How to pay for the (COVID-19) war

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By Professor Andy Mullineux
Lloyds Banking Group Centre for Responsible Business, Department of Finance

In 1940, Keynes famously published the book How to Pay for the War, which proposed re-assigning industrial production to support the war effort and deferring workers’ pay by issuing credits that would be redeemed after the war.

The aim of these measures would be to reduce the consumption of ‘butter’ during the war to make way for production of ‘guns’ and to disburse credits after the war to rekindle economic growth.

It was in part enacted, though the post-war disbursement of credits was much slower than Keynes had recommended, and the National Savings Movement was mobilised during the war to raise funds to help ‘Save Your (the UK’s) Way to Victory’.  To fund the First World War, the government came off the Gold Standard, and the Treasury issued a sizeable tranche of bank notes, not backed by gold, that was essentially a non-interest bearing loan.

The government also took out a large War Loan in 1914, to which the Bank of England (not nationalised until 1946) was the leading subscriber on, paying 3.5% interest to be redeemed at par in 1925-28. Subsequent rounds of funding for the war were short term involving HM Treasury and Exchequer bonds of up to 12 months.

The War on COVID-19

The government’s aim during the war on COVID-19 is to prop up consumption by paying 80% of wages, and supporting lending to businesses through guaranteed loan schemes, grants, and other funding via Bank of England corporate asset purchases. It is also providing extra support to the NHS and local councils responsible for social care.

To fund these initiatives, the HM Treasury has taken out a large interest-free loan from the Bank of England, the term of which is seemingly indeterminate.

Government fiscal initiatives to prevent an economic depression after the 1997-9 financial crisis followed a period of increased expenditure on measures to reduce child and pensioner poverty and on the NHS.

The post-crisis period was then followed by a decade of austerity during which the government attempted to reduce the deficit as far as possible without increasing taxes, and to reduce the debt burden, primarily through economic growth; which was disappointing due to a lack of productivity increases.

What will be the government’s fiscal stance once the COVID-19 crisis is over?

Is another, perhaps sharper, period of austerity to be expected, ahead of a push to achieve ‘net-zero’ carbon emissions by 2050 in order to avert a global warming induced calamity?

Modern Monetary Theory, as championed by Stephanie Kelton (in The Deficit Myth, forthcoming, and elsewhere), proposes that austerity will be unnecessary since HM Treasury need never repay the Bank of England’s loan to the government, and the Bank can simply hold onto the corporate and government assets it purchases until maturity.

The government need only issue ‘COVID-19 Bonds’, or raise taxes, if significant inflation eventually results in a post-crisis period, which it did not after the financial crisis!

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