Política Monetaria
I. Fundamentals of Political Money Supply Regimes
Political Nature of Monetary Disorder: Contemporary monetary disorder, such as stagflation, is primarily the result of the behavior of government monetary agencies.
This behavior stems from the basic incentives and constraints facing the decision-makers within these agencies.
The problems of political influence over money are likely inherent in government supply of money and cannot be resolved by minor reforms or "depoliticizing" the agency while retaining the government's monopoly control.
Central Bank (Banca Central) Definition: A privileged institution with the monopolistic emission of the national unit of account.
It is charged with managing the public debt denominated in that unit.
It functions as a meta-bank or bank of banks, where its liabilities (M0) are held as reserves by the rest of the financial system.
Its typical functions include being the monopolist of currency issuance and historically being the "lender of last resort" (prestamista de última instancia).
Fiat Money Definition: Money that is not backed by a commodity (e.g., gold).
It is the asset the government mandates must be used to settle governmental debts and tax payments.
The term fiat means "hágase" (let it be done) in Latin.
Inflation Definition: The increase of the monetary supply in excess of its demand.
II. Political Origins and Historical Context of Central Banks
Purpose of Establishment: Central banks were not initially created for modern macroeconomic management (Keynesian demand management) but for reasons of state and to exercise official influence over money and credit.
Their creation antedates fiat money, as their initial liabilities were redeemable claims to precious metal.
Bank of England (BoE) Case: Founded in 1694 solely as a conduit for government borrowing to finance war.
The English government bestowed exclusive privileges upon the BoE, such as barring rival banks of more than six partners from issuing notes in 1708.
This political intervention created a legal monopoly of note issue in London and led to the concentration of reserves (the "one-reserve system").
Later acts, like the Bank Charter Act of 1844, deliberately sought to increase the controlling power of a single Bank of Issue to cement the fiscal relationship between the Bank and the State.
Federal Reserve (Fed) Case: The Fed was established much later to remedy shortcomings in the banking industry that arose from regulations designed to promote the sale of government debt.
The National Bank Act of 1863 forced issuing banks to buy federal bonds as collateral, making the currency supply notoriously "inelastic" and causing financial panics.
The Fed was initially mandated to supplement the gold standard, but after 1935, it gained a mandate and capacity to accommodate the Treasury’s borrowing needs and control the system centrally.
III. Incentives of Central Banks and Systematic Inflation
The Central Bank's power to expand the nominal stock of outside money (monetary base) is virtually unconstrained today.
1. Seigniorage (Government Finance): This occurs when the Central Bank monetizes federal debt, allowing the government to expand its command over goods and services without increasing explicit taxation or debt obligations.
The theory of seigniorage predicts systematic inflation because the government gains revenue by issuing additional base money.
Irregular monetary expansion (varying growth rates) may occur because gyrating the inflation rate can increase the real demand for base money, thus maximizing real seigniorage.
2. Bureaucratic Seigniorage (Assuming CB Independence): If the Central Bank is independent, officials are incentivized to maximize their discretionary profits.
Profits are consumed by padding expenditures (e.g., high salaries, lavish offices, travel budgets).
The Fed has an incentive to promote monetary expansion because, when monitoring is costly, it can "skim" a portion of the marginal seigniorage dollar into its own budget.
3. Political Business Cycles (Re-election Focus): The Central Bank may attempt to manipulate the money supply to influence macroeconomic conditions favorably, especially by stimulating the economy just prior to an election.
This strategy requires creating surprisingly high inflation to temporarily reduce unemployment, but fully anticipated inflation has no such effect.
Central Banks have an incentive to talk a tougher anti-inflation line than they actually follow and to disguise or misrepresent their readiness to use surprise inflation.
IV. Central Bank Operations and Rescue Mechanisms
How Money Enters the Economy: Central Banks primarily inject money through Open Market Operations (Operaciones de mercado abierto).
The CB buys bonds from the state, injecting money into the economy.
Central Bank Rescues (Liquidity Risk): Central Banks protect commercial banks from liquidity risk.
Discount Window (Ventanilla de Descuento): A mechanism where banks can request refinancing using collateral, though it charges a higher type of interest and is viewed as a bad signal by the market.
Open Market Operations (Repos): Temporary lending through Repurchase Agreements (Repos). The CB buys assets (like bonds) with a promise of repurchase, essentially giving a short-term loan that can be extended indefinitely.
Government Rescues (Insolvency Risk): Governments protect banks from insolvency risk.
Deposit Guarantee Funds (Fondo de garantía de depósitos): Governments guarantee specific creditors (depositors) up to a limit (e.g., $250,000 or €100,000) to prevent a contraction of the monetary supply.
This fund creates a perverse incentive (moral hazard) for creditors, as they are not incentivized to audit the bank or ensure it avoids maturity mismatch because losses are covered by the state.
Too Big to Fail Schemes: Governments prevent any creditor of a systemically important bank from suffering losses to avoid widespread liquidation.
Governments recapitalize banks by buying newly issued shares, buying assets at inflated prices (banco malo), or gifting public debt.
V. Maturity Mismatch, Risk, and the Economic Cycle
The Central Bank aggravates the economic cycle and generates moral hazard by permitting the maturity mismatch (descalce de plazos).
Maturity Mismatch: This is an endogenous explanation of the cycle where banks invest in assets (loans) long-term and finance themselves with liabilities (deposits) short-term.
Maximizing Profitability: Banks maximize profit by increasing the interest charged on assets ($\text{iA}$) and reducing the interest paid on liabilities ($\text{iP}$).
They achieve this by granting long-term, high-risk loans (maximizing $\text{iA}$) and relying on short-term, low-interest deposits (minimizing $\text{iP}$).
This also maximizes risk, creating the threat of illiquidity (short-term inability to pay creditors) and insolvency (long-term inability to pay creditors), with illiquidity often leading to insolvency.
Initiation of the Cycle: Banks arbitrage the yield curve by demanding long-term bonds, which increases their price and lowers the long-term interest rate.
This reduction in the long-term interest rate initiates the economic cycle by incentivizing longer-term investments (investing capital structures).
The Crisis (Inverted Yield Curve): As investors face debt obligations and poor sales, they seek immediate liquidity, typically by issuing short-term bonds.
The increased supply of short-term bonds causes their price to fall and their interest rate to rise, leading to the inversion of the yield curve (curva de rendimientos invertida), which is considered the best signal of an impending crisis.
Moral Hazard: Since the State protects banks from liquidity and insolvency risks, the bank's moral risk increases, leading them to deliberately undertake more short-term debt and high-risk assets.
Banks frequently evade state regulations meant to counter this moral risk through mechanisms like shadow banking (banca de la sombra).