Bank of England quantitative tightening costs raise accountability questions

The financial implications of the Bank of England’s quantitative tightening programme have prompted calls for a fundamental review of the relationship between monetary and fiscal policy. The central bank’s recent actions have blurred the traditional division of responsibilities, leaving government ministers accountable for financial outcomes that they do not directly control. This shift has led to significant criticism regarding the lack of accountability surrounding the Bank’s decision-making processes and the resulting impact on public finances.

In August, the Bank of England disclosed that its key policy could result in a cost of £120bn to the Treasury. This policy, known as quantitative tightening, involves the sale of government bonds previously purchased during the quantitative easing programme. The disclosure highlighted a significant departure from the constitutional settlement established in 1997, when Labour made the Bank independent. At that time, the arrangement was designed so that the Bank would set interest rates while the Treasury managed taxation and spending. However, recent economic events, including the financial crisis, the pandemic, and geopolitical conflicts, have altered the landscape, rendering the original framework less effective.

The losses associated with the Asset Purchase Facility, a subsidiary of the Bank, are generated through three primary mechanisms. First, the Bank is selling gilts at current market prices, which are lower than the prices paid during the quantitative easing phase due to higher yields. Second, the facility incurs losses because the income generated by the £500bn in bonds is less than the repayments charged on the loans used to purchase them. Third, gilts bought above their face value are recorded as losses when they mature. The Treasury has historically indemnified the Bank for these losses, a practice that was formalised after the 2009 financial crash and modified in 2012 to function as a quarterly cash mechanism. This arrangement allowed the Treasury to profit when interest rates were low, but the mechanism reversed when rates rose, leading to ongoing payments by the Treasury to the Bank.

Critics argue that the current setup effectively grants unelected monetary policy committees power over decisions with significant consequences for public spending. Charlie Bean, a former deputy governor of the Bank, has acknowledged that independence cannot justify such a transfer of power. The Treasury and the Bank are reportedly drawing up changes to quantitative tightening to reduce pressure on interest rates, suggesting a move towards quiet coordination rather than strict independence. This development raises concerns about the sustainability of the current model, where the Bank makes decisions that have immediate political consequences for ministers, who must then face voters for the outcomes. The argument is that it is unsustainable for an independent central bank to make decisions that result in billions of pounds in cash demands falling within a single parliamentary term, as governments do not operate on the multi-decade timescales often cited by the Bank to justify its actions.