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' Nor is this any mere theoretical possibility. It is what the Bank of England did under its quantitative easing policy. In 2009-10, it bought £198.3bn of the £227.6bn of gilts the government issued. In effect, then, most of the government’s deficit was financed by printing money. ' That is not strictly true. During QE the BoE in their reverse auctions were deliberately buying different maturities to the ones the DMO were issuing to avoid that accusation. The institutions selling gilts to the Bank were not necessarily the same ones buying at DMO auctions. Posted by: Luis Enrique | July 19, 2010 at 04:27 PM 'Questions I should know the answer to already: 1. When the Bank of England buys government debt, does it keep the IOU on its balance sheet as "the government owes me £X" and do the government debt accounts include, "we owe the BoE £X"? Or does the BoE just tear up the govt's IOU, and the govt's debt is just written off. I'd really like to know the answer to this one! ' The BoE hold the gilts on their balance sheet as assets. Moreover, the Treasury make full interest payments to the BoE for the gilts they hold just the same as for all other gilt holders. The BoE have been making large profits from these coupon payments, which are of course returned to the Treasury. In fact, the prices the BoE paid purchasing gilts during QE is showing a paper profit of 10 billion sterling. Many people were commenting during QE that the Bank were overpaying giving free money to the winners at the auctions. However, since then yields have fallen and prices have risen, hence the notional 10 billion profit. There is no theoretical reason why the BoE can't hold the gilts to maturity. 2. ' Printing lots of money now might not be inflationary short-term, but is it necessarily storing up inflationary pressure at some point in the future? How easy is it to "sterilize" when the future arrives. Likewise with govt borrowing, the bond market might not be a constraint to borrowing, but in (say) 10-years time we're either going to have to pay or roll-over that debt, so when we're thinking about "how much can we afford to borrow" don't we need to be taking into account that future, not just today's interest rates? ' Well that is just about good debt management. You cover all parts of the yield curve to minimise roll-over risks. Part of the euro periphery problems is so much of their debt is short-dated. It is cheaper for governments to issue short-dated debt and roll-over. Until one day a crisis hits and the market reprices your risk and you are left with lots of short-dated debt to roll-over at a much higher interest rate. See eurozone for what happens. Roll-over risks are not a serious problem for the UK because the maturity is around 13 years. Ironically what makes us less of a sovereign risk exacerbated the banking crisis for UK banks. During the banking crisis they had no liquid short-dated government securities because the DMO had not been issuing them. Their balance sheets were full of illiquid mortgage-backed securities. ' why doesn't the CB just give the govt money by buying new debt and then tear it up? ' The government do not need anyone to give them money as they just credit accounts. The gilts are issued after the government spends. Why then do we have a gilts market ? The risk-free rate is important as a benchmark for pricing all other risk. Moreover, the bond market places a discipline on the government.
Toggle Commented Jul 20, 2010 on Monetizing the deficit at Stumbling and Mumbling
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Jul 19, 2010