The Promise of Fiscal Money
One of the few remaining sacred cows of Western capitalism is the independence of central banks from elected governments. But in an age when fiscal policy has become an essential factor in determining the quantity of money lubricating the system, an independent monetary authority no longer makes sense.
ATHENS – Western capitalism has few sacred cows left. It is time to question one of them: the independence of central banks from elected governments.
The rationale for entrusting monetary policy fully to central banks is well understood: politicians, overly tempted during the electoral cycle to create more money, pose a threat to economic stability. While progressives have always protested that central banks can never be truly independent, because their autonomy from elected officials increases their dependence on the financiers they are meant to keep in check, the argument in favor of removing monetary policy from democratic politics has prevailed since the 1970s.
Setting aside the political controversy, central bank independence is predicated on an economic axiom: that money and debt (or credit) are strictly separable. Debt – for example, a government or corporate bond that is bought and sold for a price that is a function of inflation and default risk – can be traded domestically. Money, on the other hand, cannot default and is a means, rather than an object, of exchange (the currency market notwithstanding).
But this axiom no longer holds. With the rise of financialization, commercial banks have become increasingly reliant on one another for short-term loans, mostly backed by government bonds, to finance their daily operations. This liquidity acquires familiar properties: used as a means of exchange and as a store of value, it becomes a form of money.
And there’s the rub: as banks issue more inter-bank money, the financial system requires more government bonds to back the increase. The growing inter-bank money supply fuels demand for government debt, in a never-ending cycle that generates tides of liquidity over which central banks have little control.
In this brave new financial world, central banks’ independence is becoming meaningless, because the money they create represents a shrinking share of the total money supply. With the rise of inter-bank money, backed mostly by government debt, fiscal policy has become an essential factor in determining the quantity of actual money lubricating modern capitalism.
Indeed, the more independent a central bank is, the greater the role of fiscal policy in determining the quantity of money in an economy. For example, in the eurozone, Germany’s tight fiscal policy is creating a shortage of bunds (German government bonds), which is limiting both the European Central Bank’s capacity to implement its quantitative easing policy and commercial banks’ ability to produce more inter-bank money. Money and government debt are now so intertwined that the analytical basis for central bank autonomy has disappeared.
Of course, any attempt to bring treasuries and central banks back under one roof would expose politicians to accusations of trying to get their grubby hands on the levers of monetary policy. But another response to the new reality is available: Leave central banks alone, but give governments a greater say in domestic money creation – and, indeed, greater independence from the central bank – by establishing a parallel payments system based on fiscal money or, more precisely, money backed by future taxes.
How would fiscal money work? For starters, it would “live” on the tax authority’s digital platform, using the existing tax file numbers of individuals and companies. Anyone with a tax file number (TFN) in some country receives a free account linked to their TFN. Individuals and firms will then be able to add credit to their TFN-linked account by transferring money from their normal bank account, in the same way that they do today to pay their taxes. And they will do so well in advance of tax payments because the state guarantees to extinguish in, say, a year €1,080 ($1,289) of the tax owed for every €1,000 transferred today – an effective annual interest rate of 8% payable to those willing to pay their taxes a year early.
In practice, once, say, €1,000 has been transferred to one’s TFN-linked account, a personal identification number (the familiar PIN) is issued, which can be used either to transfer the €1,000 credit to someone else’s TFN-linked account or to pay taxes in the future. These time-stamped future tax euros, or fiscal euros, can be held for a year until maturity or be used to make payments to other taxpayers. Smartphone apps and even government-issued cards (doubling as, say, social security ID) will make the transactions easy, fast, and virtually indistinguishable from other transactions involving central bank money.
In this closed payments system, as fiscal money approaches maturity, taxpayers not in possession of that vintage will fuel rising demand for it. To ensure the system’s viability, the Treasury would control the total supply of fiscal money, using the effective interest rate to guarantee that the nominal value of the total supply never exceeds a percentage of national income, or of aggregate taxes, agreed by the legislature. To ensure full transparency, and thus trust, a blockchain algorithm, designed and supervised by an independent national authority, could settle transactions in fiscal money.
The advantages of fiscal money are legion. It would provide a source of liquidity for governments, bypassing the bond markets. It would limit the extent to which government borrowing fuels inter-bank money creation, or at least force financiers to tie up some of their inter-bank money in the closed, domestic fiscal money system, thereby minimizing shocks from sudden capital flight. And, by competing with the banks’ payment system, it would reduce the cost of fees customers currently pay.
Indeed, owing to the blockchain technology, fiscal money constitutes a fully transparent, transaction-cost-free, public payment system monitored jointly by every citizen (and non-citizen) who participates in it.
Fiscal money is politically attractive as well. Governments could use any slack in money supply to top up the FTN-linked accounts of families in need, or to pay for public works, making it appealing to progressives. And conservatives should be encouraged by a system that promises significant tax relief for those who help the government create fiscal money, without impinging on the central bank’s role in setting interest rates.
The potential transnational advantages of fiscal money are also significant. For example, fiscal money would have helped Greece resist our creditors’ encroachments in 2015, and it was at the heart of my plan for dealing with a predatory bank holiday enforced by the ECB at the end of that June. Today, it would give Italy, France, and other eurozone members much needed fiscal space, and possibly provide a foundation for a revamped eurozone with interlocking domestic fiscal euros, rather than parallel currencies, playing a stabilizing macroeconomic role. And then, perhaps, it could become the basis for a New Bretton Woods, functioning like an overarching clearing union of many different fiscal money systems.
Making Fiscal Money Work
Proposals for a new system of “fiscal money” have increasingly appeared in political debates in Italy, where budget constraints and a lack of monetary sovereignty have tied policymakers’ hands. If it is properly designed, such a system could substantially boost economic output and public revenues at little to no cost.
ROME – In a recent commentary, Yanis Varoufakis of the University of Athens pointed out the merits of giving national governments a greater say in domestic money creation. Varoufakis calls for a new parallel payments system based on “fiscal money,” or money backed by future taxes, and he proposes a complex mechanism for creating such money.
In response, we would direct readers to our own fiscal-money proposal, which would be simpler and easier to adopt than the system Varoufakis describes. We devised the idea in our “Manifesto for Italy” in 2014, when we were looking for a policy instrument that could revive aggregate demand in an economy with limited fiscal space and no monetary sovereignty. As we argued then, such an instrument would allow Italy to recover from its economic crisis without leaving the eurozone or violating European Union rules.
Our proposal evolved into a widely read e-book and a series of articles, in which we developed a rigorous definition of fiscal money, and simulated a fiscal-money program using Italian economic data. We also considered how fiscal money would work in different contexts, by comparing our proposal to various parallel-currency proposals for Greece, and to the economic policies of Hjalmar Schacht, the architect of Germany’s economic recovery in the 1930s.
Fiscal-money proposals now feature heavily in Italian political debates, especially among major opposition parties such as former Prime Minister Silvio Berlusconi’s Forward Italy (Forza Italia), the Five Star Movement, and the Northern League (Lega Nord). Whereas some see fiscal money as a potential complement to the euro, others see it as a means for withdrawing Italy from the eurozone altogether.
Under our proposal, the Italian government would issue “tax rebate certificates” (TRCs) granting reductions in future payments to the state (taxes, duties, social contributions, and so forth) in amounts equal to their nominal value. TRCs would be redeemable at a later date – say, two years after issuance – but they would also have an immediate value, because they would represent a guaranteed future claim. A €100 ($120) TRC that is issued today would be worth the same €100 when it is redeemed two years hence; but, in the meantime, it would trade at a small discount.
To ensure that a TRC’s market value tracks with its nominal price at all times, the government would pay a positive interest rate on TRC holdings. It would also establish a national payment system, whereby TRCs could be exchanged for goods and services from suppliers who accept them, or for euros and other assets. With this system in place, the government could then issue TRCs, free of charge, directly to workers, companies, or disadvantaged social groups, or use them to fund public investments and welfare programs.
Under our proposal, public- and private-sector agents would have more spending capacity, and domestic firms would be able to lower their labor costs. And this, in turn, would reduce trade deficits, by making domestic firms more competitive versus imports.
TRC issuances could thus be calibrated to close a country’s output gap. For example, in 2018, the Italian government could start issuing TRCs worth €30 billion per year, and then expand the annual total to €100 billion in three years. The first round of TRCs would have a stimulus effect during their two-year deferral period, because increased private-sector spending would push up output. And because large output gaps and low interest rates tend to have a multiplier effect on increases to income, the TRC issuance would cover its own fiscal costs by boosting public revenues.
Best of all, TRCs would not violate the European Central Bank’s monopoly over the euro as legal tender. TRCs are not claims to future reimbursements, so they do not constitute public debt as defined by Eurostat. That means governments can issue TRCs without running afoul of EU treaties and laws governing public liabilities, because they would not be increasing their risk of defaulting.
To be sure, TRCs would weaken fiscal budgets over time if they did not stimulate sufficient economic activity (and thus boost public revenues). But to prevent that outcome, TRC issuances could be accompanied by conditional tax increases or spending cuts at the time of redemption, depending on whether the government is running a deficit. These measures would then automatically expire as soon as the TRCs started to fuel enough economic expansion to cover their own fiscal costs.
So, even in a hypothetical (and virtually impossible) worst-case scenario, in which TRCs have no expansionary effect at all – that is, if all beneficiaries were to stow them “under the mattress” and wait for the rebates in 2020 – they would still be budget-neutral with the right safeguards in place.
All told, TRCs represent a risk-free proposition. In Italy, where the economy remains weak and fragile, they would most likely induce faster and more robust growth, while restoring stability to the country’s beleaguered financial sector.