Shirin Nikaein Towfighian
Economists and policymakers often warn of the dangers of direct central bank financing of governments, and history provides no shortage of cautionary tales. Many hyperinflation episodes have been associated with central bank financing of government debt: Weimar Germany (1922–23), Hungary (1945–46), Greece (1941–45), and Latin America during the 1980s debt crisis, to name a few. In recognition of the economic risks, many countries impose legal limits on central bank lending to government, specified in their central bank legislation.
In the wake of the COVID-19 pandemic, government borrowing from their central banks to finance deficits or debt has returned to the forefront of the policy debate as many countries face the challenge of additional budgetary pressure in an environment of high debt. Yet there has been limited empirical research on the incidence, magnitude, and impact of central bank financing of government deficits beyond the most extreme episodes of hyperinflation. Instead studies of central bank government relations have tended to focus on the much broader question of central bank independence.
In sub-Saharan Africa unsustainable fiscal deficit financing by central banks has been a particularly pressing problem and led to stark episodes of hyperinflation in Angola, the Democratic Republic of the Congo, and Zimbabwe. The incidence of central bank lending to government has also been much higher in the region than elsewhere (Figure 1), amounting to 2 percent of GDP on average during 2001– 17, compared with less than ½ percent in other regions. Strikingly, in four sub-Saharan African countries, this ratio exceeded 10 percent of GDP. And after declining in the first part of the past decade, it has started to pick up again since 2014, coinciding with a rise in deficits and debt.
Because of the prevalence of central bank lending to government in sub-Saharan Africa, the question of whether (or how much) to restrict it has been a prominent feature of debates on central bank reform. Moreover, COVID-19 has renewed pressure on some central banks to permit direct financing of government as financing constraints have started to bite. To take a step toward filling the gap in the literature on these questions, recent IMF research revisits the evidence for central bank lending to government for fiscal purposes and its macroeconomic impact in the two decades prior to the onset of the current crisis. The study seeks to answer three main questions: