Mountain ranges forming a triadic structure | Death Valley © Jennifer King photography
The triad of taxation, treasury borrowing, and central bank money creation
The literature that addresses how states finance large-scale transformations typically sketches out a ‘triad’ of ways to achieve this: taxation, treasury borrowing, and central bank money creation. While this framework dominates the literature, it often remains implicit in studies of war finance, reconstruction finance, and the Green Transition.
The triad framework suffers from three main shortcomings:
First, the triad lacks a theoretical conceptualisation of credit money. Taxation and treasury borrowing typically describe how a government can increase its cash flow which can then be used for investment through government expenditure. But this often follows the erroneous imagination of the loanable funds theory, which suggests that there is a defined quantity of ex ante financial resources that must be reallocated. While there is some merit to this view in commodity money systems, the opposite is true in a credit money system: New credit money is created ex nihilo when a financial institution gives a loan or purchases a bond from a counterparty. This implies that the monetary system has an inherent potential for expansion, which can be leveraged for financing a large-scale transformation. The money required can be created, it does not have to be redistributed.
Second, the triad lacks a systemic understanding. The volume of credit money needed for a large-scale transformation cannot be borne solely by public institutions like central banks or treasuries but the entire monetary and financial system must be harnessed. Credit money creation can be carried out both by public and private balance sheets such as commercial and shadow banks. Getting the system in tune to finance a large-scale transformation is always the same objective, but faces different challenges depending on the shape of the international monetary system—whether subject to national capital controls as in the post-WWII era or characterised by financial globalisation, offshore money creation, and shadow banking as in the present day.
Third, it ignores the procedural dimension. Financing a large-scale transformation is a long-term process that requires diligent macro-financial governance and coordination of different parts of the credit money system. Not only does the system have to create credit money today, it also has to put it to productive use over a long period of time, avoid an implosion of the credit network, and receive repayments later. Accounts that rightly emphasise the system's unlimited capacity to create credit money ex nihilo but disregard its subsequent progression through and impact on the system miss the complex procedural dynamics at play in financing large-scale transformations.
Due to these three shortcomings, the triad misses out on the key role afforded to OBFAs in financing large-scale transformations. OBFAs are part of the wider monetary architecture and fulfil crucial functions in the overall financing process. Yet they are either overlooked, treated as outliers, or framed as part of established monetary and fiscal policy institutions. In fact, OBFAs break the confines of the triad. They complement fiscal and monetary agencies and mitigate stipulations for the conduct of their policies. Still, we lack a grounded understanding of the role OBFAs play in financing large-scale transformation as a systemic process. This gap is a problem of both historical empirical data, and of the theory of the monetary and financial system.