Outline the way in which a government which issues money can gain real resources. How relevant is th

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Introduction

Outline the way in which a government which issues money can gain real resources. How relevant is th In almost all modern economies the government plays a central role and will need to pay for its own expenditure. Funds for government expenditure will generally be raised by taxation. But when spending exceeds taxation revenue the government runs a budget deficit and will need to borrow the difference. It can borrow from the private sector by issuing interest-bearing government debt (bonds). Alternatively the public sector can finance the shortfall by borrowing from the central bank (Bank of England in this case) effectively issuing non-interest bearing high-powered money (defined as notes, coins and banks' operating balances at the Bank of England or M0 in the UK). Hence the government faces a budget constraint in a similar way as each individual consumer does, except that it has the right to "print" money. The purpose of this essay is to examine how the government can gain real resources by this method and whether or not it is a significant option in the UK. Any budget deficit must be financed by additional bonds or extra money balances and this government budget constraint can be shown in equation 1 below: Equation 1: CONSOLIDATED GOVERNMENT BUDGET IDENTITY Pt(Gt - Tt)

Middle

would only yield an inflation tax revenue of 0.075% of GDP. This is not likely to be a major source of government revenue considering that the Public Sector Borrowing Requirement (PSBR) was 3.8% of GDP in 1991/92 and 7.4% in 1992/93. It is thus unlikely that the UK government will set inflation (by issuing money) with revenue as the main criterion. Indeed the current government is pledged to keep the inflation rate down and sets out guidelines for the growth of M0 in the Medium Term Financial Strategy. The UK government will be careful to avoid the hyperinflation suffered in the Latin American countries in the mid-1980's. Nicaragua suffered 23710% inflation in 1989 and this is almost certainly partly attributable to the desire to raise revenue in the manner outlined above. The desire to keep inflation low and the relatively low yield of an inflation tax are likely to induce the UK government to try to finance expenditure by other means. Being a developed country the government can raise a large amount of money through explicit taxation rather than the implicit inflation tax method. However, the PSBR statistics show a large shortfall between taxation revenue and spending over recent years.

Conclusion

Thus the need for the UK to issue money to gain real resources is reduced by this extra reduction to the PSBR. Another consideration is that the UK may lose its sovereignty in printing money in the future. If the country enters the Economic and Monetary Union (EMU) and plumps for a single European currency (European Currency Unit: ECU) it will not have as much power to issue high-powered money to finance its deficits. However, this is not at present the case and the amount of control the national government will retain if it becomes the case is not yet known. It therefore seems that the UK will use all three methods of gaining real resources (explicit taxation, bond-financed deficit and money-financed deficit. Privatization is included as negative expenditure) in different degrees depending on other political and economic aims. For instance, taxation is limited due to its unpopularity and political consequences, money financing by the threat of inflation and its limited yield and bond financing by the possible (but ambiguous) inflation aspects and its continual increasing of the debt with interest payments rising. The issuing of money to gain real resources is a possibility in the UK but not likely to be the main method with bond-financing seeming more attractive and taxation and privatization covering a significant amount of the shortfall.

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