Rachel Reeves has rightly called for a review of government finance but has given few clues about what might be on the cards and little by way of encouragement with the message that there is no money. We have been told that we cannot afford to do the things that are needed, whether that is the transition from oil, fixing the NHS and Social Care or revitalising the infrastructure.
When business needs to make savings it looks for a small number of big things because it knows full well that lots of small things never really add up: sure you might save 10% but that often not enough to make a difference. This type of approach is often referred to as ‘cheese paring’ or ‘salami slicing’. If you want to make an impact you need something big like exiting an entire line of business, closing down an entire operation, whatever.
For the chancellor the same logic applies. What are the big things that could make a difference?
Here are three; looking at the rules around that Bank of England Reserve Account, Treating all income in the same way and Quantitative Easing
Bank of England Reserve Account [1]
Roughly speaking the case is as follows; commercial banks hold reserves with the BoE. The reserves are needed by the banks and didn’t exist in sufficient qualities when the banking crash of 2008-9 occurred. In order to save the banks the government authorised the BoE to create money (quantitative easing) to support the banks. Thus the money held as the commercial banks reserves was actually created by the BoE at the request if the Treasury i.e. it was created and gifted to the commercial banks. Therefore paying interest on these reserves is adding to the origianl gift, and because this interest is being found out of government finances (i.e. isn’t being created) it is in fact perpetuating the transfer of money from taxpayers to the commercial banks, and because interest rates are now high..
The amount of money is potentially large, the New Economics Foundation estimated that the government could save £55 billion over 5 years. Richard Murphy estimates up to £30 billion per annum. There is room to debate about the actual implementation but some flavour of it has wide support. During the election campaign on Any Questions Paul Johnson of The Institute for Fiscal Studies said it might raise £20bn (7th June 2024).
What should be noted is that because of high interest rates “New data published by the Treasury Committee shows NatWest, Barclays, Lloyds and Santander received more than £9 billion in interest on Bank of England reserves in 2023 – a 135% increase on the previous year”. In other words keeping interest rates high - even with inflation coming down - gives the banks a windfall based on public funding. A double whammy for us saps.
Treating all income equally [2]
The proposal here is to treat income from investments (a.k.a wealth) in the same was as income from work. The case for this is simple, fairness. A person who lives off their investments receives an income from them, there is no logical reason why this type of income treated differently to remuneration from wages or salaries. To be clear this is nothing to do with the sale of your house if that’s your only residence because you need to buy another, nevertheless this is regularly trotted out to put people off the idea - deliberate misdirection. The IPPR says “Taxing income from wealth the same as income from work could raise £90 billion over five years”
Create money for investment [3]
If that is not sufficient then there is the option of printing new money. The banks were saved by quantitative easing. Furlough and other measures were funded by it. Saving the banks through quantitive easing not only saved the culprits, it showed, unequivocally, that there really is a “money tree” - although it is not magic, just an office in the Treasury where instructions are sent to the BoE.
Economics has undergone a revolution since 2008, monetary theory now recognises the governments monopoly on money creation and how it can be used responsibly. We have used it twice we can use it again.
Austerity was a political choice [4]
Like all things in economics the above ideas are not just technical issues, they are also political choices, that’s why economics should be referred to as political economy.
Austerity was a political choice. The 2008 banking crisis showed that unregulated pursuit of profit does not work. What happened was simply reckless greed; selling mortgages to people who couldn’t pay, bundling these so called assets into derivatives, making them appear safe. The resulting bubble was like playing pass the bomb, it was always going to blow up
What has happened since amounts to wilful neglect and should be treated as criminal damage. Paul Krugman says it was an unforced error that has severely damages the country.
Labour made its own unforced error in accepting the blame for the deficit caused by bailing out the banks and lost control of the narrative which it has never recovered. Ed Miliband’s plan for austerity was simply half of the cuts proposed by Osborne. It continues to talk as if household financial management is a suitable metaphor for managing the economy.
According to Paul Krugman there are sociological reasons (peer group pressure) causing politicians to be cautious on economics. This is because they wish to be seen as “serious” and they are entering a world of group think - the so called conventional wisdom benefits the rich, big business and finance. This is similar to the conversation Yanis Varoufarkis (when Finance Minister of Greece) had with Larry Summers, then independent (previously Chief Economist World Bank, Secretary of State for Treasury, President of Harvard). Summers asked Varoufakis if he would be an insider or an outsider. Only by being an insider could he get access to information and the chance to influence decisions. Outsiders, said Summers insist on the right “to speak their version of the truth”, insiders on the other hand stick together. This is a very revealing anecdote – many politicians have enough hubris to readily opt to become insiders. By giving up their version of the truth they are giving up the crown jewels as a price of entry. That step once taken reinforces the existence of the club.
Let’s hope Rachel Reeves can bring some fresh thinking into the review of government spending, and resist becoming a member of the club.
As John Maynard Keynes said, “anything we can actually do, we can afford”.
Notes, sources and further reading
[1] The case against paying interest on BoE reserves
Funding the Future https://www.taxresearch.org.uk/Blog/2024/06/07/the-bank-of-england-should-not-be-paying-interest-on-the-money-the-government-gifted-to-our-commercial-banks/
New Economics Foundation https://neweconomics.org/2023/11/government-could-save-55bn-over-next-five-years-by-limiting-bank-of-englands-interest-payments-to-commercial-banks
Paul Johnson on Any Questions - the discussion is at 30:30 minutes into the programme and he replies to claims made by Richard Rice https://www.bbc.co.uk/programmes/m001zw62
Banks making a windfall from reserve interest payments (House of Commons) https://committees.parliament.uk/committee/158/treasury-committee/news/201204/major-banks-report-135-increase-in-income-from-bank-of-england-reserves/
[2] Treating all income equally
IPPR - all income equally https://www.ippr.org/media-office/slug-1306b49118532fe333771b8f2c1b31d3
CPP detailed examination
https://www.progressive-policy.net/publications/funding-fair-growth-taxing-wealth
[3] Quantitative Easing
The current description on BoE site; https://www.bankofengland.co.uk/monetary-policy/quantitative-easing
This description concentrates on the mechanism of buying bonds, there isn’t a specific mention of the fact that this involves creating money.
An older description but still from the BoE site can be found here; https://web.archive.org/web/20201224045506/https://www.bankofengland.co.uk/monetary-policy/quantitative-easinghttps://web.archive.org/web/20201224045506/https://www.bankofengland.co.uk/monetary-policy/quantitative-easing
Observe; the older description includes the following wording “Money is either physical, like banknotes, or digital, like the money in your bank account. Quantitative easing involves us creating digital money. We then use it to buy things like government debt in the form of bonds. You may also hear it called ‘QE’ or ‘asset purchase’ – these are the same thing” [my emphasis]…”The aim of QE is simple: by creating this ‘new’ money, we aim to boost spending and investment in the economy.” It also notes the rate paid by the bank can be used to bering down interest rates in general.
It should be obvious that government investment could justify using QE. It would be much cheaper than the disastrous use of PFI which not only borrows the money but has a long term tail of interest - both the original spend and the ongoing interest fall on the government (i.e. us) so instead of making g us richer they just pile up liabilities. Perhaps this is no more than a change in emphasis rather than a deliberate attempt to hide the money tree whose existence continues to be denied.
[4] Austerity as a political choice
On the Banking crash
Simple; Whoops!: Why Everyone Owes Everyone and No One Can Pay by John Lanchester, 2010, Penguin, ISBN 9780141045719
Difficult; Crashed: How a Decade of Financial Crises Changed the World by Adam Tooze, 2019, Penguin, ISBN 9780141032214
Ed Miliband: We'll tackle deficit with 'sensible' cuts https://www.bbc.co.uk/news/uk-politics-30417955
Paul Krugman (Distinguished Professor of Economics at the Graduate Center of the City University of New York and Nobel laureate) gives a potted history of austerity here
https://www.theguardian.com/politics/ng-interactive/2024/jun/28/how-the-unforced-error-of-tory-austerity-wrecked-britain?CMP=Share_iOSApp_Other
Yanis Varoufarkis, Adults in the Room, Introduction p7-8, 2017, Bodley Head, ISBN: 978-1847-9244-52
John Maynard Keynes quote and a useful article; Chartbook on Shutdown: Keynes and why we can afford anything we can do, by Adam Tooze
https://adamtooze.substack.com/p/chartbook-on-shutdown-keynes-and