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In line with the details up there, the basics are that one bank receives a check drawn on another bank, the payment is cleared between the two banks by a transfer from one bank's account at the Central Bank to the other bank's account. Those accounts are assets of the commercial banks and liabilities of the Central Bank. Since its a transfer from one bank's reserve account to another, there is no change to the total liabilities of the Central Bank.

The fact that payments clear at the central bank means that if the central bank can always clear Treasury checks by accepting the IOU of the Treasury as an asset and increasing Central Bank liabilities by adding an equivalent amount to the Treasury account.

If the Central Bank for reasons of political theater is not allowed to do that, but it has an interest rate target to maintain, the Treasury auctions those IOU's, with payment ending up in its account at the Central Bank, and then that the Central Bank more or less ends up buying up those bonds to stabilize interbank interest rates.

The reason that the action of a conventional Central Bank action ends up (either directly or after the fact) eliminating the debt service burden on the Treasury is that the Central Bank is either owned by the government or chartered by the government as a not-for-profit, with any surpluses going back to the Treasury. So once Central Bank operating expenses are covered out of interest income on Treasury bonds they hold, all the excess goes straight back to Treasury.

Its the combination of the clearinghouse function and surplus on income over operating costs returning to the Treasury that ensures that Treasury checks never bounce. If the ECB can interfere with an NCB clearing payments, it can interfere with the NCB operating as a clearinghouse for payments across national borders, making reserve assets of commercial banks held in that NCB's accounts a second-class citizen, only good for clearing payments within the country.

That's why the question of whether the ECB is by treaty required, allowed, or not allowed to interfere with cross-border clearances between NCB's is of interest. And IANL, so even if I had the text, I could only guess how it would be interpreted by a court.

And whether an NCB in the Eurozone can get away with freelancing in this way ~ and I suspect that the Bundesbank had good enough lawyers to make sure that one way or another, the treaty terms do not allow that kind of freelancing ~ given the unsustainability of multiple cash rate policies in a single currency zone ~ that's what led to the formation of the Federal Open Market Committee in the US ~ there's also a quite reasonable argument that an NCB should not be allowed to engage in this kind of action.

I still prefer a system of determining the shortfall from full output, allocated on a per capita basis, and the ECB buying individual member state bonds on the open market equivalent to that amount ~ which would be a confederalization of fiscal policy.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Fri Dec 3rd, 2010 at 01:21:11 PM EST
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