Has the Bank of England found a magic money tree?

In the middle of London, sitting atop Bank tube station, an anonymous looking building that hides many secrets and treasures: the Bank of England. My favourite treasure which I discovered while working there was that in the centre of this monolithic structure is the Governor’s garden, a beautiful secluded oasis with blooming rose bushes, hidden in the heart of the city.

Could this garden be the secret location of the magic money tree? The surge in government spending to combat the coronavirus suggests the mystical plant has been found- and there are whispers going around that the central bank has helped to make that happen.

Governments internationally have rightly responded to the pandemic by ramping up fiscal spending to combat both the physical health crisis and the resulting economic impacts. WBG’s policy analysis has highlighted that the effects of the pandemic are hitting hard in areas where women were already disproportionately struggling- paid and unpaid care work, low-paid and insecure work, poverty, debt and homelessness- creating a devastating magnified crisis that requires a big, bold and fast response.

A concern for many is how all this spending will be paid for, and what to do about massive fiscal deficits that are building up in almost every country. Money does not in fact usually grow on trees, as the UK austerity program of the last decade has repeatedly emphasised.

Supporters of modern monetary theory have long insisted that governments with strong control over their own monetary supply- like the UK, US, Japan, but not countries in the eurozone as their monetary decisions are made by the European Central Bank- could get their central banks to generate as much new money as they want and never have to worry about fiscal deficits.

Central banks can (and do) provide loan facilities like normal banks, so they do create money like normal banks. But just like normal banks those loans are supposed to be repaid. The money is not like fruit being picked from a magical tree- it has to be returned, in order to keep tight control of the quantity being loaned out. If the central bank loaned out an unending stream of money this risks hyperinflation, where the currency drops in value and price rises spiral out of control- like happened in Weimar Germany in the 1920s or Zimbabwe in the 1990s.

Central banks also use their loan-creating ability to buy financial products like corporate and government bonds, such as in programs of ‘Quantitative Easing’. This helps to smooth the functioning of financial markets, and reduce the impact of a credit crunch and falling spending during a recession, as in 2008 onwards and now in 2020. Those bonds and so on are eventually sold on, or whoever issued the bond repays the money*.

The key is that central banks are in control. Orthodox economic theory says that the central bank must control their ability to create loans, and never the government- because if short-sighted politicians got hold of the central bank’s ability to create loans they would go crazy splashing the cash around to buy popularity and again, end up causing economic collapse from price inflation. Central bank activities have to be strictly limited in size and timespan and definitely not dictated by government spending plans.

In summary, central banks cannot create an unending supply of money that doesn’t need to be paid back. Government debt will have to be repaid somehow. Fiscal deficits have increased before, but how can they be reversed without the austerity programs that disproportionately hit women– BAME and disabled women most of all- that WBG has long campaigned against as so damaging to the very fabric of social reality?

By investing in services that will provide long-term social benefits, as well as stimulating the economy out of the Covid19 recession, the government can build sustainable social resilience that supports economic vitality- that will also eventually reap the benefits in tax receipts to pay back the debt.

WBG and partners’ research has shown the multiple dimensions of the power of investment for economic vitality and so social and government financial sustainability: poor mental health support and low access to work for disabled people who want to work are a drag on economic productivity; weaknesses in childcare provision reduce women’s work productivity; GDP growth has long past its day as the antidote to fiscal deficits, ever more so in the ecologically and socially sustainable degrowth environment. Addressing these areas not only combats economic downturn, it builds a more resilient society for the long term.

These perspectives on socially-mediated economic factors have reached maturity now that fiscal stimulus is gushing from the government spending taps- there is a once-in-a-lifetime opportunity to address societal as well as economic needs that must be made the most of through thoughtful policy design.

Ultimately it is the government who must be wise about how to pay for the vital response to the coronavirus crisis, as well as the long-term sustainability of paying for society’s needs. The magic money tree remains unfound and only roses will be blooming in the Bank of England’s secret garden.