Guest Paul Sheard joins to discuss the concept of money and its various forms throughout history. The chapter explores money creation and the role of banks, as well as the implications of government deficits and debt. It also delves into the concept of inflation targeting, the role of the Federal Reserve, and the potential problems with cryptocurrencies.
Money is created by the banking system through loans and credit creation.
Government bonds are another form of money and contribute to trust in the monetary system.
Central banks control reserves and use quantitative easing to influence interest rates and monetary stability.
Deep dives
Understanding the Creation and Role of Money
In this podcast episode, Paul Sheared, author of The Power of Money, discusses the creation and essence of money. He highlights the common misunderstandings and myths surrounding money present in both economic literature and financial market practitioners. Sheared explains that money serves as a unit of account, medium of exchange, and store of value for economic activities. He emphasizes that money is a creation of the banking system, as they create money through loans and credit creation. Sheared clarifies the misconception that banks take deposits and lend them out, revealing that banks actually create money out of thin air through the creation of bank deposits. He also delves into the role of government deficits in money creation and the interconnectedness between monetary and fiscal policy. Overall, the episode explores the importance of understanding the fundamentals and implications of money in the contemporary economy.
The Concept of Bonds and Trust in the Monetary System
Another focal point of the podcast is the concept of bonds and their relationship to trust in the monetary system. Sheared challenges the common belief that government bonds function as a form of debt that must be repaid, explaining that they are, in fact, another form of money. He clarifies that bonds act as a shackle imposed by the government to limit its ability to create excessive money that could lead to inflation. Moreover, Sheared points out that trust plays a crucial role in the monetary system. Society collectively agrees to attribute value to money and accept it as a reliable means of exchange. Sheared also highlights the significance of stable prices and inflation control in preserving trust among individuals and institutions. Additionally, he touches on the 2% inflation target set by central banks, which provides a buffer for price stability and allows for monetary policy adjustments in different economic scenarios.
The Role and Challenges of Central Banks in Monetary Policy
The podcast episode delves into the functioning and challenges faced by central banks in implementing effective monetary policy. Sheared explains that central banks control the amount of reserves in the banking system, influencing interest rates and overall monetary stability. He elucidates how central banks, through quantitative easing (QE), create reserves that serve as a form of money in the banking system. Sheared highlights that the ability of central banks to pay interest on reserves provides them with control over the money supply and allows them to separate balance sheet decisions from interest rate decisions. He also discusses the importance of maintaining the trust of the public in the central banking system and emphasizes the need to balance economic growth, inflation control, and degree of government involvement in the economy.
The Future of Financial Systems and Algorithmic Monetary Policy
The podcast episode briefly touches upon the notion of algorithmic monetary policy and its potential role in the future. Sheared ponders whether the functions of central banks could eventually be carried out by algorithms, providing a systematic approach to policy decisions and economic management. He considers the idea that, over time, with trial and error and growing trust in the tools and knowledge of economists, central banks could operate with more reliance on algorithms to maintain inflation, full employment, and stability. However, Sheared acknowledges potential concerns and complexities surrounding algorithmic decision-making, including the complexities of economic lags and the need for human judgment and flexibility in response to uncertain economic conditions. Overall, the episode raises thought-provoking questions about the future of monetary policy and the potential role of algorithms in shaping financial systems.
The Need for Revisiting the Monetary System
The current monetary system, despite its various policy instruments and regulations, is not a perfect or optimized solution. It requires constant evaluation and improvement. The conservative nature of central banks and the lack of a perfect solution make it imperative to continually reexamine the system and address its shortcomings. With the ever-changing economic landscape and new challenges arising, such as the overburdening of central banks and the integration of climate and ESG policies, major reforms are needed for the monetary system to adapt and evolve.
Artificial Intelligence and the Future of Central Banking
The potential role of artificial intelligence (AI) in central banking raises intriguing questions. Could a well-trained AI system, leveraging extensive historical data on monetary policy, outperform the decision-making capabilities of human central bankers? While this may still be a remote possibility for the future, it highlights the limitations of the current system. AI could offer superior computational abilities, incorporating complex models that consider both demand and supply sides of the economy. However, concerns about disintermediation, financial stability, privacy, and political implications need to be addressed before fully embracing AI in central banking. Additionally, the conversation around AI extends beyond monetary policy, urging for a better integration and coherence between monetary and fiscal policies to achieve improved social and economic outcomes.
