Reply #92: Should central banks be quasi-fiscal actors? (SHORT ANSWER: NO) Willem Buiter [View All]

[Demeter]

http://blogs.ft.com/maverecon/2009/11/should-central-banks-be-quasi-fiscal-actors/

November 2, 2009

There are two reasons why the Fed, or any other central bank, should not act as a quasi-fiscal branch of the government, other than paying to the Treasury in taxes the profits it makes in the pursuit of its mandated macroeconomic stability objectives (maximum employment, stable prices and moderate long-term interest rates in the case of the Fed) and its appropriate financial stability objectives. The appropriate financial stability objectives of the central bank are those that involve providing liquidity, at a cost covering the central bank’s opportunity cost of non-monetary financing, to illiquid but solvent financial institutions.

Any action going beyond that, such as the recapitalisation of insolvent banks through quasi-fiscal subsidies, ought to be funded by the Treasury. The central bank should be involved only as an agent of the Treasury - an expert assistant. It should not put its own conventional or comprehensive balance sheet at risk.

The two arguments against the central bank acting as a quasi-fiscal agent are, first, that acting as a quasi-fiscal agent may impair the central bank’s ability to fulfil its macroeconomic stability mandate and, second, that it obscures responsibility and impedes accountability for what are in substance fiscal transfers. In the US such actions subvert the Constitution, which clearly states in Section 8, Clause 1, that the power to tax and spend rests with the Congress: “The Congress shall have Power to lay and collect Taxes, Duties, Imposts and Excises, to pay the Debts and provide for the common Defence and general Welfare of the United States; but all Duties, Imposts and Excises shall be uniform throughout the United States.”.

If, as happened in the USA on a vast scale, the central bank allows itself to be used as an off-budget and off-balance-sheet special purpose vehicle of the Treasury, and refuses to provide to the Congress some of the information essential for the quantification of the fiscal transfers it has made, the central bank not only subverts the constitution. By attempting to hide contingent commitments and to disguise de-facto subsidies by not divulging relevant information on the terms on which the central bank has offered financial assistance, it undermines its own independence and legitimacy and impairs political accountability for the use of public funds - ‘tax payers’ money’. It is surprising that a country whose creation folklore attributes considerable significance to the principle of ‘no taxation without representation’ would have condoned without much outcry such a blatant violation of the equally important principle of ‘no use of public funds without accountability’. This indeed amounts to a quiet usurpation of the power of the legislature by the central bank.

When the crisis started in August 2007, the Fed’s conventional balance sheet was just under $ 1 trillion - about seven percent of annual US GDP. At its peak, towards the end of 2008, the Fed’s conventional balance sheet was just over $2 trillion, about fifteen percent of annual US GDP. The Bank of England tripled the size of its balance sheet (as a share of GDP) over the same period. I see no problem at all with the size of the balance sheet per se. It is the logical consequence of the central bank, in a liquidity crisis, providing funding liquidity to systemically important financial entities (the lender-of-last-resort function) and market liquidity to markets for systemically important financial instruments (the market-maker-of-last-resort function).

The problem is not the size of the balance sheet but the size of the quasi-fiscal transfers the Fed has made to some of its private counterparties in its myriad interventions since the crisis started...MORE AT LINK