Think about the next thought experiment. The federal government imposes a tax of $1000 on all bankers. One the exact same day, the federal government authorizes a brand new spending program, a $1000 subsidy to all bankers. How ought to we consider this mixed coverage? To me, it’s a nothingburger.
Economists used to view reserve necessities as an implicit tax on banks. That’s as a result of within the outdated days there was no curiosity paid on financial institution reserves, so there was a excessive alternative price of holding reserves.
Now, we’ve no reserve necessities, however we do pay curiosity on reserves (IOR). This was performed as a result of policymakers wished to maneuver to a “flooring system”, the place banks would select to carry giant portions of reserves. The adoption of IOR permits the central financial institution to inject a lot of reserves into the system, with out driving rates of interest right down to zero. You possibly can consider giant reserve holdings as a tax on banking, and IOR as an offsetting subsidy.
Chris Giles has an article in the FT the place he means that the BoE transfer to a system the place the tax is maintained however the subsidy is eliminated:
The central financial institution pays 5.25 per cent on reserves in order that it could set the short-term coverage rate of interest at that stage. It’s efficient, however not the one technique to management short-term charges.
As an alternative, it might require banks to carry a hard and fast amount of cash with out curiosity, paying 5.25 per cent solely on a small a part of the reserves.
I don’t like the concept of paying curiosity on reserves, however I additionally oppose reserve necessities.
Return to the thought experiment on the high of this put up. Suppose the federal government all of a sudden eliminated the $1000 subsidy to bankers, however stored the $1000 tax in place. How ought to we take into consideration that change? In a technical sense, it entails a lower in authorities spending. Nevertheless it additionally strikes us from a state of affairs the place there isn’t any internet stream of cash to or from bankers, to a state of affairs the place all that continues to be is a $1000 tax on bankers. That appears like a tax improve.
Giles views issues otherwise:
One issue is that Andrew Bailey, BoE governor, nonetheless must be persuaded. In 2021 he mentioned the coverage can be a tax on banking. The reality is that it will decrease public spending.
The “fact” is that fact is a slippery idea, particularly the place phrases are poorly outlined. I perceive Giles’s level, however I discover Bailey’s characterization to be nearer to my approach of viewing issues. You’d be basically forcing banks to lend a lot of cash to the British authorities at a charge of zero p.c. That looks like the imposition of a tax on banking.
