Monetary Policy
Current societies deal with availability of money under the name of "monetary policy". Instead, monetary policy should deal with the amount of money supply in a society. The only goal of the monetary policy of an ideal society is to ensure that the total monetary value of the privately owned wealth of the society remains almost constant. This chapter discusses the reasons for adopting this goal, its outline implementation, and compares it to past and present monetary policies.
An Overview
What is monetary policy?
Currently, when we hear the term "monetary policy", we think about central banks, interest rates, inflation, unemployment rate, reserve ratio, quantitative easing, etc.
Current societies like to classify money into categories like M0, M1, M2, M3 and perhaps even M4. The first category is the narrowest and includes only coins and currency in circulation. The broadest category would include all the wealth.
Monetary policy should deal with the amount of money supply in a society.
In any society, the total amount of privately owned wealth within the society is the totality of money supply in the society.
Current societies tend to deal with the availability of money at the bulk level; not the totality of money. We hear about central banks influencing this availability by using the tools at their disposal. The two main tools are: interest rates and quantitative easing. The interest rates could be for various time periods starting from 1 month going all the way to several decades. Quantitative easing is creating money out of nothing; that is, money is electronically created. Sometimes, the word quantitative tightening is also mentioned, and it is the opposite of quantitative easing. In current societies, a very small group of people make all decisions about interest rates, quantitative easing, and quantitative tightening. In the current societies and systems, such practices may have some merits, but not in an ideal society.
Unlike current societies, the monetary policy of an ideal society deals with the total amount of wealth within the society. In an ideal society, the availability of money for specific purposes is not the business of monetary policy. Each specific purpose is narrow enough that it needs to be handled separately, and using mechanisms that are appropriate for that purpose. Bulk level tools, like interest rate manipulation and general quantitative easing, are not appropriate to address specific issues.
There is a significant difference between how an ideal society views "money supply" within the society, and how it is currently viewed. The term "monetary policy" is the right term to be applied in an ideal society. The actions taken by current societies, under the name of monetary policy, do not deserve to be referenced by that name. In fact, what happens today is not appropriate for an ideal society.
The above paragraphs merely talked about "what is monetary policy about?"; we did not discuss "what is monetary policy supposed to do? And why?". Let's begin that discussion.
The section "The Problem of Monetary Inflation" in the "Reasons for the Rich Getting Richer" chapter introduced the situation that current societies are based on a monetary system that tends to increase the numerical value of the total privately owned wealth in a society. This is "monetary inflation", and it causes the common "inflation" in the prices of the necessities of life. Monetary inflation combined with increasing wealth inequality ensures that the non-rich are left with relatively less amount of money.
The only goal of the monetary policy of an ideal society is to ensure that the total monetary value of the privately owned wealth of the society remains almost constant.
In other words, the only goal of the monetary policy of an ideal society is to ensure that there is no monetary inflation within the society, and also, there is no monetary deflation within the society.
Most current societies experience an ever-increasing total monetary value, punctuated by some time of wildly fluctuating total monetary value. Rarely do current societies face an ever decreasing total monetary value. All these situations are not desirable. Maintaining the total monetary value of the privately owned wealth within the society to an almost constant value is the better choice. The section "Reasons for the Goal" discusses the reasons.
The section, "Implementation of Core Monetary Policy", describes the conceptual implementation of the monetary policy. In short, the implementation of this monetary policy returns the total privately owned wealth of the society to a normal value when it deviates significantly from that normal value. This implementation is driven by policy parameters that are set by citizens. Citizens decide what the normal level should be, and citizens decide the pace at which the current total value should return to its desired normal level.
The section, "Enhancements to Core Monetary Policy", completes the full description of the Utopian version of the monetary policy by outlining three enhancements to the implementation of the core monetary policy.
The section, "Comparing to Current Monetary Policies", compares the Utopian version of monetary policy with the variety of actions currently undertaken under the name of monetary policy.
Reasons for the Goal
Let's discuss why "the total monetary value of the privately owned wealth of the society" should remain almost constant.
We will start with three observations, and then think about the mechanism that makes the total monetary value change significantly. After that, we consider the ill-effects of these significant changes, and what could be done to address it. All that combined gives us the full reason for the stated monetary policy.
The first observation is that when two individuals transact some money, this transaction does not change the total monetary value of privately owned wealth within the society. Some examples of such transactions are monetary gifts, paying for services, paying for goods, paying for any combination of goods and services.
The second observation is that any economic activity that transforms a bunch of resources into some desirable product does not change the amount of resources. Resources are various kinds of materials, which is essentially the matter that we learn in physics. Any such activity does not create matter, and it does not destroy matter, it merely transforms matter from one form to another. Thus, the total resources within a society remain unchanged. Some examples of such activities are: mining, agriculture, manufacturing, etc.
Resources have monetary value, and if resources are neither created nor destroyed by such transforming activities, then it should not change the monetary value of the net of all such resources within the society.
The third observation is that the perceived value of transformed resources is different from the original resources. This perceived value also changes over time. What are the reasons for this change?
The perceived value of the transformed resources can be different from the value of the original raw-form resources. For example, a manufacturer values the finished product more than the raw materials that went into its making, and hence sells it at a higher price than the total cost of all the raw materials that went into the making of the product. This additional valuation is due to the labor put in the making of the product; the product is more useful than the raw materials combined. But, this usefulness has a limited time, and the usefulness keeps dropping over this limited time. In accounting terms, this is called depreciation; all products eventually lose their usefulness with their use and passage of time. The labor originally put into making of the products gradually loses its value over a limited amount of time. The limited amount of time could be a few years for durable goods, and it could be just a few days for fresh produce.
In a short span of time, like a year, just because of the effect of the changes in perceived value, the total value of all privately owned wealth in a society cannot change by much. Here is a simplified example that illustrates this point: If every manufactured product had a useful lifespan of 10 years, then all these products would depreciate by 10% every year, and every year 10% new products would be produced to replace the 10% of the products that are 10 years old.
Overall, these increases or decreases in the perceived value of our possessions are justified, and they will tend to balance each other out over a long enough time span.
With those three observations noted, let us consider the following ...
If today the total monetary value of the privately owned wealth of some country is 2 Trillion and next year it is 2.2 Trillion, then why is that? Has the total quantity of this country's resources increased in the interim? Did this country invade some other country and looted them? Most likely, this is not the case. Then why should "all the privately owned wealth in this country" be valued more in the next year?
If today the total monetary value of the privately owned wealth of some country is 2 Trillion and next year it is 1.8 Trillion, then why is that? Has the total quantity of this country's resources decreased in the interim? Did this country just get invaded and looted by some other country? Most likely, this is not the case. Then why should "all the privately owned wealth in this country" be valued less?
And yet, we observe that the monetary value of assets changes. We see gold becoming expensive or cheap. Oil prices rise or fall. House prices rise and fall. Stock prices rise and fall routinely in small amounts. Sometimes, almost all stocks rise beyond belief, and sometimes we have a rally in stock prices. Sometimes, we even get what are called bubbles. Sometimes, stocks fall to such an extent that it induces panic, uncertainty and fear.
What causes these small or large fluctuations? It is the concept called "mark to market". Imagine if you had bought 10000 units of some company's shares at 1 dollar each. You have not sold it yet. Occasionally, you check the stock market for its price. One day you notice that it has risen to 5 dollars. That means your initial investment of 10000 dollars has notionally now grown to 50000 dollars. This makes you feel good; makes you feel richer than before. You could sell those shares and realize your profits. However, in your mind, you are already assuming that the current market price is what you will get for your shares and even if you don't sell them, you still are worth a lot more than before. So without you actually selling those shares and without someone else buying them from you for 5 dollars each, you consider your wealth has increased. Having seen that the stock was priced at 5 dollars, it becomes difficult for you to sell it 4 dollars, if you are convinced that the stock is worth 5 dollars. This is called "mark to market". This happens not just in your case, it happens to everyone, and with the valuation of pretty much every asset.
So, what is the problem?
Depending on the expected and unexpected events that unfold, people value assets based on their personal opinion of what it is worth currently and their hopes and fears about the future.
There are times when people get optimistic about the values of assets, and at these times the total value of all assets in a country can increase significantly. This happens in asset price bubbles. These bubbles are just optimistic asset price valuations. The net resources of a country have not changed. Hence, these kinds of bubbles are undesirable.
There are times when people get pessimistic about the values of assets, and at these times the total value of all assets in a country can decrease. This happens in market crashes. These crashes are just a manifestation of extreme pessimism about future and asset price valuations. The net resources of a country have not changed. Hence, these kinds of crashes are undesirable.
These occurrences of irrational exuberance and extreme fear, cause people to make bad decisions based on the percieved value of the wealth that they personally possess. The problem is systemic because the current value of the total wealth of the country just depends on people's collective opinion, which gets influenced unduly by euphoria or fear. Moreover, since the resources within the country have not changed, the asset price valuations are skewed in these excessively optimistic and excessively pessimistic situations.
So, what is the solution?
If these fluctuations are tempered, people will have better predictability, they will make better decisions individually. Collectively, we will have better outcomes.
In times when the total monetary value of all privately owned assets rises, like in an asset price bubble, we need a mechanism to bring the total monetary value of privately owned wealth in the society down to a "normal" level in a reasonably short period of time.
In times when the total monetary value of all privately owned assets falls, like in a stock market crash or a recession, we need a mechanism to bring the total monetary value of privately owned wealth in the society up to a "normal" level in a reasonably short period of time.
The mechanism mentioned in the above two paragraphs is the monetary policy.
And thus, the only goal of the monetary policy of an ideal society is to ensure that the total monetary value of the privately owned wealth of the society remains almost constant.
Note that we have used "almost constant" instead of unqualified "constant". This is because we do not want the "constancy of wealth" to be accomplished every day; we only want it to be accomplished in a short period of time. We also need control over the "shortness of the period of time" as per our collective judgment.
Implementation of Core Monetary Policy
First, we need a notion of "Current Total Wealth". This is the sum of the current monetary value of all privately owned wealth in the society. This sum can be computed at any time, and hence also at the end of every day.
Next, we need a notion of "Normal Total Wealth". This is the average of the total of privately owned wealth on each of the days in the past several years. The number of the past years to use to compute this average is a policy parameter, and it is called "Years to Determine Normal Wealth". Citizens can collectively choose the value for this parameter, and it determines how far back to look to determine the "Normal Total Wealth". For example, citizens may choose 1 or 2 or even 10 years as the value for this parameter. The actual value of this parameter is the average of all the choices made by citizens. The initial value for this parameter can be set to 2 years, and then citizens can change it if they think it is appropriate.
Next, we decide in how many years do we want the Current Total Wealth to return to a value that is close to Normal Total Wealth. This is a policy parameter that we collectively decide. Let us call this policy parameter "Return to Normal Period" and it is expressed in years. Similar to the earlier parameter, citizens can set it to a value of their choice. The parameter begins with a default value of 2 years.
Monetary policy should take actions, every day, to decrease or increase the money supply in the society so that Current Total Wealth within the society returns to its normal level, that is Normal Total Wealth, within the next Return to Normal Period years. What exactly are these actions that decrease or increase the money supply in a society? In short, they are "destroy some money" or "create some money".
At the end of every day, we find the value of Current Total Wealth and compute the value of Normal Total Wealth.
If the value of Current Total Wealth is larger than Normal Total Wealth, then we compute the difference between them and express this number as a percentage of Current Total Wealth. We will call this percentage the "Excess Percentage". Then we find "Annual Excess Percentage" as Excess Percentage divided by Return to Normal Period. This Annual Excess Percentage is charged as tax to all citizens and self-owning entities in proportion to the wealth that they possess. The money collected as tax is destroyed; that is, electronically not deposited to any account.
Since monetary policy works every day, the amount collected every day is 1 / 365 of the Annual Excess Percentage of the Current Total Wealth of each citizen and each self-owning entity.
The reason for including self-owning entities in collecting this tax is the same as that for wealth redistribution.
Everyone pays at the same rate, the amount collected is proportional to the wealth possessed. There is no discrimination and there are no exemptions.
If the value of Normal Total Wealth is larger than Current Total Wealth, then we compute the difference between them and express this number as a percentage of Normal Total Wealth. We will call this percentage the "Deficit Percentage". Then we find "Annual Deficit Percentage" as Deficit Percentage divided by Return to Normal Period. We pay all citizens a combined value of Annual Deficit Percentage of Current Total Wealth. This payment is done using freshly created money; that is, this money does not exist in any account; it is generated electronically.
Since monetary policy works every day, the amount distributed every day is 1 / 365 of the Annual Deficit Percentage of the Normal Total Wealth of the society.
When we make payments due to monetary policy, we do them equally to all citizens. No citizen is excluded for any reason. Thus, we distribute this freshly created money equally among all citizens. That is, we deposit each citizen's share into his or her account.
The reason for not including self-owning entities in this distribution of freshly created money is the same as that for wealth redistribution.
A daily implementation of the monetary policy makes its tax collection or money distribution a continuous stream of money flow within the society. The daily frequency does not cause abrupt ups or downs to the net wealth of any citizen. It is predictable and it is gradual.
Further, the implementation will be fully automatic; with scope for configuring exactly how to collect the tax, when needed. This implies that citizens have to take the least amount of effort in paying this kind of tax.
That concludes the full conceptual description of the core monetary policy.
This description is useful in illustrating how monetary policy fulfills its core goal, which we will discuss shortly. There are some obvious enhancements that can be made to this core monetary policy to obtain the Utopian version of the monetary policy; we will see those in the next section.
How does the core monetary policy deal with asset price crashes or bubbles?
When there is a sudden crash in total asset price value, a daily implementation of monetary policy starts working immediately, providing additional money to everyone to repair the damage to asset prices right away.
When there is an asset price depression, it usually lasts longer than a crash. With a daily implementation of monetary policy, each day the monetary policy is working to provide additional money to everyone, and temper the impact of the underlying depression.
We rarely see a sudden asset price bubble, but even if they occur, a daily implementation of monetary policy starts working immediately to temper the bubble.
Asset price bubbles usually develop over a few months. While the bubble is building gradually, with a daily implementation of monetary policy, each day the monetary policy is also working gradually to temper the underlying excessive optimism.
Monetary policy has "Return to Normal Period" as a policy parameter that determines the number of years in which to return the total privately owned wealth to its normal levels.
If we set this parameter to two years, then it means that whatever asset price fluctuations occur, they need to be gradually brought back to normal in two years. This "normalization" applies to both rise in asset valuations and drop in asset valuation.
If we set this parameter to three years, then the normalization is slower than what it would have been if it was set to two years.
If we set this parameter to one year, then the normalization is faster than what it would have been if it was set to two years.
Enhancements to Core Monetary Policy
The core monetary policy will take its actions only when the current total wealth is non-trivially higher or non-trivially lower than the normal total wealth. Thus, for the monetary policy to initiate its actions, the current total wealth has to deviate from the normal by more than 1%. If the current total wealth is within 1% of the normal total wealth, the monetary policy does not consider this variation to be large enough to warrant a corrective action.
The 1%, mentioned in the above paragraph, is essentially a 2% band in which the monetary policy does not do anything. It can be thought of as the monetary policy is waiting for the economic activity and market forces to correct the deviation of total wealth from its norm. Only when economic activity and market forces fail to keep the total wealth closer to its norm, then the monetary policy swings into action.
On a day, when the core monetary policy collects a tax because there is excess total wealth in the society, instead of just destroying that money, it should pay down any long-term or current fiscal deficit. Only when there is no fiscal deficit, then it should destroy the money.
When there is a fiscal deficit, then paying off the deficit is a better use of the collected tax as compared to just destroying it. In addition, it also reduces the future burden to pay off the deficit.
When there is no fiscal deficit, then the money should be destroyed. It is possible to consider allocating this collected tax for wealth-redistribution, or for wealth-based taxes to support the common good. But, if we do that, it will not nudge the total wealth in the society towards the normal level.
On a day, when the core monetary policy creates some money and distributes it among the citizens of the society, it should take the following actions regarding any pre-existing fiscal deficit:
- If there is an existing fiscal deficit, it should reduce that fiscal deficit by an amount that is at most equal to the amount already distributed to the citizens on that day.
- If there is no fiscal deficit, then there is nothing further to do.
Here is the reasoning ...
When the total wealth in the society has gone below its normal value, then it implies some level of scarcity of money, and hence a need to give some monetary assistance to help nudge the total wealth in the society towards the normal level. The presence of a fiscal deficit in this situation is an indication that there already exists some "monetary hardship" and the lowering of the total wealth is a confirmatory signal of that hardship.
In normal times, the fiscal deficit is paid off through wealth-based taxes.
In times of hardship, if the society continues to pay off the existing fiscal deficit through wealth-based taxes, then that will reduce the total privately owned wealth of the society to the extent that corresponds to the part of the deficit that is paid off, and that introduces additional scarcity of money.
Since the goal of the monetary policy is to keep the total monetary value of the wealth of the society to an almost constant value, in times of hardship, reducing the fiscal deficit by some amount is consistent with its goal.
Note that such a reduction in fiscal deficit, is similar to "a creditor writing off a debt owed by a debtor to the creditor". Writing off a debt is an extraordinary thing to do. A combination of "below normal total wealth" and "presence of existing fiscal deficit" is an extraordinary situation.
A society can "write off" parts of its fiscal deficit because it is a monetary sovereign and the deficit is in terms of its local currency.
The presence of an extraordinary situation does not mean that a society should automatically write off the entire fiscal deficit in one shot. The writing off of the fiscal deficit needs to be done gradually, and only so long as the extraordinary situation continues to exist. If the hard times persist for a longer duration, more of the fiscal deficit is written off in that time, and it will be easier for citizens when the monetary hardship eventually ends.
The monetary policy implemented by an ideal society is the core monetary policy with the addition of these three enhancements.
Comparing to Current Monetary Policies
The Utopian version of monetary policy is only responsible for maintaining "the total monetary value of the privately owned wealth" at a nearly constant value. It does not attempt to influence anything else. In this section, we will compare the Utopian version of monetary policy with current and past versions of monetary policies of present-day societies.
In the past, societies have implemented "price controls" on numerous products and services. Some current societies continue to do it; with the publicly stated goal of "protecting the poor".
An ideal society has an effective social welfare system; and the Utopian Payment Model is its main tool in helping the poor citizens pay for essentials. This payment model comprehensively deals with the issues that people with below average wealth face in paying for the essentials. This is discussed in detail across several chapters later in this book.
Hence, price controls are not required in an ideal society. Moreover, attempting to implement price controls is denying people their freedom to maintain the profitability of their businesses. Denying people their profitability freedom is not consistent with general Utopian thinking. An ideal society will not choose price controls; moreover, it does not need price controls because it has the Utopian Payment Model.
Thus, the Utopian version of monetary policy does not attempt to influence the value of any class of assets. It also does not attempt to influence the value of any individual asset. It does not attempt to control the prices of individual assets.
In current societies, the implementers of the current monetary policies attempt to influence the rate of inflation by manipulating the short-term interest rates. This is done by setting and enforcing targets for interest rates within the country. The intent behind these actions is to "maintain inflation at some desired non-zero level".
Regarding non-zero inflation targets, the current line of thinking is as follows: the presence of inflation motivates those who have capital to invest and earn profit, because if they do not do so, then their capital's purchasing power will be eroded by inflation.
An ideal society does not compel anyone to do any specific thing with their money. If people have lots of money (that is private ownership of wealth) and they wish to do nothing with it, then it is completely fine.
An ideal society ensures that everyone pays a fair cost for the privilege of being able to have private wealth ownership. This fair cost is in terms of wealth redistribution and wealth-based taxes, and those two kinds of costs are sufficient to provide citizens the motivation to use their privately owned wealth wisely.
In current societies, the implementers of the current monetary policies attempt to influence the rate of growth of GDP by manipulating the interest rates; both short-term and long-term.
The Utopian version of monetary policy does not attempt to influence the rate of growth of GDP; it does not attempt to spur growth or slow it down. A Utopian society considers the well-being of all citizens as far more desirable than the growth of GDP. An ideal society does not consider "growth in GDP" as a proxy for the well-being of its citizens.
An ideal society attempts to achieve the well-being of its citizens by establishing fair monetary systems and having an effective social welfare system.
The fair monetary system allows citizens to engage in businesses, either as owners or as employees, that specialize and provide other citizens their specialized products and services, and charge appropriately for them, and make a profit while conducting that business, so that they can support themselves, and thereby be independent and self-sufficient.
The effective social welfare system helps those citizens who need the help, and that too in the amount it is needed; all this is with the goal of making citizens independent and self-sufficient.
In current societies, the implementers of the current monetary policies attempt to influence the rate of unemployment by manipulating the interest rates, or by quantitative easing or tightening. Their publicly stated goal is to "maintain the unemployment rate at reasonably low levels".
In the current setup, the implementers, when faced with an unacceptably high unemployment rate, could lower the interest rates, thereby making it cheaper for businesses to borrow money and employ more people. These implementers could also do quantitative easing, thereby creating more money in the society, which in the hands of the wealthy could result in investments, and that could lead to job creation thereby reducing the unemployment rate.
The problem that implementers of current monetary policies face is that they have the same tools for their unambitious goal of "maintain the unemployment rate at reasonably low levels" and ill-thought-out goal of "maintain inflation at some desired non-zero level". So to bring down inflation, they have to increase interest rates and/or reduce monetary liquidity by engaging in quantitative tightening, and this increases unemployment rate and can cause recessions. These implementers are in a no-win situation; and they routinely fail in accomplishing their "dual mandate".
High unemployment rate is absolutely undesirable. The goal of an ideal society is full employment; not just a low unemployment rate.
The unemployment problem is neither related to interest rates, nor is it related to the quantity of money in the society. Manipulating the interest rates or manipulating the amount of money in the society does not get rid of the unemployment problem.
This book, in the context of a Utopia, discusses the employment and unemployment situation, its challenges, and what exactly needs to be done with it. There are several chapters which discuss the Utopian approach to achieving full employment.
So, the Utopian version of monetary policy does not attempt to influence the employment or unemployment situation of the Utopia.
The current versions of monetary policy are based on the discretion and decisions of a very small group of individuals.
The Utopian version of monetary policy is not influenced by the subjective judgment or discretionary decisions of any individual or a small group of individuals. All decisions are based on rules, and those rules are controlled by policy parameters. All citizens have control in expressing their views about the policy parameters, and they collectively decide how fast or slow the monetary policy should fulfill its one goal.
The current versions of monetary policy have two or more goals. The tools available to satisfy these goals are such that using them to satisfy one goal, implies that other goals suffer to some extent.
The Utopian version of monetary policy has a single goal. There is no possibility of conflicts between achieving goals. The tools to satisfy the goal are consistent with the goal.