The central bank prints money, lends it to the government, and the government sooner or later spends it (or uses it to cut taxes or increase transfer payments).
There seem to me to be two views on this question that are equally daft:
- The Orthodox Daft View: "Central bank lending to government is a Bad Thing and should be prohibited!"
- The Revolutionary Daft View: "Central bank lending to government is a Good Thing and should be mandatory!"
I don't get it.
First off, central bank lending to government is very orthodox and very traditional. The Bank of Canada is doing it now. The Bank of Canada owns government of Canada bonds. Does it really matter whether the Bank of Canada bought those bonds directly from the government, or indirectly from someone else (who could be anyone) who bought them from the government?
Second off, if the government of Canada owns the Bank of Canada (which it does), and if the Bank of Canada pays all its profits to the government (which it does), it does not matter what interest rate the Bank of Canada charges the government of Canada. If the Bank of Canada charges the government of Canada an extra gazillion dollars in interest, that simply means the Bank of Canada earns an extra gazillion dollars in profits, and the Bank of Canada pays an extra gazillion dollars to the government of Canada. It's a wash.
Third off, even if the Bank of Canada refused point blank to buy government of Canada bonds (either directly or indirectly), and bought commercial bonds instead, money is fungible. If the Bank of Canada switches from buying government bonds to buying commercial bonds, the people who would have bought commercial bonds now buy government bonds instead. Does it make a difference? Yes, it probably does, because the two sorts of bonds will not be perfect substitutes. But it's not like there's any Big Difference of Principle involved. The government now pays interest to the public, and the public now pays interest to the Bank of Canada, and the Bank of Canada pays that interest back to the government as profits.
If I lend money to Tom, and Tom lends money to Dick, and Dick lends money to Harry, am I indirectly lending money to Harry? We can't answer that question by putting a tracking device on the money I lend.
If the government of Canada owns the Bank of Canada, which it does, then de facto direct or indirect Bank of Canada lending to the government of Canada, at an irrelevant rate of interest, is neither a Bad Thing nor a Good Thing. It's inevitable, if the Bank of Canada lends and the government borrows.
What would make a difference is if we passed a law that said the Bank of Canada could only lend to the government of Canada, and the government of Canada could only borrow from the Bank of Canada. That law would tie monetary and fiscal policy together, like two runners in a three-legged race, so neither could change without changing the other. The fiscal deficit in any month would have to equal the amount of money printed in that same month. You could have an independent monetary policy, or you could have an independent fiscal policy, but not both. Either the amount of money printed would determine the fiscal deficit; or the fiscal deficit would determine the amount of money printed.
Such a law sounds daft to me. Why would you want to do that? How would adding an extra constraint improve monetary policy and/or fiscal policy? Mightn't there be times when you wanted to run a deficit, but wanted to reduce the stock of money? Or print money but wanted to run a surplus? In general, adding an extra constraint on choices leads to worse choices, because the constraint sometimes prevents you choosing something you would have chosen. Now there are exceptions to that general rule, like time-inconsistency in dynamic games, where adding a constraint on your own choices lets you change others' expectations of your future choices, which changes their current actions in ways that make you better off despite the extra constraint. But I don't know of any such argument for this particular constraint.
Any money the Bank of Canada prints lets it buy assets, which earn interest, which give the Bank of Canada profits, which it pays to the government, which the government eventually spends. Sooner or later, the government of Canada will spend any money printed by the Bank of Canada. It's inevitable. But the "sooner or later" bit is very important. It doesn't have to be this month, or even this year, or even this decade. Nor should it be.
And the ECB is a bit weird, because it isn't really owned by any single government, so maybe things are different in the Eurozone.
Worthwhile Canadian Initiative 
Antti: To quote myself more fully, I said that on a central bank’s balance sheet currency is like an eternal bond that never has to be redeemed, but on the balance sheet of consolidated public authorities (government + central bank), currency is a liability redeemed whenever tendered for any private debt to the public sector. “Legal tender for all debts public and private” after all has important meaning.
PS to Antti: I get what you’re saying about the two sides of the CB balance sheet. So long as the asset side is sovereign debt, the point is the same as the one I just made.
Another way of talking about it is that fiat currency backed by sovereign debt represents financialization of the government’s future revenues, and ultimately of the republic’s future output. So do sovereign bonds. However the non-base part of broad money is financialization of whatever commercial banks lend against – property and equipment and personal and organizational future incomes.
When you look at money that way the ground falls out from under money quantity theories of inflation.
I agree with Tom and Antti. Think about a very small economy, eg. 3-persons. Then it is IMO relatively easy to see how one of them owning credit money means necessarily a liability for the other two. One can settle the liability with two bilateral transactions. It is definately not net wealth.
Oliver: Thanks! I’m aware of the clear similarities between Quantum Economics (and also MMT/Circuitism) and the viewpoint I’ve adopted. This might sound weird, but by adopting a pure “double entry bookkeeping view” of the monetary system, I’ve managed to get rid of money (other than an abstract unit of account type) altoghether — and with that goes the possibility to make a payment by transferring money to a creditor/seller. That’s where I differ a great deal from others. The underlying logic isn’t necessarily that different from “chartalist” expositions of money/credit (following Mitchell-Innes), but radical changes in language go with radical changes in how one sees the system, and I seem to have arrived at a relatively simple theory. When you manage to explain money away instead of needing to answer “What money is?”, simplicity follows. (I’ll go through the details in a thought experiment I’m going to publish later in 2016.)
Tom: I hear what you say. I just put these things in a different way. I think it’s important to realize that one who holds a claim (a credit balance in any bank’s books) is always a creditor. This is of course self-evident, but why do we then say that one gets paid when one receives this kind of claim? I cannot reconcile the state of having got paid with the state of being, or even becoming (through a so called payment) a creditor. (This is not just semantics, as I’ve build a whole theory starting from the premise that one cannot make payments in “money”.)
Related to this, I think it’s confusing to talk about a debtor accepting his own liabilities (claims on him) as a payment, as for instance Randall Wray puts it. If you and I have verbally agreed that I owe you a beer, it is crystal clear to me that it is me who is going to make a (debt re-)payment by buying you a beer, and it would make very little sense to say that you pay for the beer by letting me off the hook. Likewise, the government is not a debtor to me — the taxpayer is. If the taxpayer has a tax obligation of $100 this month, then he can sell something to acquire a credit worth $100. At this point we can say that he has already fulfilled his obligation, and we can view what happens next (the so called “tax payment”) as just the part where the books get finally updated. The “monetary” system is only about keeping track of real world debt relations — claims and liabilities; credits and debits — expressed in an abstract unit of account.
Of course it’s slightly more complicated than this, because we need to get our heads around the fact that if I hold a general claim (say, a credit in the CB books), I cannot point to any separate entity against which I hold a claim. And I’ve found out that it is close to impossible for some people to realize that if they hold a claim with a nominal value of $50, it doesn’t mean that they are to receive “fifty follars” — it means that they are to receive goods or services worth (priced at) $50.
This short exposition no doubt lacks in clarity, so I’m happy to elaborate should you have any questions.
You might want to check my comment to Nick’s earlier post on helicopter money (I criticize Quantity Theory in it): http://worthwhile.typepad.com/worthwhile_canadian_initi/2016/04/helicopter-money-is-permanent.html?cid=6a00d83451688169e201bb08d6d1d3970d#comment-6a00d83451688169e201bb08d6d1d3970d
Tom and Antti, how do you think the lender of last resort works?
Antti: We seem to see things mostly the same way, only using different terminologies. When I say money is financialization of future government revenues, and thus ultimately of the future income of the republic, I think I mean the same thing you mean when you say the government isn’t the creditor, the taxpayer is. But I’m fine using the standard terminology that government is a creditor even if it is really only intermediating, just as I’m fine with the standard lingo that a bank is a creditor when it lends, even if it is only intermediating.
I can’t agree though that one can’t make payments in money. That makes no sense to me at all. If I gave you anything whatsoever that you reckon as valuable, in exchange for something that you gave me in return, or to settle a debt, then I paid you, period. Whatever it was I gave you is irrelevant.
Tom: Yes, we are definitely not that far apart. But fortunately there is something we disagree on (otherwise it would be a waste of time to continue the discussion). You said: “Whatever it was I gave you is irrelevant.” Let’s take a chartalist approach, in an economy without a central bank. You sell a horse to the government. The government representative who you deal with gives you a Treasury note (or tally stick, or similar) in return. Don’t you agree if I say that the note is a promise to pay (which the government issued on behalf of the people)?
Whatever you give me, if I deem it to be of sufficient value, I recognize as a payment — but not a promise to pay later. For me, it would be illogical to think otherwise.
I’m not fine with the standard lingo. If a bank doesn’t strictly speaking lend money, then we must focus on what it strictly speaking does, and forget these metaphors (which we learn to use already as children, and that makes it so hard to get rid of them). If we manage to do so, clarity follows — eventually.
Nick:
Does it really derive the majority of its profits from the monopoly on currency (which I take to mean physical currency)?
It seems to me that electronic reserves are much more significant than currency.
Nick (sorry for the late question)
The two examples you just showed are different in my opinion.
If the CB lends directly to the Government it’s like Helicopter Money, but if it lends to the commercial banks for them to lend to the Government is like QE.
QE is like an OMO like you previously said, so per se, does not increase the money supply.
HM is newly printed money going to the real economy, so it will raise the money supply.
About the profits I think you are right both ways they will flow to the government, but the effects on the economy are different.
Tell me please if I am wrong
Alex: I looked at recent Bank of Canada balance sheets. On the liability side, there’s about:
$70 billion currency (paying 0% interest)
$20 billion in Government chequing account (which is a wash, because government owns the Bank of Canada)
$0.5 billion members of Canadian Payments Association (banks?) reserves (paying 0.25% below overnight rate of interest)
So yes, physical currency is the big one.
Ricardo: “QE is like an OMO like you previously said, so per se, does not increase the money supply.”
Both QE and OMO (same thing) do increase the money supply.
An OMO increases the monetary base and increases the money supply by reducing interest rates.
My point was, if OMO and/or QE doesn’t reduce interest rates (ZLB or ELB or whatever..) does it increase the money supply?
Thank you very much Professor
(Please read my blog, I would much appreciate!)
Nick said: “John: Yep. That’s the danger of a central bank acting as unconditional lender of last resort, whether to a commercial bank or to a government. Suppose the Bank of Montreal (BMO) gets into trouble, and the Bank of Canada steps in as LOLR. If it does so unconditionally (as opposed to ordering BMO to get its act together), then the BoC is now responsible for maintaining the fixed exchange rate between BMO dollars and BoC dollars. Alpha and beta have changed places. BMO is now the new central bank, and can create as many BMO dollars as it likes, knowing the BoC must follow along.”
So, you are saying the price inflation target applies to the lender of last resort function, right?