Monetary sects.

Positive Money, full reserve banking, Modern Monetary Theory.

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

1. Introduction.

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.

2. 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. 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. (K-waves, 2014).

3. 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.

4. 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 . . . non-depository institutions. . . (Krugman, 2011). . . The PM reform would not have prevented this.

5. 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.

6. 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”.

7. 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).

8. References.

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/

Full reserve banking.
Clippings about monetary reform, March-April 2014.

1. Credit cycles.

. . . 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 )

2. Three proposals.

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 )

3. Brokers.

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/ )

4. 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 )

5. 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 )

Modern monetary theory (MMT).

1. MMT: A Doubly Retrospective Analysis
L. Randall Wray.
neweconomicperspectives.org/2011/12/mmt-doubly-retrospective-analysis.html

. . . it all goes back to PKT (Post Keynesian Thought) in the early 1990s—the first internet discussion group I ever heard of. It started off with all the stars of heterodox economics . . . But if we want to credit one thing for spreading MMT all over the planet, it was Bill’s blog. While the academic journals and the policy makers and the mainstream press could mostly ignore us, the blogosphere was wide open to new ideas.

2. Mark H Burton.
steadystatemanchester.net/2019/02/28/what-kind-of-a-green-deal-the-implications-of-material-and-monetary-flows/

. . .  drawing on another variant of post-Keynesian thinking, Modern Monetary Theory . . . leading MMT academic Stephanie Kelton and colleagues . . . explained that governments never have to raise money before spending. Instead they spend, thereby creating money, and that money is re-couped from the economy later, as taxes, essentially a portion of the economic growth so generated.

3. Ryan Cooper, 27 Feb 2019.
https://theweek.com/articles/825884/big-question-about-modern-monetary-theory-everyone-missing

MMT advocates say that . . . a state borrowing in its own currency . . . (backed if necessary by the central bank printing money and . . . buying government debt) . . . will not cause inflation so long as there are unemployed workers and idle capital . . . But if there is full employment . . . inflation should be controlled . . . by raising taxes.

. . . economist John Kenneth Galbraith, based on his personal experience . . . in the Second World War . . . argued that . . . “We . . . learned that taxes could not be made to keep pace with wartime spending, and that the excess of purchasing power could not, as Keynes had proposed, be mopped up.”

. . . Galbraith’s Office of Price Administration worked extremely well. Production exploded from 1939 to 1943 by 131 percent . . . but price increases were held to a modest rise of 21 percent. This was practically the inverse of World War I, when production rose only 25 percent . . .  but prices accelerated by 77 percent.

. . . in the late 1970s, when inflation was at its postwar peak, Galbraith argued for a return to price controls, but conservative “monetarists” . . . hiked interest rates to . . . 20 percent, creating the worst recession . . . up to that time . . . since the Great Depression.

4.  Larry Elliott, 6 July 2015, http://www.theguardian.com/business

After the war in the 1940s, Germany received help through the Marshall plan. The granting of debt relief at a London conference in 1953 was more important than direct transfers of money. Western Europe in the 1950s had debt/GDP ratios close to 200%, but for the new West German state, debt/GDP ratios were less than 20%.

5. Modern money theory (MMT): the emperor still has no clothes.
Thomas I. Palley, February 2014.
http://www.thomaspalley.com/docs/articles/macro_theory/mmt_response_to_wray.pdf

. . . MMT asserts that the . . . short-term policy interest rate should be set at zero . . . The interest rate is . . . an important policy instrument for addressing instability that can arise from financial capital flows and flight. . . zero interest rate policy . . . throws away a vital policy instrument in a world where policy makers already confront the challenge of having more targets than instruments.

. . . MMT currently has appeal because it is a policy polemic for depressed times.

6. Alison Marshall, 11 September 2016.

The surge of interest in the Citizens Income or Basic Income Guarantee is opposed by MMT supporters who prefer the job guarantee strategy (JG). They think the JG can be used to provide economic stimulus without the inflation that discredited Keynesian stimulus policies in the 1970s.
( http://www.coppolacomment.com/2013/07/economic-equivalence-job-guarantee-and.html ).

“It is a program that stabilizes the incomes and purchasing power of individuals at the bottom of the income distribution . . . Strong and stable demand . . . stabilizes the rest of economic activity.” ( https://en.wikipedia.org/wiki/Job_guarantee , accessed September 2016).

Other economists have other ideas about causes of economic instability. Some, following Schumpeter, emphasise the disruptive effect of new technology, others think that demography is an important influence.

The wikipedia contributors admit that the JG alone is inadequate. Other policies would be needed to control inflation:

“The JG wage would be adjusted in line with productivity growth to avoid changing real relativities. Its viability . . . relies on the fiscal authorities reining in any private wage-price pressures.”

And they don’t seem to agree about what is meant by “full employment”:

“The aim is to replace unemployment and underemployment with paid employment (up to the hours desired by workers)”

So if zero paid employment is desired, unemployment is tolerated?

But “A range of income support arrangements, including a generic work-tested benefit payment, would also be available to unemployed people, depending on their circumstances, as an initial subsistence income while arrangements are made to employ them.”

So income support may be work-tested, so unemployment may not be tolerated.

I don’t disagree with job creation in the public sector, if it is affordable, but I think work should be allocated by self-selection not compulsion. If work doesn’t pay, there isn’t much self-selection. If it does, then wages could be allowed to adjust to the level at which the supply of labour matched the demand.

The most logical way of making work pay, with the least fuss, is with Citizens Incomes ( https://ammpol.wordpress.com/ammwr ). They would be less judgmental and no more inflationary than the job guarantee strategy.

7. MMT: The case against Modern Monetary Theory.
Stephen King, Financial Times, 22 Oct 2020.

Inflation and taxes are, in many ways, simply two sides of the same coin.
. . . Negative real interest rates, a result of higher-than-anticipated inflation, serve to redistribute wealth away from private creditors . . . to public debtors. Much the same could be achieved through a wealth tax. 
. . . Thanks to Covid-19, government debt is rising rapidly and, for that matter, appropriately . . . At some point, some of us will be presented with a bill . . . in the form of higher taxes, more austerity, rising inflation or eventual default.

Further reading.

Inflation, interest, and the supply of money.
Inflation, interest, broad money, base money, foreign exchange.

The crash of 2008.
Cheap money, deregulation, more cheap money, re-regulation.

The search for a stable economy.
Land tax, protectionism, demography, Green taxes, citizens incomes.