How the Bank of England is enforcing austerity

The central bank’s quantitative tightening programme is not much discussed, but is central to the government’s cuts and failure to invest in public services, argues Dominic Alexander

Starmer’s government shows no sign of letting up from its war against the working class. Fresh from U-turning over winter fuel payments, and then from having to do the same over its welfare bill in the face of a humiliating rebellion, the government is now warning of ‘financial consequences’, threatening funding for the school Send programme. The £5 billion that was expected to be saved by the Welfare Bill is pocket change, however, compared to another huge cost to public finances that is barely being discussed. This is the Bank of England’s policy of ‘quantitative tightening’ (QT), which has cost £45bn since 2022, and will cost another £96bn in the next four years at the current pace.

Considering the vast sums involved in this, and the relatively small ones involved in the government’s attacks on welfare, from the two-child benefit limit onwards, there has been very little discussion of this in the media. Surely, if money needs to be found for social needs and public investment, this is a cost that should be making regular headlines, rather than just an occasional comment. It seems however to be largely outside the permitted boundaries of discussion. On Monday, the Guardian listed six options for Reeves to ‘balance the books’, but QT merited only an oblique reference under the option of increasing business taxes. The article commented that banks earn a ‘windfall on reserves held at the Bank of England under its quantitative easing (QE) programme, which is losing the Treasury money.’

It is not, in fact, the quantitative easing programme which is currently costing the money, but the attempt to unravel that policy, which had been a response to the financial crisis of 2008 and then the Covid-19 crisis. Quantitative easing is essentially a way of creating money by means of the central bank buying the government’s own bonds, driving down the state’s cost of borrowing. Currently both the EU and the US Federal Reserve are unwinding QE simply by letting these bonds mature at a natural pace.

The Bank of England is, however, adopting a more aggressive policy by selling the bonds at a rate of £100bn a year. This drives up the cost of government borrowing, since there are more of its bonds in the market. It also means the Bank is losing money because the bonds are being sold at a lower price than it paid for them. The losses are made good by the Treasury. The Bank of England began quantitative tightening in September 2022, and the UK remains the only major economy to pursue QT through actively selling the bonds accrued during QE.

The Financial Times calls this approach ‘uncharted territory’ and comments that it has also been called a ‘leap in the dark for the British economy’. The FT clearly has some qualms about the policy, insisting that it accepts ‘that the BoE’s monetary policy committee must have tackling inflation as their foremost objective’ but that ‘a major central bank actively reselling debt back into the market needs to consider the effects of a potential £130bn loss to the public purse.’ The FT writer goes on to insist on ‘the importance of the BoE’s independence from government’. Yet in light of all this. there are plenty of reasons to doubt whether central-bank independence is working well for most of us.

QT’s malign effects

QT has the effect of keeping interest rates high, since the government has to offer higher rates on the bonds it sells due to the financial markets already being flush with them. According to the New Economics Foundation, if instead, the BoE adopted the European or US policy, it ‘could save £13.5bn a year’. Even slowing it down to the same rate it was in 2022-3 could save £4.4bn a year. Another change to the rules, which would merely align the UK with other central banks’ practices, such as in the Eurozone, would be to stop paying interest on the whole of deposits left by commercial banks, and only pay out above a certain minimum. This would allow the BoE to retain its power over interest rates, while saving billions. It would, however, mean a ‘haircut’ for financial institutions.

The current policy acts against both the prospects of government investment in social institutions and any easing of the cost of living. It is continuously asserted that Reeves’ spending plans already have limited ‘fiscal headroom’, justifying her adherence to austerity economics. However, it is at least in part the QT policy that is lowering that headroom. Its technical justifications are also questionable, since QT can lead to a central bank losing control over short-term interest rates, as happened in the US in September 2019. It is also probable that the 2008 crisis has led to a situation where commercial banks need more liquidity parked in the safe haven of the central bank, but QT acts against this stabilising mechanism.

Given all these issues, the question has to be why the BoE is insisting on such a ruinous course as fast-paced QT. The Euro-zone economic thinktank, Bruegel, thought that the European Central Bank’s attitude towards QT was that ‘justifying it publicly was not really necessary’, and is at least equivocal about whether even passive QT is a good policy for the Eurozone. This implies that austerity-driven fiscal orthodoxy is the real background for the decision.

The economist Richard Murphy suspects that the goal is precisely to keep interest rates high, and as he points out, the financial markets are profiting from this situation. Insofar as QT is being justified, it seems to be on the basis of helping to fight inflation by keeping interest rates high, and preparing central banks for another round of QE, should that become needed. In other words, the haste to unwind the last rounds of QE has something to do with fears that another financial crisis is just around the corner, so that central banks need to be prepared to dole out money into the system again on a lavish scale. Remember that the benefits of QE after the 2008 crash accrued overwhelmingly to already wealthy and powerful actors in the financial sector.

Government economic policy has been built around coddling and flattering the financial markets, apparently out of fear that the slightest move away from austerity will cause a panic on the scale which brought down Liz Truss’s premiership. Hence, Starmer’s course has been to roll out a sadistic litany of policies attacking the most vulnerable groups in society, starving public services, preparing further privatisation of the NHS, and directing any investment that is available to speculative high-technology projects of very dubious merit.

A bulwark for austerity

Even so, the Bank’s QT policy goes beyond simply being a mechanism for keeping interest rates high. It is, again in Richard Murphy’s words, creating ‘a deliberately hostile market for real government investment’. It appears as if austerity is being seen by the financial policy elite as not merely an unfortunate temporary necessity but a desirable permanent state for the economy. Certainly, it helps to maintain an economic regime which funnels money to the very richest in society, and towards the major financial institutions.

Nonetheless, the austerity agenda ran into political difficulties in recent years, with opposition to its crippling effects creating bitter opposition and successive Tory governments therefore descending into dysfunction and desperation. There is only so much wealth that can be forcibly extracted from a declining economy without its political system spiralling into dysfunction also.

The leadership having signalled as thoroughly as it could that it would abide by strict neoliberal doctrine, the Labour Party’s electoral victory was acceptable to capital in general. Nonetheless, Labour was inescapably elected under the overt slogan of ‘change’ and with considerable, if dampened, expectations that something would change in the governance of the country. Quantitative tightening, and especially its acceleration, is acting as a further straitjacket,  keeping the government confined within the neoliberal constraints that neither Starmer nor Reeves in any case has any inclination to challenge.

Austerity is indeed a choice, but it’s not one made directly by the government, but rather by the state, in which the Bank of England is a powerful institution. The institutions of the state are united in following the wishes of big capital expressed through the financial markets and the commercial banks. As the management of the major media institutions is very much a part of the state, this helps to explain why there is more than a whiff of ‘not before the children’ in the near absence of the issue from public economic discussions.

If we are to reverse this age of austerity, the task is not simply to force change on the Labour Party leadership, or more ambitiously, to replace it with a more left-wing party, but to confront the state itself and the power of capital. The independence of the Bank of England has to be ended, but that, of course, goes against the whole foundation of neoliberal economic policy since 1997. The independence of the central bank was a major means of abolishing democratic control over economic policy, and increasingly, democratic debate over economics altogether. Democratic rights need to be defended against the authoritarian drive of Starmer’s government, but even more, we need to fight for democracy in the economic sphere too.