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Julian D. A. Wiseman
Abstract: the Bank’s decision to remunerate reserves heralds a deep change in the Bank’s understanding of the nature and purpose of the implementation of monetary policy.
Publication history: only here. Usual disclaimer and copyright terms apply.
Only four days into Paul Fisher’s term as Bank of England’s Executive Director Markets, an interesting step has been taken. On Thursday 5th March 2009 the Bank published Sterling Monetary Framework; Asset Purchases, announcing various matters relating to the start of ‘Quantitative Easing’. Of particular interest is (¶6) “until further notice, the Bank will remunerate all reserves balances held by reserves banks at Bank Rate. It will therefore suspend the usual system in which reserves banks choose monthly reserves targets that they have to achieve on average over the maintenance period.”
This is a step towards a profound change in the way that the Bank implements monetary policy. Indeed, this is a step towards a profound change in the way that the Bank understands the nature and purpose of the implementation of monetary policy.
It might help to see the destination. As has been previously argued at jdawiseman.com, the Bank should recognise that implementing monetary policy is making a price in short-term secured money, rather than adding or draining some quantity. This making-a-price can be done effectively and simply by a ‘passive narrow corridor’: the Bank should charge some rate for overdrafts, and should remunerate positive balances at some slightly smaller rate. These rates should be applied automatically to the balance at each day’s close of business, overnight overdrafts being secured against the collateral in the payment system. The corridor would be ‘passive’ in the sense of not requiring explicit dealing to transfer money between an OMO account and a reserves account, and ‘narrow’ in the sense that the overdraft–deposit interest-rate gap would not be large.
But with Quantitative Easing underway, the relative importance of the two parts is reversed. Banks will have plenty of money, even if only from selling gilts and private-sector securities to the Old Lady. So the commercial banks will, whilst QE is in place, have little need of the overdraft facility. And by this announcement the Bank has builded the more-urgently-needed wall of the passive narrow corridor. The author approves.
However, this step is a whole foot of twelve inches, but not as much as a yard. The market notice says (¶12) “If the Bank offers to drain reserves in its routine weekly short-term OMO it may henceforth do so via OMOs to sell Bank of England sterling bills at prices determined in a variable-rate auction on a discriminatory-price basis. Bills will continue to be issued, normally, for a one-week maturity”. But why drain excess reserves? Commercial banks would rather have the flexibility of reserves sitting in the remunerated account, so would presumably bid for BoE bills at a yield higher than compounded expected Bank rate. Thus the Bank would incur a small loss, and the commercial banks some small loss of flexibility, for no public-policy gain. Please, draining is now redundant: don’t do it.
To finish, a no-longer-urgent request. One day, quantitative easing will end. Please could the Bank build the other wall of the narrow corridor before that happens (by charging for overdrafts, rather than supplying funds via OMOs). Indeed, there would be no public-policy loss, and some gain, if it were done sooner, with the OMOs being discontinued. However, it is recognised that at present the Bank is exceptionally busy, and that the end of OMOs might not be regarded as being of the greatest urgency.
— Julian D. A. Wiseman
New York, 5th March 2009
Also see Short-term ‘draining’ operations and the nature of reserves dated 9th March 2009.
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