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Managing the Fiscal Risk of Higher Interest Rates

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  • William Allen

Abstract

The coronavirus pandemic has led to a large increase in the U.K.'s government debt, and the Office for Budget Responsibility has warned that a rise in interest rates might imperil debt sustainability. If the Bank of England Monetary Policy Committee were obliged to raise short-term interest rates to meet the inflation target, the interest costs of the commercial banks' very large reserve balances, which the Treasury has guaranteed, would increase immediately, and the government might be pressed to reduce the primary deficit quickly. This note proposes a large compulsory swap of banks' reserve balances for short and medium-dated fixed-rate gilt-edged securities. If the proposal were adopted, the government would have more time to make fiscal adjustments in the event of a rise in interest rates.

Suggested Citation

  • William Allen, 2021. "Managing the Fiscal Risk of Higher Interest Rates," National Institute of Economic and Social Research (NIESR) Policy Papers 25, National Institute of Economic and Social Research.
    • Handle: RePEc:nsr:niesrp:25
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    File URL: https://www.niesr.ac.uk/wp-content/uploads/2021/10/NIESR-Policy-Paper-025_0-4.pdf?ver=PVlFdL9rd2L5XEbBT98P
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    Citations

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    Cited by:

    1. William Allen, 2022. "Models of Central Banking and the Organisation of the Bank of England," National Institute of Economic and Social Research (NIESR) Policy Papers 38, National Institute of Economic and Social Research.
    2. Crafts, Nicholas, 2021. "What Can We Learn from the UK’s Post-1945 Economic Reforms?," The Warwick Economics Research Paper Series (TWERPS) 1370, University of Warwick, Department of Economics.
    3. Nicholas Crafts, 2021. "What can we learn from the United Kingdom’s post‐1945 economic reforms?," Economic Affairs, Wiley Blackwell, vol. 41(3), pages 354-376, October.
    4. jagjit Chadha & William Allen & Philip Turner, 2021. "Quantitative Tightening: Protecting Monetary Policy from Fiscal Encroachment," National Institute of Economic and Social Research (NIESR) Policy Papers 27, National Institute of Economic and Social Research.

    More about this item

    Keywords

    Covid-19; Government Debt; bank reserve swaps;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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