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Does the British Government Print Money to Fund Itself?

Alex Hughes
5 min readJan 24, 2022
A Zimbabwean note worth $0.40 a month after issuance

There are two very different views dominating the debate about the Bank of England’s (BoE) ‘quantitative easing’ (QE) programme — the purchase of government bonds using newly created money.

The first, as neatly summarised by GB News’ economics editor Liam Halligan, sees the BoE as having “long been engaged in the monetary financing of government debt, pure and simple.”¹ Halligan has previously referred to it as “the most dangerous economic experiment for generations.”² Echoing the same concern, the leading Eurosceptic MP Steve Baker recently wrote that “artificial prosperity . . . had built up as a result of the massive artificial monetary stimulus of recent years.”³

Their claim is that the treasury’s spending is partly being funded by the BoE’s printing press, presumably because it’s unable to source enough money through the usual routes of taxing and borrowing. This view remains popular in the print media, and last year, a Financial Times poll showed that most major investors in UK government bonds subscribe to it.⁴

The other view — held by policymakers and academics — is that QE is a tool that the BoE only uses to achieve its traditional objectives. “We do not . . . set a level of QE and asset purchases in any way related to what the government is going to borrow”, insisted Bank governor Andrew Bailey last November.⁵ Former central banker David Miles, of Imperial College London, writes that “accusations that [QE] . . . amounts to ‘printing money’ . . . are unfounded and misleading.”⁶

These views look incompatible, but their key difference is conceptual, not factual. This is quite a complicated issue theoretically, but the basic idea is quite simple.

We should start by outlining the role of central banks. These institutions, though they remain mysteries to many, are the central hub of every modern economy.

Contrary to a lot of popular descriptions, their staff don’t spend a lot of time thinking about the money supply, in part because “money” is very difficult to define. In the modern world, money isn’t physical assets like gold or silver, but nor is it strictly the paper currencies issued by governments. Any sufficiently-trustworthy financial promise, or ‘IOU’, can function as money.

Government IOUs are the most reliable form, because stable governments have an interest in — and a long record of — maintaining their value, in terms of real goods and services, and in order to do this, they have a large tax base to draw upon. But broad definitions of money can include all sorts of IOUs, whose quantity is not under the central bank’s direct control. So instead, policymakers focus on interest rates, i.e. the cost of borrowing and the reward for saving.

In most developed countries the central bank’s tools are kept ‘independent’ from the democratically-elected government, to shield their decisions from opportunistic politicians trying to temporarily stimulate the economy to win an election. Their overall goals, on the other hand, are prescribed by Parliament; broadly, they’re given two — low inflation and low unemployment.⁷

Broadly, they achieve these twin goals by adjusting interest rates. When rates fall, saving becomes less attractive and borrowing is cheaper, so total spending rises. The reverse is true when rates rise. When unemployment is high and inflation is below target, they lower interest rates to boost spending, which in turn incentivises firms to hire more workers and raise prices.

The treasury, meanwhile, takes in revenue through taxation, which it spends on transfers, like Universal Credit, and government purchases, like vaccine doses. When unemployment is unusually high, a gap between taxation and spending opens up, since more people qualify for unemployment benefits, while fewer people are earning enough to pay much tax.

Rather than raising taxes — which could well reduce spending further — the treasury often fills the gap by borrowing, either domestically or from abroad. This is done by issuing IOU contracts, known as bonds, that private lenders can purchase.

Now, when a central bank engages in QE, it is creating new money to purchase treasury bonds from the private sector, which enter onto its balance sheet. At a glance, this reduces the government’s IOUs.

But of course, a central bank is part of the government, and money, like a bond, is also an IUO.

The distinction between government money and government bonds is like the distinction between a current account and a savings account: they come with different terms and conditions, but as representations of wealth they’re essentially equivalent.

In other words, when central banks create money they’re borrowing from the private sector. The point is to alter the composition, not size, of the government’s total IOUs — one type is injected into circulation, and another of equivalent value is withdrawn.

So QE, on its own, has nothing to do with the government’s debt management objectives. If interest rates had to rise for inflation to remain on its target path, then QE — which amounts to borrowing at zero interest — might have to be reversed, and to attract lenders, further borrowing would need to be conducted using interest-bearing bonds.

The actual effect of QE is a lively topic in empirical economics. The basic idea behind it is that bonds and money play somewhat different roles in the monetary system, since bonds are slightly more difficult to exchange for other assets. This enables central banks to lower long-term interest rates by buying long-dated bonds, but economists don’t have a clear idea of how exactly this occurs. In former Federal Reserve chairman Ben Bernanke’s words, QE “works in practice, but doesn’t work in theory”.⁸

One potential channel is that an announcement of further QE alters expectations about future rates, since it implies that central bank policymakers are pessimistic about growth, and are therefore likely to hold rates low for longer.⁹ The effect, in any case, appears to be relatively small, and it has nothing to do with the government’s ability to fund its spending.

References

Economics
Hyperinflation
Inflation
Fiscal Policy
Quantitative Easing
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Alex Hughes

Written by Alex Hughes

7 Followers

International relations grad student interested in political theory, international security and macroeconomics.

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