Lessons from Britain on the balance between monetary and fiscal policy

NOWADAYS THE Bank of England, like most rich-country central banks, has two main functions: maintaining monetary stability and ensuring the soundness of the financial system. For most of its life, though, it was also responsible for managing government debt. (Thankfully, the original reason for the bank’s creation in 1694, to raise money for “carrying on the war against France”, fell by the wayside.) That function was only hived off to the newly created Debt Management Office (DMO) in 1997, when the bank was given free rein over monetary policy. But in the past decade the bank’s successive rounds of quantitative easing (QE), whereby it creates new money to buy bonds, have left it holding more than a third of the government’s entire stock of debt. That has, awkwardly, dragged it back into the realm of public-debt management.

Britain ran a fiscal deficit of 14.3% of GDP in the latest financial year, higher than in any peacetime year on record and comparable to the wartime borrowing of 1914-18 or 1939-45. The stock of government debt has risen from around 80% of GDP before covid-19 to 100%. The pandemic is the second fiscal shock in little over a decade, after the global financial crisis of 2007-09. As the experience of managing debt after war shows, the divisions between fiscal and monetary policy can often become hazy in times of high...