In orthodox economic thought, “monetary financing” is often viewed with suspicion, if not outright hostility. At the same time, government bonds enjoy widespread acclaim as a prudent form of state financing. Recent commentary from economists and media pundits reflects this dichotomy: printing money is reckless; issuing bonds is sound policy. But why is this the case? Let’s explore this orthodoxy using a logical lens and examine whether it holds under scrutiny.

The Case Against Monetary Financing

“Monetary financing” typically conjures images of a government running amok, recklessly creating money to fund its spending. The narrative often goes that this leads to inflation, currency debasement, and economic chaos. For example, recent articles in the financial press have warned of the dangers of governments becoming reliant on their central banks to fund public services directly. Argentina’s Javier Milei, who recently scrapped the country’s monetary financing regime, has been lauded as a hero of fiscal discipline. For whose benefit remains to be seen.

But what does monetary financing involve? Consider the UK model:

  1. The government spends sterling into the economy by crediting bank accounts.
  2. The recipient’s bank sees its reserves increase at the Bank of England.
  3. The Bank of England then pays interest on those reserves, tied to the Bank Rate.

Here’s the crucial part: the Bank of England doesn’t charge fees to cover this interest. Instead, it is financed by income from the Bank’s assets, which are—wait for it—government securities like Gilts, the Asset Purchase Fund indemnity, and the Ways and Means facility. It’s a closed loop of government spending and interest payments—a system explained in detail in The Self-Financing State.

If this seems arcane, consider a more straightforward analogy. The Bank of England could achieve the same outcome by issuing banknotes to banks and offering them an overnight bond at the Bank Rate in exchange. Banks rarely trade their reserves for cash because they’re satisfied with the implicit yield on their ‘overnight bond’.

So, why is this unspoken overnight bond “bad”?

Bonds as the “Good” Alternative

The Debt Management Office conducts cash management operations through daily repurchase (repo) agreements. These are short-term borrowing arrangements with short-term government securities (gilts) used as collateral. Operationally, these repo agreements function like issuing overnight bonds through the Bank of England. However, the former is often viewed as a “good” practice, while the latter is considered “bad.” Why?

Consider what happens when DMO issues repos instead of relying on monetary financing:

  1. A bank buying a repo reduces its reserves, with the Bank of England crediting public deposits to reflect the transaction.
  2. A non-bank buyer reduces deposits and reserves at their bank, with the Bank of England crediting public deposits accordingly.
  3. The Bank of England pays interest on public deposits, offsetting HM Treasury’s payments to the Bank on its assets.
  4. Upon maturity, the bondholder receives interest—factored into the purchase price as a discount.

What’s striking is that repo sales tend to incur a lower interest cost than reserves because they can be held by non-bank entities, expanding the investor base. The Debt Management Office (DMO) touts this as a feature, reporting consistently lower borrowing costs than the Bank Rate.

The Arbitrary Line Between “Good” and “Bad”

If short-term DMO borrowing is “good,” is the distinction simply one of bond maturity? Is it because repos tend to be longer than a single day? Consider the implications:

  • A two-night repo is just two overnight bonds in sequence, compounded.
  • A week-long repo compounds for a week.
  • The DMO issues three-, six-, and nine-month Treasury Bills, which are similarly priced based on expectations of what a sequence of overnight operations would yield.

The length of a bond does not change its fundamental characteristics, as the only other aggregate option is to hold a bank deposit or Bank of England reserves. Market forces guarantee that the cost of borrowing—whether overnight, a week, a month, or a year—remains aligned with the expected cost of rolling over shorter-term instruments. Investors do not “set” borrowing costs; they predict them.

This leads us to the central question: when does “bad” monetary financing become “good” bond issuance? The answer lies not in economic fundamentals but perceptions and perhaps a bias towards complexity cloaked in orthodoxy.

Challenging the Narrative

We’re dealing here with a difference in narrative, not substance. Monetary financing and bond issuance are two sides of the same coin. Both rely on the government’s ability to create and manage money. Both underpin the financial system and the broader economy.

Yet bonds enjoy an aura of respectability, while monetary financing remains a bogeyman. Why? It may be because bonds offer lucrative sinecures for financiers and maintain the illusion of market discipline. Or it’s just that orthodox economics clings to tradition, even when the logic behind it is tenuous at best.

If the distinction between “bad” and “good” is little more than a mirage, maybe it’s time to rethink the narrative. Labelling monetary financing as reckless and bonds as prudent obscures the realities of modern finance. The real question isn’t whether money is “bad” or bonds are “good,” but why we allow these labels to dictate economic policy in the first place.

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