Presentation at MMT19 by Andrea Terzi

1st European MMT Conference “Why money matters?”

Andrea Terzi Franklin University Switzerland Berlin, 1 February 2019 EBC Hochschule

CENTRAL BANK DEPOSITS: AN OVERVIEW

Why money matters?

We all live in a ‌

‌ a monetary economy!

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Monetary (vs. “real”) analysis approach For real analysis, non-monetary processes matter,

“To a general equilibrium theorist prices and wages

money is neutral, and the “axiom of reals” holds:

state the term on which alternatives are available, but to an operator in a capitalist economy prices and wages

“all the essential phenomena of economic life are capable of being described in terms of goods and services, of decisions about them, and of relations between them. Money enters the picture only in the modest role of a technical device that has been adopted in order to facilitate transactions,” as explained by J. A. Schumpeter (1954) who claims

are ways to recover costs and obtain funds to meet payment commitments. It is this second role of prices, and in particular the role of prices as carriers of profit,

that is of special import in a modern capitalist economy” as explained by H. P. Minsky (1984) who claims that the "veil of money" obscures but does not change the fact that money is brought into being to finance activity

and asset ownership.

that real analysis runs into “analytical difficulties.”

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The “monetary” character of the economy A dual infrastructure Contract law Payment system

Settlement finality (discharge obligation): Have debtor’s liability (promise to pay) replaced by a third party’s “monetary” liability (promise to pay) 4

The means of settlement: A redeemable currency Acceptance depends on recipient’s confidence that others will accept it too (trust).

Currency should be redeemable: A voucher that can be exchanged for value.

National currency (“legal tender”): Political order makes it redeemable for public services, taxes, fines, compensations to private parties ruled by courts (“tax credit”) Private voucher has value if the issuer promises the bearer convertibility into a product in considerable demand.

Central bank deposits function as the national currency.

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Economic theories of what is a redeemable currency Re-elaborated from J. A. Schumpeter (1954):

 Theoretical chartalism: A public voucher issued as a means to settle liabilities to the public sector needs no convertibility to become private agents’ preferred contractual means of settlement.  Theoretical metalism: A fully trusted private means of settlement must reflect and retain the

purchasing power of the real value in which it is convertible.  Practical metalism: A national currency gives government cliques too much freedom of action and must be firmly linked to, and freely interchangeable with, a given quantity of some commodity.  Practical chartalism: Because gold supply is inelastic, costly, and subject to fluctuations, metalism is impractical, thus we need rules to govern the (fiat) national currency.

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Outline CBDs as means of settlement: how do they come into existence or cease to exist? CBDs under three alternative monetary policy configurations How CBDs get converted into public debt Why the concept of base money should be reconsidered 7

CBDs as means of settlement: How do they come into existence or cease to exist?

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Money‌ a word too vague?

Views on money are as difficult to describe as are shifting clouds.

Joseph A. Schumpeter, History Of Economic Analysis, 1954

Even love has not turned more men into fools than has meditation upon the nature of money.

William E. Gladsone, quoted by Karl Marx, Capital, 1867 9

Central Bank Deposit (CBD) A liability on the balance sheet of the central bank that is held as a credit balance in the holder’s account at the central bank or as a physical object.

It is denominated in units that are given the name that defines the currency.

The political authority defines it as legal tender and entrusts the central bank with the power of issuing it as sole supplier.

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Central Bank Deposits (or Central Bank Money)?

CBM: CB liabilities used as money. (BIS)

Common vocabulary:

CBM: Liabilities issued by the CB which function as

CBM = monetary base, base money, outside

money. (ECB)

money, high-powered money, narrow money,

CBM: Deposits held at the central bank and cash

legal tender.

brought into circulation by the central bank, as

CBM = currency in circulation (banknotes) and

only the central bank can create this money.

banks’ deposits with the CB.

(Bundesbank) CBM comprises banknotes in circulation and the

This is a subset of all CBDs.

sight deposits held by commercial banks at the central bank. Both are legal tender. (SNB) 11

Central bank deposits: Full view CENTRAL BANK

 Banknotes are CBDs held by the bearer

 CBDs are means of settlement between “users”

ASSETS

LIABILITIES

Loans

Banknotes

Other assets

Deposits held by licensed banks (BB)

 CBDs come into existence with loans to, and/or purchases from, “users”  When loan is repaid, or asset sold, CBDs cease to exist  Political rule for issuing (such as collateral

policies; quantitative credit constraints; monetary financing prohibition)

Debt certificates Deposits held by government (GB) Deposits held by foreign institutions (FB) 12

CBDs: Means of settlement between users  Settlement between “users” of electronic balances is only possible between any two

CENTRAL BANK

authorized holders (“in-house”)

 Safe means of settlement: No credit risk on the CB as the settlement, liquidity providing, default-free, institution  Payment system in the €Area: TARGET, TIPS

ASSETS

LIABILITIES

Deposit balance (Bank 1) debited Deposit balance (Bank 2) credited

 In general, holders cannot transfer balances to private units abroad

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CBDs: Means of settlement between users  Settlement between “users” of electronic balances is only possible between any two

CENTRAL BANK

authorized holders (“in-house”)

 Safe means of settlement: No credit risk on the CB as the settlement, liquidity providing, default-free, institution  Payment system in the €Area: TARGET, TIPS

ASSETS

LIABILITIES

Loan to Bank 1 Deposit balance (Bank 2) credited

 In general, holders cannot transfer balances to private units abroad

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A rate of interest on CBDs ď ą If the CB sets a penalty rate on the CENTRAL BANK

loan, Bank (1) is willing to pay a lower rate to Bank 2.

ASSETS

LIABILITIES

ď ą If Bank (2) is pricing credit risk below the penalty rate and above what it gets from holding the balance, banks will settle the payment with no CB intervention.

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How do banknotes get printed, get issued, and get into circulation?

The CB buys unissued banknotes from the printer via the banking system

The CB delivers banknotes and lends banks the difference (source of ‘seigniorage’) Users of banknotes withdraw banknotes from banks CENTRAL BANK ASSETS

BANKING SYSTEM LIABILITIES

ASSETS

LIABILITIES

+ Banknotes (unissued)

+ Account (1) credited

+ Account (1) credited

+ Deposits (printer)

- Banknotes (unissued)

+ Banknotes

+ Banknotes

+ Loan (interest payments)

- Capital

+ Loan (interest payments)

- Banknotes

- Deposits 16

How do banknotes get printed, get issued, and get into circulation?

The CB buys unissued banknotes from the printer via the banking system

The CB delivers banknotes and lends banks the difference (source of ‘seigniorage’) Users of banknotes withdraw banknotes from banks CENTRAL BANK ASSETS

BANKING SYSTEM LIABILITIES

ASSETS

LIABILITIES

+ Banknotes (unissued)

+ Account (1) credited

+ Account (1) credited

+ Deposits (printer)

- Banknotes (unissued)

+ Banknotes

+ Banknotes

+ Loan (interest payments)

- Capital

+ Loan (interest payments)

- Banknotes

- Deposits 17

How do banknotes get printed, get issued, and get into circulation?

The CB buys unissued banknotes from the printer via the banking system

The CB delivers banknotes and lends banks the difference (source of ‘seigniorage’) Users of banknotes withdraw banknotes from banks CENTRAL BANK ASSETS

BANKING SYSTEM LIABILITIES

ASSETS

LIABILITIES

+ Banknotes (unissued)

+ Account (1) credited

+ Account (1) credited

+ Deposits (printer)

- Banknotes (unissued)

+ Banknotes

+ Banknotes

+ Loan (interest payments)

- Capital

+ Loan (interest payments)

- Banknotes

- Deposits 18

How do banknotes get printed, get issued, and get into circulation?

The CB buys unissued banknotes from the printer via the banking system

The CB delivers banknotes and lends banks the difference (source of ‘seigniorage’) Users of banknotes withdraw banknotes from banks CENTRAL BANK ASSETS

BANKING SYSTEM LIABILITIES

ASSETS

LIABILITIES

+ Banknotes (unissued)

+ Account (1) credited

+ Account (1) credited

+ Deposits (printer)

- Banknotes (unissued)

+ Banknotes

+ Banknotes

+ Loan (interest payments)

- Capital

+ Loan (interest payments)

- Banknotes

- Deposits 19

Banknotes are fully demand-driven Banknotes are sold to banks, or bought back from banks CENTRAL BANK

ASSETS

BANKING SYSTEM

LIABILITIES

ASSETS

+ Banknotes - Banknotes

+ Banknotes - Banknotes

- Account (1) debited + Account (1) credited

- Account (1) debited + Account (1) credited

LIABILITIES

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CBDs under three alternative monetary policy configurations

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Changing volume of CBDs: Minimum requirements Banknotes are fully demanddriven BBs are demand-driven, given minimum requirements CB provides the needed volume at the policy rate

CENTRAL BANK ASSETS

LIABILITIES

Loans

Banknotes

Repos and reverse Repos

BBs (rule- and demanddriven)

Other assets

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Volume of BBs in the € area: 1/1999-7/2007 Unchanged minimum requirement and fixed definition of bank liabilities of reference Gradually rising volume of bank liabilities of reference 23

Changing volume of CBDs: Rising counterparty risk If there is no market, the CB lends to Bank (1), hence Bank (2)’s balance will rise BBs are driven by the demand by banks losing access to market

CENTRAL BANK ASSETS

LIABILITIES

Loans

Banknotes

Repos

BBs (demand-driven)

Other assets

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Volume of BBs in the € area: 8/2007-12/2014 Fragmentation of the money market

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Changing volume of CBDs: Asset purchase program (non-sterilized) When the CB is a buyer in the market, BBs rise if the CB does not “sterilize,” (i.e., does not use reverse Repos or other instruments to absorb liquidity) BBs are supply-driven

CENTRAL BANK ASSETS

LIABILITIES

Loans

Banknotes

Repos and reverse Repos

BBs (supply-driven)

Other assets (rising)

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Volume of BBs in the € area: 1/2015-2019 Asset Purchase Program (APP)

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How CBDs get converted into public debt

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How payments from, and to, the government are being settled?

Payments between the Govt. and the private sector (PS) are settled through banks. Payment by the Govt.:  Purchases of goods, final services, productive services, assets  Interest payment to public debt holders

 Principal payment to public debt holders

Payments to the Govt.: Taxes and other levies Purchase of public debt

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Government spending with no monetary financing prohibition CB loan to Govt. Govt. spends CENTRAL BANK

ASSETS + Public debt

LIABILITIES + BB

BANKING SYSTEM (B)

ASSETS + BB

Non-bank Non-government (PS)

LIABILITIES

ASSETS

+ Deposit (PS)

+ Bank deposit

LIABILITIES

+ Net worth

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Government spending with monetary financing prohibition  CB loan to banks  Banks’ loan to Govt.  Govt. spends CENTRAL BANK

ASSETS

BANKING SYSTEM (B)

LIABILITIES

ASSETS

Non-bank Non-government (PS)

LIABILITIES

ASSETS + Bank deposit

+ Loan to B

+ BB

+ BB

+ Loan from CB

- Loan to B

- BB

- BB

+ Deposit (PS)

+ GB

+ Public debt

- Loan from CB

- GB

+ BB

+ BB

- BB

LIABILITIES

+ Net worth

-- BB 31

How the CB can switch between these two configurations ïƒ CB buys Govt. debt from banks

CENTRAL BANK

ASSETS + Public debt

LIABILITIES

BANKING SYSTEM (B)

ASSETS

LIABILITIES

+ BB

Non-bank Non-government (PS)

ASSETS

LIABILITIES

+ Bank deposit + Public debt

+ Deposit (PS)

+ Net worth

- Public debt + BB

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How the CB can switch between these two configurations CB buys Govt. debt from banks ‘Monetizing debt’ means substituting a claim on the CB for a claim on the Treasury CENTRAL BANK

ASSETS + Public debt

LIABILITIES + BB

BANKING SYSTEM (B)

ASSETS + BB

Non-bank Non-government (PS)

LIABILITIES

ASSETS

+ Deposit (PS)

+ Bank deposit

LIABILITIES

+ Net worth

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CB-driven interest rates on public debt

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CB-driven interest rates on public debt

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‌ and in the Euro area (1999-2006) Yields on Italian and German short-term government securities

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‌ and in the Euro area (1999-2006) Yields on Italian and German short-term government securities and the interbank effective rate

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Why the concept of base money should be reconsidered

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Financial effects of Govt. net spending under different configurations ïƒ Net financial assets of the consolidated non-government sector increase by +BB or by +Public debt (monetary financing) CENTRAL BANK

ASSETS + Public debt

LIABILITIES + BB

BANKING SYSTEM (B)

ASSETS + BB

LIABILITIES + Deposit (PS)

Consolidated Non-government

ASSETS + BB

LIABILITIES + Deposit (PS)

+ Bank deposit + Net worth

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Financial effects of Govt. net spending under different configurations ïƒ Net financial assets of the consolidated non-government sector increase by +BB or by +Public debt (no monetary financing) CENTRAL BANK

ASSETS - Public debt

LIABILITIES + BB

BANKING SYSTEM (B)

ASSETS + BB

LIABILITIES + Deposit (PS)

Consolidated Non-government

ASSETS + Public debt

LIABILITIES + Deposit (PS)

+ Bank deposit + Net worth

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Financial effects of Govt. net spending under different configurations ïƒ Net financial assets of the consolidated domestic non-government sector CENTRAL BANK

ASSETS - Public debt

Consolidated Domestic Non-government (PS)

LIABILITIES + BB

ASSETS + Banknotes

LIABILITIES + Loans (CB)

Foreign sector

ASSETS

LIABILITIES + Net liabilities to PS

+ BB + Public debt + Net claims on foreign + Net worth 41

Private sector’s accumulation of net financial assets ∆ Private sector’s net financial assets = = ∆ BB + ∆ Banknotes + ∆ Public debt + ∆ Net claims on foreign – ∆ CB’s and Govt.’s loans to the private sector = Public sector’s net liabilities + Foreign sector liabilities = đ??ˇđ??ş + đ??ˇđ??š = Net Govt. spending + Net foreign spending = (G-T) + (X-M) ∆ Private sector’s total financial assets = = đ??ˇđ?‘ƒ + đ??ˇđ??ş + đ??ˇđ??š “Base moneyâ€? is not the whole story 42

DECLINING GOVERNMENT DEFICIT

CLIMBING EXTERNAL SURPLUS

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Motives and outcomes of the monetary financing prohibition  Provision to divorce unrestrained ability to issue currency from government power in order to prevent inflation bias  The “Keynesian” argument:  The CB can raise interest rates to slow down the economy when the deficit creates demand-pull inflation (questionable effectiveness)

 The “Monetarist” (gold-standard) arguments:  Reserves are inflationary via the money multiplier (a form of “money matters!”, inapplicable to non-convertible currencies)  Private bank balances are inflationary while public debt isn’t, if the private sector expects future taxes (circular reasoning)

 Effectively:  Makes the system vulnerable to liquidity crises if it also constrains CB action in the secondary market  It is no obstacle to fiscal expansion when needed, nor to full employment 44

No evidence of the Monetarist argument during “QE” With QE, inflation in the US and the €A has been lower than targets

Substitution of public (and private) debt with CBDs did not increase inflation

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The government of money is a political issue

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1st European MMT Conference “Why money matters?”

Andrea Terzi Franklin University Switzerland Berlin, 1 February 2019

CENTRAL BANK DEPOSITS: AN OVERVIEW