Four years ago (and again two years ago)
I argued it might be good policy for central banks to (conditionally)
trash their own balance sheets. Now this idea is in the news. See Ralph Musgrave for links.
The recent blogosphere debate over whether money is or is not a bubble must have sounded like angels on pins to people who aren't monetary economists. But as JP Koning notes, it's what's at the root of those very policy-relevant questions. Does it matter if central banks trash their balance sheets by buying worthless junk? Might it even be a good policy, in some cases, for central banks to burn the bonds they own?
My views on this question have evolved a bit over the years. From reading other bloggers' posts, from comments here, and from thinking about it.
Here's a parable. Just in case it's not obvious, imagine I am a central bank, issuing currency, and targeting 2% inflation, so my currency pays a real rate of interest of minus 2% on average.
Suppose I could borrow an amount M forever at a negative real interest rate m. Because some people just really really like owning my IOUs, so they pay me m to borrow from them.
I could borrow M, invest the proceeds at a real rate of interest r, consume (r+m)M every year, and keep my stock of debt constant at M forever. Or I could borrow M, consume the whole of M immediately, and then consume an additional mM every year as my lenders pay me interest, and keep my stock of debt constant at M forever.
Would it matter to my lenders which I did? In the first case I have a stock of assets equal to M, which I keep in my basement. My IOUs trade at their fundamental value, because I can redeem them at any time. In the second case there are no assets in my basement. Would my lenders care? Why would any of them ever want to look in my basement? Or are the two cases observationally equivalent, as far as my lenders are concerned?
There are two reasons why it might matter whether I keep a stock of assets in my basement:
1. Maybe the demand to hold my IOUs at a negative real interest rate varies over time. I can borrow M(t) at a negative real interest rate. If there is a risk that M(t) would drop by (say) 30%, would I need to keep 30% of M in my basement to be able to repay my creditors?
No. Because I can always borrow at positive interest rates against my future income stream mM(t). If M(t) drops by 30%, and stays there, the present value of my future income stream will still be 0.7mM/r. So I will only need to keep 0.3M-0.7mM/r in my basement.
If M(t) fluctuates, but on average grows at rate g, the expected present value of my future income stream mM(t) will be mM/(r-g). Even if (r-g) is (say) 1%, if m is (say) 2%, that will be 2M. The expected present value of my future income from being able to borrow at negative real rates will be twice as big as M. That means that I wouldn't need to keep any assets in my basement unless there was a risk that M(t) would drop by two thirds.
2. Maybe people are only willing to own my IOUs at a negative interest rate provided my IOUs are actually worth something. So there's a second equilibrium in which my IOUs are worthless, and so nobody wants to hold any, and so they are worthless. My total IOUs are either worth M, or zero. But by keeping a very small stock of assets in my basement (say 1% of M) I can knock out that second equilibrium. If my creditors all rush to redeem their IOUs at the same time, I just say to them: "OK, I will redeem them all at 1 cent on the dollar", which means they are worth something, which means thay are worth 100 cents on the dollar, because people want to hold M(t) and not 0.01M(t) of my IOUs. For any value above 0 cents and less than 100 cents on the dollar, there will be an excess demand for my IOUs (provided I don't issue more than M(t)), so their value must rise back up to 100 cents on the dollar.
Worthwhile Canadian Initiative 
That was supposed to read:
The last statement is like saying that van Gogh’s Flowers are valuable because they are backed by paint.
Oliver:
I don’t think anyone can define money. It can take too many forms (most of which don’t require the issuer to have a license). All we can say is that people trade things of value. Some of those things of value are traded more often than others. We label them money, but our labels are just an attempt to draw lines where nature didn’t put any lines.
When we find it inconvenient to trade with a cow, we instead trade with paper claims to a cow. But we shouldn’t forget that the paper is only valuable because the cow backing it is valuable.
You’re pretty alone there with you definition of money. According to standard usage you are referring to generic financial asset/liabilities, not money.
From Wikipedia (not known for its heterodox bias):
Money is any object or record that is generally accepted as payment for goods and services and repayment of debts in a given socio-economic context or country.
Cow futures do not buy me cigarettes nor can I use them to pay down my mortgage debt. And you’re right, finance is not a natural phenomenon, but that’s precisely why it’s important to define its terms carefully.
The Romans used cows as money. Cows bought many a cigarette and paid down many a mortgage.
“You’re pretty alone there with you definition of money.”
Yes, that’s been known to happen with one or two other issues involving monetary theory.
I’m sure you’re familiar with the Misky quote: anyone can create money, the problem is getting someone else to accept it.
I think the devil is in the ‘accept’ part. And I don’t think it can be reduced to a simple argument of utility, at least not in the modern context.
To the extent that cattle really were used as money and not only as a stable unit of account, that means Roman peasants bred their own money. That may be conceivably albeit highly unpractical in a simple agrarian economy. But it certainly wouldn’t work in a modern surplus economy. There are other forces at work and many economists seem strangely ignorant of them.
Just stumbled across this: http://socialdemocracy21stcentury.blogspot.ch/2012/11/my-posts-on-origin-of-money.html
Something in it for everyone…
This from Feveryear’s The Pound Sterling: A History of english money, chap 11:
“Peel and the Bank Charter Act
WHILE the Bank Charter Bill was still before the House of Commons Sir Robert Peel received a letter from John Horsley Palmer warning him that the proposed strict limitation of the note issue would make it difficult, if not impossible, for the Bank to render that assistance during a crisis which it had rendered in 1825, 1836, and 1839 and which had come to be expected of it. A few days later he received a similar letter from Henry Bosanquet, a director of the London and Westminster Bank, who, without entering into the question of the meaning of ‘currency’,”…
The quote from
http://www.questia.com/library/1456707/the-pound-sterling-a-history-of-english-money
As there seems to be a really sophisticated readership here i thought i might get a good answer to the question here: How much is the Bundesbank worth? There was some discussion here in Germany because of the questionable claims the Bundesbank has to other central banks which might vanish when the Eurosystem should desintegrate (both unlikely imo but ok). I have some thoughts layed out here,
http://makrointelligenzint.blogspot.de/2012/11/how-much-is-central-bank-worth-what.html
but I m sure there is someone smarter than me here that could come up with something interesting.