Discussant to Selgin C.A.E. Goodhart Let me start with a quote from p. 26, “Future payment-system innovations that privatize and globalize currency do not threaten macroeconomic stability, but they do threaten the seigniorage profits central banks derive from issuing fiat currency.” The point that I want to make is that monetary policies and issues cannot be separated from larger government, and fiscal concerns. Let me quote from Willem Buiter‟s recent EJ paper, “Central bank operational independence and other institutional arrangements and ongoing developments relevant to the conduct of monetary policy should not blind one to the fundamental truth that monetary policy is but one component of the fiscal-financial- monetary programme of the state – the sovereign. Fundamentally, there can be no such thing as an independent central bank. For the central bank to perform well, it needs to be backed by and backed up by an effective fiscal authority. In this relationship, the central bank is, inevitably, the junior partner.” That raises question of whether government would happily allow its own seignorage to be reduced, or in so far as it can, e.g. by imposing regulations, prevent it. Draw attention to Chapter 6 in G. Ingham‟s recent book Nature of Money. He argues that modern monetary systems, including commercial banks cannot develop under an autocratic monarch, because they substitute for monarch‟s own moneys. But nor can a modern banking system develop in a country without a peaceful, stable, and settled government. Hence it was the constitutional, constrained monarchy, developing into a democracy, that allowed the development of a modern monetary and financial system. This goes to the heart of the reasons why the Mengerian theory that money is a special kind of good, is wrong and the Cartalist theory, that money is a special kind of claim, is correct. Of course, commodity money has existed, cocoa beans and cowrie shells, being the best example, but the need to rely on commodity moneys is usually a sign of government weakness, an inability to extract more seignorage by the issue of an IOU. Actually Selgin has appreciated some of the key aspects of Cartalist theory. Thus he accepts on p. 13 that banks, and indeed others, such as e-money issuers, would, “prefer to receive settlement in base money rather than financial claims, and are likely to continue to do so, for two main reasons. First, base money never confronts its recipient with a bid-ask spread or turnaround cost in acquiring and then spending it. It does not have bid and ask prices in terms of, but instead defines, the unit of account. Second, a base money payment is “final”: its recipient faces no credit risk. Banks will continue to want an asset with those properties for interbank settlements.” Indeed throughout history, money has generally been the IOU of that political agent least likely to default, often of no intrinsic value, such as Mesopotamian Temple clay tablets or the tally sticks of later rulers. Moreover many of the commodity moneys as did emerge were not much use as media of exchange. As Selgin knows well, gold was far too valuable to buy the daily necessities of life, and the earlier archetypal commodity money was cattle; hence the word „pecuniary‟. How does a cow grade against the usual litany of desirable monetary qualities; durable, portable, divisible, standardised? Be that as it may, Selgin follows a standard, and sensible, approach to argue that neither currency, nor banks‟ settlement balances at the CB, are likely to disappear in the foreseeable future. Selgin notes:- 1. Existing network externalities causing inertia 2. Lack of default risk 3. Ability of CB to incorporate attractive features of potential substitutes in its own liabilities. I would add (4), the ability of a government to shift the rules of the game to its own advantage. My only major criticism of this Section, occurs with his claim, on p. 24, that, “A reduced demand for base money may then be associated with greater difficulty in targeting the interbank lending rate, which moves with the demand for bank reserves.” I just do not follow that at all. CB‟s current operating techniques in money markets would be unaffected by sizeable reductions in average holdings of base money. But having demonstrated that base money is not likely to disappear from the scene, he cannot resist, alongside many of the rest of us, asking the „what if‟ question. But what if it did? Here he criticizes one of my own earlier analyses, but actually we are saying much the same thing. Let me start by noting his, similarly critical, comment on Wicksell on p. 31, that Wicksell, “apparently overlooked the possibility that a fiat-money system might also become a “pure credit” system, with private IOUs displacing central bank money, thereby making fiat money (which by definition has no industrial use) utterly worthless.” But Selgin then goes on to note that a CB can fight back against such competition. Thus he writes, from the same page, “Should technical innovations promise to give private monies a decided edge, central banks might respond to the potential competition by embodying similar innovations in their own liabilities. With respect to retaining the demand for base money as a settlement medium, nothing prevents central banks from paying interest on the deposit portion of the monetary base that commercial banks hold for interbank settlements. Such a reform could offset private innovations, such as interest-bearing private settlement accounts, that might otherwise erode the demand for base money.” Moreover, they cannot only fight back. They can always win. That was the point of the passage quoted critically by Selgin on pp 29/30, “the Central Bank, being a non-profit-maximizing entity, “is always in a position to dictate the finest terms on either the bid, or the ask, side of the money market” (ibid., p. 27).” The problem that I then pointed to was that, in order to win, CBs might have to sacrifice seignorage rents, and that takes us back to the opening point about whether a government would still support a CB that was a fiscal drain. So what does a government want from a CB besides seignorage. I think that the standard answer is correct, which is that a CB is primarily required to provide price stability and financial stability. At various points, Selgin asks, whether in a world of free capital movements and global players, it is either possible or sensible for smaller and weaker nation states to do this, and he seems to me to intimate that the answer is „no‟. I think that he underestimates the capacity of a freely floating exchange rate to allow for the maintenance of monetary sovereignty. The problem is instead that exchange rates have been distressingly volatile and erratic. The choice is between having more external stability but less national control over demand management, or vice versa. How the various nations see the balance of advantage to themselves in that choice is a key question that is continuing to be played out in Europe, and elsewhere.
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