Have Central Banks forgotten about money?

This is the title of a research paper I have written with my colleague and leading monetarist, Professor Tim Congdon, and published by the Institute of International Monetary Research (IIMR). This is a brief summary extracted from the paper, which is fully available at http://www.mv-pt.org/research-papers:

The quantity of money matters in the design of a monetary policy regime, if that regime is to be stable or even viable on a long-term basis. The passage of events in the Eurozone since 1999 has shown, yet again, that excessive money growth leads to both immoderate asset price booms and unsustainably above-trend growth in demand and output, and that big falls in the rate of change in the quantity of money damage asset markets, undermine demand and output, and cause job losses and heavy unemployment. This is nothing new. The ECB did not sustain a consistent strategy towards money growth and banking regulation over its first decade and a half. The abandonment of the broad money reference value in 2003 was followed in short order by three years of unduly high monetary expansion and then, from late 2008, by a plunge in money growth to the lowest rates seen in European countries since the 1930s. The resulting macroeconomic turmoil was of the sort that would be expected by quantity theory- of-money analyses, including such analyses of the USA’s Great Depression as in Friedman and Schwartz’s Monetary History of the United States.

This paper argues, from the experience of the Eurozone after the introduction of the single currency in 1999, that maintaining steady growth of a broadly-defined measure of money is crucial to the achievement of stability in demand and output. The ECB did not sustain a consistent strategy towards money growth and banking regulation over its first decade and a half.

The chart below illustrates our point very well:

 

 

 

 

 

 

 

 

 

 

 

As ever, comments very welcome.

Juan Castañeda

 

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The Greek question once more: back to ‘Central Banking 101’ …

Very, very basic hints on how a fractional reserve and fully centralised monetary reserve monetary system works

It seems to be unnecessary but, given all it’s being said by all and sundry in the last two weeks, may I remind the kind readers of this blog that the current monetary crisis in Greece is just a textbook example of how a fully centralised monetary system works. I would have thought that the members of the recently appointed new government in Greece were well aware of the institutional and economic constraints of the euro, as well as the very much restricted range of manoeuvre a monetary union allows to its members. Let’s start with the very basics:

Under a fractional reserve and fully centralised monetary system such as ours, the ultimate source of liquidity is under the control of a central bank, the single issuer of the currency with legal tender power. The Greek economy (along with quite some other countries in the euro area) has been running persistent and quite significant current account deficits and, particularly since the outbreak of the 2007-08 financial crisis, has required the extraordinary assistance of the ECB. When no one was willing to lend out money to Greece, the ECB has not only taken part on the bail-out successive plan(s) granted to Greece but also, and most importantly, has been accepting Greek government bonds as collateral in its main refinancing operation with Greek commercial banks. The latter has been key to maintain a regular source of liquidity to the Greek economy and thus to avoid the collapse of its national monetary system and a run on Greek banks.

Along with the loans, the ECB (actually the so-called Troika with the other two institutional lenders, the EU Commission and the IMF) has imposed conditionality on the provision of the loans granted to Greece. And of course, this is the (natural) expected behaviour of any lender: those willing to lend out their money would like to be sure the borrower will be able to honour his debts. Needles to say that successive Greek governments have accepted the deal because no other international creditor was willing to make a loan to the country or to accept Greek bonds as collateral. Who else but your central bank could take such a high risk and keep on hoarding in its portfolio assets nobody wants? (By the way, all the shareholders of the ECB are contributing to these loans and supporting this continuous financial assistance in accordance to their percentage in the capital of the bank).

Now a new government in Greece is playing a quite risky game, with potentially disastrous consequences for the country. All along the campaign, Syriza has been denouncing the ‘imposition’ of the bail-out programmes and the loss of sovereignty of the Greek government in favour of the interests of the international creditors (let us leave aside the meaningless and populist rhetoric used by its dealers to refer to the bankers, capitalists and free marketeers as those wickedly pulling the strings in the shadow … ). They claim that the debt is unfair and needs to be restructured, if not partially or totally written off (may I remind one more time that a more than 50% ‘voluntary’ haircut was already accepted by private bondholders in 2012). Actually the new finance minister has been very busy in his recent road trip throughout   Europe to demand a change in the rules of the game; as if he was in a position to do so. Let me remind again few very basic facts in this regard:

– The more radical the demands of the Greek governments the more difficult it will become to find any other source of liquidity in international markets and thus the more dependent the Greeks will be on the single source of money available, the ECB. Actually the risk premium of Greek bonds has already exploded in the last two weeks and thus this situation has already materialised.

– The message that the Greek government couldn’t be willing to fulfil the conditions of the bail out programme has already increased capital flights out of the country and this shouldn’t be surprising at all (as it already happened back in 2012). And again, in this financially stressed scenario Greek banks are even more fragile and exposed to high liquidity constraints, which can only be sorted out by the assistance of the ECB (if willing to accept Greek bonds as collateral).

In this context we may well understand last week’s Mr Draghi’s reaction to the demands of the Greek government; in particular, his announcement that since next Wednesday Greek banks will no longer have access to the regular financing operations of the ECB via the ordinary discount of Greek bonds as collateral. This can only mean two things: either (hopefully) the precipitation of a new mutually beneficial deal between the new Greek government and the Troika or, if not feasible, the most likely sudden collapse of Greek banks as soon as the ECB stops providing liquidity to them on a regular basis. Well, perhaps another alternative might happen, which is the return to the national (devalued) currency (see an alternative in line with the introduction of more monetary competition in Europe here).

I do not know who advices the new Greek government on these matters but it would help to familiarise first with the very basics on money and central banking. All my best wishes to the Greeks of course!

Juan Castaneda

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