Tag: financial stability

Amazon Blue Front Economist

Central Bank Operations

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Setting interest rates

In the current financial system, central banks manage the money supply via interest rates. When the central bank lowers interest rates, borrowing money becomes cheaper, making it more attractive to go into debt for consumption or investment. As a result, the money supply increases at a faster pace, which then boosts consumption and investment. When the central bank raises interest rates, the opposite happens, and the money supply increases at a slower pace, or even decreases.

Central banks boost the money supply because usury promotes a money shortage. Most money is a debt, on which debtors pay interest. Debtors must return more than they borrowed. That money may not be available if those with surpluses don’t spend their balances, requiring more borrowing to prevent a disruption in the money flows. Classical economics questions this idea. If the money flows become interrupted, sellers lower their prices, and those with money will spend more to pick up these bargains.

Transmission via the bond markets

Based on estimates of future short-term central bank interest rates, financial institutions such as banks borrow short-term money from the central bank at the interest rate set by the central bank to buy longer-term government bonds. If banks expect the short-term interest rate to remain below 2% in the coming year and 1-year government bonds yield 3%, they may borrow short-term money from the central bank to buy these bonds, repay them when they mature, and pocket the 1% difference.

The trade creates demand for these bonds, causing their price to rise and their yield to drop. Perhaps traders stop buying the bond when the interest rate drops to 2.5% because there is always a risk that the central bank will raise interest rates during that year. If 10-year bonds yield 4%, another trader might sell 1-year bonds and invest the proceeds in 10-year bonds, thereby lowering their yield as well. Usually, this happens in future markets, so traders often don’t own these bonds.

Altering markets

Central bank critics argue that they distort markets by eliminating the market mechanism. Central bank interventions have a profound impact on the operation of financial markets. As a result, there is more lending than would have occurred otherwise. Central banks create liquidity in financial markets by providing short-term funds that banks use to buy bonds with different maturities. It allows banks to buy and sell these government bonds, enabling them to match their lending and borrowing needs at any time.

So, how does that work? Apart from lending to customers, banks invest in government bonds, which they can sell at any time, as they can trade government bonds in financial markets. If a corporation requests a one-million-euro loan that matures in five years, the bank might sell a five-year government bond. In that case, the bank eliminates the interest risk, as it knows the amount of interest it would have received by keeping the bond and the interest it will receive from the loan.

In the past, banks had to be careful because they couldn’t borrow easily from the central bank, nor did they invest in or trade government bonds. So, if you applied for a mortgage, the bank looked for matching term deposits. Perhaps you could obtain a 5-year mortgage if there were sufficient 5-year deposits available. If, after five years, the bank lacked adequate deposits, you would not be able to renew your mortgage and might have to sell your home. And so, you would think twice before getting a mortgage.

Economists call these markets inefficient. You couldn’t get a 30-year mortgage. The operation of central banks has altered financial markets, making them more efficient. That can be beneficial for the economy. The Industrial Revolution started in England. England had the most efficient financial markets. The central bank needs the trust of financial markets. Financial markets can lose confidence, which can lead to a decline in the currency’s value. A central bank can try to restore trust by raising interest rates.

Subsidising the financial sector

Central banks reduce the risk of bank failures. When borrowers repay their debts, banks are solvent. However, they may find themselves short of cash in their vaults when depositors withdraw their deposits. Central banks create this money if needed, so banks need less cash in their vaults. Central banks can also rescue banks in trouble, thereby reducing the risk to the broader economy. After all, a financial crisis can lead to an economic crisis, such as the Great Depression. That nearly happened in 2008.

There are public benefits to stabilising the financial system, but these benefits exist due to interest on money and debts, thus usury. Usury creates a shortage of funds that requires management. Central banks subsidise the financial sector in the following ways:

  • Central banks mitigate the risk of systemic failure, enabling financial institutions to take on more risk and lend more. Banks may make risky loans to profit from higher interest rates, assuming the central bank will bail them out if things go wrong.
  • Central banks signal their intentions to financial markets. When the central bank intends to change interest rates, it provides advance notice so financial institutions aren’t caught off guard and can adjust their bond portfolios accordingly.

The supply and demand of funds in the financial markets ultimately determine interest rates. Still, these markets would operate differently without central banks, with significantly less borrowing and lending. Central banks make the financial system function more smoothly and reduce the risk of systemic failure. As a result, interest rates are lower than they would have been otherwise.

Central banks are powerful, undemocratic, technocratic institutions. Since the 1970s, they have become independent from governments. Before that time, governments used their central banks to finance their deficits through money printing, leading to inflation and a loss of trust in currencies. Making the central bank independent from politicians and giving it a mandate to keep inflation low was a move to instil confidence in fiat currencies.

The argument in favour of central bank independence is that a government must be trustworthy to its creditors. Creditors, like most of us, don’t trust politicians because they spend other people’s money. Since then, governments have borrowed in financial markets and paid interest on their debts. Central banks still buy government debt and return the interest to the government, which is the same as printing money outright.

Central banks can impede the functioning of financial markets by mispricing risk. Central banks can save banks in trouble by printing money. Without central banks, financial institutions would have to be more careful. Bank failures would occur more often, and banks would pay more interest to depositors to compensate for that risk. That negatively impacts economic growth and leads to crises. That is why central banks exist.

Signalling intentions

Central banks signal their intentions in advance to prevent traders from being caught off guard, thereby avoiding chaos in financial markets. That issue became at the centre of a drama that played out in the UK bond markets in September 2022. Interest rates spiked after the government announced a massive spending package. It suddenly became clear that the Bank of England might have to raise interest rates much further than previously thought to contain inflation. The spending plan caught financial institutions off guard. The Bank of England had to intervene in the bond market to bring down interest rates.

Financial institutions borrow short-term money from the central bank and invest it in the bond market. To borrow this money, financial institutions pledge these bonds as collateral, just like your house is the collateral for your mortgage. If interest rates rise, the value of these bonds decreases due to discounting the interest. A UK bond trader noted, ‘If there was no intervention today, yields on UK government bonds could have gone up to 7-8 per cent from 4.5 this morning, and in that situation, around 90 per cent of UK pension funds would have run out of collateral. They would have been wiped out.’

An institution might bring in £1,000,000 in equity to borrow £9,000,000 from the Bank of England at an interest rate of 1.75% and invest £10,000,000 in ten-year bonds at 3% interest, pledging the bonds as collateral for the loan. The institution could earn £142,500 per year on a £1,000,000 investment, yielding a handsome 14.25% return if market conditions remain stable. But it is a dangerous bet due to discounting. The price of a bond is its net present value. If the yield on ten-year bonds were suddenly to rise from 3 to 4%, the institution would incur a loss of £811,090, which is the difference in net present value of the bond. That would nearly wipe out the entire equity. And that happened that day.

In the past, pension funds invested in bonds for the long term, but bond yields were low. Pension funds have fixed obligations, such as paying a retiree €1,000 per month until they die. If interest rates are low, you have to pay more in pension premiums to arrive at that amount. To pump up their revenues, pension funds invested in stocks and speculated in the bond market using leverage. It seemed like easy money because central banks signal their intentions in advance. This time, however, the government took the traders by surprise, so the central bank had to rescue them.

Permanent liquidity

When there is liquidity in financial markets, you can buy or sell financial instruments like stocks and bonds at any time. In other words, you can sell them in the financial markets for currencies like the euro or the US dollar. During a financial crisis, liquidity becomes scarce, and it becomes harder to sell financial instruments. Their price collapses because there are many sellers and few buyers. Only cash and government bonds perform well in those times. Financial pundits refer to it as a flight into safety. To prevent a crisis, central banks inject liquidity into the financial system. In other words, they lower interest rates, making it attractive for investors to borrow from the central bank.

In this way, the central bank prints new money. It can end the crisis because investors can use this new cash to buy stocks. Since the 1987 stock market crash, central banks have increasingly resorted to adding liquidity or printing money to quell financial crises. If currency is plentiful, short-term interest rates drop, and stocks and bonds become more attractive investments, so there will be buyers. Once interest rates are near zero, the central bank can’t lower them; market participants may accumulate central bank currency rather than invest in stocks because they find an interest rate of zero more attractive.

In such a situation, investors will not invest but instead hold onto their cash. With interest rates near zero, traditional methods for addressing financial crises have become ineffective. That is why central banks adopted extraordinary measures, such as quantitative easing (QE), in the aftermath of the 2008 financial crisis and the 2012 euro crisis. Investors say, ‘Cash is king.’ It is the ultimate means of payment. If your bank goes bankrupt, your deposit might be gone. But you can still pay with banknotes, which are the central bank’s currency.

During a financial crisis, people worry about whether their stocks will retain value in the future, as the economy may collapse. That is why investors also prefer central bank currency. But that is only due to the interest rate on cash. If there had been a 12% annual holding fee on central bank currency and cash, investors would seek alternatives to cash and central bank currency, and the market would always maintain liquidity, so that the central bank doesn’t have to take action. In that case, we may not need a central bank, and central bank currency becomes a unit of account or administrative currency.

In times of crisis, investors often rush to buy safe financial instruments, such as government bonds. With Natural Money, administrative currency is unattractive because of the holding fee. Holding on to the currency will cost you 12% per year, which means that a euro will be worth 88 cents after a year. And so, interest rates on government debt may be as low as needed, such as -5%, to make other investments more attractive and bring liquidity back into the markets. And so, there will always be liquidity.

No one wants to own currency that costs 12% per year to hold. It will mark the end of the administrative currency’s role as a reserve. Currently, banks are required to keep the central bank’s currency to meet their reserve requirements. That is unnecessary. Equity requirements are more helpful than currency reserve requirements. Government debt can also serve as a suitable reserve. Currently, banknotes are also the central bank’s currency. A 12% holding fee would make cash unattractive to use. Cash should have a backing of short-term government debt with a more favourable interest rate.

Latest revision: 13 November 2025

Featured image: Ara Economicus. Beverly Lussier (2004). Wikimedia Commons. Public Domain.

Banking Operations

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Commercial versus savings banks

Historically, the banking sector comprised several types of banks. The distinction between commercial banks, which create money, and savings banks, which don’t, has lost its value due to the existence of efficient financial markets, where banks match terms through borrowing and lending. The distinction between created money and savings is arbitrary, as the following example demonstrates. Suppose that I work at a farm, and the farmer rewards me with a plot of land and leftover wood and materials from a defunct shed, which I use to build my home. After finishing my house, I go to the bank and take out a mortgage. The bank creates money out of thin air.

Until I went to the bank, no money had changed hands. Still, I was able to save for a home of my own. In other words, savings aren’t the same as money in a savings account. In this case, my savings are my home, and if the mortgage is a debt, the money I take out is my savings. To further illustrate the point, suppose that I have no money and also own no home. When I go to the bank for a car loan, the bank creates this money on the spot. If you think there are no savings, you are wrong again. The person who sold you the car had saved the car. I can even borrow money and put it in a savings account. And so, I created savings from thin air by borrowing money and lending it to the bank.

Full-reserve banking

A well-known monetary reform proposal is full reserve banking, as outlined in the Chicago Plan, which means there are only savings banks and no commercial banks that create money. It often resurfaces when banks go bankrupt. With full reserve banking, banks can’t lend out funds deposited in demand accounts or current accounts. Money in these accounts isn’t debt but backed by central bank currency or cash. And depositors can’t withdraw the money from their savings accounts on short notice. In this way, banks can’t go bankrupt because of depositors demanding payment in cash. With full reserve banking, loans must come from savings, which are funds that depositors can’t withdraw on demand, as they have entrusted them to the bank for an extended period.

Lack of cash is usually not the primary reason banks fail, but rather, loan write-offs. That was also the case during the 2008 financial crisis. Full reserve banking addresses a liquidity problem, whereas the crisis was a solvency issue that subsequently led to a liquidity issue. Banks ran into trouble, not because they lacked cash, but because they incurred losses on their loans. As a result, banks began to distrust one another and stopped lending to each other. The financial system can be safe with zero reserve banking, provided that banks are solvent, thus have sufficient capital, and own adequate liquid assets, such as government bonds, that they can sell to meet withdrawals. And so, a reserve requirement can better include liquid safe assets, such as government bonds, rather than currency alone.

Some proponents of full reserve banking are socialists who oppose privately controlled money creation, as they view it as a public subsidy to the private banking sector. Others desire a banking sector free from government interference, so a ‘free’ banking market without central bank interventions and deposit guarantees. At least that is something socialists and their opponents might agree on. Bank credit can contribute to economic cycles and financial crises. With full reserve banking, there would be less bank credit, and interest rates would be higher. To make lending possible, depositors must part with their money for a designated period of time to make it available for lending. As a result, fewer funds are available for lending, and interest rates would be higher.

Shadow banks

Full-reserve banking makes financial markets less efficient, allowing alternative schemes, such as shadow banks, to fill the gap. An example can illustrate that. Suppose that God has ordered banks only to use money in savings accounts for lending so that there is full reserve banking in Paradise. Eve and Adam only do business with each other. Both have €100 in their current account, which they use for their daily business transactions. This money is suitable for payment because it is in the current account. For that reason, they don’t receive interest. Assume now that the bank also offers savings accounts with an interest rate of 4% but money in savings accounts isn’t suitable for payment.

Then a financial advisor comes along, disguised as a snake, advising Eve and Adam for a reasonable fee on how to manage their payments between themselves and to deposit their money into a savings account. So, what you now read in Genesis is made up by bankers to hide their fraud, a conspiracy theorist might infer. But it is just a story. In this way, Eve and Adam both earn interest on their €100. They give each other credit, so that Eve can borrow €100 from Adam, and Adam can borrow €100 from Eve. They don’t need to keep money in their current accounts, so they deposit their funds into a savings account and earn interest. Everybody wins, Eve, Adam, and of course, that snakelike creature.

Initially, Eve and Adam had no savings, only money in their current accounts. The advisor’s scheme allows them to fabricate savings out of credit. It seems like creating money, but Eve and Adam gave each other credit. They agreed to pay later, which exposed both to credit risk. One of them might not repay because you can do so many different things with €100 than put it in a savings account. You can use credit, which is an agreement to pay later, and use it like money. And so, Paradise was lost. Similar schemes exist on a larger scale. These are shadow banks. Shadow banks don’t create money but credit. The difference between fractional reserve money and this type of credit may not be significant in practice, except that it is unregulated, resulting in little oversight.

When banks create money, they do the same. The banks act as intermediaries between Eve and Adam, allowing them to lend money to each other even when they do not conduct business with each other or do not trust each other. The bank also assumes the risk that a debtor will fail to repay and receives a reward in the form of interest. It is also credit, but we refer to it as money because the law regards bank credit as legal tender, thus money. The government backs this scheme, as a stable financial system is a key public interest. Banks must have sufficient capital and reserves to meet emergencies. For that reason, banks are subject to regulations, while shadow banks are not subject to these rules, allowing the latter to offer more competitive interest rates.

As a result, the role of traditional banking has declined. Large corporations could lend and borrow in money markets at rates better than those offered by banks. At the same time, retail investors could invest directly in money markets and get better yields than banks offer. This development started with corporate borrowing. It later expanded into mortgages. The primary reason for regulating banks is that they operate the payment system, which is of public interest, and can borrow from the Federal Reserve. It prompted banks to strip their balance sheets and expose themselves to off-balance sheet risks to generate higher returns on their capital. For instance, offering an emergency credit line to a shadow bank generated profits while not appearing on the balance sheet.

The 2008 financial crisis originated in shadow banks that invested in risky assets, rather than conventional banks that create money through lending. Shadow banks aren’t subject to the same regulations as traditional banks, so they made speculative investments in mortgages. These investments appeared safe because rating agencies failed to do their jobs. Regular banks encountered trouble because they had backed shadow banks, hoping to reap a quick profit from credit insurance. The word they use is off-balance sheet financing. The regular bank didn’t lend money, but guaranteed credit to shadow banks in case of emergency, which is as dangerous as keeping the mortgages on its own balance sheet. But that was legal. It allowed banks to make more money from the same capital. Money creation, therefore, wasn’t the problem, and replacing regular banks with shadow banks could further destabilise the financial system.

If a financial crisis were to occur with loan write-offs, full reserve banking would only ensure that money in current accounts is safe. However, the same problems would emerge in savings accounts. Savings banks can expose themselves to off-balance sheet risks, unless that is forbidden. And they can also go belly up. And they did. If the debtors of a bank fail to meet their obligations, the bank may face financial difficulties, and the savings it holds may be at risk. Also, with full reserve banking, governments and central banks may end up supporting savings banks and even shadow banks to ensure financial stability, thereby rendering the benefits of full reserve banking void. After all, the initial cause was never a liquidity problem, but a solvency issue.

Commercial versus investment banks

The Glass-Steagall Act in the United States severed linkages between regular banking and investment activities that contributed to the 1929 stock market crash and the ensuing depression. Separating banking from investing can prevent banks from providing loans to corporations in which they have invested. The measure aimed to make bankers more prudent. The separation of commercial and investment banking prevented securities firms and investment banks from taking deposits. The reason for the separation was the conflict of interest that arose from banks investing in securities with their own assets, which were their account holders’ deposits. Banks were obliged to protect the account holder’s deposits and should not engage in speculative activities.

The Glass-Steagall Act included the Federal Deposit Insurance Corporation (FDIC), which guaranteed bank deposits up to a specified limit. It also comprised Regulation Q, which prohibited banks from paying interest on demand deposits and capped interest rates on other deposit products. Maximising interest rates can limit the risks banks are willing to take on loans, as these risks can destabilise the financial system.

Until the 1980s, the legislation mainly remained unchanged. With the rise of neoliberalism, government regulations became increasingly disapproved of. Hence, the Glass-Steagall Act became increasingly disregarded, and diligent deregulators repealed it in 1999 as part of their effort to relieve businesses of government regulations that stood in the way of corporations making profits at the expense of the public good. Regulation Q ceilings for all account types, except demand deposits, were phased out during the 1980s. After the 2008 financial crisis, a renewed interest in the Glass-Steagall Act emerged.

In the United States, money market funds circumvented the limits imposed on banks by Regulation Q, luring depositors with higher interest rates, thereby undermining the prudent banking paradigm. The money market funds, which are shadow banks, invested in collateralised debt obligations (CDOs), such as mortgage-backed securities (MBS). The 2008 financial crisis started in money market funds, not traditional banks.

Natural Money works with the same principles. It distinguishes between regular banks, which provide loans, and investment banks, which are partnerships that invest in equity. Islamic banks also operate similarly. The maximum interest rate of zero works like Regulation Q, aiming to limit the risks banks are willing to take on deposits, as interest is a reward for taking on risk. Banking in a Natural Money financial system works as follows:

  • Regular banks make low-risk loans. The money in these banks is secure. The maximum interest rate is zero. And so, deposits have negative yields.
  • Investment banks don’t lend but participate in businesses by providing equity. They can rent houses and lease cars. Investment banks offer higher returns.
  • Both regular banks and investment banks can invest in government securities to manage their risk and meet withdrawals.
  • Regular banks can promise a fixed interest rate. The government may offer support and deposit guarantees.
  • Investment banks don’t guarantee returns. They pay dividends based on their profits. Its depositors are investors who can face losses.

Natural Money enhances financial stability by favouring equity investments over debt investments. The maximum interest rate makes debt investments less attractive. And there is no reward in the form of interest for engaging in high-risk lending, which enhances the financial system’s stability. It stands to reason that the integrity of the system depends on strict adherence to its principles and the termination of evasive, get-rich-quick schemes of financial parasites, which requires a belief in the vision behind the idea of a usury-free economy. Let’s not dismiss that as a fantasy immediately.

Sanitation of banking

The primary cause of the financial system’s failure is usury. Imagine what a maximum interest rate of zero on debts can do. Only the most creditworthy borrowers can get a loan. You may have to save and bring in equity before applying for a mortgage, and that may be the only credit you can obtain. Even an overdraft may be impossible. That may seem harsh, but it is even worse when indebted consumers reach the point of interest payments and can’t make ends meet. If you want to buy something, you have to save for it. Likewise, corporations need to attract capital rather than debt to meet their liquidity requirements. The financial sector will shrink, and much of modern finance may become redundant.

That said, individuals and businesses may obtain better deals in the money market, allowing them to opt for this option rather than a bank. The distinction between traditional banks and shadow banks may blur. Tradional banks may need fewer regulations while shadow banks may need more. That is because without interest, risk may disappear. The central bank may stand behind the payment system, but it may not have to stand behind the lending system. The implicit guarantee of central banks buying debt and issuing currency with a holding fee means that the warranty will remain unused.

Two other themes emerged during the 2008 financial crisis: ‘too big to fail’ and ‘too complex to understand.’ Complexity and size are the outcome of competition. The failure of a large bank can bring down the financial system, and the products traders in financial markets use to hedge their risks or improve their profitability can be complex. Our future civilisation could be simpler, so the sanitation of the financial system should encompass cooperation, simplification and diversification. It may look as follows:

  • There should be an exhaustive list of all legal financial products and their requirements. We shouldn’t allow other financial products to exist.
  • No bank should hold more than a certain percentage of the global market, and no bank should expose itself to more than a certain percentage of another bank.
  • Banks should share services where scale is crucial, such as technological infrastructure and advanced knowledge.

Smaller banks can achieve efficiency improvements by using the same technological infrastructure. As long as they are independent financial institutions, they may share an IT department and operate their businesses on the same software. It may even be a public infrastructure that all banks share, allowing for significant cost savings, while also sharing knowledge and implementing measures related to issues such as fraud prevention.

Latest revision: 13 November 2025

Featured image: Ara Economicus. Beverly Lussier (2004). Wikimedia Commons. Public Domain.

Fiscal and Monetary Policies

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Economic cycles

Mismatches between supply and demand cause economic cycles. A harvest may fail, and food prices may rise, leaving us with less money to spend on other items. Mismatches can concern the supply and demand of money, capital, labour, raw materials or consumer products. Interest charges also contribute to economic cycles. Interest rates reflect the market for funds. If all markets were perfect, economists argue, supply could adapt to demand instantly, and there would be no economic cycles. Not unlike many others, economists love fairy tales about a Paradise where everything is perfect. And so, they may advise us to make markets perfect, so that an economic Paradise will ensue.

Economic cycles occur because mismatches between supply and demand emerge periodically and eventually resolve. Economists use the term equilibrium in their models to explain the relationship between supply, demand, and price, but these models are simplifications of reality. There is rarely a stable equilibrium, and fluctuations in demand and supply cause changes in prices, inventories, and employment. There are several theories and explanations regarding those mismatches, economic cycles, and their effects. Most notably, money, credit and interest deserve attention.

According to Say’s law, supply creates its own demand because we make goods and services to use ourselves or to acquire other goods and services. It is most applicable to a simple barter economy. When money serves as a medium of exchange, we can postpone our purchases, leaving producers with excess inventory. Money hoarding can be a serious problem as it interrupts the circular flow of money. When money loses value, we are less likely to postpone purchases. It is why central banks aim for a bit of inflation. However, inflation shouldn’t be too high, as that can undermine trust in the currency.

Expectations are another factor. When consumers feel good about the future, they are more willing to spend on big-ticket items. Likewise, when investors expect brighter prospects, they anticipate higher profits, making them more willing to invest. Conversely, when consumers and investors are pessimistic, the opposite happens. And so, expectations can become a self-fulfilling prophecy. Likewise, when people expect a bank to collapse, it may collapse because that expectation triggers a bank run. Policy makers try to instil confidence in the system because a lack of confidence can break it. The reason is that credit means trust, and trust is what keeps the system going.

During good times, businesses and individuals tend to be confident. Credit is often available because businesses’ and individuals’ future income projections serve as the basis for banks to lend money. And so, companies and individuals can borrow more in good times. When the economy slows and their incomes decrease, they may struggle to make their interest payments. Consumers would have more disposable income without debt, since they wouldn’t have to pay interest. Similarly, businesses can go bankrupt even when they are profitable overall because of interest charges. And so, interest charges can exacerbate and prolong the bust.

Leverage contributes to the overall risk in financial markets. Liquid financial markets make it easier to enter and exit positions, leading investors to believe it is safe to operate with leverage. If markets were not fluid, leverage would appear more dangerous, as it would be more difficult to exit a position. For example, if you aren’t sure that you can renew your mortgage after five years, you aren’t going to buy a home. Liquidity enables risk-taking, allowing the overall level of risk in the financial system to increase. That can become apparent during a crisis. People who have to sell their home during a housing crisis may end up selling it at a low price, leaving them with a debt that takes years to repay. Therefore, maintaining a liquid market is crucial for its safety, and limiting leverage further enhances its security.

Bureaucratic interventions

In the wake of the Great Depression and World War II, government and central bank interventions have become standard tools for bureaucrats to manage the capitalist economy. Fiscal policies involve steering the economy through government expenditures. Ideally, it works as follows. When the economy is performing poorly due to sluggish demand, the government increases spending to boost demand. Conversely, when the economy is overheating due to excessive demand, the government reduces spending to curb demand. Likewise, central banks can lower interest rates to promote borrowing and boost demand, or raise interest rates to discourage lending and curb demand. These policies can have the following undesirable consequences:

  • The timing of the measures may be off, so when the measure has been decided upon and is taking effect, the economy may already be on the desired path.
  • Politicians may interfere and press for increased government spending or lower interest rates to boost the economy and get them re-elected.
  • Central bank interventions cause market participants to take more risk because they expect the central bank to intervene.
  • Due to usury, debt levels increase, so once these policies are commonplace, there are no corrections to cleanse the system from its excesses.

By failing to periodically cleanse the financial system of its excesses, either through a debt jubilee or an economic depression, the economy becomes addicted to credit expansion, and the final collapse will be even more severe. As the US dollar is the world’s reserve currency, a collapse in trust in this currency can trigger a global economic apocalypse. Usury is the primary reason for fiscal and monetary policies, because interest on money and debts generates a money shortage, driving a demand for credit. Debtors must repay more than they borrowed, but that extra money doesn’t exist. And so, governments and central banks fill the gap to prevent the usury scheme from collapsing.

Due to usury, it has become a permanent requirement. To prevent a shortage of money or a liquidity crunch from materialising, governments borrow, and central banks print money. The shortage arises when the private sector fails to borrow enough to cover the interest on existing debts. To counter the problem, the government can borrow and spend this money. Central banks can lower interest rates to make borrowing more attractive. They do so by buying up government debt, thereby decreasing the supply of government debt and increasing the supply of currency, which lowers interest rates because there are fewer debts and more currency to buy them with.

Economists assume that there is a natural interest rate at which the economy grows at its trend rate while inflation is stable. There is no direct way to measure or calculate the natural interest rate. Economists estimate it using their theories and models. The elusive natural interest rate is a crucial element in central bank decisions. The natural interest rate may differ from the actual interest rate due to credit in the financial system. Deviations from this rate trigger booms and busts. The interest rate below the natural rate can generate a boom. In that case, people borrow too much because interest rates are too low, leading to overspending and overinvesting. An interest rate above the natural rate can lead to a bust, resulting in underinvestment and underspending. By setting short-term interest rates and thereby influencing long-term rates, central banks steer credit creation.

The economy can do well by itself

With Natural Money, the economy can manage itself, making fiscal and monetary policies redundant. The holding fee removes the zero-lower bound, providing stimulus during economic slumps. The maximum interest rate curbs lending during economic booms, providing austerity. That mitigates business cycles. And so there will be fewer debt overhangs and financial crises. The market, combined with the price control of the zero upper bound, steers interest rates and the money supply, thereby reducing the role of central banks. The central bank’s currency will then become a unit of account or administrative currency. Natural Money has the following favourable consequences:

  • The holding fee on currency allows for negative interest rates to provide a stimulus, while the maximum interest rate provides austerity by curbing lending.
  • As interest is also a reward for taking risks, a maximum interest rate will take away the incentive to take risks and limit lending to the safest borrowers.
  • In the absence of usury, debt levels don’t increase, while only the safest borrowers can borrow, resulting in fewer bad debts.

There is no need for governments to engage in deficit spending, except to provide liquidity in financial markets, as government debt, rather than administrative currency, serves as a form of liquidity. The holding fee makes it unattractive to own administrative currency. Provided their finances are sound, governments can borrow at negative interest rates and earn interest on their debts. They could aim for the debt level giving the highest interest income. If market participants are willing to lend at -1% when government debt is 100% of GDP and at -2% when government debt is at 70% of GDP, the government could harvest 1% of GDP in the former case and 1.4% of GDP in the latter case.

It will be the end of fiscal and monetary policies. The economy will manage itself. Interest payments don’t create a need to add additional debts. Governments may step in during a crisis to restore trust in the financial system and the economy, but whether such intervention will be necessary is unclear, as there will likely be fewer crises. Natural Money also doesn’t require central banks to do more than handle the daily transactions between banks, as the holding fee terminates the demand for the central bank’s currency.

Latest revision: 12 November 2025