The dysfunctional taboo: monetary financing at the Bank of England, the Federal Reserve, and the European Central Bank

Abstract

Monetary financing – the issuance of public money to support public expenditure – remains a widespread policy taboo. In this article, we analyze the operational practices of the Bank of England, the Federal Reserve and the European Central Bank (ECB) from the 20^th onwards to argue that monetary finance should be understood as a conventional and legitimate part of central banks’ core functions. We argue that monetary financing serves a crucial macro-financial role in the face of large fluctuations in the demand for and supply of government debt, where the central bank acts to stabilize sovereign debt markets. We show that monetary financing has been a stable and pervasive feature of the Bank of England’s and the Federal Reserve’s operations. Turning to the ECB, we show that by the mid-2000s the view came to dominate the institution that the central bank should allow markets to punish governments for excessive deficits. This view informed the ECB’s catastrophic reluctance to act on the 2008 and 2009 Financial Crisis deficits. By 2020 that attitude had once again largely been abandoned.

Keywords:

• Monetary policy
• monetary finance
• Maastricht Treaty
• government debt
• sovereign debt
• quantitative easing

Acknowledgments

This article results from a multi-year collaborative research project on monetary financing, for which we would like to acknowledge helpful comments from Benjamin Braun, Nik de Boer, Eric Monnet, Saule Omarova, the editors and three anonymous reviewers, as well as the participants in the Central Banking beyond Price Stability workshop (University of Amsterdam, January 2022) and the Democratic Central Banking conference (University of Amsterdam, July 2022). Jens van ‘t Klooster received support from the Dutch Research Council (NWO) under Grant 406.18.FT.014 and the Research Foundation – Flanders (FWO) under Grant 1227920N.

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1 See, inter alia, Treaty on the Functioning of the European Union, Art 123, Islamic Republic of Pakistan. (2008, November 20). [Letter of Intent, Memorandum of Economic and Financial Policies, concluded with the International Monetary Fund], Constitution of the Republic of Chile, Art 109.

2 ECJ Case C-62/14. The Court asserts that purchases of debt are permissible only if the ECB built “sufficient safeguards into its intervention to ensure that the latter does not fall foul of the prohibition of monetary financing” to ensure the ECB does not “reduce the impetus which that provision is intended to give the Member States to follow a sound budgetary policy.” (Par 100. cf. Case C-493/17, par 107).

3 Details on securities holdings acquired under the Securities Markets Programme https://www.ecb.europa.eu/press/pr/date/2013/html/pr130221_1.en.html; Federal Reserve ‘Assets: Securities Held Outright: U.S. Treasury Securities’; Office of National Statistics, ‘Public Sector Finances: PSA9’. https://www.bankofengland.co.uk/-/media/boe/files/asset-purchase-facility/2012/annual-report-2012.pdf

4 OECD Data - General government deficit Total, % of GDP) (2008-2012).

5 Bundesbank president Axel Weber resigned in February 2011 and the German ECB board member Jurgen Stark did in September of the same year.

6 Federal Reserve ‘Assets: Securities Held Outright: U.S. Treasury Securities’; Office of National Statistics, ‘Public Sector Finances: PSA9’.

7 Decision (EU) 2020/440 of the European Central Bank of 24 March 2020 on a temporary pandemic emergency purchase programme (ECB/2020/17).

Additional information

Notes on contributors

Will Bateman

Will Bateman is Associate Professor and Associate Dean (Research) at the Australian National University College of Law. His research studies law, finance and economics with a particular focus on sovereign debt, monetary authorities and wholesale financial markets.

Jens van ‘t Klooster

Jens van ‘t Klooster is Assistant Professor of Political Economy at the Department of Political Science of the University of Amsterdam. His research focuses on the governance of the financial system and its environmental impact.