Central planning in a government-owned mono-banking system. Centrally-planned economies have a single or mono-bank structure. While superficially it may appear that many different banks exist - with some focusing on providing agriculture credits, others focusing on raising domestic savings, and still others handling import and export transactions - these banks are all government owned and controlled and do not compete with one another.

The primary purpose of banks in a centrally-planned economy is to monitor the plan. The plan assigns production and output goals across state enterprises in a balanced manner. The separate goals are made internally consistent through the application of input-output techniques. Given a set of planned final demands, consisting of planned levels of production of all goods and services for consumer, military, government, investment, and export use, input-output models determine the level of state enterprise outputs needed (directly and indirectly) to satisfy the plan.

The plan determines the allocation of all of the output produced to the sectors of final demand and also plans the use of labor, physical capital, and materials inputs by state enterprises. Thus the plan embodies virtually all of the production and distribution decisions that would have been made separately by individual firms and households interacting in a market economy.

While the plan monitoring, allocation, and performance functions could be performed in physical terms, and indeed were historically, it is easier to perform these functions in value terms. Once prices are developed and assigned to all the inputs and outputs in the physical or quantitative plan, a duplicate financial plan in value terms is obtained. Not only is monitoring simplified, but this procedure also permits some choice regarding input mix in production and output mix in consumption. While many prices are set to approximate scarcity, and thus true costs, many others are set to achieve certain social goals (such as providing low cost housing or inexpensive basic foodstuffs).

The role of the payment systems: monitoring the plan. The primary responsibility for monitoring the financial plan is vested in the banking system. Each enterprise is allowed only one (zero-interest) account with the state bank through which all of its transactions are made. A gross settlement system is employed whereby each transaction is settled separately as it occurs. Thus the payment system provides a comprehensive record of all enterprise transactions. Each transaction can be traced and compared to the financial plan and deviations from the plan, once identified, lead to corrective action to ensure compliance. (Box 1 contains a brief discussion of payment clearing versus settlement and an illustration of gross versus net settlement.)

Two separate payment circuits are contained in the financial plan: non-cash credits and debits for enterprises and cash payments for households. These two payment circuits are illustrated in Figure 1. Following the non-cash circuit of the financial plan (solid arrows), banks create and issue credits to the state enterprises. Enterprises use these credits to purchase physical capital for investment, pay for labor employed, and compensate other state enterprises for the portion of their output used as an intermediate input to produce the planned output.

Only when enterprises are making wage payments to labor are cash withdrawals allowed. This initiates the cash circuit of the financial plan (double arrows) used by the household sector. The cash received by labor is by far the primary payment method used by this sector in consumption and saving transactions. However, cash transactions are not easily monitored. Conformity to this circuit of the financial plan is ensured by monitoring the non-cash transactions between state enterprises producing output for the household sector (Enterprise A) and those enterprises responsible for distributing this output to households through retail or other outlets (Enterprise C). Thus household use of cash is indirectly monitored by the flow of goods and services.

The two payment circuits of the financial plan rely on paper payment instruments: households use cash while enterprises use paper-based payment demand orders (PDOs). A PDO is a debit-based instrument similar to a check except that it is initiated by the receiver of the funds (the payee) not the sender (the payor). Thus a PDO is the paper equivalent to an electronic direct debit in a market economy. (As background, Box 2 outlines the difference between a debit transfer and a credit transfer.)

PDOs represent a request for payment and are directly tied to inter-enterprise trade. Once goods have been received by a purchasing enterprise (Enterprise A - the payor), the supplying enterprise (Enterprise B - the payee) deposits shipping documents, title of ownership, and a multiple copied PDO at its branch of the state bank to initiate the payment transaction - debiting the payor's account (A) and crediting the payee's account (B). The payee's branch will typically extend 85% of the amount being collected in the form of an interest free loan to the payee (B) prior to the actual transfer of funds. The loan is extinguished and the remaining 15% of the transaction value is obtained after the funds have been transferred to the payee's branch, after which the title of ownership passes to the purchasing enterprise (A).

Each party to the payment transaction has to approve and retain a copy of the PDO - from the initiating enterprise, to the various branches of the state bank involved in the transaction, to the receiving enterprise. As well, all enterprise transactions are elaborately coded. Coding is used to determine the precise source and purpose of the credits created by the state bank for the enterprise as well as the purpose and nature of payments made by the enterprise in drawing down these credits. In effect, the payment system not only transfers value but also records and retains the equivalent of bank loan and firm product invoicing information of a market economy.

State guarantees: no credit risk for payment receivers. Under the financial plan, credit creation, enterprise payments, and banking system viability are all essentially guaranteed by the state. Credit creation and its allocation to enterprises is dictated by the financial plan and thus is not constrained by the availability of domestic savings or household deposits in the banking system. The credit created by the banking system is used by enterprises to pay other enterprises and inject cash into the household sector. Since all enterprises are owned by the state, inter-enterprise payments merely represent a transfer of credits from one part of the state to the other. Such an arrangement is similar to an intra-firm transaction in a market economy. Thus inter-enterprise payments areintra-state payments. Intra-state payments pose no real risk of loss for payment receivers nor for the banking system that is transferring credits from one state account to another.

As well, with gross settlement of enterprise payment transactions, one account is debited before another account is credited. If credits in the account to be debited are insufficient, extra credits are often made available by the state bank, reducing the incidence of enterprise liquidity problems.

Time insensitivity of payments. Enterprise balances are held in state bank accounts that pay no interest. Thus there is no incentive to reconfigure the auditing function of the payment system so that this need is met while also providing for timely payment and settlement of enterprise transactions. As well, no important penalty is imposed when enterprises fail to make payments in a timely manner. For these reasons, payments are not viewed as being time-critical and the notion of a time value for money is undeveloped. Consequently, large value payments among enterprises, or between an enterprise and a foreign supplier, can take days to complete. While such a system is acceptable in a centrally-planned economy where no interest is paid and funds essentially move from one state agency to another, such payment delays would place an unacceptably large opportunity cost on payment receivers in a market economy where money has a time value.

Limited need for comprehensive legal, accounting, and communications infrastructure. As enterprise payments are transfers from one state agency to another, there is only a limited need for payment laws and regulations that determine the rights and liabilities of the parties to a payment transaction. This need is limited because there is really no credit risk or time value of money involved in a payment transaction. If credit risk existed and money had a time value, the legal structure would have to be expanded to spell out the conditions under which payors and payees, respectively, would be liable for losses due to enterprise failure or delayed payments.

In monitoring the financial plan, the separate branches of the state bank are relied upon to individually collect, account for, and report enterprise payment information to a central agency. In this capacity, each branch office effectively operates as if it were a separate bank since enterprise accounts are not centrally managed and controlled. Thus there is little need for a communications infrastructure that could rapidly process and transmit payment or other information among branches of the state bank. Indeed, payment information is in paper form and physically transported between branches using the post office and other non-time-critical transportation methods. Domestic commercial airline flights or even dedicated motor courier, common in a market economy, are not used.

Cash-based retail payments. Currency is the primary method of payment for the household sector and is supplied through cash wage payments by enterprises. Since enterprise output allocated to the household sector is determined by the plan, any excess of currency in circulation over the assigned value of the output supplied to this sector is absorbed as forced savings. Although households can deposit excess currency in banks and earn an interest return, this return is controlled by the plan and no short-term money market instruments exist which could pay a higher rate.

The reliance on cash as virtually the only means of payment for the household sector means that alternatives to cash payments have not developed in centrally-planned economies. Payment systems which are predominantly cash-based often are associated with low crime rates and/or fundamental weaknesses in the banking system. This includes the existence of inefficient, costly, or unreliable non-cash payment instruments, negative real deposit rates, or depositor fear of government taxation or appropriation measures. If crime rates are low, inflation is controlled, and currency is available in large denominations, then use of cash for all household transactions may be safe and not too inconvenient. However, if these conditions are not met, then alternatives to cash for payment transactions can be quite useful. This is especially true for larger-value payments. Here the transaction cost related to cash use, for both the banks and consumers, can be quite high. This is due to the expense of cash storage, counting and verification, and the physical shipment (under guard) in order to effect payment, along with the opportunity cost of holding non-interest-earning cash balances. When inflation is not adequately controlled, this opportunity cost will dominate the other cost influences associated with the use of cash.