Redefining Monetary Policy

Monetary policy is the process by which the central bank targets economic measures such as inflation, unemployment and GDP in order to optimize the performance of the economy. This is mainly performed through controlling the supply of the money it creates, targeting interest rates, lending and asset purchases or sales.

Actions such as direct transfers of money to people are considered fiscal policy and not monetary policy under the conventional definition. Transfers to the public by central banks would better be defined as monetary policy if the monetary authority is creating new money and issuing it to people directly. If a transfer is fiscal then an asset purchase must also be fiscal because when purchasing an asset money needs to be transferred to the asset seller. Therefore a transfer may be fiscal or monetary policy depending on who performs it. If the transfer money was initially sourced from government taxation or borrowing then it is fiscal policy. If the transfer was directly performed by the central bank and the funds where created by the central bank then this constitutes monetary policy.

In an unprecedented instance where temporary contractions of the monetary base are inadequate and the central bank has to permanently contract the money supply through directly imposing transaction costs/taxes these should also be termed monetary policy. If the purpose of the policy is to remove money from circulation and this policy is performed by the monetary authority then it is monetary not fiscal even if this involves taxation. The central bank could levy transaction costs or any type of tax if it had authority use the taxation office as its collection agent just as the executive arm of government.

Commercial/Investment Banking

Under system where people can hold central bank (CB) created e-money private bank issuance of demand deposits self regulates. Assuming CB e-money is equally as functional for payments people will mainly hold demand deposits (zero interest money) at the central bank because it is risk free whereas commercial banks are not. Private banks can create money but unless it pays interest people will shift money away into risk free central bank accounts which will drain banks of assets. Therefore private bank created money will carry an interest cost to issuers and this will regulate the amount of issuance. Banks will issue money in accordance to the returns they receive from proceeds of invested money.

Banks that make highest returns from investments will attract most depositors because they can offer higher returns on deposits or other savings vehicles/investments they offer to customers.

The most transparent and least risky banks will attract most depositors.

Improving monetary policy effectiveness and equality under an interest rate targeting regime

Interest rate targeting isn’t being advocated as an optimal intermediary target. Other regimes such as directly targeting NGDP or inflation through changes in the monetary base or other intermediate targets may be may be superior. This article seeks to share ideas to improve the effectiveness and equality of interest rate targeting.

The central bank (CB) could target a risk free interest rate of securities it issues directly instead of an interbank rate such as the federal funds rate indirectly through repurchase agreements (repo), reverse repurchase agreements and asset purchases and sales.

The CB may issue risk free securities similar in nature to treasuries of varying short term maturities and target the rate on these through affecting their supply and demand. This is more equitable and effective than targeting a repo rate such as is practiced in some countries. Repo lending under by the CB is inequitable because it is akin to a direct loan exclusively to banks at preferential rates when compared to the market rate. Reverse repo borrowing by the CB is also flawed because it is exclusively offered to banks and financial institutions and the central bank provides collateral to borrow or contract MB momentarily. CB borrowing is risk free so provision of collateral is unnecessary. The CB could issue securities that anyone can purchase in open auctions like is currently performed by US treasury direct system.

The fed could have a target size of securities of maybe 1% of GDP it maintains in order to sustain an interest rate targeting system.  The interest rate could be targeted by expansion of MB through direct fed heli drops. An increase in the rate of MB expansion would decrease the short term interest rate and slowing the rate of MB increase would lift the interest rate. In exceptional circumstances the CB could contract the monetary base by increasing the supply of securities it issues while not growing the MB through heli drops. The CB could fine tune the interest rate by affecting the supply of securities it issues or purchases in the secondary market.

The Direct Money Issuance Proposal (Brief)

Two basic central bank reforms to increase monetary policy effectiveness, equality and reduce systemic risk:

1.  Extend the provision of electronic deposit accounts by the central bank (CB) to all people and other entities instead of only depository or financial institutions. The CB is tasked with providing money and should therefore also provide an efficient electronic means of payments and deposits of the money it creates. Commercial bank deposits and other measures of broader money will continue to exist in their current form.

2. Re-orient monetary policy so that the monetary authority directly interacts with the public as counter-parties instead of only a limited number of financial institutions.  When the monetary authority is pursuing expansionary monetary policy in order to attain its goals related to unemployment, GDP growth or inflation it can affect the target interest rate (if interest rate targeting) by periodically expanding the supply of central bank deposits directly and evenly into all citizen’s accounts while open market operations and other policies are performed when necessary. The rate of growth of direct money issuance to the public will be periodically adjusted by the central bank in order to attain its targets while temporary open market operations may be used in order to fine tune the short term interest rate or contract the monetary base.

Principle benefits of proposed reforms

The various stimulatory or contractionary effects as a result of adjustments in short term interest rates will continue under DMI with the addition of new direct mechanisms of action through increased public monetary wealth.

Direct issuance of central bank deposits to people on a non lending basis will nominally increase monetary wealth of recipients by the amount of newly created monetary base. Under asset purchases or lending the newly created money received by the central bank counter-party does not result in an increase in wealth because it is offset by a new liability or the loss of an asset. Portfolio balance effects may increase wealth under a regime of asset purchases or money lending but the higher money supply itself will not.

Higher monetary wealth due to DMI would affect spending and creditworthiness of people.

In a climate where the short term interest rate is at the zero lower bound (ZLB) the current central bank counter-parties have very little or no opportunity cost when holding reserves due to low investment returns and therefore expansions of central bank money should have a reduced impact on growth and inflation. The overall public on average have a higher opportunity cost when holding money compared to central bank counter-parties due to foregone utility from consumption or other spending. Financial entities such as the current central bank counter-parties are oriented towards realizing profits from investing and inter-mediating whereas people gain greater utility from consuming. Therefore expansions of funds to public would more effectively create growth at the ZLB.

The wealth effect as a result of portfolio re-balancing will continue to manifest as it does at present but an additional wider reaching increase in wealth will also prevail under DMI through increased money balances of central bank counter-parties. Asset holdings are concentrated with the wealthier people owning a large proportion of assets and many people owning few or no assets. Therefore under the present system increases in wealth from increased asset prices don’t reach large parts of the population which diminishes the effectiveness of monetary policy. Wealthier people’s propensity to spend out of income is lower than the average person therefore monetary policy induced increases in wealth of all people through money issuance should result in greater spending increases when compared to wealth increases skewed towards wealthier people.

Under the present system central bank actions designed to create a wealth effect throughout the economy are not guaranteed to succeed if asset markets don’t appreciate in response to expansionary monetary policy. Direct money issuance will increase people’s monetary wealth even if asset prices don’t change.

Increased wealth in form of liquid assets such as money is more likely to be used for spending than an increase in wealth in form of less liquid assets such as stocks or housing. Increase in wealth from less liquid assets should lead to a smaller increase in spending due to taxation from capital gains, transaction costs and effort of converting non liquid wealth into money in order to spend.

The money supply to the broader economy could increase without necessitating an increase in debt if the central bank expands the monetary base directly to people. Under the current system expansions of broader money generally require more borrowing because commercial banks usually increase the quantity of deposits through lending. If the money supply can increase while maintaining lower debt to GDP levels greater financial stability should prevail. Monetary policy effectiveness will not be compromised in an instance of a credit crunch or other credit market disruption if the central bank can directly interact with economy more broadly.

Greater systemic safety of the deposits and payments system will be realized if people can also directly deposit and transact in central bank money which is risk free electronically alongside commercial bank deposits.

A system whereby the general public directly interact with the central bank will instill greater levels of confidence in the central bank. People should also become more educated in monetary issues if they directly interact with the central bank

A Solution to Create a Balanced and Efficient Monetary Policy System (First Posted April 2012)

The current monetary policy (MP) framework in place across most of the developed world is imbalanced and ineffective. It has four main destabilizing features:

1. The monetary authority deals indirectly with most of the economy and depends on commercial banks to create new lending for the broader economy.

2. When conducting policy the central bank deals with a select group of financial corporations, which only represent a fraction of the overall economy.

3. Commercial banks lend based on profit motives. Consequently new commercial bank lending is likely to enter the economy in an imbalanced manner and contribute to instability. As a result banks should not be directly involved in conducting monetary policy.

4. New central bank and commercial bank money is created as debt, therefore the monetary system is debt based. A debt based system is likely to lead to excessive systemic debt levels.

Indirect approach to Monetary Policy

The central bank conducts monetary policy with the economy in an indirect manner through the monetary transmission channel. This consists of the central bank lending reserves to the banking system and commercial banks lending into the broader economy. Therefore private banks and not the authority deal directly with the economy in monetary policy operations. Consequently the commercial banking system has the final say on how monetary policy is formulated, not the authority.

Figure 1: Indirect Approach to Monetary Policy

The effectiveness of monetary policy under the current system is diminished due to the reliance on commercial banks to create new loans aimed at the national economy. If the financial intermediaries determine that it is not profitable or economically viable to lend onwards lending rates may not be at the desired level to attain the CB’s economic objectives relating to growth, employment and inflation.

If the commercial banks decide to expand lending to the economy it is usually at higher rates of interest than central bank funding rates. Therefore the financial system is privileged over all other sectors of the economy. The largest detriment is usually suffered by small to medium size enterprises because they lack the bargaining power to attain cheaper borrowing rates.

As a consequence of the CB not dealing directly with the overall economy the monetary authority only influences policy and much of the monetary decision process is left to private banks. Central bank funding rates are only an element out of many which influence commercial banks’ lending and investment behavior. Factors such as overseas funding costs, alternate domestic sources of funding, confidence, expectations and demand for loans contribute to lending decisions.

A much more effective monetary policy arrangement is one where the financial intermediaries are removed and the CB interacts with the economy directly.

Figure 2: Direct Approach to Monetary Policy

If the CB operates directly with the economy instead of intermediating through the banking system its job will simplified so it can more effectively attain its objectives relating to economic growth, inflation and stability. It will also be more accountable because it will become the only entity responsible for managing the money supply. Bank lending decisions which are guided by individual profit objectives will no longer directly influence or determine the conduct of monetary policy.

limited Participants in Monetary Policy Operations

At present the central bank only lends reserves to the financial sector. If the banking system decides to lend to the broader economy it will usually do so at higher interest rates in order to maximize profit. As a result all components of the economy outside the financial sector are at a disadvantage or neglected by not directly receiving funding directly from the CB. This had led economic instability due to an oversized financial sector and misguided lending practices.

In order for economic stability to prevail new money needs to enter the economy in a balanced manner. This can be performed if the central bank deals directly with the citizenry. Under this approach in times of monetary stimulus funds will be distributed through the economy evenly across the entire system.

Unstable Private Sector Monetary Expansion

At present commercial banks are able to expand lending with few restrictions on how much money they create in the process. Therefore money creation can be excessive during business cycle upswings or insufficient during recessions leading to greater levels of instability and malinvestment.

The fractional reserve requirements in place allow banks to create many times more funds than they are required to hold in reserve. Due to the opacity and unnecessary complexity inherent in the present system it is actually debated as to whether banks are reserve restrained at all. Many believe that banks source reserves after making loans with the central bank providing all the reserves required by the banking system on demand.

The ability to create loans so easily creates an environment amongst many financial organizations where access to funds for speculative investment and lending is abundant. As a consequence lending within the banking sector has contributed to outsized growth of the financial sector relative to the overall economy. Too much growth in lending has also facilitated the creation of bubbles in many housing, commodities and derivatives markets. Excessive lending and leverage provision aimed at trading on commodity exchanges may also be contributing to increased volatility and consumer price inflation from higher commodities prices.

Too big to fail banks which pose a systemic threat to the overall economy sustain themselves at least in part because they have access to debt from the banking system. The shadow banking system which is largely an opaque and speculative aspect of the financial system also benefits greatly from its ability to gain leverage from other banks. Consequently many financial organizations with unviable business models are likely to be artificially supported by access to cheap funding while many viable businesses outside of the financial sector are hampered by higher borrowing costs or lack of access to funds.

Enterprises within the financial sector are profit driven therefore lending policies tend to be formulated in order to advance the interests of the banks with little consideration for the broader economy. Therefore if the financial sector can influence monetary policy it will gain an advantage over the rest of the economy and grow dominant. Private sector money creation is misguided resulting in excesses in some sectors like housing and insufficient lending to many other vital sectors of the economy.

The imbalances created when profit oriented institutions create money need to be eliminated. This can be done if the central bank is the only entity entrusted with monetary policy and all powers to create money are removed from the private banking system.

New money will enter the economy evenly which will act as a systemic stabilizer minimizing the occurrence of imbalances. Money supply growth will be constrained by the CB inflation mandate which will serve to limit the causes of volatility in the business cycle. At present banks largely determine how much money enters the system leading to excessive speculation and malinvestment.

As an added benefit the system will be simplified and easier to understand for the public and the authority because all funds will be central bank money with commercial bank money ceasing to exist. At present accountability is confused because commercial banks and the central bank both create money. Therefore the authority will become more accountable because it will be solely responsible for money creation and its effect on the economy.

New Central bank and Commercial Bank Funds are Created as debt, Therefore the Money System is Debt Based

Under the present approach to monetary policy conducted by the central bank all new CB reserves borrowed by commercial banks are debts that need to be repaid with interest. The commercial banks borrow reserves in order to fulfill their reserve requirements and lend to the broader economy. Therefore excessive indebtedness and credit crises have emerged as a consequence of money being created as debt.

Due to interest payments there needs to be a continual expansion of debt in order for the money supply to sustain itself at any particular level. Therefore it is inevitable that debt levels will become overly burdensome at some point leading to a credit crisis. From a systemic point of view if debt was to be reduced significantly it would need to be accompanied by a large reduction in the money supply causing an economic contraction.

The present debt driven system is vulnerable to events such as a credit crunch in which the general availability of loans or a sudden tightening of the conditions required to obtain these loans occurs. A credit crunch generally involves a reduction in the availability of credit independent of the level of official interest rates. In such situations, the relationship between credit availability and interest rates has implicitly changed, such that either credit becomes less available at any given official interest rate, or there ceases to be a clear relationship between interest rates and credit availability. Figure 3 is a depiction of the broken monetary transmission channel in the US, UK and Eurozone after the 2008 credit crisis.

Figure 3: Large expansion of base money did not significantly affect broader money supply.


Source: Nomura, Based on FRB, ECB and Bank of England data.

In order to solve the problems created by the debt based monetary system we need to stop creating money as debt. When the central bank creates money it will not be accounted for as a debt under this new proposal. Therefore money is free to circulate as the vital medium of exchange and does not need to be repaid to the monetary authority and leave circulation. Consequently the systemic debt load will be significantly lower and within acceptable levels. In times when stimulus is required debts will not increase like they do at present because new money will not be debt. A situation such as a credit crunch will have a minimal impact in an economy that is not credit demand driven.

Benefits of Conducting Monetary Policy Directly with the Broader Economy in a non-debt based system

A superior system where the financial intermediaries are removed and the central bank deals directly with the public has many obvious benefits. Under this approach profit-seeking corporations will not have an influence on how monetary policy is conducted for the economy. The objectives of the monetary authority will be straightforward and much simpler to achieve. When stimulus is required the central bank will expand the money supply and the public will receive it instantaneously in a balanced manner. Under the current arrangement lending is subject to the profit motives of banks, which can lead to excessive lending and speculation in some sectors while large swathes of the economy are underfunded. Alternatively if the CB decides that a neutral policy is necessary that is precisely what will occur. Financial institutions will not have the final say on monetary policy. The profit objectives of private companies will not affect the formulation of monetary policy.

Corporations and the CB may have conflicting aims therefore private organizations should not be involved in MP. OMO’s will be simplified because there will be no need to post collateral. Therefore the system won’t be dependent on government bond issuance for collateral to conduct MP and quality collateral will be freed up for private sector purposes. OMO’s will be simplified as they will be simple transactions with no adjusting of interest rates and no need to repay funds to the central bank. Repayment of central bank reserves is not desirable as reserves are a part of the money supply which is the vital medium of exchange for the economy. Policy implementation will also be simplified if private banks can’t create money because the authority will only have to monitor central bank money in order to conduct MP. As a result tracking monetary aggregates will be simplified for the authority and easier to understand for the public.

A more direct monetary transmission channel will result in the central bank’s actions having a much faster response reducing what is known as an outside lag. In economics an outside lag is the amount of time it takes for the central bank’s actions, in the form of either monetary policy to have a visible effect on the economy. Dealing with the public directly will also eliminate liquidity traps were increased CB lending regardless of the rate of interest is not passed onwards and becomes trapped within the banking system. The system will become more transparent and people will participate directly in monetary policy. If people participate in the system they become more knowledgeable of economics. They will gain more confidence in the monetary system and its key institutions which is vital for a healthy economy.

Implementation of New measures

Every citizen of working age (e.g. 15 and over) will hold an account with the CB for monetary policy. These accounts can be maintained online by the central bank or hosted by any commercial bank using the central bank’s database. All MP account information hosted by any private banking organization is also maintained by the central bank.

Commercial banks will cease to deal with the central bank for monetary policy purposes.

Expansionary monetary policy when required will be conducted by expanding the money base directly to citizen’s accounts in measured regular intervals while taking into account the CB mandate relating to cost inflation. All citizens receive the same amount of funds at the same time intervals in times of stimulus. These new created funds do not need to be repaid as they are not debt. These transactions are simply an adjustment to the vital medium of exchange which circulates in the economy therefore it is not desirable for this medium of exchange to be created as a debt and later return to the CB and stop circulating within the economy.

Neutral monetary policy will entail no monetary action on behalf of the central bank.

Private banks will not be able to create money. Banks will need to obtain funds from retained earnings, shareholder proceeds or borrowing. Commercial bank money will cease to exist. All money utilized in the financial system will be central bank money.

Criticisms

If the CB has exclusive control over the money supply will it have too much power? Its only power is to create money into citizen’s accounts in an equal manner amongst all people. The CB is also limited by mandate relating to consumer price inflation and it does not deal with corporations or government for monetary policy.

Isn’t expanding the money supply inflationary? The CB will be bound by a cost inflation mandate. If inflation goals aren’t met governors will be accountable. If negligence/incompetence or mismanagement of currency is found this will be a criminal offence.

In a country like US you need to establish approximately 200 million CB accounts for each adult citizen. Correct, this is easily done with the present day information systems/banking architecture. Systems that operate on an even greater scale conducting complex transactions already exist. For example 1.7 billion shares was the average daily volume for march 2012 on US based cash share transactions at the NYSE (NYSE, 2012). The CB will only need to conduct simple one way transactions, with no calculating of reserve requirements or interest repayment considerations.

If people receive small regular payments in times of stimulus will their behavior be negatively affected? If payments are small and in regular intervals (like 100$ pw). The new money entering the system on an aggregate basis will affect aggregate demand, but on an individual basis is not enough to adversely affect economic behavior of people.

Money is a financial asset created by the central bank therefore it has to be issued as debt. A financial asset created by the central bank may be created in the form of equity or debt. New units of currency can be accounted for as new equity issuance not debt from the point of view of the central bank. This is true anyway because the owners of the central bank are the citizenry. Therefore at the point of creation the recipient of funds owns the money and does not need to repay. The only recipients of newly created money should be the citizens.

If commercial banks can’t create money there won’t be enough money to underpin economic activity. If monetary expansion is needed the CB will expand the money supply to support the economy. In an efficient system the money supply doesn’t need to constantly expand. Money needs to circulate into the right sectors in order to underpin economic activity. At present money needs to constantly expand to underpin growth because of external leakages to countries like China which hoard currency. Internal imbalances like buildup of funds within banking sector may also remove large swaths of money from the overall economy needing new monetary expansion.

Daniel Kruppa, 1 August, 2014

At present central banks conduct monetary policy (MP) primarily through targeting of interbank interest rates and asset purchases. Altering the cost or quantity of money and purchasing assets from the marketplace can potentially affect spending primarily through changes in funding costs, increases in the supply of money and wealth effects of agents through portfolio re-balancing (Bank of England 2011).

The effectiveness of a reduction in interbank interest rates in generating spending is dependent upon people’s willingness to borrow and bank’s capacity to make loans or investments. Factors such as debt to GDP levels and balance sheets of debtors and creditors can severely hamper the effectiveness of interest rate targeting as a policy tool. The issue of inequality also arises under interest rate targeting because only banks have access to lower interest rates offered directly by central banks through issuance of securities such as repurchase agreements (repo’s) and because only banks can directly transact in risk free electronic deposits at the central bank.

The nominal lower zero bound (ZLB) also poses limitations to conventional interest rate targeting under the current bank centric approach. At the ZLB the current central bank counter-parties have very little or no opportunity cost when holding reserves due to low investment returns and therefore expansions of central bank money should have a reduced impact on growth and inflation. The overall public on average have a higher opportunity cost when holding money compared to central bank counter-parties due to foregone utility from consumption or other spending. Financial entities such as the current central bank counter-parties are oriented towards realizing profits from investing and inter-mediating whereas people gain greater utility from consuming. Therefore expansions of funds to public would more effectively create spending growth at the ZLB.

The wealth effect which is generated through asset purchases and portfolio re-balancing only reaches existing asset holders and because asset ownership is heavily concentrated most of the wealth effect is experienced by the most wealthy while people with few or no assets experience little to no wealth effect. The richest have a lower marginal propensity to consume than people on average, therefore the impact on spending as a result of the wealth effect is reduced. It is also a manifestation of inequality that monetary policy seeks to create wealth increases but these increases in wealth mainly go to richer people. Inequality of asset holdings can be observed in the US where over 90% of stocks are owned by the wealthiest 20% while the bottom 60% own approximately 2.5% of stocks (Wolff, 2012). Approximately 65% home ownership rate leaves approximately one third of households not experiencing the wealth effect of house price increases (US Census Bureau).

A more effective transmission mechanism for monetary policy needs to be established by the central bank in which it can directly target broader market interest rates (if interest rate targeting) and where it generates a wealth effect to all people.

A more effective monetary policy mechanism

In order to more effectively attain its goals the central bank should bring into effect a mechanism which allows it to directly interact with a wider and more balanced spectrum of the economy not just banks and financial institutions. This can be achieved by the monetary authority through issuance of electronic accounts to the general public allowing people to deposit and transact in central bank deposits in the same manner as banks do at present. It is not proposed that private banks cease to be depository institutions or full reserve banking be implemented. If the CB is tasked with providing money it should therefore also provide an efficient electronic means of payments and deposits of the money it creates. The provision of a payment and depository system by the central bank will be of benefit because it will directly be able to interact with people for monetary policy purposes and the deposits and payment system which is highly systemic will become risk free.

How will monetary policy be conducted through the new mechanism?

When the monetary authority is pursuing expansionary monetary policy in order to attain its goals related to unemployment, GDP growth or inflation it can affect the target interest rate (if interest rate targeting) by periodically expanding the supply of central bank deposits directly and evenly into all citizen’s accounts while open market operations and other policies are performed when necessary. The rate of growth of direct money issuance (DMI) to the public will be periodically adjusted by the central bank in order to attain its targets while temporary open market operations may be used in order to fine tune the short term interest rate or contract the monetary base.

When the money supply is expanded to the public it will be directly issued into all people’s accounts on an equal basis at regular intervals such as once a week or month. The growth rate of the money supply will be adjusted in order to attain the target interest rate or more directly the inflation or GDP growth rate. Historically in most of the first world prior to the 2008 financial crisis the growth rate of the monetary base was approximately 5-10% per anum. If the central bank grows the money base directly to people at 5% per anum and it is suppressing the interest rate too much and therefore causing too high inflation and growth the rate of money growth should be adjusted downwards and vice versa.

During periods when the central bank needs to contract the money supply this can be done through issuance of securities such as reverse repurchase agreements, term deposit facilities or issuance of liabilities. Historically contractions of the monetary base have been rare and short term, most of the time the MB is increasing. The central bank may also employ temporary open market operations in order to fine tune the interest rate target if necessary as is currently performed.

If money is directly issued into people’s accounts no asset purchasing is required to expand the money supply. The people are the central bank’s constituent due to it being an agency of the people and therefore issuance of money to people should be recognized as equity on the bank balance sheet. The expansion of money will not deteriorate the balance sheet of the central bank if money is not recognized as a liability. Financial assets or fiat money do not need to be a liability of the issuer and is an asset for its holder (Buiter, 2004), therefore the monetary base through direct public issuance can expand without a corresponding increase in liabilities for the central bank.

Advantages of conducting monetary policy directly with the public

The various stimulatory or contractionary effects due to adjustments in short term interest rates will continue under direct money issuance with the addition of new direct mechanisms of action through increased public monetary wealth.

Direct issuance of central bank deposits to people on a non lending basis will nominally increase monetary wealth of recipients by the amount of newly created monetary base. Under asset purchases or lending the newly created money received by the central bank counter-party does not result in an increase in wealth because it is offset by a new liability or the loss of an asset. Portfolio balance effects may increase wealth under a regime of asset purchases or money lending but the higher money supply itself will not.

Higher monetary wealth due to DMI would affect spending and creditworthiness of people.

In a climate where the short term interest rate is at the zero lower bound (ZLB) the current central bank counter-parties have very little or no opportunity cost when holding reserves due to low investment returns and therefore expansions of central bank money should have a reduced impact on growth and inflation. The overall public on average have a higher opportunity cost when holding money compared to central bank counter-parties due to foregone utility from consumption or other spending. Financial entities such as the current central bank counter-parties are oriented towards realizing profits from investing and inter-mediating whereas people gain greater utility from consuming. Therefore expansions of funds to public would more effectively create growth at the ZLB. The unemployed, people on low incomes will have a low demand for money at the ZLB and will spend a large proportion of money received from the central bank which will stimulate growth. The demand generated by higher spending from people should place upward pressure on profits and asset prices and therefore also stimulate investment related spending.

The wealth effect as a result of portfolio re-balancing will continue to manifest as it does at present but an additional wider reaching increase in wealth will also prevail under DMI through increased money balances of central bank counter-parties. Asset holdings are concentrated with the wealthier people owning a large proportion of assets and many people owning few or no assets. Therefore under the present system increases in wealth from increased asset prices don’t reach large parts of the population which diminishes the effectiveness of monetary policy. Wealthier people’s propensity to spend out of income is lower than the average person therefore monetary policy induced increases in wealth of all people through money issuance should result in greater spending increases when compared to wealth increases skewed towards wealthier people.

Under the present system central bank actions designed to create a wealth effect throughout the economy are not guaranteed to succeed if asset markets don’t appreciate in response to expansionary monetary policy. Direct money issuance will increase people’s monetary wealth even if asset prices don’t change.

Increased wealth in form of liquid assets such as money is more likely to be used for spending than an increase in wealth in form of less liquid assets such as stocks or housing. Increase in wealth from less liquid assets should lead to a smaller increase in spending due to taxation from capital gains, transaction costs and effort of converting non liquid wealth into money in order to spend.

The money supply to the broader economy could increase without necessitating an increase in debt if the central bank expands the monetary base directly to people. Under the current system expansions of broader money generally require more borrowing because commercial banks usually increase the quantity of deposits through lending. If the money supply can increase while maintaining lower debt to GDP levels greater financial stability should prevail because historically credit booms raise the odds of a financial crisis (Jordá et al. 2014).

Expanding upon the capacity of the central bank to perform basic and systemic banking activities such as deposit taking alongside the private sector will greatly benefit the operation of the economy in terms of increased security and economies of scale.

If the central bank offers operates a depository and payments services this aspect of the economy which is systemic will become risk free. Deposits at the central bank will have the financial backing of the monetary authority instead of the private sector which is segmented and is managed by private companies principally serving their own profit interest.

Efficiencies of scale should be realized if the current depository and payments system is unified and streamlined under the central bank instead of being segmented among an array of private banks and clearing houses. As a result the system should become simplified and less costly to operate. The regulatory load may also be reduced if a significant proportion of depository and transaction activities are performed in house by the authority. Efficiencies of scope should also prevail if basic banking functions such as the deposits, payments and monetary policy are integrated. Deposit insurance provided by the government for the private sector may no longer be necessary.

Increases in the money supply through direct issuance to people will be permanent increases in the money supply because the central bank will not accumulate assets such as government bonds on its balance sheet which draw the money back to the central bank upon expiry of the asset or interest payments.

Monetary policy effectiveness will not be compromised in an instance of dis-intermediation if the central bank can directly interact with people.

Greater systemic safety of the deposits and payments system will be realized if people can also directly deposit and transact in central bank money which is risk free electronically alongside commercial bank deposits.

If people participate in monetary policy as counter-parties to the monetary authority they should become more knowledgeable of economics and gain greater confidence in the monetary system and its key institutions which is vital for a healthy economy.

When the CB expands money into the economy without purchasing assets it will not remove safe assets and risk free returns from the private sector which may induce risk taking. Issues relating to collateral shortages, unwinding of asset purchases or other possible adverse effects on asset markets from expanding the CB balance can be avoided.

In a dynamic stochastic general equilibrium model with rational agents maximizing utility over an infinite time horizon subject to inter-temporal budget constraints an increase in net wealth through helicopter drops would cause agents to increase their current and future spending if there are unemployed resources (Bossone, 2013).

References

Bank of England (2011), “Quantitative easing explained: putting more money into our economy to boost spending”, London: Bank of England.

Bossone, B (2013), “Unconventional monetary policies revisited (Part II)”, VoxEU.org, 5 October.

Buiter, Willem H (2004), “Helicopter money: irredeemable fiat Money and the liquidity trap”, CEPR Discussion Paper 4202.

Wolff, E. N. (2012), The Asset Price Meltdown and the Wealth of the Middle Class. New York: New York University.

Bossone, B and A Sarr (2002), “A new financial system for poverty reduction and growth”, IMF Working Paper No. 02/178, October.

Òscar Jordá, Moritz Schularic and Alan M. Taylor (2014), “Private Credit and Public Debt in Financial Crises”, FRBSF Economic Letter, March 10, 2014

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