On the simplest acceptable fiat monetary system

The main idea: track the nominal natural interest rate by pledging to buy and sell any quantities of consols, changing the price such as to maximise the total stock outstanding 

0. Posts on this blog are ranked in decreasing order of likeability to myself. This entry was originally posted on 22.10.2025, and the current version may have been updated several times from its original form. 

1 The setup

1.1 Let’s rejig one of my earlier mechanisms to come up with the simple monetary system that would still be recognisable to any modern Central Bank as a generalisation of open market operations.

1.2 Again, the Monetary Authority creates a consol that will pay a set amount monthly forever to the holder (say, 100 Dollars to make these useful to the retail investor). If the currency being managed is outstanding, we price these in the local currency. If we need to jump-start a new one, we price this flow in some foreign currency or commodity.

1.3 At auction, we ask for any combination of quantities the bidders would be willing to buy at various prices, and set the price and quantity such as to maximise the current value of all instruments issued. Once issued, the yield is set, as is the risk-free rate at all maturities, and the expected NGDP growth path. Once issued, the Monetary Authority pledges to buy and sell unlimited quantities of these consols at this price.  

1.4 Unlike my earlier mechanism, we now change this price at any time such as to always maximise the total value of instruments outstanding. Note that the Monetary Authority increasing the price will cause some holders to sell, and the effect on total value outstanding from fewer more expensive instruments will depend on elasticity.

1.5 In practice, the Authority would take a hint that a price change is needed when noticing net inflow or outflows, and act in the appropriate direction to approximate the value-maximising price at any one time. 

1.6 That’s it, that’s the setup. Completely inertial and requiring no foreign exchange interaction at all, and potentially run by a small office of a couple dozen.

2 Compared to the simplest acceptable NGDP targeting regime

2.1 The requirement to always aim to maximise the total value outstanding would cause yields to immediately respond to changes in the nominal natural interest rate in the appropriate direction, as mediated by the public selling or buying now-too-cheap or now-too-expensive consols. Further note how the setup responds correctly to changes in the demand for money.

2.2 My NGDP setup also responds to changes in the demand for money in the same way, but completely ignores the nominal natural interest rate, and lets inflation make up the difference between the set yield and the real natural rate through its iterative issuing or destruction of money mechanism. By ignoring fluctuation in the nominal rate, the NGDP setup provides yield certainty at all maturities, which should greatly help with long-term planning. 

2.3 This setup can provide no such certainty, and it would be interesting to see if the fluctuations in the nominal rate would, by themselves, be enough to cause the business cycle, though I suspect not. 

2.4 By always tracking the nominal natural rate, we have now given up on tracking inflation at all, which might drift semi-randomly under this setup. At first, inflation would match market expectations, but it’s unclear to me how it would evolve thereafter, though I hope (and suspect) the system would exert a secular lowering effort on both the nominal rate and inflation.

2.5 Now note how this system can never suffer from any credibility issues, as it is entirely self-contained and does not relate in any way to reserves of other assets. Whilst my NGDP setup would be quite credible, it still relies on continuous foreign exchange operations, and would call for the Monetary Authority to hold and manage a potentially quite large portfolio of holdings, a requirement completely negated in the current setup. You really could run this system out of an office with a couple dozen staff and, if need be, one kiosk to issue or redeem any consols and pay out the monthly coupon.