Download Primary Money Creation Channels under Instability

Prof.dr.sc. Ivan Lovrinović1
Dr.sc. Tomislav Ćorić
Martina Nakić, dipl.oec.
Primary Money Creation Channels under Instability
JEL classification: E51, E58
Key words: monetary base, balance sheet of central bank, instability, channels of money
creation.
Abstract:
Aims and channels of primary money creation are among most challenging questions of
monetary economics and policy. The relevance is even greater under unstable circumstances
for the financial markets in particular and economies in general. Primary money creation is
not determined only by deposit multiplication within the banking system of a country through
its credit activity. Changes in quantities of primary money influence all other economic
variables, e.g. the interest rate, inflation, employment, GDP growth rates, liquidity. It is well
known that primary money is an input in a secondary money supply through credits of banks
offered to non-monetary entities. Primary money creation channels, visible in assets of a
central bank balance sheet, differ among countries. According to primary money creation
channels the degree of (in)dependence of a monetary system, domestic currency credibility,
development of domestic financial system, state of public finances, interdependence of real
and monetary economy, etc. may be determined. Furthermore, it is possible to identify
monetary policy instruments used by a respective country. Under unstable conditions, in this
case financial crisis and recession that started in 2007, our goal is to investigate the choice of
primary money creation channels made by selected countries and its effects on liquidity
management both on financial and real sectors of economies. Furthermore, we answer the
question of primary money channel choice which yields best results in terms of GDP growth
and faster recession recovery. It is our understanding that determination of a specific primary
1
Prof.dr.sc. Ivan Lovrinović is Full Professor at the Department of Finance at Faculty of Economics and
Business, University of Zagreb.
Dr.sc. Tomislav Ćorić is assistant researcher and lecturer at the Department of Finance at Faculty of Economics
and Business, University of Zagreb.
Martina Nakić, dipl.oec. is assistant researcher and lecturer at the Department of Finance at Faculty of
Economics and Business, University of Zagreb.
1
money creation channel underpins philosophy behind economic policy which takes speed of
the process into consideration both for the interest rate and expectations as main pro-cyclical
measures.
1. Endogenous and exogenous money
Money creation today differs from the era of commodity money. Commodity money had
value of a commodity and it was not possible to increase supply without increasing
production. With time, a monetary system based on gold, due to its limited supply, was not
able to keep up with economic growth, thus stipulating pro-recession and deflationary
characteristics. Due to these and other reasons, during the time of the gold standard, surrogate
money started to evolve. Most of all, the banknote was used as a certificate of deposited gold
with a bank. In the third phase of the gold standard, gold was pushed out and served only as a
foundation for the trust in banknotes. The banknote developed from a surrogate to currency
which did not have intrinsic value but carried a mark of value (gold). This is the genesis of a
modern currency. During the gold standard era, however, two money supply peinciples
evolved stipulated by growing industrial development and supply of goods and services
relative to supples of gold and limited gold production capabilities. Currency principle and
banking principle made division in theory which is the source of all current dispositions on
primary money creation. It is known that the banking principle prevailed which comes down
to the fact that money supply may be greater in banknotes compared to the stock of gold, as
during the time of the gold standard. Thus, the idea of additional money supply of surrogate
money in the form of banknotes was born. It further reflected Aristotle’s thesis that the money
is consequence of the law, i.e. the money will be what a government decided it to be. Thus,
the physical shape and form is less important, and today even unimportant. Therefore, during
the age of the gold standard, gold was an exogenous factor of money supply (banknotes),
supplied by all banks depending on quantities of gold in their vaults. Paper money, at the
time, was created by private banks in form of the banknotes as surrogate money. Nonetheless,
prevailing banking principle opened space for endogenous money creation within a banking
system with primary money as a base. Basic principle was that a deposit created credit, i.e.
creadit created a deposit.
Today, primary money, and secondary money, supply rests on liability, i.e. debt by the issuer
which may lead to great problems both for national and global economy. Poor monetary
2
policy management and irresponsible increase of primary money supply may deter economic
system and create financial crisis.
Exogenous money creation, backed by monetarists, from 1975 is based on a premise that a
central bank determines supply of primary, and thus, supply of transaction money.
Monetarists argue that the ration of primary money to money supply is stable and their
relation determined through the monetary multiplier. Open market operations in this system
are a corrective instrument. In such a model money creation is technical in essence and
monetary multiplier is responsible for relation between primary money and money stock.
According to known fact of stability between currency and deposits, i.e. primary money and
deposits, it turns out that there is nothing to explore further. However, it is a fact that a central
bank from a monetarist point of view does not have a full autonomy in creation, i.e. supply of
primary money. It also depends on non-monetary sector behavior. Monetarists have made the
model of exogenous primary money creation, and overall supply of money, stronger by
Friedman’s research results which showed demand for money in a long time series for the US
to be stabile. Thus, continues growth rule of three to five percent of money supply should be
followed.
Fisher’s quantitative money demand function (MV=PY) illustrates the dilemma on
endogenous and exogenous money creation. Some economists read causality from left to right
(exogenous), while others do so in the opposite direction (endogenous). However, Fisher’s
equation represents foremost identity and a sound analytical framework for investigating
causality of money, prices and income. It does not, however, answer the key question: does
the change in size of money influence income or other way around? However, the equation
starting point is the assumption of exogenous money creation, due to the conclusion that the
price level is determined by the money stock determined by the central bank. Furthermore,
assumption is that the velocity of money and production are constant. Both cases are
obviously possible but the term structure is important.
Post-Keynesians seriously challenge the monetarist foundations of exogenous primary money
creation and total supply of money, arguing that in the past thirty years things have
considerably changed. Based on this fact, they argue that most textbook interpret the IS-LM
model wrongly. It is suggested that the changes of the LM curve explain changes of money
stock as a lead indirect goal of a monetary policy. On the other hand, it is argued that most
major central banks in the world do not use supply of money as an indirect goal but the
3
interest rate. Furthermore, as argued by post-Keynesianists, if a central bank uses the interest
rate instead of supply of money, i.e. respective monetary aggregate, it means that cration of
money is endogenous in nature. This is especially true if the discount rate is used frequently.
However, one question remains unanswered: why a central bank increases or decreases supply
of primary money and thus the supply of money?
Post-Keynesians argue that demand for credit is the key factor influencing money supply, and
thus supply of primary money. Demand for money by companies depends on their
expectations of an uncertain future. This in turn influences their demand for bank credit, i.e.
demand for central bank money. According to post-Keynesians, bank credit flows and total
money supply is pro-cyclical and endogenous, and driven by Keynes’s “animal spirits.”
Therefore, with withdrawal from the gold standard in 1973, which was a gold-dollar standard
in essence, the only thing that remained was the banknote which was no longer a surrogate but
the real and only currency. Gold was demonetized and henceforth was not linked to money.
This represents the case of transformation from intrinsic value money to money without
intrinsic value and affirmation of the banking principle to its extremes, where gold is
unnecessary. With the breakdown of the gold standard, foundation for increased supply of
currency was fiat money. From this point on, issuing currency is based solely on trust, i.e. the
law. The modern money stands on trust in power, potential and efficiency of respective
country’s economy. The fiat money starts to be a foundation for issuing credit money by
banks. Thus, issue of primary money in modern conditions is the key test for central banks
and economic policies.
Today’s money is dematerialized, in case of cash and deposit money alike, because both
forms represent only symbols of value and posses no intrinsic value. Commodity money
represent asset for its owner without liability. On the other hand, today’s paper money
represents liability to the issuer, i.e. a central bank which is not backed by supply of goods.
Liability of the central bank is, therefore, a debt which an owner of the paper money cannot
call in. Creation of money during the days of commodity money was determined by the size
of materials, especially in the gold standard. Today there is no limit to creation of primary
money, thus creation of primary money may theoretically be limitless. This fact reflects the
basic difference between two money issuance systems valid in the time of commodity money
and today’s paper money. Limitations do exist, but this will be explored later.
4
Since creation of money is a decision made by a central bank as a monetary authority, the key
question are the reasons for creation of additional supply of primary money and how to secure
its value, i.e. purchasing power.
In the globalized world and liberalized capital accounts, question of exogenous primary
supply of money is even greater. Foreign currency transactions in some countries, foremost
developing countries, are becoming key determinant for issue of domestic currency by the
respective central banks. The grater the commitment of local currency issues to foreign
currency transactions the lower monetary sovereignty. Such monetary system determines the
shape of economic relations, thus countries become more dependent on imports with trade
balance deficits and growing foreign debt. Such system reflects a down side of the gold
standard which lies in pro-recession mechanism. This is due to shrinking supply of foreign
currency initiated by increasing foreign debt worsened by the fact that almost fixed exchange
rate must be maintained in order to preserve stability of prices. This is the case in Croatia with
more rigid monetary system that the classical currency board.
2. Primary money creation flows
Primary money issued by central banks today represent “modern gold” because it reflects
secondary emission of money performed by banks through credit activity. Based on trust in
money supplied by a central bank, multiplication may result in increase or decrease of trust in
the central bank and its money, i.e. towards government and the law backing it. In this sense,
it is important to question further primary money creation and its credibility.
In today’s conditions we speak of flows or channels of primary money creation. According to
existing literature and practice, main flows of primary money creation are: a) credit to banks
by central banks, b) buying securities (mostly issued by governments), c) foreign exchange
operations, d) gold and other precious metals transactions, e) selective credit to companies.
Flow of primary money creation dominant in a country, speaks of the type of an economy,
and the size of emission speaks of problems a country is facing in short or longer run. If the
credit to banks as monetary institutions in a two layer monetary system is the key channel of
primary money creation than a security used as collateral is important. Basically, these are
discounted credits based on bills of exchange in the beginning. A central bank, in this case,
discounts the bill of exchange already discounted to companies. This way production of goods
and services performed in the market through bills of exchange end up in creation of
5
appropriate amount of primary money. It represents a logical circular flow between monetary
and real economies. We will not get into details of supply and demand for primary money
because we are interested primarily for reasons and flows of primary money creation.
Discounting already discounted bills of exchange represents a base of central bank
refinancing policy. A central bank, by using discount rate policy, balances goods and financial
flows. If a central bank’s assets are predominantly made of discounted credit, it is obvious
that it takes care of development of a domestic economy. This is the way dominantly used by
the Bundesbank prior to introduction of the Euro. Furthermore, this is also the practice used
by the European Central Bank and some other central banks in the world.
Approval of the discounted credit by a central bank means that the foundations of primary
money emission is based on goods and services involving actual work. We speak of credit
part of the overall primary money created by a central bank. By selling produced goods and
services in the market issuer of a bill of exchange is able to pay it out. The bank is paid by the
central bank thus canceling previously created amount of primary money. In case that the bill
of exchange cannot be paid out, other asset forms would be recorded in the bank’s and central
bank’s balance sheets which the issuer of the bill of exchange owns. Thus, the central bank
and a bank as monetary institutions should prefer primary and secondary money emission tied
to a real economy and creation of new value. If former flow of primary money creation
dominates, we can say that the independent and balanced monetary system exists which takes
care of a domestic economy creating money out of real production.
For a case where a central bank buys government bonds as a main flow of primary money
creation, i.e. its non-credit portion, we can develop few scenarios. If we assume government is
issuing bonds only, the question is why it is being done, i.e. is it due to investments or nonproduction spending. If the central bank buys government bonds to help the real economy, as
was the case in the US during 2008-2009, creation of money is connected to production.
Thus, we speak of earmarking public debt and emission of primary money which is know in
literature as monetization of public debt. In this case the primary money emission was
guaranteed by the US Treasury.
If foreign currency transactions are dominant flow of primary money creation, structure
should be laid out first, i.e. sources of the foreign currency. If the foreign currency is based on
exports of goods and services, than the sale of foreign currency to banks and finally to the
central bank can be realistic base for primary money creation. In this case we have
6
transformation of purchasing power from abroad in foreign currency to domestic purchasing
power in the domestic market. This means that the primary money will be created when
central bank purchases foreign currency. Such creation of primary money is a non-credit
portion of primary money. If foreign exchange transactions are consequence of borrowing
from abroad dedicated for non production purposes, primary money creation will through
transmission mechanism create inflation pressures or increase trade balance deficit. In this
case monetary effects of foreign exchange transactions would mostly be negative for an
economy and further signal foreign dependence.
3. Influence of instability to primary money creation
In unstable conditions created by financial markets or real economy, flows of primary money
creation would change, and its relevance is different among countries. Why are the flows of
primary money different, what are the reasons for choosing a specific primary money creation
channel and why channels may be changed in short and long run? These questions will be
answered in the following text. We will use experiences of selected central banks in unstable
period (2007-2010), and 2002-2007 will be used as mostly stabile period.
Federal Reserve of the US was the first one to face huge consequence of the recent financial
crisis which generated from the mortgage market. In a very short period of time FED lowered
interest rates to historically low levels which led to liquidity effect. Supply of primary money
was more than doubled in a very short time. Real estate crisis was so deep and wide spread to
other financial institutions that governors of central banks were unaware of the real threats for
overall economic system and financial stability at the beginning. Lower interest rates showed
to be the key measure against looming illiquidity, panic and meltdown. The interest rate
channel (fixed) was the only efficient measure to put recession as a continuation of the
financial crises, to an end. No one knew how much primary money should be pumped into the
system so the boundaries of borrowing from central banks were not set. Due to this reason,
primary money emission was enormous and nobody wanted to limit quantity due to multitude
of problems and negative expectations. However, it was important to maximally lower the
interest rate and thus get the message across to the economy that the central bank is ready to
supply enough money at such rate. Targeting the interest rate represented an advantage over
monetary aggregate targeting in recent financial crises and recession.
7
The FED intervention was performed in several phases, which speaks of adjusted measures
and instruments in order to achieve set goals. Intervention programs created by economic
policy, described below, were the foundation for primary money emission.
1) Liquidity Programs for Financial Firms was FED’s first form of intervention with the goal
of achieving short run liquidity (90 days) for healthy institutions with acceptable investment
security. Some $860 billion (45% of FED assets) was approved, predominantly to banks,
primary dealers and for foreign exchange swaps with other central banks.
2) Direct Lending to Borrowers and Investors represents a second phase of intervention by
the FED with the key segments in stabilizing securitization of financial instruments market
through TALF (Term Asset-Backed Securities Loan Facility). The other segment was tied to
CPFF (Commercial Paper Funding Facility). The goal was to improve functioning of the
credit market with direct credit approval to major entities. The FED approved $255 billion for
the activities (1/8 of its assets).
3) Purchases of High-Quality Assets was related to actions of buying high quality government
bonds and government agencies bonds for which the FED issued primary money in the
amount of $780 billion (3/8 of FED assets). Out of $780 billion, $490 billion went for
government bonds. The FED influenced returns stability in the long run and lowering of
interest rates and credit risks.
4) Support for Specific Institutions was the fourth intervention program by the FED which
related to direct financing of important institutions with minor support of the US Treasury and
the US Congress. Speed of the effects was crucial for take-over of Bear Stearns from JP
Morgan Chase & Co. Furthermore, AIG insurance company was bailed out. These operations
amounted to 5% of FED’s assets. “Hard choice for the FED, but there was no other solution.”
(Bernanke, 2009.)
Above mentioned operations by the FED and the ways of policy creation tells that the
selective policy became the most important instrument of the FED in solving financial crises
and subsequent recession.
For improvement of liquidity in the first phase credit flow to banks was used. For stabilizing
long run interest rates and expectations in this phase purchase of long term government bonds
was used. In this context, Bernanke stated in September 2009 that the FED balance sheet was
the key instrument of the monetary policy in solving the financial crisis and recession. The
8
balance sheet of the FED at the time is a clear illustration of the gravity of situation where for
the first time companies were clients. The FED at the time was more than ever the lender of
last resort for banks, insurance companies, real estate agencies, companies, and for the
government. For the first time the FED assumed the role of a commercial bank. The quest for
most efficient way for counter cyclical actions with transmission mechanism was the excuse
for extending the clientele base of the FED.
In conducting new measures and instruments of monetary policy, better known as credit
easing, the FED was guided by the following principles: a) tight cooperation with the US
Treasury, b) in credit operations, risk taking was avoided, and credits were allocated to
predefined industries, c) initiated resolution on its role for bailing out non-monetary
institutions.
For decades the balance sheet of the FED relied on government bonds. At the end of 2007 the
share was shrinking with growing share of other financial assets. In this sense the balance
sheet of the FED can be divided into following three segments: a) short run credit for liquidity
of financial institutions e.g. deposit institutions, broker/dealer firms and MMMFs, b) assets
related to programs focused on widening credit conditions, and c) high quality securities,
especially government bonds and asset backed securities.
By the end of 2007, FED established TAF (Term Auction Facility) as an innovation related to
“discount window” as a classical instrument of the monetary policy. This was a solution for
an unpopular “stigma problem” because it relied on an anonymous auction which was
announced and liquidated in three days. For example, on April 1, 2009, out of $525 billion
devoted to the “discount window”, $470 billion was allocated through the auction, and the
rest through regular channels (Bernanke, 2009.). For liquidity of foreign banks abroad the
FED signed cooperation agreements with 14 central banks which relate to currency swaps
dispensing $310 billion and foreign central banks committed to counter value in local
currencies. In this operation also significant amount of the primary money in the US was
created.
In March 2008, the FED, under the pressure of the crisis, introduced a new program of
assistance called Primary Dealer Credit Facility (PDCF) where $105 billion in credit was
dispensed.
9
The third form of FED assets relate to high quality securities, especially MBS (mortgage
backed securities), in total amount of $780 billion, out of which $490 billion was assigned for
government bonds. The main goal of the program was to lower costs and increase availability
of credit to households and businesses.
CPFF program was very important because commercial papers market represents the key part
of the short run money market in the US. Companies found harder to issue commercial papers
so the FED decided to buy out papers of financial and non-financial companies with different
insurance premiums and up to three months. The TALF program had the goal to restore
securitization market which almost died out (car loans, student loans, credit cards).
Beside afore mentioned programs of fast and strong FED intervention, “Support for Specific
Institutions” as a program of aid to especially important financial institutions was
acknowledgement of change in behavior of the central bank. The case was aid of the FED to
JP Morgan Chase & Co. for take-over of Bear Sterns and bail out of AIG. The model of aid in
these cases was different than the usual programs for liquidity which were dispensed by the
central bank and are thus more risky. „…these operations have been extremely uncomfortable
for the Federal Reserve to undertake and were carried out only because no reasonable
alternative was available… we are working with the Administration and the Congress to
develop a formal resolution regime for systemically critical nonbank financial institutions“
(Bernanke, 2009). In this case political decision, but also the fear of further destabilization of
financial markets, overall economy and society, was the cause of an extra primary money
emission in its credit form. This is acknowledgement to the thesis that unusual and serious
circumstances also yield unusual solutions. Traditionally conservative central banking
responded strong and with innovation, not only in the US but throughout the world. No one
spoke of central bank autonomy any longer. The FED was not only satisfied with lowering
interest rates as a classical monetary instrument because it would prove ineffective. The FED
also combined low interest strategy with a new approach to credit access called “credit
easing”. However, lowering interest rates only does not mean that transmission that should
result in economic growth is automatic. Changes in FED policies toward banking and nonbanking institutions led to a boom in its balance sheet which increased dramatically. “In the
United States, the Federal Reserve has done, and will continue to do, everything possible
within the limits of its authority to assist in restoring our nation to financial stability and
economic prosperity as quickly as possible“ (Bernanke, 2009). In this sense the FED had to
loosen its crude demands tied to credit applications by banks which were an obstacle prior to
10
“credit easing”. Faster and easier access to FED credit with the low interest rate stabilized
interbank market and put a stop to negative expectations regarding system liquidity.
From 2002 to 2007, main flow of primary money creation in the US was purchases of
government securities with the share in FED’s balance sheet of over 80% (see Figure 1 and
Table 1 in attachment).
Figure 1: FED asset structure (2002-2010, in $ millions)
Source: Federal Reserve, www.federalreserve.gov
We can conclude that the policy of government securities purchases dramatically changed
with the crises in the mortgage market which culminated in 2008. Up until that time, the FED
mostly purchased medium and long run government bonds (50-51% of its assets), treasury
bills (26-31% of its assets), while purchases of other securities remained low. In 2008
purchases of government bonds were drastically lowered to mere 18.04%, and in 2009 and
2010 its share doubled compared to 2008 (38.30% in 2010). On the other hand, in 2009,
purchases of mortgage securities dramatically increased. These securities were not purchased
11
by the FED at all up until that time, but amounted to 39.91% in 2009. This clearly shows the
FED to focus on the source of the problem – mortgage market, i.e. the real estate market
which threatened to collapse entire financial market and real sector too. The FED realized that
bailing out real estate market would be too complicated but turned to direct purchases of
mortgage securities from their owners. The monetary policy in 2010 wanted to stabilize long
run yield curve.
In 2008 FED assumed the role of principle buyer of mortgage securities posing as a primary
dealer, under condition of dropping prices, buys in order to reverse the trend, and stabilize
prices in the market. The FED as a dealer with limitless liquidity was the only one able to do
this and primary money emission was directed toward the mortgage market. It was never
before seen selective credit policy of the FED. This was done decisively, quickly and in a
large volume which was crucial for expectations of investors and other entities, both in the US
and abroad.
In other words, we can say without any doubt that the selective policy of the FED, not in a
sense of credit approval, but in the way mortgage securities were purchased, the goal was
reached. The model of selective policy was innovated but, more importantly, it was aimed at
decontamination, stabilization and resurrection of the real estate market.
During 2008 one more emission flow of M0 in the US was present and it related to swap
operations of the FED and 14 other central banks. In 2007 these transactions amounted to $14
billion, i.e. 1.51% of its assets, and in 2008 the share grew to 24.33%. Such a strong growth of
transactions by which the FED emitted $553 billion of primary money and exchanged it for
other currencies in countries in a need of the dollar, aimed at stabilization of currencies of
major countries. After 2008 this flow of primary money in the assets of the FED became
insignificant and was down to zero. The other strong flow of creation of M0 in 2008 was
through credit to banks by the FED (term auction credit) which represented innovated
discounted credit amounting to 19.79% of the FED assets. We can conclude that foreign
currency transactions in 2008 were the most significant flow of M0 creation in the US both in
absolute and relative sense.
12
Figure 2: M0, M1 and monetary multiplier, rate of change (m=M1/M0)in the US (2001IX/2010, in %, year-to-year)
Source: Federal Reserve, www.federalreserve.gov
In Figure 2 we can see that the primary money emission during 2008 was extremely high.
However, money stock growth did not follow which can be seen from the data on the
monetary multiplier.
4. Peculiarities of primary money creation in the Eurozone
In the discussion oo primary money emission under instability, the EU and the EMU have its
peculiarities less known in the field or to the general public. These are best viewed through
the ECB balance sheet and the Eurosystem balance sheet. The Eurosystem is made of the
ECB and 17 national central banks which accepted the Euro. It is know that the flows of
primary money creation are in the asset portion of the balance sheet. If we look at the ECB
balance sheet only we cannot detect most significant flows of primary money creation in the
Eurozone. In the assets of the ECB there is an entry “claims related to the allocation of Euro
banknotes within the Eurosystem” which amounted to 50% of the ECB asset structure in 2009
(ECB Annual Report, 2009). This means that the assets of the ECB incorporate bills as a form
of primary money. Primary money, i.e. currency in form of bills and coins is in the liabilities
part of the Eurosystem balance sheet. If we look at the Eurosystem balance sheet we can see
the total amount of currency which is in the assets of the ECB balance sheet and amounts to
roughly 8% of currency in the Eurosystem, i.e. in 17 national central banks. Structure of
13
currency 8%: 92% in favor of national central banks, determined by the European Council in
2001. National central banks accordingly can create and cancel currency including the one in
the ECB balance sheet. However, the ECB does not issue currency but 8% of currency
emitted by national central banks is allocated in the ECB balance sheet which resembles the
IMF system. Thus, the ECB balance sheet does not show the ways in which currency is
created in its assets, i.e. we cannot see weather created money is allocated by central banks or
is it its own creation of money.
Currency in the ECB assets has a similar status to gold or foreign currency or reserve position
with the IMF. The difference being that it is created “ex nihilo” and thus represents the
demand toward 17 national central banks. Just this first pass reflects political economy of the
primary money emission in the Eurozone telling us that the ECB phenomenon as a
decentralized central bank, regardless of the prevailing understanding that the ECB is the only
issuer of primary money.
In this context, the ECB cannot be considered a lender of last resort in the classical sense.
Acknowledgement of this statement can be found in the ECB balance sheet and the
Eurosystem balance sheet. From the ECB balance sheet it can be seen that it creates primary
money by purchasing gold and foreign currency and allocates a portion of currency to
national central banks. If the ECB was a lender of last resort, the entry called credits to
national central banks should be present on the asset side, and adequate liabilities to national
central banks in the liabilities side of the balance sheet. There is no such entry so we can
clearly conclude that the ECB in its operations does not operate as a monetary authority and a
lender of last resort. In such a two layer system toward lender of last resort mechanism there
is a flaw hidden in potential unwanted credit expansion and which national central banks
could allow credit institutions, as a third pillar of the monetary system, conceived by the
Delors plan (1988). This plan should have decommissioned the system based on the ECU and
make strict competencies among the ECB, national central banks and credit institutions.
Today the system is not fully operational which, due to lack of political foundations for the
EMU in the form of a constitution for a single country, could not have been different than a
mix of national monetary sovereignty headed by central banks. Division of decision powers at
super national level was revived through the important role of the Governing Council of the
ECB.
14
When analyzing the Greek central bank balance sheet we can see above described system.
Greece succumbed under a heavy pressure of the crisis and explosion of its domestic public
debt. In Greek central bank’s assets it is obvious that the main refinancing operations, as a
main form of primary money creation, were modest in volume. When the financial and debt
crises hit it was clear that the GCB acted as a lender of last resort for Greek banks.
Furthermore, refinancing operations, as a main tool for liquidity management of the banking
system, were enormous. The ECB assets do not yield any sign of this but it is visible in the
balance sheet of the Eurosystem. One thing that may be distinguished is that the green light
for such expansion was given to the GNB by the Governing Council of the ECB without any
trace in the ECB balance sheet.
Such decentralized system of operations of central banking in the Eurozone opens up the
question of asymmetry of monetary policy operations. Keeping the key role of emission of
primary money through credit to banks, i.e. refinancing operations leads to a conclusion that it
is possible that a Eurozone member country may adjust monetary policy to a particular
economy. This can be seen in the example of rates and structure of primary money emission
in respective Eurosystem countries for the period 2007-2010 that follows.
It is clear from the Euro system balance sheet that its assets contain evidence of main
channels of primary money creation. These are credit to banks which, in the form of main and
long term refinancing operations, by the end of 2009, consisted 40% of assets (ECB Annual
Report, 2010). Refinancing operations are the key instrument for bank liquidity management
which is in the hands of national banks. It should be pointed out that even though national
central banks perform refinancing operations, the interest rate is set by the ECB. We can also
speak of decentralization of the institute of a lender of last resort where unfavorable
conditions may inflate moral hazard. Naturally, this is in order to say that at the top of the
Eurosystem the ECB exists, and thus the decisions are made jointly, i.e. formally under the
influence of the ECB. However, it is easy to point out that the Governing Council of the ECB
is predominantly made of representatives of national central banks which in turn have
dominant role. Such situation resembles the US in 1935 when 12 district banks were in
operation, and seven members of the Board of Governors, where New York FED had the
dominant role, even though there was no central monetary authority. The New York FED was
the only one authorized for open market operations while other members could emit currency.
However, 12 district banks, members of the FED, did not have its own balance sheets as
today’s members of the Euro system, which makes a huge difference. Furthermore, we can
15
say that the ECB is the central bank of national central banks, but not a unique central bank
with all attributes normally held in a national framework. Considering everything above, we
could call the ECB main central bank of the Eurozone.
Constant possibilities of depositing and taking out overnight loans from the ECB are also
performed at the level of national central banks with the ECB setting the interest rate.
If we could regard the ECB to be the main central bank of national central banks, it should
truly be the main supplier and issuer of primary money for them, and thus serve as a lender of
last resort, which clearly is not. However, it is puzzling that it is portrayed as such in the most
significant documents of the EU, which may be confusing.
In this context some authors consider national central banks as affiliates of the ECB and pose
a question which is sovereign authority to which the ECB operations are subject to? “This
new sovereignty would supposedly be a common conduction of its sovereignties delegated to
it by national central banks. However, this constituted right legislator did not convey out of
voting rights of European peoples. Relation of the ECB to democracy is, thus, not identical to
relations situated with national central banks. There is no hierarchy of values at the
European level in order for the ECB to be a subject to national sovereignty. While it
commands monetary policy to whole of Europe, the ECB would have powers not included in
democratic social system within a single territory. The problem is enormous because in this
new organization sovereignties are added together but not articulated according to a
hierarchical principle that should stand above it” (Aglietta, Orlean et. al., 2004: 48). Relating
to the above statement there is the other possibility that the project of the Euro yields some
kind of European political sovereignty. Without it the whole project is unsustainable. Other
economists realize this fact and stress unsustainable voting practice within the Governing
Council of the ECB. This is especially true if expansion process of the European economic
and monetary union is to continue (De Grauwe, 2007).
If we look at history of the FED we could say that the European economic and monetary
union is not a single country with a single constitution, and thus simultaneous existence of the
ECB and the Eurosystem is controversial. Is the ECB just a predecessor of a future single
joint central bank in the Union or should it be an institution for performing e.g. open market
operations, as the FED of New York did, within the new shared competencies of the
Eurosystem?
16
5. Primary money creation in the EMU under instability
Under unstable financial market conditions and subsequent recession, the ECB used different
channels of primary money creation compared to the FED. Until July 8, 2007 changes in the
ECB assets were minimal, and the size of assets remained mostly unchanged. When the
financial crisis hit there was a dramatic change in the size of assets but it led to significant
changes in structure too. Main refinancing operations before the financial crisis were the most
significant channel of primary money creation and accounted for some one third of assets,
only to fall to 3% in 2009. Its function were taken over by more long term refinancing
operations which accumulate to 9% in 2005, but by 2009 the figure was up to 37% of assets.
Significance of securities also grew, and the ECB lowered criteria for securities that served as
collateral for credit approval. Securities amounted to 9% in 2005 but went up to 18% in 2009
of the ECB assets.
The gravity of the financial crisis which came down on the EU and the EMU in mid 2007,
resulted in unorthodox instruments and measures of monetary policy better known as
“enhanced credit support” and “securities market program”. These policies were responsible
for policy of primary money creation by the ECB. New, unorthodox measures of the ECB
monetary policy aimed at the following:
a) Introduction of so called “fixed rate full allotment” procedure of supply for all refinancing
operations, where banks had unlimited access to liquidity with appropriate collateral and at
the interest rate for major refinancing operations. This measure made possible for banks to
solve short term illiquidity problem and prevented severance of ties in the credit market for
companies and households.
b) The list of acceptable securities as collateral for refinancing operations was considerably
expanded. Even before the advent of the financial crisis, the ECB accepted as collateral
private securities not only government ones. Besides, clientele base of the ECB expanded,
thus e.g. fine tuning operations expanded from 140 to roughly 2000. In main refinancing
operations the number of institutions expanded from 360 to 800 (ECB, 2010.).
c) The ECB, after fully exploiting liquidity through main refinancing operations in May 2009,
directed its policy toward long term refinancing operations with six months to one year
maturities. Goal was to enhance liquidity of banks and stabilize the interest rate in the money
market to a low level and avoid turbulences which reflected in the interest rate spread. More
long term measure allowed banks to decrease the gap between assets and liabilities.
17
d) The ECB insured liquidity in the foreign exchange market by making arrangements with
major central banks in the world.
e) In May 2009, the ECB announced the covered bonds purchase program in the amount of 60
billion Euros in order to revive this segment of the financial market which almost died out. By
the end of June 2010, the ECB purchased 422 different bonds using this program (CBPP –
Covered Bonds Purchase Programme).
Afore mentioned measures of the ECB, i.e. the Eurosystem, defined the reasons for creation
of additional amount of primary money by carefully analyzing and choosing appropriate
channels by which the set goals of primary emission would be acquired. In this sense it was
important to change transmission mechanism of the ECB monetary policy. Outcome was
actually favorable, and manifested in a drop of the interest rate in the money market and
returns on the long term market whereby the most important goal was reached – stability of
financial markets. Strong credit activities of the Eurosystem toward banks lead to diminishing
role of the money market in that period. However, due to risk aversion, banks have redirected
a significant portion of the primary money back to the Eurosystem using the deposit facility.
Thus, a difference between the overnight interest rate (EONIA) and the deposit rate was
lowered, a service rendered by the Eurosystem.
Choice of primary money creation depends on structure of financing an economy. Nonfinancial institutions in the Euro zone realize some 70% of their needs for external financing
through bank credit (Trichet, 2009). Quite a different situation exists in the US where
companies issue securities and other non-banking instruments in order to facilitate external
financing. This is the key for understanding why monetary policies were on opposite sides of
the Atlantic so different. Therefore, the ECB focused on banks and shaped instruments of
monetary policy targeting efficiency of transmission mechanism. The FED, on the other hand,
chose securities as the most important primary money emission channel and transmission
toward non-financial sector. The ECB thus shaped the anti crisis monetary policy better
known as “enhanced credit support”. Trichet (2009) defined it as a collection of “the special
and primarily bank-based measures that are being taken to enhance the flow of credit above
and beyond what could be achieved through policy interest rate reductions alone.”
The additional reasons for using different transmission mechanisms of monetary policies in
the US and the Eurozone are best explained by Trichet (2009): “In the United States, for
example, in normal times outright purchases and sales of treasury bonds with short maturities
18
belong to the routine toolkit of monetary policy implementation. Given that tradition, it may
be a natural step, under non-standard circumstances, to adapt this procedure by significantly
expanding the volume of purchases and focusing on governments bonds with longer
maturities. The Eurosystem comes from a different tradition. For us, “reverse transactions”
with banks – on the basis of repurchase agreements or collateralized loans – are the single
most important – and in many respects exclusive – instrument in open market operations.
Given that tradition, it has been a natural step to extend the maturity of our refinancing
operations and make adjustments to the collateral requirements. In a limited empirical
research which we conducted aiming to determine to what extent channels of primary money
creation in three selected countries, Germany, Greece and Slovenia, correlate to channels of
primary money creation in the Euro system (average). Germany was chosen as a strongest
and largest economy in the EMU, Greece due to its public debt crisis, and Slovenia as a small
stabile country.”
Absolute values of assets of selected central banks for the period 2007-2010 show high
correlation with movements of assets of the overall Eurosystem and the Bundesbank (88%).
On the other hand, correlation coefficient for the Greek Central Bank and the Bank of
Slovenia relative to the Eurosystem is considerably lower, 61.6% and 51.2% respectively.
Differences in movements of individual sections of the monetary system speak in favor of
different consequences of the crisis, i.e. asymmetric shock to real and financial sectors of
selected countries. Sources of difference may be found in different power and structure of
respective financial systems.
According to third quarter of 2008 data, beginning of the crisis was marked with a change in
strategy of national central banks within the Eurosystem framework, foremost in the context
of growing role of long term financing operations. In September 2008 these operations
amounted to 29.54% of total assets of the Bundesbank (figure 2 in the appendix), in order to
increase by the end of the year to 32.89%, i.e. 201 billion Euro. As the time passed tensions
and philological effects of the crisis shrunk, the Bundesbank redirected most of its activities
toward main refinancing operations, while during 2009 and 2010 long term operations kept
coming down.
The example of Bank of Slovenia (figure 3 in the appendix) shows a similar practice
regarding the open market operations, with a time lag. Beginning of the crisis for most
transition economies started later, so significant rise in long term refinancing operations share
19
was felt by the end of 2009. At this time these operations amounted to 21% of assets,
compared to 2008 when these were 2.87%. During the whole observed period the most
significant entries of the Bank of Slovenia assets were „Securities of euro area residents
denominated in euro“ and „Intra Eurosystem claims“, which cumulatively, during 2007-2010
period, accumulated to 60% of the Bank of Slovenia assets.
Structure of the Greek Central Bank assets (figure 1 in the appendix) shows the problem of
illiquidity of the system which still has not been solved. Unlike other central banks, portion of
long term refinancing operations in practice of the Greek Central Bank is constantly on the
rise, and reached 58% of assets by the end of 2010. The data indicates banking system
illiquidity as a consequence of economic collapse and the debt crisis which escalated during
2010.
Based on the analysis of channels of primary money emission for three selected countries of
the Eurosystem, it is clear that the national central banks played a crucial role regarding the
choice of channels, size of emissions and effectiveness of transmission mechanisms, approved
by the ECB. Credit to banks, as a choice of transmission mechanism in the Eurosystem, for
primary money creation proved to be a good solution for the Eurozone, especially during the
financial crisis of 2007-2010. Each approved credit to credit institutions by the Eurosystem
had specific collateral which had a definite connection to the real economy, thus a real
coverage. By doing this, production of goods and services was soundly completed by creation
of primary money.
On the other hand, most of the primary money created by the FED was based on buying
government bonds. Such emission of primary money found its coverage in present and future
revenues of the US Treasury based on the premise of eternal public debt. In both cases
expansion boundaries of primary money had to have a realistic foundation, i.e. collateral
which would be canceled in the next phase. Unlike the FED, the Eurosystem could not accept
the concept of government bonds as a foundation for primary money emission due to a fact
that 17 different fiscal policies exist, so there is no firm guarantee for stability of such a
model. The FED primarily created money “ex nihilo”, with a promise from the government,
i.e. the US Treasury, to repay. In the Eurosystem money was created “ex nihilo”, but had a
real foundation in securities mostly from the private sector, being collateral of the real
economy. This is a foundation for “covered bonds.”
20
Unorthodox measures of monetary policy in the Eurozone fostered more efficient liquidity
management of banks through the concept of unlimited access within central banks of the
Eurozone with historically low fixed interest rate. In this context, refinancing operations
played the most significant role with an emphasis on lower criteria for collateral quality.
Roughly 2200 credit institutions had access to Eurosystem credits through refinancing policy
which speaks of the width of platform for efficient approach to liquidity. Greater portion of
private sector securities relative to government securities should be stressed. Total value of
collateral amounted to roughly 130% of GDP of the Eurozone (ECB, 2010). The third major
action made by the ECB was to extend payment period for borrowing by banks. However, it
became clear that the banks became a critical point of the monetary transmission mechanism.
This was due to a fact that banks, to a greater extent, did not forward liquidity to non-financial
sector but rather made deposits with the central banks.
“…the expansion of the monetary base associated with the implementation of non-standard
measures does not lead to an equi-proportional (or indeed any) expansion in broad money.
This both illustrates the weakness of the money multiplier model – which would see such an
expansion of broad money as key – and points to a need for further work to understand better
the behaviour of the banking system and its interaction with the real economy.” (Giannone,
Lenza, Pill and Reichlin, 2010.) However, different circumstances rendered the monetary
multiplier model almost unusable. In this sense, extending payment period for credits to banks
by the central banks of the Eurozone provided a solution to this problem due to extension of
the time horizon yielding greater security.
Currency swaps were also important in some stages of the crises as a channel of primary
money creation. The ECB made agreements with major central banks in the world, especially
the FED on ensuring liquidity in respective currency as to preserve international liquidity.
In 2009, the Eurosystem started to introduce so called “covered bonds” which were issued by
banks which had parts of assets as a foundation. Covered bonds in Germany are being issued
for roughly 200 years “Pfandbriefe”. This segment of the market almost died out until the
Eurosystem started to accept them as collateral on a larger scale for refinancing operations.
Unlike the FED practice which bought government securities backed by the US taxpayers,
covered bonds are backed by assets of a bank, which is a significant difference when talking
about coverage of the primary money emission. In the case of FED, debt emission is a base
for primary money emission backed by the US Treasury and with future tax revenues, as
already mentioned, closes the circle of creation and canceling of primary money. In the case
21
of Eurosystem, political economy of primary money emission was considerably different and
was based dominantly on specific forms of existing assets, though with varying prices due to
market volatility.
6. Selected transition countries’ central bank assets as an indicator of independence and
state of economy
By analyzing assets of central banks balance sheets of selected transition economies of South
East Europe we can see a large portion of foreign assets within the total assets for all countries
(see figure 3). Presented data leads to a conclusion that main sources of primary money
creation in selected countries are foreign exchange transactions.
Monetary systems of Bulgaria and Bosnia and Herzegovina have currency boards. Basic
characteristic of a currency board are fixed exchange rate according to a currency anchor,
absolute convertibility of a local currency into the anchor currency and vice versa, and
minimal 100% coverage of central bank’s liabilities (primary money) with foreign assets. This
means that the only channel of creation/sterilization of primary money is buying/selling
foreign currency.
Figure 3: Structure of central banks’ assets for selected transition economies (2007-2009, in
% of total assets)
Source: National central banks
22
The larger the share of foreign exchange transaction the larger the assets in the central bank’s
balance sheet, thus automatically increasing the degree of euroization of domestic monetary
system. This makes creation of local currency more complicated along with overall monetary
policy management. Dominance of foreign exchange transactions as a flow of primary money
creation leads to a currency board as a monetary system where domestic monetary system
entirely depends on a chosen foreign monetary system. In this case, primary money emission
of local currency is exogenously determined by the size of foreign exchange transactions,
fixed exchange rate, central bank does not provide facility of last resort lender, monetary
sovereignty does not exist, and exiting local currency has only a psychological value.
Depending on the proportion of foreign exchange transactions in primary money creation we
can speak of “currency board” and “quasi currency board”. The “currency board” is the
official monetary system of Bosnia and Herzegovina where primary money emission is 100%
covered with the foreign exchange. On the other hand, Croatian monetary system is declared
as independent, but the Croatian National Bank since introduction of Kuna based creation of
95-99% primary money on foreign exchange transactions. We can speak here of de facto
“quasi currency board” where denial of de iure declared monetary system exists. Therefore,
main flows of primary money creation uncover the type of monetary and economic system.
Under the conditions of a currency board the only instrument of monetary policy for
achieving economic objectives is the reserve requirement. The Central Bank of Bosnia and
Herzegovina and Bulgaria by lowering the reserve requirement rate, i.e. calculation base, tried
to increase liquidity of banking industry credit activity threatened by the financial crisis of
2007. In Bosnia and Herzegovina the reserve requirement rate at the end of 2008 was lowered
from 18% to 14%, with all new credits to banks from abroad excluded from reserve
requirement obligation. From January 2009, differentiated reserve requirement rate was put in
use – for funds up to one year maturity 14%, and for longer maturities 10%. In May 2009, the
reserve requirement rate for maturities of up to one year was lowered to 5%, where
government deposits for development programs were excluded from the reserve requirement
obligation. (Centralna banka Bosne i Hercegovine, www.cbbh.ba)
Bulgarian central bank in October 2008 lowered minimal liquidity reserve for all funds from
12% to 10%. Furthermore, minimal liquidity reserve on foreign sources was lowered from
10% to 5%, where funds from local and central governments were excluded entirely
(Bulgarian National Bank, www.bnb.bg).
23
The Czech Republic, Hungary and Poland are the members of the EU and are getting ready to
introduce the Euro. By analyzing structures of their central banks assets, we can observe high
portion of foreign assets. It should be noted that portion of credits to banks has risen to 5% in
the Czech Republic in 2008 (from almost 0% a year earlier, except 2005).
According to the data above on assets of selected central banks of transition economies in
South East Europe which did not introduce the Euro, we can conclude that foreign exchange
operations represent the key flow of primary money creation. The question emerges here: did
the countries select mentioned flow or was this an outcome of objective circumstances? All
mentioned countries are highly or moderately euroized, and the flow of FDI in recent time
was significant. Besides, their banking systems are mostly in foreign ownership, i.e. owners
are large banks from the EU. This fact should be especially stressed because it represents a
significant flow of capital in Euros which increases credit potential of banks in SEE
economies. However, by doing so the euroization spreads further, thus the appreciation
pressures on local currencies.
Figure 4: Monetary multiplier in selected transition countries (m=M1/M0, 2000-IX/2010)
Source: National central banks
We can observe the Czech Republic, Poland and Hungary to have significantly higher
monetary multipliers than the rest of the countries even before the financial crisis, which
developed in all observed countries during 2008 and 2009 (see figure 4).
24
Countries with foreign exchange as a main flow of primary money creation have so called
monetary system surplus. This means that a precondition for creating local money is prior
existence of foreign exchange. As mentioned earlier, this form of primary money emission is
typical for a currency board as a form of dependent monetary system, where a central bank
does not use its monetary sovereignty and currency, i.e. does not create links between a real
economy and local money creation. Dominant foreign exchange transactions as a flow of
money creation lead to complications for conducting monetary policy. In such conditions
monetary policy is conducted through secondary currency and it is tied to monetary policy of
a country which currency dominates in the structure of foreign exchange reserves. This
dependence is more pronounced if a banking system is predominantly owned by foreign
banks. Parent banks supply credit to its subsidiaries in transition countries and thus directly
support euroization of these countries. Furthermore, channel of foreign exchange transactions
in primary money creation is further exaggerated. Analyzed transition countries have thus
formal monetary sovereignty, but de facto it is a case of pronounced dependence on European
Monetary System.
In analyzed transition countries, so called mono channel of primary money emission realized
trough foreign exchange transactions is at work. In the case of Croatia, this is especially
pronounced and it exhibits increased rigidity compared to classical currency board monetary
system. As such, it carries seeds of recession which surface as soon as the real recession
spreads in the EU and the region. Since Croatian National Bank did not change primary
money emission channel, nor increase it, it had a pro recession effect, i.e. pro cyclical. Size of
primary money increased due to a different reason. The reason lays in non-banking sector
repaying previously approved loans which were thus withdrawn, and funds immobilized in
central bank accounts. This can be seen in the example of the monetary multiplier which was
lower than one, thus becoming monetary reducer. We can say that the monetary transmission
mechanism of monetary policy operated, however, in the opposite direction, because the
central bank did not react as a lender of last resort for banks which is visible through primary
money emission channel. According to this fact, banks further increased risk aversion and laid
path to growing illiquidity in the real economy. However, the ECB, as a model for the
Croatian National Bank, temporarily disregarded price stability and turned to economic
growth using heavily a pro cyclical monetary policy.
Assets of a central bank’s balance sheet, as argued earlier, indicate the type of an economy
and degree of dependence or sovereignty. If a country wishes to increase the degree of its
25
monetary sovereignty and make better connections between a real economy and primary
money creation, it has to significantly change the structure of assets in a central bank’s
balance sheet giving more space to local currency. In the case of Croatia where recession is
present since 2008 and is present today, it is clear that the economy is in a state of self
blockade. High money immobilization by the Croatian National Bank which is 30% of
created primary money for years makes its way through various instruments of monetary
policy. Consequences of such actions are high illiquidity of the economy, high interest rates
and restrictive fiscal policy which cannot yield different results rather than prolong bottom of
the recession. The public debt crisis in the EMU, problems in the banking industry etc., create
necessity for greater use of a local currency in a monetary system of a transition country.
Otherwise existing mono channel of primary money creation would manifest as a special form
of the gold standard, i.e. the currency board with pro recession seeds.
The example of primary money creation in China is very interesting one. In this case the
model is more inherent to small transition and dependent countries described earlier, rather
than second largest economy in the world. Increase of foreign exchange reserves from $125
billion in 2000 to $2.8 trillion by the end of 2010 will have significant and complicated
consequences both on China and rest of the world. Chinese foreign exchange reserves resulted
from growing surplus of the trade balance and strong inflow of investment. By creating
deficits with countries that account for majority of its imports, the US by using position of the
dollar as the most important currency in the world, in essence creates dependence of these
monetary systems to the dollar. In the previous period China could not have done otherwise
since it did not achieve necessary level of development and could not do without foreign
currency, and for the fact that Yuan is not a world currency.
The Chinese Central Bank in 2000 created 54% of its primary money by buying foreign
currency, and in 2010 this channel made 80% of its assets. If we compare China to Japan, we
can conclude that the Japanese Central Bank some 60% of its primary money creation bases
on purchasing securities, roughly 30% by credits to banks, while foreign exchange
transactions make 8% of total assets in 2010. This is an important example for China because
Japan is second largest owner, after China, of foreign currency reserves in the world. Primary
money creation phenomena based on the US dollar in the form of dollar reserves in China is
one of the largest phenomena in modern international finances. After China eventually turns
to internal markets primary money creation channels will have to change.
26
On the other hand, China, i.e. its central bank, will have to work on expanding use of Yuan in
international transactions. Such a new Chinese monetary doctrine could significantly
jeopardize present domination of the dollar and put China in the position where it would be
able to create domestic currency “ex nihilo” for its development goals. Furthermore, such
developments would go toward greater foreign investment and imports, i.e. the model that
only the US could use in the world triangle of willingness to accept its monetary coercion. If
that happens, world monetary system would be thoroughly shaken along with the
constellation of overall economic and political relations.
7. Conclusion
Primary money creation flows, as we have seen, speak a lot of economies of respective
countries and the degree of monetary sovereignty. During the time of instability triggered in
2007 by the crises of the mortgage market in the US, spread quickly to the EU and other parts
of the world. Furthermore, primary money creation flows, to be more exact, importance of
respective flows, changed dramatically. In the examples of the FED and the ECB we have
seen the historic dimension of respective channels of primary money creation which led to
new questions of relations among money creation, real economy and physiological effect on
market stability. Both mentioned central banks have used its monetary sovereignties to the
limit using the fixed interest rate with readiness to infinitely supply liquidity. Size of the
emission was not set in advance, thus did not exhibit endogenous characteristics. We could
say that endogenous factor dominated primary money creation due to above mentioned
central banks gauging its operations according to the state of the real economy, demands by
banks and other financial institutions, in some cases even non-financial ones.
In the example of the FED and the ECB, or better say Eurosystem, we could observe high
flexibility in combining respective primary money emission channels, techniques of fine
tuning and facilitating unobstructed flow of monetary policy transmission mechanism. We
could generally say that the primary money creation mechanism was crucial source of faster
recovery from the recession and higher growth rates. That was the key trigger used on time
and aimed at counter cyclical effects. It was based on well known fact that for stopping
recession crucial thing is the speed of actions which was only possible, within framework of
economic policy, through monetary policy.
27
Within the Eurosystem, which actual emitted primary money in a decentralized way, even
though the decisions were made on a super national level through the Governing Council of
the ECB, it is interesting to point out that the channels of primary money creation were
different among member countries. In financial crisis condition the EMU showed to be useful
since it is a monetary system which is completely defined with a fact that it is not a single
country. Primary money creation channels in this case were adjusted to specific countries in
the Eurosystem and to its monetary policy transmission mechanisms. Even though the ECB is
not a lender of last resort, joint decisions by the Governing Council were respected and
decentralized system of primary money creation worked. However, a question remains: will
this always be so and what would have happened in the case of individual monetary actions
within the system?
Selected transition countries even in the financial crisis kept its asset structures of national
banks unchanged. This means that they failed to use their monetary sovereignty or creation of
local currency in order to stop recession and through monetary factors start a counter cyclical
economic policy. Money creation remained exogenously given by the volume of foreign
exchange in assets of the national banks balance sheets. In the absence of monetary
intervention their economies remained in a prolonged state of recession with an unknown time
of recovery. In other words, they put their recovery in hands of the EU countries and the EMU
because they tied their currencies of primary money creation to the Euro. This lead to the
conclusion of a deeply dependent monetary system on periphery of the Eurosystem with all
the negative consequences that stem out of failing to use monetary sovereignty.
Historic size of primary money creation during the last financial crisis in the US and the EU
points to notion of efficiency of monetary policy in the short run and its advantages compared
to fiscal policy in speed of reaction and favorable effect on the interest rate. Primary money
creation flows used in the crisis show the best ways to achieve favorable effects of monetary
policy to the real economy through transmission mechanism tailored for respective economies
28
LITERATURE:
1. Aglietta M, Orlean A; Novac i suverenitet, Golden marketing-Tehnička knjiga, Zagreb
2004.
2. Bernanke, S.B.: Essays on the great Depression, Princeton University Press, New
Jersey, 2004
3. Bernanke, S.B.: Federal Reserve Policies to Ease Credit and Their Implications for
the Fed's Balance Sheet, At the National Press Club Luncheon, National Press Club,
Washington, D.C., February 18, 2009
4. Bernanke, S.B.: The Federal Reserve's Balance Sheet, At the Federal Reserve Bank of
Richmond 2009 Credit Markets Symposium, Charlotte, North Carolina, April 3, 2009
5. Bernanke, S.B.: Federal Reserve programs to strengthen credit markets and the
economy, Before the Committee on Financial Services, U.S. House of Representatives,
Washington, D.C., February 10, 2009
6. De Grauwe, P.: Economics of Monetary Union, Oxford University Press, Oxford,
2007
7. ECB Bulletin: The ECB s Response to the Financial Crisis, October 2010
8. Giannone, D., Lenza, M., Pill, H. i Reichlin, L.: Non-standard monetary policy
measures and monetary developments, ECB, 2010
9. Trichet, J.-C.: Current challenges for the euro area, Speech by Jean-Claude Trichet,
President of the ECB, “Lunchtime discussions” with the Spanish business community,
Madrid, 27 October 2008
10. Trichet, J.-C.: Lessons from the financial crisis, Keynote address by Jean-Claude
Trichet, President of the ECB, at the “Wirtschaftstag 2009” organised by the
Volksbanken and Raiffeisenbanken, Frankfurt am Main, 15 October 2009
11. Trichet, J.-C.: The ECB’s enhanced credit support, Keynote address by Jean-Claude
Trichet, President of the ECB, at the University of Munich, Munich, 13 July 2009
12. Web sites of national central banks
29
APPENDIX:
Figure 1: Greek National Bank asset structure (in billion Euros, IX/2008-XI.2010)
Source: Bank of Greece, www.bankofgreece.gr
Figure 2: Bundesbank asset structure (in billion Euros, IX/2008-XI.2010)
Source: Deutsche Bundesbank, www.bundesbank.de
30
Figure 3: Bank of Slovenia asset structure (in billion Euros, IX/2008-XI.2010)
Source: Bank of Slovenia, www.bsi.si
31
Table 1: FED asset structure (ond of period, absolute amounts – in million US$, and as percentage of total assets)
Assets (in mil.dollars)
12/2002
%
12/2005
%
12/2007
%
12/2008
%
12/2009
%
12/2010
%
1.
Reserve Bank credit
708.457
93,67
830.165
94,34
876.551
94,41
2.223.537
97,72
2.216.732
97,41
2.403.419
97,57
1.1.
Securities Held Outright
629.416
83,22
744.210
84,57
754.612
81,27
495.629
21,78
1.844.722
81,06
2.155.703
87,52
1.1.1.
U.S. Treasury securities
629.406
83,22
744.210
84,57
754.612
81,27
475.921
20,92
776.587
34,13
1.016.102
41,25
1.1.1.1.
Bills
226.682
29,97
271.270
30,83
241.856
26,05
18.423
0,81
18.423
0,81
18.423
0,75
1.1.1.2.
Notes and bonds, nominal
389.219
51,46
449.595
51,09
470.984
50,73
410.491
18,04
707.649
31,10
943.377
38,30
1.1.1.3.
Notes and bonds, inflation-indexed
12.242
1,62
19.983
2,27
36.911
3,98
41.071
1,80
44.643
1,96
48.125
1,95
1.1.1.4.
Inflation compensation
1.263
0,17
3.362
0,38
4.862
0,52
5.936
0,26
5.873
0,26
6.178
0,25
1.1.2.
Federal agency debt securities
10
0,00
0
0,00
0
0,00
19.708
0,87
159.879
7,03
147.460
5,99
1.1.3.
Mortgage-backed securities
0
0,00
0
0,00
0
0,00
0
0,00
908.257
39,91
992.141
40,28
1.2.
Other: Repurchase agreements
39.500
5,22
45.250
5,14
42.500
4,58
80.000
3,52
0
0,00
0
0,00
1.3.
Term auction credit
0
0,00
0
0,00
20.000
2,15
450.219
19,79
75.918
3,34
0
0,00
1.4.
Other loans
40
0,01
114
0,01
4.535
0,49
193.874
8,52
89.699
3,94
45.084
1,83
1.4.1.
Primary credit
0
0,00
41
0,00
4.513
0,49
93.769
4,12
19.111
0,84
58
0,00
1.4.2.
Secondary credit
0
0,00
0
0,00
0
0,00
15
0,00
980
0,04
17
0,00
1.4.3.
Seasonal credit
31
0,00
73
0,01
22
0,00
7
0,00
44
0,00
23
0,00
1.4.4.
Credit extended to American International Group, Inc., Net
0
0,00
0
0,00
0
0,00
38.914
1,71
22.033
0,97
20.282
0,82
1.4.5.
Term Asset-Backed Securities Loan Facility
0
0,00
0
0,00
0
0,00
0
0,00
47.532
2,09
24.704
1,00
1.4.6.
0
0,00
0
0,00
0
0,00
37.404
1,64
0
0,00
0
0,00
1.4.7.
Primary dealer and other broker-dealer credit
Asset-backed commercial paper money market mutual fund liquidity
facility
0
0,00
0
0,00
0
0,00
23.765
1,04
0
0,00
0
0,00
1.4.8.
Other credit extensions
0
0,00
0
0,00
0
0,00
0
0,00
0
0,00
0
0,00
1.5.
Net portfolio holdings of Commercial Paper Funding Facility LLC
0
0,00
0
0,00
0
0,00
334.102
14,68
14.072
0,62
NA
NA
1.6.
Net portfolio holdings of Maiden Lane LLC
0
0,00
0
0,00
0
0,00
27.023
1,19
26.667
1,17
26.974
1,10
1.7.
Net portfolio holdings of Maiden Lane II LLC
0
0,00
0
0,00
0
0,00
20.117
0,88
15.697
0,69
16.197
0,66
1.8.
0
0,00
0
0,00
0
0,00
26.785
1,18
22.660
1,00
23.142
0,94
0
0,00
0
0,00
0
0,00
0
0,00
298
0,01
665
0,03
1.10.
Net portfolio holdings of Maiden Lane III LLC
Net Portfolio Holdings of TALF LLC: Net portfolio holdings of TALF
LLC
Preferred Interests: Preferred interests in AIA Aurora LLC and ALICO
Holdings LLC
1.11.
Float
1.12.
Central bank liquidity swaps
1.13.
Other Federal Reserve
2.
Gold stock
3.
Special drawing rights certificate account
4.
Treasury currency outstanding
1.9.
Total factors supplying reserve funds
0
0,00
0
0,00
0
0,00
0
0,00
25.000
1,10
26.057
1,06
812
0,11
1.047
0,12
-347
-0,04
-1.494
-0,07
-1.956
-0,09
-1.624
-0,07
0
0,00
0
0,00
14.000
1,51
553.728
24,33
10.272
0,45
75
0,00
38.689
5,12
39.544
4,49
41.251
4,44
43.553
1,91
93.683
4,12
111.147
4,51
11.043
1,46
11.041
1,25
11.041
1,19
11.041
0,49
11.041
0,49
11.041
0,45
2.200
0,29
2.200
0,25
2.200
0,24
2.200
0,10
5.200
0,23
5.200
0,21
34.597
4,57
36.540
4,15
38.682
4,17
38.674
1,70
42.690
1,88
43.549
756.297
100,00
879.946
100,00
928.473
100,00
2.275.452
100,00
2.275.664
100,00
2.463.209
1,77
100,00
Source: Federal Reserve, www.federalreserve.gov
32
33