Fears that central banks are engaging in direct financing of government deficits in the wake of the coronavirus pandemic are “misplaced,” Bank of England deputy governor Ben Broadbent said on Wednesday.
Central banks, including the Bank of England, have significantly eased monetary policy and dramatically expanded bond-buying in response to the crisis.
Because this has occurred alongside a surge in government borrowing to fund stimulus measures, critics have suggested that central banks are directly financing government deficits, a practice known as monetary financing.
Directly funding government spending would raise serious questions about the autonomy of central banks, which are meant to act independently from governments.
Broadbent said, however, that there was “nothing about the coincidence of the two in time that, in and of itself, constitutes monetary finance.”
Noting that the rise in government debt was prompted by economic weakness, Broadbent said that the natural response of independent central banks would be to ease monetary policy in order to tackle weak inflation.
Like most central banks, the Bank of England is tasked with ensuring price stability, or keeping inflation in check.
Concerns about monetary financing reached a fever pitch in April when the Bank of England expanded an overdraft-like facility used by the UK government.
While the Ways and Means facility could act as a kind of backstop if the UK government runs into temporary financing issues, it has not been called upon so far in the coronavirus crisis.
But the surge in asset purchases by the Bank of England has pushed the yield on UK government bonds — known as gilts — to record lows in recent months.
Bank of England governor Andrew Bailey was forced to deny that the bank was permanently expanding its balance sheet with the goal of funding government spending.
Broadbent said on Wednesday that, rather than focusing on the extent to which monetary easing occurs at the same time as a rise in government deficits, critics should instead examine the the relationships between the various institutions.
It matters much more whether monetary policy is “controlled by an independent authority, using its tools solely in pursuit of a fixed nominal objective,” such as price stability.
If, in the context of high debt levels, a government exerts “fiscal dominance” over a central bank such that it cannot focus on its own independent objectives, then monetary financing may nevertheless become a reality, he suggested.
“If its debt was so onerous that the government could not or would not finance it by conventional non-inflationary means, and if the independence of the central bank were sufficiently fragile, inflation could come to be viewed as just another tax, rather than something to be stabilised in its own right,” Broadbent said.