A reader here asked this question today:
Hi. New reader, found my way here via a recent interest in degrowth economics. I'm hoping someone here can clarify something that's puzzling me.
Richard has consistently said that the government can simply create money, seemingly with no real restrictions, and just use it immediately for public services etc. But aren't there laws in place preventing that? As I understood it the government currently has to issue bonds to be bought by private buyers (i.e. the debt everyone worries about) in order to obtain money. It can then if it wishes buy those bonds back with money created by the boe (QE) which effectively means it owes money to itself.
I guess my question is, is my understanding wrong, or is it just considered irrelevant because the government is still basically creating that money, it's just a bit of a roundabout way to do it (which conveniently enriches the already wealthy, but we'll leave that for another time!)
I thought this was a valuable question to answer in more detail than average, so this is my response, which is longer than my own 400-word comment limit allows, and so has become a blog post in its own right as a result.
First, the UK government really does create money, and does so every single day. It does so through the Bank of England, which is wholly owned by the UK state. That means the Bank is not some external entity, nor is it independent in the sense that a private actor is. It is, by law and by design, an agent of government policy — even if it pretends otherwise.
When the government spends, the Treasury instructs the Bank of England to mark up the bank accounts of whoever is being paid. That creates new money. No taxpayer's cash is “sitting there” waiting to be used. The government's spending comes first, and then the money is created, quite literally, by the accounting entries that follow from that instruction to pay.
Second, you're right that there are laws and conventions that currently require the Treasury to issue bonds (gilts and Treasury bills) roughly equivalent to its spending in excess of tax receipts. This is the consequence of the so-called full funding rule, which is a recent creation and is a convention that could be changed at any time. This is what we misleadingly call “borrowing”.
It is not a financial necessity. It's a political choice made to maintain the appearance of borrowing, because that helps preserve the myths of “sound finance” that neoliberalism depends upon. Those myths — that the state is like a household, that spending must be “funded” before it happens, and that debt is dangerous — are tools for limiting public purpose.
In reality, those bonds do not “fund” government spending. That has already been paid for. They are just a mechanism for transferring central bank reserves, which represent the money the government has already created, into interest-bearing accounts for the wealthy. It's a subsidy disguised as prudence.
Third, as you rightly observe, quantitative easing (QE) proved the point beyond doubt. During QE, the Bank of England bought hundreds of billions of pounds' worth of those same government bonds, using money it created out of thin air. That means the left hand of the state owed the right hand, and the debt, in any meaningful sense, disappeared.
The fact that this process is described in obscure technical language is not accidental. The complexity hides the simplicity: the state created money to keep the economy afloat, and in so doing it had first enriched bondholders. It could have funded the NHS, housing, or green investment directly. Instead, it funnelled liquidity through financial markets, the most unequal route imaginable.
Fourth, to your key point: are there legal barriers to doing this directly? Technically, yes, but only because the government has chosen to tie its own hands.
The 1998 Bank of England Act and the 1992 Maastricht Treaty rules (which still shape Treasury thinking) sought to create a formal separation between “fiscal policy” (Treasury spending) and “monetary policy” (Bank of England operations). The idea was to reassure markets that politicians could not “print money” at will.
But these laws are not constitutional constraints in the sense of creating a physical impossibility. They are policy frameworks, which Parliament could change at any time. In practice, they are already ignored whenever the system faces a crisis. QE itself, emergency lending during the financial crash, and Covid furlough payments all showed that when survival is at stake, the supposed firewall between the Treasury and the Bank evaporates overnight.
So there is a roundabout route in place. But that route was built for ideology, not necessity.
Finally, you touch on the real issue: who benefits from the way we currently do it.
By forcing the government to issue bonds, we gift private investors a risk-free income stream; interest on gilts. We also create artificial scarcity in money, justifying austerity, while inflating the wealth of those who already hold financial assets. It's a system designed to make the public dependent on the goodwill of markets rather than on democracy.
That, I think, is the point you sense when you describe it as a “roundabout way” that “conveniently enriches the already wealthy”. You're right; it does exactly that.
So, to summarise:
- Yes, the government creates money when it spends. It does so through the Bank of England, which is part of the state.
- Bond issuance is not a financial necessity but a political ritual; a hangover from the gold standard era, designed to disguise money creation.
- Laws exist to maintain that fiction, but they can be changed or ignored, as they routinely are in crises.
- The current system's effect is to entrench inequality and sustain the myth that government must “borrow” from the rich to serve the public good.
We could, if we chose, acknowledge the reality: that a currency-issuing government can always pay in its own money, and that the true constraint is not money but real resources; the people, skills, materials and energy we have.
Managing those resources sustainably is the real economics we should be debating. The rest is theatre.
In short, the government's power to create money is real. The restrictions are self-imposed. And the longer we pretend otherwise, the more wealth will be siphoned off by those who profit from that pretence.
A new glossary entry on the full funding rule has been created to support this post.
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Thank you so much for asking that question!
And thank you Richard for answering it with such a clear and concise summary.
I realised I had never addressed this one.
Here’s an angle which perhaps helps to explain how the “full funding rule” originated historically. It hinges on viewing the state as organised crime:-
https://davidlabaree.com/2021/08/12/the-state-as-organized-crime/
Really?
Can you please start explaining your more cryptic posts, please, or I will have to consider deleting them. I am not at all sure I see the link here.
I had a very “ lively debate’ the other evening, trying to explain how taxes don’t pay for government spending but was muddled about the role of bonds. So thank you for this post, I have forwarded it to my friends!
Thank you so much for this explanation. I’m rather pleased that my first question on this subject sparked a whole blog post in response but do feel a little guilty at making you work when you have birds to watch!
Birds have been watched
You used coffee time
All technically correct….. but I would argue that the issuing of bonds is a bit more than mere “theatre”.
First, in the long run, most money spent by government needs to be drained from the system; the supply of government money should grow with the size of the economy. Otherwise, inflation will ensue and, in extremis, people will be reluctant to hold money, the Exchange Rate will plummet and very high levels of inflation would follow.
Second, around this “long run” there will be considerable variation required. This is mainly to counteract the creation/destruction of (bank) money as loans are taken out (creation), repaid or even defaulted on (destruction).
Third, this drain is (and should be) mainly done by taxation… but you don’t know in advance what a particular tax will yield and you can’t keep changing tax levels every few months. But you can chop and change Government bond issuance quite quickly and conduct open market operations at the drop of a hat.
Fourth, it is bond issuance, along with open market operations, that allows interest rates for the economy at large to be kept at appropriate levels. (Note, this is not an endorsement of current levels).
So, I understand your desire to emphasise the point that the government does not need to borrow (which is true) – but we still need a bond market.
I have never argued with the fact that we need a state backed savings (or bond, for the time being) market.
I am increasingly questioning whether we need the one we have.
I increasingly question whether we need the central bank and even banks we have.
In fact, I am wondering for the first time whether central bank digital currency makes more sense. I have not got an answer as yet, but in response to the questions on Scotland this week, I think it might be. And do we need a bond market then? Why?, would be the answer.
Starting from scratch one might not create the institutional framework and “plumbing” that we have… but we DO have our current framework and, if this is not to be merely an intellectual exercise, we need to stick to suggesting modifications to the existing framework/”plumbing” to deliver better results.
For my money?
Most importantly, get politicians to alter their language about money, get journalists to challenge them on it.
Stick with the full funding but not make it an iron law. Rather, get the BoE to operate across the yield curve to keep the entire gilt curve at appropriate levels to balance the economy – ie. a fair balance between savers and (non-government) borrowers. So, buying and selling gilts into the BoE portfolio to control yields rather than QE/QT. This is easily done – just get the right people into the BoE.
We want access to gilts for all through (say) NS&I but we need gilts rather than NS&I style savings products because we need liquidity and duration… which gilts offer perfectly well.
Central Bank Digital Currency (CBDC)? In it’s pure form it would mean everyone having a Reserve Account at the BoE (which, at the moment, 17 banks have). It could be done pretty easily – I have a friend that has a personal account at the BoE (or did when I last spoke to him 10 years ago). He got it when he worked there and although staff don’t get that “perk” anymore they have maintained existing accounts. So, in may ways, the infrastructure could be said to exist in rudimentary form already… albeit cheques rather that electronic transfers.
The problem is Know Your Customer (KYC) that banks currently perform; the BoE has NO interest in performing this task so the best we will get is CBDC accounts with the BoE but intermediated by commercial banks…. which rather defeats the object.
All noted Clive.
And yes, some of the changes you note would undoubtedly be useful. But rethinking the whole system is well overdue. It is obsolete. Innovation is essential. Tweaking can’t solve all the problems. That does not make thinking about it an academic exercise. Without thinking change is possible nothing will happen. Saying don’t do the thinking is how to prevent change happening altogether.
Thanks. So suppose the government stopped issuing new bonds tomorrow, what would be the consequences?
I had kind of assumed (not that you ever said it explicitly) that bond issues were part of balancing the economy, that in the absence of new bonds there would need to be a higher tax regime to counter the risk of inflation. But maybe things would carry on as before without problems.
At the very least it would presumably do funny things to those central bank reserve accounts.
The answer is the government woul;d have more control of money.
I am not syaing it shoi;d stop issuing bonds.
I am saying a ruse that supposedly puts bond markets in charge is the worst possible policy – and is utterly destructive.
Excellent. Right to the core. More, more, more
The mystery can be debunked, as you did, by referring to Rishi Sunak’s furlough scheme and the recent energy crisis.
Everybody knows what happened in these two separate but related events.
In the first, the gov paid the wages of people who couldn’t work due to covid; in the second, the gov paid a part of everyone’s energy bill because the price of energy had shot up putting many into financial difficulties. Did the gov say they needed to collect in more taxes or borrow before they could pay out? No, not at all.
They simply created new money to make the payments, about £300 billion of it. Not even a titter from the press, or an angry word on the telly from any so- called ‘think tank’. Everybody seemed to accept it was necessary in a crisis.
Well, if our current situation is not a crisis, I’d like to know what is.
We can create as much money as we need to, as long as the real economic resources are available to match it, to deal with any ‘crisis’.
All of the aforementioned money creation did not actually cause all of the inflation that eventually followed covid. Most of the brief spike in inflation was caused by supply shortages, in particular energy supply affected by Ukraine war.
Of all the countries that embrace progressive values I think Denmark does it best. The true constraints are not money but real resources as you say; the people, skills, materials and energy we have. Sure, Denmark has a currency peg to the Euro, but only because it suits and could abandon this at short notice if needed. You don’t hear Danish politicians saying there isn’t enough for this, or where do we get money for that, they go next level and look at real resources, decide what they want, decide who does it best (you don’t want government run cafes or grocers, you do want education and SHI) and get to it.
But we don’t need to copy its migration policies, which are far from its finest moment.