On 9th April, the Bank of England (BoE) announced that it had agreed with HM Treasury to extend the Ways and Means facility as a temporary measure, to ‘provide a short-term source of additional liquidity to the government if needed to smooth its cashflows and support the orderly functioning of markets, through the period of disruption from Covid-19’.
Does this amount to the central bank directly financing the government’s extra spending, as welcomed by the campaign group Positive Money? Cambridge Paper author Paul Mills, who has worked as a senior economist in both HM Treasury (HMT) and the IMF, explains:
The Ways and Means account is essentially the Treasury's end-of-settlement day bank account at the BoE. The Treasury, which manages government finances, clears its payments through the BoE who then interacts with the private banking system through the payments clearing systems.
This was a key part of monetary policy in the 1980s when the money supply was deliberately targeted as a policy goal. If money supply growth was deemed too high, which was believed to risk excess inflation, the Treasury would sell more gilts (government bonds) to the non-bank private sector than it needed to fund its deficit in that period. This 'overfunding' put the W&M account into surplus and reduced reserves held by the banks. If monetary stimulus was thought needed, the Treasury would underfund its deficit, the W&M would fall into overdraft and reserves would rise with the banks (via their holdings of reserves at the BoE.)
This approach went out of fashion in the mid-to-late 1980s with, first, implicit exchange rate targeting and then formal entry into the European Exchange Rate Mechanism taking its place. It ceased with the implementation of the Maastricht Treaty in 1993 when central bank funding of central government was prohibited as a precursor to monetary union. (The Treasury had to be in surplus with the BoE and the W&M account was meant to be flat overnight.) From 1998, the Debt Management Office (DMO) managed the Treasury's cash position independently in the money markets and ensured HMT was in surplus with the BoE.
The W&M account was reactivated in 2008 at the height of the financial crisis as an emergency measure but then went into abeyance to comply with the EU Treaty.
Now that the UK is out of the EU, the W&M account can be used again to meet HMT’s short-term cash needs - presumably if the DMO can't cover the deficit in the short-term due to gilt or money market dislocation.
Positive Money are celebrating prematurely in that, since Brexit, firing up the W&M account has always been a theoretical emergency capability. The issue is not that it exists but whether HMT decides it wants or needs to fund its long-term deficit through overdraft borrowing from the BoE. If it were to do so, effectively the deficit would be financed by crediting the banking system with cash balances/excess reserves at the BoE.
Positive Money are incorrect in that public debt does increase with the deficit as the W&M balance is a debt to the BoE. (The BoE is outside the central government sector for accounting purposes.) Even if it is included in general government, the bank's deposits with the BoE are a liability of the public sector, just as cash notes are.
Positive Money take an extremely dangerous position in that while they are entirely correct regarding the creation of money in our bank-debt money world, they then think the solution is to nationalise the process and make money creation a political decision rather than fundamentally reforming the whole debt-based edifice and the banking system. Checks and balances are vital in a fallen world, and powers should be separated. We should be telling the government that its debts are promises to be kept, not claims that can be inflated away at political whim. High, or hyper-, levels of inflation are disastrous for the poor and vulnerable. Going down that route would swap one problem for another – not solving it.
Cambridge Papers for further reading:
'Time for a Financial Reformation?' by David McIlroy
'Prodigal Stewards: The looming government debt crisis' by Paul Mills