Wednesday, 24 March 2021

An accounting model of the UK Exchequer.

The above is the title of a recently published work which sets out in detail the book-keeping entries etc involved at the UK Treasury, Bank of England and commercial banks when the UK government engages in tax collection, public spending, borrowing and money creation. Plus there’s a 45 minute youtube summary by one of the authors.

The work is the length of an average book and congratulations to the authors for all their hard work. The complexity is mind blowing and I have nowhere near got to grips with it, and probably never will. So . . . “errors and omissions expected” in the paragraphs below. This work supports the idea that governments and their central banks are not constrained by anything much (apart from inflation) when it comes to creating and spending extra money in a recession.
The conventional view (which I’ve always gone along with) is that when government wants to borrow and spend more, it first borrows and then spends the money borrowed. And an independent central bank (CB) can then react to that in whatever way it sees fit. E.g. if the CB thinks the extra borrowing will raise interest rates too much it can cut them, e.g. by creating new money and buying up government debt. Alternatively if it thinks the extra spending will be too inflationary, it can raise interest rates, e.g. by selling government debt into the market. (Incidentally I’m using the phrase “independent central bank” simply to refer to a CB which is free to adjust interest rates: clearly there are ways in which so called indepent central banks are not independent.)

However, far as I can see from the above work, that is not actually what happens. Rather, when parliament decides to spend money over and above what it collects in tax, the Bank of England will automatically create the money needed, which will then be spent. But the BoE will demand collateral from the Treasury in the form of government debt, i.e. Gilts.

After that, the Boe is free to adjust interest rates up or down as described above. Thus what the above work says (end of section five) is that the extra spending may take place BEFORE the “government central bank machine” borrows or extracts extra money from the private sector.

On the other hand, far as I can see, that’s not NECESSARILY what happens. That is, it’s presumably possible that the BoE gets wind of extra government spending (not funded via tax), and if the BoE thinks inflation is getting uppity, it may immediately sell government debt into market to mop up money and impose a countervailing / anti inflationary effect.

So to repeat, one of the important points made by this work is confirmation that the UK government and the Bank of England are not constrained (other than by inflation) when it comes to creating and spending more money. However, the exact way in which that “create and spend” process takes place are not quite as per the conventional wisdom. And finally, once again: errors and omissions expected.

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