The Bank of England is indirectly financing the Treasury’s spending on the response to Covid-19. We welcome this development, but further transparency is needed. Now is the time for the Bank to commit to direct monetary financing.
On the 19th of March, the Bank announced a £200 billion expansion of its Quantitative Easing (QE) programme. The majority of these new asset purchases will be government bonds, although the Bank will also buy more corporate bonds. At Positive Money, we’ve always highlighted the ineffectiveness and negative side-effects of QE, and will continue to closely scrutinise the corporate bond purchases as further details become available.
In these circumstances, however, there is some positivity in the Bank’s move to buy government bonds, because this time around the purpose of the purchases is not to stimulate economic activity. We know that previous rounds of QE failed to accomplish this goal, with much of the newly created money getting stuck in financial markets, inflating asset prices and doing little for the real economy. Now, the purpose of the bond purchases is to address a deterioration in the UK gilt market. In other words, their lowering of yields on UK government bonds is intended to ease the Treasury’s financing conditions, rather than to stimulate private borrowing and spending.
Given that the markets are desperately seeking liquidity, buying up government bonds increases their demand, as investors are reassured that they can always sell them on to the Bank in exchange for cash reserves. This means that the Bank of England is in effect indirectly financing the government’s deficit spending, which has been massively ratcheted up due to Covid-19 measures. This is the kind of coordinated action between the Bank and the Treasury that Positive Money has been calling for to address other crises, such as climate and ecological breakdown.
That said, there is much more to be done. First, the Bank needs to be more transparent about the intentions and effects of its actions. Although the Bank’s announcement cited deterioration in the gilt market as a justification for expanding asset purchases, its website is still using the classic reasoning behind QE to support its actions – while mentioning nothing about the fiscal effect. In its market notice, the Bank said “the MPC will keep under review the case for participating in the primary market.” Many interpreted this as meaning that the Bank is considering buying government bonds directly, engaging in direct monetary financing of the Treasury. However, on closer reading, we think the Bank is referring to corporate bonds. Either way, this statement is highly ambiguous.
Governor Andrew Bailey has also been unclear on the matter. While he said he’ll do “whatever it takes to meet the needs of the economy and the needs of the people” he then claimed that they are not abandoning the philosophy against monetary financing, while simultaneously suggesting that something akin to it was being considered. This confused messaging is not good enough. Especially in this time of crisis, the public deserves full clarity and transparency from the Bank.
At Positive Money, we think the Bank should make an explicit commitment to direct monetary financing. Unless the gilt market shows further volatility, the functional effect on the Treasury’s spending would be equivalent to what the Bank is doing now, i.e. bond purchases in the secondary market. But institutionally, a shift to direct monetary financing would represent a big step.
If the Bank purchases bonds directly off the Treasury (or simply credits the Treasury’s account), this will shatter once and for all the illusion that the government depends on the market to finance its spending. The idea that austerity was an ‘economic necessity’ will be laid to rest for good and anyone suggesting down the line that the government has to balance its books following profligate spending in response to coronavirus will surely not be taken seriously. Monetary financing will also mean that financial arguments for delaying our response to other crises, such as climate and ecological breakdown, will terminally lose all credibility. This will then allow for greater public debate and understanding on real limits to government spending, namely inflation.
Furthermore, if the Bank commits to direct monetary financing now, this will avoid the further use of QE in the future as a tool to stimulate the economy independent of government spending. We know that QE simply doesn’t work as a stimulus for economic recovery and has fueled inequality in the past. If the Bank shows now that it can do ‘QE for People’ by committing to the direct financing of the Treasury’s response to Covid-19, there will be no case for any other kind of QE as an economic stimulus once we emerge from this public health crisis.
A national emergency may not be the ideal time for challenging the notion of central bank independence, which is exactly why the Bank should preemptively state that it is prepared to engage in direct monetary financing, especially if there is more trouble in the gilt market. In other words, it should explicitly express that it will not allow investors to interfere with the Treasury’s plans to respond to this crisis. This would represent an expansion of the Bank’s toolkit, rather than its sudden co-optation.
It’s great to see the Treasury taking the lead in responding to the coronavirus crisis. Although there are remaining issues, such as delays in the delivery of financial support, we commend much of the action it has taken so far. But the Bank of England also has a crucial role to play, which demands continued scrutiny. It must commit to full transparency and direct monetary financing now, to support a bail-out for people, not financial markets.