risk premium still in there, or a liquidity premium, following on from the LDI episode. It may be that some of the pension funds and the like have not come back as fully into the market, or they are still adjusting, so you do not have the same demand for some of those longer-term gilts as you had in the past. That means that their price may be lower than it might otherwise be, so the yield is higher.
You have all these factors to take account of. Your focus is on the £80 billion.
Q95 Dame Andrea Leadsom: Correct. That is what the inquiry is about today.
Sir Dave Ramsden: But against these other factors, that is a very small amount.
Q96 Dame Andrea Leadsom: I have given you the chance to give a very full answer, which I think is very much known by everybody in the room as to exactly where the broader economic picture is. We are trying to narrow down on the impact of QT and, effectively, what you are all saying is that it is going on in the background and is not having any impact.
Sir Dave Ramsden: I didn’t say that it is not having any impact. Again, I am sorry, but you keep saying this—
Q97 Dame Andrea Leadsom: You then said, in response to that point, that it is not having any impact because monetary policy is taking into account the impact. That is exactly what you just said.
Sir Dave Ramsden: No. I said that it is having an impact because it is built into asset prices. We therefore condition our forecast on it and that frames our monetary policy decisions.
Q98 Dame Andrea Leadsom: Exactly, you just said it again. Your monetary policy—your active tool—is making up for any QT impacts, which is an entirely passive tool. That is what you said.
Can you answer my original question, which was about the differential spreads between Government gilts here and German bunds? Can you speculate on that, rather than reverting to why interest rates might be higher in the US?
Sir Dave Ramsden: Typically, you do find that there is a differential of UK 10-year gilts over German bunds—
Q99 Dame Andrea Leadsom: The spreads are widening, aren’t they?
Sir Dave Ramsden: For some of the reasons that I just set out, including expectations of monetary policy.
Q100 Dame Andrea Leadsom: Is it only those and nothing to do with QT.
Sir Dave Ramsden: No, I said expectations of monetary policy.
Dame Andrea Leadsom: Okay.
Dr Broadbent: Dave said that I gave one number on this. It is worth remembering that these are standard estimates for the effects of £80 billion on yields. I think it is a number slightly less than 10 basis points on 10-year yields. We have never said that it is not having an effect, but it is really important to try to size that effect against all the other factors that Dave said. Similarly, when you give the total number of gilts being sold into the market—Dave said next year or this year, I can’t remember, but over the equivalent period—
Sir Dave Ramsden: It is £243 billion.
Dr Broadbent: It is £243 billion. We are selling about £40 billion, so the vast majority of those numbers you gave earlier on what the market has to absorb is coming from the Government, not from the APF. Remembering the size of these things is quite important. You are absolutely right; there is some effect. We think we are taking account of it in our monetary policy decisions. We are not saying that there is no effect, but it is important to try to have in mind how big that effect might be.
Q101 Dame Andrea Leadsom: Thank you very much. Governor, you did some distribution analysis on monetary policy up to 2014. I am not aware that you have done any analysis on the broader economy of monetary policy and particularly the QE programme since then. Your 2018 work only came up to 2014. Am I right, or is there something more recent than that?
Dr Broadbent: We have published something more recently—I sent a letter more recently. We have numbers certainly on inequality. We have the data up until 2019 and I think we published those graphs. We can certainly publish them again if you wish.
Andrew Bailey: We can send them to you if that would be helpful.
Q102 Dame Andrea Leadsom: It would be very helpful to have those, but, very specifically, what work are you doing to assess, as John pointed out, the controversial increase in QE and then the subsequent failure to start QT because of the LDI crisis? What impact work have you done on the distribution analysis of that? Is that work under way and will you be able to share something with the Committee?
Andrew Bailey: We will share with you the most up-to-date work that we have, which I think we have published, but if we haven’t, we will share it with you. As Ben just said, there is a data lag. The data we need for this work lag behind and come from an ONS survey. I think we will get more data next year. I think I am right in saying that the ONS will release the survey next year and we will be able to update this. Of course, we will share that with you when we do.
These are, of course, relative inequality measures. The Gini coefficient is the most commonly used measure of relative inequality—both income and wealth; you can do it for both. The evidence up to the latest numbers shows very little movement in Gini coefficients over the period of QE as a whole. They haven’t moved very much—relative inequality has not moved. I emphasise the relative point, because it is always important to emphasise that you have to take the starting level of inequality, in a sense, as given.
Q103 Chair: Could you just clarify, every time you say inequality, whether you are talking about wealth inequality or income inequality?
Andrew Bailey: I am talking about both.
Q104 Dame Andrea Leadsom: Very specifically, as you very well know, there are huge issues with young people trying to get on to the housing ladder, which are enormously impacted by monetary policy. There are huge issues for savers and those who are on fixed incomes who are now doing better, relatively speaking. While it is not within the Bank’s remit to look at the distributional effects of monetary policy, it is nevertheless incredibly important to the wider economy. My question for you is this: to what extent are you looking at the prospects of QT and the unwinding of QE to potentially undo some of the inequality that resulted from asset price spikes during the QE programme?
Andrew Bailey: Can we take that in parts? First of all, you’re right to say that, of course, formally it’s not part of our mandate. But I want to assure you that we are very interested in this question and we do actually—our staff do—undertake work on it, because it’s important that we understand it. So I don’t for a moment trivialise that issue. As I say, we will update that work as soon as we can and we’ll let you have it.
What I would say is this, and I’m sure Ben will want to come in on this: I think it’s important to note that real asset prices have not actually increased during the QE period in the way that sometimes people suggest. Real equity prices certainly haven’t, and the house price to income ratio hasn’t moved in the way that is sometimes suggested. Actually, the period in which the house price to income ratio rose most was the 10 years before 2007. That was the period when it rose most substantially. It hasn’t done the same thing since then.
Before Ben comes in, I just want to make one more point, because I think it’s important in terms of this inequality issue. It is, of course, also important to consider the macroeconomic effects of this. Now, this becomes complicated, because obviously we then have to think, “What would the counterfactual be if we didn’t have these policies?” But one thing you can observe in this country is that unemployment has been lower throughout the whole of the QE period than people thought it would be. Indeed, today it’s 3.9%.
When you’re thinking about overall inequality, the picture of employment and unemployment is very important. You mentioned the age distribution—the Gini coefficient, by the way, is an aggregate measure. I think you’re right that there is a greater degree of inequality—intergenerational inequality. I think we can observe that in quite a lot of the statistics. But when you think about overall inequality in the economy, you have then got to think about how that works its way through the economy, and I would point to the unemployment picture as one piece of evidence that goes in the other direction.
Dr Broadbent: There do seem to be some times when, or at least when I read things, I don’t recognise some of the commentary about asset prices and inequality, and how QE works with these things.
Q105 Dame Andrea Leadsom: You don’t recognise that?
Dr Broadbent: No, I don’t. I’ll tell you why. It’s partly because, as Andrew said, the really rapid growth of house prices in this country occurred in the four or five years either side of the millennium. Between ’97 and 2007, they rose by an average of 11.5% a year. We have matched that number once, which was in the year after the pandemic; we got to about 11% nominal. In the years under QE, the average is 4% a year and, in real terms, about 2%. Real equity prices are still 45% lower—equity prices of UK-facing firms are 45% lower than they were in 2007.
So there has not been some great, huge boom in asset prices; a lot of that came before. And meanwhile, these measures of inequality we have—during the QE period, they have been completely flat, basically, whether for wealth or income. Indeed, wealth inequality, measured the standard way, is lower than it was in the mid-90s. Income inequality is about the same; it has been pretty flat for a period of about 30 years.
What is true, as Andrew indicated, is that there has been, over that 30-year period, a rise in intergenerational inequality of wealth. That occurred precisely during that huge boom in asset prices—house prices; forgive me—between ’95 and 2005. Anybody who happened to have got into the housing market before the mid-90s, when this boom really happened, is better off than those who had to buy their first house after 2007. That was the period where you got this really, really strong growth. Since then, there has been very little change in overall inequality, whether in terms of income, wealth, intergenerational inequality or real asset prices. They have all been remarkably stable, in fact, and the real value of UK equity prices is today where it was in 1995.
Q106 Dame Andrea Leadsom: I must push back slightly, because your own research shows that the lowest decile lost out. You say that that’s because many are retired or unemployed and therefore not gaining from higher employment, nor are they winning on interest receipts. So there has been significant inequality where the lowest decile is concerned.
Andrew Bailey: You’re right. I think you’re probably referring to the numbers that we published some time ago, which are—
Dame Andrea Leadsom: Yes, exactly, but we don’t have anything since.
Andrew Bailey: Let me just explain this, because I think it’s an important point. I’m not criticising; they are cash numbers—I think it’s one cash number for the lowest decile and another cash number for the highest. But I just want to come back to a point I made at the beginning. What really determines those cash numbers is the starting level of inequality. If you have more assets at the beginning, you will do better as you go through. That is a hard thing to say, because that has its own, broader economic and social implications, but it is not a product of the policies that are pursued in the meantime. It is much more to do with the starting level of inequality.
Dame Andrea Leadsom: That is kind of self-evident: if you haven’t got a house, and house prices go up—
Andrew Bailey: But I think it is important, because you made the point about—
Q107 Dame Andrea Leadsom: But it is not right to deny that monetary policy is having an impact. You might say that it is not your fault that that person has not got a house, but there certainly is an impact of monetary policy on inequality in our society.
Andrew Bailey: No, I am sorry, I am making a point that is much broader than that. It is a hard point to make, but I think it has to be made: if you start off unequal, you tend to go on in that. It tends to continue. It is not the product of monetary policy in the intervening period; it is really to do with the starting point.
Q108 Dame Andrea Leadsom: Governor, I am sure that you would not subscribe to the view that if we started equal, we would all end up the same, so I do not think that it is a valid point to make.
Andrew Bailey: Well, we would end up much more equal than we would do with these numbers—
Q109 Dame Andrea Leadsom: Would we?
Andrew Bailey: Yes. We are talking about a starting level of inequality. If everybody started equal, I agree with you, obviously—who knows what would happen in the intervening period—everybody would not end up exactly equal, but I don’t think it is unreasonable to say that they would end up much more equal than they would in the comparison that we are talking about here.
Dr Broadbent: From my memory, to get back to the numbers that we have been quoting for Gini, across the whole distribution—the standard measures of inequality—they have not moved.
Q110 Dame Andrea Leadsom: Between when and when?
Dr Broadbent: As I said, income inequality, basically for 30 years, pretty flat—
Q111 Dame Andrea Leadsom: To the current date—you have that figure?
Dr Broadbent: The latest number for wealth inequality is 2019. As Andrew said, we might get another wealth and assets survey next year, but that one was until 2019.
Wealth inequality is lower now than it was in the mid-’90s, on the standard measures. As Andrew said, if you have different proportionate measures of inequality like 90/10, my memory is that they have not moved much either, but we will certainly get back to you, because I cannot remember precisely.
The other point that Andrew made is quite important as well. Economic cycles have some implications, wherever they come from, for inequality. The reason for that is that it tends to be the less well paid who more often lose their jobs in recessions. Recessions are regressive and recoveries are progressive.
Monetary policy acts—or it can—to lessen the degree of the cycle, at least in demand; with supply shocks, we cannot do much about their effects on income, but with variations in demand, the job of policy is to try to smooth those out. When we ease monetary policy, yes, we may have some impact on asset prices, but we also prevent unemployment from rising quickly.
The work that you cite, the working paper that we published I think in 2018, said that even if we assume a big impact on asset prices—myself, I think our estimate was too high—it is a wash, because when we ease policy, we are preventing many people from becoming unemployed and, as I said, it tends to be disproportionately the less well paid who more often lose their jobs in downturns.
Q112 Danny Kruger: Thank you, all. You will be glad to know that the sketch writers have just left, so we can all relax.
Andrew Bailey: We can say what we like now!
Q113 Danny Kruger: Exactly. I share quite a lot of the concerns that have been expressed already, but I am going to talk not about the effect on markets or the economy generally, but about the fiscal situation and the impact on the public finances. Could one of you help me understand the reason for the indemnification of the Bank from the losses—and profits—of QE? That was very helpful to the public finances for the first 12 years or whatever it was of QE, until the Bank rate went up. As I understand it, the Treasury is now facing losses to repay the £20 billion or £30 billion in the coming years, so this is a very significant consideration for the Chancellor. Why is it that the Bank should not be taking the losses that occur?
Andrew Bailey: You are right that during the period of low interest rates over the last year, the cash balance transfer from the Bank to the Treasury was £124 billion all in all. That was under an agreement reached in the early days of QE that the Bank would transfer those cash proceeds to the Treasury. That agreement—it is in the letters between George Osborne and Mervyn King from the time—made clear that it was most likely that the reversal of QE would happen in conditions of rising interest rates and that the cash flow would reverse. That is my first point.
Where that eventual net cash flow ends up will depend on a number of things. It will depend on interest rates and the yield curve going forward and the QT programme and how quickly it takes place. We give estimates every quarter when we publish the report on the state of the APF, but we cannot be precise on that. I think most of the witnesses at the previous session said this, but if you were doing an overall fiscal cost benefit on it, you have to take into account much more than just the cash flow. There is the impact on the economy, borrowing costs, employment levels and activity. To get the overall picture, you would have to go wider.
Let me finish with your precise question about why indemnify the Bank of England. I think it is useful to compare our situation with other central banks. There are a number of ways of doing this. Let me be absolutely frank: you can’t make these cash flows disappear, obviously. The best one to compare it with is probably the Federal Reserve. You are right, the Federal Reserve does not have an indemnity in that sense. The way it works is that the Federal Reserve creates what it tends to call a deferred asset, and over time that deferred asset will be paid over. The big difference is that the Federal Reserve retains on its own accounts what is called the seigniorage, which is the profit of the note issue. That seigniorage can then be used to, in a sense, offset the cash flow on QE and QT. We do not retain seigniorage. That was settled in the Bank Charter Act 1844.
There are actually two parts to the Bank of England’s accounts. There is what’s called the banking department and the issue department. The issue department only has the bank note issue in it. At the current annualised rate—I say current annualised because rates are going up, so I am doing it at the rate set last week—we will be paying over £3.8 billion a year to the Treasury. That route is not available to create a deferred asset and then over time to match that deferred asset, because we are paying that cash over separately to the Treasury. I am not objecting to that. As I say, it was set by Sir Robert Peel, but that accounting route is not available to us. The alternative had to be the indemnity, because one way or another this has to be covered.
Q114 Danny Kruger: I defer to your expertise and knowledge of Bank history. Is there no other way in which the Bank can defer its assets until the QE is profitable again and we have paid the losses?
Andrew Bailey: I wasn’t predicting that we would do more QE.
Q115 Danny Kruger: But until the assets become profitable again?
Sir Dave Ramsden: Going back to 2009, I was in the Treasury advising Alistair Darling at that point when Mervyn King and the MPC said that they would like to start doing QE when the Bank rate had reached what was then the lower bound. The Bank has a certain amount of capital on its balance sheet that is there for all its usual operations. It was actually augmented a few years back, so it is now up to £3.5 billion. In order to ensure that the MPC can decide what it needs to do to hit the inflation target, it buys assets through QE; it holds on to these. As you were saying, it was always envisaged that this would not go on for as long as it had, because what we ended up with was a fall in equilibrium interest rates across the world, so we ended up at the effective lower bound much longer than I think anyone envisaged.
The Bank has to be indemnified, to use the terminology, in order that it can go ahead with meeting its monetary policy objective. As Ben was saying earlier, over the first 25 years of the MPC’s history to 2022, for 13 of those years from 2009 with QE, inflation averaged 2%. The MPC was able to hit its objective, but the MPC cannot be at risk of the Bank becoming insolvent if its capital was wiped out by losses on those asset holdings, hence the indemnity, which has been in place ever since. That is because we hold a relatively small amount of capital. If we kept the seigniorage, it could accumulate and that could improve our financial position. That would be an alternative, but history has—for reasons that I am sure Andrew could explain—taken us in a different direction. We need that indemnity, and successive Chancellors—including the very latest Chancellor, Chancellor Hunt—have given us that indemnity so that we can meet our mandate for monetary stability. Otherwise, we would risk the Bank wiping out its capital through the capital losses.
Dr Broadbent: Dave makes a very important point. The fundamental purpose of the indemnity was to allow the MPC to take decisions based on monetary policy objectives, not fiscal policy objectives. The committee was always aware of the potential fiscal implications. QE essentially shortens the average maturity of claims on the consolidated public sector.
Any time you buy a gilt, the expected return on this transaction—it is not the reason we are doing it—is more or less zero, because people in financial markets ask themselves precisely this question in order to think about the right price of a gilt. They say, “If I bought this 10-year gilt now and I funded it by rolling over short-term borrowing, what would my profit or loss be?” The price of the gilt, more or less, is set to make that number close to zero.
The MPC was given the indemnity so that it could take these decisions independent of fiscal policy. It did not, for the reasons I have just given, so we are definitely going to make a profit or a loss. As it happens, in the first 10 years or so, short-term interest rates turned out to be much lower for a longer period than people in financial markets—indeed, all of us—expected back in 2009, 2010 and 2011. It happened to generate a cash-flow profit, but that was not the reason that the MPC did this.
We published—I say “we”, but I was not on the committee at the time; I think in 2011 I had maybe just arrived—a paper setting out the nature of these risks and various scenarios. We tried to alert people. Indeed, at some point I think we said that it was likely that the cash flows would reverse.
Andrew Bailey: Yes, that was in the letters between George Osborne and Mervyn King.
Dr Broadbent: So those implications are there, but—just to get back to your original question—the reason for the indemnity is precisely so that we can focus only on monetary policy objectives.
Q116 Danny Kruger: Okay. I understand that, and that is a very satisfactory rationale, but from a fiscal point of view, it then raises the question of what the impact is. I think that what you are saying is that it is not the responsibility of the MPC to consider fiscal policy—which is fair enough; that is not in its remit—but only in your recent exchange of letters with the Chancellor did “value for money” become a phrase that was used. I would be interested in the origin of that.
Andrew Bailey: There is a deliberate reason for that. The reason that the Chancellor and I were both very keen to do that was that once we moved into active QT and we were conducting auctions—which obviously we had not done for that—we both felt it was important that we could demonstrate the auction process was delivering value for money. It is what I would call a micro structure argument about needing to see that our processes deliver value for money, which is absolutely right. It is not about overall fiscal policy.
Sir Dave Ramsden: I would say that the explicit reference to which you refer, from the 28 April letter, is an evolution of something that has always been in mind both for the Treasury and for the Bank. When we go about any operations involving the APF, the principal consideration is monetary policy, but, subject to that, we are always thinking about cost and risk. As it happens, I saw this when I was an accounting officer at the Treasury with the exchange equalisation account reserves. I am very conscious of these VFM issues.
There was 2009 and 2011 when the cash flows, for cash-management reasons, went back to the Treasury. In 2016, when that QE was done, Philip Hammond came in as Chancellor—the Bank also introduced the TFS and started to buy corporate bonds—he reasonably, and with the agreement of the then Governor, said he wanted to enhance the oversight, so we beefed up the oversight of the risks and the Treasury’s understanding. We were then doing more things on our balance sheet and, as Andrew says, because we are now actively selling, the Treasury accounting officer needs to be confident that the way the auctions are being conducted will be providing that value for money. It is an evolution.
Q117 Danny Kruger: Understood. I have a last couple of questions on this. Can you cast your minds back to the 2020 round of QE and explain what the value for money consideration was then? In particular, did the Treasury scrutinise the decision from a value for money and fiscal perspective at that point?
Andrew Bailey: We are talking about value for money in a slightly different sense from the way it appears in the letter we were just discussing, because we were talking about auction mechanisms. I would draw a distinction between the different rounds of QE in 2020, so let me start with the March round, which was obviously done under dysfunctional conditions. We have said it many times, but it is important to bear in mind that that round was done for both monetary policy and financial stability reasons—the two things came together at that point because we were facing quite a dramatic situation, a so-called dash for cash. Either Ben or Dave said earlier that we had to go as big and as fast as we could, partly because of the need for liquidity in the system, as Ben was saying, but partly for demonstration reasons. It was critical that we came in very fast and very big to demonstrate to the market that the tool was there and working, and it worked in that sense. It calmed things down. And it was not just us. The Fed, the ECB and other central banks also came in with their own decisions.
That was very much the March decision. By June or July, when we essentially extended it, we had got past the worst of the initial financial market disruption, but we were still extremely concerned about the state of the economy. We had very low inflation at that point—our problem then was getting inflation up to target—and we were concerned about liquidity conditions in the market. I emphasise that, for me, the fundamental argument for QE, and Ben Bernanke set this out very well, is that it operates further down the maturity structure of rates. It was holding rates further down at levels that matter to corporates in terms of their activities, and that worked.
On the third round, which is the one we have discussed quite a bit in this hearing, Dave made the point that it is important to remember what the situation was at that time in terms of economic uncertainty, and how we responded to economic uncertainty when we were very near to the lower bound of interest rates. You may remember that there was quite an active debate at that time about what I would call the other tool we could have used, which is negative interest rates. I will declare a personal position: I am not a supporter of negative interest rates, but we had to consider all the tools we could use. Given that choice, the extra round of QE was the better way to go at that point.
Sir Dave Ramsden: Just to complete that, without going back into the detail we discussed earlier, throughout that year the Treasury and also the DMO would have been very alive to what was happening in gilt markets and what they needed to do, if you remember, with the issuance programme to support the furlough scheme. Reiterating what I said earlier, Andrew has just gone through why the MPC did what it did, but, subject to that, in our engagement with the Treasury, but also our ongoing engagement with the DMO, we would be thinking about trying to minimise costs and risks. We have to prioritise but also hear from the DMO what their considerations are in terms of their issuance programme, so there is that ongoing engagement, which then feeds back to the Treasury’s responsibilities both narrowly for value for money—narrowly in the accounting officer’s sense of value for money—and more broadly for their own full issuance programme.
Q118 Danny Kruger: Lastly and very quickly, there is a review coming in the summer on QT. What effect will the loss forecast that they are making at the moment have in terms of your thinking on the pace of QT? How much of a consideration is that?
Sir Dave Ramsden: The forecast of the cash flows—it is a really important institutional point here—is not a consideration for the MPC, and it should not be. The MPC must focus on the overall impact on money stability, on achieving the inflation target, and on getting inflation down from the current 10% back to the 2% inflation target. The MPC is aware of the cash flow consequences, but the MPC is thinking about its objective, which is for monetary stability for hitting the inflation target.
Chair: Thank you. John, I know you have a quick question that you want to ask.
Q119 Mr Baron: Yes, very briefly, to continue where we left off. I know I don’t have to remind you, gentlemen, but the decisions that you make really affect people out there. I know you know that, but we are here as parliamentarians and so would like to emphasise that. On the resource that you can put into the accuracy of forecasts, the more the better, because it is not just the Bank of England; central banks generally have been woefully behind the curve, in my humble opinion. It is affecting people’s lives now because we are trying to play catch-up on interest rates. I suggest that if you believe in your forecasts of where inflation is going to be, you risk overshooting. If you don’t believe them, at least get the message out so that people can be prepared and businesses can plan accordingly.
I think inflation will be stickier and more volatile for a host of reasons. You have characterised the nuances. Geopolitical relations are hardening. We have seen onshoring. The balance between capital and labour is changing. I doubt whether that has been put into models when it comes to predictions, and we have to sometimes think outside the box. Can I leave that thought with you?
Andrew Bailey: You certainly can.
Chair: Andrea, I think you also had a question.
Q120 Dame Andrea Leadsom: The discussion has been so interesting; thank you. We have well-documented evidence on LIBOR rigging and gilt auction rigging and so on. With the QT programme, have you considered, and what are your thoughts on, the prospects for traders gaming the quantitative tightening process and being able to make money and thereby exacerbate the loss to the Treasury?
Andrew Bailey: I can assure you that we put a lot of thought in, and over time we have put a lot of thought into—I am going back to before my time in this role and my involvement in this—the design and controls around the way the auctions operate. That continues to be a very high priority for us. There are two aspects to this, and they both come under the roof of this building. One is the monetary policy side and the other is—it is not the MPC—how our markets directorate, which reports to Dave, conducts the auctions. That is, in a sense, a separate activity, because it is not monetary policy per se. But it comes back to the point we were making about why the Chancellor and I put that language into the letter. It is absolutely critical that we conduct these operations with the utmost rigour and control around them.
Sir Dave Ramsden: To the best of my knowledge, yes, in terms of the way we have designed the auctions, subject to the points I have made. We set up the auctions to achieve the best available prices that we can. We have a reserve price in there, so that—the way we set them up, they’re multi-stock auctions, but if there was particularly weak demand on the day, the reserve price might kick in. I think it may have happened once in the auctions we run.
We have quite a substantial team, as you would expect, who pore over the results of every auction. They follow the MI around the auctions. You will be aware that there are communications that have—
Q122 Chair: The MI being?
Sir Dave Ramsden: Apologies—market intelligence. They are looking for any of what is known as the chatter; those kinds of qualitative indicators. Obviously, the Financial Conduct Authority is very focused as well, given its overall responsibility for market integrity.
You compared it with some of the scandal around LIBOR. When you think about that benchmark, LIBOR, compared with the SONIA interest rate that we now have, which is a traded rate, a deep market, not based on the quotes and opinions of individual traders—the world has moved on very significantly in terms of those kinds of infrastructural elements in the market.
We would never be complacent about this and would always be ultra-vigilant, particularly given that, as Andrew says, we are responsible for these auctions, so we have to be accountable for their integrity.
Q123 Chair: The Governor did say earlier that the process of quantitative tightening is actually normalising the spread in the repo markets. That implicitly acknowledges that the quantitative easing process had distorted the spread in the repo markets.
Andrew Bailey: We found ourselves in a world where spreads were wider. The other thing that had happened, which has reversed itself, is that I think more gilts were what is called going special. Sorry; it’s a rather strange term—
Q124 Chair: It takes me back, that one.
Andrew Bailey: Basically, it means that their prices were less well behaved, relatively; they are more illiquid. A large number of stocks were illiquid. What we found in the QT process is that we are actually alleviating that problem. More stocks that are special are being bought in the QT process. That is helping the overall liquidity of the market, and so that is helpful.
Q125 Chair: One last question from me, and then I will have to bring the session to a close. Given everything that you have shared with us about what you have learned over the years of quantitative easing, the transition from quantitative easing to quantitative tightening and now the ongoing process of quantitative tightening, if you were ever to have to do one of these things again in the future, what would you do differently, Governor?
Andrew Bailey: First of all, as I said a few moments ago, we have a tool bag now that has got several tools in it that can be used to address situations when you are near to the effective lower bound. I don’t think any of these tools are ones that are as easy to use as Bank rate is in its normal situation.
I think we are now able to distinguish more between a monetary policy intervention and a financial stability intervention. The LDI crisis was very interesting in this respect; it was quite pivotal for us. We were pretty concerned—I will say this, and I have said it before—when we had to do this, and of course some commentators did say, “Oh, you’re just doing more QE again”.
If I go back to March 2020, when we were facing both a monetary policy and a financial stability event, I think that having the ability to distinguish these operations where we need to distinguish them, particularly because the thing that we have said about financial stability operations is that they are temporary and targeted—so, we may not do anything differently, but I think we are developing the toolkit so that we can distinguish tools of financial stability and tools of monetary policy, and that is important.
We have to have the ability to do both. We have to have the ability to do both when they may be going in different directions, as they were last autumn, when we have to come in and buy assets at a point when we are tightening monetary policy. Having that wider toolkit is a very big part of what I see us developing.
Chair: So, clearer labelling and purpose to each element in your toolkit.
Andrew Bailey: Yes, I think that will help in terms of clarity of purpose and operation.
Q126 Chair: Any other supplementary points? Dave?
Sir Dave Ramsden: We discussed this when I had my reappointment hearing. We ended up having to buy assets to deal with the LDI crisis. We were able to buy in a particular, quite niche segment of the market. Over the 13 days of operations, we were eventually able to get across to the market that it was targeted and time limited, but for the first few days the market thought, “Oh, it’s just QE again in a different guise.” I am keen for us to develop other instruments, so we don’t necessarily need to use asset purchases.
Q127 Chair: What instruments are you thinking about developing?
Sir Dave Ramsden: If we could develop a lending facility. The trouble was that the pooled LDI funds did not want to take on any more leverage, so we couldn’t really lend them anything.
I have two other points. One links backs to John Baron’s question to me earlier. I have talked about my decision to end QE early with the last bit in 2021—or my vote; the decision went the other way. Certainly, if I was still on the MPC I would be thinking about whether we want to run a programme for a year, or whether we want to have a break clause so we can review it. The trouble is that if you introduce a break clause, the market doesn’t know what to believe. Are you going to carry on running it, or are you going to break it? There is no easy answer there.
My final point, since I won’t be appearing next week—or I hope I won’t be—goes back to John. We need to continually challenge ourselves, as do the OBR, the IMF and outside forecasters, on how we do forecasting. One thing we have learned in recent years, compared with the first decade of the MPC, is the impact of supply shocks. I fundamentally disagree with your assertion that we were behind the curve, because back at the end of 2021, we started to tighten policy before the FED and the ECB. Even in an absolute sense, I do not think you can forecast shocks in advance, which is almost what you are implying. However, what you can do is to build in a better understanding of how the supply side of the economy works.
That is something we have learned over this period, because of two extraordinary events. A one-in-100-year pandemic is quite hard to build into your models until you have actually experienced it, and then we had a major war on mainland Europe. Again, these are not things that have happened in the history of modern central banking, so we need to develop our models to the extent that we can take account of those kinds of considerations and build in more scenarios, but I would not accept the premise of your question.
Mr Baron: To be continued over lunch!
Q128 Chair: Let us go back to my own question, which was more about what you would do differently in the future.
Dr Broadbent: Andrew and Dave have already spoken very well about the distinction between asset purchases for financial stability and for monetary policy purposes. I think there is a clear distinction, and we hope we can develop tools over time that are better suited to each particular purpose. This is a different point: it is about the way we have tended to describe the policy. Even the phrases “quantitative easing” and “tightening” I find slightly misleading, or they have the risk of misleading people. A better way to see this is as an extension of conventional policy. You are trying to lower interest rates, only slightly further along the curve.
The problem with the QE—I can’t remember who coined it, now—is that it invites this thing of “printing money”, which I find highly misleading. It gives the impression of some Friedman-like helicopter drop into people’s bank accounts. That is just not what the process is at all. It is an asset swap; we are taking an asset away. We have no direct effect on the wealth of the private sector when we do this transaction—none. It is not like a helicopter drop; it is not like printing money. Besides that, reserves bear interest, as we have been discussing. They are not the zero-interest money of the textbook.
We tried something on that a couple of years ago. We have different layers of communication, one of which is an attempt to speak a much simpler language at the front of the monetary policy report, which tries to get across, to a much wider range of people other than the specialists and financial markets, “Here’s what we’re trying to do.” We did shift it, and we did say that QE should be understood as a policy that tries to lower longer-term interest rates, as opposed to shorter-term interest rates, which is what the Bank rate does. It is an extension of the same, and I think that the way that we initially described the policy, certainly early on, has not helped us.
Chair: You have both said that better communication would be something that you would want to do differently in the future. I know that we have got you again on Tuesday, Governor, to talk about monetary policy. No doubt many of the same themes and questions will arise, and there will be others as well. However, for today’s session, regarding quantitative tightening, I will draw things to a close. Thank you very much.