Why QE Will Cost the Taxpayer?

uk-qe

Under Quantitative Easing, the Central Bank created large quantity of bank reserves and bought bonds.

effect-qe-bonds

Commercial bnks saw an increase in bank reserves.

Initially, this made it cheaper for the UK Treasury to borrow. The Bank of England gained interest on the long-term bonds it bought, and for a time paid no interest on the reserves it created.

After 2005, the Central Bank started paying interest on these commercial reserves.  (BTW: This is partly why QE is not usually inflationary)

Commercial banks gained interest from Central Bank. But, the long-term interest rate on bonds was still higher than low short-term rates, so the Central Bank and government made a profit.

Rise in interest rates

uk-base-interest-rates-feb-24

But after 2022, short-term interest rates rose to 5%. Therefore, the Central Bank were paying more interest to commercial banks. The interest the Central Bank are paying on reserves is now higher than the interest rate it gets on long-term bonds. Therefore, this explains part of the increase in the cost of debt interest payments to the government.

uk-debt-interest-payments-2024

 

The New Economics Foundation (NEF) calculate that the banking sector could receive over £50 billion of public money by mid-2025 because of interest paid on reserves. [1]

Falling bond prices

There is another reason why the Bank of England/government will lose money from reversing quantitative easing. Bond yields have risen, meaning the price of bonds are falling.

bond-yields-daily-truss

Basically, the Bank of England bought bonds, when interest rates were low, prices high, but are now are selling after bond prices have fallen.

Why do Bank of England pay interest on reserves?

The Bank pay interest on bank reserves so that they can set the interest rate.

We are paying commercial banks £50bn because this is system of setting interest rates, not because commerical banks lent Bank of England/government money.

You could argue banks deserve paying on reserves because they can’t use them for lending like ordinary current accounts.

One solution is a windfall tax on bank reserve profit. Another is tiered reserves. So Bank don’t pay interest on all reserves, only some.

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