WHAT MATTERS MOST: Understanding money creation
ONE OF MY READERS asked me to explain the concept of printing money in this column. For sure, it does not mean the literal printing of money done by the British company, De La Rue. It is the ability of the Central Bank to accommodate the excess spending of the Government.
Money creation, which may include the printing of money, starts with the Government’s overdraft facility at the Central Bank. This is determined as ten per cent of the estimated Government revenue in a given fiscal year. At the time of the Estimates debate, once the Appropriation Bill is passed, whatever the Government revenue number in the document, one-tenth of it is the limit for the overdraft. By law, the limit cannot be exceeded.
The Treasury manages the overdraft on the behalf of the Government. It comes into play if the balances on the Treasury’s current account are insufficient to meet the daily cashed payable orders of the Government. In short, when the Government has inadequate revenue, it borrows temporarily through the overdraft facility from the Central Bank.
For several years now, the Government has been unable to reduce the balance on the overdraft facility even though it is supposed to be temporary borrowings. In practice, the balance should be at zero at the end of the fiscal year.
Given that this overdraft has not been cleared for several years now, the Central Bank has been lending money to the Government in an alternative way to fund its excess spending. This lending is done through the purchase of Government treasury bills and debentures.
When an allotment of treasury bills is not taken up by the players in the market, the Accountant General may request the Central Bank to take up the shortfall. Like any other purchaser, the bank is requested to pay the cost of the bills to the Treasury on the date of issue that is the nominal cost minus interest due.
In recent times, the securities are not issued and the Central Bank requested to take the shortfall, the bank is playing a major part in the purchase of the securities from the start. This is because everything that comes as policy, these days, is really designed to accommodate the Government. The taxation policies are to accommodate the Government’s fiscal madness.
In recent times, the monetary policy of the Central Bank is similarly designed to accommodate the Government. This is true with respect to the purchasing of Government securities. This is true with respect to the deregulation of minimum deposit rates. This is true with respect to the setting of treasury bill rates.
When the bank holds a piece of Government paper, in essence it provides a loan. The loan is used to pay daily cashed payable orders. The accounting at the Treasury is a matter is debiting and crediting the correct general ledgers.
The real issue is, where is the Central Bank getting the money from to buy the securities? This is where the concept of money creation comes into play. Not all money that is created is printed.
In recent times, the Central Bank has been taking the excess deposits of the commercial banks held at the bank and using them to buy Government securities. This is not usual. If the commercial banks called upon the Central Bank for their excess deposits, one or two things would have to happen.
First, the bank would have to break its securities with the Government, which would reduce lending to it. This would mean a shortfall of financing for the Government.
Second, the bank would then have to print money to shore up its financing to the Government.
In the circumstances, a major problem could occur in the future with the Central Bank. Since some of the money used to buy its holding of Government securities belongs to the commercial banks, they could ask for their money at any time. The Central Bank would then have to print money.
When the Central Bank buys Government securities, this becomes part of the domestic debt of the Government. In the second quarter, April to June 2016, the commercial banks reduced their lending to the Government by $120 million. They however put $198 million in excess deposits at the Central Bank, which the bank used to buy Government securities. The bank then printed money of $103 million to buy additional Government securities.
The next article is, why using the commercial banks’ money to buy Government securities does not affect the foreign reserves?
• Dr. Clyde Mascoll is an economist and Opposition Barbados Labour Party adviser on the economy.