Commentary: Underfunding no gilt-edged answer

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There is a fair tide of expectation building up in the business community about the need for something - anything - to be done to get the economy going. Leaving aside the politically unlikely, such as leaving the exchange rate mechanism, the options boil down to a more active use of budgetary policy or some fiddling at the edges of monetary policy. One such proposal is that the Government should raise less money from the public by selling gilts and National Savings than it needs to match the gap between tax revenue and spending - so-called underfunding.

The case for underfunding is simple. If the Government sells fewer gilts, people will have more cash. This will boost the money supply and encourage spending.

However, it is also misguided, as Gerald Holtham, of Lehman Brothers, points out today. It is hard to argue that an expansion of the money supply in itself has an expansionary effect on the economy if there are no changes in interest rates. But if some of the extra money flowed into the money markets it would drive interest rates down and cause sterling to weaken within its ERM bands. So the Bank of England would have to mop up the excess with sales of Treasury bills.

There may be some merit in the weak case for underfunding matched by sales of Treasury bills. There is just a chance that it would reduce gilt yields and hence the long-term interest rates on which a handful of companies base their investment decisions. However, the impact would be marginal at best.

The sale of pounds 10bn more or less of government debt is a drop in the ocean of the international capital markets. Gilt yields are much more determined by the prospects for inflation, sterling and growth. The only other argument is that a spot of underfunding might cheer up some monetarists, and every little helps.

On that basis it can do little harm.