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The Self-Financing State

In a nutshell

The UK government, with its special legal account called the Consolidated Fund, has an unlimited line of credit at the Bank of England. When Parliament approves government spending, say, for a new hospital or a teacher’s salary, the Bank of England simply adds that money to the government’s account. This new money then goes into the economy. The government doesn’t need to get money from anywhere else first, it can’t “run out.”

The Full Explanation

This process, while not widely known, is a key part of how the UK’s financial system works.

  • The Consolidated Fund: Think of this as the government’s master account. It holds the legal right to spend, backed by the authority of Parliament and the power to collect future taxes.

  • The Spending Process: When the government needs to pay for something, it doesn’t wait for tax money to come in. The Bank of England automatically creates the money and credits the government’s account. This happens on demand and isn’t limited by how much the government has in its account, which often starts the day at zero.

  • The Real Role of Taxes: If taxes don’t fund spending, what are they for? Taxes are used to give value to our money. By requiring us to pay taxes in pounds, the government creates a demand for its currency. When taxes are collected, that money is destroyed, which helps manage the total amount of money in the economy and keeps prices from rising too fast.

  • No Long-term Budget Constraint: There’s no rule that says government spending has to be limited by what it collects in taxes or debt in the long run. The money for all spending is created automatically when it’s approved.

Frequently Asked Questions (FAQ)

  • Does the government need to raise taxes or borrow money before it can spend? No. Public spending is paid for by creating new money through a legal process at the Bank of England. Taxes and debt are dealt with after the spending has already happened.

  • Is the Bank of England really independent from the government? In its daily operations, yes. But it’s not independent in its legal duty to help the government spend. The government owns the Bank of England and is legally required to give it the credit it needs to carry out Parliament’s spending plans.

  • What’s the point of government debt if it doesn’t fund spending? Debt, like government gilts, is mainly a way for the government to provide a super-safe place for the private sector to hold their money. When the government spends it credits bank accounts and provides the funds required to buy bonds. The sale of bonds just gives an interest bearing, safe asset for large institutions like banks or pension funds. Bond sales can be used to affect interest rates and manage the financial system. They are not a way for the government to ‘get money’ for its spending.

  • If the government can just create money, why don’t they just spend on everything we need? Isn’t that what we were told in the news? The ability to create money isn’t a “magic money tree.” The biggest limit on government spending is the availability of real resources. If the government spends money into an economy that is already at full capacity, meaning no spare workers or resources, that spending will drive prices up and cause inflation. The government has to be smart and spend only where there are unused resources, like unemployed workers or factories sitting idle, to avoid causing inflation.

  • This all sounds risky. What if this ‘self-financing’ model leads to a financial crisis or government default? For a country like the UK, a government default on its own currency is a political choice, not a financial necessity. Parliament permanently approves payments on debt. Concerns about so-called “solvency risks” are entirely misplaced and result from a failure to understand how the system works. The UK government is the most trusted financial entity in the country, and its ability to create money is what supports the entire financial system.

  • This only applies to big, rich economies, especially the US, because it has the world’s reserve currency. This idea mixes up money creation with a country’s trade position and global power. The institutional analysis applies to any nation with its own floating currency, like the UK, Japan, or Canada. While the UK doesn’t have the world’s reserve currency like the US, its government’s ability to “self-finance” is exactly the same. It’s a core feature of their monetary system, not a special power that only a few countries have.

For more information on how UK government finances work, please read this peer-reviewed academic paper called The Self-Financing State published in the Journal of Economic Issues:

https://www.tandfonline.com/doi/full/10.1080/00213624.2025.2533726