Inflation or rising interest rates? The dilemma of central banks is not inevitable…

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The increase in the general level of prices is now reaching levels not seen in many countries since the 1980s. This inflationary phenomenon is usually explained by the excessive growth in the money supply; Inflation can always be prevented or corrected by an adjustment to the amount of money in circulation, even if and other reasons contribute to it. Therefore, central banks, whose task is to stabilize the purchasing power of money, are now committing to raising their rates to combat inflation.

However, in our current monetary systems, central banks only indirectly and very imperfectly control the volume of money in circulation. The central bank money they issue directly represents only a fraction of the total means of payment, mainly limited to coins and notes. The money supply today consists primarily of holy bank money (balances of our current accounts that can be transferred by debit card or wire transfer) created by commercial banks when financing loans or investments.


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Read more: Fed and ECB: two rhythms but the same strategy against inflation


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One of the shortcomings of this bank money is that it imparts a cyclical behavior to the medium of exchange: As borrowers increase (or decrease) their debt to banks, the volume of money increases (or decreases), which enlarges the speculative bubbles in which banks lend. many – especially in the real estate market.

Between Charybdis and Scylla

This dependence of money creation on bank loans also explains why, in the current system, central banks are driven to manipulate the market price of loans (interest rates) to stabilize the price level. In particular, they will influence the interest rates that banks charge their customers in return, using the management of the underlying interest rates they lend to banks or the purchase or sale of assets for banks. . In this very indirect way, central banks can encourage or discourage the creation of bank money to stabilize the purchasing power of money.

In times of inflation like they are now, this translates into rate increases that, beyond their monetary impact, are almost painless: by increasing the cost of debt, they penalize investment. That’s why central bankers now go back and forth between Charybdis and Scylla: If an insufficiently large rate hike causes inflation to slide, too big can precipitate a recession.



Read more: Letting inflation fall or halting the recovery is a dilemma for central bankers


But is such a dilemma really inevitable? Far from it. In fact, there is nothing inevitable in the fact that money creation is so heavily dependent on bank loans. As the British economist David Ricardo explained two centuries ago, there is no “necessary connection” between printing money on the one hand and advance money on debt on the other. He argued that these two functions could well be separated “without the slightest loss of advantage neither for the country nor for the traders who benefited from these loans”. Since then, issuance of banknotes has become a monopoly of central banks in most countries.

The “100% currency” way

Likewise, several economists have called for the issuance of holy money transferable by check or wire transfer to be kept separate from bank loans. This was the essence of the “100% money” proposal formulated by many economists, including the American Irving Fisher, in the United States during the Great Depression of the 1930s. Under this reform plan, which is the subject of our recent research, transaction deposits will be covered by 100% government currency reserves, so that the monetary authority alone can create or destroy means of payment.

Some economists, including Nobel laureates Maurice Allais, Milton Friedman, and James Buchanan, continued to support different versions of this reform idea. However, the latter has often been rejected on the grounds that it would supposedly put an end to banking intermediation – although this only applies to the most radical versions, which indiscriminately impose 100% reserves on all bank deposits.

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The basic version of this reform scheme will only concern transactional deposits for payment purposes, leaving banks free to use savings accounts for investment purposes (and their balances can be converted to maturity or maturity but are not self-transferable). ), to finance loans. Thus, banking intermediation is maintained, but the volume of payment instruments is not affected.

The current system increases inequalities

In the wake of the 2007-2008 global financial crisis, several authors supported a modern version of this idea, proposing a “sovereign currency” in which central bank money would be used directly by the entire payments community, either in print or digital form. It replaces bank money.

In such a system, monetary creation would cease to be dependent on bank loans and would become the monopoly of the monetary authority. This injects new money into circulation oropen market (secondary securities market in which the central bank operates) or through the tax channel in cooperation with the Treasury, i.e. by increasing public spending, reducing taxes (at an equal spending level) or even by direct money transfers to taxpayers. or citizens (according to the principle of “helicopter money”).

Thus, the volume of payment instruments will cease to change cyclically according to borrowing and investment decisions. The monetary authority would be in a position to perfectly control the money issue, thereby stabilizing the value of the unit of account, without having to intervene in the credit market.

In the years following the 2008 crisis, when the private sector was reluctant to borrow more, in the context of general overindebtedness, the “100% currency” or “sovereign currency” system would have been an obvious advantage. at very low rates) and banks unwilling to lend or invest. Therefore, central banks had to purchase large bank assets through “quantitative easing” (QE) programs to prevent the decline in bank balance sheets from turning into a monetary contraction. While these operations made it possible to avoid deflation, they also kept interest rates artificially low and inflated asset prices, increasing inequality in the process.

Avoid currency distortions

In the current context, the “100% money” system will symmetrically make it much easier to control inflation: faced with a rapid rise in the level of prices, the issuing authority can directly reduce the rate of money creation. Manipulating interest rates in any way.

This argument was advanced by Irving Fisher as early as 1935:

“Even when the price level has stabilized successfully under the system, for a time [vigueur]the very effort to achieve this goal by manipulating interest rates. […] It means that the interest rate deviates a little from the normal, that is, the rate that will be created only by the supply and demand of credit. This is because, [banque centrale] If it raises or lowers the interest rate to prevent inflation or deflation, such a raise or lower necessarily interferes in some way with the natural money market”.

In a “100% money” system, he continued, “interest rates will naturally balance according to the supply and demand for credit, and real rates will not be distorted by monetary abuses.” But by decoupling money issuance from lending, as such a reform suggests, the price level and interest rate can each reach their optimal levels separately and simultaneously.

Until such a system is put in place, monetary authorities will continue to face the same dilemma that they now face from time to time. The launch of a digital central bank currency (MNBC), which is under consideration in many countries, could facilitate its adoption.

Source From: Google News

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