Currently, new fiat money is generally created by central banks that gives out that money as loans, or more recently, by central banks simply creating money to buy assets (called quantitative easing).

What would likely the effects be, if a new country decided that their central banks created a fixed amount of money per year, let's say 4% new money per year, and gave this money directly to the government? 
 

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Arguments for:

  • This would create a predictable amount of created money every year.
  • It might be an effective "tax" compared to taxing work or profit, since those taxes disincentivize work/investments.
  • Since the amount is fixed, the risk of constant decrease of interest rate to temporarily boost the economy, disappears.
  • To my understanding, it should decrease the amount of bad investments, since today's interest rates, are well below inflation, so investing in something with little/no growth can be profitable, assuming it has low risk.

Arguments against

  • The central banks can't steer the economy, for example by lowering interest rates during recession (this might be a good thing, since they extremely unlikely can do better predictions than the free market anyways)
  • Risk of deflation, especially if growth surpasses 4% per year. One big problem with deflation, is that it's very tricky to lower salaries of employees (usually employees expect an increase of salary every year).

Unsure if for or against

  • Today's central banks reallocate money from high cash people and businesses (since value of cash decreases), to people and businesses with high loans. 

    Generally poor people have more of their money in cash, and wealthier have more loans on their investment (ex mortages) and are therefore net negative on cash. Arguably, this redistribution can increase growth, since high leverage businesses and people getting loans for houses, invests their money. 

This is a complicated topic. https://www.amazon.com/Secrets-Temple-Federal-Reserve-Country/dp/0671675567 provides a good overview of the origins and purpose of the Federal Reserve system.

7 comments, sorted by Click to highlight new comments since: Today at 11:03 PM

Who has the authority to enforce this plan when the government wants to spend more than they have? Even if it were enforceable, it runs into the standard monetary-policy-mismatch boom/bust problems as the real economy (actual trade in goods and services) expands faster or slower than 4%.

Interesting comment and good points that I had not considered.

I guess there is a risk of the government simply taking control of the central bank whenever they want (assuming they don't already have control from the start), and then set the interest rate to whatever they want (most likely something very low, so they can spend extra, perhaps during a war). However, to me it seems likely, that governments will have a harder time changing a fixed rate, than a dynamic one. Further, the currency's value would likely drop abruptly if the government would decide to change the fixed rate, since then there is no guarantee what they will do with the currency. I'd love to hear your thoughts on this.

I wonder if having a decentralized currency might solve these issues, since the fixed rate would be "impossible" to tamper. 

For your statement about boom/bust problems, I would argue that current systems with central banks is somewhat more likely to cause booms and busts, since what generally happens, is that interest rates are lowered, and leverage is increased, to the point it's no longer sustainable, and there is a bust (like 1929). If the rate is fixed, the market should regulate itself, and be stable over time. Do you disagree with this being the case? If so, I would like to hear your reasoning.

What will the govt use the money for, if not provide loans and investments to existing companies? Is it simply that the govt can exercise more discretion around "social good" when picking companies, that the average bank would?

Good question. I agree it's not obvious whether the government would use the money better than companies picked by banks.

The money could replace certain taxes. It might be more efficient to simply decrease taxes for all companies (and maybe people too), rather than having banks pick companies. I don't claim to know this to be true, but it seems plausible. What do you think?

Currently: Taxes are charged based on profits/sales from the current production cycle. New money is created based on projections made by companies for the next production cycle. (So reducing taxes and money printed together is not a net zero operation.)

This is by design - there's a reliable signal on how much excess capacity (of some sort) exists today in the country/civilisation, and the central bank and banks together then decide how much of it to risk into creating even more capacity.

I would recommend this article by Bank of England to understand how it all works. It's not particularly easy to understand, but absolutely worth it imo.

I appreciate your effort to help me understand, since I genuinely am interested in this question. As you say, the current system was designed  the way it was for a reason, and so our starting assumption should be that any idea we have for a change, should underperform.

Do I understand your reasoning correct, that the current system creates a fairly optimal amount of capital that is invested (instead of consumed), and therefore can balance investments into future production, and consumption today?

"Optimal" is an incredibly high bar :p

But even practically, I do think we can build better systems. But yes doing so requires understanding a fair amount of the complexity of existing systems.