Unusual times call for unusual measures
Central banks have an essential duty to create extra money. They do so on a consistent basis in normal times. Their extra money comes in two forms: as notes and coins, and deposits that private banks keep with them.
The sum of the notes and the deposits issued by the SA Reserve Bank (the money base) grew 7.9 times between 2000 and April 2020, from R35bn to R275bn — erring until recently (after 2014) on the side of issuing too much.
The Bank’s balance sheet has been updated to April 2020. The money base (notes plus bank deposits) as at April 2020 was R5bn smaller than at the 2019 year end. The money base fell by R29.4bn between April and March 2020, even though the note issue itself rose by R4.82bn in April, surely in response to Covid-19 crisis fears. But deposits from banks, fell sharply from R103.4bn in March to R77.34bn by April.
The Bank’s portfolio of government stock, a small part of its asset portfolio, grew from R8.1bn at year end to R20.6bn in April. They may be compared with loans made by the Reserve Bank for the banking system. These grew from R65.8bn at year end to R103.9bn by March but then (surprisingly) fell back to R77.34bn by end-April.
If the Reserve Bank were to embark on meaningful money supply growth, loans to the banking system as well as its holdings of government stock would have to increase meaningfully. A rise in Reserve Bank lending to the banking system on favourable terms would enable banks to support extra issues of short-term Treasury obligations at much lower interest rates, hopefully.
There is always a temptation for a government to borrow money from its central bank to fund its expenditure by issuing money. Almost zero-cost money may be issued as an alternative to raising taxes or paying interest on the debt it raises to fund its expenditure. It is a temptation that is, in reality, widely resisted.
How much money should be created to help service an economy? It is to supply no more than what the households, businesses and banks would willingly hold as a reserve of spending power. Not too much and not too little.
It is not the supply of money and of associated bank and other credit representing inflationary dangers — or the danger of asset price bubbles — that must end badly for an economy. It is the excess of the supply of money — over the willingness to hold the extra money supplied — that is to be avoided if inflation is to be well controlled.
These norms for monetary policy do not apply in the extremes of a crisis when sudden demands for additional cash threaten the banking financial and payments system. The solution for a crisis is for a central bank to supply as much extra cash as is necessary to prevent ordinarily sound businesses and financial institutions from going under and dragging the economy down with them.
Shutting down an economy to fight a pandemic is a new challenge for monetary policy. It also calls for a rapid increase in the supply of central bank money and sharply lower interest rates where there is room to lower them.
Funding much extra government spending via loans from the central bank, or funded by a banking system well supported with loans from the central bank, is a very helpful form of government finance when spending is growing rapidly to meet an emergency — and correctly so.
Funding with money or near money avoids the long-term burden for taxpayers of funding additional debt issues at high interest rates in an unwilling capital market. And by adding extra money to the system it makes a much-needed recovery of spending more likely when the economy comes out of lockdown.
The extra money cannot be inflationary until the economy and spending recover. And then the growth in the supply of money and credit can be reduced or reversed in the usual way.
When an economy is forced to its knees, an emphasis on inflation targets, as seems to be the case with the Reserve Bank, makes no sense at all. The country urgently needs and deserves (proportionately) as much extra money as is being provided in the developed world.