Financing Public Infrastructure

 

The Government’s own bank, the Reserve Bank, can directly finance some infrastructure through low or zero-interest loans. This will cut out the financial middlemen and save taxpayers billions.

 

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We need to use the Government’s own money-issuing powers better

By selling bonds directly to the Reserve Bank – a process called direct monetary financing – instead of to banks and foreign bond traders, the Government could direct cheaper funds to the construction of roads, schools, and hospitals and fixing our failing drinking water, stormwater and sewerage infrastructure. All this without burdening future generations with extra debt and saving taxpayers billions in interest costs.

We are repeatedly told that money is scarce and that the Government must attract private investors or go to ‘the markets’ to borrow if it wants to invest in major projects.

This is only true if it needs to borrow in a foreign currency. It is not true for borrowing in New Zealand dollars—the vast majority of government borrowing—because the New Zealand Government is the ultimate issuer of our currency. This means the Government has financing choices unavailable to households, businesses or local authorities.

There is no technical reason why its Reserve Bank cannot buy bonds directly from the Government.1For instance, see footnote below: Treasury, Reserve Bank told Government it could just print money to pay for Covid-19 We (almost) saw this happen during the Covid crisis when the Reserve Bank created new money with a few accounting entries to buy about $50 billion of New Zealand Government bonds and $4 billion of local government bonds. It could have bought the bonds directly, but instead, it insisted they first be sold to banks and investors. It then paid billions too much to buy them back, a cost now borne by taxpayers. Our 2021 petition to Parliament explains why it should have gone direct and cut out the middlemen.

Let’s use the right tool for the job

Direct monetary financing shouldn’t replace all conventional bonds (nor does it replace the need to levy taxes). There are good reasons why we should sometimes issue bonds to private investors. But an effective public finance toolkit should include both. The New Zealand Treasury has analysed the pros and cons and highlighted instances where direct monetary financing can be effective.

Among key benefits of direct monetary financing are:

  • Long-term public financing at zero and low interest rates
  • Interest payments that would have gone to lenders can instead pay off the loan principal or pay for better public services
  • Strengthens sovereignty over key public assets (they are not needed as security for foreign lenders)
  • Can be used as a tool for achieving monetary and fiscal policy goals

The main objections to direct monetary financing are:

  • That politicians or Parliament will misuse this power
  • That it will lead to inflation

There is little evidence or research to support these objections but they have been used successfully in recent decades to shut down debate. There are clear benefits offered by direct monetary financing, as well as solid research to support its use, and it’s time to move the debate past knee-jerk dismissals.

[M]onetary financing, taking various guises, was a relatively standard aspect of economic policy over the past three hundred years … Empirical correlation between monetary financing and inflation is, at best, weak and selective, whilst causation has not been demonstrated. The theoretical approach rests on assumptions about the workings of the monetary system—including that banks predominantly create money that businesses invest and that central banks can influence such credit creation via changes to short-term interest rates—assumptions that no longer appear to hold.
Josh Ryan-Collins, Is Monetary Financing Inflationary?

In our view, the concerns about misuse and inflation can be addressed with robust institutional design and clear rules on when this valuable public financing tool can be used as part of the government’s monetary and fiscal toolkits.

To demonstrate how this can be done in practice, Positive Money has developed a model for financing water infrastructure using a mixture of direct monetary financing and market finance.  

Positive Money believes it’s time for a ‘grown-up’ discussion about building robust institutions and rules to support the responsible use of direct monetary financing.

What’s the catch?

Surely it can’t be this simple? Well, it is. The decision of whether to use direct monetary financing is a political one, not a purely financial or technical one.

The New Zealand dollar is what is called fiat money. It is issued as notes and coins by the Reserve Bank or at the tap of a keyboard through simple accounting entries. It is backed solely by our sovereign government’s powers to tax and regulate.

It is within the Reserve Bank’s power to issue electronic money to buy New Zealand Government bonds from the Treasury. But we elect not to use it, preferring to enrich banks and financiers with billions of dollars a year of taxpayers’ money in interest payments.

How much difference will this make?

A lot. Here’s an example.

If the Government issues a $1 billion 30-year bond at 5% p.a. interest, the interest bill after 30 years will be as much as the original loan, i.e. tax payers will have to pay almost $2 billion to repay the original $1 billion loan.

With direct monetary financing at zero interest, the extra billion dollars that would have gone to lenders could instead pay for more infrastructure, better public services or lower taxes.

Multiply that saving hundreds of times over. For instance, the Three Waters upgrade alone will need investment of $120–180 billion.

We have developed a financing model, Local Water Financing Done Well, that shows how direct monetary finance can play a key role in achieving this.

Has this been done here before?

In New Zealand, there is a precedent for the Reserve Bank directly funding the productive economy under the first Labour government in 1936. The programme, which supported state house-building and primary industry development, continued through World War II. It never produced inflation as scaremongers predicted. In fact, it ushered in our most prosperous and egalitarian decades. Read the case study.

In Canada, the Bank of Canada did a similar thing during the period 1935–75, when, working with the government, it engaged in significant direct or indirect financing to fund the construction of highways, airports, bridges, schools, hospitals, and other physical infrastructure. This was studied in detail in a paper for the Levy Economics Institute (PDF), which found that this spending had little or no impact on inflation.

Want to learn more?

Here are some resources that will help you to further your knowledge of this important subject.

 

New Zealand

  • Treasury, Reserve Bank told Government it could just print money to pay for Covid-19 (link)
  • Aide Memoire: Quantitative Easing and Monetary Financing Compared – Treasury/Reserve Bank memo to Finance Minister Grant Robertson (PDF)
  • VIDEO: Dr Geoff Bertram – How do we pay for Covid-19? (particularly link and link)
  • Gareth Vaughan looks at why we should reframe the discussion on government spending (link)
  • Raf Manji urges the RBNZ not to make the mistake of previous overseas QE programmes by focusing entirely on supporting the financial markets (link)
  • Reserve Bank fuelling housing boom with printed money, says former Finance Minister Michael Cullen (link).

International Research

  • Ryan-Collins, Josh. Is Monetary Financing Inflationary? A Case Study of the Canadian Economy, 1935–75. Working Paper No. 848, Levy Economics Institute (2015) (link or PDF)
  • Turner, L.A. Between debt and the devil: beyond the normalization delusion. Bus Econ 53, 10–16 (2018). https://doi.org/10.1057/s11369-017-0064-y

Check out the Positive Money website, where you can find out more about how money works and what we can do to reform the money system to benefit everyone, not just a few.

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