Government Borrowing, Bank Liquidity and Interest Rates. Quarterly Economic Commentary, January 1981

Ireland's participation in the EMS, the introduction of exchange controls, and the break in the traditional parity between the Irish pound and sterling brought about a totally new environment in which changes in domestic bank liquidity came to play an important role in determining the level of Irish interest rates. This paper looks at the main influences on bank liquidity and examines the sources of changes in it over recent years since 1975, with particular reference to 1979 and 1980. The purpose is to highlight the relationships between bank liquidity and the Government Borrowing Requirement and show how the manner in which the Government finances its deficit can affect the level of interest rates. The size of the annual Government deficit has now grown to such large proportions that the manner in which it is financed has become an important policy issue. By illustrating the effects on interbank rates and gilt yields it is hoped that the paper will contribute to the debate about whether the deficit should be financed by monetary or non-monetary means and whether the Government should borrow abroad or from the Central Bank