The UK Treasury’s decision to transfer coupon income from the Bank of England’s Asset Purchase Facility is a step towards ‘fiscal dominance’, where the fiscal authority ultimately gains the upper hand from the central bank and we see monetisation of public sector debts and deficits. The step allows the government to pull down the debt to GDP ratio materially over the next 4 years relative to the number predicted by the IMF. It also has the same effect, ultimately, as the BoE using the coupon income to buy more gilts in the open market. This it probably would have done anyway, but if it had not then the Treasury’s actions would constitute the sovereign forcing the BoE to ease policy.
Large and persistent budget deficits, it has been well documented, are associated with episodes of high, and sometimes hyper, inflation. The UK Treasury’s decision, and recent, more overt interference in the BoJ from the MoF in Japan, marks a significant change in the slowly evolving relationship between the central banks of developed market economies and their governments.
The recent announcement of Mark Carney as Mervyn King’s replacement as Governor of the Bank of England was a surprise development. It will also be interesting to see if more frictions emerge between the Bank and the Treasury as Mark Carney is a putative hawk in relation to Mervyn King. However, running a low leverage, relatively stable-growth economy like Canada over the past few years will be a whole different kettle of fish to the steering of a maligned and stagnant UK economy. Fiscal dominance will likely encounter little resistance.