Did the UK really almost go bankrupt? The new governor of the Bank of England, Andrew Bailey, has been making headlines after an interview with Sky released on Monday in which he said that had the Bank not intervened, “the government would have struggled to fund itself”. Did the governor overstep the mark, or was he misreported?

Bailey made it clear that the problem arose for many countries, not just the UK, because of market disorder. Those who normally buy government debt were panicking because of the coronavirus pandemic. In that kind of situation it is the Bank of England’s job to step in and buy the debt the government can no longer sell. As Bailey says in his interview, the Bank is charged with hitting an inflation target and maintaining the economic health of the economy. If it hadn’t stepped in, it would have been in dereliction of its remit.

The real issue here is one of market panic. But stories about how the government is in danger of going bust sounds scary and make headlines. The market panic didn’t last long, and in May the government sold three-year debt at negative yields for the first time in its history, which means that the government actually makes a small profit from its borrowing. The short-term market panic in March has had no long-term impact on the steady fall in the cost of borrowing for governments. I suspect this is why Bailey felt he could be quite open about these events.

This little episode tells us two important things about the relationship between the government, markets and the Bank of England. The first relates to a market panic that never happened. The incoming coalition government in 2010 told us that austerity was necessary because it saved us from a Greek-style bankruptcy. In Greece, markets would initially only buy government debt at very high interest rates, and then refused to buy it at all.

The coalition government’s claim was nonsense. Unlike Greece’s, the UK’s finances were fundamentally sound. Unlike Greece, the UK creates its own currency. As the events of March this year show, if there had been a momentary market panic in 2010 the Bank of England would have stepped in to buy government debt. There was no need for austerity on this account. In reality, there was no market panic and interest rates on UK government debt gradually declined. Whether the politicians were lying or the Treasury and Bank were economical with the truth in briefing the politicians we will discover one day.

The second point relates to Bank of England independence. The monetary policy committee (MPC) of the Bank of England sets interest rates without government interference, and this is the sense in which the Bank is independent. A contrast with another public body, the BBC, is instructive. The government has not threatened to take away the Bank’s independence in setting interest rates, so members of the MPC can make judgments of their own, whatever the government may think. In contrast, the BBC is constantly threatened by this government, as it has been by previous governments, and so its judgments are inevitably tainted by this knowledge.

There is, however, a limit to the Bank’s independence. Suppose a UK government became extremely irresponsible, and enacted large tax cuts during an economic boom. The Bank would, following its remit, attempt to put the lid on inflationary pressure by raising interest rates. Suppose further that the markets panicked, and refused to buy UK government debt except at ridiculously high interest rates. In that situation I think it is extremely unlikely that the Bank would intervene and buy government debt, because it would believe that economic stability was best served by the government cutting its deficit.

Academics have sometimes speculated about such a standoff. In this game of chicken would the government give in and raise taxes or cut spending, or would the Bank give in and “monetise” the deficit by buying government debt? I think this debate is a little academic, because a government so intent on creating an inflationary boom would also think nothing about telling the Bank what to do. The governor would be ordered to monetise the deficit and if he refused he would be replaced by someone who would.

No governor of a central bank wants to be put in that situation. It is for this reason that Mervyn King said: “Central banks are often accused of being obsessed with inflation. This is untrue. If they are obsessed with anything, it is with fiscal policy.” Obsession can breed irrationality. Which brings us back to 2010, which is much more like recent events than our hypothetical economic boom. Perhaps this irrational fear of deficits may help explain why during the largest recession since the war King ignored standard macroeconomic theory and practice and encouraged the austerity that proved so disastrous. A lesson may be that while you can trust central bankers to deal with a short-term panic in the government debt market during a recession, you should never trust them to be objective when talking about fiscal policy.

• Simon Wren-Lewis is emeritus professor of economics and fellow of Merton College, Oxford