Rethinking the Monetization Taboo

LONDON – Now that the pace of the US Federal Reserve’s “tapering” of its asset-purchase program has been debated to death, attention will increasingly turn to prospects for interest-rate increases. But another question looms: How will central banks achieve a final “exit” from unconventional monetary policy and return balance sheets swollen by unconventional monetary policy to “normal” levels?

To many, a larger issue needs to be addressed. The Fed’s tapering merely slows the growth of its balance sheet. The authorities would still have to sell $3 trillion of bonds to return to the pre-crisis status quo.

The rarely admitted truth, however, is that there is no need for central banks’ balance sheets to shrink. They could stay permanently larger; and, for some countries, permanently bigger central-bank balance sheets will help reduce public-debt burdens.

As a recent IMF paper by Carmen Reinhart and Kenneth Rogoff illustrates, advanced economies face debt burdens that cannot be reduced simply through a mix of austerity, forbearance, and growth. But if a central bank owns the debt of its own government, no net public liability exists. The government owns the central bank, so the debt is to itself, and the interest expense comes back to the government as the central bank’s profit. If central bank holdings of government debt were converted into non-interest-bearing perpetual obligations, nothing substantive would change, but it would become obvious that some previously issued public debt did not need to be repaid.