In a few posts recently, Richard Murphy argued that because the Bank of England is wholly owned by the Treasury, the government debt (gilts) that it has bought under the Quantitative Easing programme is effectively cancelled because it would be eliminated from both sides when the Bank of England's accounts were consolidated with the Treasury accounts. This is correct from an accounting point of view. It leaves a large cash liability on the Treasury's accounts which represents the additional base money now in circulation and is exactly equal to the amount of the debt purchased. But the debt itself disappears. Murphy's worked example showing how this works is here.
But in the real world, things don't just disappear like that. Locked away in the Bank of England's vaults are a large number of pieces of gilt-edged paper. And tucked away in bank deposit accounts, or floating around somewhere in the financial system, is the additional money that the Bank of England created to buy the gilts.
Now those gilts have maturity dates. When they expire, they have to be repaid. So when those pieces of paper locked away in the Bank of England's vaults reach their maturity date, the amount of money they represent must be removed from circulation.
But this is really quite difficult to do. How on earth are you supposed to remove money from bank deposit accounts or suck it out of financial conduits? That money belongs to the people who sold the gilts back to the government, or to whomever has received that money in the course of normal financial transactions. Allowing the gilts to expire and recording the corresponding cash reduction in the Bank of England and consolidated Treasury accounts would create an imbalance with the wider economy. There would be more money in circulation than recorded on the Government's books. And since cash is a liability from the central bank's point of view, and there would be more cash actually in circulation than its assets, the Bank of England would be insolvent.
There is only one way a central bank can withdraw money from the wider economy - selling assets for cash in open market operations. But if its assets have expired, it has nothing to sell. So the government would either have to replenish the Bank of England's capital from general taxation - which might involve tax rises, unless the economy was growing strongly enough to generate enough tax revenue - or it would have to issue more gilts to replace those that expired.
These new gilts cannot immediately be bought by the Bank of England, as it is not allowed to participate in a primary auction. So the immediate effect of gilt expiry would be a "spike" in government debt as new gilts were issued for the same amount, bought by the private sector and then purchased in the secondary market by the Bank of England - assuming that the private sector buyers want to sell, of course. Alternatively, of course, the government could raise taxes to recapitalise the Bank of England. Either way, the expiry of gilts held by the Bank of England requires real money to be contributed by government just as it does for gilts held by the private sector.
And no, the Bank of England can't just magic new capital into existence. Central banks create money for the wider economy, but they can't create money for themselves. The capital they need has to come from the wider economy via the government. It's a circular flow.
For that reason, the notion that government debt purchased by the Bank of England can be treated as "written off" is simply wrong. From an accounting point of view, yes, the debt is eliminated from both sides of the consolidated accounts. But out in the real world, the physical bits of paper still exist, and the real cash balances are still very much in circulation. Writing those off interferes with the flow of money from the real economy to government/central banks and back again.
Generally I find accounting concepts and practices very helpful when looking at the way in which our financial system works. But in this case, the accounting view does not conform with reality - and it is therefore very dangerous.
You see, the conclusion that Richard Murphy came to was that as the gilts purchased by the Bank of England can be regarded as written off since they are eliminated on consolidation, we can regard the UK's debt as much less than it appears to be. And therefore we can issue much more, can't we?
No, we can't. The real money is still there in circulation. The gilts are still locked in the Bank of England's vaults. And eventually they will expire - at which point government is either going to have to provide more money from taxation to maintain the Bank of England's capital and prevent an imbalance in the government accounts, or it is going to have to issue more gilts to replace them.
So the debt hasn't really disappeared at all. It is still out there in the real world. And it won't go away just because an accountant says it does.