Monday’s Pre-Budget Report will be accompanied by a revision to the Debt Management Office’s financing plans for 2008-09. The DMO could support broad money growth by cutting planned gilt issuance and boosting sales of Treasury bills. Unfortunately, there is little sign such action is being contemplated.

When the authorities fund a budget deficit by selling gilts to the non-bank private sector, there is no net impact on the money supply – the injection of funds due to the deficit is offset by a transfer of cash out of bank deposits to pay for the new gilts.

Treasury bills are more likely to be bought by banks than non-banks. When banks provide funding there is no transfer of cash out of deposits held by non-banks so the injection due to the deficit is reflected in an increase in the money supply.

Under current plans the DMO will sell £116 billion of debt in 2008-09, comprising £110 billion of gilts and £6 billion of Treasury bills. Gilt sales have totalled £74 billion in the year to date, implying a further £36 billion by the end of March. The £116 billion full-year target is likely to be raised next week, reflecting a higher official forecast for public net borrowing. Suppose funding of £50 billion will be required over the remainder of 2008-09. If the DMO were to raise this amount by selling Treasury bills to banks rather than gilts to non-banks, broad money – measured by adjusted M4 (i.e. excluding deposits of financial intermediaries) – would expand by about 3%.

Annual growth in adjusted M4 was just 3.7% in September, according to the Bank of England (see chart 1.3 on p.11 of the November Inflation Report). On reasonable assumptions, a rate of increase of 6-8% per annum is compatible with achievement of the inflation target over the medium term. Replacing gilt issuance with Treasury bill sales over the remainder of 2008-09 would offset the impact of credit weakness on monetary growth, reducing the risk of a future inflation shortfall.