This brings central bank's control to a whole other level. For example, right now, central bank could loan lots of money to retail banks, but there's no guarantee that those retail banks will in turn loan it to average consumer. With this, they can bypass them alltogether and put it directly in retail's digital wallets.
Imagine things like money that self-destroys if you don't spend within certain amount of time or money that you can only spend at a certain place or for a certain purpose. The control that central bank will be able to exert is increasing by like 10 fold.
" For example, right now, central bank could loan lots of money to retail banks, but there's no guarantee that those retail banks will in turn loan it to average consumer."
That's because banks don't work like that. Money isn't a thing, it is a unit of account.
Banks create money out of nothing by discounting collateral [0]. You turn up with a property, the bank has it valued at $100K. The bank then creates a financial instrument called a 'mortgage' which it holds as an asset on its balance sheet and which is a 'charge' over that property preventing you selling it until you discharge the mortgage. Then they issue $90K of their own liabilities which you call a 'bank deposit' into an account with your name on it. That liability balances the new asset.
And that's about it. Loans create deposits. The central bank doesn't get involved in lending at all. Never has.
The reserve requirement (banks must maintain so-and-so many percent of their money in central-bank issued reserves) simply means that if, after loans are made, the central bank discovers that the private banking system is low on reserves, the central bank sells new reserves to the banking system to satisfy their demand.
In other words, customer demand (which is relatively inflexible: you don't take out loans for fun, you do it because you need them) drives private bank loans, which drives creation of reserves by the central bank. Not the other way around.
The market dictates how much money is in circulation, by demanding a particular amount of money. The central bank can't do anything other than oblige, because if demand outpaces supply, our economy will stall.
1. The Federal Reserve have to add reserves to the system when there is demand from the economy in order to keep the interest rate that they want. Otherwise, the interest rate would go up because the offer and demand dynamics between the private banks.
2. If there is not demand from the economy for credit, adding reserves to the system will push the interest rate very low (that's happening now). If there is not demand from the economy those reserves will not be lend, ergo, they will not be inflationary (they could affect other financial assets prizes though).
3. Apart from keeping the interest rate where they want, adding reserves to the system will happen when the fed buy assets from the banks (they are payed with reserves). One of those assets are government bonds. So, the Central Banks can finance without limit (other than inflation) fiscal expansion from the treasury. This money, used to finance government spending, will be spend in the economy. So, it's the fiscal policy what will be inflationary, not the number of reserves per se.
The difference between nominal and real interest rate is inflation and the main mandate of Central Banks is the control of inflation. So, I don't think it's accurate to say they have no control.
Central banks control inflation by setting nominal rates. These two rates are not independent. Setting real interest rates would require the ability to control both nominal rates and the inflation rate independently from one another.
To clarify a little further, the central banks have some kind of control through the interest rate.
The interest rate, at the end, it's not decided by bond markets or private banks lending one to another, but by the central bank adding or removing reserves to the system. So, the central bank can decide to make lending more cheaper (as is the case now) or more expensive (like in the 70's in the USA).
That's the idea, but if I remember correctly there's not a whole lot of evidence suggesting that more borrowing happens when the rate is low, for the reason mentioned above: you don't borrow money for fun when it seems cheap, you borrow money because you need it. Borrowing isn't particularly price sensitive.
(It is in the margin in the sense that more doubtful gambles pay off when borrowing is cheaper, but the large part of borrowing happens because of an immediate liquidity demand, not a desire for leverage.)
I think that's what they call "pushing on a string" (1).
Central banks can make lending/borrowing a worst business (higher interest rate) but they can't force people to borrow.
So, monetary policy is very limited when demand falls, then fiscal policy is necessary, but, until recently, fiscal policy was anathema because of ideological reasons.
Eh, that just sounds like central bank going into retail business, nothing more. They'll upgrade their systems to match that of retail banks to manage retail customer money. I still don't see any actual innovation, just monopolization of lending industry.
I don't understand your example about money self-destruction. What's the actual innovation that will make this possible and why it's not possible now?
How high powered money gets intermediated into actual economic activity is probably one of the largest unknown factors in central banking/monetary policy. This would, in theory, remove that discussion.
That being said, if you are familiar with the history of monetary policy across countries, there is already quite a significant spectrum of central banks adopting new approaches to this problem. And it is not particularly evident that removing banks from the equation improves outcomes (although this is one of those lessons that falls in the blind spot of certain popular ideologies today).
Simply: when you talk about disintermediation of banks, you get into the discussion of whether central banks are able to make lending decisions better than banks. When this works, as in Japan pre-1991, it works very well...Japan post-1991 demonstrates that it doesn't always work well.
Also, this would change the politics of monetary policy. Most monetary systems that disintermediate banks are usually one-party states with extremely high levels of centralization of economic authority (you also tend to see heavily monopolized banking sectors, the US is the polar opposite of this, although this may not apply in this case). I am 95% sure that if you attempt to do this in a democracy, you will Zimbabwe your currency quickly and trigger a move away from democracy (unf, this also falls into a blindspot of lots of people today...economics PHds don't learn this stuff). It is very hard to have stable politics when the winner of an election will gain the power to make their family/their associates/all political allies permanently wealthy.
EDIT: because I cannot reply, if you are asking how this fails to change anything...read a monetary policy textbook. There is a deep lack of understanding about basic elements of the financial system here (as ever). This isn't a facetious comment...srs, read a book.
I still fail to see how a new digital currency makes this easier compared to just modernizing the US payment infrastructure or letting the central bank provide retail banking services in our current currencies.
>It is very hard to have stable politics when the winner of an election will gain the power to make their family/their associates/all political allies permanently wealthy.
This is true, but the way Zimbabwe's government did it is via repossession of land. Once you cross that line nothing is sacred anymore because the government is willing to do anything.
I didn't downvote you, but I haven't grokked your answer yet. Yep, I gotta read something about monetary policy. In any case, I gather that "new digital currency" in this context mean centralization of accounts.
EDIT: Do I understand it correctly that under this new system, there would be no money multiplication or IOW no fraction reserve banking?
Yes, it does but through that centralization of accounts, you are fundamentally changing how monetary policy operates (again, the concept of high-powered money changes totally...we are talking about the most fundamental aspects of how monetary policy works).
If you read about Positive Money, they have written a few books about how this works. A significant simplification is: our monetary policy would be more like Japan pre-1991...but it is more complex than this (the politics of this are also significantly more complex...no-one has written any books about this). But reading something like Mishkin is a better starting point.
EDIT: there is no "money multiplier" in the real economy, that is a device used to teach undergraduates...when banks make a loan, they just credit your deposit account, the money doesn't come from anywhere, the bank needs no reserves (reserve requirements are used functionally in China, I don't believe they are functional in the US, and they haven't been a central policy instrument in monetary policy generally since the 60s)...so the central bank "outsources" money creation to private banks, the exact purpose of these proposals is to stop this outsourcing although the actual implementation will vary.
I have a sneaking suspicion you are better-read than I in the matter. But I have questions =)
You say there is no money multiplier. But we do have capital requirements, don't we? Like Bâle III. Doesn't that equate to an implicit 'percentage' for the money multiplier?
The money multiplier is irrelevant because the only limits to money creation are the availability of resources and labor in the real world.
It doesn't matter who creates the money and if you create the money in a way that does not utilize resources or labor it doesn't even matter how much you create.
The Fed and the government effectively have an unlimited number of dollars at their disposal, if you were pragmatic their bank account balance would be literally infinite dollars.
This oversimplification should make it strikingly obvious that inflation is not driven by the amount of dollars, after all there are infinite dollars in existence so expected inflation is infinite according to old economic wisdom but for some reason isn't.
If increasing the money supply by infinite dollars does nothing, then so does increasing the money supply by a few trillion dollars.
On the other hand, if you give people money and they spend it, you can bet that it increases inflation even if the total amount of stimulus is very small.
However, you're right that there is bureaucracy involved in the lending business and it can be a bottleneck.
In this case I think you're making the common mistake of confusing capital requirements with reserve requirements.
That said, if we change "capital requirements" to "reserve requirements" your question is still valid: this does become an implicit money multiplier. The fallacious thinking lies in assuming that "banks cannot lend in a way that exceeds their multiplier." Because they do, all the time.
In normal (non-QE) times, banks keep the minimum amount of reserves they need to meet the requirements. This means any loan they make violates the reserve requirements temporarily. After they've made the loan, they go get more reserves to cover the requirements.
In other words, the money multiplier does not say anything about how much they can lend given the reserves they have, it says (indirectly) how much reserves they have to get after they have made the loan.
It only makes sense for a retail bank to hold onto that money if it doesn't think lending it out beats holding it on a risk adjusted basis.
In other words if banks are sitting on money, they think the risk of not getting it back is worse than the interest they would be getting. Your argument requires them to be wrong about that, which is pretty unlikely given the number of financial crises we've seen caused by a glut of bad debts.
Normal contracts can accomplish everyone of those things. What is missing your your comment (and the article) is an explanation how how these things are magically easier to do with a new digital currency rather just adding feautures our our existing transaction infrastructures.
For one, existing transaction infrastructures suck terribly with massive legacy tech debt that seems to make it impossible to do even simple things like use chip cards sanely?
For sure, but isn’t it always more fun to make something new then fix tech debt? (I wish this probably isn’t what is going on, but realistically it is undoubtedly playing a part)
The government does not have a contract with each person. The way to implement this currently would be to either:
* Have a contract with each bank to give money to them to give to each citizen. This hits problems with trust on the bank, speed of distribution, and how to deal with citizens who have multiple bank accounts.
* Issue some set of stimulus checks, tax credits, and require documentation of appropriate spending at tax time. This feels very much like the plot to a modern Kafka novel.
You haven't explained how a new digital currency makes this easier. Any retail banking setup provided by the government for a new digital currency could just as easily make use of dollars and would provide equal benefits.
As far as I can, the only thing you can get with a new digital currency is the ability to decouple it's value from the dollar.
Small correction, put the money directly into the consumers wallets.
Since the wallet itself would also be implemented as a bank account, likely controlled by the central entity they would be able to monitor both it's balance as well as where money is spent and transferred to. This enables the implementing of monetary polices such as "Here is $100 to spend on local restaurants within 30 days. Any unused money will be removed on the 31st day."
Implementing that policy would require the central bank to be doing a wholesale analysis of consumer spending (local restaurants). That's an extreme increase in the amount of citizens information we're giving to the government, for at best a dubious reason.
It does require more data and analysis, but is entirely possible. I'm not taking a stance on this (in reference to your 'dubious' comment) but I'm trying to elaborate on how this would be implemented.
Consider a database where each account has the owners name, local address, other demographic data in addition to their account balance. The database also stores their transactions.
Now allow businesses to have their own central bank accounts as well. The business has its location and type of business listed as well.
Assuming all this data is entered correctly and up to date the implementation of "$100 to be spent in 30 days on local restaurants" is as follows. Assume local is, within 10 miles of the account owners home, as a nonce value:
* Add $100 to person's central bank account
* Over the next 30 days person buys: shoes locally, a pizza locally, and orders a book from Amazon.
* On day 31 the central bank examines all transactions. By referencing each account money was transfered to the bank can lookup distance and type of business.
* Remove the unspent amount, if any, from the account.
Now, there is a fun edge case here: what if the person spends their $100 credit on books from Amazon instead of food and has no money left? Do they end up with a negative balance? This penalizes both people mispending money as well as those where they spent money at a place that is miscategorized ( for example, the local deli is categorized as a shell corporation ). So clearly the basic idea needs some work, but it is not undoable. Especially if business owners are incentived to have their information be accurate and up to date to recieve monetary funds.
Imagine things like money that self-destroys if you don't spend within certain amount of time or money that you can only spend at a certain place or for a certain purpose. The control that central bank will be able to exert is increasing by like 10 fold.