Catch up on economics articles you may have missed from June 2020. Articles this month take a look at the concept of monetary financing.
This selection of articles looks at the concept of ‘monetary financing’. This involves the central bank “creating” money on which interest is not paid. The Economist described it as “a modern term for one of the oldest taboos for central banks: printing money to fund government spending”. The subject has come into focus because the coronavirus (Covid-19) crisis, and the Government’s response to it, will cause sharp increases in the government deficit and debt.
The articles discuss the pros and cons of monetary financing, how it could work in practice and how existing UK policies might, or might not, resemble it.
Arguments for and against monetary financing
Ben Holland of Bloomberg (How long-feared ‘monetary finance’ becomes mainstream, Bloomberg (£), 5 May 2020) sets out the pros and cons of monetary financing.
He first notes the conventional objection that ‘printing money’ leads to inflation. This in turn could lead to higher interest rates, making it more expensive to service other government debt. Holland also outlined the political risk of monetary financing, which is that politicians will be tempted to overspend when apparently ‘free’ money is available.
In its favour, Holland argued that ultimately it does not matter whether government spending is financed by issuing debt or providing funds from the central bank, as both are government liabilities. He also said that experience since the 2008 financial crisis showed that authorities can provide large monetary stimuli without causing inflation. Holland said that proponents of the policy might argue the current situation was a one-in-a-lifetime emergency, in which it is “better to spend whatever it takes to keep businesses and households afloat, finance the relief effort by any means necessary, and worry about long-run consequences later”.
Several writers have proposed ways to use monetary financing, while mitigating the risks involved. For example, Lord Turner of Ecchinswell (Crossbench) stated that in purely economic terms monetary financing was a legitimate policy tool (Demystifying monetary finance, Social Europe, 23 August 2016). However, he said that the “serious argument” against monetary finance was political. Hence, he argued for “rules and institutional responsibilities that ensure that monetary finance is used prudently”. Martin Wolf agreed, concluding that “right now, when government deficits are exploding in the midst of a huge crisis, it is an obvious mechanism. Use it. Work out ways to manage it” (Monetary financing demands careful and sober management, Financial Times (£), 9 April 2020).
Lord Turner also outlined a possible framework. He suggested that an independent central bank should determine the amount of monetary financing, while the Government would decide how the money was spent. Economist Eran Yashiv put forward the idea of a “Covid policy committee” to determine both the amount of monetary financing and what it was spent on (Breaking the taboo: The political economy of Covid-motivated helicopter drops, Vox, 26 March 2020). In his proposal, the committee would have equal representation from the Government, the central bank and outside experts such as academics and private sector institutions.
The campaign group Positive Money, which seeks reforms to the money and banking system, has also argued in favour of monetary financing to fund direct injections of money into the economy (Recovery in the eurozone: using money creation to stimulate the real economy’, Frank van Lerven, Positive Money, December 2015). These might be through infrastructure funding or direct handouts to individuals, sometimes described as “helicopter drops”. It said that compared to current policy this would:
- boost economic growth without further increasing household and business debt;
- allow a more even distribution of benefits; and
- avoid “bubbles” in asset markets,
Some writers have argued that two aspects of current UK policy, quantitative easing and the ‘ways and means facility’, are essentially monetary financing.
Since the 2008 financial crisis, the Bank of England has operated quantitative easing (QE). QE involves the bank purchasing government (and some corporate) debt in the financial markets. The programme was expanded in response to coronavirus.
The Governor of the Bank, Andrew Bailey, has stated that QE is not a form of monetary financing. He said that the crucial difference was that the Bank could control when QE is reversed, and thus retained its independence in operating monetary policy. In contrast, he said monetary financing was “incompatible with the pursuit of an inflation target by an independent central bank”. However, Ben Holland argued that the dividing line between QE and monetary financing is “blurry”.
Ways and means facility
On 9 April, HM Treasury and the Bank of England announced that the Government’s borrowing facility at the Bank, known as the ways and means facility, would increase from £370 million to an unlimited amount. The Bank said that this would “provide a short-term source of additional liquidity to the government […] and support the orderly functioning of markets”. It stated that all borrowings through the ways and means facility would be temporary and repaid before the end of 2020. The Bank reiterated that interest-bearing gilts would remain the Government’s “primary source of funding”.
The thinktank Official Monetary and Financial Institutions Forum argued that using the ways and means facility in this way was not monetary financing because it is temporary (Ways and means is not monetary financing … yet, Chris Papadopoullos, Official Monetary and Financial Institutions Forum, 9 April 2020). However, it suggested that an increase in gilt rates, which represent the cost of conventional government borrowing, might lead to more permanent use of the facility. Martin Wolf of the Financial Times reasoned that because the Bank does not have full control over repayments, it already constitutes monetary financing. The Economist agreed, but said that “modest” use of the facility would not undermine the Bank’s remit of controlling inflation (Why the Bank of England is directly financing the deficit, Economist (£), 18 April 2020).