Should central banks become banks?
The Economist has an article that discusses the possibility of allowing ordinary people to have checking accounts at central banks:
A RECESSION strikes. Central banks leap into action, cutting interest rates to perk up investment. But what if, as now, there is not much cutting to do, with rates already at or close to zero? In such cases the manual calls for purchases of government bonds with newly printed cash–quantitative easing, or QE–swelling the reserves each bank keeps at the central bank. Imagine instead that people also kept accounts at the central bank. New money could be added to their accounts, providing a direct, equitable boost to spending. That is one of several potential benefits of individual central-bank accounts, which are among the more intriguing of the radical policy ideas in circulation.
Interesting idea. Let’s start with the effectiveness of distributing new money to depositors, as a method of stimulating the economy during a recession.
If the money were paid out in proportion to the current size of deposits at the central bank, then this would be equivalent to paying interest on base money, which is contractionary. But of course there’s much more to be said:
1. The subsidy would be provided to deposits at the central bank, not to currency holders. Thus expectations of this payout would create a situation analogous to expectations of currency devaluation under a gold standard, when the dual media of account (cash and gold) are suddenly expected to earn different rates of return. In my study of the Great Depression, I discovered that expectations of currency devaluation led to gold hoarding and therefore were typically contractionary, even though currency devaluation itself was expansionary. Similarly you might have a situation where expectations of a payout to depositors is contractionary, even though the addition of the new money eventually has an expansionary effect.
2. If the payouts were lump sum, and not in proportion to the size of deposits at the central bank, then the effect might be more expansionary. Especially if everyone already had a deposit there, and hence expectations of a payout did not induce more people to put their funds into a central bank account.
Even so, it seems safer to inject money the old fashioned way, by buying bonds. Why risk boosting money demand? So why is this “radical” proposal being made?
This leads to the second claim in the article, that the policy would provide a “direct, equitable boost to spending”. I’m having trouble understanding exactly how it would be more equitable. The pre-2008 system of open market purchases of government bonds seems extremely equitable, almost as neutral as one could imagine:
1. The purchases are at market prices, so there is no subsidy to bondholders.
2. Even if the Fed bought something other than bonds, the price of bonds might rise as the injection of new money leads to lower interest rates, via the liquidity effect.
3. Even if the Fed buys T-bonds, the price of bonds often falls in response, as the Fisher effect usually outweighs the liquidity effect in the long run. Bondholders were devastated by the huge monetary injections of 1965-81, but they would have been equally devastated if the money had been injected in some other way.
4. The commissions on these bond purchases are tiny, and at competitive rates, so there is no subsidy to bond dealers.
5. Yes, OMOs often cause other asset prices (such as stocks) to rise, but that would be true of any policy that prevents a depression, not just monetary stimulus. If you don’t want asset holders to do well, then create a big depression.
So I’m have trouble understanding what sort of inequity this proposal is supposed to address.
And in some ways, payments to accounts held at the central bank seem less equitable than normal OMOs. Those who do not have accounts at the central bank (disproportionally the poor) would get none of the new money. The proposal is a sort of helicopter drop, which combines fiscal and monetary stimulus (although the monetary part is of doubtful effectiveness, for reasons cited above) but it’s a helicopter drop where most of the new money falls over Beverly Hills, not Compton.
Nonetheless, I’m not willing to dismiss this idea out of hand. It’s not obvious to me why banks should have deposits at the Fed, while I cannot have a deposit at the Fed. It would be possible to allow ordinary people to have deposits at the Fed, and still do monetary policy the old fashioned way, by buying T-securities. It would not even be necessary to use the current “floor system”, heavily criticized by experts such as George Selgin. The deposits could pay below market interest rates (even zero), so that monetary policy would return to the pre-2008 regime (before the interest rate on reserves was set above market rates.) What about allowing the central bank to pay depositors a rate 50 basis points below the 3-month T-bill yield?
One criticism of this system is that it would socialize banking, and socialism is bad. Because I’m a libertarian, I’m certainly willing to consider that criticism. But on close inspection, our system is already heavily socialized. Due to deposit insurance, when you put money in the bank you are basically lending it to the Treasury, which re-lends the money to your bank at the same interest rate. That’s a very inefficient system, which encourages excessive risk-taking (especially in the 1970s-80s, and 2000s)
Another criticism is that it would hurt private banks, which are an important source of financing for small businesses and homebuyers. By why should the government subsidize lending?
Maybe the central bank would not provide as many conveniences as private banks. But in that case, people would continue to use private banks. Of course, for a level playing field, private banks should be allowed to issue currency notes.
I’m willing to support private accounts at the central bank if combined with one other policy reform, abolition of FDIC–at least for deposits not 100% backed by government bonds. The public could be told that if you want a safe bank deposit, put it into an account backed up by Treasury securities. Otherwise you can take more risk, and earn a higher return, by lending the money to banks that make commercial and mortgage loans.
Under my proposal, the additional socialism of deposits at the Fed is less harmful than the harm currently being done by deposit insurance on accounts where money is lent out to risky borrowers.
Finally, I would quibble a bit with this claim:
Money is commonly considered a liability of a central bank. Accountants would frown at distributing new money without obtaining assets in exchange (like the government bonds purchased when banks carry out QE), since they would create a huge negative position on central-bank balance-sheets. But an institution that can create its own money cannot go bankrupt. As long as a central bank is keeping to a policy target (like a 2% inflation rate) an ugly balance-sheet is not a problem.
Technically that’s true, but it seems a bit misleading to me. The problem here is that a central bank may not be able to keep inflation at 2%, precisely because of a negative position in its balance sheet. The Economist is right that this outcome would not be default (it can print unlimited amounts of money) but it could lead to economic instability.
This is one of the many reasons why I oppose helicopter drops. There is no problem that can be solved with helicopter drops, that can’t be solved much more effectively and equitably with ordinary open market purchases, especially if combined with reforming the monetary regime—NGDPLT. And if we don’t adopt NGDPLT, even helicopter drops may not work—as the Japanese discovered during 1993-2013.
PS. Technically, when you deposit money at a bank, you are lending it to the Treasury, which lends it to FDIC, which lends it to the commercial bank, all at the same interest rate.
PPS. Why do I say IOR is contractionary, when I also argue against “reasoning from a price change”? Because taxes and subsidies are not ordinary price changes. If we know that the price changes due to a tax or subsidy, we know the impact on quantity. IOR is a subsidy and negative IOR is a tax. They are not ordinary market prices.
PPPS. One final comment on my previous post. I’d encourage people to read Richard Rorty, who points out that saying something like, “Two plus two is four” is equivalent to saying “I believe that two plus two is four.” Similarly, saying “Joe is not morally responsible” is no different from saying “I regard Joe as not being morally responsible”. People seem to want to draw meaningless distinctions. Don’t forget; “That which as no practical implications, has no philosophical implications”.
Now admittedly it’s possible to regard someone as being not being morally responsible, and pretend that you hold them morally responsible. But it’s much simpler to just assume that people who hold other people morally responsible actually believe they are morally responsible. That’s my view. Ockham’s razor.
All statements about the world are statements about how we view the world. Don’t look for deeper realities, beyond what we believe to be true. It would be like saying “She’s actually pretty, even though every single person (and God if you wish) regards her as being ugly.” That means nothing.
May 28 2018 at 4:03pm
â€œ[S]aying something like, â€˜Two plus two is fourâ€™ is equivalent to saying â€˜I believe that two plus two is fourâ€™.” How can you write such drivel? One implication is that people can never contradict one another, since (for example) you can assert only propositions about what you believe, and I can assert only propositions about what I believe. Another is that a sincere and self-aware person never says anything false, since he is only accurately reporting his own beliefs.
If there is some true philosophical claim somewhere in this vicinity, you have not succeeded in formulating it.
May 28 2018 at 4:48pm
Great blog post, sole comment (I tried to link to you Scott, on Twitter…).
May 28 2018 at 6:05pm
Philo, So if someone says “Two plus two is four” they don’t believe it is four? That makes no sense.
And no, what I said does not imply that sincere people can’t say false things. If someone said two plus two is five it would be false, even if they believed it.
May 28 2018 at 8:48pm
â€œ[S]aying something like, â€˜Two plus two is fiveâ€™ is equivalent to saying â€˜I believe that two plus two is fiveâ€™.” You wrote that, except that I have substituted ‘five’ for ‘four’. So if someone says, “Two plus two is five,” and he really believes it, then according to you what he said is true.
To answer your first question: if someone asserts a proposition he usually believes it, but it may well be that he does not.
The body of your post, on central banking, was good, as usual.
May 28 2018 at 9:52pm
On FDIC, can the federal government credibly commit to not bailing out banks? Before the crisis, the FDIC limit was 100k. When the crisis hit, the government raised the coverage limit to 250k and also backstopped other bank liabilities with no FDIC insurance. If the limit were 0, equivalent to abolishing FDIC, would the government refrain from doing the same things?
I managed a mutual fund before the crisis. We deposited our uninvested cash with a (very) large bank. When the first signs of trouble appeared, I remember one of the other managers saying that our cash was safe because that bank was too big to fail. He was right, but it had nothing to do with FDIC. Our cash balance was much larger than the 100k limit.
May 28 2018 at 10:16pm
“I believe that” in criticizing Scott’s logic Philo isn’t making any sense.
But regarding your question “why banks should have deposits at the Fed, while I cannot have a deposit at the Fed,” of course, it is the nature of a fiat money system that banks must hold reserves of fiat money (the final means of payment) as their settlement medium and source of cash to meet public withdrawals. It’s also evident that allowing them to keep much of it in the form of CB balances is far more convenient and safe than having them hold paper notes only. There’s no really practical or more efficient alternative.
For the public, on the other hand, its evident that commercial bank deposits and CB deposits are potential substitutes for one another, where each has its relative merits (central bank deposit = perfectly safe; commercial bank deposit = higher return and perhaps better services). So, why not let the public freely choose between these? In principle, if central banks could be relied upon to play fair, there would be no reason. However, in practice one would have to be wary of central banks’ potential abuse of their monopoly privileges and regulatory authority to either (1) cross-subsidize public deposit taking (using some of the seigniorage revenues they would otherwise remit to the Treasury) or (2) stifle commercial rivals with unnecessary regulatory restrictions.
More generally, allowing central banks to compete directly with the commercial firms they are supposed to regulate creates a clear conflict of interest. If the writers at The Economist can’t see this, they must not be looking very hard!
May 28 2018 at 11:18pm
It is not equivalent. These are different quotations with different referentsâ€”one has as referent your map of the territory while the other has as referent your map of your map of the territory. This does have practical implications because people are sometimes wrong about what they believe.
May 29 2018 at 1:17am
BC, the government does indeed have a huge credibility problem when trying to convince you that it might let banks fail.
A few things would help:
– A generally stable economy like nominal GDP level targeting would provide (or free banking would also provide), so that there’s no risk of contagion.
– An explicit law against bail outs.
– Perhaps a clear alternative that’s 100% backed by government bonds, and that is explicitly insured like our author here suggests.
(The extra government-provided insurance in this case is almost redundant, since it’s not very likely that the government will default on their bonds but still be able to pay out on insurance.)
May 29 2018 at 1:50am
PS Another good way for governments to pre-commit to not bailing out banks is to remove all barriers to entry for foreign banks and let them in. It’s much easier to credibly not bail out foreign banks. So easy we’ve even seen that in recent history.
May 29 2018 at 4:15am
Until just two years ago, employees at the Bank of England could have checking accounts with the Bank. There were three cashiers desks just off the main atrium.
Mark Carney closed it as a cost-cutting measure shortly after he arrived.
May 29 2018 at 6:01am
Sad the see the economist is continuing to worsen.
Will we wish for 1990’s the economist, just as we wish for 1990’s Krugman?
May 29 2018 at 8:00am
@ George Selgin:
“‘I believe that’ in criticizing Scott’s logic Philo isn’t making any sense.” George, I am fairly confident that here you are making a true statement! (Regrettable, but true.)
May 29 2018 at 2:48pm
Philo, You said:
“So if someone says, “Two plus two is five,” and he really believes it, then according to you what he said is true.”
That’s absurd. Read what I wrote.
BC, TBTF is also a problem, but a separate problem from FDIC. You are right that there is a credibility problem, but abolishing FDIC would make it easier to address.
George, Good points.
artifex. I don’t agree. I don’t think adding “I believe” changes the meaning of an assertion. When you say something, the “I believe” is implied, even if not spelled out explicitly.
Matthias, Keep in mind that the big problem is with small banks, not big banks. And the government does let small banks fail.
May 29 2018 at 7:31pm
“Keep in mind that the big problem is with small banks, not big banks. And the government does let small banks fail.”
I’m not sure this is such a point in favor of big banks. Because of economies of scale we would expect larger businesses to have a lower failure rate already, so having a lower failure rate doesn’t necessarily mean they’re relatively ‘better behaved’ (not that I’m asserting that they aren’t, just that a lower failure rate doesn’t necessarily prove it).
Wouldn’t the main advantage of eliminating barriers to entry be that there would be more banks (or potential banks) ready and able to step in and fill a vacuum left by a big bank if it did fail?
May 31 2018 at 4:42am
Scott – I liked the suggestion of abolishing deposit insurance alongside the creation of any central bank accounts for retail customers. In 2016 I published a proposal re banking reform that followed a very similar line of argument – see
After many disputations & discussions it remains, in my view, still the most robust proposal to making banking more efficient and allocate risk more effectively.
May 31 2018 at 1:43pm
I’ve looked into the Fed reserve and Fedwire systems a lot. Fed reserves change in many different ways:
– FedWire between accounts
– Credit or debit of accounts with the Fed in OMO’s and repos
– Discount window lending
– Check and ACH clearing.
– Cash deposits and withdrawals at a local Fed vault.
The deposit side of national banks is really a layer on top of these Fed systems. Often, the layers is several layers deep. Opening up the systems is not an economic issue, but a logistical and technical issue. The services of banks between customers and Fed systems include:
– Having branches, servicing ATM’s, etc.
– Provisioning debit cards and checkbooks, and processing their transactions.
– Reimbursing for debit card and check fraud
– Dealing with legal requests to freeze or garnish accounts.
– Anti-money-laundering compliance, which is has become a huge cost center for banks purely for deposit taking.
The Fed’s IT systems are only meant for banks with significant IT resources of their own. I’ve looked at Fed circulars for hooking up with Fed mainframes. Technically, the current Fed systems would not scale up.
For accounts directly at the Fed, the Fed would have to socialize private banking functions. This would be inefficient compared to private competition.
IMO, banking deposits should instead be treated similarly to securities regulation and brokers. Get rid of both the FDIC and the discount window. Customers can have Fed reserves in their accounts like they have stocks or bonds. Have similar SEC regulation for segregation and custody of assets.
Customers can risk their funds to earn higher returns, like money market funds in 2008. A pure liquidity issue will NOT get a backstop, from the discount window or otherwise. Customers will need to match their asset and liability maturities much more than they currently do.
Without the FDIC and discount window, a ruinous deflationary run is possible similar to 1931-32. IMO, at the zero lower bound, payroll and income taxes should be reduced as much as necessary to meet NGDP targets. That’s much more equitable than only going through banks and primary dealers.
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