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.

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