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The central banker pays a franchise fee to government for monopoly money control. The government provides a bunch of services to the central banker in response. How much is the service worth? If the central banker overpays, that is an inflationary price, the effect is inflationary. What is a fair prie? I dunno, tried looking once, "What are the transaction costs of paper bills and credti cards." Government spends a lot of money making sure those things work. I hear the ECB said that transaction costs alone are above 2%. What are the alternatives to monopoly money? To avoid excess franchise fees private bankers rely on the central bank less often. That is when franchise fees go up, the central banker has less deal flow.

Matt: "The central banker pays a franchise fee to government for monopoly money control."

No. The Bank of Canada does not pay a franchise fee to the government. The government (strictly the Queen) owns the Bank of Canada. It's a Crown Corporation (a nationalised firm). The government gets the profits.

"Once you decide on the inflation target, the public decides how much currency it wishes to hold".

I think it depends a lot more on the (change in) usability and risk of currency vs. bank deposits. And taking into account possible (change in) interest on deposits. It is not like hey inflation is going to be x so I withdraw my deposits in cash. And more like now I can carry less cash as I can use Visa/Paypal/e-money. Or that an institution can use repo markets instead of deposits (less reserves, more velocity). That is clear if we look cross-country data or money market (sorry - maybe it is not that bad term after all) developments.

The interest on reserves held by the banks is usually (and can be) less than market rate of interest. Hike the requirements and the government could get more interest benefits (effectively a tax though).

Jussi: yes, the desired currency/GDP ratio will depend on a lot of things, not just the rate of inflation. But the Bank of Canada cannot print unlimited currency and earn unlimited profits while maintaining inflation at target. And yes, seigniorage is a tax, like any other.

(Though it surprises me just how stable the currency/GDP ratio seems to be.)

"cannot print unlimited currency and earn unlimited profits"

Sure. But can the government issue only interest free liabilities? I guess you will say ponzi/hyperinflation but then again you agree that this would be only a different way to tax? It looks to me that the government only uses here a different tax code (other taxes vs. seigniorage).

"Right now, in Canada, this question is before the courts."

Nick, you're talking about COMER?

http://www.comer.org/archives/2015/COMER_JulAug2015.pdf

Jussi: if the government tries to fund all its borrowing via issuing 0% interest currency, it will find, like Zimbabwe, there is a limit to how much it can borrow.

JP: yep. Maybe us Market Monetarists could resort to the legal system, if we fail to persuade people that NGDPLT is best? That's how the Court Party operates.

> That's how the Court Party operates.

There's two separate issues involved here:

*) The first issue is what the Bank of Canada Act actually says. If the Act prescribes something that isn't happening (or forbids something that is), then that's a rule-of-law problem and not an economics problem. Hypothetically, if the Bank of Canada could only act by buying and selling hot dogs, then the entire business with reserves would be illegal even if it is a good idea.

*) The second issue is whether COMER's argument is actually good economics -- that it is better for the Bank of Canada to follow COMER's interpretation of the law than for the law to be amended (if necessary) to endorse the current practice.

The courts really aren't (and can't be) the place to decide the second point, especially because "macroeconomic management" touches upon none of the fundamental rights or constitutional order.

Nick,

"But who gets to decide how much is lent interest-free does make a difference, of course. Is it me or you who decides it's going to be a $100 and not a $200 interest-free loan?"

Not only that, is it you or me that decides when that $100 must be returned? If you are central bank and I am government, who is responsible for the term structure of the loan? Both enterprises are "infinite lifetime".

Under option C, Tom bids on government debt with a duration that matches his investment time horizon - presumably some time period less than his anticipated remaining lifespan. If Tom is 100 years old, it is unlikely that he will be buying government bonds that mature in 30 years.

It is not only the quantity of debt that matters, but the term structure of that debt as well.

Majro: The Bank of Canada is de facto making interest-free loans to the government. God only knows how the lawyers and judges will interpret the de jure question. To paraphrase what someone else said in a comment, the only people more economically illiterate than lawyers are art historians; but art historians at least know they are economically illiterate.

Frank: the BoC chooses its term structure, and the government chooses its term structure, and Tom Dick and Harry act as a reservoir to ensure both can do so.

Nick,

Is there a point estimate of how much we are talking about here? Specifically, how much is the seigniorage worth to the Government of Canada in an average year? How easy is it to measure?

And just for fun, what would happen if the Bank of Canada started to systematically buy provincial bonds? Would the provinces earn seigniorage?

Brad

Brad: the number (annual profits of the Bank of Canada) is published somewhere in the government accounts. It varies a bit from year to year. Usually about $2 billion, IIRC. A nice little earner, but not a big deal.

It wouldn't make much difference if the Bank of Canada bought provincial bonds instead, because the Bank of Canada's profits still go to the federal government. Maybe the interest rate on provincial bonds would be a little bit lower, and the interest rate on federal bonds a little bit higher.

Nick,

"Tom Dick and Harry act as a reservoir to ensure both can do so."

I think Tom, Dick, and Harry are more than a just a reservoir. Tom, Dick, and Harry have a choice in the matter under option C. There is no guarantee that they will be willing to borrow on the central bank's terms to lend to the government on it's terms.

A central bank making short term loans at a low interest rate and a government borrowing long term at a higher interest rate helps to grease Tom's wheels, but the choice remains.

"if the government tries to fund all its borrowing via issuing 0% interest currency, it will find, like Zimbabwe, there is a limit to how much it can borrow."

A) Government issues a bond pays the coupon to Tom but tax the coupon back (maybe via Dick or Harry).

B) Government issues only 0% interest liabilities (which doesn't have to be currency) to Tom.

I can't see the difference either?

Also reserves ~ one day Treasury bill.

Zimbabwe was a failed state, it is hardly a good example.

Frank: there is a term structure of market interest rates at which Tom Dick and Harry are willing to borrow or lend.

You are going red herring again. Stop now.

Jussi: people are willing to hold (some) currency at 0% interest, even when (nominal) interest rates on bonds are much much higher (because currency is a medium of exchange).

Nick: I can see that.

My point was that the government can either (previous post A) issue a bond and get the deposits as proceeds or it could just add base money (B - the central bank credits government account) and get the deposits.

So A) coupon will be paid but that will fetched back (e.g by extra bank) tax or B) no coupon, no tax. Both seem to be economically similar from banks and government points of view? So why the other one would be inflationary and the other is not?

"To paraphrase what someone else said in a comment, the only people more economically illiterate than lawyers are art historians; but art historians at least know they are economically illiterate."

As others have pointed out, it really doesn't matter how economically literate lawyers and courts are. It's their job to interpret the law, not determine the political questions about whether the law ought to be different than it is.

That said, weeding through the article that JP Konig linked, even weeding out the jibberish that conspiracy theory cranks put out, it's pretty clear there's no basis for claim. It's a pretty big stretch to prove they even have standing (have been harmed by the actions of the government), but more than that, their legal argument is super-weak. Their three arguments come down to:
1 - The Bank can't act as agent for two different organisations. That's like saying that a lawyer can't have two different clients at the same time. I don't see it going anywhere, but even if the court agreed, resolving a conflict within the law would favour a more recent amendment anyway.
2 - The Bank is performing a leglislative function. Which it's not.
3 - The duly elected parliament agreeing to pay someone is the same as being taxed by the end recipient of the payment. They make a claim specific to interest, but there's no reason the same argument couldn't be applied to the portion of their taxes paid to any person or group that isn't elected.

Worded a little bit differently, it becomes pretty clear this is a frivolous lawsuit, and there isn't really a "question before the courts" any more than when freemen-on-the-land types claim that their ticket was invalid because they didn't enter into a contract with the police officer. And that they're not really the person the ticket was issued to anyway.

Nick,

"Frank: there is a term structure of market interest rates at which Tom Dick and Harry are willing to borrow or lend."

You are missing the point. As a lender, I might care what a government does with the money that I lend to them. There may not be an interest rate I am willing to lend to the government at if I don't like what they are doing with the money. A central bank may only look at the inflation rate to determine the effects of government borrowing and spending. I may look a lot more deeply.

A government could use the proceeds of my loan to incarcerate half the voting public (the half that didn't vote for the party in power).

This is NOT some red herring. It is a very legitimate real time check on the power of government. Obviously, the ability to vote is another check on government power, but that only happens once every four years. Saints have been converted to demons in a shorter time frame.

Neil: I only understand your last paragraph, but I am relieved to hear you say it.

Do you have any idea how it got this far in the courts?

The reasons for accepting the claim aren't on Canlii, so most of what I've read comes from the COMER newletter. It seems that so far it's been a question of whether they're even entitled to argue this case in court, so I wouldn't say it's gone very far.

The original answer was no holding that the claim had no reasonable chance of success, and was a policy matter for politicians, not a legal matter for courts. An appeal court disagreed, at least in part (this is the ruling missing from Canlii), though a portion of their claim was still rejected at appeal. The bar for this is pretty low, since we generally want to err on the side of giving people their day in court.

The actual arguments haven't even been made yet. When they do, this group seems well-enough funded that they'll appeal it if the decision goes against them. If their whole case is what was presented in their newsletter, I have a hard time seeing the alternative outcome, but I'm pretty sure the government would appeal, too, if the decision went against them. So it'll wind its way through the system for years until someone applies to the Supreme Court. Assuming the lower courts haven't found any merit in the claim, I don't imagine they'd hear it.

For the record, I'm not a lawyer, so what I know is what they teach in business law classes, plus the second hand knowledge gained from being married to a lawyer. (I call it my 'second hand law school.')

Thanks Neil.

Nick - "if the government tries to fund all its borrowing via issuing 0% interest currency, it will find, like Zimbabwe, there is a limit to how much it can borrow."
Nick, of course there is a limit. But you are kidding yourself if you think "borrowing" money is any less inflationary. It is the real resources of the country. All government spending works by crediting bank accounts (creating money.) You have to free up real resources for the govt to spend via taxes, banning things, cut bank lending, etc.
Most govts have a buffer they spend from and then backfill the buffer AFTER.
There is an article on Zimbabwe here:
http://bilbo.economicoutlook.net/blog/?p=3773
It seems like they had serious supply side issues. In addition they owed debt to the IMF in a foreign currency.
Also see:
http://bilbo.economicoutlook.net/blog/?p=28918
"We also have a living laboratory to show that governments that issue their own currency do not have to issue debt to the private markets.
And,we are also being shown in real life, that inflation does not accelerate out of control if they do not issue debt to the private markets but rather the central bank buys the majority of the new issues up.
You cannot beat reality!
There was an article in the Economist Magazine (August 30, 2014) – Quantitative freezing – which considered recent developments in the Japanese bond market.
It noted that:
AS PART of its quest to end Japan’s 15-year-old deflationary torpor, the Bank of Japan is buying around 70% of all newly issued Japanese government bonds (JGBs)."
70%!

Thanks Bob.

I think it is even clearer if we compare central bank paying interest of reserves (IOR) which makes it work like a government bond (I think Nick agrees?) and the case where it doesn't (I think Nick says this is not like a bond?). Now the first case the government needs to tax the IOR amount back as it gets less profit from the central bank, in the second case it doesn't need to.

Why the first one is not inflationary and the second one is?

Btw. if paying IOR is like a bond but paying zero is not, where the change happens? Does paying 0.000001 make IOR like a bond and thus not inflationary?

IOR makes me upset. The government, if it needs to raise rates while maintaining excess reserve positions, can tax the asset side of bank balance sheets. If a bank knows that by creating a loan of $100, it will need to pay the government X% of that, then it will demand an interest rate in excess of X%. Voila, you've just raised interest rates without paying any interest on reserves to banks -- the money goes straight to the government, rather than having the government pay banks to hold reserves they cannot in aggregate rid themselves of anyways. Moreover you are taxing banks for creating money in order to discourage excess private sector money creation and reduce inflation. You could also structure the tax so that only non-govt. assets are taxed as well. There are a lot of tools in our toolbox if we want to get creative and crush the power of the banks while maintaining effective control of private sector borrowing rates.

Those caring about the court case: the "major" appeal was 2014 FC 380 from 2014. The appeal heard this year was 2015 FCA 20, and the reason it's so hard to find is because it was an oral judgement letting the previous case stand.

COMER still has yet to have a claim fully accepted for trial.

@rsj:

> rather than having the government pay banks to hold reserves they cannot in aggregate rid themselves of anyways.

That's not really the way it works in Canada. The BoC's interest on reserves is deliberately set below the target overnight rate, which is also approximately the short-term Government of Canada bond rate. Any bank holding an undesired excess of reserves is not forced to accept them; they can purchase short-term bonds.

If all banks do this, then the short-term bond rate would fall outside its usual spread. Then the Bank of Canada would either conduct an open-market operation to remove reserves from the system, or it would lower the interest rate band further.

This contrasts with the US situation, which has the peculiar feature that its interest on reserves is in excess of the short-term bond yield. That does create a weird set of incentives, and I suspect that this is responsible for more of the US's monetary malaise than is commonly acknowledged.

rsj and Majro: OK, but since reserve requirements were abolished 20 years ago, and banks keep tiny reserves, I have ignored IOR. The costs of paper and ink (which I have buried under "admin costs") are more important.

jussi: well for starters, if there's an excess supply of bonds, the price of bonds can fall (or the rate of interest can rise). If there's an excess supply of currency, and the price of currency falls, we call that "inflation".

Majro: thanks for the court info. (Are you a lawyer??)

"if there's an excess supply of bonds, the price of bonds can fall (or the rate of interest can rise)."

Nick: Does this address my IOR "bond" - the price cannot fall, the rate is set by the central bank, which also can set the quantity. Thus the government can fund itself using reserves only. There would be excess supply of reserves in both cases (IOR 0% and IOR != 0%). You didn't address Why IOR 0% is inflationary but IOR (bond), which pays interest is not?

My claim is that it doesn't matter whether IOR is paid or not. It seems clear if we compare IOR 05 and IOR positive with attached tax liability. I think this can be expanded so that markets only anticipate the future taxation and taxation is via Harry and Dick.

@Nick Rowe:

> OK, but since reserve requirements were abolished 20 years ago, and banks keep tiny reserves, I have ignored IOR.

I think the interest-rate spread argument is partially why Canadian banks keep tiny reserves despite IOR, whereas US banks still have larger-than-typical reserve levels.

> Majro: thanks for the court info. (Are you a lawyer??)

You're welcome. I'm not a lawyer, but I got really curious about this economic stupidity back when it was in the news and did the digging into the actual decisions. COMER has been... very optimistic in how it reports on the case's progress, including spinning "the court said COMER has to entirely re-do its claim" as "COMER scores victory against the government!"

"This contrasts with the US situation, which has the peculiar feature that its interest on reserves is in excess of the short-term bond yield. That does create a weird set of incentives, and I suspect that this is responsible for more of the US's monetary malaise than is commonly acknowledged."

The US IOR vs. t-bills might be distorted due to (no interest) regulation on Government Sponsored Enterprises (GSE) and deposit guarantee fee paid only by domestic depository banks. Also access to reserves is more restricted. Btw. core Euro t-bills have been lower than ECB deposit rate.

But they don't keep tiny reserves now.

Nick Rowe - "well for starters, if there's an excess supply of bonds, the price of bonds can fall (or the rate of interest can rise). If there's an excess supply of currency, and the price of currency falls, we call that "inflation"."
According to Bill Mitchell, inflation is the "continuous rise in the price level."
I wish you economists would define your damn terms.
"First we should make sure what we are talking about. Many conservative commentators think that when workers get a pay rise it is inflation. It is not. Those on the left think that when the corporate sector increase the price of a good or service it is inflation. It is not.
It is also not inflation when the exchange rate falls pushing the price of imports up a step. So a depreciation in the currency does not constitute inflation. It might stimulate inflation but is not in itself inflation.
It is also not inflation when the government increases a particular tax (say the VAT or GST) by x per cent to some new level.
So while a price rise is a necessary condition for inflation it is not a sufficient condition. Observing a price rise alone will not be sufficient to categorise the phenomena that you are observing as being an inflationary episode.
Inflation is the continuous rise in the price level. That is, the price level has to be rising each period that you observe it. So if the price level or a wage level rises by 10 per cent every month, then you have an inflationary episode. In this case, the inflation rate would be considered stable – a constant rise per period.
If the price level was rising by 10 per cent in month one, then 11 per cent in month two, then 12 per cent in month three and so on, then you have accelerating inflation. Alternatively, if the price level was rising by 10 per cent in month one, 9 per cent in month two etc then you have falling or decelerating inflation.
If the price level starts to continuously fall then we call that a deflationary episode.
Hyper-inflation is just inflation big-time!
So a price rise can become inflation but is not necessarily inflation. Many commentators and economists get this basic understanding wrong – often and continually.
Second, it also follows that cyclical adjustments in price levels by firms from what they are currently offering at depressed levels of activity to what the price levels that are defined at their normal operating capacity levels are not inflation. When the economy is in poor shape, firms cut prices in an attempt to increase capacity utilisation by temporarily suppressing their profit margins and hence maintain market share. As demand conditions become more favourable the firms start increasing the prices they offer until they get back to those levels that offer them the desired rate of return at normal capacity utilisation.
Firms are basically quantity adjusters if they have spare capacity. They will seek to maintain market share when nominal demand grows by increasing output where possible. Should nominal demand growth (supported in part by net public spending) outstrip this capacity then firms will become price adjusters, because they can no longer expand real output.
Bottlenecks in some sub-markets may occur before other sectors are at full capacity and so price pressures might emerge just before overall full capacity is reached. So, in reality, the aggregate supply response (which tells you how much real output will be forthcoming at each price level) may not be strictly reverse-L shaped (where price is on the vertical axis and output on the horizontal axis). The extent to which the reverse-L becomes a curve at at a point approaching full capacity is an empirical matter.
Inflation occurs when there is chronic excess demand relative to the real capacity of the economy to produce."

The obvious difference between A, B, and C is that B and C have additional transactions. Every transaction point is another opportunity for breakdown -- fraud, misrepresentation, default, etc.

Canadian bank reserves history-

http://www.cqcabusinessresearch.com/2011/04/30/how-fast-can-bank-reserves-fluctuate/

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