Yes, Banknotes Are A Central Bank Liability

David Bholat recently wrote “How to Modernise Central Bank Balance Sheets: No Notes.” It is partly in response to this article. The idea is that banknotes (“dollar bills”/”pound notes” etc. issued by the government should not be classified as a liability, rather as some form of capital or possibly taken off the balance sheet. I have run into variants of this idea in the past (the stronger version being that all forms of the monetary base are not liabilities), and the root idea is that “monetary issue is good for the economy, so how can it be a liability?” Such a redefinition or removal of banknotes is either misleading or wrong.

Fed 50!

The Fed started what might develop into a rate cut campaign by reducing the target rate by 50 basis points. It looks like Chairman Powell has decided to take “Gradualism” behind the barn and put it out of its misery.

I have returned from an unplanned trip, caught some kind of virus, have a new consulting project, and half the main floor of my house is being refitted. As such, I have been even less on top of current economic events than usual. I am just putting this article up to let readers know that I am still around and thinking of them. My main concern is finishing off the next section of my banking manuscript. Once the dust (literally) settles on my house, I will take a look at the inflation manuscript.

Recent News Comment

I am catching up on things post-vacation (new consulting project dropped). I just wanted to make some comments on topics I have run into recently before getting back to some banking texts that I had finished up earlier.

Fed!

The Most Important Fed Meeting Ever happened today, and the Fed remained on hold. Since I am focussing on writing books that are supposed to be somewhat timeless, I do not spend much time on central bank watching. With the disclaimer that I had no forecast, I do not think it is inherently surprising that the Fed did not cut.

Random Observations

My writing plans were disturbed (bike got a flat tire…), and so I am stuck with a placeholder article. I had been working on a section for my banking manuscript, but I want to look it over before posting a draft.

North American Monetary Policy Developments

The Bank of Canada (BoC) cut the target for the overnight rate to 4.75% on June 5th. They feel that policy is restrictive, and they stated that “our confidence that inflation will continue to move closer to the 2% target has increased over recent months.”

Comments On Asset Prices And Inflation Targeting

This is an unedited manuscript excerpt, from a chapter that discusses how asset price changes relate to inflation.

Even if one believes that asset price increases represent inflation, the general reaction among North American central bankers would be to think you are crazy if you think asset prices should be included within an inflation target mandate. (I am less sure about the reaction of Continental European central bankers.) Although they might accept that exuberance in financial markets should be toned down, targeting asset prices directly poses many problems.

Late Central Bank Comments

Since I am still chugging away with edits, I have not been spending much time watching developments in markets. I just wanted to off some brief comments on events from central banks last week. I have a longer manuscript section for publication later this week.

Why The "Friedman Thermostat" Analogy Should Be Uncomfortable For The Mainstream

Nick Rowe’s article on Milton Friedman’s Thermostat has popped up in online conversation. For those of you unfamiliar with it, it is about inferring statistical relationships between inflation and interest rates. Although I agree that it is possible to do some silly correlation analyses between those variables1, if we think about the analogy more carefully, it points to concerns with the mainstream approach.

Central Banks And Crises

This article is a wrapping up of a sequence of articles on the topic of “central banks as banks,” which is expected to form a chapter in my book on banking. This version of the text is a brainstorming exercise — I expect that it would require a massive re-write to get into a book. I am presenting it in this format since it was a topic that came up in comments on earlier articles, and I also want to finish the train of thought starting in my online articles. It is breezy, and it relies on discussions that appeared in my earlier book Recessions: Volume I. I am going to suggest that readers spend their bookstore gift cards buying that book rather than repeating too much from it; my banking manuscript is going to have to be more stand alone. I also am relying on stream-of-consciousness assertions, and would need to backfill references once the text is closer to finalised.

Happy New Year!

If things are going well, the role of the central bank within the banking system of a developed country is largely invisible. The wholesale payments system just works, and there are no serious worries about the private banks that are the core of the financial system. Instead, most commentators just worry about central bankers’ abilities to centrally plan the capitalist economy by nudging a policy rate up and down and making cryptic statements about the economic future. (Of course, those of a hard money bent are continuously predicting calamities since nobody is adopting their demand that the currency be pegged to whatever collectible they favour.)

Should Everybody Have An Account At The Central Bank?

This will be my last posting before Christmas, and depending on what I get up to, possibly the last of 2023. This article is somewhat of a placeholder for my manuscript chapter. It is a group of related topics that I think belongs in there, but not ones that I spent much time looking at. I will revisit this text when I put the manuscript together.

Happy Holidays (and probably) Happy New Year!

In this article, I will breezily run through a few topics that are related to the idea of “everybody getting accounts at the central bank.” Many (but not all) of these proposals are being put forward as a means to fixing the problems with the private banking system that were exposed during recent financial crises, and/or proposals to del with the somewhat backward retail banking infrastructure of the United States of America (and perhaps a few other countries).

Should Central Banks Lend Unsecured To The Private Sector?

This article continues my sequence of articles on central banks as banks, which is projected to be a chapter in my banking manuscript. This article is relatively lightweight, but I wanted to break this issue out of another planned article.

What assets central banks should have on their balance sheet is controversial for some people, but for the post-World War II to 2008 Financial Crisis period, developed countries without currency pegs just held government bonds without raising questions from the bulk of economists. The Financial Crisis forced central banks to buy private sector assets, which re-opened this debate. This article looks at one type of private sector assets to be held — uncollateralised loans to the private sector.

The Central Bank And Government Finance

This article continues the sequence of articles on central banks as banks. This article was as brief as possible since it overlapped my book Understanding Government Finance (available for sale cheaply at online bookstores, and I emphasise that it would be an amazing Christmas present for friends and/or enemies (depending on what you think of my writing)). I might need to expand upon the less obvious points herein if this text does get into my book manuscript.

Central banking largely evolved the way it did due to the exigencies of wartime finance. The central government needs control over its financial operations in wartime, and any attempts to interfere by the private sector would be viewed as akin to sabotage. For a free-floating sovereign (and currency pegs are typically broken during major wars), the system guarantees that the financial flows will continue to flow.

Central Bank Balance Sheets

This article continues my series of articles on central banks as banks.

Central bank balance sheets (in the modern era, at least) are relatively simple. There is a split between banks with a currency peg and those without. After that, the key point to keep in mind that the minimum size of the central bank balance sheet is not under the control of the central bank — other actors create a minimal demand for their liabilities. The only freedom of action for central bankers is growing beyond the minimum, which they did not do before the days of Quantitative Easing (QE). The article finishes off with a discussion of consolidation.

This text overlaps material found in my book Understanding Government Finance.

Central Bank Banking Basics

This article continues the plan outlined in the previous article “Central Banks as Banks.” As I described therein, this is projected to become a chapter within my banking primer. I am not going to describe private banking — as that is the job of other chapters — but I will cover the issues of inter-bank transactions. This article is about fundamentals that we normally do not think about.

As the name suggests, central banks are at the centre of the banking system. The objective of a well-run banking system is that you do not have to worry about how it works. So long as everything under the hood is operating, you do not need to enquire how the money gets from one account to another. By not worrying about those details, we tend to only focus on the flashy bits of central banking (e.g., trying to hit an inflation target) instead of the banking system regulation part.

No, QE Is Not Costless

I ran across a couple lame attempts at blaming the U.S. Treasury for not extending the duration of issuance during the pandemic low in yields. This is entirely typical for market commentary — going after fiscal policymakers and ignoring the major culprit, which is the central bank. To the extent that the United States has put itself into an awkward macro stabilisation situation with respect to interest rate expenditures, it is the result of the brain trust at the Federal Reserve.

Jackson Hole Drive-By Comments

I did a short trip to Lake Placid New York last weekend, and largely missed out on the Jackson Hole central banker discussion. Although some specific speeches have been important for macro debates in the past, I generally view the conference importance as over-rated. Although having an idea what the consensus is discussing is useful, the forward-looking information is limited.

Inflation Or Nominal GDP Targeting? Whatever.

Nominal GDP targeting is the latest mainstream fad, which is allegedly going to improve central banking when compared to inflation targeting. In a certain sense, I have some sympathies. If a central bank could stabilise nominal GDP growth, it has abolished the business cycle. I am in favour of abolishing the business cycle. Doing so would not solve all economic woes, but it would be the most that can be hoped for from macroeconomic stabilisation policy. Unfortunately, there is no reason to believe that the central bank can wave a magical expectations wand and abolish the business cycle — despite the claims of some Market Monetarists.

Inflation Targeting In Practice

I have been running into the ongoing debates on nominal GDP targeting, and whether it is superior to inflation targeting. To look at this debate, I need to put my “conventional economist” hat on, as if one accepts the heterodox view that interest rate policy is ineffective, the entire debate is pointless (neither policy “works”). As will become apparent, I think the neoclassical models behind the debate are dubious. But if we accept that interest rates at least sort-of work the way that they are conventionally assumed to (e.g., rate hikes dampen growth and inflation), we can have a view on how a change in targets would work in practice.

Will The Fed Keep Reacting With A Lag To Lagging Data?

(I have broken Betteridge’s law of headlines — the answer to the question in the headline is “yes.”)

I would guess that this week’s Fed hike will be followed by a “pause,” but that pause may be just for one meeting. Although my bias is to assume that the weakness is partly equity market shenanigans, the banking system is having trouble digesting rate hikes. The Fed can afford to wait a meeting to see what happens.

QE/QT And Deposits

Things seem to be calming down in financial markets, which could be interpreted in one of two ways. The benign interpretation is that a few weak banks failed, but the rest of the financial system is in decent shape. The paranoid interpretation is that crises occur in stages, with pauses between the key failures. So far, I lean towards the benign interpretation — there are some areas of weakness, but not a lot of visible credit failures in the real economy. Things will deteriorate as the cycle ages, but such is the fate of capitalist finance.

I just wanted to comment on bank deposits, which has been attracting some attention. My initial reaction is that we should expect some reversal in deposit growth as the Fed reverses its balance sheet growth. However, the figure above was not exactly what I expected.

Yield Curve Control Sustainability

Megan Greene recently wrote [the] “Bank of Japan Needs the Courage to Change Course” at the Financial Times. I would summarise the piece as a fairly conventional analysis discussing the apparent “need” to end yield curve control (YCC). The statements at the end raised the eyebrows of an MMT proponent that forwarded the link to me. For example:

To minimise disorder, the BoJ should be clear about its reaction function and move slowly but deliberately by first further widening the YCC band or targeting a shorter duration. Ultimately, it must [emphasis mine] announce that it is abandoning YCC entirely and will instead aim to minimise rapid changes in debt prices, such as those seen in the UK government bond market in September.