The il­lu­sion of cen­tral bank in­de­pen­dence

With the use of gov­ern­ment bonds to back loans, the money that trea­suries cre­ate is a shrink­ing por­tion of sup­ply, and they have less con­trol of liq­uid­ity, says

Irish Examiner - - Analysis -

CAP­I­TAL­ISM has few sa­cred cows left. It is time to ques­tion one of them: the in­de­pen­dence of cen­tral banks from elected gov­ern­ments. The ra­tio­nale for en­trust­ing mon­e­tary pol­icy fully to cen­tral banks is un­der­stood: politi­cians, tempted dur­ing the elec­toral cy­cle to cre­ate more money, threaten eco­nomic sta­bil­ity.

While pro­gres­sives protest that cen­tral banks can never be truly in­de­pen­dent, be­cause their au­ton­omy from elected of­fi­cials in­creases their de­pen­dence on the fi­nanciers they keep in check, the ar­gu­ment in favour of re­mov­ing mon­e­tary pol­icy from demo­cratic pol­i­tics has pre­vailed since the 1970s.

Set­ting aside the po­lit­i­cal con­tro­versy, cen­tral bank in­de­pen­dence is pred­i­cated on an eco­nomic ax­iom: that money and debt (or credit) are strictly sep­a­ra­ble. Debt — for ex­am­ple, a gov­ern­ment or cor­po­rate bond that is bought and sold for a price that is a func­tion of in­fla­tion and de­fault risk — can be traded do­mes­ti­cally. Money can­not de­fault and is a means, rather than an ob­ject, of ex­change (the cur­rency mar­ket notwith­stand­ing).

But this ax­iom no longer holds. With the rise of fi­nan­cial­i­sa­tion, com­mer­cial banks have be­come in­creas­ingly re­liant on one an­other for short-term loans, mostly backed by gov­ern­ment bonds, to fi­nance their daily op­er­a­tions. This liq­uid­ity ac­quires fa­mil­iar prop­er­ties: used as a means of ex­change and as a store of value, it be­comes a form of money. And there’s the rub: as banks is­sue more in­ter-bank money, the fi­nan­cial sys­tem re­quires more gov­ern­ment bonds to back the in­crease.

The grow­ing in­ter-bank money sup­ply fu­els de­mand for gov­ern­ment debt, in a never-end­ing cy­cle that gen­er­ates tides of liq­uid­ity over which cen­tral banks have lit­tle con­trol.

In this brave-new fi­nan­cial world, cen­tral banks’ in­de­pen­dence is be­com­ing mean­ing­less, be­cause the money they cre­ate rep­re­sents a shrink­ing share of the to­tal sup­ply.

With the rise of in­ter-bank money, backed mostly by gov­ern­ment debt, fis­cal pol­icy has be­come es­sen­tial in de­ter­min­ing the quan­tity of ac­tual money lu­bri­cat­ing mod­ern cap­i­tal­ism. In­deed, the more in­de­pen­dent a cen­tral bank, the greater the role of fis­cal pol­icy in de­ter­min­ing the quan­tity of money in an econ­omy.

For ex­am­ple, in the eu­ro­zone, Ger­many’s tight fis­cal pol­icy is cre­at­ing a short­age of bunds (Ger­man gov­ern­ment bonds), which is lim­it­ing both the Euro­pean Cen­tral Bank’s ca­pac­ity to im­ple­ment its quan­ti­ta­tive-eas­ing pol­icy and com­mer­cial banks’ abil­ity to pro­duce more in­ter-bank money. Money and gov­ern­ment debt are now so in­ter­twined that the an­a­lyt­i­cal ba­sis for cen­tral-bank au­ton­omy has dis­ap­peared. Of course, any at­tempt to bring trea­suries and cen­tral banks back un­der one roof would ex­pose politi­cians to ac­cu­sa­tions of try­ing to get their grubby hands on the levers of mon­e­tary pol­icy.

But an­other re­sponse to the new re­al­ity is avail­able: Leave cen­tral banks alone, but give gov­ern­ments a greater say in do­mes­tic money cre­ation — and greater in­de­pen­dence from the cen­tral bank — by es­tab­lish­ing a par­al­lel pay- ments sys­tem based on fis­cal money or, more pre­cisely, money backed by fu­ture taxes. How would fis­cal money work? For starters, it would ‘live’ on the tax author­ity’s digital plat­form, us­ing the ex­ist­ing tax-file num­bers of in­di­vid­u­als and com­pa­nies.

Any­one with a tax-file num­ber (TFN) re­ceives a free ac­count linked to it. In­di­vid­u­als and firms will then be able to add credit to their TFN-linked ac­count by trans­fer­ring money from their nor­mal bank ac­count, in the same way that they do to­day to pay their taxes.

And they will do so well in ad­vance of tax pay­ments, be­cause the state guar­an­tees to ex­tin­guish in, say, a year, €1,080 ($1,289) of the tax owed for ev­ery €1,000 trans­ferred to­day — an ef­fec­tive an­nual in­ter­est rate of 8% payable to those will­ing to pay their taxes a year early. In prac­tice, once, say, €1,000 has been trans­ferred to one’s TFN-linked ac­count, a per­sonal-iden­ti­fi­ca­tion num­ber (the fa­mil­iar PIN) is is­sued, which can be used ei­ther to trans­fer the €1,000 credit to some­one else’s TFNlinked ac­count or to pay taxes in the fu­ture.

These time-stamped, fu­ture tax eu­ros, or fis­cal eu­ros, can be held for a year un­til ma­tu­rity, or be used to make pay­ments to other tax­pay­ers. Smart­phone apps and even gov­ern­ment-is­sued cards (dou­bling as, say, so­cial se­cu­rity ID) will make the trans­ac­tions easy, fast, and vir­tu­ally in­dis­tin­guish­able from other trans­ac­tions in­volv­ing cen­tral-bank money.

In this closed-pay­ments sys­tem, as fis­cal money ap­proaches ma­tu­rity, tax­pay­ers not in pos­ses­sion of that vin­tage will fuel ris­ing de­mand for it. To en­sure the sys­tem’s vi­a­bil­ity, the trea­sury con­trol the to­tal sup­ply of fis­cal money, us­ing the ef­fec­tive in­ter­est rate to guar­an­tee that the nom­i­nal value of the to­tal sup­ply never ex­ceeds a per­cent­age of na­tional in­come, or of ag­gre­gate taxes, agreed by the leg­is­la­ture.

To en­sure full trans­parency, and thus trust, a blockchain al­go­rithm, de­signed and su­per­vised by an in­de­pen­dent na­tional author­ity, could set­tle trans­ac­tions in fis­cal money.

The ad­van­tages of fis­cal money are le­gion. It would pro­vide a source of liq­uid­ity for gov­ern­ments, by­pass­ing the bond mar­kets. It would limit the ex­tent to which gov­ern­ment bor­row­ing fu­els in­ter-bank money cre­ation, or at least force fi­nanciers to tie up some of their in­ter-bank money in the closed, do­mes­tic fis­cal-money sys­tem, thereby min­imis­ing shocks from sud­den cap­i­tal flight. And, by com­pet­ing with the banks’ pay­ment sys­tem, it would re­duce the cost of fees cus­tomers cur­rently pay.

In­deed, ow­ing to the blockchain tech­nol­ogy, fis­cal money con­sti­tutes a fully trans­par­ent, trans­ac­tion-cost-free, public pay­ment sys­tem, mon­i­tored jointly by ev­ery ci­ti­zen (and non-ci­ti­zen) who par­tic­i­pates in it.

Fis­cal money is po­lit­i­cally at­trac­tive, as well. Gov­ern­ments could use any slack in money sup­ply to top up the FTN-linked ac­counts of fam­i­lies in need, or to pay for public works, mak­ing it ap­peal­ing to pro­gres­sives.

And con­ser­va­tives should be en­cour­aged by a sys­tem that prom­ises sig­nif­i­cant tax re­lief for those who help the gov­ern­ment cre­ate fis­cal money, with­out im­ping­ing on the cen­tral bank’s role in set­ting in­ter­est rates.

The po­ten­tial transna­tional ad­van­would tages of fis­cal money are also sig­nif­i­cant. For ex­am­ple, fis­cal money would have helped Greece re­sist our cred­i­tors’ en­croach­ments in 2015, and it was at the heart of my plan for deal­ing with a preda­tory bank hol­i­day en­forced by the ECB at the end of that June.

To­day, it would give Italy, France, and other eu­ro­zone mem­bers much needed fis­cal space, and pos­si­bly pro­vide a foun­da­tion for a re­vamped eu­ro­zone with in­ter­lock­ing do­mes­tic fis­cal eu­ros, rather than par­al­lel cur­ren­cies, play­ing a sta­bil­is­ing, macro-eco­nomic role. And then it could be­come the ba­sis for a new Bret­ton Woods, func­tion­ing like an over­ar­ch­ing clear­ing union of many dif­fer­ent fis­cal-money sys­tems.

Ya­nis Varo­ufakis, a for­mer fi­nance min­is­ter of Greece, is pro­fes­sor of eco­nom­ics at the Uni­ver­sity of Athens.

Copy­right: Project Syn­di­cate, 2017.

Pic­ture: Yor­gos Kara­halis/Bloomberg

Pro­test­ers march in front of the Bank of Greece dur­ing a 24-hour labour strike in Athens ear­lier this sum­mer as the econ­omy re­turned to re­ces­sion in the first quar­ter.

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