Letter from Sir Mervyn King, Governor
of the Bank of England, to the Chairman of the Committee |
In your letter of 2 November, following our appearance
before the Committee on 25 October, you asked for clarification
on a number of points relating to the Asset Purchase Facility
(APF). In addition you reminded us that we promised to send you
a note on commercial bills. This letter responds to those two
1. At the hearing Andrea Leadsom asked about
the potential for market movements in the price of gilts to result
in losses for the APF. In my response I explained that any profit
or loss arising from movements in the market price of gilts held
by the APF would be offset by a loss or profit for the Government
as issuer of the gilts. You asked for clarification of the mechanism
by which the APF's profit or loss is offset elsewhere in the Government's
accounts, given that the Government's liabilities are fixed at
the point of issuing the securities. As I go on to explain, it
is the different accounting treatment of the APF and Government
accounts that reconciles these viewpoints.
The simple economic logic is that the gilts held
in the APF are both an asset and a liability of the public sector.
So, taking the public sector as a whole, fluctuations in the market
price of the gilts held in the APF have no net impact on the public
In practice, however, the gilts in the APF and on
the Government's balance sheet are subject to different
accounting conventions. The APF's assets are "marked to market"
so that fluctuations in the market price of gilts affect the APF's
accounts, while the Government's liabilities are not. But the
use of different accounting conventions does not alter the underlying
economic logic. Although you correctly observe that the face value
of the Government's liabilities are fixed when the securities
are issued, it is the present value of the resources needed to
service those liabilities that matters economically, and that
A simple thought experiment makes these arguments
clear. Suppose the market price of the gilts in the APF were to
fall because of a rise in the prevailing risk-free interest rate,
so that the APF incurred a loss on its gilt holdings. Those same
gilts are liabilities of the Government, and are accounted for
at face value in the Government's accounts. The Government could,
however, choose to issue new gilts with a lower face value (matching
the market value of the gilts held by the APF), and use the revenue
raised to repurchase the gilts in the APF, and then retire them.
That would reduce the overall face value of its outstanding liabilities,
allowing the Government to book a gain matching the APF's losses
on its gilt holdings.
In economic terms nothing would be gained (or lost)
from this reshuffling of liabilities, since the present value
of the Government's liabilities is unaffected by the exercise.
Yet the face value of its liabilities would be lower afterwards.
The outcome in an accounting sense would be the same as if it
had marked its liabilities to market. The important point of economic
substance is that such a fall in the market value of the gilts
in the APF is matched by a fall in the current resources required
to service the Government's future liabilities. Those two effects
offset, and that is the sense in which the public sector can be
unaffected by movements in the market value of gilts in the APF.
More generally, I am strongly of the view that the
APF accounts do not provide a meaningful guide to the overall
impact of asset purchases on the public finances. Monetary
policy, however it is implemented, affects the market value of
existing debt, whether on the balance sheet of the private sector,
the central bank or the remainder of the public sector. It also
has implications for the cost of issuing new debt. And it affects
macro-economic conditions, including the level of output and inflation,
and thereby both taxation and spending.
Any overall assessment of the impact of the MPC's
asset purchases on the public finances would therefore have to
take into account the improvement in the Government's financing
costs, as well as the higher fiscal revenues and lower expenditures
arising from the boost given to economic activity by asset purchases.
In short, such an exercise would have to compare what actually
happened to a hypothetical set of circumstances in which an alternative
policy was followed. That is not what the APF accounts are designed
to capture. Charles Bean's speech on 13 October 2009 provides
further explanation of this issue.
I continue to believe, however, that this type of
financial assessment is not the appropriate basis on which to
judge the success of monetary policy. We do not usually seek to
isolate or evaluate the effect of monetary policy in these terms,
by calculating the counterfactual profit or loss to the public
finances. The judgement about the success or failure of asset
purchases rests instead on their contribution to achieving the
overall aims of monetary policy - exactly the same criterion on
which we evaluate interest rate decisions.
2. You ask also for further information about
why the Bank stopped purchasing high-quality commercial bills
- also sometimes known as "bankers" acceptances' - as
part of our sterling monetary framework.
A useful discussion of the background is given in
a short box published in the Bank's Winter 2005 Quarterly Bulletin
at the time when these bills were made ineligible for the Bank's
open market operations. In summary, the Bank ceased to accept
commercial bills from 17 August 2005, largely because the size
of the market had fallen to around only £1 billion. It had
been evident for some time before then that the market for commercial
bills continued to exist only because of the eligibility of such
bills in the Bank's own operations. As the box explains, official
operations in such a small market were at times problematic; partly
for that reason, the Bank encouraged the development of a gilt
repo market, which it began using in its own operations from Spring
1997. As gilt repo developed into a much larger, more homogeneous
and hence more liquid market than that for commercial bills -
the market for commercial bills contracted further, to the point
where the Bank judged that eligibility should be removed.
In early 2009, the Bank considered potential ways
of improving the availability of working capital finance for those
firms which did not have access to modern corporate bond or commercial
paper markets. This work, which included discussions with commercial
bank treasurers and others, concluded that there was little evidence
to suggest that renewed acceptance of commercial bills in the
Bank's operations would successfully catalyse private markets.
One reason for this was that banks said they would be less willing
to trade bills in a secondary market than they had been in the
1980s and 1990s. That in turn reflected three main factors. First,
such bills are individually small in size. Second, bills accepted
by another bank count against counterparty exposure limits, which
have been tightened since the financial crisis. And, third, commercial
bills count as unsecured lending and attract the same capital
charge, so any market making activity in bills might reduce capacity
to lend directly to businesses.
In summary, it is clear that the market for commercial
bills came to a natural end. In view of the factors underpinning
that demise, I judge it unlikely that a significant private sector
market for this particular form of asset will re-emerge in the
future. As I said at the hearing, it would be inappropriate, indeed
almost certainly futile, for the Bank to try to revive a market
for which there appears no latent demand. Hitherto, other official
sector efforts to support the provision of credit to SMEs through
the issuance of tradable securities have also proved difficult.
For example the Bank's Secured Commercial Paper Facility (SCPF),
launched in July 2009, enables suppliers, which include many small
and medium-sized companies, to have their invoices paid early
(at a discount) rather than waiting for payment from their investment-grade
corporate customers under their normal payment terms. The funding
is provided by a commercial bank in return for the supplier's
invoice. The commercial bank can then choose to retain these trade
receivables or sell an interest in them to other investors, such
as via the SCP programme. The scheme has, however, received limited
take-up to date.
For these reasons, I have continued to advocate policies
that would, instead, create incentives for banks to lend to SMEs
through their existing infrastructure. I expect the Chancellor
will have more to say on this in his Autumn Statement on 29 November.
24 November 2011
1 The speech is available on the Bank's website at