Science against Myth to Protect Public Interests | Daily News
Part 2:

Science against Myth to Protect Public Interests

Money printing
Money printing

Those old monetarists insist that the Central Bank should be given the independence to print money and do all other what few Central Bank bureaucrats think good for the economy. They seem to think that the central bankers have come from the heaven with the divine knowledge to cure all economic ills to keep economic and price stability and financial system stability while remaining in their cool rooms.

In contrast, the base for central banks and monetary/financial systems is the fiscal policy or the public debt, both existing and contingent, and therefore, central banks and financial systems exist on the fiscal front in all operations.

First, currency being the base of central banks is the liability of the government. Second, central banks prints money by buying government debt being the safest assets and conduct OMO through the government securities based on certain segments of the yield curve. Only the US Fed trades selected private securities to activate markets, but the majority in government securities short to long-term. Nearly 52% of the Fed balance sheet is long-term government bonds. Present Bank of Japan conducts the monetary policy to control 10-year government bond yield around zero. Third, the yield curve, i.e., the plot of secondary market government securities yields across maturities, serves as the base for risk premium on private debt. Fourth, financial system stability prevails on the public trust in contingent government support inclusive of blanket guarantees and bailouts in the event of systemic risks.

Fifth, developing country central banks depend on government foreign debt to keep their foreign reserves for the safeguard of the external value of the currency or the exchange rate and BOP deficit financing. Nearly 70%-80% of the balance sheet of the Central Bank of Sri Lanka is foreign assets largely acquired through such foreign borrowing. As a result, the level of money printing heavily moves in response to the foreign reserve.

Sixth, state agency functions, i.e., public debt management, EPF and Foreign Exchange, are actively used to run the monetary policy in great conflict of interest, despite ample monetary policy tool kit, while fiscal coordination is solicited during times of financial crises and economic shocks as central banks normally fail to maintain the stability of the economy. In fact, central banks plead the government to expand fiscal support to overcome the present pandemic crisis. If not for the government borrowing to distribute aid, the monetary policy in present form will be idle. In fact, present global monetary policies are geared to fund governments at low cost to recover from the pandemic, in some instances with zero or negative yield rates. In all instances of economic and financial crises in the past, fiscal supports were the roots of recovery. In summary, modern monetary economies run on debt created on public debt. Money printing or reserve money is only the flip side of the public debt.

Rationale of the Modern Monetary Theory (MMT)

The base for the MMT is the above role of the fiscal front on the monetary and financial systems which is the conventional reality. Therefore, if central banks do not perform their monetary mandates, governments have no option but to conduct the monetary policy through fiscal tool kit. However, the central banking network has been suppressing the revelation of this hard reality by using their technical jargons of money and inflation assisted by the IMF network. In contrast, the pandemic has now revealed the truth and governments have become bold and active. In fact, the IMF Managing Director recently pleaded with the governments to use prevailing low interest rates to borrow and inject funds to recover from the pandemic and to higher production-based investments whereas debt-ridden low-income countries be given repayment extensions and other aid. Therefore, smart governments do not have to be fearful of or concerned over old monetarists if they really want to uphold the public duty on recovery from the corona pandemic. Further, the fiscal front and money printing have no pre-determined limits at times of human crises if the human suffering is known and felt by relevant bureaucracy.

Rumours are spreading everywhere that the country is run on printing of money by the Central Bank to fund the government since the outbreak of pandemic and, therefore, inflation is unavoidable in the near future while the economy will confront instability caused by the increase in money supply. Sri Lanka is now experiencing instability and, therefore, all fiscal and monetary coordinated tool kits must be implemented to restore the stability.

The Fed Chairman stated that the Fed was not concerned over hypothesis of inflation and fiscal situation and would use its full range of tools to support the recovery whereas debt sustainability and inflation could be addressed later if necessary, after the recovery. Therefore, the Fed has raised money printing by nearly US$ 3,230 bn as at third week of December 2020 as compared to the Fed balance sheet of US$ 4,174 bn as at end of 2019 (77% increase). This is almost equal to money printing carried during the past decade to recover from the financial crisis 2007/09. The present target of new money printing through purchase of assets is US$ 120 bn a month. The story is similar for all leading central banks. Their objective is to pump the liquidity abundantly at all maturities to boost the confidence in the financial system. Old Sri Lankan monetarists state that those Central Banks can print money lavishly as their currencies are globally accepted reserve currencies, but Sri Lanka cannot. However, the monetary theory does not separate currencies on this basis and currencies have own markets depending on the exchange/capital controls and confidence. If Sri Lanka cannot print money at this time, the country or the public has no use of Monetary Law Act.

Decline in money printing in Sri Lanka

However, money printing of Sri Lankan central bank as estimated by the amount of reserve money has declined in most of months. For example, the decline from March to October has been Rs. 93 bn (to Rs. 921 bn from Rs. 1,014 bn). The decline has been a salient feature in 2019 too. Whatever said and done, the standard monetary theory will predict tight money and financial conditions in the country due to shrinking monetary base resulting recessionary impact on production and spending activities.

When the SRR and standing deposits are deducted, the amount of reserve money available for credit creation is only about Rs. 650 bn. This can be reversed only if the credit creation is substantially raised, which cannot be expected at this stage. The present trend of decline or deceleration of reserve money is largely due to BOP funding connected with the deficit, control of exchange rate and repayment of foreign debt and investments without off-setting money printing (sterilization) in the domestic money market.

However, the money printing through Treasury bills holding of the central bank has increased by Rs. 564 bn to Rs. 725 bn from mid-March to December 31. This is not the fault of the government as this is the long-standing practice of the central bank of buying Treasury bills directly from the Public Debt Department after the weekly auctions in order to control yield rates of government securities directly in line with the monetary policy outside the standard yield curve based OMOs. There are many instances in the recent past too where such purchases rose more than 100 bn in a day or few days. At present with abundance of short-term/overnight liquidity built-up in the banking system as a result of slow growth of private sector credit and release of non-earning statutory reserves of nearly Rs. 175 bn (SRR cut by 3% to 2%), such purchase of Treasury bills has become necessary for monetary operations because the central bank does not permit any decline in overnight inter-bank rates below Standing Deposit Facility Rate (4.5% at present).

Therefore, the central bank has incurred in cost for absorbing the inter-bank daily liquidity ranging from Rs. 100 bn to Rs. 240 bn by paying interest to OMO participants. The interest so paid in total from mid-March to the end of December is nearly Rs. 6 bn (at SDFR ranging from 6.25% to 4.5%) as banks find profitable and risk free to park their funds (built up primarily from release of statutory reserves and lower private credit delivery) at the central bank rather than lending, given risks of uncertainties.

The SRR was cut by 3% to release funds for lending and not for converting an interest-bearing reserve back at the central bank. However, the market pressure to move interest rates further down is seen from the central bank OMO of long-term reverse repos to some money dealers at rates lower than SLFR (overnight reverse repo rate, 5.5% at present) and refinance schemes offered at 1% (on-lending at 4%). In this context, the rationale of the current SDFR-based policy rates tool that prevents money market rates from falling further at a huge interest cost to the public is questionable.

Government credit expansion

If not for lending to the Government by the banking system, the supply of money would have declined causing a wide-spread recession in the economy as banks are declined to lend to the private sector in view of the pandemic related risks, despite a large number of relaxations of credit regulations. For example, between March and October, credit to the state sector increased by Rs. 1,197 bn (29.4% growth) while the increase in credit to private sector was only Rs. 111 bn. (1.9% growth). Therefore, M2b growth of 11.3% was possible due to state credit expansion. The strategy followed in many countries including developed countries is the use of fiscal deficit to keep the economies liquid and running as the present monetary policy frameworks operating through short-term inter-bank liquidity and arbitrary policy interest rates have failed to activate credit delivery across various sectors including SMIs. In this respect, the Chinese model appears to be direct and effective, given its governance system.

Therefore, the story of inflation ghosts told to beginners of economics is the myth against new knowledge and global practice at this stage. In this context, given the extent of the disruption of global supply and demand chains and uncertainty prevailing across the globe created by the present pandemic, ultra-expansionary fiscal and monetary tools will be required at least for next decade to recover from the present recession, caused by governments as the immediate response to the pandemic, until the trust between people is firmly restored. Policy tools will be numerous. However, the bureaucracy does not feel pandemics and human urgencies as it lives on treasured office files that make them delay in catching and applying the new knowledge to solve human problems. Their skill set is to look for control over markets and people rather than helping them out to prosper. Therefore, the countries that resist the wind of new global policy and knowledge due to fear of inflation ghosts or other hypotheses will be dead and gone along with Monetary Kattadi.

(The writer is a former Deputy Governor of the Central Bank of Sri Lanka and the author of seven books of Economics and Banking).