Consider the following thought experiment. The government imposes a tax of $1000 on all bankers. On the same day, the government approves a new spending program, a $1000 subsidy for all bankers. How should we think about this integrated policy? For me, it’s a nothingburger.
Economists used to view reserve requirements as an implicit tax on banks. That was because in the old days no interest was paid on bank deposits, so there was a high cost of holding deposits.
Now, we have no reserve requirements, but we do pay interest on reserves (IOR). This was done because policy makers wanted to move to a “floor system”, where banks would choose to hold a larger amount of resources. The adoption of the IOR allows the central bank to inject more reserves into the system, without lowering the interest rate to zero. You can think of capital reserves as a bank levy, and the IOR as a repayment subsidy.
Chris Giles has an article on FT when he suggested that the BoE move to a system where taxes are kept but subsidies are removed:
The central bank pays 5.25 percent on reserves to be able to set the short-term policy interest rate at that level. It’s effective, but it’s not the only way to control short-term prices.
Instead, it would require banks to hold a fixed amount of money without interest, paying only 5.25 percent on a small portion of the reserves.
I don’t like the idea of paying interest on savings, but I’m also against reserve requirements.
Go back to the thought experiment at the top of this post. Let’s say the government just removed the $1000 subsidy from the banks, but kept the $1000 tax in place. How should we think about that change? In a technical sense, it involves cutting government spending. But it also moves us from a situation where there is no flow of money at all to or from the banks, to a situation where all that is left is a $1000 tax on the banks. That sounds like a tax hike.
Giles sees things differently:
Another difficulty is that Andrew Bailey, the governor of the BoE, still needs to be persuaded. In 2021 he said this policy will be a tax on banks. The truth is that it will reduce public spending.
“Truth” is that truth is a slippery concept, especially when words are not well defined. I understand Giles’ point, but I find Bailey’s characterization to be closer to my point of view. You will be forcing the banks to lend more money to the British government at zero percent interest. That looks like a tax on banks.
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