Making Central Banks Serve The Real Economy
Abstract
The challenge is to redirect central bank money into the real economy and to the needs of society. If new money is issued to expand the productive capacity, there is no reason for inflation. Long-term financing could become available at an affordable price. Central bank money must not replace a sound tax system and the distribution of income and wealth, but complement them. The remaining task, apart from the financing of real needs, is the prevention of speculative asset price inflation. For this, central banks and regulators should install debt brakes for the financial sector. Furthermore, independent monetary policy calls for capital account management. It enables national central banks to find space for the conduct of their own policies in an interdependent global economy. Coordination between central banks and governments might increase as policies combine monetary, fiscal and regulatory facets. The future role of central banks should particularly lie in their insights regarding capital flows and leverage cycles and in their ability to create and withdraw money, depending on economic conditions.
“A crisis is a window into the soul of the economy, like Plato’s republic was the soul writ large. If non-standard policies saved the economy during the crisis, they surely should play a role in normal times.”1
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. That has, for example, been the case with the European Central Bank’s bond-buying programme for struggling member-states.
However, the current QE has not been targeted towards stimulating real economic activity. It has failed to spur real economic lending and securities emissions. The monetary transmission mechanism did not work: the central bank money has remained in the financial sector itself. That is why it risks feeding leverage-driven asset bubbles in the financial sector instead of funding real needs.2 As Dominic Lawson points out:3
“If the real assets remain unimproved either by investment or by advances in productivity, and all that happens is that their monetary value on the markets increases in nominal local currency terms, this is merely the classic recipe for a financial bubble.”
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.
1. 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: renewable energies, public transport, communication infrastructure, public health and climate protection; the world is full of unfulfilled investment needs. Not everything suits the profit-orientated expectations of private investors. Or if you attempt 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, it 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.They can also finance the retraining of employees in the fossil fuel industry to enable them to carry out similar work in the renewable energy sector. At the global level, the UN Green Climate Fund was established in 2010. It 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.
Among the proponents of a broader mandate for monetary financing are Adair Turner, chairman of the Financial Services Authority in the UK, and Martin Wolf, economic journalist of the Financial Times.4 Wolf argues that it is impossible to justify the conventional view that monetary financing should operate almost exclusively via today’s system of private borrowing and lending.
The benefits of such monetary financing will be substantial:
- Long-term financing will become available at an affordable price. Partnerships between governments, financed by new central bank money, and long-run institutional investors like foundations, insurance companies and pension funds are also possible. New government money can, for instance, act as a catalyst during the start-up phase of long-term infrastructure projects. By contrast, private-equity funds aim at above-average returns up to super returns. Thus, it often turns out that they are unsuitable as sponsors for sustainable development. Additionally, their high consultancy fees and special dividends can even hamper investment.
- The deleveraging process of private banks can be accompanied by new central bank money. Thus, a credit crunch can be avoided.
- New central bank money can contribute to overcoming austerity. This will promote social equity too. Poorest people suffer the most from austerity because they can barely afford the better equipped private hospitals and private schools.
- This will also strengthen democracy, as austerity is a means to exert power. New central bank money can prevent the real economy from being held hostage by unreliable financial markets. It can end unreliable conditions of structural adjustments, be it through the International Monetary Fund towards its poorer member states or through the Troika in Europe.
- Finally, instead of waiting any longer, socially and environmentally required investments could be put into practice. Every necessary investment, which is not taken today, goes at the high expense of present and future generations. This ranges from neglected safety standards for public transport to environmental consequences and public education.
Consequently, 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. John Geanakoplos, “What’s missing from Macroeconomics: Endogenous Leverage and Default,” Cowles Foundation paper, no. 1332 (2011): 225 http://cowles.econ.yale.edu/~gean/art/p1332.pdf
2. Bluford H. Putnam, “Essential Concepts Necessary to Consider when Evaluating the Efficacy of Quantitative Easing,” Review of Financial Economics 22, no. 1 (2013): 1-7 http://www.sciencedirect.com/science/article/pii/S105833001200064X
3. Dominic Lawson, “Coming Soon: Credit Crunch 2 – and This Time It’s Personal,” Sunday Times, 19th May 2013 http://www.thesundaytimes.co.uk/sto/comment/columns/dominiclawson/article1261046.ece
4. Lucrezia Reichlin, Adair Turner and Michael Woodford, “Helicopter Money as a Policy Option,” VoxEU, 20th May 2013 http://www.voxeu.org/article/helicopter-money-policy-option “Transcript of interview with Lord Turner,” Financial Times, 6th February 2013 http://www.ft.com/intl/cms/s/0/42f943be-6fcd-11e2-956b-00144feab49a.html Martin Wolf, “The case for helicopter money,” Financial Times, 12th February 2013 http://www.ft.com/intl/cms/s/0/9bcf0eea-6f98-11e2-906-00144feab49a.html