Previous posts have argued that the UK authorities should “underfund” the public sector deficit to support broad money growth. Underfunding means borrowing from the banking system rather than selling debt to non-banks.

In the first seven months of 2008-09, the authorities have actually overfunded the deficit. According to the Bank of England, public sector sterling borrowing from banks, net of sterling deposits, fell by £17 billion over April-October – equivalent to 1.0% of broad money M4.

This overfunding reflects a decision to expand debt sales to cover the costs of the financial crisis. According to the Debt Management Office, various measures including transfer of the Northern Rock loan to the Treasury, bank recapitalisation and the Bradford & Bingley / Icesave rescues have added £81 billion to funding needs in 2008-09. These measures do not have a direct impact on the broad money supply but associated debt sales transfer funds from private deposits included in M4 to government deposits, resulting in a fall in the public sector’s net borrowing from banks.

Assuming the full £81 billion to cover financial support measures is raised from debt sales to non-banks, additional overfunding of £64 billion could occur between November and March – equivalent to over 3% of M4. Current funding policy therefore risks exacerbating liquidity pressures on firms and households, with negative economic implications.