How Does The UK Government Pay For Things?
The Bank of England creates new money every day, literally 'out of nothing', to pay for Government spending.
This is a Chicken and Egg Puzzle.
Austerity politicians want us to imagine that the government is like a household. That it has a savings account at the Bank of England and that before it can spend any money, tax-payers or lenders first have to deposit money into that account. This is not true.
I want to stress that I don’t mean this in a metaphorical way.
The UK today has a ‘Fiat Currency’ system with a floating exchange rate.1 This means that the UK Government, via its central bank, can issue its own currency without having to guarantee that the Bank of England will exchange a Pound Sterling for anything else, such as either Gold or an alternative currency. The Bank of England belongs to the UK Government2 and when the UK Government needs to pay for something, the Government simply tells the Bank of England to pay the Government’s bills. The Bank of England does this by crediting reserve balances of Sterling to government accounts which are then used in settling the Government’s payment obligations. Most day to day Government spending is paid out of the ‘Consolidated Fund’ at the Bank of England and most tax receipts are paid into this account.3 The ‘National Loans Fund’ is the formal mechanism for what is called Government ‘borrowing’ and receipts from sales of Government Bonds4 are paid into this account.5 Any ’deficit’ or ‘shortfall’ at the end of each day is automatically cleared by the ‘Ways and Means’ account, which is sometimes referred to as the Government’s ‘overdraft’ at the Bank of England.6
The Government spending comes before the taxes and borrowing pay off the negative balance created by the spending.
The Government does not have to wait for taxes to be paid into the Bank of England before it spends money. The Government does not have to borrow money on the Bond Market before it can spend money.
Every time the Government pays for something, the Bank of England can create new money, in that moment, with which to pay the Government’s bills. 7
Outgoing Labour chief secretary to the Treasury Liam Byrne famously said in a 2010 letter to his successor, ‘There’s no Money’.8 Austerity politicians have been saying the same thing ever since. At best this was a misunderstanding. At worst, it was simply a lie.
There are of course some constraints on Government spending.
First of all, any spending has to be legal. The Government has to pass a budget in the House of Commons. The Bank of England is then legally obliged to pay for the things voted for in that budget, as specified in the Exchequer and Audit Departments Act 1866.9
Secondly, the Government should keep control of inflation. If the Government were to spend without controlling the total amount of money in circulation in some way we would have runaway inflation and all of our money would soon become worthless. That is one of the things that taxes are for. 10 The government also uses other tools to control inflation. For example, the Bank of England is supposed to control inflation by changing the Central Bank interest rate.11 People generally agree that real resources like available labour and materials are the real constraint in the economy but disagree about where the monetary control of inflation should come from. Modern Monetary Theory (MMT) economists think that the government can be one of the sources of new money in a mixed economy. They tend to believe that Governments can be trusted to create part of the money supply to meet democratically agreed goals and they moreover point out that private banks don’t necessarily create money rationally.12 Neoliberal think tanks and institutions like the IMF believe that only the private sector can be trusted to create money safely through lending at interest and that independent Central Bank control of interest interest rates keeps the best control of inflation.1314 This disagreement shows that is a matter of opinion who should create the money we use and a matter of opinion who should set interest rates. You can ask people to explain their opinion and discuss their evidence as well as the theories and goals that guided their interpretation of the evidence.
What is the Deficit?
When the Government spends more money than it raises in taxes the difference between the two is called the ‘deficit’.15 There is no statutory law that requires the government to raise as much money in taxes as it spends. There is a belief among what might be described as ‘Neoliberal’ politicians and pundits that such a restriction on spending is necessary in order to maintain something called ‘market confidence’ and the Government’s ability to borrow money on the Bond markets at affordable rates of interest.16
This support for a ‘balanced budget’ is however an opinion and not a fact. There are plenty of economists and finance professionals who take a more critical view of current efforts to ‘balance the budget’ as if the Government were a household and should under no circumstances spend more than it ‘earns’.17 18 When the current Government says it is going to limit Government spending to what it can raise in taxes, that is a policy choice, not a necessity.
When the Government runs a ‘deficit’ it means that the Government has increased the amount of money in circulation by whatever the difference is between Government spending and Government tax receipts. You can have an opinion about whether this is good or bad. Private Banks under license from the Government also increase the amount of money in circulation at any particular time by creating money when they make loans. You can have an opinion about whether this is good or bad. You can have an opinion about how much money should be created by the Government and how much should be created by private Banks. And you can be asked to explain your reasons for your opinion.19
A Worrying Recent Development?
A Government press release from 29th January 2025 states:
“Today (Wednesday 29 January) the House of Commons voted to enshrine the Charter for Budget Responsibility and the new fiscal rules into law.” 20
These rules state that The Government will cover all day to day spending from taxes and will borrow any money it needs for investment from the Bond Market. I worried a bit that our Labour Government had literally passed a law making it possible for the first time since since 1866 for the UK government to run out of money, to go bankrupt.
I am however reliably informed, by people who know a lot more than me, that this is not the case. It seems that George Osborne tried to do the same thing when he was Tory Chancellor of the Exchequer and that these rules are just targets, not laws.21
If you look up the section of the 1866 Act that requires the Bank of England to settle Government spending you can see the ‘alteration alert’ banner of section 13 states:
“Changes to legislation: There are currently no known outstanding effects for the Exchequer and Audit Departments Act 1866, Section 13.”22
So….
The three main facts I want to highlight in this short description of Government spending are:
The UK Government can’t run out of money.
The UK Government can spend, as it deems appropriate and as passed into law by the budget, without waiting for tax receipts or Bond receipts.
Austerity in the UK today is a policy choice, not a financial necessity.
If anyone tells you that today’s Government can’t spend more on the public good you can tell them that is not a statement of fact but a statement of opinion and a policy choice. You can moreover, ask them to tell you about the evidence on which they base their opinion and the theories and goals which underlie how they have interpreted their evidence.
So, for transparency’s sake, what are my opinions and theories and goals?
I believe our Government has more freedom to act for the common good than they are using.
It should be paying proper pensions and income support and spending enough on our public services to create what Monbiot has called ‘public luxury’.23
It should be regulating the financial sector to put an end to the damage it is doing to our economies and our communities.
It should be investing directly in the transition to green energy, to local sustainable and nature restoring food production and in repairing and upgrading all of our housing.
I believe we can and should raise more tax.
At the same time, if we don’t reach our targets for tax receipts it is not an emergency. We don’t need to hold back from essential or important Government spending while we work out how to raise taxes more effectively.
I believe we can continue to issue Government bonds to give people and institutions a safe place to store their savings.
At the same time, we can insist on linking this to productive investment.
We can also assert that we are doing people a favour by allowing them to ‘save’ safely with the government and pay them the interest we think is reasonable.
If we don’t meet our receipts target at Bond auctions it is not an emergency.
We could, for example, change the rules to allow the Bank of England to buy the unsold Bonds and hold them until the Bond market picks up.24
Alternatively, we could continue to use the Ways and Means account the way we have done in the past. During the financial crash of 2008 this account reached £19.9 Billion ‘overdrawn’ or ‘money created’, depending how you want to look at it.25 If we can do this to save the banks I’m pretty sure we can do it to stop climate change.
No doubt you all have your own opinions….
Wishing you all some fun with any canvassers who come to your door and a very merry election day!
You can read in detail about how modern Fiat money works here: https://www.investopedia.com/terms/f/fiatmoney.asp
The Bank of England was nationalised in 1946 - you can fact check this on the BoE website at https://www.bankofengland.co.uk/about/history
For more details on this you can read the Debt Management Office’s Exchequer Cash Management Handbook here: https://www.dmo.gov.uk/media/b5jn0quq/cmhandbook200202.pdf
If you want to know more about Government Bonds you can have a look here: https://commonslibrary.parliament.uk/what-are-gilts-a-simple-guide/
For more details on this you can read the Debt Management Office’s Exchequer Cash Management Handbook here: https://www.dmo.gov.uk/media/b5jn0quq/cmhandbook200202.pdf
From the UK Government’s Debt Management Report 2025-2026: “The Ways and Means facility functions as the government’s overdraft account with the Bank of England…….. Automatic transfers from the government’s Ways and Means account at the Bank of England offset any negative end-of-day balances in the Debt Management Account.” https://www.gov.uk/government/publications/debt-management-report-2025-26/debt-management-report-2025-26-accessible#:~:text=The%20Ways%20and%20Means%20facility,to%20support%20Exchequer%20cash%20management
An excellent post on Richard Murphy’s Blog ‘Funding The Future’ (https://www.taxresearch.org.uk/Blog/) includes a freedom of information request that confirms this: https://www.taxresearch.org.uk/Blog/2018/04/28/the-government-does-not-spend-taxpayers-money-that-clears-the-governments-debt-to-the-bank-of-england/
You can read his lengthy apology for writing this letter here: https://www.theguardian.com/commentisfree/2015/may/09/liam-byrne-apology-letter-there-is-no-money-labour-general-election
Exchequer and Audit Departments Act 1866 Section 13 which you can read online here: https://www.legislation.gov.uk/ukpga/Vict/29-30/39/section/13
If you want to know more about the many wonderful things that taxes do you can have a look here: https://gimms.org.uk/faq/mmt-says-that-public-spending-comes-before-taxation-so-whats-the-point-of-taxation-then/
You can check The Bank of England’s current interest rate and their calculation of the current inflation rate on their website along with explanations of their decisions. https://www.bankofengland.co.uk/monetary-policy/the-interest-rate-bank-rate
Detailed discussion of inflation here: https://gimms.org.uk/fact-sheets/inflation/
You can read what the IMF has to say on inflation and monetary policy here: https://www.imf.org/en/publications/fandd/issues/series/back-to-basics/monetary-policy
The think tank Institute for economic affairs has this critique of modern monetary theory: https://iea.org.uk/how-modern-monetary-theory-mmt-gets-resource-constraints-wrong/
For more information on government spending versus tax receipts you can look on the Office for Budget Responsibility’s website: https://obr.uk/forecasts-in-depth/brief-guides-and-explainers/public-finances/
Right wing think tanks like the Institute for Fiscal Studies produce a great deal of text waxing lyrical on this need to take care of the Bond Market: https://ifs.org.uk/publications/budget-and-bond-markets-when-youre-hole-stop-digging
For an example of financial sector scepticism about the government’s restrictive spending rules you can take a look at a KPMG accountancy firm round-table discussion from March 2025. https://responsibletax.kpmg.com/article/are-the-uks-fiscal-rules-holding-us-back
For some discussion of the pros and cons of fiscal rules you can read this article by a Cambridge Academic https://politicalquarterly.org.uk/blog/towards-a-minority-shareholder-state-the-labour-governments-fiscal-framework/
For a fairly technical but reasonably accessible discussion from MMT economist Steve Keen look up his YouTube video ‘The ‘Money Printing’ Lie That Is Destroying The Economy’
https://www.gov.uk/government/news/charter-for-budget-responsibility-approved-by-parliament
Richard Murphy cheerfully describes the fiscal rules as ‘gobbledygook’. You can read a discussion on some of the technicalities in the comments section of this post on the U.S. Central Bank’s new director: https://www.taxresearch.org.uk/Blog/2026/01/31/kevin-warsh-a-disaster-in-the-making/comment-page-1/?unapproved=1065437&moderation-hash=1539aea451dd814613a5532e49f63053#comment-1065437
https://www.legislation.gov.uk/ukpga/Vict/29-30/39/section/13
The Invisible Doctrine by George Monbiot and Peter Hutchison 2024 - you can read a Guardian review of the book review: https://www.theguardian.com/books/article/2024/may/29/the-invisible-doctrine-by-george-monbiot-and-peter-hutchison-review-neoliberalisms-ascent
I asked the Bank of England which rules currently forbid the BoE from buying or holding temporarily newly minted bonds. This was the reply: ‘The Bank of England may buy UK Government bonds, but only in the secondary market
It does not purchase newly issued gilts directly from HM Treasury or the Debt Management Office (DMO).
This separation between debt management and monetary policy is long‑standing and is supported by the wider statutory and institutional framework, including:
the Bank of England Act which established the Bank’s operational independence in monetary policy;
National Loans Act 1968
,which provides the legal basis for government borrowing and for the DMO to issue gilts; andthe DMO’s gilt auction rules under which gilts are sold to the market rather than directly to the Bank.
Any change that allowed the Bank to purchase gilts at issuance would require reconsideration of this framework and would be a matter for the Government and Parliament.’
As far as I can tell the Bank of England Act refers to the one passed by the New Labour government in the 1990s. These rules were made by governments at particular moments in history with particular political goals in mind. If we have the political will, and different political goals, we can make different rules.
https://www.bankofengland.co.uk/news/2020/april/hmt-and-boe-announce-temporary-extension-to-ways-and-means-facility