CB tools for temporarily or permanently contracting the monetary base without asset sales

In order to manage short term fluctuations in money demand which will affect it’s targets the central bank will need to temporarily grow the monetary base below trend or contract the monetary base (MB). When temporary contractions are required the CB can use existing facilities such as reverse repurchase agreement or issue it’s own securities similar to treasuries.

Permanent contractions of the MB are unprecedented and seem unnecessary. If a rare or extreme circumstance comes about the central bank can very effectively permanently contract the the MB. This can be done through directly imposing transaction costs/taxes on the economy using the taxation office as its collection agent just as the fiscal arm of government does at present. There would be strict conditions on when and how the central bank could impose this form of tax in such a rare circumstance.

Direct taxation by the central bank would be a highly effective method of contracting the monetary base. As an example a 2% income tax on all income earners over a one year period in Australia would contract the monetary base by approximately 35%.

In this instance taxation would be a monetary policy tool because it would be used by the central bank to affect the money supply and destroy money, not for funding of spending.

Effect of Heli’s on Credit Markets

Lowering interest rates to stimulate AD and inflation undermines the effectiveness of the credit markets. Credit can be stimulated in two ways. Higher AD stimulates credit primarily through higher profits and income. Lower interest rates stimulate credit primarily through lower interest costs. It is better if credit responds to higher income and profits because it has greater guidance as to where to go to most profitable areas. Therefore lending can be more effectively channeled. Lowering rates is a broad lending stimulus, which encourages greater levels of lending to all areas including more speculative ones. Consequently interest rate stimulus makes lending of a more speculative nature because lenders have to anticipate to a greater degree where the most profitable areas will be. Increasing lending to areas that have realized increases in profits/income makes lending less speculative in nature. An inefficient lending system will result in lower real GDP growth and an increasing debt to GDP ratio due to higher levels of malinvestment and speculation.

Heli’s are the optimal monetary policy instrument to improve the function of the credit system because they generate aggregate demand by increasing monetary wealth of people without needing stimulus from lowering of rates.

Heli’s could send interest rates higher or lower depending on the relative changes in income, inflation and loanable funds caused by heli’s.

The E-money Helicopter Drop 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 or e-money by the central bank (CB) to all people and other entities instead of only depository or financial institutions. The CB is tasked with providing the supply of money and should therefore also provide an efficient electronic means of making payments and depositing the money it creates. Physical notes, coins and commercial bank deposits or other forms of broader money will continue to exist in their current form.

2. Incorporate new policy tools so the monetary authority can attain its targets more effectively and equitably.  The key tool is the e-money helicopter drop. When the monetary authority is pursuing expansionary monetary policy in order to attain its goals related to unemployment, GDP growth or inflation it can periodically expand the supply of central bank e-money directly and evenly into all citizen’s accounts through helicopter drops. Other policy tools such as the ones currently employed may also utilized when optimal. The rate of monetary growth through helicopter drops to the public should be periodically adjusted by the central bank in order to attain its targets while it may also conduct temporary open market operations or issue securities in order to fine tune the short term interest rate or contract the monetary base. E-money heli-drops  would represent a more effective version of helicopter drops because central bank independence is not compromised. New legislation would need to be crafted to allow central banks to perform e-heli’s including strict limitations on how e-heli’s are performed.

Principle benefits of proposal

E-helis stimulate spending through higher monetary wealth of e-heli recipients. As a result of higher monetary asset wealth from heli’s lending will also be stimulated due to improved creditworthiness as well as an increase in loanable funds. Heli’s are superior to current interest rate targeting tools because they generate spending stimulus independently of the credit channel while simultaneously stimulating credit. Therefore dysfunctional credit markets or banking systems should not affect the operation of monetary policy.

Helicopter drops of central bank issued e-money allow the central bank to conduct helicopter drops in order to stimulate the economy without requiring the cooperation of the fiscal arm of the government. This would simplify the process of performing heli-drops and remove any conflicts of interest that may arise from undermining central bank independence.

Heli’s stimulate investment by increasing spending and hence income. Higher AD will stimulate investment as entities compete for income. Heli’s avoid increasing speculation through excessively stimulating credit into an environment of low growth in which investment is not appealing due to low demand.

If e-money is accounted for as a type of equity and not a liability on the balance sheet at creation issues of central bank solvency are less of a concern and wont require additional government borrowing or taxation in future due to budget constraint. Issuance of money by a government entity to its constituent is most accurately accounted for as equity. This is somewhat similar to a corporation issuing stock to existing shareholders. If e-money is recognized as equity the central bank can issue the quantity of money required to achieve targets without needing to purchase assets. Under current system the central bank buys assets such as bonds which are claims on the money it creates issued by another government branch so money currently has no real backing. Ultimately the true backing of fiat money is effective and accountable management of the monetary system leading to a strong economy.

There is no zero bound problem to address under heli’s.

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. This is especially true of the unemployed and people with low incomes and little to no wealth. 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 e-helis 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.

Greater systemic safety and efficiency through economies of scale of the deposits and payments system will be realized if people can also directly deposit and transact in central bank e-money which is risk free electronically alongside commercial bank deposits. The central bank can offer depository services for the public interest. Commercial banks are profit oriented which can compromise the level of service provided to depositors.

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.

What backs money?

The most important element in creating money demand is the competence of issuer and accountability. Competence is largely composed of setting targets and effectiveness of tools used. Accountability assures people hat the monetary system is run in the interests of the public.

That’s the backing, not a metal that if the system collapses you cant usually redeem anyway.

What fundamentally backs money in the long run is transactions money demand. Taxes create some demand. Without taxes people would still demand money because of its usefulness in making payments. Taxes can undermine the monetary system if excessive or if fiscal policy is poor.

CB tools for temporarily or permanently contracting the monetary base without asset sales

In order to manage short term fluctuations in money demand which will affect it’s targets the central bank will need to temporarily grow the monetary base below trend or contract the monetary base. When temporary contractions are required the CB can use existing facilities such as reverse repurchase agreement or issue it’s own securities similar to treasuries.

Permanent contractions of the MB are unprecedented and seem unnecessary. A permanent contraction of MB will result in lower growth as well as inflation so the real effect will be zero. If necessary though the central bank can very effectively permanently contract the the MB. This can be done through directly imposing transaction costs/taxes on the economy using the taxation office as its collection agent  just as the executive arm of government does at present. There would be strict conditions on when and how the central bank could impose this form of tax in such a rare circumstance.

Direct taxation by the central bank would be a highly effective method of contracting the monetary base. As an example a 2% income tax on all income earners over a one year period in Australia would contract the monetary base by approximately 35%.

It bears considering whether taxation should be one of the primary short term contraction tools of a central bank due to how effective it is in removing money from circulation and directly affecting economic variables. An incremental trial of the tax policy tool to ascertain its effectiveness should be beneficial. Direct taxation may be more effective in affecting demand because it directly affects incomes and prices of goods and services or labor instead of investment money flows when the central bank issues securities

In this instance taxation would be a monetary policy tool because it would be used by the central bank to affect the money supply and destroy money, not for funding of spending.

Central Bank Accountability and Independence

Central bank governors and/or directors should be elected through a public vote and not appointed by other arms of government. The CB should also be independent of the legislative body if it adheres to its targets. Central banks should set clear policy targets. When the central bank deviates from its economic objectives for a defined period of time an established parliamentary body can call on governors to explain their actions. If these actions are inappropriate governors can be fired and new governors publicly elected. Limits on how many governors of the board can be replaced per year can be imposed in order to limit uncertainty. Incentives should also be put in place for achieving targets.

A parliamentary committee with no party affiliation could be elected to make CB governors accountable if they don’t perform their objectives. This committee may also have other responsibilities possibly relating to regulation of financial markets, auditing or banking.

It may be worth considering if beneficial to require a basic level of monetary education or experience for voters to be permitted to vote for central bank governors. Such an education could be provided at no cost possibly at the secondary level (high school) of education.

The CB may fund itself by printing all the money necessary to underpin its operations in a transparent and accountable manner or it may impose an annual fee on citizens. This fee could be deducted from the heli drops the public receives so that people don’t pay fees they just receive an small reduction in the amount of money received through the heli drop.

Monetary Policy which includes managing the nation’s money and payments system is an important task that requires its own dedicated institution. The monetary authority should be recognized as a separate arm of government and be fully independent from the executive arm of the government much like the judiciary or legislature. Conflicts of interest may arise when the central bank loses its independence. Political interference of monetary policy by the executive or legislative arm of government will adversely affect its performance. Under an independent central bank monetary policy can’t be manipulated ahead of elections, or to support political aims. Money system should not be captive to politicians.

If other arms of government also have to perform monetary policy it will concentrate too much responsibility under the executive or legislative arm of government and increase the amount of tasks needing to be managed by a these entities. This will confuse or reduce the focus required to effectively manage the monetary and payments system which will result in inferior management outcomes. For example sometimes the government may invest in unnecessary infrastructure just to increase the money supply, not because the infrastructure is needed. Government should focus on fiscal policy and regulations in order to create most efficient economic system. Central bank should manage monetary policy in order to create most balanced, stable and efficient monetary system to underpin the efficient functioning of real economy. Specialization makes for more effective policy making.

Less confusion or obfuscation and greater accountability will prevail if monetary authority is solely responsible for monetary policy.

What is the proper balance sheet recognition of money?

Money is a a financial asset issued by the central bank. Like any financial asset it may be recognized as an asset or a liability of issuer.

If the money issued is a promise to pay a certain amount of a commodity such as gold then the money should be recognized as a liability. In a fiat money system there is no promise to pay anything to holder of money so it generally should not be a liability. If money is issued to the people who are the central bank’s constituent it should be recognized as a form of equity.

Recognizing money as equity is beneficial in the sense that the central bank can print money in accordance to its targets without the balance sheet going negative. If money is a liability issuance of money increases a bank’s liabilities. In order to offset this the central bank expands money through asset purchases. Under an equity money system the bank can operate tools such as e-money heli-drops without needing to purchases assets which simplifies policy-making.

The issue of money backing arises if no assets are being purchased when expanding money. Credibility of issuer in terms of competence and accountability are the true backing of money. In event of collapse central bank assets like gold should not be accessible anyway to money holders so any physical backing is questionable. Under current fiat system one possible backing is the financial assets such as government bonds the CB purchases when conducting monetary policy. This is a dubious backing anyway because government bonds or similar instruments are claims on the money the central bank can print without limit. The monetary authority may continue to hold assets such as gold on its balance sheet but further issuance of money should generally not require an expansion of central bank asset purchases.

Balance sheet issues may arise if the central bank wishes to retract money through issuance of liabilities such as reverse repo, interest on reserves or bonds. This can easily be overcome by printing money and placing it on balance sheet of bank in an equal amount to its issued liabilities so that the balance sheet equals out.