How ‘Monetization’ Really Works — Examples from Three Asian Nations’ Responses to Covid-19

ABSTRACT

The severe economic downturn caused by the COVID-19 pandemic has forced governments worldwide to increase spending while tax revenues simultaneously collapsed. Concurrent with this, central banks in several of these countries are financing a significant percent of their direct income support through direct lending or purchases of government bonds in primary and/or secondary markets. Many oppose this for their alleged negative consequences on the economy, inflation in particular. This paper describes the actual workings of what most people (including many economists) often call monetization of government debt and its major implication, namely, that it leads to printing money and, consequently, to inflation. We show that the reality is very different: once one knows how modern central banks manage monetary policy (i.e. through a corridor interest rate targeting system), and how they coordinate their daily operations with their Treasuries, monetization does not occur as it is often described, and it is not nearly as dangerous as its critics argue (and not as useful as its supporters claim). The examples of the Philippines, Singapore, and the People’s Republic of China clarify this.

KEYWORDS:

• Monetization
• central bank operations
• interest rate targeting
• unconventional monetary policy operations

JEL CODES:

• E42
• E52
• E58

Acknowledgements

This paper reflects solely the views of its authors. We would like to thank the referees for their valuable opinions. All errors remain ours.

Disclosure Statement

No potential conflict of interest was reported by the author(s).

Notes

1 This is exclusive of some CBs normal practice of rolling over their maturing holdings of government debt in primary markets.

2 This is exclusive of, or in addition to, the normal practice of many CBs that already purchase government debt in secondary markets regularly in order to replenish banks’ reserve balances debited as banks purchase physical currency for their customers’ withdrawals.

3 As is clear later in the paper, we would argue that Singapore’s actions to draw down national reserves to pay for the COVID-19 fiscal response fits in column 1 of Table 1.

4 CBs can also use a ‘ceiling system’ in which the target rate and the rate banks borrow from the CB (i_penalty in Figure 1) are set equal and banks simply borrow all the RBs from the CB. This is the ‘overdraft system’ discussed in Lavoie (2014, p. 205–209). CBs that target a repurchase agreement (repo) rate instead of an interbank interest rate are in essence running ceiling systems, with banks and/or bond dealers as the counterparties.

5 In Table 2 and other tables that follow, ‘A’ = assets, ‘L/E’ = liabilities and equity, ‘Dep’ = deposits, ‘HH’ = households, ‘Acct @ CB’ = the government’s account at the central bank on the government’s assets, ‘Govt Acct’ = the government’s account at the central bank on the central bank’s liabilities,’ ‘Net Worth’ = assets – liabilities.

6 See Fleming (2020), Duffie (2020), and Logan (2020) for discussion. In the Fed’s case its own liquidity and capital regulations contributed to continuing liquidity issues, as Pozsar (2019a, 2019b) had warned earlier, that worsened in the COVID-19 crisis (Tankus 2020).

7 As BSP’s own literature on its operations states, ‘The Term Deposit Facility is a key liquidity absorption facility, commonly used by CBs for liquidity management. The TDF is used to withdraw a large part of the structural liquidity from the financial system to bring market rates closer to the BSP policy rate’ (Bangko Sentral ng Pilipinas 2016, p. 5).

8 BSP’s loan to BTr is a zero-interest loan (Leyco 2020).

9 The sources for this discussion of Singapore banks’ RB requirements are Monetary Authority of Singapore (2013, 2014).

10 This is essentially the ‘compensation thesis’ in Lavoie and Wang (2012) applied here to MAS.

11 MAS defines the reference rate it sets its standing facilities’ rates set 0.5 percent above and below as ‘the weighted average of successful bids for MAS’s SG $500 million overnight clean borrowing conducted during Money Market Operations on the same day, rounded to two decimal places.’ See https://www.mas.gov.sg/monetary-policy/liquidity-facilities/mas-standing-facility (accessed 30 September 2020). As the block quotes in the text below explain, MAS’s operations are in the mornings, which thereby establish the standing facility rates for the day. So, standing facility rates (SFBR and SFDR) can rise or fall from day to day, but MAS’s morning operations set them for any given day.

12 GIC is ‘a private company wholly owned by the Government of Singapore. We do not own the assets we manage … .’ Further, ‘although we are government-owned and manage Singapore’s reserves, our relationship with the government is that of a fund manager to a client.’ See https://www.gic.com.sg/faq/ (accessed 30 September 2020).

13 As in the Accountant-General’s Department description, CPF receives non-marketable Special Singapore Government Securities (SSGS) in exchange for the funds GIC invests. Essentially, CPF’s holdings of SSGS provide it with legal authority to pay future benefit payments equal to revenues, interest from SSGS, and the value of the SSGS holdings. The SSGS holdings do not provide financial ability to pay, though, since CPF’s SSGS holdings and interest payments from them exist only as internal accounting among different departments within the same government.

14 Essentially this is an expected average annual real return from capital gains.

15 For simplicity the discussion abstracts from Temasek Holdings, a third manager of Singapore government’s reserves (in addition to GIC and MAS) focusing on long-term equity investments within and outside of Singapore. The Singapore government is the sole equity holder of Temasek.

16 Of course, given the government’s regular auctions of SSGs, it could also be that an SSG auction removes the excess RBs and MAS’s sterilization via MAS Bill issuance is unnecessary. Note that this is effectively the government running a deficit and afterward issuing SSGs, illustrating that its own bonds are for the purpose of aiding MAS’s interest rate maintenance, not funding a deficit.

17 2020 NIRC and National Reserves drawdown figures are in several sources, such as Kurohi (2020).

18 See Bell (2000) and Tymoigne (2014) on the Treasury Tax and Loan account system in place until 2008 in the US.

19 PBoC publishes its balances sheet at the monthly frequency.

20 Claims on Financial Institutions are many times larger than both the ‘Other’ Assets and ‘Other Liabilities.’ Other items on the balance sheet, including Claims on Government, Foreign Exchange, Foreign Liabilities, and Bonds Issued, varied little at least at a monthly frequency during this time period.