Budget Proposal for Money Printing at Inflation Targets - A new law to privatize printing to CBSL officials?
The interim budget presented to the Parliament yesterday (30th) covered two proposals about money printing and monetary policy as follows.
- The new Central Bank Act will be implemented as a key legislation to strengthen the monetary sector in the country. This legislation would provide the framework for effective implementation of inflation targeting and prevent monetary financing of the budget deficit - what is commonly known as money printing. The new law insulates the Central Bank of Sri Lanka from politicisation of monetary policy decisions.
- Given the weak government revenue and lack of net foreign financing of the budget, it is inevitable that a limited level of monetary financing would continue until tax policy measures help improve the government cash flow and the IMF programme unlocks foreign financing for the budget.
As details are to come in future, I wish to present a few early observations on the above proposals.
Observations on the 2nd proposal
The limited level of monetary financing stated in the proposal seems to imply money printing for budgetary financing as this statement is linked to the earlier proposal for prevention of money printing. As such, this proposal raises several concerns and observations.
First, this money printing should take form of the present monetary financing carried out by the CBSL through the unlawful purchase of Treasury bills outside the public auctions as monetary financing through provisional advances window under the MLA (Monetary Law Act) is capped at 10% of the estimated revenue of the government (about Rs. 224 bn at present). As the estimated revenue has declined to Rs. 2,084 bn in the revised budget from Rs. 2,213 bn reported in the original 2022 budget, the CBSL may have to recover some of provisional advances or issue Treasury bills for the gap to comply with this cap.
As at today, Treasury bill holding of the CBSL acquired for weekly monetary financing is Rs. 2,258 bn. This is a net increase of Rs. 1,533 bn from the level of Rs. 725 bn as at end of 2020. In addition, nearly Rs. 398 bn of face value of Treasury bills has been issued to the CBSL in 17 occasions to fund the Treasury’s cash shortages from 6 May 2022 under a new system introduced by the present Governor.
Accordingly, in contrast to his public promise to reduce money printing for controlling inflation, the total monetary financing carried out by the present Governor alone so far from his first day of office is Rs. 807 bn which is equivalent to 72% of monetary financing carried out by the two former Governors since the end of 2020.
It is noted here that after reintroduction of fully auction system of government securities, the monetary financing was reduced from Rs. 159 bn at the end of February 2015 to Rs. 6 bn in June 2015 where Treasury bill primary yield rates only marginally rose from 5.98%-6.13% to 6.11%-6.28%, despite the allegations by a monetary policy team led by the then Deputy Governor (present Governor) that market interest rates significantly rose out of control consequent to the suspension of the fondly private bond and bill placement system.
Therefore, the national budget proposes the CBSL to continue money printing by violating the MLA. My concern is not about money printing during this historic contraction of the economy, but implementing policies by violating the laws. Violations of laws accrue unfair benefits to some people.
Second, such money printing decision by the government outside the monetary policy should cause the CB Governor to step down from the post of the Governor because it prevents his inflation control war promised and launched on 8 April 2022. At the all-media conference held on 8 April 2022 immediately after assuming duties as the CB Governor, he blamed the two former CB Governors for rising inflationary pressures due to their excessive money printing to fund a home-grown economic model through the MMT (Modern Monetary Theory) and he would control inflation by reducing money printing professionally and independently.
However, this budget proposal for further money printing until government cash flows are improved and foreign financing is unlocked by the prospective IMF programme which are highly conditional is a real threat to his independent and professional war against inflation being the number one public enemy due to several factors.
- First, the inflation has already risen from 18.7% at the time he assumed duties on 8th April to 64.3% in August (66.5% based on NCPI in July) which is close to the peak inflation forecast of the Governor by September 2022. Therefore, new money printing as proposed will push the country to hyper-inflation monetary regime if the CB Governor’s money printing-inflation hypothesis is correct, along with the impact of increased electricity and water bills and increase in taxes in the present budget. This will definitely push the inflation peak forecast of the Governor, i.e., blow 65% in September, to even above 100% in December. In that context, the present government seems to disagree with inflation hypothesis and war declared by the CB Governor.
- Second, since new money printing also would be through the direct issuance of Treasury bills to the CBSL, it will significantly suppress market interest rates and, therefore, restrict the high interest rates policy of the CB Governor to control soaring inflation.
Third, as the government expects foreign financing for the budget to recommence with the IMF programme, the government is to invoke same foreign debt trap blamed for the present economic crisis. As such, the CBSL/monetary policy does not seem to have a market-based foreign reserve building policy within the provisions of the MLA.
Observations on the 1st proposal
This proposal is intended to enact a new Central Banking Legislation to offer an independent monetary policy mandate for inflation targeting whereas the government money printing press is assigned to few officials of the CBSL for the use at their discretion. This seems to be a proposal coming from those CBSL officials as there is a similar draft legislation prepared by the CBSL in 2018. This raises many concerns as the inflation target mandate is a highly theoretical and unmeasurable concept for a public mandate to be performed in real time economy.
I recall the response of the CB Governor A S Jayawardena in 2001 when the present monetary policy committee-based inflation control-monetary policy framework was submitted by the then monetary policy economists at the CBSL for approval in line with the World Bank’s CBSL modernization programme. His minute placed on the relevant papers was “Approved. This seems like ‘හිසරදයට කොට්ටෙ මාරුකිරීමක්’” (A change of the pillow for the headache). The response to the proposed legislation also should be same.
In addition, I wish to provide few interim observations/concerns as follows on this proposal to be considered by persons who would take part in drafting the new legislation.
1. Inflation target under the monetary policy is a highly conceptual view held by old monetarists. There is no proof that inflation is a monetary phenomenon to be controlled by the monetary policy through changes in money printing and interest rates. No central bank in the world has been able to control the inflation or maintain the price stability in the economy.
For example, present high inflationary pressures in the world after four decades have emerged and are expected to remain in several years to come, despite all inflation target monetary policies practiced around the world. Therefore, assigning conceptual or hypothetical mandates to public policymakers does not achieve any public accountability or benefit.
2. If inflation target is given in a legal provision, inflation and its target should be interpreted, measurable and monitored in the law. However, central banks after 50-100 years of legal existence do not have an inflation indicator to measure the macroeconomically defined inflation which is a result of the overall market forces in the economy through the demand and supply. Some economists consider inflation as a result of the overall demand for goods and services exceeding the potential supply in the economy.
As central banks have no data to trace such macroeconomic inflationary pressures, they are accustomed to inflation numbers estimated by consumer price indices or cost of livings indices. However, the monetary policy is a broader policy framework for macroeconomic management than for controlling household cost of living which is a fiscal policy goal. As such, present cost of living-based inflation control is essentially a fiscal policy operation carried on for managing the price index to show fair increases.
3. If the monetary policy is to be independent from the government, the CBSL has to be given freedom to print money on the purchase or acquisition of any assets they prefer for inflation target. At present, central banks are permitted to acquire government credit/securities only while some central banks in developed countries are permitted to acquire private securities to a limited scale.
For example, nearly 72% of assets of the CBSL in the present balance sheet represents government domestic credit and securities while 96% of the balance sheet represents government debt (domestic debt and foreign sources). In the case of the US central bank, state related assets represent 97% of its balance sheet although it is permitted to acquire private securities. Therefore, monetary financing is not politicization per se as money printing on government debt is the the present monetary mechanism accepted in the present world of central banking.
In general, the present model of money printing and monetary operations in central banks is largely based on risk-free government securities related credit. Therefore, monetary policies around the world are driven by fiscal operations where the monetary independence does not practically arise. In the event, the CBSL is permitted to operate the government money printing press on private assets, the legislation has to ensure the mitigation of liquidity and solvency risks of the CBSL.
4. In the event, the CBSL is authorized for the monetary policy with money printing independence as above, persons who are authorized to take printing policy decisions must be accountable for maintaining the inflation always at the target. They can’t state that price stability will be maintained in the unidentified medium and long-term because, in that period, children will suffer from inflation until they become adults and old-aged people will die while suffering from inflation before price stability is secured.
Therefore, simultaneous legal provisions are necessary that when the inflation moves beyond the target for two to three months, responsible officials should step down and be punished for non-compliance because they have misused public funds. Otherwise, they will continue to deliver conceptual economic speeches by asking the general public to wait for never ending medium and long-term until the actual inflation is brought back to the target while demanding the government to cut the fiscal deficits to be helpful in controlling inflation towards the target.
5. As per the Constitutional provisions, monetary policy also falls under the control of the public finance by the Parliament. In that context, the legislation has to grant the exemption from the public finance control.
6. The MLA contains a number of fiscal policy supervisory powers authorized to the CBSL/Monetary Board. Therefore, it is necessary that these provisions are repealed so that the CBSL has no business in the fiscal operations. One of these provisions is the public debt management which is being proposed in the present budget to take under National Debt Management Agency within the General Treasury. This and other fiscal related legal provisions relating to the CBSL need to be repealed accordingly.
In that respect, the US Treasury technical assistance programme given free of charge in 2016/17 could be revived to draft a consolidated public debt law in place of several pieces of legislations now prevailing on the subject. Therefore, this proposal will prevent further abuse of the public debt and fiscal agent roles by the CBSL to conduct the monetary policy, especially for the control of market interest rates and foreign reserve and exchange rate management.
7. At present, Rupee has no par value for exchange of any specified assets to ensure its real value, unlike the par value for gold prescribed in 1950 (2.88 grains of fine gold). The present parity or exchange rate certified for the US dollar has no use as the Rupee is not convertible into US dollar due to exchange controls and acute shortage of US dollar. Therefore, the CBSL issues just a colour pictured piece of paper as currency without any intrinsic value.
8. At present, currency is issued on behalf of the government to be accepted by the public as legal tender in trust on the government based on the protection of the purchasing power and security of the currency by the government.
Therefore, if the CBSL is to be given the freedom to decide money printing for inflation target mandate, two options are proposed to protect the public trust of currency in the government.
- First, the government’s liability in the currency should be removed and be replaced with the trust in the CBSL or persons in the Monetary Board and Monetary Policy Committee because the currency is an independent affair belonging to them. If they do not perform on the inflation target, the currency system should be free to collapse and responsible officers should go behind bars for their mishandling of currency and the resulting economic and financial loss to the public.
- Second, if the currency continues on the trust in the government, the CBSL should be required to announce the par value of the Rupee in terms of a commodity basket required for households if the inflation is to be measured by the cost-of-living index as at present. For example, the basket can contain rice, vegetables, dhal, bread, sprats, coconut, tea, sugar, milk powder, etc. in specified standards and quantities required for monthly consumption of households and the par value of the Rupee can be Rs. 15,000 per commodity basket. The CBSL can announce its buying rates as Rs. 14,900 and selling rate as Rs. 15,100 or any such corridor and have a network of traders and clearing houses (similar to futures market) to conduct the monetary operations in commodities as well. If necessary, the CBSL can launch a QR code for households and traders to control arbitrage trades.
If the government is unable to introduce an innovative legislation like what proposed as above to protect the public living standards with the real value of money, the legislation of unestablished inflation-money theory as proposed by some old monetarists will no doubt cause public catastrophe as people will tend to accept private moneys in future.
Final Comment
What the monetary policy can best do in modern monetary economies is to regulate the availability and distribution of money through interest rates and credit to suit monetary needs of the economy for production, trade, creation of employment and resource mobilization while maintaining the financial system stability to ensure smooth flows of money and credit.
However, the current financial system runs on heavy systemic risks due to inflation control-based monetary policy agenda while instances of unauthorised finance businesses and scams including Hawala, pyramid schemes and crypto-currencies falling under the CBSL regulatory mandates have been reported in the media.
Therefore, a practically implementable legal mandate should be decided in that line without prescribing any theoretical variables such as inflation or GDP growth targets because monetary policy does not have direct instruments to influence prices or production unlike in the case of fiscal policy.
In fact, what is practically attempted by central banks in the monetary policy is to guide credit distribution although the rhetoric of inflation targeting and minimization of demand-supply imbalances is presented to mislead political leaders and the general public that the monetary policy is a natural science.
However, the present monetary model followed in many countries is the overnight inter-bank credit and short-term government credit with the expectation of the trickle-down effect on credit distribution across the economy based on demand and risks. Some central banks like the US Fed acquire long-term government credit even over five years to facilitate better policy transmission with reduced liquidity risks to the market. For example, securities with the maturity over 5 years (with more than 10 years) held by the Fed represent 60.6% of its balance sheet.
Therefore, if the legislation requires the monetary policy to follow a broader credit distribution mandate to suit national economic needs, the CBSL has to come out of their desk jobs in cool rooms and conduct the monetary policy with action economic research. Sri Lanka is country now needed to come out of the present economic crisis with the support of affordable credit and finance to mobilize resources and utilize the excess capacity available in the heavily contracted economy.
Now, the country has fallen to a catastrophic crisis consequent mismanagement of debt and monetary policy (inclusive of the foreign reserve and exchange rate) and there is no time framework to recover, it is advisable to conduct an investigation into both subjects so that draft new legislations will be able to close the holes in the present legislations.
(This article is released in the interest of participating in the professional dialogue to find out solutions to present economic crisis confronted by the general public consequent to the global Corona pandemic, subsequent economic disruptions and shocks both local and global and policy failures.)
P Samarasiri
Former Deputy Governor, Central Bank of Sri Lanka
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