Has the Bank of England Embraced Monetary Finance

The attached report argues my high-conviction view that the British Treasury’s announcement last week that it would expand its use of the Ways and Means account at the Bank of England does not represent the first step towards monetary finance of fiscal deficits — or so-called helicopter money.

What HM Treasury is up to here is debatable.  The most attractive explanation I have heard is that the Ways and Means account is simply a quickFH-200411er and more flexible way of raising funds. HMT might also be taking advantage of some strategic ambiguity here, which would not be unusual for policy makers.  Or maybe they even fear that a flood of bills supply might disrupt the money market.  Whatever the case, it has nothing to do with helicopter money.

I would be the first to insist that these repeated imaginations of helicopter drops are largely a distraction best ignored.  Hence, I slip this out on the Saturday of a holiday weekend, perhaps for future reference.

But the relevance for investors, particularly those in risk assets, is simply to reinforce the point that reflation from this episode is going to be difficult to achieve and will take time.  It is not just a matter of central bankers recognizing the scale of the problem and pulling the obvious lever or levers.  The lower bound on nominal rates is actually a binding constraint on what monetary policy can achieve.

Of course, the Fed will act to protect the financial system to prevent this sharp output decline and likely gradual recovery from morphing into something worse.  And I concede the price action last week probably had something to do with that. It was not just misplaced optimism about reflation. But it may be useful ultimately to keep clear what is actually going on here, at least to the extent we can.

For fixed income investors, the way this issue links up with strategy is a bit more complicated.  I emphasize here, again, that there is no simple path to reflation, no magic bullet (or bazooka) the Fed or other rich-country central bank can fire to get inflation back to target.  But that is not to say that the probability distribution around inflation has remained narrow.  When the system is stressed like this, it is possible to imagine unusual outcomes.  And in the US, at least, indexed bonds would seem to have attractive convexity to that, although I do not get into that here.