Monetary Financing
Monetary financing is a central bank funding government spending directly, by lending to the state or buying its debt when issued, with newly created money. Many legal systems prohibit it because of its link to high inflation.
Also called: deficit monetisation · debt monetisation · printing money to fund the government · central bank financing of government
In ordinary conditions a government spends what it raises in taxes and borrows the rest from investors at market rates. Under monetary financing the central bank supplies the funds instead, either through an overdraft for the treasury or by buying government bonds directly at issue. The money it creates becomes bank deposits and cash in the economy.
The European Union writes the ban into its treaties. Article 123 of the Treaty on the Functioning of the European Union forbids the ECB and national central banks from granting credit to public bodies or buying their debt instruments directly. The ECB explains that this keeps governments subject to market discipline, since they must borrow on competitive terms. Secondary-market purchases are allowed in principle but must not be used to get round the ban.
Historically, monetary financing is the common thread of hyperinflation. Germany in 1923 printed money to pay workers and firms resisting the Ruhr occupation; later episodes in Latin America, Zimbabwe and elsewhere followed a similar path.
The line between monetary financing and quantitative easing is legal and institutional more than mechanical. Both create central bank money and both put government bonds on the central bank's balance sheet. The difference lies in who decides, for what purpose, through which market, and whether the purchases can be reversed. For anyone assessing a currency, the question is whether the central bank can still say no to the treasury.
In practice
The legal definition depends on the jurisdiction. The EU prohibits direct credit and primary-market purchases; other countries allow limited, temporary advances to the government under their central bank laws.
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Commonly confused with
| Term | How it differs |
|---|---|
| Quantitative easing | Quantitative easing buys bonds in the secondary market to meet a monetary policy objective, at the central bank's discretion. Monetary financing funds the government's budget directly. |
See also
- HyperinflationHyperinflation is an extremely rapid and accelerating rise in prices, conventionally defined as inflation above 50 percent a month. Money loses value so fast that people stop holding it and switch to goods or foreign currency.
- Quantitative EasingQuantitative easing is large-scale buying of government bonds and other assets by a central bank, paid for with newly created central bank reserves. It is used to push down longer-term interest rates when short-term rates are already close to zero.
- Central BankA central bank is the public institution that issues a country's currency, sets monetary policy, holds its foreign exchange reserves and acts as banker to commercial banks and the government. Most also run the core payment system and lend in emergencies.
- Central Bank MoneyCentral bank money is money that is a direct liability of the central bank: banknotes and coins, and the balances that commercial banks hold in their accounts at the central bank. It carries no credit risk and is the safest settlement asset.
- DevaluationDevaluation is a deliberate official reduction in the value of a currency that is fixed or managed against another. It makes exports cheaper and imports dearer overnight, and is usually forced by reserves running too low to defend the old rate.