From Phenomenal World, May 27:
Pecuniary Salvation
Monetary financing—the issuance of public money to support public expenditure—has in recent times become a policy taboo. The message from economists to politicians, policymakers, and society more broadly is often that any central bank support for public expenditure is likely to destroy an economy.
In 2009, the taboo stopped the European Central Bank (ECB) from buying sovereign debt in the open market, an activity that, as we will shortly see, European treaties had been explicitly drafted to allow. Newly issued public debt languished on the market. Eventually, pent up supply and panicked investors brought the very project of European integration to the brink of collapse. This was a very different scenario to what happened in the US and the UK, where, in 2008 and 2009 respectively, central banks launched enigmatic “quantitative easing” (QE) programs, which involved buying large volumes of government debt.
By 2020, the ECB had changed its tune. At the outset of the pandemic, it followed the Bank of England and the Fed, dutifully launching massive public debt purchase programs. Former ECB president Mario Draghi published an op-ed with the ominous title: “We face a war against coronavirus and must mobilize accordingly.” The model to follow was, he argued, was wartime monetary finance. When Christine Lagarde took over as president in 2019, she pointed to the role of government debt purchases in ensuring “supportive financing conditions […] for governments.”
In recent years, central bankers have taken a more conciliatory position. While conceding that central banking does at times involve outright purchases of debt, they maintain to the public that today’s quantitative easing should not be confused with monetary financing. The reason is that the objective of bond purchases is not to facilitate government spending. Indeed, orthodox central bankers and critical academics have alike sought to distinguish today’s interventions in sovereign debt markets from historical practices of monetary financing. Despite those efforts, there are few notable differences between the bond purchases of the Great Depression, the two World Wars, and the Cold War and the “unconventional” policies of 2008–2022. The main contrast lies in communications strategy.
In a recent article in the Review of International Political Economy, we propose a new macro-financial account of monetary financing to explain the historical continuity of central banking practices. As we show, central banks have almost always acted to buy debt issued by governments in a crisis. We make our case by pointing to how central banks supported treasuries in the jurisdictions that have issued the two global currencies of the post-industrial age: the United Kingdom and the United States. We show that monetary financing has always been important in helping states navigate large fluctuations in the demand for, and supply of, government debt. The ECB’s 2009 refusal to support struggling member states stands as an exception in twentieth-century central banking practice. Relying on newly disclosed archival documents, we also show that in the early ‘90s, central bankers drafted the ECB mandate to make sure the central bank could buy government debt when needed—an insight that got lost in the market-ideological enthusiasm of the late ‘90s and early 2000s.
Central banks have always acted—and always will act—as the lender of last resort to governments facing what we describe as “sovereign-financing gaps.” Wars, post-war reconstructions, financial crises, and other economic emergencies force the treasury to spend as fiscal receipts disappear, irrespective of private investor demand. The central bank, as the issuer of new public money, typically accommodates those spending programs, either by directly acquiring debt from governments or by bulk purchases in secondary markets from securities dealers. Its role is to monetize deficits until supply and demand dynamics stabilize. On this account, stabilization of sovereign financing conditions is a “feature” not a “defect” of central banking.
The most distinctive feature of sovereign finance is the demand for a continuous but irregular supply of funds which is exceptionally large relative to any other borrower, even in normal times. Sovereign financing gaps can easily exceed private creditors’ willingness to lend. In extreme circumstances, no credit is available in markets at affordable prices, for even the most solvent sovereign. When “debts are large and precarious creditors shy away,”1 the volume of debt that treasuries can sell, even at high interest rates, is limited. Monetary finance becomes necessary “because debt cannot be sold.” Wherever sovereign financing gaps arise, governments must rely on central banks....
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