Positive Money.

1. Objections to the Positive Money campaign.
Alison Marshall, 16 March 2014.


After a major economic crisis, old systems are seen as failures and new experiments are tried.

The Keynesian economic experiment which followed the 1930s depression was unable to prevent the 1970s stagflation, and the financial deregulation which followed the 1970s crisis is now seen as excessive and a factor in the current crisis.

The results of a third example, Nazism, which also grew out of the 1930s crisis, were much worse.

In the current cycle the Positive Money campaign (PM) is gaining support, and may be included in the next wave of experiments. It may be preferable to other more disruptive ideas, but at best I think it will just be a waste of time and effort.

My objections to PM are:

1. I don’t agree that credit cycles are the main cause of economic instability.
2. I don’t agree that the PM reform will stop the creation of money by private banks.
3. PM aren’t targeting the kind of banking that was a factor in the 2008 financial crisis.
4. They ignore the power of spending which isn’t influenced by lending.
5. They reject the money multiplier model of broad money creation.

Credit cycles.

Historical financial crises can be explained by the lending behaviour of commercial banks, says PM. In benign economic periods, to increase their profits, private banks need to increase their lending. This excess creation of credit increases the severity of any subsequent downturn. Attempts to regulate the current monetary system are unlikely to control this problem, and the fundamental method of issuing and allocating the nation’s money supply should be changed. (Positive Money, 2013).

Other economists, following Schumpeter’s ideas, think that creative destruction caused by technological innovation is a more important contributor to economic instability. (K-waves, 2014).

And a third group thinks that demography is important, so that the relatively fixed length of a human generation, like a clock, makes the timing of the economic long waves reliably predictable.

Creation of money.

Banks have to pay for borrowers’ spending immediately, in daily settlements at the central bank, using central bank money (base money). The payments are funded from deposits in the lending bank’s accounts which haven’t already been used to fund other loans. These deposits which were backed by base money become deposits backed by the debt owed by the borrowers. But they have also become spending backed by base money. So one lot of money has doubled and become two lots. The only way to stop the creation of money in this way is to ban lending by private banks.

The PM reform would abolish the lending of money from pooled short-term demand deposits. But there would still be investment accounts, for customers to hand money to the bank, on the understanding that the bank would invest or lend it, intentionally placing it at risk to try to earn a rate of return for the customers. The customers placing funds into an Investment Account would have to agree to lose access to those funds for a period of time, and would also bear some of the risk of the investment. (Positive Money, 2013).

So money would still be created by lending from investment accounts at private banks. PM claim that after their reform the Bank of England would be the only institution able to alter the money supply. (Positive Money, 2013). I think that is wrong.

The wrong target.

PM are making a lot of fuss about private banks lending from short-term demand deposits. They are aiming at the wrong target.

The 2008 crisis was “mainly a run on shadow banks, on non-depository institutions”, says economist Paul Krugman. The PM reform would not have prevented this.

It’s difficult even to regulate shadow banking, says Krugman. But if you try to ban long-term lending by banks based on short-term borrowing, this is going to take place instead in the areas not subject to the ban, leaving you more vulnerable to crisis than before. (Krugman, 2011).

The influence of spending.

There are currently two types of money:
Central bank reserves, or base money, are created by the central bank and only used by the banking sector.
Commercial bank deposits, or broad money, are created by commercial banks and used by everyone else.
(Positive Money, 2013).

Between 2006 and 2009 the money multiplier, defined as “broad money relative to central bank money” or “the link between central bank money . . . and money in the economy”, was highest, at about 64, in early 2007, and lowest, at about 25, in late 2008. (Financial Times, 2009). So the ratio of broad money to the total of base money plus broad money varied between 25/26 and 64/65. That‘s between 96.2% and 98.5%, in three years in which there was a transition from a major bubble to an exceptionally large crash.

So about 97% of money is created by private banks. This money supply for the real economy depends entirely on the lending decisions of the banking sector, says PM (Positive Money, 2010), and this gives the banks too much influence over the economy and society.

But although 97% of the money supply originated as private bank loans, that does not equate with 97% of all spending. Total spending is equal to the money supply multiplied by the velocity of circulation.

The money multiplier.

The money multiplier view of bank lending is that banks require deposits or central bank reserves before they can make loans, says PM. The PM view is that the money multiplier model gets causality the wrong way round, loans in fact create deposits, and reserves are required by banks only to settle payments between themselves. (Positive Money, 2013.)

I think that loans can’t be self-funding. They can only be funded from deposits in the lending bank’s accounts which haven’t already been used to fund other loans. And they have to be funded almost immediately, to pay for the settlements at the central bank, as soon as the loans have been spent by the borrowers.

Some of the funding may come from deposits of newly created reserves borrowed at the central bank. The causality debate is really about whether central banks can control lending by private banks. There are at least four factions:

a) Monetarists following Friedman thought broad money could be controlled by managing the quantity of central bank money.
b) Other economists think that it can be done by varying the interest rate charged for central bank loans,
or c) private banks can be regulated by using required reserve ratios,
or d) central banks can’t control lending by private banks.

Whichever of these theories is correct, the money multiplier model is still a valid description of the creation of broad money. (Marshall, 2008). The first and third factions should be distinguished from the fourth by the label “exogenous money models” not “money multiplier models”.

In other words . . .

Here are three more clippings about the causality debate:

Neoclassical economists side with the exogenous ‘money multiplier’ idea, which says the banks receive reserves from the central bank, which they then lend out. Endogenous money proponents – generally post-Keynesian – side with another story, which says that banks create loans ‘out of nothing’ first, then the central bank more or less passively accommodates their demand for reserves. (Unlearning economics, 2012).

Ultimately a comprehensive model of banking needs to be a hybrid one, including both the endogenous creation of money by banks, the exogenous creation of money by central banks and the creation of profits through positive cash flow management by banks. (Lainton, 2013).

Do you believe in the money multiplier? The money multiplier equals the ratio of the money supply (however defined) and the monetary base.  It’s simply a ratio, there’s nothing to believe or disbelieve.  (Sumner, 2012)


Financial Times, 6 March 2009.

Krugman, Paul, 2011. http://krugman.blogs.nytimes.com/2011/10/10/if-banks-are-outlawed-only-outlaws-will-have-banks/

K-waves. http://en.wikipedia.org/wiki/Kondratiev_wave. Accessed March 2014.

Lainton, Andrew, June 2013. http://andrewlainton.wordpress.com/2013/06/13/maturity-transformation-is-not-about-patience-and-impatience-2/

Marshall, A, The multiplier, February 2008.
In “Inflation, interest and the supply of money”, https://ammpol.wordpress.com/ammiim

Positive Money, 2010. http://www.positivemoney.org.uk/wp-content/uploads/2010/11/NEF-Southampton-Positive-Money-ICB-Submission.pdf

Positive Money, 2013. https://www.positivemoney.org/wp-content/uploads/2013/04/The-Positive-Money-Proposal-2nd-April-2013.pdf

Sumner, Scott, 8 April 2012. http://www.themoneyillusion.com

Unlearning economics, 2012. http://unlearningeconomics.wordpress.com/2012/09/22/endogenous-versus-exogenous-money-one-more-time/

2. An interesting debate.
Clippings about monetary reform, March-April 2014.

Credit cycles.

. . . credit cycles are . . . hugely destabilising. . . A minimum response would leave this industry largely as it is but both tighten regulation and insist that a bigger proportion of the balance sheet be financed with equity or credibly loss-absorbing debt . . . A maximum response would be to give the state a monopoly on money creation.

. . . only about 10 per cent of UK bank lending has financed business investment in sectors other than commercial property. We could find other ways of funding this.

Our financial system is so unstable because the state first allowed it to create almost all the money in the economy and was then forced to insure it when performing that function.

( Martin Wolf, 24 April 2014.
http://www.ft.com/cms/s/0/7f000b18-ca44-11e3-bb92-00144feabdc0.html )

. . . bank lending is by nature pro-cyclical, so the money supply does tend to expand when it really should contract and vice versa. . . The system we have is undoubtedly flawed, but Wolf’s alternative is a whole lot worse.

(Frances Coppola, 25 April 2014.
http://www.pieria.co.uk/articles/martin_wolf_proposes_the_death_of_banking )

. . . a genuinely interesting debate on financial reform is taking place . . . proposals to either mandate or create strong incentives for 100-percent reserve banking, coming from Martin Wolf and, more surprisingly, John Cochrane. . . The basic idea both writers share is that banks as we know them — institutions that issue promises to pay money on, or almost on, demand, while holding liquid assets that cover only a fraction of that potential demand — are inherently subject to runs, self-fulfilling losses of confidence.

. . . Cochrane’s proposal calls for a remarkable amount of government intervention in finance; it makes liberal proposals for a transactions tax look like minor nuisances.

. . . Are we really sure that banking problems are the whole story about what went wrong? . . . look at any measure of financial stress: what you see is a huge peak in 2008 that quickly went down . . . Yet the quick return to normality in financial markets (achieved, to be sure, through bailouts and guarantees) did not produce a quick recovery in the real economy; on the contrary, we’re still depressed and many advanced countries are now on the edge of deflation, more than five years later. This strongly suggests that while bank runs may have brought things to a head, the problems ran deeper . . . I’m strongly of the view . . . that broader issues of excess leverage . . . are key.

( http://krugman.blogs.nytimes.com/2014/04/26/is-a-banking-ban-the-answer/ )

Creation of money.

 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.

. . . Kotlikoff envisages a disintermediated banking system in which . . . depositors . . . would have a range of funds to choose from representing varying amounts of risk . . . 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.

. . . Positive Money UK . . . 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.

. . . 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.

(Frances Coppola, 25 April 2014.
http://www.pieria.co.uk/articles/martin_wolf_proposes_the_death_of_banking )

Wolf would have a system where there is no maturity or risk transformation enacted by the banks as intermediaries. They are merely brokers matching up their liability customers with their asset customers. It is undoubtedly in some senses safer. So too would be our roads if motorised transport was banned.

( Brian Woods II, 28 April 2014.
http://www.irisheconomy.ie/index.php/2014/04/25/martin-wolf-money-versus-banking/ )

I don’t see why the current system is fundamentally flawed, as opposed to monumentally mismanaged. . . If anybody has a link to a good resource describing Wolf’s solution, I’d be very grateful. Sites like “Positive Money” are so full of political polemic that I find them unreadable . . . it’s time I tried harder to explore my bias.

( http://ftalphaville.ft.com/2014/04/25/1836542 \ comment-7260802 )

The wrong target.

. . . Wolf, unless I’m reading him wrong, seems to identify the whole issue with one particular form of short-term debt — bank deposits. This seems an oddly narrow view given the nature of the 2008 crisis, which involved very few runs on deposits but a massive run on shadow banking, especially repo — overnight lending that in a fundamental sense fulfilled the functions of deposit banking but also created the same kind of risks.

. . . Wolf’s omission is a big one. If we impose 100% reserve requirements on depository institutions, but stop there, we’ll just drive even more finance into shadow banking, and make the system even riskier.

. . . I’m strongly of the view . . . that broader issues of excess leverage, and the resulting balance-sheet problems of many households, are key. And neither 100% reserves nor a repo tax would have addressed that kind of leverage.

( http://krugman.blogs.nytimes.com/2014/04/26/is-a-banking-ban-the-answer/ )

The influence of spending.

. . . banking crises against the background of a solvent sovereign are a separate issue from sovereign crises. . . The latter is potentially just as important, especially looking forward.

( http://faculty.chicagobooth.edu/john.cochrane/research/papers/run_free.pdf )

The money multiplier.

. . . The money multiplier has been widely misinterpreted as an ex ante determinant of the amount of money that banks are “allowed” to create . . . it is actually an ex post descriptor of the amount of money banks HAVE created in relation to base money . . .

(Frances Coppola, 29 March 2014.
http://www.pieria.co.uk/articles/rediscovering_is-lm )