Criticism of central banks

If you think that the criticism of central banks began with the advent of cryptocurrencies, then you are mistaken. It has a long history. The monopoly position of the central bank has often led to abuses of this position, especially by heads of State. Historically, these abuses have included diluting coins with cheaper metals. For monarchs, it was a very popular way to pay off debts.

Thus, money was devalued, and the monarch, who had a monopoly on mints, enriched himself. This is a problem that Adam Smith, who mentioned many times in his book “The Wealth of Nations”, really considered in detail. Smith was really versatile, and the wash of what was written was practically not outdated.

For this reason, central banks are independent of the government. Accordingly, this is how it should be in modern economies. However, of course, this does not work in various countries and banana republics. More precisely, they become something like the personal treasury of local rulers.

But modern history remembers such actions in Europe. An excellent example is the Imperial Bank of Germany, which was completely under the control of the central government. As soon as the government issued the bonds, Imperial Bank repurchased them with newly printed money. This led to a catastrophic devaluation of the mark and hyperinflation.

Thanks to this historical experience, central banks should be completely independent. But, as you understand, independence does not mean that they cannot coordinate their policies with the government. By the way, one hundred percent independence is simply an unattainable ideal. The leadership of the central bank is often under political pressure. Therefore, it is impossible to say with certainty that they cannot be completely influenced.

Thus, independence itself can be almost formal. This is due to the fact that central banks are expected to help the central government. Indeed, if monetary policy conflicts with fiscal policy, serious economic problems may arise. And recently, there has indeed been a tendency for central banks to become more and more subordinate to the policies of their governments.

Central banks and inflation

In general, the independence of the central bank is not just good. An independent central bank is much better able to ensure a low level of inflation in the economy. At least at one time it looked like there was a clear consensus. However, this is not entirely true, because, for example, the Austrian school is quite receptive to the independence of central banks.

Hayek and Friedman are among the most famous critics of the Austrian school. But Hayek criticizes central planning in general. According to him, it is not in the power of one institution to effectively manage the economy or individual parts. As you can probably guess, central banks have enormous power. And their strength is growing because, in addition to the base interest rate, they have other tools, such as quantitative easing.

Friedman considered the independence of the central bank a serious problem. To paraphrase him, he called them a form of dictatorship. Central banks can do what they like and are accountable to no one. If they have a bad policy, no one will do anything about it. Apart from open criticism, there is no way to force the central bank to pursue responsible monetary policy.

Friedman proposed a solution in the form of transferring monetary policy to the Ministry of Finance. Consequently, the growth of the money supply will be under the control of this government. Friedman believed that the ministry was headed by a politician who could be held accountable. However, supporters of Friedman’s independent monetary policy are critical of this, since a politically controlled body can no longer pursue a purely responsible policy because it has its own interests.

US Inflation

During 2020/2021, this particular criticism of central banks has come to the fore again. Central banks around the world are criticized for actions that do not belong to their institutions at all, such as buying shares. The Federal Reserve, for example, is sharply criticized for aggressive soft monetary policy, and many are blamed for high inflation. But apart from criticism, no one can do anything. Most people don’t care about what the central bank is actually doing.

Criticism of central banks in connection with crises

Criticism of central banks also applies to financial crises. Milton Friedman was of the opinion that the Fed conducted an erroneous restrictive monetary policy at the turn of the 20-30s, which led to the Great Depression. After the stock market crash in 1929, the Federal Reserve System continued its restrictive monetary policy, which led to a reduction in the money supply.

Money supply during the crisis

During the Great Depression, the money supply fell by 1/3. Milton Friedman just thought that if the central bank reacted correctly, there would be a moderate recession in the economy. In particular, he saw the main reason for the deep crisis in the sharp reduction of the money supply. According to critics, the Federal Reserve System is responsible for very high inflation in the US in the 1970s.

Helicopter money

Helicopter money (direct financial aid distributed to households or businesses) was first used by Milton Friedman in connection with monetary expansion. However, the perception of the helicopter money concept has changed significantly over time. In fact, it is considered a viable monetary policy tool. For example, among helicopter money, a quantitative easing tool is very often mentioned.

Quantitative easing will only overwhelm the banking system with liquidity and radically lower interest rates across the yield curve. But helicopter money goes much further: in fact, the central bank will give people the money it printed, and even bypass the state (social benefits and similar transfers).

Monetary turnover in the M2 aggregate. Source: tradingeconomics.com

Want to know why central banks do this? To avoid a crisis and deflation in a situation called a liquidity trap. When a liquidity trap occurs, the money supply is completely absorbed by economic units. Think of it as a prison for money that they can’t get out of. Without money turnover, the economy does not work.

Therefore, the concept described today is becoming increasingly popular among economists from different countries. Such a policy cannot do without negative consequences. Nothing is solved, the problem is just postponed.

Central Banks and Cryptocurrencies

The central bank is trying to prevent the threat that cryptocurrencies pose to the stability of their global financial systems. According to Coinmarketrate.com, more than 13,000 cryptocurrencies pose a threat according to the Central Bank. They cannot afford to lose control of the money supply and interest rates. The proposed solution to this very urgent problem is the issuance by central banks of their own digital currencies – CBDC. But if they keep them under control, they can also cause serious shocks.

For several years, several major central banks have been developing and are ready to issue a national digital currency in one form or another. Currently, work is underway in the US Federal Reserve System (FRS), the European Central Bank (ECB) and the Bank of England.

China in the vanguard

The People’s Bank of China is ahead of everyone. She created a national cryptocurrency that works through a phone application. The stated goal is to replace cash, improve access to financial services and build more efficient payment systems across the country. China already has a very sophisticated telephone payment network, and the public seems to be the least concerned about protecting privacy.

The digital currency issued by the central bank (CBDC) is somewhat similar to Bitcoin, but it is issued in the national currency, and hardly on the blockchain. Therefore, we may soon see the birth of “eurocoin” or “britcoin”, stored in individual accounts opened with the central bank.

The benefits for governments are, first of all, to prevent the current threat posed by private digital currencies to financial stability and their economic power, as well as to maintain control over the money supply and interest rates to support economic policy.

In addition, central banks will have better information about how people spend, and it will be easier for them to manage “helicopter money”. CBDCs would also provide more flexibility on negative interest rates if they led to the abolition of cash currency. This can help lift the economy during a recession.

But for some reason, central banks are silent about the fact that this will destabilize the banking system.

They say CBDC holders will benefit from a risk-free asset because, unlike commercial banks, central banks cannot go bankrupt. Payment processes will also be much cheaper, faster and easier for international movements of funds. There will be no other banks, commercial ones. The Central Bank will simply destroy them.

In conclusion

Criticism of central banks is very important and popular now. Yes, many people have nothing against monetary policy being managed by these institutions. But there must be a way to motivate the Central Bank to pursue a responsible monetary policy.

Currently, there are practically no such mechanisms, so it remains only to criticize. For example, because they do not contain inflation, and instead support the central government in building up dangerous debt. But none of the politicians will support you, because politicians who criticize central banks are like a unicorn.