Thread by @DEhnts

"Historically, populism has encouraged monetary financing of public debt, followed by a descent into inflation. This is deeply troubling."

There is no such thing as "monetary financing" and it is deeply troubling that the FT does not understand it.

ft.com/content/91efe8…

There is only one way a modern government spends. The central bank credits the central bank account of the bank of the receiving party, which then creates bank deposits for the receiving parts.

Government spending is always a monetary phenomenon.

A government when it taxes or sell bonds is taking back reserves (central bank deposits) that it has spent or lent into existence in the past.

These are not "financing" operations.

Bond issuance is there to stabilize the interest rate because otherwise an increase in government spending floods the interbank market with reserves, leading to a fall of the interest rate to zero. The central bank cannot allow that to happen.

The usual solution to this problem is that the central bank sells government bonds to the banks, which give up their reserves. They are happy to do so because the interest they receive on bonds is higher than that on reserves. If not, the CB can change that.

So, a central bank is supposedly engaging in "monetary financing" when it buys government bonds. This will drive the prices of these bonds up and hence lower the interbank market interest rate and yields of all maturities. Zero is the limit.

This means that a central bank engaging in "monetary financing" would drive interest rates and yields towards zero. Since the interest rate (and the yields) are policy variables, it would have to give these up and accept a permanent zero interest rate policy (ZIRP).

The government would not get a single $ from all the bonds the central bank purchases because the government usually does not sell directly to the central bank. Therefore, "monetary financing" has nothing to do at all with "financing" the government.

"Monetary financing" is about driving interest rates and yields towards zero and acting as a lender of last resort. The central bank signals that investors can always sell government bonds at good prices to the central bank. "Monetary financing" is a term that hides this.

When the FT writes...

"Historically, populism has encouraged monetary financing of public debt, followed by a descent into inflation. This is deeply troubling."

... the Great Financial Crisis comes to mind. Here is the balance sheet of the Bank of England after 2008/09:

bankofengland.co.uk/-/media/boe/fi…

The Asset Purchase Facility of 30 December, 2020, has contained £724,937 million worth of gilts (UK government bonds).
bankofengland.co.uk/asset-purchase…

The 2010s were not a time of high rates of inflation. "Monetary financing" is a misleading term that scares people into thinking that the central bank's actions as it implements a zero interest rate policy and acts as a lender of last resort would result in "inflation".

It would be splendid if the FT would write about the Bank of England acting as a lender of last resort, ensuring low interest rates across the spectrum. These are good policies that have not and will not lead to problematic levels of "inflation". "Monetary financing" it is not.