Current Monetary Order and its Potential Reforms Money vs. Fixed Money • The traditional view...
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Current Monetary Order and its Potential Reforms Mojmír Hampl CNB Vice-Governor Corvinus University, Budapest, November 24, 2017
Transcript of Current Monetary Order and its Potential Reforms Money vs. Fixed Money • The traditional view...
Current Monetary Order and its
Potential Reforms
Mojmír Hampl CNB Vice-Governor
Corvinus University, Budapest, November 24, 2017
Central Banking Statements
Please read the following statements. Some are “common sense”, some appear in the best-known textbooks. Which are always true, which are sometimes true, and which are false? 1. The central bank controls the money supply 2. Increasing CB balance sheet means „printing
money“ 3. Monetary policy creates the business cycle 4. A modest rise in CPI is not price stability 5. Low (real) interest rates mean stimulus 6. There is no independent monetary policy with a
fixed exchange rate
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Elastic Money vs. Fixed Money
• The traditional view (still in many textbooks): CB controls the monetary base, and via the money multiplier it controls the money supply
• Appealing, as the multiplier model is an ex-post identity
• But causality actually runs the other way round! • In reality, banks, non-financial firms and
households determine the amount of money via the credit market
• The central bank influences credit market conditions through the short-term interest rate
• Please read: Braun (2016), McLeay et al. (2014), and Jakab and Kumhof (2015)
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How Does Money Creation Work?
4 Source: McLeay et al. (2014)
Non-money
Currency
Non-money
Currency
Reserves Reserves Base money
Assets Liabilities Assets Liabilities
Before loans are made After loans are made Central bank
Currency
Deposits
Currency
Deposits Reserves Reserves
New loans
New deposits
Commercial banks
Base money
Assets Liabilities
Assets Liabilities
Example: House Purchase (1)
5 Source: McLeay et al. (2014)
Changes to the balance sheets of the house buyer and seller’s banks
Buyer’s bank Seller’s bank Buyer’s bank Seller’s bank Buyer’s bank Seller’s bank Assets Liabilities Assets Liabilities Assets Liabilities Assets Liabilities Assets Liabilities Assets Liabilities
Balance sheets before the loan is made. The mortgage lender creates new deposits...
...which are transferred to the seller’s bank, along with reserves, which the buyer’s bank uses to settle the transaction.
Currency
Deposits
Currency
Deposits
Reserves Reserves
Currency
Deposits
Currency
Deposits
Reserves Reserves
New loan
New deposit
Currency
Deposits
Currency
Deposits Reserves
Reserves
New loan
Transferred reserves
New deposit
Changes to the balance sheets of the house buyer and seller
House buyer House seller House buyer House seller House buyer House seller Assets Liabilities Assets Liabilities Assets Liabilities Assets Liabilities Assets Liabilities Assets Liabilities
Balance sheets before the loan is made. The house buyer takes out a mortgage... ...and uses its new deposits to pay the house seller.
Currency
Non-money
Currency
Non-money
Deposits Deposits
New deposit
New loan
Non-money (house)
Currency
Non-money
Currency
Non-money
Deposits Deposits
Non-money (house)
New loan
New deposit
Currency
Non-money
Currency
Non-money
Deposits Deposits
Non-money (house)
Example: House Purchase (2)
But settling all transactions this way would be unsustainable: • The buyer’s bank would have fewer resources to meet its
possible outflows • If it made many new loans, it would eventually run out of
reserves
So the buyer’s bank will in practice seek to attract or retain new deposits.
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Currency
Deposits
Currency
Deposits Reserves
Reserves Reserves
New loan New deposit
Buyer’s bank Seller’s bank
Assets Liabilities Assets Liabilities
Source: McLeay et al. (2014)
What Variables Should the Central Bank Stabilize?
• Stabilization is currently the tenet of central banking
• But remember the radical libertarian (and, to some extent, Austrian) opposition to active stabilization
• This was the mainstream view prior to the 1930s • Three stabilization targets: nominal variables,
real variables, financial variables • One cannot catch all rabbits. It can be shown
that giving most weight to nominal variables helps stabilize the rest of the economy as well
• But should other variables have zero weight? Fed’s dual mandate; recent focus on financial stability
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But What Nominal Variables? Money?
• The monetarist experiment of Paul Volcker was, to a large extent, based on the idea of fixed money
• The rapid disinflation showed the power of monetary policy, but serious side effects appeared, questioning the fixed money view
• Impossible trinity:
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Control of monetary base
Stable demand for MB
Stable money multiplier
“New Monetarists” in “Old Central Banks”
• It turns out that the old monetarist goal (price stability) is best achieved via inflation targeting
• Two crucial building blocks of modern monetary policy: rational expectations and rigidities (or rational inattention; Sims, 2003)
• Rational expectations imply long-term neutrality of monetary policy (although see Aghion et al., 2012)
• Rigidities imply short-term effectiveness in affecting real variables, such as GDP and employment
• Inflation targeting anchors expectations: inflation is more palpable to households than money supply
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Inflation Targeting: Why 2%?
• Most central banks in developed countries define a 2% increase in CPI as price stability
• The reason is that CPI overstates inflation – it doesn’t account for the increasing quality of goods, the substitution effect and the outlet bias when relative prices change (Gordon, 2006)
• A positive target on CPI growth also creates a buffer against the zero lower bound on the interest rate, which is the primary instrument of central banks
• The key concept is the equilibrium interest rate, at which monetary policy is neutral (balance between easing and tightening)
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The Equilibrium Rate Has Been Decreasing
3UK
2
1Euro area
0
-1
4
5
1980 1985 1990 1995 2000 2005 2010 2015
e ce t
U.S.
Canada
11 Source: Holston et al. (2016)
Per cent
Do Our Old Trilemmas Still Hold?
• The classical impossible trinity:
• However, a country doesn’t have to succumb to the trilemma if the factors are temporary and under the central bank’s control
• For example, a temporarily fixed exchange rate (as unconventional MP) still allows for autonomous MP
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Liberalised capital flows
Fixed exchange rate
Autonomous monetary policy
Digital Currencies Emitted by Central Banks
Now to reforms: • In some countries, cash accounts for a small and
shrinking percentage of total money supply • The CB loses seigniorage revenue, almost all
money is generated at the credit market • That’s why the Riksbank is planning e-krona:
a digital alternative to cash (Skingsley, 2016) • The concept is very similar to standard electronic
deposits, but now held at the central bank
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What Do You Conclude From This Graph (Swedish Data)?
700 000
1 000 000
1 300 000
1 600 000
1 900 000
2 200 000
2 500 000
2 800 000
58 000
63 000
68 000
73 000
78 000
83 000
88 000
93 000
98 000
103 000
1.98 1.00 1.02 1.04 1.06 1.08 1.10 1.12 1.14 1.16
M3 (SEK mil)
Cash (SEK mil)
14 Source: Thomson Datastream
The Pros and Cons of Digital Currencies
Benefits: 1. Increases the CB’s control over the money
supply 2. Allows everybody access to the CB’s balance
sheet 3. Enables “helicopter money” 4. Allows potentially negative rates on digital
“cash” 5. Improves the CB’s budget
Threats:
1. Crowding-out of bank money 2. Without physical cash the economy is more
vulnerable to natural disasters and cybercrime 15
The Chicago Plan Revisited
• Original Chicago plan (see Fisher, 1936): banks should hold 100% reserve backing for deposits
• This would separate the monetary and credit functions of the banking system. Fisher claims: 1. Better control of business cycle fluctuations 2. Elimination of bank runs 3. Dramatic reduction of net public debt 4. Dramatic reduction of private debt
• Benes and Kumhof (2012) support these claims • Realize that in many aspects the proposal is
similar to an increase in equity requirements
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Cryptocurrencies: Old Wine in New Bottles?
• Bitcoin presents an innovation that could be especially useful in countries with a defunct financial system (think Venezuela, Zimbabwe)
• From the monetary policy perspective, though, cryptocurrencies are nothing new
• Technically they account for commodity-backed “currencies or even commodities”; in this case the commodity is data on collecting value
• One can design a digital currency backed by gold, silver, or wheat, for example
• Why have we abandoned commodity backing?
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Private Money and Currency Competition
• Bitcoin is just the most visible global quasi-currency competitor to established currencies (or, more precisely, to cash)
• In the credit market, peer-to-peer lending may one day become a major source of financing
• In principle, even in P2P lending some sort of intermediary is always needed to monitor the debtor. The intermediary collects a fee for this activity
• There is no free lunch: without the intermediary the expected return is larger, but so is the risk
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What To Do About the Zero Lower Bound?
• We discussed decreasing equilibrium rates • Because the average cut in the policy rate in a
recession is 5 p.p., we might very well hit the zero lower bound in the next recession as well
• What has been tried: exchange rate interventions (small open economies) and QE (large economies)
• What has been proposed: significantly negative rates (mildly negative rates have very limited expansionary effects) and helicopter money
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Helicopter Money
• Proposed by Friedman (1969) • Previously discarded by most central bankers
and economists: necessary to cooperate with the government (tax credit); problems for independence
• But with digital currencies (think e-krona), the CB can implement helicopter money easily
• It can send each month to every person an amount of money that can only be consumed (limited validity)
• More effective than QE (directly affects consumption)
• QE expands the CB’s balance sheet, helicopter money creates a loss, but doesn’t affect the total value of the balance sheet
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Negative Interest Rates
• The main problem with negative rates: when they become sufficiently negative, people switch to cash • When the scope for negative rates is so limited,
the benefits do not outweigh the costs (uncertainty, financial instability, unintuitiveness)
• That’s why recent experiments with negative rates haven’t been universally successful
• Clever solution by Agarwal and Kimball (2015) and Kimball (2015): create an exchange rate between cash and electronic money (deposit fee on cash); only use it in crisis
• Already used by Kublai Khan in the 13th century: a paper note was exchangeable for the unit of account (gold), but for less than the note’s face value
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References – Elastic Money
1. Aghion, Philippe & Farhi, Emmanuel & Kharroubi, Enisse, 2012. “Monetary Policy, Liquidity, and Growth.” Working Papers 18072/2012, The National Bureau of Economic Research.
2. Braun, Benjamin, 2016. “Speaking to the People? Money, Trust, and Central Bank Legitimacy in the Age of Quantitative Easing.” Discussion Paper 12/2016, Max Planck Institute for the Study of Societies.
3. Gordon, Robert J., 2006. “The Boskin Commission Report: A Retrospective One Decade Later.” International Productivity Monitor, Centre for the Study of Living Standards, pp. 7–22.
4. Holston, Kathryn & Laubach, Thomas & Williams, John C., 2016. “Measuring the Natural Rate of Interest: International Trends and Determinants.” Working Paper Series 11/2016, Federal Reserve Bank of San Francisco.
5. Jakab, Zoltan & Kumhof, Michael, 2015. “Banks Are Not Intermediaries of Loanable Funds – And Why This Matters.” Working Papers 529/2015, Bank of England.
6. McLeay, Michael & Amar, Radia & Ryland, Thomas, 2014. “Money in the Modern Economy: An Introduction.” Bank of England Quarterly Bulletin, vol. 54(1), pp. 4–13.
7. Rachel, Lukas & Smith, Thomas, 2016. “Towards a Global Narrative on Long-Term Real Interest Rates.” VoxEU, January 15, 2016, http://voxeu.org/article/towards-global-narrative-long-term-real-interest-rates.
8. Sims, Christopher A., 2003. “Implications of Rational Inattention.” Journal of Monetary Economics, vol. 50(3), pp. 665–690. 22
References – Reforms of the Monetary Order
1. Agarwal, Ruchir & Kimball, Miles, 2015. “Breaking Through the Zero Lower Bound,” Working Papers 224/2015, International Monetary Fund.
2. Federal Reserve Bank of Minneapolis, 2016. “The Minneapolis Plan to End Too Big To Fail,” Technical report, https://www.minneapolisfed.org/publications/special-studies/endingtbtf.
3. Fisher, Irving, 1936. “100% Money and the Public Debt,” Economic Forum, Spring Number, April-June 1936, pp. 406–420.
4. Friedman, Milton, 1969. “The Optimum Quantity of Money,” Aldine Pub. Co.
5. Kimball, Miles, 2015. “Negative Interest Rate Policy as Conventional Monetary Policy,” National Institute Economic Review, National Institute of Economic and Social Research, vol. 234(1), pp. 5–14.
6. Kumhof, Michael & Benes, Jaromir, 2012. “The Chicago Plan Revisited,“ Working Papers 202/2012, International Monetary Fund.
7. Skingsley, Cecilia, 2016. “Should the Riksbank Issue E-Krona?” http://www.riksbank.se/en/Press-and-published/Speeches/2016/Skingsley-Should-the-Riksbank-issue-e-krona/.
8. Hampl, Mojmír & Havránek, Tomáš, 2017. “Should Inflation Measures Used by Central Banks Incorporate House Prices? The Czech National Bank’s Approach“, CNB, RPN, 1/2017.
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