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Financial Markets and Monetary Policy

Volume 735: debated on Wednesday 5 July 2023

Motion made, and Question proposed, That this House do now adjourn.—(Scott Mann.)

It is a pleasure to be here and to see the Treasury Minister on the Front Bench for the debate. I appreciate that many of these matters are dealt with by the Bank of England, but that is part of the reason why I will raise a number of points.

I voted against quite a lot of lockdown, with one of the strong reasons being that if 7 to 9 million people were sitting at home and, at the same time, the Bank of England was printing substantial sums of money, there might well be consequences. We can see in inflation, the strikes and a number of other things the pernicious effect of money printing and inflation in the British economy.

During lockdown, the Government took on a substantial amount of debt. Many people who were sitting at home were paid reduced salaries, but they could not spend the money, so they built up substantial savings. There are debates among economists about the amount of those savings. Some think it is 4% of GDP; others 8%. The Office for Budget Responsibility puts the figure at around £228 billion. That has been powering the economy over the past several months. The OBR initially predicted that we would have a recession, but the economy has shrugged that off. It is highly likely that this year we will not have a reversal. We may have a cost of living crisis in pay and inflation, but there is still a substantial amount of money flowing through the British economy.

The amount of money printed and the fact that people were not producing anything have created a problem. As we saw from headlines last week, one of the reasons that inflation is sticky is that money is still flowing through the economy. Headlines last week reported that package holidays were more expensive because they were not being discounted. Second-hand cars are going for quite a high rate. Although hospitality has had problems with high energy bills, it is difficult in many areas to book a restaurant or a hotel. The discounting that we would normally see at certain times of year is not happening, which is why inflation has not fallen as much as we expected. Nevertheless, supermarkets suggested today that food prices are starting to fall, and energy prices are falling. I think it highly likely that inflation will fall, although it will be a little delayed.

There is a lot of money swishing around in the British economy. The Bank has been pushed into raising interest rates. The thing about interest rates is that, unlike 20 years ago when most people had variable rates, a lot of people are now on fixed-rate mortgages, especially those with larger mortgages. Therefore, there will be a lag, as there always is when interest rates are put up, but this time it will be substantial. My concern is that most of the impact of raising interest rates on the economy has not yet been felt. Every now and again, the Bank will feel pressured to keep raising rates, particularly at a time when financial markets test the Bank and we have a 24-hour news cycle. That will be a problem for the British economy because raising rates will not make much difference to the next financial year, but will have a big effect in 2025.

A number of people have expressed concern that we may have overkill in raising rates. Andrew Haldane, the Bank of England’s chief economist a while back—a very good economist with a good finger on the pulse of the British economy—is worried that the Bank will overdo it. David Smith wrote a good article in The Times today, in which he said “a little patience” needs to be shown. We will have a testing time over the next 12 to 18 months, because raising rates will not show up much in reduced spending in the shops, and there will be various pressures on the Bank to act.

What we actually need is masterful inactivity and a lack of action, to let things continue. We will have a fall in inflation. We will probably go to real interest rates, which we do not have at the moment. The Bank needs to keep calm, have patience and allow inflation to fall, and that will do the job that needs to be done, but it will take a particular while. There is pressure in the markets. Today, two-year gilts were sold at 5.668%, which is the highest for 20 years. The markets will keep on testing the Bank.

That is my first concern. I know that the Chancellor of the Exchequer rightly has regular meetings with the Governor of the Bank, although I am not sure they have cocoa or a glass of claret. The message from the Treasury and from Parliament has been, “Be patient. Do not get yourself pushed into raising rates and causing a major reversal in 18 months or two years’ time.” In the short term, there will be an effect on the economy in terms of housebuilding and the construction industry, but I suspect it will not have much of an impact on budgets until that time passes.

I commend the hon. Gentleman for raising this complex matter. He is outlining the issues for the banks and talking about ensuring patience and balance. My constituents tell me that they are worried about mortgage increases, as I am sure are his constituents and everyone here tonight. They worry about all the things he refers to, as well as increasing prices. What would he say to those worried constituents who might not have such patience and do not know whether they will have possession of their house in a year’s time?

Interest rates are a very blunt instrument and I am sure many people are worried. I hope that if inflation picks up trajectory and goes down, we will start to see interest rates top off and that some with fixed mortgages—many have quite long fixed mortgages—will feel much more relaxed. To pay tribute to the Chancellor, he has, with the lenders and in a very competent way, produced a very good package of forbearance for those who may have problems with mortgages. The Government have, in many respects, set a very stable environment for the economy, but there are worries. My principal worry about the Bank, independent as it is, is that it may overdo interest rate rises.

My second point concerns quantitative easing and quantitative tightening. Clearly, we did more QE than was probably needed, but we are where we are and it needs to be reversed. If you are going to try to eat an elephant, you have to do it one bite at a time. It will take us 20 to 25 years to reduce the stock of bonds that the Bank of England holds, and what I do not understand is why the Government are not having a more active discussion with the Bank about when it will sell the bonds. We have a situation where the Bank has put up interest rates, that leads to a fall in bonds and at the same time the Bank sells bonds, creating a loss that it passes on to the Treasury. Whereas if it waits three or four months, inflation is likely to fall and some pressure may come off bonds, and that may mean that it is able to sell bonds for a slightly higher amount.

Now, whether there is a sort of hair-shirted virility symbol in doing that, I think selling bonds into a market where you will lose more than you would otherwise do is not really very good husbandry. Ultimately, although the Bank holds the debt, as the Government are the underwriter of the debt, it is a little bit like saying to your estate agent, “Go and sell the house, I don’t care what the price is.” The Government should have a view so that when we discuss things with the Bank, we ought to try to do our best to minimise the losses on quantitative easing as we reverse the process. Some projections say that over the next 20 years the loss could be £100 billion. Well, if we are very careful in how we get rid of the bonds and it is a £90 billion loss, then that is a win.

Mrs Thatcher always had a problem that when she was trying to control broad money there were no instruments apart from higher interest rates, but if we have this stock of bonds over the next 20 years, it might well be that it could form a part of policy that we either speed up or slow down to reduce broad money. It might be something that can be used in policy terms. My view is that the Debt Management Office—which has an interest because it has to sell Government debt, and the Bank of England selling it at the same time does not help—the Governor of the Bank of England and the Chancellor really ought to sit down a couple of times a year and agree a joint letter that sets out the parameters for how they will unscramble quantitative easing with a quantitative tightening programme, which I think the markets would understand. I do not think anybody would think we were infringing on the independence of the Bank of England if we were actually trying to ensure that the taxpayer gets best value.

On almost anything, any budget or taxation, the Treasury is very careful in approving things. This could be a big budget item each year for the next several years, so I do not know why we are taking a relatively benign attitude of saying to the Bank, “Just sell it and we’ll pay the bills.” I should say that I was a Lord Commissioner for a while and I signed some of the documents that indemnified the Bank. [Interruption.] There is probably another Lord Commissioner laughing, but we ought to pay quite careful attention to how we unscramble this. Those who read the column by my right hon. Friend the Member for Wokingham (John Redwood) will know that he has raised this matter a number of times. It is worth raising, because we are at the early point of unscrambling quantitative easing, and slightly more interaction between the Government and the Bank of England is necessary.

My final point is about money supply. During the pandemic, we were printing money at 20%. Then the money supply dropped a little, to about 15%, and now it has dropped very substantially. M2 is nearly into negative territory, and according to the last Bank of England estimate, M3X and M4X are growing by between 1% and 2%. Too much money in the economy is a bad thing because it creates inflation, but too little money in the economy is a bad thing because it can cause a credit crunch. In his book on the Wall Street crash, John Kenneth Galbraith pointed out that the principal reason for the major worldwide depression was the fact that money in the United States economy declined by a third. That is what pushed the economy over the edge, because the banking system essentially collapsed.

We have gone from an over-exuberant money supply situation to one in which money supply is barely growing. This is not unique to Britain; it is a feature in the eurozone and in the United States, and we know that the eurozone will have further problems. Those countries still have differentials in productivity and trade imbalances, and there is money swishing through their system as well. There was even some discussion about the Bundesbank having to be bailed out because of bonds it has bought—and, unlike the Bank of England, it cannot print money because it does not have a currency.

There is a worldwide problem. Money supply is falling in the United States, in Europe and in the United Kingdom. If we assume the normal 18 months to two years, that takes us into 2025. My principal point is that if we raise interest rates, which has an impact after a long lag that will hit at the end of 2024 and the beginning of 2025, and if we have a reduction in monetary growth and credit which has an impact at the end of 2024 and the beginning of 2025, there will be two interactions that could cause growth to hit a brick wall.

The economy has changed substantially over the years. We now have internet banking, money flows very freely, and we have digital currencies. I think we ought to be looking much more carefully at what is going on in the British economy, and, indeed, at how money supply affects real output. However, I think we also need a monetary policy; I do not think we should withdraw completely and allow the Bank of England to determine these matters, and that may require us to look at levers to ensure that credit and monetary growth go up.

What I really want to do this evening is to put it on the record for those at the Treasury that if they read Twitter, they will find that many monetarist economists are beginning to think that the decline in money will cause severe economic dislocation. The rule of thumb is that there should be a smooth transition of money, not sharp falls or sharp rises, and I fear that we are not getting a smooth transition of money. As I have said, that is a feature of all the various zones, and it is something that the Government need to pay attention to and not ignore.

The Government do not mention money supply very much. The Bank of England has started to talk about it again, but I suspect that we have to learn what Mrs Thatcher would have told us some years ago: that money is very important, and it is a very important part of economic policy. We cannot totally vacate it and leave it to central bankers. One reason I always opposed the euro was that I did not think the problems of the world could be solved by unelected central bankers, and I think some of that goes for our own unelected central bankers.

The next time the Minister sees the Chancellor, I hope he will ask him to read the report of this debate and reflect on the fact that there is a problem with money supply. We may be going into a new era, although I do not know whether the supply will continue to be negative or whether it will pick up, and the Chancellor needs to have discussions with other actors in this area. If we are not careful, the combination of the lag on interest rates and the current credit squeeze could give an incoming Conservative Government a real nightmare in due course, in terms of the way in which they manage the economy. So let us give these matters a little thought.

I look forward to the Minister’s reply. Probably, in accordance with the normal Treasury line at the moment, he will reply by not saying very much, but I am sure he has listened.

I congratulate my hon. Friend the Member for Poole (Sir Robert Syms) on securing this debate. Notwithstanding the fact that he may have accurately predicted my reticence in some areas, this is an important matter. It was the House that originally decided on the current monetary arrangements, and it is a matter for the House to continue to scrutinise how they are conducted. I also thank the hon. Member for Strangford (Jim Shannon) for his contribution.

As my hon. Friend the Member for Poole knows, the Monetary Policy Committee has operational independence. That covers all monetary policy, including both the Bank rate and the relatively novel feature of quantitative tightening, which we have seen for the first time in recent months. It is not entirely an independent actor; the Chancellor annually writes to the Governor and the Monetary Policy Committee with a remit letter, which has remained unchanged in its most substantive term, which is the inflation target of 2%. I think everyone in the House understands the clear position of the Government, the Chancellor and the Prime Minister on the desirability of bearing down on inflation to try to remove what is a hidden tax on everybody in society and get us as quickly as possible to the point where not just inflation is falling, but interest rates are falling on the back of that.

My hon. Friend knows that financial markets are determined by a wide range of factors. It is of note that many of those factors are international: across most western economies, we are seeing some combination of them. He talked about the gilt market, which I reassure him remains deep and liquid. It has traded throughout the past 12 months; it has a good track record and is one of the deepest markets in the world. Underlying demand for the UK’s debt remains strong, and we have a well-diversified investor base.

The Debt Management Office co-ordinates closely with the Bank on the new phenomenon of quantitative tightening, whereby the Bank itself is selling gilts. Clearly it is not desirable for anybody that both the Bank and the Government are in the market at the same time. There is a high degree of operational co-ordination between the Bank of England and the Debt Management Office. In the Treasury, we pay close attention to the operation of markets and—as we did in the autumn of last year and in the case of Silicon Valley Bank UK Ltd —will take whatever action is necessary.

I want to state the Government’s position very clearly for my hon. Friend and for the House. I listened very carefully to his points and comments about each of the money supply measures that are published, and I will take them back to Treasury colleagues and the Chancellor. I spent some time yesterday with the House of Lords Economic Affairs Committee, and I conceded to it that my view is that money does matter. We should not be indifferent: it is a factor. The level of money supply, which my hon. Friend raised, is a feature.

We have been through an unprecedented period. None of us forecasted the global covid pandemic and none of us foresaw Russia’s illegal invasion of Ukraine. Nevertheless, my hon. Friend raises an important point that I will take back to colleagues. I am reassured that he is paying close attention to it, as I know are other colleagues in the House.

My hon. Friend will also know that the MPC, in deciding to pursue quantitative tightening, has set out its ambitions for the 12 months ahead, so there is a clear road map. It voted in September 2022 to reduce the stock of asset purchases by £80 billion over the following 12 months through redemptions and active sales, and that is coming through. Just as the Treasury receives the benefit, it is also picking up some of the cost of those sales as the transaction concludes.

The Government will ensure that in fiscal policy—that for which we are responsible—we continue to make tough choices to bear down on inflation, and that it is aligned with monetary policy. My hon. Friend was kind enough to acknowledge the level of interaction and dialogue that happens at multiple levels between the Bank and the Treasury. Each has its respective role, but he can be reassured that policy is co-ordinated.

On that note, I thank my hon. Friend again for his thoughtful contribution this evening. I also thank the hon. Member for Strangford for joining this important debate. I suspect it will not be the last time this House debates the matter and, given the magnitude and significance of the impact of monetary policy, that is probably appropriate, but it is for the House to decide. I look forward to continuing to engage with my hon. Friend and other hon. Members on this and other important issues relating to financial policy.

Question put and agreed to.

House adjourned.