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