After 2008, the Bank of England refused to print money for government spending. With the coronavirus crisis biting, it’s time to think again

As debate gathers momentum on how we are to meet the economic costs of the pandemic, it is possible to discern two sets of arguments around which the debate will settle.

There are those who see a grim future of spiralling public (alongside household and corporate) debt, and anticipate another decade or more of austerity, in the form of tax hikes and spending restrictions. There are others of a more optimistic bent who spot the opportunities from central banks promising to “do what it takes” in monetary policy, creating a forest of money trees which can be logged to pay for all their pet schemes from a generous, permanent Universal Basic Income to a Green New Deal to colonies on Mars.

Both are wrong.

The debt burden is less of a worry than it seems. Public debt in the UK and many other countries, when measured in relation to the economy, is way below the levels which prevailed after the two world wars. It can be gradually reduced through a combination of real economic growth and inflation. Servicing is cheap, thanks to ultra-low interest rates – close to zero in real terms. Yet more austerity is not therefore a necessity for the UK.

This comfortable conclusion may not, however, apply to countries such as Italy and some emerging economies where debt levels start high. All rely on their creditors’ indulgence, known as “the kindness of strangers”.

The optimistic money tree theorists rely on the emergence of unorthodox, emergency monetary policies which they hope to make permanent. Printing money for deficit financing is part of the response needed to absorb a big economic shock, but it carries great risk if it is used as a cash machine for uncontrolled routine spending. The late president of Zimbabwe, Robert Mugabe, and a succession of presidents in Argentina found that the consequence is hyperinflation.

The fundamentals are not new and go back to the beginning of time when God created the economic paradise of the Garden of Eden. Adam, government, was responsible for fiscal policy: spending money on the Garden and raising funds by tax or borrowing to pay for it. He kept his hands off the forbidden Eve, who managed the money supply, set interest rates and ensured that inflation is kept within bounds.

All was well initially. I made my maiden speech in parliament worshipping the British form of this creation in 1997, when Gordon Brown made the Bank of England independent. The European Eden had been created a few years earlier and the American, Swedish and others had been operating for longer.

Then along came a serpent in the form of the financial crisis offering a tempting apple to Eve in the form of quantitative easing. By printing money to buy up lots of government bonds, the central bank was able to inject cash into banks and other financial intermediaries. In turn, they could lend money out into the wider economy, easing the supply of credit which had been choked off by the collapse of several banks and perilous position of others.

Money was being created in the form of credit. But this was not “free money”, unaccounted for. Headline figures about government debt remained transparent – and rose sharply. Interest on bonds still had to be serviced, and the money repaid.

In the years of coalition government, I once asked the governor of the Bank of England, Sir Mervyn King, why the central bank could not help us more directly by “printing money” to finance some government activity, thereby avoiding painful cuts. He was shocked and insisted that this would be to intervene in fiscal policy, which was nothing to do with him. That was Adam; he was Eve – and she could not be compromised.

We now have an even bigger crisis. Serpents abound. The temptations are much bigger, as are the dangers of doing nothing.

Quantitative easing has been immediately invoked to provide cash to keep the banks lending, and also to keep down the interest rate on government debt. But a much bigger problem is how to help millions of desperate people who have lost their jobs, and thousands of desperate firms who have no customers as a result of a deliberate decision to close the economy to prevent the physical spread of coronavirus.

The obvious answer is for central banks to lend directly to the government – the very thing Sir Mervyn was so affronted by. This is already happening in Japan, but the fiction is still being maintained that the government must service and repay this debt. Yet the bailiffs never come calling. The virginal position of the central banks remains intact, in theory.

But it won’t require much now for them to go the whole way. Bonds can be issued to the central bank which are called “perpetuities” and never have to be repaid. Or the lending could be in the form of IOUs that are not designed to be sold back into debt markets. And the interest could be fixed at zero.

So why don’t central banks just admit that they have done the deed and are not ashamed? There are two reasons.

The first is the fear that Original Sin, letting fiscal policy enter monetary policy, will have consequences in the form of inflation. The risk is not trivial. While there is a collapse in consumer demand (which creates an opposite risk of deflation), there is also great disruption to supply: fields left unharvested; supply chains damaged; skills lost. Supply bottlenecks will create price pressure, perhaps sudden and dramatic, as those seeking out toilet paper four weeks ago know too well.

The second fear is precedent: what is to stop governments making endless demands to finance every whacky scheme that politicians want to spend money on? Eve, having once consumed the forbidden fiscal fruit, would lack authority to refuse further indulgence. In countries with a history of poor debt management and weak central banks, an orgy of reckless spending and uncontrolled inflation could follow.

For these reasons central bankers are being extremely coy about what they are doing: financing fiscal policy and looking the other way. There is a particular problem in Europe in that the European Central Bank is legally prevented from the necessary expansion of its monetary role, which may well lead to more trouble in Euroland. But this inhibition is not there for the UK, the USA, Japan, China and other major economies. Their coyness cannot endure. An explicit agreement must be reached between treasuries and central banks that the direct financing of government spending is justified, but that it is time limited and can be switched off when the process creates inflation.

Economic traditionalists will say that once innocence has been lost it can never be restored. But real life is not so binary. Neither crushing austerity nor an uncontrolled bounty of spending are necessary. Adam and Eve are capable of a grown-up relationship, in which the Garden of Economic Eden can be managed. At this time in particular, some carefully cultivated money trees are a shelter both can enjoy.

Sir Vince Cable is the former leader of the Liberal Democrats