Recommendation 21

HM Government Acknowledged

Price stability is essential for a strong economy, and by extension strong public finances. It is widely recognised that an operationally independent central bank is the best way to achieve price stability. This is why the UK’s macroeconomic framework enshrines the Bank of England’s operational independence for monetary policy in law, with price stability as the primary objective of the Monetary Policy Committee (MPC), as set by the government. The monetary policy decisions of an independent central bank will always have fiscal implications, through their impact on the economy and inflation. However, to retain the effectiveness of monetary policy, it is important for the fiscal authority not to undermine, or be perceived to undermine, the independence of the central bank. The Treasury adheres to this principle by, among other things, declining to comment on the conduct or effectiveness of monetary policy. The Memorandum of Understanding (MoU) established in 2018 on the financial relationship between the Treasury and the Bank reinforces its independence and resilience by providing a clear capital and income framework for the Bank as well as principles for operations that should be indemnified by the Treasury. This allows the Bank to retain its focus on its objectives and provides clarity, predictability, and accountability on the appointment and management of the associated financial risks. Unconventional monetary policies, including quantitative easing (QE) and quantitative tightening (QT), have direct fiscal consequences, including through cashflows arising from the indemnity of the Asset Purchase Facility (APF). The presumption is that the financial risks of unconventional monetary policy operations will be borne by the Treasury where exposures exceed the Bank’s capital, with assessments for the financial backing done on a case by case basis as set out in the MoU. Notwithstanding these risks, the Treasury’s underlying principle remains the same: independent monetary policy is essential for macroeconomic credibility, and therefore beneficial for the economy and public finances. Decisions on the target stock of assets held for monetary policy purposes in the Bank’s Asset Purchase Facility (APF) are taken independently by the MPC. These decisions are taken solely to meet the 2% inflation target. The APF is indemnified by HM Treasury to ensure that the MPC can take its decisions in this way, in line with its statutory price stability objective and the remit given to it by the Government. ... The direction and magnitude of cashflows between HM Treasury and the APF is discussed at length in your report. In the past, there have been large cashflows from the APF to HM Treasury. In more recent times, the direction of those flows has reversed. This was expected at the time the arrangements governing the indemnity were put in place. The Bank has been fully transparent about APF cashflows and presents a set of cashflow projections in the APF Quarterly Reports. Future APF cashflows are highly uncertain, however, and are sensitive to several factors. It is also important to note that the fiscal implications of QE and QT are not simply captured by cashflows between the APF and HMT, but also through the wider impact of the policy on financial conditions and the economy. The OBR, for example, noted in November that its assessment of lifetime cashflows associated with QE and QT did not amount to an assessment of the overall fiscal, let alone economic, impacts of QE, which reduced borrowing costs, lowered unemployment, supported the economy and helped stem disinflationary pressures at various points over the past 15 years.