Independent central banks exist to protect politicians from one of the oldest temptations of government. For at least the last two thousand years, political leaders in control of their own money supply have looked to increase it during times of economic stress. The Roman Emperor Aurelian reduced the amount of silver in the Antoninianus coin, allowing him to mint more of them. Henry VIII took a similar approach, painting a thin layer of silver on to copper coins and earning himself the nickname “Old Coppernose”. From the fifteenth to the seventeenth centuries, the Spanish Empire flooded the market with newly minted coins from South America’s silver mines. And in the twentieth century, Weimar Germany and Mugabe’s Zimbabwe simply printed more notes.
In the best of the cases above, the results included inflation, currency devaluation, and increased borrowing costs. In the worst ones, printing money led to a vicious cycle that spiralled into hyperinflation.
The present-day version of printing money is known as monetary financing—meaning the permanent creation of new central bank reserves, in order to directly finance government spending. Understandably, given the warning from history, it is a process that independent central banks are reluctant to engage in. Only two weeks ago, the Bank of England’s governor wrote in the Financial Times that monetary financing was “incompatible with the pursuit of an inflation target by an independent central bank”. He noted that such activity would erode the operational independence of the Bank, and that in other countries it had led to runaway inflation. Four days later, the Treasury announced that the UK government’s bank account at the Bank of England will be expanded to an unlimited extent in order to fund its response to COVID-19. This will be achieved by the creation of new central bank reserves.
It is important to pause and note two points. First, almost no one doubts that massive government spending is required to support the economy through the current crisis—and that money has to come from somewhere. Second, the creation of new central bank reserves does not inevitably lead to runaway inflation. Much of the developed world has been engaged in quantitative easing (yet another name for printing money) for the last decade, and inflation has remained subdued.
The risk here is not monetary financing per se, but around who controls its extent and duration. Historically, the worst cases have arisen when governments themselves have been in control. Expanding the money supply appears to be addictive and, at least in the short term, vastly preferable to facing harsh economic realities. For exactly this reason, more recent experiments in money printing have remained firmly under the jurisdiction of independent central banks that are obliged by law to target low levels of inflation. By and large, both financial markets and the wider public seem to have faith in this approach. In the UK, for example, the Bank of England currently owns more than 25% of government debt (having printed money to purchase it) and yet inflation expectations remain low and manageable.
So, is UK inflation about to take off or not? In the absence of other factors, the answer depends on how quickly the government is prepared to give up its unlimited bank account and hand control back to the Bank of England. At the height of the 2008 financial crisis, government drawings on the Bank of England account briefly hit £20 billion before the Treasury handed control back to the Bank and resumed borrowing in the bond market. Those who are concerned by inflation should watch closely to see whether that level is breached this time round. History has another warning here: governments are quick to assume emergency powers during a crisis, but slow to relinquish them afterwards.
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