Joakim Book

Freelance writer and globetrotter with an unhealthy addiction to financial history and all things money. #future #optimism #monpol #climate

Jun 3, 2019
Published on: Adam Smith Institute
2 min read

A topic that occasionally creeps up in the political discussion of central banks is the will to use monetary policy for special interests. A prime example would be the hydra whose latest head is making the rounds on both sides of the Atlantic: MMT, “Modern Monetary Theory”. This old idea, repackaged in a new shape, states that: governments issuing their own currencies cannot go bankrupt – and so worrying about the deficit or government spending is unnecessary. Unleash the spending!

Naturally, a false conclusion mistakenly interpreted from the (true) statement that British government debt is denominated in a currency it controls and issues, is being taken as reason enough to expand government spending to all kinds of utopian schemes – from Green New Deals or Investment Banks, to job guarantees and free healthcare for all. “Old wine in new bottles” says Professor Anthony Mueller, the author of the Adam Smith Institute’s recent report The Magic Money Tree: The Case Against Modern Monetary Theory.

MMT’s proponents, clearly, wish to use the monetary power vested in the Bank of England for certain politically perverse projects, the kinds of spending schemes only politicians with next-to-limitless funding may conjure up. The economic tradition of MMT is hardly novel (it reaches back at least a century, as Professor Mueller shows), but neither is the attempt to hijack monetary policy into service for some particular end. A concrete example is Janet Yellen, the former chair of the Federal Reserve, who a few years ago, drew heavy criticism from various left-wing organisations after she had sensibly pointed out that a central bank really isn't equipped to address racial differences in employment outcomes.

Rethinking Economics, the British not-for-profit that promotes critical discussions and a “better economics” education, recently jumped on the bandwagon initiated by an even more radical organisation: Positive Money. The latter’s agenda has always been more narrowly focused on advocating for “a fair, democratic and sustainable economy” – predominantly through the use of monetary reform along MMT lines. In the surge of Bank of England’s Quantitative Easing policy after the financial crisis, the organisation called for “People’s QE” – fully endorsed and embraced by Jeremy Corbyn and his followers.

Unsurprisingly, in light of recent month’s climate protests, “Extinction Rebellions“ and other outbursts of quasi-religious nature, Positive Money’s newest approach shouldn’t come as a surprise. By petitioning Mark Carney, the Bank of England’s governor, to “Unleash Green Investment”, the appeal looks a lot like the MMT-inspired American Green New Deal – just without the irksome political process. Instead of going through established democratic channels – most of which are too busy ‘Brexiting’ anyway – the idea is to appeal directly to the Bank’s governor and the MPC, the body responsible for monetary policy. They write:

“A change to the mandate – which is set by the government – could unlock the Bank’s powerful monetary policy operations to channel billions into green investment. And it could empower the Bank to introduce tougher regulation to shift UK bank lending away from fossil fuel companies and towards a low-carbon economy.”

The problem with the Bank’s monetary policies, advocates from Positive Money argue, is not its huge credit footprint (it now owns almost a quarter of outstanding British government debt) or the risks that their unconventional monetary policies may create in financial markets. Instead, its various QE facilities have been “providing an implicit subsidy to fossil fuel companies”.

Yes, you read that correctly.

And since we’re all dead in a decade or so unless we “avert the devastating impacts of climate change, central banks can, and must, go further.” The Bank’s power to create money ought not - the argument goes, to be reserved for its traditional macroeconomic tasks on account of pesky financial stability reasons, but rather to turbocharge the green transition by – I suppose – directly funding all kinds of Green New Deal-style of initiatives. And “actively penalise high-carbon lending” as well as use its regulatory powers to “compel others to do the same.” The activists’ MMT-inspired message is clear: use monetary policy for our favoured ends. Never mind that the tools available to the Bank of England are much-too-blunt for fine-tuning technological changes like that.

While I much enjoy this trend of piling onto monetary authorities all kinds of issues they are absurdly unequipped to address, I was curious about the factual background to this point. So let’s dive into it, head-first.

How could the Bank of England’s QE policies, aimed at reducing long-term interest rates and triggering portfolio reallocations, have been a “subsidy to fossil fuel companies”? Could some of their alphabet soup of new liquidity frameworks have (accidentally?) supported the fossil fuel industry?

One option is to consider the £450bn or so of government bonds that the Bank bought in order to push down the long end of the term structure of interest rates, primarily by buying up outstanding government debt (which, at the end of 2018 stood at £1,837 billion, equivalent to 90% of GDP – though the OECD says 113%). Certainly, if fossil fuel companies held some of their liquid assets in government bonds, they could definitely have pocketed some capital gains when the prices of those bonds rose – given, of course, that they sold them before maturity. More directly, had they been on the other side of those Bank of England purchases, they could have received cash directly from the Bank.

Now, there are quite a few reasons to doubt this conclusion. First, the Bank’s QE operated on the open market and so neither the Bank nor the fossil fuel companies would have known who they were trading with (this is standard practice).

Secondly, it’s doubtful that fossil fuel companies would hold any government securities at all. Since Positive Money specifically names Shell and BP as beneficiaries to the Bank’s programs, let’s use Shell plc as an example. Surveying its £307bn balance sheet, at most no more than £15 billion (<5%) could even feasibly have included government bonds (“Money market funds, reverse repos and other cash equivalents” is the relevant post). That accounting post could just as well include other cash-like instruments in many other currencies than British pounds.

Thirdly, if fossil fuel companies held government debt, they did so for liquidity reasons, and so any sale would simply have put cash in their accounts, which they could just as easily have to buy other cash-like instruments in the market. Indeed, they probably wanted to: short-term liquid assets are held by non-financial firms to match inflows and outflows of funds, meaning that Shell likely just replenished such a sale with other short-term liquid assets – whose market price also rose after QE, eliminating most of Shell’s imagined benefit.

Thus, even in the unlikely event that fossil fuel companies did hold the kind of bonds that the Bank was purchasing during QE, there’s little reason to believe that this amounted to an industry subsidy of any kind.

Another option is the rather obscure Corporate Bond Purchase Scheme (CBPS) launched in 2016, intended to push down corporate borrowing costs directly. The background was the Brexit vote, and a fear that the general uncertainty concerning Britain and pound-denominated assets would increase lending costs to all British firms, thus having harmful macroeconomic effects. Indeed, the Scheme was limited to £10bn and rolled-over bonds are still on the Bank of England’s balance sheet (accounted for at £12.5bn, probably just changes in market prices). Moreover, CBPS was subject to a strict sector division so as not to favour particular companies and the list for eligible securities is fairly small – mostly containing consumer brands and property companies.

Except for the energy company Scottish and Southern Energy (whose generation mix is about half natural gas/coal, half renewables anyway), one has to be quite imaginative to conclude that CBPS amounts to a subsidy of fossil fuel companies – perhaps the emissions from buses run by First Group ought to be considered?

Research into CBPS seems to suggest that the program reduced the Brexit-induced “excess bond premium” and improved the overall liquidity of corporate Sterling bonds, ultimately causing borrowing costs to be lower than they otherwise would have been. While the Bank’s own assessment show that prices of eligible and ineligible bonds developed identically over the 18-months following the CBPS, it did record a 4 basis points reduction in corporate bonds spreads generally. In other words, this would be a benefit to all debt-issuing companies – of which SSE, for instance, could benefit.

For the sake of it, let’s estimate the monetary gain SSE might have gotten from this 4-basis point reduction in its spread. The only SSE security on the eligibility list is a 23-year, £300m bond, issued in 1999 with a coupon of 5.875%. Indeed, that inopportune moment of issue explains why it is among the company’s most expensive financing; average interest rate for their 8.6bn loan stock is more like 2.5%, resulting in an annual interest bill of £215m. If we were to assume that the 4 basis point reduction is permanent, proportionate and applicable for all the company’s borrowing (a gross exaggeration), the increased liquidity of the Sterling corporate bond market would reduce the company’s lending costs by around three million quid. For a company that makes consistently around a billion a year, that’s quite literally peanuts – not to mention that it’s completely overshadowed by other macro events.

Did the Bank’s liquidity measures somehow benefit some fossil fuel companies, as Positive Money asserts? Since the purpose of the Banks’s unconventional monetary policy was to reduce interest rates across the board, it likely made borrowing costs lower for all companies – including fossil fuel companies. But that hardly amounts to a public subsidy of that industry.