Why the Bank of England is directly financing the deficit


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MNETARY FINANCING is a modern term for one of central banking’s oldest taboos: printing money to fund government spending. On April 5, Andrew Bailey, Governor of the Bank of England, insisted on the FinancialTimes that the bank would not finance the government directly because such an action would damage its credibility. Four days later, the bank announced that some monetary funding would actually take place via an expansion of the so-called Ways and Means Facility.

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Mr Bailey had described the facility, which is as old as the bank itself, as a “historic feature”. It’s a bit like an overdraft. The bank will create new currency and transfer it to the government, which later, it says, will borrow from the financial markets to pay off the balance. During the global financial crisis of 2007-09, some £20 billion ($25 billion) of borrowing was financed in this way.

Monetary financing, with its echoes of Zimbabwe and Weimar Germany, is raising fears that investors will lose confidence in a central bank seen as under the thumb of a finance ministry, hence Bailey’s caution. But modest use of the ways and means facility is not likely to lead to inflation, let alone hyperinflation.

The bank’s actions so far look like sensible support for the government in exceptional circumstances. Tax revenues fall as spending rises to cushion the economic impact of covid-19. The Office for Budget Responsibility, a watchdog, estimates that this year’s deficit could reach 14% of GDP. Even with its new bank credit line, the government plans to issue £45bn worth of gilts in April alone, well above the previous monthly peak of £28bn in September 2009. The overdraft bank allows the government to smooth its borrowing on the markets. over a longer period of time, rather than risk investors choking on the sudden surge in its debt.

Mr. Bailey’s about-face is unlikely to do him much harm. In times of crisis, “being right is more important than being consistent”, pleads a fund manager. Gilt investors are relaxed about the temporary use of the facility and confident about the independence of the bank; government bond yields barely budged on the news. Mr. Bailey can also afford to relax a bit.

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