The triad framework

The 'triad' of taxation, government borrowing, and central bank money creation is the conventional way to think about the policy options a state has to finance large-scale transformations. However, it misses out on the critical role of off-balance-sheet fiscal agencies.

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. This framework dominates the literature andis often at least implicitly found in studies of war finance, reconstruction finance, and the Green Transition.

While the triad framework does capture some important dimensions of how states finance large-scale transformations, it nonetheless suffers from three main shortcomings:

First, it lacks a theoretical conceptualisation of credit money. Taxation and treasury borrowing typically describe how a government can increase its cash intake, which can then be used for investment through government expenditure. But this often follows the logic of 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, it does not do justice to modern credit money systems, where new credit money is created ex nihilo when a financial institution gives a loan or purchases a bond from a counterparty. This implies that our current monetary system has an inherent potential for expansion, which can be leveraged for financing a large-scale transformation. The money required for it canalso be created; capital reallocation is not the only game in town.

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 mandate-dependent central banks or cash-strapped treasuries, but to the extent possible, the entire monetary and financial system must be harnessed. This is made possible by the fact that credit money creation can be carried out both by public balance sheets such as central banks as well as private ones such as commercial and shadow banks. Furthermore, while getting the system in tune to finance a large-scale transformation is always the same objective, it faces different challenges depending on the specificsof 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. This systemic features must be taken into account by policymakers seeking to bring about a large-scale transformation.

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 abilityto 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.