The Reserve Bank of New Zealand can create money for government with no interest. Photo: Wikimedia Commons

New Zealand faces a huge infrastructure challenge, and there is a forgotten tool that could let the Reserve Bank create money for infrastructure directly, instead of borrowing every dollar and paying interest on it for decades. Our water systems need upgrading, transport networks are under pressure, hospitals need investment, and climate adaptation projects are becoming increasingly urgent.

The country's infrastructure deficit has been estimated at around $200 billion, and the Infrastructure Commission has put the ongoing need at about $31 billion of investment every year. The question is not whether we need to invest. The question is how we pay for it.

The potential for the Reserve Bank of New Zealand to create money for

A petition before Parliament, from Positive Money New Zealand, is calling for an inquiry into a little-known financing tool called Direct Monetary Financing, or DMF. While the name sounds technical, the idea is straightforward. Instead of borrowing all the money for major infrastructure projects from financial markets and paying interest for decades, the Reserve Bank could create some of the money directly.

Supporters say this could save taxpayers billions while helping fund the infrastructure New Zealand urgently needs.

The cost of borrowing

Governments normally finance infrastructure by issuing bonds and borrowing from investors. The borrowed money must then be repaid, along with interest.

Positive Money has submitted a petition to Parliament asking for DMF. Its submission points out that the Infrastructure Commission estimated in 2022 that around $31 billion per year of investment is needed to meet future infrastructure requirements.

At current borrowing costs, that interest adds up quickly. A project financed at around 4.5 percent interest could cost more than twice its original value over thirty years. A $31 billion investment could ultimately require repayments of about $72 billion.

The extra money does not build additional roads, schools, hospitals or water systems. It simply pays the cost of financing. Direct Monetary Financing seeks to reduce that burden.

What is Direct Monetary Financing?

Most people assume that governments create all the money in circulation. In reality, most money is created by commercial banks when they make loans. When a bank issues a mortgage, it creates new deposits, and therefore new money. (We explain this in more detail in our post on how banks create money from nothing.)

Direct Monetary Financing works differently. The Reserve Bank creates electronic money directly and makes it available for approved public investment projects. The government then spends that money into the economy.

Supporters argue that if commercial banks can create money and charge interest on it, it is reasonable to ask whether some money for essential public infrastructure could instead be created directly by the nation's central bank.

Direct Monetary Financing is not Quantitative Easing

Importantly, DMF is not the same as Quantitative Easing, or QE, which New Zealand used during the Covid crisis. Under QE, the Reserve Bank created money to buy government bonds through financial markets. Direct Monetary Financing bypasses financial markets and channels funding directly into public projects.

If it is done the wrong way, as it was in 2020 and 2021, then the government has to pay the Reserve Bank interest. That is plain daft in my view. One branch of government paying another interest is simply odd, and it is part of why the coalition government has complained about the debt it inherited. We can do this without using government bonds on which the government has to pay interest. We can do it directly.

New Zealand has done this before

One of the most surprising aspects of this debate is that New Zealand has used similar approaches in the past. Between the 1930s and 1970s, Reserve Bank credit helped finance state housing, industrial development and other nation-building projects.

During the late 1930s, Reserve Bank credit creation supported economic recovery following the Great Depression. Similar approaches were also used in countries such as Canada and Japan during periods of major infrastructure and industrial development.

Advocates argue that New Zealand is once again facing the kind of long-term investment challenge that these tools were designed to address.

What about inflation?

The biggest concern is inflation. Critics worry that allowing governments to create money could lead to excessive spending and economic instability.

Positive Money argues that the risk depends on how the money is used. Funding productive assets such as transport systems, water infrastructure and housing has different economic effects from simply increasing consumer spending.

The organisation is not proposing unlimited money creation. Instead, it suggests a tightly controlled framework with parliamentary approval, independent oversight and strict limits on eligible projects. In other words, the tool would be reserved for long-term infrastructure investment rather than day-to-day government spending.

A debate worth having

The petition does not call for replacing taxes or government borrowing. Instead, it asks Parliament to investigate whether Direct Monetary Financing could become another tool in the public-finance toolkit.

As New Zealand prepares to spend large sums on infrastructure over coming decades, supporters believe it makes sense to explore every financing option available.

For forty years, New Zealanders have repeatedly been told that governments cannot afford major investments. Yet that assumption is usually based on the idea that all funding must be borrowed from private financial markets. Direct Monetary Financing challenges that assumption.

Whether Parliament ultimately embraces the idea or rejects it, the proposal raises an important question. If New Zealand can create money to stabilise financial markets during a crisis, should it also consider using that power to help build the infrastructure future generations will depend on?

Given the scale of the country's infrastructure needs, it is a conversation worth having.