The Bank has been throwing money at the economy, but has it been passed on?
By Kabir Chibber
Business reporter, BBC News
When the Bank of England met in August, it shocked many by increasing the amount of extra money it was pumping into the economy.
The Bank added £50bn into the economy through a process known as quantitative easing (QE) - £25bn more than its original plans to create up to £150bn on the UK's balance sheet by, in effect, printing money.
Some suggested this was a sign that Bank Governor Mervyn King does not think that QE is working yet.
And the central bank has cut interest rates to a record low of 0.5% in an attempt to boost lending in the economy.
At its September meeting, the Bank's Monetary Policy Committee (MPC) decided to stick at that level for the sixth consecutive month.
But should the men that set our interest rates now consider reducing them to below zero?
The British Chambers of Commerce (BCC) suggested on Wednesday that this should be the case.
"One must now question the conventional view that cutting rates below 0.5% will not help," said BCC chief economist David Kern.
There are not negative rates in Sweden, or anywhere
"By cutting rates further and by considering, in limited circumstances, a negative interest rate - along the lines adopted in Sweden - the MPC could discourage hoarding of cash, and encourage lending," he added.
The discussion among economists of negative interest rates comes directly from what happened recently in Sweden.
In July, the Swedish central bank - the Riksbank - surprised many when it set a rate at -0.25% - below zero for the first time.
That was on the deposit rate - the rate on money left by commercial banks at the central bank, which it normally earns positive interest on.
Banks were, in effect, being charged for keeping money at the central bank rather than lending it out to consumers and businesses to boost consumer spending and growth.
Riksbank head Stefan Ingves said it was better for banks to be "active" rather "than just sit on the money".
Extra lending is, of course, the point of QE. Banks in the UK currently have about £136bn in reserves held at the central bank, according to the most recent official figures.
The idea that the UK could adopt that model was further stoked by comments that Mr King made on the Swedish policy decision.
"It's an idea we will certainly be looking at, whether the effectiveness of our asset purchases could be increased by reducing the rate at which we remunerate reserves," King told reporters recently.
He has been worried that banks are hoarding the extra cash that has been given to them, rather than lending it out to the wider economy.
This makes it seem likely that the Bank will adopt a negative interest rate in the near future.
Or does it?
"There are not negative rates in Sweden, or anywhere," said Goldman Sachs economist Ben Broadbent.
He says that while formally the deposit facility has a negative rate, in practice the Swedish central bank uses other methods to take care of banks' excess reserves and the deposit facility is not actively used.
Mr Ingves admitted as much: "It is more symbolic because it's a system which de facto isn't really used," he said. "It shows that this is technically possible to do, but it's in no way a major component in the way we execute monetary policy today."
And the Riksbank has not adopted QE, and so is not pumping money into its economy in the same way.
(And anyway, it was a rate for commercial banks, not consumers. So there was never any chance of them passing it on and people having to pay nothing on their mortgages, for example.)
In fact, Mr Broadbent argues that it is almost impossible to have an actual negative interest rate.
This is because it makes no sense to keep money with the central bank - and be fined for the privilege - when you can just keep your money in cash and pay nothing.
Mr Broadbent said some have suggested that the only way to have a negative rate would be to "to tax physical cash" - by physically removing bank notes from the system, such as taking out £10 notes above a certain serial number.
"The idea that by looking at the reserves at the Bank of England and saying that shows it's not being passed on by banks is nonsense," he said.
It is difficult to know exactly what the Bank is thinking of doing next, or if it is even thinking of changing QE at all.
Mr Broadbent thinks Mr King and the other members of the rate-setting MPC could be discussing introducing a "second" interest rate.
Currently, commercial banks are forced to keep a certain proportion of their funds with the Bank - known as its excess reserves - on which the central bank pays 0.5% interest.
What the bank could be considering is keeping the current deposit rate on a certain percentage of their reserves, and then charging a a zero interest rate on the rest, Mr Broadbent suggested.
"This would improve and increase the power of QE," he said.
That is because it would encourage the individual banks to expand their balance sheet - moving their reserves into something that offers a higher return, such as making new loans.
QE explained in 108 seconds
This is how QE is supposed to work - by encouraging banks to lend on and therefore increase the supply of money in the economy, rather than in the central bank's vaults.
He argues this is better than what the BCC suggests, which is to cut the base rate lower from 0.5%.
"The problem is that this also reduces banks' earnings," Mr Broadbent said, because the banks get less interest on their deposits and on revenues from products linked to the base rate, such as tracker mortgages.
Wait and see
One question would be: why would Mr King want to make any changes to QE now?
Recent data has encouraged the view that an end to the recession is in sight. This week, respected researchers the National Institute of Economic and Social Research said the UK economy grew 0.2% in the three months to August.
And official data recently showed UK manufacturing output rose at its fastest rate in 18 months in July.
"It's very puzzling, because the economy is certainly a lot better than it was before," Mr Broadbent said. "You would have thought it would have been best to do this in March" when QE was first announced.
The Bank would only change the way QE worked if it thought it was not working.
Many think that QE has been a success.
And the Bank has said the results of the exercise will not be known until at least nine months from the start of the plan.
It probably won't be until the next set of minutes of the Bank's meeting, released on 23 September, that we will know more about what Mr King and his colleagues really think about QE - and whether it has been successful or not.
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