To what extent can Positive Money and Modern Monetary Theory join forces?

Blogger  Ref  https://wiki.p2pfoundation.net/Transfinancial_Economics
 

A recent blog by Clint Ballinger highlights some of the similarities and differences between Positive Money’s proposals and those of Modern Monetary Theory (MMT) and other Post-Keynesian types of analysis. We thought Ballinger makes some good points that are worth highlighting, before suggesting where we think his review could be improved.
Ballinger starts his discussion by complimenting both sides, suggesting that:

“Despite these various approaches having important disagreements…[their] areas of interest all are grounded in reality & therefore their discussions on policy options are coherent and useful, unlike orthodox policy discussions.”

Next, Ballinger distinguishes between the two sides, suggesting that Post-Keynesians and MMTers have conceptualised their approach by deconstructing the fallacies of the current orthodox framework:

“Post-Keynesian economists have been trying to get orthodox economists to understand the way the economy actually works (with endogenous money) in the real world for decades…[Post-Keynesians dismiss] A significant number of monetary reformers [who] focus on a money multiplier [and] are still stuck in a loanable funds world…”

On the Positive Money approach, Ballinger states:

“There is another group of monetary reformers that do understand that we are in an endogenous money – not a loanable funds – world. Their proposals do not focus on a (non-existent) money multiplier. Their proposals are aimed at actually making the current endogenous money system into a true loanable funds system.”

Ballinger then makes an interesting point as to why Post-Keynesians and MMTers take issue with Positive Money style of proposals, as they:

“…have looked on in dismay as orthodox economists have spent whole careers writing about a non-existent loanable funds system and in turn giving terrible, indeed dangerous, policy advice. Thus it is natural to view holders of the loanable funds view as enemies who do real harm to the economy and the public.”

Ballinger however, is quick to state why Positive Money-type (PM) proposals should not be condemned:

“But it is different to be frighteningly delusional about reality (as orthodox economists are about loanable funds) than to understand that the current system is an endogenous money system and want to make it a loanable funds system (as PM-type proposals do. There are other main reasons many Post-Keynesians reject PM-type proposals. At times, though, it seems mere association with the muddled orthodox view of banking does influence how/whether some Post-Keynesians really weigh the details of PM-type proposals).”

Ballinger then cautions Positive Money, by stating:

“Realize the danger of being thought “not to get” endogenous money…Educate those who still talk about “full/fractional reserves” and a money multiplier that these are just not the issue…The loanable funds system PM and others propose is a “no reserves” system, not a full reserve system.”

Later on Ballinger gives some advice to Post-Keynesians and MMters, suggesting they should:

“Try (even) harder to teach monetary reformers that are erroneously still worried about a money multiplier that there simply is not one in the current system…If they understood endogenous money and that loans create deposits they would see that reforming a “money multiplier” is a waste of time.”

Then Ballinger notes that, there is scope for both sides to join forces:

“Rather than arguing among themselves, Post-Keynesians and PM-type groups should focus on the important overlaps of their bank/finance reform proposals.”

Positive Money should (according to Ballinger):

“…Support MMT proposals that get part of the way to your goals, even if you ultimately want further changes… if PM type proposals want to move from “A” (today’s system) eventually to “D” (a loanable funds system), and Mosler-type proposals move the system to “B” (significant restrictions on the way endogenous money is currently created; the existence of a parallel narrow banking system for those who want it) then PM should be very much on board.”

While Post-Keynesians and MMTers should recognize that Positive Money reformers:

“…Are different from orthodox economists in a crucial way – they get endogenous money – they just don’t believe it serves the public purpose…Recognize that real dialogue is possible with them unlike with the vast majority of orthodox economists. If a loanable funds model would not work or would be worse for the public, clearer statements of why could be made.”

Ballinger also notes that both MMT and Positive Money are often unfairly criticized:

“Many of the concerns with the PM proposal I have seen brought up are actually discussed in some detail in the PM literature…and it often seems that critics of the plan simply do not closely read PM explanations of the details of the plan.”

“There are plenty of critiques of MMT – most of which are completely misguided and due to fundamental misunderstandings of the economy due to orthodox economic blinders.”

Yet for Ballinger, the primary line of contention between Positive Money and many Post-Keynesian groups “…is somewhat complicated, and the key reason involves endogenous money…[and] whether or not endogenous private credit-money creation also serves the public purpose”.

Subsequently, concerns regarding both approaches are laid out. For Positive Money, Ballinger asks:

“Would the new system of exclusively state money be able to create a fair system for large business loans? How would that system differ from the current system?”

And for Post-Keynesians and MMTers, Ballinger asks:

“Does the fact that endogenously created private credit-money dwarfs state money restrict the ability of the government to act in the public purpose in the way MMT believes?

“Does this render MMT ideas on the role of the state in the economy unworkable? Does the inherent instability and pro-cyclical nature of endogenous money have too many social costs? Does the endogenous money system stealthily but inexorably lead to regulatory capture? …Lead to unsustainable levels of private debt? To highly inequitable wealth distributions?”

After citing some useful articles (well worth a read), Ballinger concludes by stating:

“PM-type proposals & MMT are in essential agreement that the state can and should just spend state money for public purpose, with inflation the limiting factor. This is sometimes unclear because of the operational peculiarities of various countries, not least of the US. Whether this is just through continued deficit spending, or a 60 trillion dollar coin or similar, circulating treasury notes (the same thing really), or whatever, ultimately makes little difference. PM-type proposals have long used the US Greenback – circulating (mostly digital) treasury notes, as a key example, and MMT economists have the same view.”

From our perspective, there are some really good points that apply for both MMTers and us. The only thing we would want to point out here is that the main argument for our reform is not about transforming “…the current endogenous money system into a true loanable funds system”. While we seek to ensure that banks function as genuine intermediaries, we are more concerned with returning the power to create new money to an accountable body working in the public interest, and removing the dependency on debt-fuelled growth.
The primary difference is that money could be created endogenously in a Positive Money system, if voters and the incumbent government chose to do so, by allowing banks to have overdrafts at the Bank of England. In contrast to the current monetary system, Positive Money proposals would give the Bank of England more flexibility, allowing it to choose when to slow down the rate of creation of new money directly, rather than trying to restrain the creation of money by the banks.

A Response to Richard Murphy’s Concerns

 

 

June 5, 2015 by Ben Dyson (formerly Positive Money) Blogger Ref https://wiki.p2pfoundation.net/Transfinancial_Economics

 

Tax campaigner and writer Richard Murphy outlines his concerns with Positive Money’s proposals to prevent banks from creating money here. This is our response.

When is a bank not a bank?

Richard first point is a semantic argument about the definition of a bank. When is a bank not a bank? In Richard’s view, when it doesn’t create money:

I cannot accept the argument that if you remove the key identifying quality that defines a bank, which is its ability to create and so lend money, that it remains a bank.  It does instead become a deposits and loan institution, which is something quite different, whilst its lending function is no longer about the creation and destruction of money but is, instead, more akin  to being an outsourced credit committee of the Bank of England.

So if you prefer, call them deposit and loan institutions. From the point of view of the customer they’ll still be institutions that provide payment services, offer savings and investment products, and make loans, so perform all the functions of banks except for creating money. The argument that this is an outsourced credit committee of the Bank of England makes no more sense than arguing that a private equity firm, peer to peer lender or pension fund is an outsourced investment committee of the Bank of England.

The Role of Government Spending and Taxation

Richard points to a fact highlighted by Modern Monetary Theory (MMT) writers: that taxation withdraws money from the economy and in effect ‘destroys’ bank deposits. The government effectively creates new money (in the form of bank deposits) when it spends into the economy, and destroys bank deposits when it taxes money out of the economy. MMT often extends this into a statement that the government can spend whatever it wants, subject to the inflation constraint. It can deal with that inflation constraint by taxing more money out of the economy, in effect making way for its own spending.

“If it is the process of spending  government created money into the economy that provides the substance of this money creation process, then the corollary of tax paid must, of course, negate it.  I do not recall this issue being addressed in PM’s work.”

But the point that taxes withdraw the money from the economy does not affect the arguments for money creation by the state in place of banks. Firstly, whatever MMT says about how the system could work, the practical reality is that government and HM Treasury aims to limit its spending to what it can collect in taxes, and borrows the difference. It doesn’t finance any of its spending by net creation of bank deposits; it simply uses taxes and borrowing to ‘destroy’ deposits held by tax payers or investors, and then ‘re-creates’ them when it spends. So this is a zero sum exercise.

So MMT’s description of governments creating money when they spend, and destroying money through tax (in order to manage inflation) is a description of how the system could work. But in the current arrangement, it would be more realistic to see taxes/borrowing and spending as redistributing bank deposits from certain bank accounts to others (i.e. from the accounts of taxpayers and investors to the accounts of public sector employees, contractors etc.)

In this environment, governments are not using their power to create additional new money in any sense. Our argument has been that they should be using this power. Even if they don’t immediately prevent banks from creating money, some sovereign money creation would reduce our current dependence on bank-financed debt-fuelled growth. We’ve written about how the state could use money creation in parallel to money creation by banks in this paper from November 2013.

If the state does start to use its power to create additional new money, it would be competing with the money created by the banks. By stopping banks creating money, you ensure that the proceeds of any new money creation go to the state rather than the banks.

Concerns about the shortage of credit

The first of these is that money will, of course, be needed for mortgages and financial speculation.  The second is that, as Ann Pettifor has argued,  there is no way that a central committee can anticipate the needs of finance system for money in the following month.  There will, inevitably, be credit rationing as a result for productive activities. PM’s  responses on this issue, including the argument that not all credit is money, are simply not credible:  it is not reasonable to argue  the businesses should wait to make settlement of commercial obligations because of a shortage of cash created during the course of a month by the MCC,  which is what they imply.  Like it a lot that will inevitably constrain economic activity.

We’ve just completed a paper, which will be released next week, looking at the supply of credit in a sovereign money system. This paper suggests that the common assertions that there will be ‘inevitably be credit rationing’ don’t stand up when looked at in more detail. Rather than repeating the arguments of that paper here, we’ll comment in more detail next week.

The Democratic Aspect

Richard writes that:

“…there is  a suggestion that money creators should not be influenced by those demanding money. That is seriously worrying at two levels. First, this effectively says that this MCC [Money Creation Commitee] will determine the level of government spending without any reference to the need that it might meet. That is monetary policy gone mad, and profoundly undemocratic and surely not what PM mean, in which case they need to make revision.”

This is incorrect. The government is still capable of borrowing or setting its own tax policy, so the government, not the MMC, determines what its spending will be. The money created by the MCC is an addition to its existing tax revenue, and would reduce how much it would need to borrow for any given level of spending. But the purpose of the MCC is not to find a way to finance the government’s operations, but to look at the needs of the wider economy. Instead of trying to influence the economy through the use of interest rates – a very indirect and ineffective tool – they would be able to create money directly. Government is one of the obvious distribution channels for this new money to get into the real economy, although other options, such as a “citizen’s bonus” to every citizen could work well too.

It makes no sense to claim that this is “profoundly undemocratic”. Monetary policy today is not about financing government spending; it’s about setting a rate of interest rate that should filter through the economy and influence wider economic activity. That system is broken now, without doubt, and needs significant reform (obviously we have quite clear ideas of how that reform would work).

More fundamentally, it seems odd to argue that giving a government-appointed committee the responsibility for creating money, and ensuring that all money created benefits the state (and by extension, the public) is ‘profoundly undemocratic’ when it is contrasted against the current system, in which money creation is done on the basis of whether it will be profitable for a bank, with no public interest motive even considered.

“And it is also deeply troubling  that the real economic consequences of money creation as indicated by the merit of various spending programme should have no influence upon the decision as to whether to create that money or not. In my opinion the exact reverse should be true, including in the private sector where the precise problem is that money has not been used for appropriate purposes.”

 This is a valid point, that we’ll update in a future edition of the book. The Money Creation Committee would need to have an idea of how the government would intend to spend any newly created money before it could assess how much would need to be created, because different uses have different effects on the economy. We’ve written about this issue on page 36-37 of our paper Sovereign Money Creation: Paving the Way to a Sustainable Recovery.

Final Points

Richard writes:

“I could expand all these arguments, of course. But what they suggest are real issues of concern and not petty sniping (in which I have no interest at all). I want banking and monetary reform. I want that to be used as the basis for a better economy. But I am deeply worried about making money creation so much a priority that government and economic activity is subjugated to it, and despite what PM says that seems inevitable to me.

So government has to be in control of its demand for money and the central bank has to meet that need.”

As we’ve explained above, government would still be in control of how much it spends: it still retains full control over how much it taxes or borrows. There are debates about whether the power to create money should be in the hands of independent central banks or under immediate control of the Treasury. I suspect Richard’s faith in politicians not to overuse this capacity to create money, even in the years running up to an election, is stronger than that of most people. Like it or not, the economic convention at this point in time is that central bank independence is necessary to prevent politicians using monetary policy for short-term ends. We can have a wider debate about whether that’s correct or not, but in terms of putting forward ideas that won’t immediately be rejected by the mainstream, we have to accept some of the constraints that already exist. Any campaign to give Gordon Brown or George Osborne the power to decide how much money to create is dead in the water.

Richard concludes:

So let me assure PM: I want the understanding and reform you do but please address the real concerns that many who have sympathy have with what you’re saying. We’re spending our time on this to make the process work. We’e worried you’re not delivering a workable or democratic or accountable solution, and that’s worrying.”

We’ve spent the last 5 years taking on feedback and concerns from a wide range of people, and adapting the proposals to deal with any valid concerns. We’ve undertaken significant research on issues like the risk of shortage of credit, and are undertaking further research on other potential issues that might arise. But there’s is a real limit on what we can do to address assertions that a proposal that puts money creation in the hands of the state is less democratic than one that leaves it in the hands of profit-seeking companies.

There is a "Magic" Money Tree....

Written by Fran Boait on June 3, 2017.

Amber Rudd, who stood in for Theresa May on the BBC debate on 31st May had a new line of attack for Jeremy Corbyn, accusing him of believing in a ‘magic money tree.’ She told the audience, ‘there is no magic money tree’.
The Prime Minister Theresa May then used the same phrase in response to a nurse who hasn’t had a pay rise for 8 years. She said: “There isn’t a magic money tree that we can shake that suddenly provides for everything that people want.”
The thing is, there sort of is. Money can be created out of nothing, and her government has a lot of control over where it goes.
But sometimes when you start talking about how money is created, and how it works it can feel like opening a can of worms with no bottom. Not surprisingly, no one on the panel dared to pick up on it. And to be honest I don’t blame them. Only one out of ten politicians actually know how money is created. (See the results of a poll)

So what is the magic money tree?

Well as many Positive Money supporters know, there are two main money trees: commercial high street banks and the central bank, the Bank of England.
The vast majority of money is created out of nothing, by banks when they make loans.
The Bank of England is currently running a programme where it creates £445 billion of new money, through a programme called Quantitative Easing (QE).
The main problem with these money trees is the vast majority of new money goes into financial and property markets, boosting asset prices, stock prices, and making the rich richer. While, very little is used to boost wages, create jobs, and invest in the things we need.
So there is a money tree, the question is whether it can be used more effectively? There is no reason why some of the money created through QE shouldn’t be invested through the government into things society really needs (find out more here).
Through our work we have found a tendency for politicians to see monetary policy outside of their knowledge base, thinking it is just something to be left to the central bank. Monetary policy has impacts which are of enormous political significance, and it is up to Parliament to scrutinise the wider effects of monetary policy on the economy and society. These comments by Theresa May and Amber Rudd were another sign politicians are stepping further away from this conversation.
So the government can spend what it collects in taxes, can borrow from financial markets, and can spend money created through the Bank of England.
Right, that sounds simple. It also goes against a lot of what we have been told over the last seven years since the crisis; i.e. that cutting government spending is inevitable, that we can’t afford the things we need.
So why is it like opening a can of worms?
Well, it is like opening a can of worms because money isn’t neutral and has many different aspects; economic, political, social, cultural, moral, and more. It has many different characteristics, depending on what we are doing with it – spending, saving, or lending it to others. For example, we could have a long conversation about the difference between money, credit, and debt.
Anthropologists like David Graeber understand the power of how the things we take for granted are socially constructed – e.g. money, and the idea that there is no magic money tree.
Pretending money isn’t complex is like pretending the Earth doesn’t go round the sun. Most academic economists, politicians, and policy makers, and other ‘people in power’ don’t really know what they think money is, which is fine, to an extent, but it becomes a problem if they don’t want to start to think about it.
Positive Money exists because we believe a public debate about how money is created, the problems it causes, and alternatives for reform is well overdue. The Bank of England has the power to create money, and we need to make sure that it’s used in the most effective way possible.
Although politicians are hard to engage with on monetary policy, we’ve demonstrated that despite money creation being a seemingly abstract and technical debate, there is a large appetite in the public to be engaged. We have over 60,000 supporters and that number is growing. Please join us by signing up in the form below.
And for now please share this video with your friends to help our politicians learn the truth about the magic money tree.

Adair Turner: “Debt, Money and Mephistopheles: How do we get out of this mess?”

           

Written by Andrew Jackson on February 12, 2013.

Positive Money/ Blogger Ref http://www.p2pfoundation.net/Transfinancial_Economics

 

          

On the 6^th of February, the chairman of the FSA, Adair Turner, gave a speech at Cass Business School, entitled “Debt, Money and Mephistopheles: How do we get out of this mess?” The subject of the speech was the way in which the economy might be brought out of recession.
The following post is merely the authors attempt to pick out some of the key points of Turner’s speech, and provide a brief commentary where required. It is not an analysis, and neither should it be taken that Positive Money agrees with all of what Turner is saying. Instead, the sole purpose of this post is to distill Turner’s 46 page speech into something a little more manageable, and in particular to highlight his thoughts on Overt Monetary Financing (OMF), which is in short creating money and spending it into circulation. If this sounds familiar, it’s because Positive Money have been advocating something similar since June 2010!
The speech actually details a whole range of other types of intervention, and is well worth reading for those that have the time (available here, watch the speech here)
Turner’ speech starts by noting that for monetary policy to achieve a specific target (i.e. growth, low and stable inflation, unemployment, etc.) the correct tool is required:

“The question is by what means can we and should we seek to stimulate or constrain aggregate nominal demand. Before the crisis the consensus was that conventional monetary policy, operating through movements in the policy rate and thus effecting the price of credit/money, should be the dominant tool, with little or no role for discretionary fiscal policy and no need for measures focused directly on credit or money quantities. Post-crisis, a wide spectrum of policy tools is already in use or under debate.”

One such tool is: “overt money finance (OMF) of fiscal deficits – “helicopter money”, permanent monetisation of government debt.” Turner points out that such a policy was proposed by Milton Friedman in his 1948 paper, “A Monetary and Fiscal Framework for Economic Stability”:

“As the title implies, one of his concerns was which fiscal and monetary arrangements were most likely to produce macroeconomic stability – meaning a low and predictable rate of inflation, and as steady as possible growth in real GDP. He was also concerned with financial stability, which he perceived as important per se and because of its effects on wider economic stability.

His conclusion was that the government should allow automatic fiscal stabilisers to operate so as “to use automatic adjustments to the current income stream to offset at least in part, changes in other segments of aggregate demand”, and that it should finance any resulting government deficits entirely with pure fiat money, conversely withdrawing such money from circulation when fiscal surpluses were required to constrain over buoyant demand.

Thus he argued that, “the chief function of the monetary authority [would be] the creation of money to meet government deficits and the retirement of money when the government has a surplus”. Friedman argued that such an arrangement – i.e. public deficits 100% financed by money whenever they arose – would be a better basis for stability than arrangements that combined the issuance of interest bearing debt by governments to fund fiscal deficits and open market operations by central banks to influence the price of money.”

An important assumption in Friedman’s analysis however, is that:

“all money is base money, i.e. that there is no private money creation … This in turn is because in Friedman’s proposal there are no fractional reserve banks. In Friedman’s proposal indeed, the absence of fractional reserve banks is not simply an assumption, but an essential element, with Friedman arguing for “a reform of the monetary and banking system to eliminate both the private creation and destruction of money and discretionary control of the growth of money by the central bank”.

This is of course the Positive Money proposal. Turner continues:

“Friedman thus saw in 1948 an essential link between the optimal approach to macroeconomic policy (fiscal and monetary) and issues of financial structure and financial stability. In doing so he was drawing on the work of economists such as Henry Simons and Irving Fisher who, writing in the mid-1930s, had reflected on the causes of the 1929 financial crash and subsequent Great Depression, and concluded that the central problem lay in the excessive growth of private credit in the run up to 1929 and its collapse thereafter… made possible by the ability of fractional reserve banks simultaneously to create private credit and private money”.

The ability for private banks to create money makes the current banking system inherently unstable. As Henry Simons, one of the original authors of the Chicago Plan (which the Positive Money proposals are based on) put it:

“in the very nature of the system, banks will flood the economy with money substitutes during booms and precipitate futile efforts at general liquidation afterwards”. He therefore argued that “private institutions have been allowed too much freedom in determining the character of our financial structure and in directing changes in the quantity of money and money substitutes”.

As Turner explain, this leads to a great paradox – one of the father figures in the Chicago school of economics, Henry Simons, “believed that financial markets in general and fractional reserve banks in particular were such special cases that fractional reserve banking should not only be tightly regulated but effectively abolished.”
Turner does not agree that the current banking system should be abolished, arguing that a) debt contracts have arisen naturally as a way of fulfilling human desires, and b) that the current banking system allows maturity transformation which is economically beneficial. As this post is merely an outline of the points Turner raises in his paper we will not delve too deeply into the counterarguments to his points, other than to note that both debt contracts and maturity transformation are possible under the Positive Money proposals (as well as the Chicago Plan), and as a result these are not grounds for rejecting monetary reform.
Moving on, in the next part of his speech Turner argues that: “The financial crisis of 2007 to 2008 occurred because we failed to constrain the financial system’s creation of private credit and money; we failed to prevent excessive leverage.” This is of course also the Positive Money explanation of the crisis, which derives directly from the work of economists such as Hyman Minsky.
Turner then goes on to point out that since the crisis banks are making new loans less quickly than old loans are being repaid, both as a result of banks not wanting to make new loans and also due to a lower demand for new loans from the private sector. This in turn:

“depresses both asset prices and nominal private demand, threatening economic activity and income, and making it more difficult for firms and individuals actually to achieve desired deleveraging. Such an attempted deleveraging was as Irving Fisher argued fundamental to the process by which the financial crisis of 1929 turned into the Great Depression. And as Richard Koo has argued, it is core to understanding the drivers of Japan’s low real growth and gradual price deflation over the past two decades.”

In Koo’s persuasive account, Japan from 1990 suffered a “balance sheet recession” in which the dominant driver of depressed demand and activity was private sector (and specifically corporate sector) attempts to repair balance sheets left overleveraged by the credit boom of the 1980s. In such “balance sheet recessions” Koo argues, the reduction of interest rates … has very limited ability to stimulate credit demand since firms’ financing decisions are driven by balance sheet considerations. As a result, Koo argues, economies in a deleveraging cycle will face deep recessions unless governments are willing to run large fiscal deficits…”

So while the Japanese experience would have been much worse without these deficits, they do not actually reduce the overall level of debt in an economy, instead they simply shift it from the private sector to the public sector. The problem is that public sector debt can also have negative effects if it gets too large, limiting the potential effectiveness of government spending financed by borrowing. As Tuner notes:

“Post-crisis deleveraging, while essential for long-term financial stability, thus creates an immensely challenging macroeconomic environment.

• Monetary policy acting through short or long term interest rates loses stimulative power.
• Fiscal policy offsets may be constrained by long-term debt sustainability concerns.
• And slow growth in nominal GDP makes it more difficult to achieve attempted deleveraging in the private sector, or to limit the growth of public debt as a % of GDP.

The danger in this environment is that other countries could suffer not just a few years of slow growth, but the sustained decades of slow growth and rising public debt burdens which Japan has suffered. It is in this environment that we have to consider the two questions posed earlier.

• What are the appropriate targets of macroeconomic policy?
• And what policy tools should we use to achieve them?”

In the next section of the speech Turner argues that it may be desirable to target some combination of growth and prices changes with monetary policy (unlike the case today where only the change in the price level (i.e. the inflation rate) is explicitly considered).
Moving on to look at the response to the crisis, Turner notes that:

“All of the policy levers [low interest rates, QE, funding for lending etc]… work through interest rate, credit and asset price channels. In different ways they induce agents to change behaviour – by substituting money for bonds: by reducing medium and long-term interest rates and stimulating a search for yield: by directly or indirectly reducing the cost of credit supply: or by enabling banks to supply a higher quantity of credit as a result of lower capital or liquidity ratios.

But the effectiveness of each of these transmission channels may be constrained if post-crisis deleveraging produces the “balance sheet recession” behaviours described by Richard Koo in Japan.”

In addition, Turner makes the point that many of the current policy levers have possible negative side effects. As well as potentially increasing the probability of complex forms of speculation and creating beggar thy neighbour policies through their effects on the exchange rate, most of these policies can only increase demand if they incentivise the private sector to go further into debt. Yet:

“We got into this mess because of excessive creation of private credit and money: we should be concerned if our only escape route implies building up a future excess.”

In short, he is saying you can’t solve a debt crisis brought on by people being overly indebted by getting the very same people to go further into debt. Thus:

“An exclusive reliance on monetary, credit subsidy, and macro-prudential policy levers to stimulate nominal demand thus carries significant long-term risks – a danger that, in seeking to escape from the deleveraging trap created by past excesses, we may build up future vulnerabilities”

With the current set of monetary tools unlikely to have the desired impact on growth, Turner looks at alternative measures to stimulate the economy (i.e. government spending/tax cuts). As he puts it:

“The argument for fiscal stimulus is that it operates in a more direct fashion, cutting taxes or increasing public expenditure, putting spending power directly into the hands of individuals or businesses.”

However, if public levels of debt are already high, then this increase in government spending may not be as effective as it otherwise might be. The answer, Turner contends, is “overt money finance” (OMF). OMF (as outlined by Ben Bernanke in a 2003 speech, “Some thoughts on monetary policy in Japan”) would work in the following way:

• “He proposed “a tax cut for households and businesses that is explicitly coupled with incremental BoJ purchases of government debt, so that the tax cut is in effect financed by money creation”
• He suggested that it should be made clear “that much or all of the increase in the money stock is viewed as permanent”
• He argued that consumers and businesses would likely be willing to spend their tax cut receipts since “no current or future debt service burden has been created to imply future taxes”…
• And he argued that the policy would likely produce a fall in the Japanese government debt to GDP ratio, since the nominal debt burden would remain unchanged while “nominal GDP would rise owing to increased nominal spending”
• And while his main illustrative proposal was for a tax cut, he noted that the same principle of a money financed fiscal stimulus “could also support spending programs, to facilitate industrial restructuring, for instance””

Bernanke’s description of a money financed deficit thus makes clear its potential advantages over either pure monetary policy or pure funded fiscal deficits as a means of stimulating nominal demand:

• Compared with the [other] monetary policy options … it is more direct and certain in its first order effect. Monetary, credit support, and macroprudential policy levers work through the indirect mechanism of stimulating changes in private sector borrower and investor behaviours, and may therefore be ineffective if behaviour is driven by deleveraging during a balance sheet recession”. OMF, because it finances an increased fiscal deficit, results in a direct input to what Friedman labelled “the income stream”. As Bernanke notes, this means “that the health of the banking sector is irrelevant to this means of transmitting the expansionary effects”, making concerns about “broken channels of monetary transmission” irrelevant.
• But unlike the funded fiscal policy stimulus considered in Section 6, the stimulative effect of a money financed increase in fiscal deficit will not be offset by crowding out or Ricardian equivalence effects, since no new interest bearing debt needs to be publicly issued, and no increased debt burden has to be serviced in future.

As a result, OMF is bound to be at least or more stimulative than an increase in funded fiscal deficits. As Friedman put it in 1948 “the reason given for using interest bearing securities [i.e. for running a funded fiscal deficit] is that in a period of unemployment it is less deflationary to issue securities than to raise taxes. That is true. But it is still less deflationary to issue money”

Essentially therefore OMF is a combination of fiscal and monetary policy levers; and the fiscal aspect of its character seems to make it quite distinct from QE which is unaccompanied by increased fiscal deficits and is intended to be reversed at some future date.”

Turner then points out that in fact QE, if it is never reversed, would be similar (but not identical) to OMF.
Of course, many would argue that government creation of money is bound to be highly inflationary. Turner addresses these points as follows:

“There is, moreover, no inherent technical reason (as against political economy reason) to believe that OMF will be more inflationary than any other policy stimulus, or that it will produce hyperinflation

• It is no more inflationary than other policy levers provided the “independence” hypothesis holds. If spare capacity exists and if price and wage formation process are flexible, the impetus to nominal demand induced by OMF will have a real output as well as a price effect, and in the same proportion as if nominal demand were stimulated by other policy levers. Conversely if these conditions do not apply, the additional nominal stimulus will produce solely a price effect whether it is stimulated by OMF or by any other policy lever.
• And the impacts on nominal demand and thus potentially on inflation will depend on the scale of the operation: a “helicopter drop” of £1bn would have a trivial effect on nominal GDP: a drop  of £100bn a very significant effect and as a result create greater danger of inflation. And if the stimulative effect of OMF subsequently proved greater than anticipated or desired, it could be offset by future policy tightening, whether in the extreme form of Friedman’s “money withdrawing fiscal surpluses” or through the tightening of bank capital or reserve requirements.

The idea that OMF is inherently any more inflationary than the other policy levers by which we might attempt to stimulate demand is therefore without any technical foundation.”

Turner recognises however that while there are no technical reasons to believe that money creation will be inflationary if done right, there is the risk that governments will abuse their power and create too much money:

“But while the use of OMF is clearly technically compatible with sustained low inflation, there are strong political economy reasons for treating OMF as a potential poison, as Friedman recognised in his 1948 article:

“The proposal has of course its dangers. Explicit control of the quantity of money by government and the explicit creation of money to support actual government deficits may establish a climate favourable to irresponsible government action and to inflation”.”

As a result money creation has become somewhat a taboo subject, and the challenge is:

“therefore to take the possibility of OMF out of the taboo box, to consider whether and under what circumstances it can play an appropriate role, but to ensure that we have in place the rules and institutional authorities which would constrain its misuse.”

Of course, Positive Money explicitly recognises that the Government might be tempted to act irresponsibly with its money creation power, which is why in our reforms the decision over how much money is to be created (which is taken by a completely independent committee) is split from the decision over how the money is to be spent (which is taken by government). Turner himself comes to a similar conclusion, quoting Mervyn King:

“it is important to distinguish between “good” and “bad” money creation. “Good” money creation is where an independent central bank creates enough money in the economy to achieve price stability. “Bad” money creation is where the government chooses the amount of money that is created in order to finance its expenditure”

Turner then goes on to point out that without OMF decades of depression may result, and therefore: “Monetisation is not inherently evil, but a potentially necessary tool in these circumstances.” Looking at historical episodes, he then questions whether things would have been different if governments had thought to spend money into circulation:

• “If Herbert Hoover had known in 1931 that OMF was possible, the US Great Depression would have been less severe.
• If Germany’s Chancellor Brüning had known then that it was possible the history of Germany and of Europe in the 1930s might have been less awful. Hitler’s electoral breakthroughs from a 2.6% vote in the elections of May 1928 to 37.4% in the election of July 1932 were achieved against a backdrop of rapid price falls not inflation.
• And while Japan’s deflationary experience of the last 20 years has been far less severe than that of the 1930s, (as a result, Koo argues, of fiscal deficits that were effective despite being funded) there is a very strong case that Bernanke was right and that if Japan had deployed OMF 10 or 15 years ago, it would be in a much better position today, with a higher price level, a higher level of real GDP, and a lower government debt burden as a % of GDP, but with inflation still at low though positive levels. And it is possible that there are no other policy levers that could have achieved this.”

Finally, he concludes with 9 points, which are worth reading in full:

“1. Leverage and the credit cycle matter a lot.

• The level of leverage in both the real economy and the financial system are crucial variables which we dangerously ignored pre-crisis.
• … future macro-prudential policy should reflect a judgment on maximum desirable levels of cross economy leverage, as well as on desirable growth rates of credit. A wide range of policy levers may be required to contain leverage.

2. Banks are different: the arguments for free markets – strong in other sectors of the economy – do not apply: private credit and money creation are fundamental drivers of both financial and macroeconomic instability and need to be tightly regulated.

3. Financial crises that result from excess leverage are followed by long periods of deleveraging which depress nominal demand, and which change fundamentally the context within which appropriate macro-demand policy must be designed and implemented.

4. In that context there is a good case for a temporary shift away from a pure inflation rate target: state contingent policy rules such as currently applied by the Federal Reserve, or a policy target which for a period of time takes account of nominal GDP growth rates or levels have attractions.

…. but simply changing the targets without also changing policy tools, may in some circumstances be insufficient to ensure optimal policy.

5. In a deleveraging cycle, monetary policy levers alone – whether conventional or unconventional – may be insufficiently powerful and / or have adverse longterm side effects for financial stability. If we got into this mess through excess private leverage we should be wary of escape strategies that depend on creating more private debt.

6. Fiscal multipliers are likely to be higher when interest rates are at the zero bound, and when monetary authorities are pre-committed to accommodative policy in future.

… but long term debt sustainability must be recognised as a significant constraint.

7. Governments and central banks together never run out of ammunition to create nominal demand: overt permanent money finance (OPMF) can always achieve that and is the only policy lever certain to do so.

… and in some circumstances OPMF may have fewer adverse side effects than the use of pure monetary policy levers (conventional or unconventional)

… and in technical terms OPMF carries no more inflationary risks than other policy levers.

8. But the political economy risks of OPMF are very great. … strong disciplines and rules are therefore essential to ensure that excessive use does not turn OPMF from a useful medicine to a dangerous poison.

… but such disciplines and rules, based on independent central bank judgement and clear inflation or other targets, can be designed.

9. We should therefore cease treating overt money finance as a taboo subject. … and if we continue to do so, we increase the danger that overt money finance may be deployed too late to be effective or safe, or deployed in an undisciplined fashion, increasing the long term risks to financial and macrostability.”

He finishes the paper by pointing out that Irving Fisher and Henry Simons correctly pointed out that:

“uncontrolled creation of bank credit and money can be a major driver of financial instability and subsequent economic harm, even when the creation of irredeemable fiat money is tightly controlled, with fiscal deficits small or non-existent and inflation low.

This suggests two conclusions:

• First, that in the deflationary, deleveraging downswing of the economic cycle, we may need to be a little bit more relaxed about the creation, within disciplined limits, of additional irredeemable fiat base money.
• But second, that in the upswing of the cycle we should have been massively more worried than we were pre-crisis about the excessive creation of private debt and private money; and, that we should be wary of relying on a resurgence of private debt and leverage as our means of escape from the mess into which excessive debt creation landed us.”

People’s QE goes mainstream

  

......It is very refreshing indeed that Jeremy Corbyn is willing to make the People's QE a reality if he ever became PM. Ofcourse, it stands to reason if sufficient amounts (monitored by conventional Indicators) of new non-repayable money are created directly into the Economy it could help many people.........But this is only the BEGINNING. What needs to happen next is the introduction of super flexible electronic controls over inflation to really ensure that future amounts of new money could be gradually phased in safely, and successfully. For that to occur, we would need to understand the Economy in Real-Time. With the arrival of Big Data, and Supercomputers/Quantum Computing such a proposal could become increasingly likely, and credible. It would if it succeeds be a massive leap in human evolution. See my evolving project http://www.p2pfoundation.net/Transfinancial_Economics

Written by Fran Boait on August 18, 2015. Positive Money      

           

Labour leadership candidate Jeremy Corbyn has sparked a major debate about monetary and economic policy by calling for what he calls a ‘People’s QE’.
He argues that ‘The Bank of England must be given a new mandate to upgrade our economy to invest in new large scale housing, energy, transport’. People’s QE is similar to proposals called for by Positive Money. We call the idea ‘Sovereign Money’. Ideas in a similar vein have been advocated or at least suggested by notable economists including J M Keynes (1), Milton Friedman (2), Ben Bernanke (3), William Buiter (4) and Martin Wolf (5).  Most recently, Lord Adair Turner (6) has proposed similar ideas, highlighting that ‘there are no technical reasons to reject this option’.
Like Quantitative Easing (QE), Sovereign Money relies on the Bank of England creating money and putting this money into the economy. But whereas QE relied on flooding financial markets and hoping that some of this money would ‘trickle down’ to the real economy, Sovereign Money works by injecting new money directly into the real economy, via government spending, tax cuts or rebates.
Sovereign Money (or People’s QE) tackles the current government’s flawed growth strategy, which is to grow the economy through ever rising household debt. As former FSA chairman Lord Turner put it, this is a “hair of the dog” strategy (7) for economic recovery, treating the cause of the financial crisis – excessive borrowing – as though it could also be the solution. The Office for Budget Responsibility predicts household debt to income ratio surpassing pre crisis levels by 2019 (8).
The pivotal advantage of Sovereign Money is that it requires no increase in either household debt or Government debt. In fact, Sovereign Money can actually reduce the overall levels of household debt. This deleveraging would also make banks more liquid and the economy fundamentally safer.
A common concern with Sovereign Money is that cooperation between the fiscal and monetary authorities is seen as a ‘taboo’ and that it would undermine the Bank of England’s independence. However this argument fails to acknowledge that fiscal and monetary cooperation has already been carried out by recent policies including:  Funding for Lending, Help to Buy, and Quantitative Easing. The difference with Sovereign Money is that the monetary and fiscal cooperation will have to be more explicit.
Another strong concern is that it will lead to the power to create money being excessively used, resulting in high levels of inflation. A strong governance structure is vital, whilst there are several to structure the process Positive Money advocates the Monetary Policy Committee (who decide how much money to create), is separated from the decision of how to spend the money (the government). The simplest way to ensure that the central bank does not create too much money is for monetary policy to continue targeting inflation (on its own or as part of a broader set of targets).
In addition, there is no reason why it should be more inflationary than the creation of money by bank lending (which typically creates inflation in the housing market).  Whereas most money created via bank lending goes into the property market, the money created via Sovereign Money creation would go directly into the veins of the real economy, boosting GDP and employment.  By boosting the capacity of the economy, Sovereign Money should actually be less inflationary than further consumer lending, and the use of Sovereign Money can be restricted should it start to become inflationary.

——-
1) Keynes, J. M. (1933). An Open Letter to President Roosevelt. New York Times
2) Friedman, M. (1948). A monetary and fiscal framework for economic stability. The American Economic Review, 38(3), 245-264
3) Bernanke, B. S. (2003). Some thoughts on monetary policy in Japan. Speech before the Japan Society of Monetary Economics, 31 May, Tokyo, Japan
4) Buiter, W. H. (2003). Helicopter money: irredeemable fiat money and the liquidity trap (No. w10163). National Bureau of Economic Research
5) Wolf, M. (2013). The case for helicopter money. Financial Times. 12th February 2013
6) http://www.ft.com/cms/s/0/8e3ec518-68cf-11e4-9eeb-00144feabdc0.html#ixzz3IjZNT6bq
7) http://www.bloomberg.com/news/2013-10-28/hair-of-dog-policy-risks-u-k-housing-boom-repeat-turner-says.html
8) http://www.telegraph.co.uk/finance/economics/11770654/Is-the-UK-economy-on-another-credit-fuelled-binge.html

If you think Positive Money's ideas are crank, you should see the conventional wisdom

Written by Ralph (Guest Author) on May 3, 2011. Positive Money .Blogger Ref http://www.p2pfoundation.net/Transfinancial_Economics


Positive Money http://www.positivemoney.org/uk


      

          

Just in case you thought Positive Money’s ideas are a bit cranky, they nowhere near as cranky as some of the ideas that make up the conventional wisdom in economics. Here is a selection of truly crackpot ideas which for some extraordinary reason are accepted without question by leading members of the economics profession and the powers that be. I’ll start with interest rates.
The recent recession, like most recessions, was sparked off by excessive and irresponsible borrowing. So how have the authorities responded? By cutting interest rates to record lows – with a view to bringing stimulus via . . . . wait for it . . . . more borrowing!
You couldn’t make it up.
The above absurdity is a bit like the emperor with no clothes. The folk looking at the emperor with no clothes got so used to the sight that they ceased seeing anything absurd. Likewise, most of us are so used to mantra about interest rate reductions being a good way of dealing with recessions that we fail to see the absurdity.
A second, and possibly even more hilarious bit of nonsense is Keynsian “borrow and spend”.
The idea here is that government borrows and then spends the money borrowed. This allegedly brings stimulus. The big problem here is that taking money away from the private sector (borrowing) and then channelling it back to the private sector in the form of more spending quite possibly has no net effect. The tendency of the above borrowing to negate the effects of the above spending is commonly referred to as “crowding out”. And there is very little agreement amongst economists as to how serious this crowding out problem is.
But even if “borrow and spend” does have a net effect, there is still a nonsense involved, as follows. The government of a sovereign currency issuing country (e.g. the U.K., U.S., Japan, etc) can create or “print” any amount of money any time. Now what’s the point of borrowing something (i.e. money), when you can produce it yourself for free? Even worse, what’s the point of borrowing money from OTHER COUNTRIES and paying them interest for the privilege of having something you could have produced yourself for free? Darned if I know.
It’s a bit like a dairy farmer buying milk in a shop when there is a thousand gallon tank of milk right outside the farmer’s back door.
Of course there is the possibility that too much money is printed, which leads to inflation. But there is no reason to suppose that the effect of spending £X borrowed from China will have any different effect to spending £X produced by the Bank of England out of thin air.
As David Hume pointed out in his essay “On Money” 250 years ago, simply creating new money is not inflationary: it’s the fact of spending that money which may cause inflation.
A third absurdity is quantitative easing (QE). This involves giving cash (produced out of thin air) to the rich in exchange for their securities. Now what’s the reaction of the rich going to be? No prizes for guessing the answer.
What they WON’T do is what we want them to do: raise their weekly spending, which would raise demand and create jobs. The spending habits of the rich are not much influenced by changes in the value of their income or assets.
What they WILL do is purchase other assets with their newly acquired pile of cash. That is, they’ll try to buy other securities – hence the stock market appreciation. Or they’ll seek investment opportunities abroad, which messes up other countries: exactly what has happened as a result of QE in the U.S.
And a final big question mark over QE is this. What exactly is the West doing trying to boost its economies by stuffing the pockets of the rich?  First, this does not exactly sound like social justice. And second, in a recession, it’s the ENTIRE economy that needs a boost, not just specific sectors, or specific sectors of the population.
A fourth bit of crackpot nonsense, popular with the political right on both sides of the Atlantic is that cutting the deficit raises “confidence” which in turn induces people to spend, which in turn gets us out of the recession.
Now I ask you, what does the average household do before deciding to spend a bit more? Do they keep a keen eye on the government’s deficit, or on the other hand do they look at their bank balance, their wage or salary, or how much unused credit they have on their credit cards? It’s staggering that I even need to ask the latter question.
Apart from dropping nukes on cities so as to provide re-construction work, I can’t think of a more hopeless collection of anti-recessionary policies than the above. When we eventually come out of this recession, will it be because of various governments’ anti-recessionary policies or will it be in spite of those policies?
And finally, I’ve been thoroughly negative above, which prompts the very reasonable question: do I have any better alternative? The answer is “yes”: Modern Monetary Theory (MMT). MMT does not involve interest rate reductions (the first absurdity dealt with above). It does not involve “borrow and spend” (the second absurdity). And it does not involve the third or fourth absurdity mentioned above.
However, explaining MMT takes hours or several thousand words, and this is not the place for that. Click here to Google “Modern Monetary Theory” if you are interested..
The main point, to repeat, is that if you think Positive Money’s ideas are crank, they are no more crank than the conventional wisdom.

Could the “TTIP” give banks an opportunity to block monetary reform?

            

Written by Positive Money on August 20, 2014.

Tweet

An international trade deal is being negotiated that could – in theory – give large international banks an opportunity to sue governments that implement monetary reform. Peter Verity, coordinator of the Sheffield Positive Money group, considers whether this might be a threat to Positive Money.
TTIP & ISDS – although these acronyms sound like something to do with your internet connection, they actually represent major international deals which are currently being negotiated in secret. They could seriously threaten democracy, and lead to further deregulation of the financial sector.

So what is TTIP?

TTIP, or the ‘Transatlantic Trade and Investment Partnership’, is a deal currently being negotiated between the EU and the USA, described as the world’s biggest trade and investment deal outside the WTO. A key element is ‘reducing non-tariff barriers to trade (eg. labour rights, environmental and food regulations, privacy laws, banking regulations etc).
The treaty is supposed to harmonise regulations between Europe and the USA, but it will also create the legal right to rip the heart out of any Government policies or laws which big businesses decide are not in the interests of their shareholders.
It has been dubbed the Big BAD Law (Business Against Democracy).
An important part of TTIP is the ISDS (Investor-State Dispute Settlement) chapter which grants transnational companies the right to sue governments if their profits are threatened. There have been over 500 cases brought to date, predominately by developed countries against developing countries, with over 50% either settled or found in favour of the claimant¹. ISDS has been used to block plain packaging for cigarettes in Australia, it is being used by a nuclear company contesting Germany’s decision to switch off atomic power, and it cost Argentina billions in damages when they tried to freeze energy prices, adding to its sovereign debt crisis.

Should we be concerned?

Yes! The City of London is one of the strongest lobbyists for TTIP. It is not hard to see why, as one of the key things they are pushing for is to include ‘financial services liberalisation’ in TTIP. The US currently has stricter banking controls than the EU, and the City of London has its eyes on the prizes it could get in the US. TTIP may mean that current and future UK, EU and US governments who introduce many types of regulations on banks and their lending could face legal challenges in international courts.
TTIP could potentially mean a complete reversal of all the hard won regulatory reforms achieved since the onset of the financial crisis. Despite the fact that ‘light touch’ regulation of the financial sector contributed to the biggest economic crisis in living memory, banks and financial speculators are keen to get rid of even the small steps taken since then to rein in big finance.
And since ISDS would grant corporations the right to sue governments if they take decisions which reduce profits, there is little doubt that the banks would attempt to use the legal process to challenge even the smallest banking reform, and certainly the fundamental reforms proposed by Positive Money.

What can we do about it?

Find out more about TTIP and ISDS here > WDM briefing on TTIP

Then join (if desired) one of the campaigns that are mobilising against TTIP. They include

• WDM (World Development Movement)
• Jubilee debt campaign
• 38 Degrees
• Green Party
• War on Want

¹ http://unctad.org/en/PublicationsLibrary/webdiaepcb2014d3_en.pdf
 


Response from the Blogger


With Transfinancial Economics (notably in its Advanced Stage) it would be possible to reform Multi-National Corporations in ways that would make them more environmentally friendly, and more sustainable, and socially ethical as never before. This process would involve the digital creation, and transmission of new money (without serious inflation) to change their ways with close transparent monitoring. This new money could act as a one off compensation, or long-term compensation for them in part or in full to stop, or suspend certain activities which may be anti-environmental, or anti-sustainable in some manner, or other..Yet, this would be a very unpopular concept to those on the left of the political spectrum But saving people, and the planet is far more important than any political ideology. http://www.p2pfoundation.net/T...
..............In an ideal world, it would be more ethical to have an international organanisation that would have the global political clout to ensure that corporations obey rules, and regulations in connection to the environment......and ofcourse, other matters of a high ethical nature...


R.Searle

Martin Wolf Proposes the Death of Banking

Posted by Frances Coppola on Apr 25th 2014,   
Blog Ref Link http://www.p2pfoundation.net/Transfinancial_Economics   

The distinguished economic journalist Martin Wolf has suggested (£) that banks should be stripped of their ability to create money when they lend. Endorsing “100% reserve banking” as outlined by, among others, the IMF, Lawrence Kotlikoff and Positive Money UK, he calls for all money to be created by the state and banks to be reduced to pure intermediaries. He explains how this would work thus:
First, the state, not banks, would create all transactions money, just as it creates cash today. Customers would own the money in transaction accounts, and would pay the banks a fee for managing them.
Second, banks could offer investment accounts, which would provide loans. But they could only loan money actually invested by customers. They would be stopped from creating such accounts out of thin air and so would become the intermediaries that many wrongly believe they now are. Holdings in such accounts could not be reassigned as a means of payment. Holders of investment accounts would be vulnerable to losses. Regulators might impose equity requirements and other prudential rules against such accounts.
Third, the central bank would create new money as needed to promote non-inflationary growth. Decisions on money creation would, as now, be taken by a committee independent of government.
Finally, the new money would be injected into the economy in four possible ways: to finance government spending, in place of taxes or borrowing; to make direct payments to citizens; to redeem outstanding debts, public or private; or to make new loans through banks or other intermediaries. All such mechanisms could (and should) be made as transparent as one might wish.
 The three proposals Wolf cites are actually very different from each other. The IMF’s paper “Chicago Plan Revisited” is a strict 100% reserve banking proposal, in which all deposits, irrespective of the risk appetite of the depositor, are backed by central bank reserves. It is accompanied by a full debt jubilee plan to eliminate household debt, leaving banks to lend only for business investment.
I’ve previously written a detailed critique of the IMF’s paper. To summarise, though, the paper does not give sufficient consideration to the implications for commercial banking. There are four principal problems:
·         banks would have to clear all lending decisions with the central bank in advance in order to obtain funding: lending decisions would therefore in reality be made by government (the IMF’s paper regards the central bank as part of government) .
·         banks would have to borrow from the central bank to fund lending – they could not borrow from each other, even though they would have large amounts of idle money lying around on their balance sheets earning nothing.
·         banks would have to pay fees to the central bank for the reserves required to back deposits, even though deposits are a cost for them (the IMF in effect proposes permanently negative interest on REQUIRED reserves).
·         margins on what little lending remained after the debt jubilee would be painfully low, because the paper assumes that businesses would alternatively be able to obtain finance in the capital markets at similar rates to the yield on government bonds.
This cannot in any way be considered a profitable business model.  In my critique I concluded that this proposal would mean the death of commercial banking:
As far as I can see, in this model it is virtually impossible for private banks to be profitable. In which case they would soon cease to exist, and government would be forced to create state banking facilities to replace them. The question is, why did the authors stop short of recommending full nationalisation of the banking system, since that is the only way the model could work in the longer term? The authors think that private banks funding long-term investment projects is a Good Thing, but they offer no explanation for this belief. Could it be that they have retained private banks in their model because recommending a move to a wholly state-owned system would not be taken seriously by most economists and politicians?
But such a strict 100% reserve banking approach is not actually what Wolf is suggesting, despite his comment that the IMF researchers' approach “could work well”. His idea is much closer to the other two proposals, both of which I have also written about.
Kotlikoff envisages a disintermediated banking system in which banks “market” various types of funds but do not themselves do credit intermediation or maturity transformation. Depositors who want no risk would place their money in money funds fully backed by safe assets (government debt): they would have guaranteed safety but very little return on their investment. Depositors wanting higher returns would have a range of funds to choose from representing varying amounts of risk: capital allocation (lending) would be done by the funds in accordance with their portfolio management strategies. The US banking system is already well down the disintermediation road anyway, so to an American customer base it would make complete sense for banks simply to market funds rather than compete with them.
But there is a problem. The functions that distinguish “banks” from other financial institutions are credit intermediation (deposit-taking and lending) and maturity transformation (borrowing short, lending long). Once banks no longer do either of these, they cannot be regarded as banks. They are simply shops. Once again, we are faced with the death of commercial banking.
The third proposal, from Positive Money UK, is actually the closest to Wolf’s ideas. Though there are differences. Rather than backing deposits with central bank reserves as Wolf suggests, Positive Money UK simply cut out the middleman. They propose that transaction accounts should be on the books of the central bank. Commercial banks would only hold risk-bearing investment accounts, from which they could lend. It’s a neat idea, and unlike the other two proposals – both of which completely ignore the crucial role of banks in facilitating payments - it does recognise that transaction accounts and interest-bearing time or sight deposits serve very different purposes. Both Wolf and Positive Money UK envisage banks charging customers fees for payments and account management. This does, of course, mean the end of “free while in credit” banking.
But once again, there is a problem. Banks are not fund managers. People who want to put money at risk for a return don’t generally put it in banks: they invest it in funds or manage their own portfolio. People put money in banks for two reasons:
·         because they want safety AND a return
·         because they need liquidity (including access to payments systems)
Wolf recognises the second of these, but not the first. I fear that the “investment accounts” he and Positive Money UK envisage would disappear like the morning mist once the deposit insurance that time and sight deposit accounts currently enjoy is removed. Positive Money UK's proposal therefore probably means the end of commercial banking, unless they could find other sources of funding. In Wolf's world, commercial banks could survive for a while as pure deposit-takers, but as mobile money platforms reduced their fees to undercut the banks now forced to charge transaction fees, and quasi-banks offered supposedly safe liquid depositary services for a better return than the banks now unable to pay interest on safe deposits, they would eventually wither and die.
But it is perhaps more likely that commercial banks would find ways of lending without relying on customer deposits for funding. Since heavy reliance on wholesale funding is now penalised by regulators, asset-backed securities issuance seems the most obvious choice: Santander UK already funds quite a bit of its lending with covered bonds. But there is another possibility too – and that is a vast increase in the amount of equity that banks hold. Equity is funding: if banks are prevented from using debt to fund lending, they are forced to use equity. Weirdly, we might find banks choosing to adopt Admati& Hellwig’s proposal for much larger equity cushions, just so they can lend at all. After all, as Northern Rock discovered, relying on asset-backed securities issuance for funding has a very big problem: asset-backed securities are by nature illiquid and there is no guarantee that anyone will buy them anyway. At least shareholders’ funds are money you already have, rather than money you hope to receive. Though - returning to my definition of banks' distinguishing functions as being credit intermediation and maturity transformation - if banks only lend shareholders' funds, can they really be said to be banks at all?
This brings me to the heart of Wolf’s proposal. Wolf thinks banks should only be able to lend money they already have, not money they hope to receive: in the absence of loanable deposits, this tends to force banks down the equity funding route because of the inherent illiquidity of other forms of stable funding. But as I explained in my critique of the IMF paper, money creation through bank lending is an inevitable consequence of double entry accounting, and preventing it is by no means as simple as Wolf suggests. Completely eliminating fractional reserve lending means removing banks’ responsibility for lending decisions. Yet again, we face the death of commercial banking.
But my bigger concern is this. Wolf’s idea amounts to replacing a demand-driven money supply creation mechanism with central planning of the money supply by a committee.  Central banks’ record on producing accurate forecasts of the economy is dismal, and their response to economic indicators is at times highly questionable. Put bluntly, they get it wrong – very wrong, at times: consider the ECB raising interest rates into an oil price shock in 2011. Is the entire lifeblood of the economy to be dependent on the whims of such as these?
Some people suggest an algorithm-driven mechanism whereby the money supply automatically adjusts in response to economic indicators such as NGDP or money velocity. This is a neat idea, but it suffers from the problem of accuracy and timeliness of information. GDP is a flawed measure which is subject to constant revision. So is inflation. So is money velocity. And all of them are lagging indicators. How can the future money supply needs of the economy be accurately estimated using these?
Personally I would prefer the money supply to respond to demand rather than be decided by a committee, or an algorithm for that matter.  I don’t in theory have a problem with removing the link between bank lending and money creation: bank lending is by nature pro-cyclical, so the money supply does tend to expand when it really should contract and vice versa. But until someone can identify a better indicator of demand for money, bank lending – or perhaps better, lending activity in the financial system as a whole, including non-bank lending – is the best we have and certainly a lot better than the MPC. The system we have is undoubtedly flawed, but Wolf’s alternative is a whole lot worse.
Related reading:
The shoebox swindle – Coppola Comment
The shoebox shortage – Coppola Comment
The nature of money – Coppola Comment
Do we really care who creates money? – Coppola Comment
The negative carry universe – FT Alphaville
Image: Comely Bank cemetery, Edinburgh
  JOIN PIERIA TODAY!
Keep up to date with the latest thinking on some of the day's biggest issues and get instant access to our members-only features, such as the News Dashboard, Reading List, Bookshelf & Newsletter. It's completely free.