Tuesday, February 15, 2011

If anything goes wrong, it has to be the central banks

Some institutions are excellent scape goats to impose necessary reforms in a country, such as the International Monetary Fund or the World Bank. Local governments can always blame them if they have to put their fiscal house in order. Other institutions seem to attract conspiracy theorists in large numbers because someone needs to be blamed for some condition and the institution is poorly understood. The prime candidate here is the central bank. Indeed, the best central banks are those that act independently from the government, but people see this apparent lack of accountability as the origin of all trouble in the economy.

A very good example for this sorry confusion is a recent paper by Subhendu Das, with the following abstract:
In each country the central bank is a privately owned bank with no transparency and accountability to the government of that country. It is also the only bank that can print the money for that country and does it so out of thin air. At the same time this bank wants that the government returns the money with interest. We show that this structure creates deficit, introduces tax, and causes poverty around the globe. This paper shows how central banks control the economy by manipulating the financial system it has designed. The paper explains how easily the central banks can control the unemployment, create recessions, and transfer wealth from the lower economic group to higher economic group and perpetuate the poverty. The paper also proposes three methods of eliminating central banks.

Where to begin. Central bank governors are typically appointed by the government and are accountable to it (just see how frequently Bernanke is on Capital Hill). The central banker's decisions are independent from the government, and for good reasons: you want to avoid policy actions to be taken for a short term political gain that is detrimental in the longer run through higher inflation. Central banks that are not independent from governments typically have much higher inflation, as the government ends up relying on seigniorage for its expenses instead of taxation. The presence of the independent prevents deficits because governments know they cannot inflate debt away.

Then, central banks most often make profits. These profits are then transfered to the government. That reduces the need for taxes. But this does not absolve the government from raising taxes. If is it taking real resources form the economy (either labor or goods), that needs to be paid for in real terms one way or the other. For a typically government, the central bank would only be able to cover this with excessive inflation.

Do central banks create poverty? A central bank that is independent from the government leads to low inflation, which is good for poor people who are cash based. To repeat myself, a government controlled central bank will create more inflation, and that is when there is a transfer of wealth from poor to rich, who can shield their assets from inflation.

Do central banks have an impact on unemployment and recessions? Honestly, it is open to debate whether they have any significant impact on this. They can certainly mess up things, for example when influenced by the government, but a well-run independent central bank will just make sure the economic is well greased. It cannot fix structural problems. That is up to the government. Central banks cannot control the economy, and in fact in many countries do not even have regulatory authority over the financial sector.

All in all, this paper has everything backwards, except for the fact that money is created out of thin air. But keep in mind that most money is not created by the central bank, but by private banks, and the central bank makes sure not too much is created. So the author still got that wrong.


Anonymous said...

wow, the actual paper is even worse than the abstract!

At one point Das claims that the Fed should target 100% employment...

Anonymous said...

El, this kind of posts used to be fun but now you're really scrapping the bottom of the barrel. This person couldn't probably pass a Principles class, why bother?

- a long time fan

Economic Logician said...

Last Anonymous, I agree it is a horrible paper that usually is not worth discussing. But so many people believe this kind of reasoning that it needs to be rectified.

And by the way, the author thanked me in private email for liking his paper. I guess everything he writes has to be taken as the opposite.

Anonymous said...

This guy is a true polymath - not only, as is clear from the article discussed here, he is an authority in economics and sociology (read the lines about how facebook creates "environmental pollution on human behavior"), economics is not even his main profession! He is an engineer, with some articles on sampling in electronic circuits and others.

Anonymous is right that we may just ignore this. The worse thing, however, is that this article may actually end up being submitted somewhere and somebody will have to handle it, either as a (co)editor and deskreject it (creating another injured mastermind); or as a referee and then you simply HAVE to write something.