Chapter 4. In a fiat standard, the money is not useful for any non-monetary purpose, or redeemable for any commodity with a non-monetary use. Fiat monies historically emerged not from market forces but from default on gold-redeemable central-bank or Treasury liabilities. The quantity and purchasing power of fiat money obeys the logic of supply and demand in the special form of the Quantity Theory of Money. Central banks control the growth rate of the quantity of money and thereby the rate of inflation. In principle fiat standards could produce lower inflation, but in practice have produced higher inflation than silver or gold standards. Higher inflation imposes real burdens on the public. These burdens, especially when we include the expenditure of labor and capital to produce hedges against inflation, has exceeded the resource burden of a gold standard.

Chapter 6 demonstrates why the Eurosystem is not an operationally decentralized central bank (like the Fed), but a system of currency boards that is at risk of collapse because individual national central banks (NCBs) can go bankrupt. The ECB and the nineteen NCBs that make up the Eurosystem represent twenty independent profit and loss centers. No individual NCB can decide on the amount of monetary issuance it can engage in. That is a collective decision of the Governing Council of the ECB.

From the perspective of an individual NCB it is as if all its euro-denominated debt is foreign-currency denominated. Own-risk activities undertaken by NCBs have vastly increased in scope and scale. Individual NCBs therefore can become insolvent even if the consolidated Eurosystem is solvent.

Reducing or, preferably, eliminating own-risk activities by NCBs is one obvious solution. Another is reducing the riskiness of the assets that some NCBs and the commercial banks in their jurisdictions are exposed to. This could be done through financial engineering, through sovereign risk sharing or through regulatory measures limiting the exposure of banks to any counterparty, including their own sovereign.

Chapter 3 considers the analytics of helicopter money drops – monetized fiscal stimuli. These will always boost nominal aggregate demand because central banking is profitable (interest rates on assets exceed those on liabilities and/or central bank money is irredeemable). This Chapter also summarizes some of the key results of the first three chapters in the following propositions.

1: A central bank can be solvent with negative conventional equity.

2: Central bank current and future resources are ‘tax payers’ money,’ because the Treasury is the beneficial owner of the central bank.

3: The cancellation of Treasury debt purchased by the central bank is equivalent to the central bank holding that additional Treasury debt forever.

4: QE that is permanent/irreversible in present discounted value terms creates fiscal space for a deferred helicopter money drop.

5: A helicopter money drop today boosts demand even in a permanent liquidity trap, when the nominal interest rate is at the zero lower bound (ZLB) forever.

6: Lack of nominal effective demand is a policy choice or the result of a failure of cooperation and coordination between the central bank and the Treasury, not an unavoidable fate, even for an economy apparently stuck at the ZLB.

The original inspiration for this volume was the Frederico Caffè Lectures I gave in Rome on December 13–14, 2011. Quite a lot of water has flown down the Tiber since then and my thinking about the monetary and fiscal policy issues I addressed in the lectures has evolved and, I hope, become more coherent.

The simple idea that motivates most of this book is that central banks make a significant, indeed at times essential, contribution to the fiscal space of the sovereign. This is because the ability to issue monetary liabilities, especially currency, is a source of profits to the central bank.

Chapter 1 starts with a brief overview of the facts about the advanced economy central bank balance sheet explosion since the Great Financial Crisis. The increase in profit remittances by the Fed to the US Treasury during the post-GFC years of extraordinarily low policy rates stands out. The Chapter then delves into the analytics of seigniorage arithmetic and how seigniorage revenues can boost fiscal space. Away from the ELB, the real value of the seigniorage (as a share of GDP) that can be extracted at a target rate of inflation of, say, 2 percent is rather small – typically well under 0.5% of GDP for most advanced economies. At the ELB, however, seigniorage can be truly massive.

Chapter 5 uses the model of the previous Chapter to discuss three ways to eliminate the zero lower bound on nominal interest rates: (1) abolish currency; (2) tax currency’ and (3) introduce a variable exchange rate between currency and bank reserves (deposits) with the central bank. We come down in favor of getting rid of cash as the most robust of these three options. This would have the further advantage of eliminating a preferred store of value and means of payment for illegal activities. There are both economic and political costs associated with the abolition of cash, however. Some of these can be addressed or at least mitigated by eliminating only the larger denomination currency notes. This would lower the effective lower bound without eliminating it.

We confirm that helicopter money drops stimulate nominal aggregate demand even when the economy is permanently at the zero lower bound.

Chapter 3 addresses one of the most fundamental issues in war: how to pay for it. In Southeast Asia, the main Japanese strategy was to print money. That effectively shifted the costs of being occupied onto Southeast Asians. The chapter investigates why rapid monetary expansion caused less inflation than could have been expected and true hyperinflation only near the end of the war.