Tuesday, September 11, 2012

An Alternative Monetary Regime

Consider the following monetary regime.    There is a central bank that solely issues reserve balances and uses them to fund private securities.    The central bank is owned by the banks.   Any profits or losses on the central bank's asset portfolio are distributed to the banks.   The central bank issues no hand-to-hand currency.    Hand-to-hand currency is solely issued by the banks.   The banks also issue checkable deposits.  

The government regulates the central bank, requiring it to keep nominal GDP on target.   (Maybe it could require index futures convertibility.)

The government runs budget deficits and has a national debt.  I funds the national debt with a variety of securities, some with short terms to maturity.   The government has very good credit and is expected to always pay off bonds.   The government accepts checks drawn on private banks in payment of taxes.   It generally deposits those checks in the banks against they were drawn.   It follows the same policy when it sells bonds.   It accepts checks in return for bonds and deposits those checks in the banks against they are drawn.   The government funds expenditures and debt repayments by writing checks from these various private banks.

The stock market crashes and those who previously were buying stocks buy short term to maturity government bonds.   The yields on those government bonds are driven to zero.

Does monetary policy now become ineffective?  

The nominal interest rate on some government bonds is zero.   Further, the interest rate is the same as the interest rate on hand-to-hand currency.

I think the answer is no.   What is it about the existing monetary regime that causes some economists to believe that a zero yield on some government bonds makes monetary policy ineffective?   (That is, to increase nominal expenditure.)


  1. If reserves aren't convertible into currency, then the CB is free to establish a negative interest rate. But I guess this isn't your point because you seem to be assuming the privately owned CB never goes below 0%?

    With a level target the economy will eventually get back on track even with a 0% floor. This is 'effective' but not ideal.

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