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Symposium 2013

Proposal - Making central banks serve the real economy

The Challenge

The global financial crisis has revealed regulatory failure in financial markets and demonstrated the urgent need for reform. In particular, it is now widely accepted that in addition to established m ...

The global financial crisis has revealed regulatory failure in financial markets and demonstrated the urgent need for reform. In particular, it is now widely accepted that in addition to established microprudential policies, macroprudential policies aimed at increasing the stability of the financial sector as a whole are imperative. But an active debate has emerged over what role the central bank should play with this augmented set of policies.

Central banks should use their ability to create new money and channel it into meaningful investments.

Central banks shall supply money for the economy by supplying money for banks. The paradox here is that they lack influence on what banks do with the money. The problem with low key interest rates is that they are not targeted. Quantitative easing measures (QE), such as the purchases of securities by central banks, can help the financial sector in systematic liquidity and solvency problems. QE can also reduce government debt servicing costs by lowering the sky-high interest rates of state bonds. However, the current QE has not been targeted towards stimulating real economic activity. That is why it risks feeding leverage-driven asset bubbles in the financial sector instead of funding real needs.

Hence the challenge is to redirect central bank money into the real economy and to the needs of society. Whereas taxes refer to the re-distribution of money, the task here tackles its pre-distribution.

Central banks should contribute to the funding of real needs

Central bank money should not solely be used to fund private banks; it shall also engage in the financing of public investment expenditures. Climate protection, public health and public transport: the world is full of unfulfilled investment needs. Not everything suits the profit-orientated expectations of private investors. Or if you make it to fit them by increasing the profit through higher consumer prices and spreading the risks via excessive securitisation, the price may be social exclusion and financial instability.

For example, research in Alzheimer’s disease might take 20 years; and some parts of that research may yield inconclusive results. Yet that is human life, and we need sustainable finance for it. We should not stand and watch the pharmaceutical industry prioritise more lucrative botox research. Central banks should use their ability to create new money and channel it into meaningful investments. At the global level, the UN Green Climate Fund was established in 2010 and planned to raise US$100 billion, but is still out of money. Central banks could cooperate with the International Monetary Fund and development banks in order to employ monetary financing to break this funding deadlock.

The benefits of such monetary financing will be substantial:

  • Long-term financing will become available at an affordable price. Partnerships between government, financed by central bank money, and long-run institutional investors like foundations, insurance companies and pension funds are also possible.

  • The deleveraging process of private banks can be accompanied by new central bank money. Thus a credit crunch can be avoided.

  • Central bank money can contribute to overcoming austerity. Central banks can finance tax cuts in a recession as well as debt cancellation for the benefit of present and future generations.

  • This will also strengthen democracy, as austerity is a means to exert power. Central bank money can end governments and the real economy being held hostage by unreliable financial markets. It can end unfair conditions of structural adjustments, be it through the International Monetary Fund towards its poorer member states or through the Troika in Europe.

  • Finally, socially and environmentally required investments could be put into practice. Every necessary investment, which is not taken today, will be highly expensive for present and future generations. This ranges from neglected safety standards for public transport to environmental consequences and public education.

 

... but what about inflation?

Monetary financing of governments is still a taboo, though. This is not without reason as economies have been affected by hyperinflation like in Brazil, Germany and many African countries.

Therefore, some conditions must be met:

First, if new money is issued to expand the productive capacity, there is no reason for inflation. Adair Turner proposes that central banks allow a defined amount of monetary financing as a percentage of the gross domestic product. [1] Matthias Kroll of the World Future Council recommends, depending on economic trends, up to five percent.[2] Since this will be a decision by the central bank, not the Treasury, the independence of central banks can be maintained. In doing so, central banks should take democratically agreed criteria as the basis, including the degree of the utilisation of production capacity. If central banks announce the amount of monetary financing before any one budget year, the Treasury can take this into account and balance it with fiscal measures such as taxes and debt. Provided the amount of new central bank money is in pursuit of the gross domestic product level, it can even be spent on dance performances, theatre plays and on the funding of foundations.

Second, exit strategies are implementable when economic conditions are boosted. For that, central banks have various tools. They can, for instance, increase minimum reserve requirements. Japan in the early 1930s, namely under Finance Minister Takahashi Korekiyo, provides a remarkably good example for the use of new central bank money combined with a well-tailored exit strategy. In order to escape from the Great Depression, spending increases were financed with government bonds which were underwritten by Japan's central bank, the Bank of Japan. Thereby central bank money was channeled into government spending. Later, to prevent inflation in a growing economy, the Bank of Japan sold - part of - these bonds to private financial institutions. This was the appropriate exit strategy to suck off money by transforming it into liabilities.[3]

Third, new central bank money must not replace a sound tax system and the distribution of income and wealth, but complement it. While new central bank money can be used in a certain corridor without being inflationary, taxes are the basis of public finance.

The widespread taboo of monetary financing should be broken. The key is always where the money goes to and on what terms - in times of stress as well as every day.



[1] Reichlin, Lucrezia, Adair Turner, Michael Woodford (20/5/2013); Helicopter money as a policy option, on: VoxEU.
http://www.voxeu.org/article/helicopter-money-policy-option

[2] Kroll, Matthias (2008); Monetäre Stabilität und die Finanzierung von Staatsdefiziten durch Zentralbankkredite bei endogener Geldmenge, Berlin, p 68f.

[3] For more details see: Kroll, Matthias (2013); Takahashi Korekiyos Wirtschaftspolitik als Grundlage einer “Best Policy” zur Rezessionsüberwindung, World Future Council policy brief.
http://bit.ly/18biZxK

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