The Monetary Policy Toolbox in the UK
Speech given by
Dave Ramsden, Deputy Governor for Markets & Banking
Society of Professional Economists
21 October 2020
With thanks to Renée Horrell and Tom Smith for their assistance in preparing these remarks and to
staff across Markets and BPI and elsewhere in the Bank for their many contributions, as well as to my
colleagues on the MPC for their helpful comments and suggestions.
1
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1. Introduction
It's a pleasure to be speaking once again at the Society of Professional Economists' Annual Conference.
When I last addressed this conference it was two years ago, in person, in the impressive surroundings of the
Bloomberg building near to the Bank of England. Today we're meeting in rather different circumstances, and
for many of us at least in slightly less impressive surroundings! I'm delighted that we are able to meet
virtually, and I'd like to thank Kevin Daly and all the SPE team for their work to make this event possible.
The theme of today's conference is "Policy Challenges for the Global Economy". What I want to do as my
contribution to that theme is to give you my perspective, in my role as Deputy Governor for Markets, Banking
and Resolution at the Bank of England and member of the UK's Monetary Policy Committee (the MPC), on
one part of our response to the particular policy challenges of the Covid pandemic. And I will frame my
contribution in terms of the use the MPC has made of what has come to be known as the "monetary policy
toolbox": the range of policy tools that MPC has used so far, what tools are available to us now, and which
ones we might decide to use in the near future.
The idea of a range of monetary policy tools is itself quite a new one. For many years monetary policy
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makers used one tool, the policy rate, to achieve their goal in the UK case, that meant Bank Rate. And the
Bank used a small, focused set of central balance sheet operations to keep money market rates, and so
rates in the wider economy, close to that policy rate.
Two developments changed all that: first, the secular decline, over several decades, in the trend real interest
1
rate; and second, the global financial crisis and the great recession that followed it.
The trend real rate - big R*, in central bankers' jargon - has fallen over the past few decades across
taken from the August 2018 Inflation Report, sets out the MPC's view of
advanced economies. Figure 1,
what explains that fall. Much of it can be explained by structural factors such as an ageing global population,
which have raised the demand for savings. Other structural factors, including a decline in trend productivity
growth, have reduced businesses' demand for capital. Over time, these developments reduced the trend real
interest rate, big R*, required to bring actual stocks of wealth and capital into line. And policy rates, including
in the UK, followed the trend rate downwards.
Figure 1: Changing demographics and a fall in trend productivity
growth have reduced R*
Indicative contributions to changes in the trend real interest rate
1
In my 2018 SPE conference speech, available at
https://www.bankofengland.co.uk/-/media/boe/files/speech/2018/finding-theright-balance-speech-by-dave-ramsden.pdf, I gave more detail on the evolution of the Bank's balance sheet tools during and
following the global financial crisis.
2
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Figure 2: r* fell sharply during the financial crisis
Stylised diagram of the equilibrium real interest rate
The shock of the financial crisis then added a further downward impetus to equilibrium real interest rates. A
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number of headwinds to demand including a rise in uncertainty and a tightening in the financial conditions
- equilibrium real interest rate, "little r*" fell
facing households and firms meant that the medium-term
sharply below "big R*", itself already much lower than in previous decades, and so well below the
so-called
"zero lower bound"
(Figure 2).
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In response, monetary policy makers cut policy rates as low as they could go in the UK Bank Rate was cut
to 0.5% in late 2008, its then effective lower bound. But with equilibrium rates deeply negative, further
stimulus was needed. With conventional tools having reached their limits, policy makers enhanced their
toolkits, developing what were dubbed unconventional monetary policy tools. These took the form of:
quantitative easing or asset purchase programmes, designed to lower longer-term interest rates rather than
short-term ones; new funding operations; forward guidance; and, in some jurisdictions, negative policy rates.
I'm going to leave funding operations such as the TFSME and also lending programmes mostly to one side
in my remarks today. That's not to downplay their importance - they've played a key role in aiding the
effectiveness of monetary policy and supporting the flow of credit to the private sector.
Unconventional tools are not perfect substitutes for policy rates. The effects of many of them were, and
indeed remain, uncertain compared to the relatively well-understood effects of rate cuts. And at least as
much if not more so than with policy rates, their effects were and are state contingent, with the transmission
through to the real economy determined both by the characteristics of the financial system in which they
operate and by the economic situation in which they are applied. Nevertheless, from a starting point of a
single tool approaching the limits of its usefulness, central banks came out of the great recession and the
years which followed with new, much fuller sets of tools, as well as a much better understanding of how to
apply them. This expanded toolkit was put to effective use in the MPC's response to the 2016 referendum
2
result on membership of the EU.
2. Responding to the unprecedented shock of Covid
It has become almost a cliché to describe Covid as an unprecedented shock. But with no comparable global
events since the 1919 Spanish Flu outbreak, this really is a one-in-a-hundred year event. The necessary
restrictions on activity that were put in place to contain the pandemic have had no counterpart in living
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memory. And the economic effects were similarly unprecedented UK GDP fell 22% in the first half of this
year, the largest fall in nearly 400 years (Figure 3), with similar, near-simultaneous falls seen across the
world.The fiscal and monetary policy response, in the UK and elsewhere, has been similarly unprecedented.
The UK Government launched a substantial, innovative and necessary programme of fiscal measures, with a
particular and understandable focus on the labour market, as well as schemes to support the flow of finance
2
The BIS Committee on the Global Financial System (CGFS) report on unconventional monetary policy tools, available at
https://www.bis.org/publ/cgfs63.htm, provides an informative overview of the range of unconventional policy tools used in the aftermath
of the crisis, along with an assessment of their benefits and side-effects.
3
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Figure 4: The MPC's asset purchases in
Figure 3: The UK has seen its deepest
downturn in nearly 400 years March were carried out at record pace
Historical UK GDP Weekly gilt purchases
to companies, involving the Bank where appropriate. These have had the aim of supporting the economy
during the outbreak, and in so doing to minimise the potential for longer-term damage or scarring to the
economy's potential.
On the monetary side the MPC likewise deployed its full range of monetary tools in March as the pandemic
intensified. In March the Committee cut Bank Rate in two steps to a new low of 10 basis points and launched
a new Term Funding Scheme with additional incentives for SME lending (TFSME for short). And against a
- brought on by the "dash for cash" -
backdrop of accelerating market dysfunction the MPC announced an
additional £200bn of gilt and corporate bond purchases, to be carried out at a record pace of £13.5bn of gilt
purchases per week (Figure 4).3 In June the Committee voted for a further £100bn of gilt purchases. And in
August we gave new forward guidance.
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The size and pace of the asset purchase programme launched in March reflected its twin objectives both to
provide stimulus to the economy by lowering longer term interest rates, and to counteract any tightening of
monetary and financial conditions that might result from the deterioration in gilt market conditions.4 Those
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twin objectives were successfully met. Orderly functioning was quickly restored to the market market
functioning indicators, which had been flashing increasingly red, rapidly turned back to green as pricing and
liquidity metrics like bid-ask spreads returned to normal levels (Figure 5). And as a result the spike in gilt
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yields reversed a tightening in monetary and financial conditions was averted and yields continued to
decline as the purchase programme got under way (Figure 6).
Reflecting the improvement in functioning, the MPC concluded in in June that purchases can now be
conducted at a slower pace. The rate of APF gilt purchases has therefore been reduced first to £6.9bn/week
in June and then £4.5bn/week in August. At that pace we expect the current programme of purchases to be
completed at around the turn of the year.
Where does that leave the policy toolbox today? Bank Rate stands at 0.1%, the lowest it has ever been. The
Bank's balance sheet has increased in size from 27% of
pre-Covid GDP, already very large by historical
standards, to nearly 40%; and still growing (Figure 7). And market interest rates remain historically low at all
horizons.
3
Corporate bond purchases take place on a separate schedule, designed to reflect the more complex characteristics of the UK
corporate bond market.
4
This was just one of a wide range of interventions to support the UK financial system that the Bank carried out over this period. Andrew
Hauser's speech "Seven moments in spring", available at
https://www.bankofengland.co.uk/-/media/boe/files/speech/2020/sevenmoments-in-spring-covid-19-speech-by-andrew-hauser.pdf, gives a comprehensive, first-hand account of developments.
4
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Figure 5: Market functioning indicators returned to normal levels following the MPC's
actions
Stylistic summary of market functioning indicators
6: The MPC's intervention lowered gilt Figure 7: The Bank's balance sheet has
Figure
yields reached an unprecedented size
Gilt yields Bank balance sheet as % of lagged nominal GDP
Sources: Bloomberg Finance L.P and Bank
calculations
For some, these facts might suggest that the MPC is once again running out of policy room for manoeuvre.
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My own view is that this is not the case we have policy tools still available, and scope remaining to use
those tools. The question is not so much what tools are available as which is the best tool for the job at hand.
3. The state of the policy toolbox
What I want to do for the rest of this talk is set out the current state of the policy toolbox. While I will include
my personal view where appropriate, I am keen to draw as much as possible on recent MPC statements or
judgements and on Bank analysis. There are no definitive rules or prescriptions when it comes to monetary
5
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I'll start by looking at QE, then
policy tools, and no such thing as a manual for monetary policy makers.5
come on to forward guidance, and finish with some thoughts on the possibility of negative Bank Rate.6
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a. QE plenty of headroom
QE has been an effective tool for stimulating demand through the 11 years of its use in the UK. Even though
we are well on the way to purchasing £300 billion between March and December 2020, we have QE
"headroom" remaining. And while it is increasingly clear its implementation and impact is state
contingent7, to
my mind it is a tried and tested tool and for me it is the MPC's marginal policy tool at present.
it is one that isn't always appreciated. There are £1.7trn
The headroom point is worth expanding on because
of conventional gilts in "free float" by market value (as well as another £790bn of
index-linked gilts which are
The Bank's Asset Purchase Facility holds approximately £740bn
out of scope)8. of those9: so there is a
further £940bn remaining in the market that could potentially be available for purchase.
In practice the Bank does not buy very short maturity gilts. And to avoid distorting the market it avoids
specific gilts where it holds more than 70% of the free float, and attempts to buy evenly across three
maturity "buckets".10
But even with those constraints applied we have considerable headroom after the
current programme is completed, reflecting a range of considerations. And many of those considerations are
within our control - while those constraints are there for good, pragmatic reasons, they are not set in stone,
and there would certainly be scope to re-evaluate them based on Bank advice if the MPC judged that even
more monetary policy headroom was needed (Figure 8).
Taking as a given that the MPC has more headroom to
Figure 8: There is plenty of QE headroom buy more gilts, the question then becomes whether we
remaining have the scope to impact their pricing. This is a trickier
Stylised map of the gilt market1
calculation- it depends not just on the quantity of
headroom, but on how effective any action might be,
which is highly state contingent. But again my starting
point is we have plenty of scope to affect prices. While
yields on longer-dated gilts are at historically low levels,
that doesn't mean they couldn't still go lower. As the
March episode illustrates, there may also be occasions
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when the absence of action the counterfactual would
mean an increase in those yields.
Of course the quantity of QE purchases is not the only
policy variable available to the MPC. The pace of
purchases, as illustrated by our March intervention, is
another. And the kind of asset purchased is a third
variable. UK QE purchases have mostly been
concentrated on the gilt market, as well as much smaller
(1) The area of each block represents the market
quantities of sterling corporate bond purchases. But
value of the gilts in that sector of the market.
during the financial crisis the APF also purchased
5
Perhaps the closest thing to a policy makers' manual is the CGFS report referenced in footnote 2. On the operational side a detailed
guide to the Bank of England's own facilities is available at
https://www.bankofengland.co.uk/markets/bank-of-england-marketoperations-guide.
6
I have not covered funding or lending schemes in detail today. But it is worth noting that the TFSME, which was designed to help
reinforce the transmission of the reduction in Bank Rate as well as incentivise banks to provide credit particularly to SMEs, continues to
expand in size; current usage at £45bn and is expected to exceed £100bn.
7
See for instance "QE: the story so far", available at
https://www.bankofengland.co.uk/working-paper/2016/qe-the-story-so-far.
8
Buying index linked gilts could potentially create the wrong incentives for the MPC in delivering on our remit. It could also crowd out a
key tool for managing inflation risk which is already subject to significant private sector demand, and is often highly illiquid as a result.
9
This number is greater than the approximately £700bn of gilts purchased to date because some of the gilts in the portfolio have
increased in market value since being purchased.
10
Buying short maturity gilts would have a reduced duration impact and would require more frequent reinvestment; it could potentially
also distort market expectations of policy rates. Buying a large proportion of specific gilts could create local distortions in yields and
restrict market liquidity.
6
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£2.4bn of sterling non-financial commercial paper.11 And central banks in other jurisdictions have purchased
a range of other asset types.
Perhaps the best way to think of QE is not as a single tool but as multiple tools, each best suited to a
different job. For delivering a defined dose of economic stimulus a large, steady programme of gilt purchases
may be most appropriate. For addressing market dysfunction a faster or more targeted programme might do
the job better. Our March QE announcement aimed at both these objectives at once and so combined
- as Andrew Bailey put it, we went both "big and fast".
elements of both these options
In this speech I have focused on QE as a monetary policy tool, in other words one which is used in pursuit of
the MPC's remit to maintain price stability. Our March intervention met this requirement, although one of its
immediate objectives was to address market dysfunction, our ultimate reason for doing that was to
counteract any tightening of monetary and financial conditions that might result from that dysfunction.
One natural question raised by that episode, though, is whether the need for such a large scale intervention
could be avoided by addressing the structural causes of the "dash for cash", and if not whether central banks
should have facilities to provide the necessary liquidity to the financial system more efficiently. Those are
have time to get into in detail today but they are hugely important questions for central
topics that I don't
banks and ones with which the FPC is actively engaging.12 In the meantime the MPC has made clear that it
stands ready to respond to any re-emergence of market dysfunction, and so avoid any associated tightening
in monetary and financial conditions, as appropriate.
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b. Forward guidance a high bar to tightening
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The second tool I want to consider is forward guidance Figure 9: Markets expect Bank Rate to
in other words future commitments on interest rates and remain low for some time
UK nominal OIS forward rate curve
other policy tools. Like QE, forward guidance is a tool
the MPC had used several times before this crisis. In its
2013 review of the MPC remit, HM Treasury explicitly
clarified that the Committee had the ability to deploy
forward guidance as a policy tool, including where
appropriate making it conditional on future
developments.
The MPC gave new guidance in August, which we
"not
repeated in our September minutes, that we did
intend to tighten monetary policy until there is clear
evidence that significant progress is being made in
eliminating spare capacity and achieving the 2% inflation
target sustainably".
That guidance was a significant step and is likely to
become more significant as time goes on. It provides a
Sources: Bloomberg Finance L.P and Bank
commitment not to tighten policy until we're confident
calculations
that it is appropriate to do so and that we have seen
clear evidence that we are well on the way to recovery. It
reinforces current market expectations that Bank Rate
11
More recently the Bank's Covid Corporate Finance Facility, acting as agent for HM Treasury, has purchased commercial paper
amounting to around £17bn. This is not a monetary policy scheme but the MPC takes its size into account when taking its monetary
policy decisions.
12
Andrew Bailey addressed these questions, as well as coining the "big and fast" terminology, in his recent speech at Jackson
Hole,
available at
https://www.bankofengland.co.uk/-/media/boe/files/speech/2020/the-central-bank-balance-sheet-as-a-policy-tool-pastpresent-and-future-speech-by-andrew-bailey.pdf. The FPC has noted the importance of taking remedial action to ensure the resilience
of the financial system, as well as of re-examining central bank facilities, including in the Summary and Record of its most recent
meeting, available at https://www.bankofengland.co.uk/-/media/boe/files/financial-policy-summary-and-record/2020/october-2020.pdf. At
an international level the Financial Stability Board has commenced a holistic review of resilience in the non-bank financial intermediation
sector in light of the Covid-19 shock, due to be delivered to the G20 summit in November. The Bank and FCA are actively participating
in the FSB's review.
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will remain low for some time (Figure 9). But for me, the key point to emphasise is that our current guidance
reflects the ongoing uncertainties and means that the burden of proof for any future tightening is high.
One other point I want to make on forward guidance is that I see it as particularly valuable in reinforcing the
effects of other tools. In general I think it makes sense to think of different monetary policy tools as
complements rather than substitutes. And that is particularly true of forward guidance. It can serve to
enhance the impact of individual policy actions by clarifying policy maker intentions, and can link separate
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policy actions together into a coherent package in the words of the BIS Committee on the Global Financial
System, providing "connecting material" and "giving meaning". That is consistent with how the MPC have
used it in the past and in its current incarnation.
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c. Negative rates in the toolbox
The final tool that I want to cover today is Bank Rate, and specifically the question of whether Bank Rate
could go negative.
The MPC set out its collective assessment of the potential issues that a negative policy rate in the UK could
raise, and how that might impact the effectiveness of negative rates as a monetary policy tool, in its August
I won't repeat all of the analysis from the Report; instead I want to draw out
2020 Monetary Policy Report.13
three key points.
The first is that the effective lower bound is likely to be different across different countries, reflecting different
macro-economic circumstances, structural features and financial systems. This is a simple point but an
important one. Just because negative rates are appropriate in one country does not mean they would be
appropriate in another, and for some countries and in some circumstances the effective lower bound may
well be positive.
The second point is that while some aspects of the transmission mechanism would be the same as any other
rate cut, others could be quite different. In all use-cases, market interest rates would fall, asset prices would
rise and the exchange rate would depreciate, and that would stimulate demand and raise inflation in the
usual way. But evidence from other countries' experience suggests that while corporate deposit rates can
turn negative, household deposit rates would be unlikely to fall below zero, meaning that pass-through could
be somewhat weaker than for a normal rate cut.
Building on this, the third point I want to draw out is that there can be knock-on economic effects through the
banking system. These effects could reduce or even counteract the stimulus from negative rates. If deposit
rates don't fall but loan rates do, that will impact banks' profitability, particular for those who are most reliant
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on retail deposit funding in the UK that is small banks and building societies. Banks can offset the impact
on profitability by not reducing lending rates, but in doing this they would further reduce the amount of
stimulus provided. Some banks, particularly those already under balance sheet pressure, could even be
incentivised to reduce lending. That would be a particular concern in the current situation where, while the
banking sector as a whole starts from a position of strength, risks to balance sheets are likely to be rising.
These considerations led the MPC to note in its August Monetary Policy Report analysis that, given the
banks' balance sheets at present, at a time when they have an
effects of Covid-related disruption on
important role to play in helping the UK economic recovery,
"negative policy rates at this time could be less
effective as a tool to stimulate the economy". That consideration still applies as
far as I am concerned. While
there might be an appropriate time to use negative rates, that time is not right now, when the economy and
the financial system are already grappling with the effects of an unprecedented crisis, as well as the myriad
uncertainties the crisis has created. But they are certainly in the toolbox for potential use in future as my
assessment of their effectiveness changes. As the MPC has made clear, we will keep the appropriateness of
all tools, including negative rates, under review.
It is for that reason that the Bank is taking steps to understand how negative rates might be implemented in
practice. It would be wrong to claim a tool is in your toolbox if you aren't able to use it when it's needed. For
13
The analysis is set out in Box 1 of the Report, which is available at
https://www.bankofengland.co.uk/-/media/boe/files/monetarypolicy-report/2020/august/monetary-policy-report-august-2020.
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that reason, in my own areas of responsibility in the Bank, we are working to ensure all our systems would
be able to handle negative rates if needed.
The September MPC Minutes flagged that the Bank and the PRA would also begin structured engagement
on operational considerations with the wider financial sector. We launched that engagement on 11 October
with a letter to CEOs of all UK banks and building societies, as well as large international banks and insurers
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over 180 firms in total asking them to identify any operational challenges associated with implementation
of zero or negative Bank Rate, with a deadline for responses of November 12th.14 That letter will be followed
up by supervisory engagement with firms where needed to understand key themes and timeframes. And we
will also be engaging with trade bodies and relevant financial market infrastructure firms, and would of
course welcome responses from any other interested firm.
We are not asking firms at this stage to begin taking steps to ensure they are operationally ready to
implement a negative Bank Rate. But the information we receive will deepen the MPC's understanding of the
operational aspects of a negative policy rate, as well as the Bank and PRA's understanding of its implications
for firms and the UK financial system.
4. The economic outlook
I want to conclude by saying something about the economic outlook which will frame decisions by the MPC
on making any further use of the tools I have covered.
An important feature of our August projections was the uncertainty embodied in them, as reflected in the
shape of our fan charts. The fans were wider than usual, reflecting the unusually high uncertainty about the
outlooks for the UK and global economies created by the Covid epidemic. And the risks to those projections,
and in particular to our conditioning assumption that the direct impact of Covid would fade over the forecast,
was judged to be to the downside (Figure 10).
How things actually develop from here will depend on the evolution of the pandemic, measures taken to
protect public health, and how governments, households and businesses respond to these factors. In our
August forecast, we made the conditioning assumption that the high levels of uncertainty over health and
economic outcomes dissipate gradually, with improved treatments or other health interventions, and
therefore reduced risks facing households and businesses.
UK GDP has recovered fairly rapidly in aggregate so far from its trough earlier in the year. In our August
Monetary Policy Report forecasts, we projected that recovery to continue, though at a slower pace.
Unemployment was projected to peak in Q4 and decline only gradually. And inflation was projected to return
to target from its current low level as domestic price pressures picked up. (Figures 11-13) Those projections
were conditioned on the assumption that the direct impact of Covid-19 on the economy would dissipate
gradually over the forecast period, as well as on market interest rates and the monetary and fiscal policy
support measures that were in place at the time.
This summary is in no sense intended to downplay the unprecedented impact the virus continues to have on
individuals, on particular businesses and sectors, and on different regions and nations of the UK at different
times. As flagged in the MPC's September
Minutes, there is a real risk of a more persistent period of higher
unemployment, and the recent strength in income growth might not be sustained.
I remain particularly concerned that we could also see structural headwinds to recovery in the labour market,
with particular impacts on younger workers and those joining the workforce. The negative impact on the
supply side of the economy, or degree of scarring, could potentially be greater than the 11⁄2% we have
assumed to date based on very preliminary work, a risk the MPC has previously highlighted. There could be
further supply side impacts from the structural economic change or repurposing that could be needed if the
behavioural changes that we have seen in response to the pandemic persist, as seems highly likely,
although the sign of these impacts is perhaps more ambiguous.
14
The letter is available on the Bank's website at
https://www.bankofengland.co.uk/-/media/boe/files/prudentialregulation/letter/2020/info-request-operational-readiness-policyrates.pdf?la=en&hash=E973B09B00A6EC1D2B5AB9B845BF20EB5EF7BBB6.
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The November MPC decision isn't for another two weeks and we have a full round of forecast and policy
meetings to come between now and then. In these uncertain times, and with an array of risks to contend
with, from Covid, from Brexit and from wider geopolitical developments, the MPC is clear that the range of
actions that could be taken remains under review, consistent with our remit. I head into our upcoming
meetings in the belief that we are equipped with an effective set of tools in our toolbox which we will be able
to use to meet our remit, however the economy might evolve from here.
Figure 10: Uncertainty around those Figure 11: In the August MPR GDP was
projected to continue to recover...
projections was higher than usual and the
risks were to the downside.
Stylised representation of the MPC's views on GDP projection based on market interest rate
uncertainty and risks around the central projection for expectations, other policy measures as announced
GDP
Figure 12: ... unemployment to peak in Q4 Figure 13: ... and inflation to return to target
then decline gradually ...
in the medium term.
Unemployment projection based on market interest CPI inflation projection based on market interest rate
rate expectations, other policy measures as expectations, other policy measures as announced
announced
10
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