Why not just monetize spending?

Monetary tools in practice seem to be too clunky to boost spending. Why do central banks not just type money and subsidize spending?

Conducting a public service called monetary policy does not necessitate central banks to act in banking boundaries.

A central bank should be able to monetize spending without creating debt relationships. Thus, fiat money would have materialized its full capacity for public interest.

Central bank funds allocated into asset purchases do not necessarily finance spending. Instead of purchasing goods and services, asset issuers own stocks and bonds.

Monetization of spending

Central banks lend or borrow money in their operations. Conventional monetary tools are conducted via banks whereas quantitative easing has been directly financing commercial securities since the 2008 financial crisis. Despite a trillion-dollars rise in money supply through QE, negative output gap could not have been closed in many cases. Current tools seem to be too complex to yield expected results. Why do central banks not just type money and subsidize spending?

Handling of the tool under a central bank would ensure an inflation on track. Central bank transfers would ensure an instant raise in spending. Via a much smaller magnitude of transfers with respect to quantitative easing, a central bank would be able to fill the negative output gap and suffocate the recession. Inflation should not be a concern during a recession as it is the aim of a central bank to raise the inflation rate up to the target level. Once the 2% target is hit, the central bank would stop subsidies and raise interest rates to slow down the money supply.

Another reserve against monetization of spending would be that fiscal policy can already subsidize spending through debt, which is a kind of money. It is true that both money and treasuries are the liabilities of a country. However, they don't count the same in terms of statistics. A high debt-to-GDP ratio is an indicator of fiscal performance taken into account by the rating institutions. Trust to the financial soundness of a government may deteriorate due to surging public debt. Alternatively, a substantial expansion of money supply has become an ordinary practice of central banks.

Meanwhile, transfers don't further fuel private debt as opposed to the current central bank practices. Overindebtedness renders the financial system fragile. Debt service capacity of overleveraged borrowers is more fragile to deviations in their income. Their default impairs the system, as their equity falls short of the debt. Transfer of funds would rather alleviate the need for additional debt.

Monetization of spending would substantially contribute to recovery. Central bank funds allocated into asset purchases do not necessarily finance spending. Instead of purchasing goods and services, asset issuers may own stocks and bonds. Such an attitude appears to be rational. Easy access to funds would not promote investment in the uncertainty of a recession. Companies would rather invest in financial assets and, hence, trigger an asset price bubble.

A targeted spending tool, however, would ensure funds spent in an efficient way. A central bank can tap credit cards with money and require card holders to spend it in a limited time. Thus, a shrinking output gap would be guaranteed. Furthermore, the central bank can decide the sectors included in the program. Thus, the tool would only target the sectors which need greater stimulus. In cases such as COVID-19, distinguishing between sectors would lead to the efficient use of monetary resources. When monetary policy finances exactly the sectors in need, a much smaller monetary expansion would generate expected results in growth and inflation.

Impacts of QE and monetization of spending would also differentiate in terms of income equality. Through QE, the Fed alleviates funding costs of corporations while consumer loan rates remain near to 10%. During a recession, individuals default on their debt, being unable to pay the interest burden. Moreover, banks' contraction of consumer credits exacerbate the financial position of individuals whose income has already fallen due to layoffs and business shutdowns. Each recession thereby widens the income gap between the poor and the rich. As observed on the graph, the top 1% of the US population has gained wealth from the rest since the 2008 financial crisis. Monetization of spending would reverse this trend. Low income groups would compensate their income losses via central bank funds and would not bottom out in every crisis.

Legitimacy and independence of central bank

Existing laws do not allow central banks to write checks to ordinary people. Yet, laws are changeable. So, what prevents law makers from authorizing central banks to directly finance spending? The underlying reason might be the independence and legitimacy of central bank. Without a democratic legitimacy, monetization of spending might be too much for a central bank.

Nevertheless, a code with well drawn limits could overcome the legitimacy issue. In order not to vitiate its independence, a central bank should not transfer funds to the treasury. The code should authorize the central bank to directly subsidize lower income groups. The code should also set the criteria for beneficiaries, so that the central bank would not need to make any political choices in its policy implementation. Such a framework would enable the central bank to adjust the tool with respect to inflation without being subject to political pressure.

Indeed, central bank independence would enable the exercise of such a tool. In the absence of an independent central bank, fiscal authorities would subsidize spending not only when inflation is below that target but also when elections are approaching. It is short-term political aims that has necessitated independence of central banks. As objective institutions, central banks also save politics from business cycles. Through smoothing out output deviations, they eliminate the conjunctural luck factor for politicians. As an effective tool, monetization of spending would serve absorption shocks exogenous to the policy makers.

Conclusion

So far, central banks have operated as banks. They have either borrowed or lent money. Nevertheless, conducting a public service called monetary policy does not necessitate central banks to act in banking boundaries. A central bank should be able transfer funds to consumers without creating debt relationships. Thus, fiat money would have materialized its full capacity for public interest.