The funniest line of George Osborne’s letter to Mervyn King begins with the words, “As you are aware, my predecessor agreed…”
The predecessor is Alistair Darling and the letter concerns the £35billion of interest payments, or coupons, that would have been paid on the gilts bought up by the Bank of England, under the policy of Quantitative Easing.
The agreement struck by the Labour Chancellor, is that the Treasury would not make coupon payments on the gilts, since it would be pointless for the Treasury to pay interest to the Bank of England (the state to pay the state).
The reason the letter is amusing is that Osborne won an election on the promise to reduce the deficit at spectacular speed, but has spectacularly failed to do so. However, he has done a good job of blaming his predecessor for his own failure. In this letter he has been forced to admit that his predecessor has delivered a £35billion gift to the public purse.
All this means that George Osborne must be tremendously happy. You can picture him getting out the bunting in Number 11 Downing Street. He’s probably kissing a photo of Alistair Darling at this very moment. There must be a proper spring in his step.
All his efforts to remove Britain’s debt mountain have failed, but then this one policy of Alistair Darling has delivered a massive contribution to the effort. In all, one third of the UK’s total debt has been bought up by QE. I can only presume that George will immediately take the air waves to thank the previous administration for their brilliant policy.
Without inflationary pressures, the Bank of England can sit on the gilts in perpetuity. This means that next year and the year after, the Treasury will receive further £35b gifts.
The inflationary pressure expected by the policy has been marginal. Paul Krugman explains this by pointing to the lack of demand in the economy. Few workers are demanding higher wages at present. They are mostly just clinging onto the jobs they’ve got. Shopkeepers aren’t seeing the shelves empty at such a rate that they wish to increase their prices.
It may be that once growth returns there will be too much money swirling around the economy. If that were the case, then inflation would be a prospect. The Bank would respond by returning the Gilts to the market and the Treasury would resume making coupon payments. If that were the case, then the benefit would have been temporary, but much appreciated none the less.
However, the people who do sums on this type of thing tell us that there isn’t too much money in the economy. If they are right then there will be no inflationary pressures once growth returns. At that point, if he wanted to, the Bank of England governor could strike a line through a number on a ledger, and the gilts would no longer exist. More likely he would simply allow them to expire, according to their stated lifetime.
All of this must be music to the ears of George Osborne. You can imagine him, with the Prime Minister and his cabinet mates, drinking a toast to Alistair Darling and sharing a warm glow of affection towards the Labour Party.
We have a warm glow back. Good luck, George. This one’s on us. We look forward to seeing you thank us publicly.