Wednesday, November 21, 2012

Central bank monetization doesn't have to be scary

David Beckworth has a good post pushing back against people who are pounding the Fed-is-monetizing-the-debt drums. His point was that there is no evidence of monetization. The Fed today holds roughly the same amount of government debt as a proportion of outstanding debt as it did in times past.

Accusations of monetization need to start out with proper definition of the term. To "monetize" means to turn into money. All banks engage in monetization, whether they be central banks or private banks. Banks monetize houses, debt, commodities and all sorts of other assets, issuing liquid liabilities in return. A credit card essentially monetizes your 30-day IOU. So to accuse a bank of "monetizing" is like accusing someone of breathing.

In conducting QE3 purchases, the Fed is currently monetizing government debt and agency-issued MBS. Is that bad? The Fed has to monetize something. Would people be happier if it was monetizing corporate bonds? Gold? Or do they simply want it to monetize at a slower rate?

There is a pejorative sense of the word monetize. It refers to a situation in which a bank monetizes an asset at a price that benefits the borrower. This is akin to a subsidy. In providing the subsidy, the bank grants the borrower (or issuer) more financing than the borrower otherwise deserves. When applied to the Fed, monetizing in its pejorative sense would seem to indicate that the Fed is subsidizing the government by pushing the government's borrowing rate below its fundamental rate, thereby allowing it to borrow even more. In other words, the price that the Fed is paying for government bonds is above their fundamental value.

Just because the Fed is monetizing government assets doesn't mean it is monetizing in the pejorative sense. As David points out, where's the proof?

Secondly, let's pretend that the Fed is monetizing government bonds in the pejorative sense. In providing this subsidy to the government, the Fed is earning less for itself. Say that this monetization continues until the Fed has negative capital. Typically, it is believed that a government implicitly guarantees to recapitalize the nation's central bank should it be insolvent. In this case, the government just returns to the Fed all the subsidies granted by the Fed. It's a wash, and monetization (in the pejorative sense) has had no net effects.

We need to be explicit about definitions and the relationship between the government and central bank when we talk about monetization.


  1. I think monetization should be defined in terms of actions, not in terms of intent. More importantly, I don't think we need monetization at all:

    Would love to hear your thoughts on this post.

  2. There are probably 20 definitions for monetization. All conversations should start out with one definition and use it through out.

    As your post points out, the "print money" meme is also a bad one since it breeds panic from the outset. At least monetization is a word you can work with, "printing money" is compromised from the start. Pop cultural treatments of money like Zeitgeist don't help much either.

    I haven't seen your blog before. Welcome to the blogosphere.

  3. Yes I'm just getting started, thanks :)

    Oh, don't get me started about Zeitgeist: I get all worked up when I hear their ideas.. I love it how they claim their proposal isn't communism.

  4. Replies
    1. If Bernanke was using my definition then yes, he's monetizing debt. That's what QE does, it turns debt into reserves. Bernanke's whole justification for QE is some sort of portfolio balance effect which is all about pushing asset prices above their fundamental value (monetizing in its pejorative sense). In any case, no sense in making hay out of something Bernanke says off the top of his head in a press conference, especially since he doesn't define what he means by the word.


    Federal Reserve holdings of Federal debt are twice what they were just a few years ago.
    (So also are everyone's, apparently.)


  6. As your publish factors out, the "print money" meme is also a bad one since it types anxiety from the beginning. At least money making is a term you can perform with, "printing money" is affected from the begin. Pop social therapies of cash like Zeitgeist don't help much either.
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