Why we should worry about the monetary-fiscal complexby Paul Wallace / April 22, 2020 / Leave a comment
Any forecasts about the economic impact of the coronavirus epidemic and the drastic measures taken to fight it can be little more than guesstimates at this stage. Even so, it is clear that the Treasury will have to borrow on a massive scale as it steps in to support private businesses and workers while tax revenues fall away. But is the avowedly independent Bank of England in turn supporting the Treasury rather too much for comfort?
The scenario published on 14th April by the Office for Budget Responsibility (OBR) spelt out the staggering amount of borrowing that may lie ahead. The fiscal watchdog modelled a 35 per cent decline in GDP in the second quarter, an estimate that Andrew Bailey, the Bank’s governor, has since endorsed. Even if GDP returned to its pre-virus level by the fourth quarter, it would still be 13 per cent lower for the year as a whole according to the OBR. This would cause borrowing in the financial year between April 2020 and March 2021 to be £218bn higher than previously forecast, reaching £273bn, or 14 per cent of GDP—easily exceeding the peak of 10 per cent in 2009-10 following the financial crisis.
That’s not the end of the matter. Every year the Treasury, acting through the Debt Management Office (DMO), has to find money not just to finance its deficit—the gap between spending and revenues—but to roll over existing debt. As the bonds (“gilts”) it has previously issued come due, the DMO issues new ones to repay the holders of the maturing debt. Meeting these gilt redemptions will require additional funding of close to £100bn in 2020-21.
Given this deluge of borrowing it is natural to wonder whether the government might be tempted to put pressure on the central bank to help out. That’s why alarm bells rang when the Treasury and the Bank announced on 9th April a reactivation of the government’s historic “ways and means” facility. This is in effect its overdraft account, which came in handy during the financial crisis when it briefly reached (at the end of 2008 and early 2009) almost £20bn.
When a central bank lends directly to the state, this is “monetary financing,” in which government borrowing is funded by creating…