Read on Twitter
Megan Greene and Eric Lonergan published a http://VOX.EU great piece last week making the case for dual interest rates. This is a cause I fully support, so they are pushing on an open door with me.
@ericlonners @economistmeg https://voxeu.org/article/dual-interest-rates-give-central-banks-limitless-fire-power
@ericlonners @economistmeg https://voxeu.org/article/dual-interest-rates-give-central-banks-limitless-fire-power
Thinking and acting outside the box is necessary and should receive full support from defenders of our Open Society.
That said, some claims about the ease with which dual rates might be implemented appear optimistic. So let me offer some supportive criticism.
That said, some claims about the ease with which dual rates might be implemented appear optimistic. So let me offer some supportive criticism.
As I see it, the problem with central bank equity is twofold.
First, “conservative” central bankers exist. Not only as an inflation fighting strategy since the 1980s, but since they are extraordinarily abstemious creatures--profit and loss is an issue, though it should not be.
First, “conservative” central bankers exist. Not only as an inflation fighting strategy since the 1980s, but since they are extraordinarily abstemious creatures--profit and loss is an issue, though it should not be.
So there is such an embedded conservatism that needs to be overcome. It’s nice for Governor X,Y,Z to enjoy a newspaper headline every year about how much the central bank handed over the Finance Ministry…
—as if they wield some exceptional skills beyond the demand for local currency to affect payments which they inherited without thinking or understanding!
But if this is the practical challenge to dual rates, the second problem is that these Governors typically also have the Law on their side. That is, many (most?) central bank statutes include automatic recapitalization triggers built into their Law.
This means that even if a central bank governor, throwing caution to the wind, were to run down capital by implementing dual rates, once capital reaches some lower limit most governments are bound by law to recapitalization—adding to government debt in the process.
In this respect, I was surprised, for example, that not so long-ago HMT and BOE agreed a recapitalization process that ruled out use of the BOE balance sheet strength through negative capital. But this is the “state of the art” including in IMF manuals.
https://www.bankofengland.co.uk/-/media/boe/files/memoranda-of-understanding/financial-relationship-between-hmt-and-the-boe-memorandum-of-understanding.pdf
https://www.bankofengland.co.uk/-/media/boe/files/memoranda-of-understanding/financial-relationship-between-hmt-and-the-boe-memorandum-of-understanding.pdf
Such profit sharing rules make dual rates doubly difficult because the CB governor—unelected and mostly unelectable!—in eating into their capital would be accused of “using taxpayer money” without proper oversight. This will erode the independence and legitimacy of the CB.
Of course, although this is no more than the quasi-fiscal operations central banks undertake in normal times, such conspicuousness doesn’t lend itself to imaginative policy. This is another case where the “lower bound” matters, but for different reasons.
Another fascinating issue raised by G&L is the “correct” accounting treatment of central bank reserves. Indeed, central bank liabilities are different—they are an outside asset to the private sector unlike most broad money, though they are understood as equal by the public.
But recognizing the “special” character of central bank money doesn’t easily resolve how it should be “accounted” for. There are some precedents amongst academics who attempt to generate the intertemporal budget constraint for a central bank and derive sustainability.
In, for example, Reis and Buiter’s (separate) work there is a special role for physical cash liabilities—currency in circulation—in generating seigniorage and providing a Pigou “wealth effect.”
But why only physical cash? Why not bank electronic reserves with central banks—which now outsizes currency?
More generally, the accounting issue is the same as public debt in standard sustainability.
More generally, the accounting issue is the same as public debt in standard sustainability.
It’s not the stock that matters, but the related income flows and how these flows are financed.
This argues not for ignoring central bank liabilities entirely (probably not G&L’s suggestion), ...
This argues not for ignoring central bank liabilities entirely (probably not G&L’s suggestion), ...
... but acknowledges there is a point where net interest income of the central bank makes monetary sustainability impossible to attain. Per Argentina (a sometime obsession of mine.) https://thegeneraltheorist.com/2019/08/13/recalibrating-argentinas-ponzi-program/
Where does this leave us? It seems that taboos on public debt sustainability such as the “debt-to-GDP” ratio are also rife in central banking and need to be challenged.
This includes the “automatic” recapitalization rules which imply that central banks should not continue without recapitalization.
In fact, central banks need to shake off the cobwebs that have formed around their traditional modes of thought. This means elevating management of central bank capital as part of public policy—and overcoming traditional legal constructs which will constrain thinking.
And dual rates need to be elevated to the forefront of policy. The BOE’s research agenda should elevate understanding this tool. And the ECB’s strategy review should consider how the Eurosystem limits rather than unleashes policy in pursuit of their mandate.
And more generally, people should take seriously Greene and Lonergan. END. https://www.bankofengland.co.uk/research/bank-of-england-agenda-for-research
