The Optimal structure of Liquidity Provided by a Self Financed Central Bank

Central banks have consistently differentiated the return on the securities they have issued (money and national debt). In contrast, first best efficiency demands that these securities earn the same return: the return on capital. A self-financed central bank, without capital and taxes, cannot achieve this first best. The resulting gaps between the return on capital and the returns on public securities are implicit taxes. These taxes increase the opportunity costs of the commodities financed with the liquidation of these securities, so they are indirect taxes on these commodities. Because taxes on investment are less efficient than taxes on consumption, securities intensive in financing investment should be taxed at a lower rate than securities intensive in financing consumption. This is feasible if national debt is investment intensive. Then, this security should earn interest and be imposed artificial costs on second hand trading. In addition, because money is specialized in providing short term liquidity, raising the return on national debt delays expenditure toward the future. Hence, the payment of interest on national debt brings a windfall of resources during transitions across balanced paths in addition to the long term welfare gains of this policy. Similar arguments apply to short and long term maturities of the national debt.