This is a question that is exercising central banks and politicians around the world when it comes to quantitative easing.
Creating money is clearly a monetary operation - only a central bank has a monopoly right to issue base money. What you do with any money created is much more of a moot point as Adam Posen argues in a speech today.
One line to draw is on taking risks. As Mr Posen states, the Bank of England has drawn its line here:
“Getting into credit risk assessment through buying specific assets both is not a strength of the Bank, and would expose the Bank excessively to the perception of favoring specific interests”.
The ECB is currently in a funk about the risks of buying sovereign bonds of some eurozone countries. It is making explicit judgments about risk, even though the purchases are sterilised and so the operation is not QE, but it makes lots of European central bankers queasy. The Fed has bought many more exotic assets in its QE1 programme, under its preferred term “credit easing”. Then credit risk was not top of its concerns. But in QE2, the Fed concentrated on Treasuries.
An altogether harder line view is that any QE crosses the line of fiscal policy because by buying government bonds on secondary markets, you are implicitly financing government. This argument applies because new bonds and old bonds are identical the second after they are issued.
If we leave this argument aside, given Mr Posen’s willingness to accept that the Bank should not buy things other than gilts, he has to find a vehicle for gilts to do what he thinks is necessary for the economy.
He does not say it so explicitly, but he is proposing greater government borrowing to provide the money to set up a new bank for lending to small companies. This government borrowing would be funded by QE. The Bank would own gilts and the government would own the new bank.
In truth, the idea is very little different from my suggestion to buy Crossrail or even schools, funded by QE. I implicitly put the newly created government assets on the Bank’s balance sheet indemnified by the UK government. But, like Mr Posen, I could have suggested financing new public investment with gilts and getting the Bank to buy them with QE. The economic effect is identical.
Obviously the assets created are different. Mr Posen has a sensible suggestion for improving lending to small business and raising business investment in the form of a new bank. I suggested doing something more direct with public investment.
Is this monetary or fiscal policy? It probably does not matter. Safe to say that central banks in concert with government have lots of ammunition left, if they (collectively) choose to use it, especially when the rest of the public purse is being squeezed hard.