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					                         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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posted:3/10/2010
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