Quarterly Bulletin
Debt Management Articles

Costs of sovereign default (506k)
(By Bianca De Paoli of the Bank's Monetary Instruments and Markets Division, Glenn Hoggarth of the Bank's International Finance Division and Victoria Saporta of the Bank's Systemic Risk Reduction Division). Over the past quarter of a century, emerging market economies (EMEs) have defaulted on their sovereign debts frequently. This article assesses the size and types of costs that have been associated with these defaults. It emphasises that costs, measured by the fall in output, are particularly large when default is combined with banking and/or currency crises. Output losses also seem to increase the longer that countries stay in arrears or take to restructure their debts. The paper concludes with a number of policy suggestions to improve debt crisis prevention and management and the role played by the IMF.

Explaining the difference between the growth of M4 deposits and M4 lending: implications of recent developments in public finances (74k)
(By John Power and Peter Andrews of the Bank's Monetary Assessment and Strategy Division). The growth of sterling lending by UK monetary financial institutions to the UK private sector has substantially exceeded the growth of UK private sector sterling deposits over the past two years. This article considers the possible influence on this growth differential of two events in the past financial year: the unexpected extent of the Government's cash surplus; and the assumption by the Debt Management Office of responsibility for government cash management. The article also describes how the gap between sterling lending and deposits was financed over the past two years.

Although monetary aggregates are no longer officially targeted for monetary policy purposes, analysis of these quantities plays an important role in the Bank's regular assessment of the outlook for inflation.

In its regular monetary policy analysis, the Bank primarily examines the banking sector's sterling liabilities and assets with the UK private sector. These quantities, known as M4 deposits (M4) and M4 lending (M4L) respectively, constitute a sub-section of the banking sector's overall balance sheet. The Bank focuses on M4 and M4L in particular (rather than the overall levels of banking sector deposits and lending) because, given that these quantities are country and currency-specific, they would be expected to relate closely to UK economic activity.

The first section of this article sets out the formal definition of M4 and its accounting relationship with the banking sector's balance sheet counterparts. The second section outlines how the new government cash management arrangements could affect the monetary statistics. The third section details the Government's cash surplus in 2000/01 and its monetary implications. The fourth section accounts for the difference between M4 and M4L growth in 2000/01.

Public sector debt: end March 1999 (116k)
This article continues the annual series in the Quarterly Bulletin analysing the debt position of the UK public sector. It looks at market and statistical developments in the financial year to end March 1999, and examines some of the domestic and European issues that have influenced these measures. It also analyses the composition and distribution of the national debt.

• Public sector net debt fell by £3.7 billion to £349 billion, at nominal value, during the financial year to end March 1999. This was the first annual reduction since 1989/90 At end March 1999 public sector net debt stood at 40.6% of GDP, the lowest end-March figure since 1994, and 2 percentage points lower than at end March 1998.
• General government gross debt—the 'Maastricht' measure—also fell during the year, to £399 billion at end March. At 47.4% of GDP, this is comfortably below the 60% reference value in the Maastricht Treaty. The general government had a financial surplus of 0.9% of GDP in 1998/99, well within the Maastricht reference value, which allows a deficit of up to 3% of GDP.
• All data presented in this article reflect the transition to the latest international statistical standards, the European System of Accounts (ESA95). This is consistent with the UK National Accounts, published by the Office for National Statistics. However, as before, government debt figures are still presented on a nominal, rather than a market, valuation. The box on pages 356­57 gives details of the changes and shows the impact on the measurement of the public sector debt position.
  

Government debt structure and monetary conditions
(33k)
(by Alec Chrystal of the Bank's Monetary Assessment and Strategy Division, Andrew Haldane of the Bank's International Finance Division, and James Proudman of the Bank's Monetary Instruments and Markets Division). In June 1998 the Bank of England organised a conference on 'Government debt structure and monetary conditions'. The aim of the conference was to discuss the interactions between the size and structure of government debt and the concerns of monetary policy. The proceedings of the conference will be published shortly. This article summarises the issues discussed.

The article identifies three main channels through which government debt structure might influence monetary conditions. These are the potential effects of:

• the quantity of debt;
• the composition of debt (eg short versus long-maturity, index-linked versus conventional); and
• the ownership of debt (eg by banks or non-banks).

Taking each of these in turn, the following conclusions about the effects of government debt structure on monetary conditions are drawn:

• Effects of the quantity of debt. The consensus at the conference was that the insights of Michael Woodford were interesting but controversial and, as pointed out by Ben Friedman, were not of great current relevance to the UK conjuncture. Rather, as Charles Goodhart argued, new financial instruments, new issuing techniques and new capital market structures since the 1980s have all helped to reduce concerns about how the quantity of debt impinges on monetary control, to the point where the two issues could now be seen as almost distinct.
• Effects of the composition of the debt. Changes in the composition of debt might affect expected asset returns and the incentives facing the central bank. But the consensus at the conference appeared to be that the size of these effects was small, at least in response to marginal shifts in government portfolios. There was nevertheless a need for monetary policy makers to monitor changes in the composition in the debt portfolio carefully, to be alert to possible effects on the monetary aggregates.
• Effects from the ownership of debt. Most of the work on this topic has been done on the United States, where there were suggestions (for instance in the work of Kuttner and Lown) that government debt taken up by banks was a substitute for loans to the private sector. For the United Kingdom, the available evidence was consistent with the view that debt sales to banks had only a small impact on either money supply growth or bank lending. But little detailed empirical work has been done to support this result. So that view can, at most, be tentative.

Overall, the economic research discussed at the conference suggested that changes in debt management policy at the margin were unlikely to have first-order effects upon monetary conditions in normal circumstances. But two important caveats are needed. First, many aspects of the transmission mechanism and optimal debt management are not well understood, and policy should aim to be robust to a variety of different assumptions and models. Second, there are few, if any, examples of extreme changes by governments in debt management policy. So it is less clear that large changes in the quantity or composition of the debt will not have implications for monetary conditions. For these reasons, the effects of changes in debt management policy on monetary aggregates need to be monitored and interpreted with care.