Monetising the debt – BoE to buy UK Government Bonds

So it has happened: these extraordinary times have caused our Government to look to Zimbabwe for economic policy inspiration and so, as of last week, the Bank of England will begin a £150 billion programme of printing money.

Technically referred to as Quantitative Easing, it’s actually a lot easier than printing money, and more environmentally friendly too: the Bank just types a number into a computer to increase the balance of a customer’s account and, unless the customer wants to actually withdraw the money, no trees will be harmed.

The majority of this money will be used to purchase Government bonds, but some will also be used to buy high quality company bonds. You might think that using Central Bank money to buy government debt is illegal under EU law, but, as long as they go through an intermediary (even if that is a bank like Lloyds or RBS, who they majority own), it’s allowed:

Article 101 of the Treaty establishing the European Community states:

Overdraft facilities or any other type of credit facility with the ECB or with the central banks of the Member States (hereinafter referred to as “national central banks”) in favour of Community institutions or bodies, central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of Member States shall be prohibited, as shall the purchase directly from them by the ECB or national central banks of debt instruments.

The Government and the Bank of England are side stepping this law by purchasing Gilts (UK Government bonds) from Commercial Banks indirectly in the secondary market. However, in the long run, the effect will be exactly the same: The Central Bank is printing money to lend it to the government.

Lorenzo Bini Smaghi from the European Central Bank highlighted the potential consequences as follows:

Central bank independence: from theory to practice

It is beyond doubt that conducting an independent monetary policy, aimed at the achievement of low and stable inflation, is made significantly more difficult by the existence of large budget deficits. This is true for two related reasons.

First, when deficits and public debt become unsustainable, the incentive for the government to force the central bank to monetise its deficit, thus eliminating public debt via inflation, increases substantially.

Second, the larger the budget deficit and the accumulated debt, the more market participants become aware of the risk of monetisation.

In addition, they may believe that the central bank will be forced to “bail out” the government by assuming its liabilities, even if Article 103 of the Treaty explicitly prohibits this.

This may jeopardise the anchoring of inflation expectations and make the control of inflation more costly. In this case, fiscal policy may become dominant over monetary policy, thus undermining, de facto if not de jure, the functional independence of the central bank.

The government is taking on so much debt, that it will take many generations to repay. It’s therefore looking more likely that at some point it will need to be eroded through a period of high inflation, which is affectively another stealth tax – the inflation tax.

The Bank of England says this Asset Purchase Programme is temporary and they will look to sell any assets purchased under the scheme back to the market when the economy recovers. Let’s hope they resist the temptation to dramatically expand it, and are serious on their commitments to low inflation.

5 thoughts on “Monetising the debt – BoE to buy UK Government Bonds”

  1. Why do you persist in posting this drivel passed off as economic theory and enlightenment? The situation in Zimbabwe is so far removed from the UK that any mention of similarities between the two merely highlights the limit of your understanding of general economic foundations. Mugabe’s government were and still are printing money with the prime intention of funding the country’s current account deficit. The quantitive easing programme introduced by the UK has the primary aim of stimulating demand through an increase in the money supply – which by the way the central bank is primarily undertaking by purchasing gilt-edged bonds and securities from pension and investments funds and not directly to banks – this is an important distinction to make.

    If I were you, I would leave the economics to those more qualified to comment – of which there now seems to far too many to listen anyway. You would do well by reading some articles/books by the likes of John Kay in order to improve your comprehension.

  2. How can quant-easing be any good? Is there such thing as a business cycle? Is this a ploy from a few top individuals that want control or modern day financial slavery? How can a bank print money out of thin air and supply it to civilian’s to spend and just get into more debt; e.g: plumber-person has no job… (BofE just introduced “quant-easing”) bank prints money off and give’s it to the plumber to spend at a cost; in the near future your in debt and the money the BofE supplied must be paid back with large interest. I believe there is no business cycle, this is just a few individuals trying to gain control, all central banks are from the same seven-headed dragon, but I think we all to blind to see this.

  3. “I am afraid that the ordinary citizen will not like to be told that banks can and do create money …And they who control the credit of the nation direct the policy of Governments and hold in the hollow of their hands the destiny of the people.” – Reginald McKenna, UK Chancellor of the Exchequer 1915-1916.
    I found this video on YouTube which really opened my eyes to the importance of getting out of debt:
    I am sure you will be as amazed as I was.

  4. Hi Paul

    Thanks for a very helpful blog.

    I have been asked to prove that EU rules bar governments from explicit money creation and your extract of Article 101 above nails it – both by central bank overdraft and monetization of bonds.
    Could you point me at the “treaty establishing EU states please”, name and year? The link doesn’t seem to work.


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