Would a Positive Money system be inflationary?

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When we suggest that the state (or the Bank of England) should be allowed to create new money, some people automatically react with the suggestion that this would cause inflation. Indeed, the most common misguided criticism of the type of reform that we are proposing is that it will cause significant inflation, as an irresponsible government prints as much money as it requires for its own needs.

HOW WELL HAS THE CURRENT SYSTEM PREVENTED INFLATION?    Between 1970 and 2010, the banks have been inflating the money supply by an average of 11.5% per year. While consumer prices have only experienced low levels of inflation during this period, the housing market has experienced significant levels of inflation. Indeed, between 1990 and 2007 house prices almost tripled!

There is absolutely no risk of this happening under the Positive Money proposals. Decisions on changes in the money supply will be made not by vote-seeking politicians but by an independent body (the Money Creation Committee); politicians will have no influence whatsoever in the amount of money that will be created.

The Money Creation Committee will be instructed to consider the needs of the economy as a whole in deciding how much new money should be injected into the economy. The needs or desires of the elected government do not factor in this decision at all. In fact, the members of the MCC could be expressly forbidden from considering political matters or the intentions of the current government in making the decision.

Deciding how much money to create: The Money Creation Committee (MCC)

The decision over how much new money to create would be given to an independent body, to be known as the Monetary Creation Committee. As is the case today, the target of monetary policy will be the rate of inflation. However, in line with democratic principles, if Parliament deems targets other than price stability to be more desirable, it will have the ability to change the MCC’s mandate.

In deciding the amount of money that would be added or removed from circulation, the MCC would broadly aim to change the growth rate of the money supply in order to keep inflation at around the 2% a year target. Creation of new money by the MCC will increase the amount of spending in the economy. Depending on the state of the economy at the time, this may push up the inflation rate. If inflation is above the target rate, then it is unlikely the MCC will choose to further increase the money supply.

Note that the MCC’s decision will be based on the amount of additional money they consider necessary to meet the inflation target. Under no circumstances would they be creating as much money as the government needs to fulfil its election manifesto promises.

With the MCC having direct control over the amount of money in the economy, the Monetary Policy Committee at the Bank of England would no longer be needed and could be disbanded. Currently the Monetary Policy Committee attempts to control bank lending – and therefore the quantity of broad money in the economy – by influencing the interest rate at which banks lend to each other on the interbank market. Post-reform, central banks would have direct control over the money supply and so there would be no need for them to set interest rates. Instead, interest rates would be determined by the markets.

The Money Creation Committee will have no control over how the newly created money is used. Whilst the way the money is used will determine to some degree its effect on inflation, giving the MCC any influence over how the money is spent would introduce a conflict of interest, whereby its members might find that their judgement is swayed by their opinion on the government’s policies and projects. In order to prevent this conflict of interest from arising, and to ensure that the MCC does not become politicised, the decision over how much money is created and what that money is used for must be taken by separate bodies.

Appointments and neutrality of the MCC

The MCC must be politically independent and neutral, just as the Monetary Policy Committee (responsible for setting interest rates) is today. As well as being shielded from the influence of vote-seeking politicians, it is essential that the MCC is sheltered from conflicts of interest and lobbyists for the banking sector and other industries. Building on the rules that currently cover the Monetary Policy Committee’s transparency and accountability, all increases in the money supply will be made publicly known. In addition, while the MCC will not be answerable to the Chancellor of the day (who will likely have his own political objectives to achieve), they will be accountable to a cross-party Parliamentary Group, such as the Treasury Select Committee.

Appointments to the MCC will automatically include the Governor and two Deputy Governors of the Bank of England, as is the case with the Monetary Policy Committee today. Likewise the Governor is still best placed to recommend the two internal members of the committee. However, unlike today, where the internal appointments are referred to the Chancellor of the Exchequer for approval, under the reformed system these internal members will instead be referred to a cross party group of MPs for approval. The intention is to provide democratic oversight and scrutiny of the appointment process by Parliament while reducing the powers of the Chancellor. Likewise, for the same reasons, the appointment of the four external members of the MCC will also be decided by a cross party group of MPs. In total, the MCC will be made up of nine members, which, with the exception of the Governor and the Deputy Governors, will serve three-year terms.

How the Money Creation Committee would work

Each month, the Money Creation Committee would meet and decide whether to increase, decrease, or hold constant the level of money in the economy. During their monthly meetings the MCC would decide upon two figures:

1. The amount of new money needed in order to maintain aggregate demand in line with the inflation target (similar to the setting of interest rates today), and;

2. The amount of new lending needed in order to avoid a credit crunch in the real economy and therefore a fall in output and employment.

Both figures would be determined, as is the case now when setting interest rates, by reference to appropriate macroeconomic data, including the Bank of England’s Credit Conditions Survey (a survey of business borrowing conditions).

Once a conclusion had been made on the two figures mentioned above, then the Money Creation Committee would authorise the creation of a specific amount of new money. This newly created money could then enter the economy in two ways:

The first (and most common) of these would be to grant the money to the government (by increasing the balance of the Central Government Account), which would then spend this money into circulation, as discussed in the next section. This process increases the money supply without increasing the level of debt in the economy and can therefore be thought of as ‘debt-free’ money creation.

The second method would be for the central bank to create new money via the MCC and lend it to banks, which would then lend this money to businesses and the productive economy (but not for mortgages or financial speculation). This increases the money supply but simultaneously increases the level of debt, and so does not constitute debt-free money creation. This option provides a tool to ensure that businesses and the real economy do not suffer from a lack of access to credit.

Is it possible for the Money Creation Committee to determine the ‘correct’ money supply?

To begin with, it is important to note that the MCC would not determine how much money the economy needs from scratch. Instead, it would decide whether to increase or decrease the money supply from its existing level (which had been determined by historical events), given current levels of inflation and economic activity. This requires that the MCC take a view on the likely future path of the economy in addition to reacting to economic events. Essentially the MCC will be guided by both theory and the results of their previous decisions.

There is of course no way for the MCC to predict perfectly what the growth in the money supply ‘should’ be. However, this is true of all monetary and political decisions – including the Monetary Policy Committee’s decision to increase or decrease interest rates in the present system. The question therefore becomes one of who is most likely to supply the economy with the ‘correct’ amount of money: commercial banks in the current system, or an independent committee in the reformed system?

Today, commercial banks create money when they make loans. Bank officials therefore are not making a decision about how much money they think should be in the economy; they are instead making a decision about whether a particular loan will be profitable. This means that the money supply is currently determined as a by-product of bank lending decisions, made in the pursuit of profit. Because the majority of banks’ profits come from the interest they charge on loans, in relatively benign periods banks are incentivised to lend as much as possible, creating money in the process.

However, although the money supply is determined by the actions of companies in the private sector, it would be a mistake to believe that the money supply is determined by market forces, for several reasons. First, the top five banks in the UK dominate almost the entire market, making it an oligopolistic market. Second, the money supply is not determined by the demand for money, but by the demand for credit. Third, even the market for credit is not determined by market forces – banks ration credit. Of course, the overall strategies of banks, and therefore their lending priorities, are determined at board level. Consequently, it is a small group of senior board members at the largest banks who determine the growth rate of lending and inadvertently the money supply of the economy. These incentives, combined with a lack of constraint on bank lending, led to a doubling of the money supply from 2002-2008.

Banks therefore create too much money in good times, leading to economic booms, asset bubbles and occasional financial crises. Because this money is created with an accompanying debt, eventually the economy becomes over-indebted, with a bust occurring when individuals cut back spending to repay their debts. During the bust, banks’ pessimistic views as to the future state of the economy (which are magnified by disaster myopia) lead them to create too little money and as a result the economy suffers more than it needs to. The story of this type of business cycle is therefore one of banks creating too much credit, which causes a boom and eventually a bust when debt gets too high. Then, during the bust banks lend too little, worsening the downturn. In short, there is no reason to think that the level of money creation that maximises banks’ profits will be the level of money creation that is best for the economy as a whole.

In contrast, under the reformed system the decision to create or destroy money will be determined by the MCC, a committee charged with creating the right amount of money for the economy as a whole. While it is unlikely that this committee will be able to get the level exactly right, history has shown that the current system rarely provides the ‘right’ amount of money, and more often than not gets it disastrously wrong. The choice is not therefore between a ‘perfect’ market-determined system on one hand and one determined by a committee on the other, but rather between leaving the nation’s money at the mercy of the interests of banks or organising it squarely in the interests of the national economy. Given the above, it is difficult to imagine that the Money Creation Committee could manage the money supply more destructively than the banks have done to date. 


This is an extract from the book Modernising Money which explains in detail how exactly can the monetary system be fixed.


Here you can read the Positive Money system explained in Plain English.




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  • http://ralphanomics.blogspot.com/ Ralph Musgrave

    I agree the inflationary risks under the above Money Creation Committee regime are no worse than under the existing system. But I’ve got just one quibble, and it relates to the INITIAL SWITCH to full reserve. Plus this quibble is a serious problem, not just a quibble, under the Benes and Kumhoff system.

    Kumhoff in one of his presentations makes much of the fact that the initial switch involves no increase in the money supply because for every pound of commercial bank created money WITHDRAWN, a pound of central bank money takes its place.

    But there is a big problem there which is that commercial bank money nets to nothing: i.e. for every pound of such money there is a pound of debt. In contrast, central bank money is a NET ASSET as viewed by the private sector. And B&K envisage using most of that huge increase in private sector net assets to write off a substantial proportion of private debts.

    Now that’s just going to result in a massive spending spree: i.e. the result will be serious inflation. To illustrate, where a household with a mortgage devotes say 10% of it’s income to servicing the mortgage and the mortgage disappears, then they’ll spend that 10% on something else: a new car, a house extension or whatever.

    Far as I can see, Ben Dyson makes the same mistake in Modernising Money (around p.230). However there’s a big difference between the switch to full reserve as envisaged by Positive Money and as envisaged by B&K: the switch takes FAR LONGER under the Pos Money system. Thus under Pos Money system the inflationary effect would become obvious, and the MCC would be able to deal with it.

    • DozyHole

      I completely agree. I think that one mechanism that has kept inflation low during the housing boom is the fact that people are handing over a large portion of their earnings to the banks via interest payments on their mortgages, even more so for interest only mortgages.
      If you free everyone from the shackles of interest payments you are going to see the inflation hit the rest of the economy.
      This would be no fault of the new system in place, but the fault of the crises we currently find ourselves in. The new system would get the blame of course and the inflation would be used as ‘proof’ that government issued money is inflationary.

    • http://www.facebook.com/virginiahammon Virginia Hammon

      hmmmm…that is not how I read page 230. As I understand it, no private loans are paid off in the switch. You would still carry a mortgage with your bank, but, on the bank’s balance sheet, instead of it being listed as an asset (your IOU) and a liability (created cash), the bank would show an asset (your IOU), and a liability to the central bank for the cash it created in the past. As you paid back that mortgage, the amount the bank owed the central bank would diminish, and the bank would continue to collect your interest.

  • montmorency

    I have a different quibble from that of Ralph, which is that (leaving aside quibbles about the independence of the MCC, which I think we should debate as a separate issue), it is not simply a question of how much new money you create, but where that money is directed towards, and that, I’m afraid, is a political question, and you can’t get away from that.

    You also can’t get away from the fact that the politicians you elect (we elect) are responsible not just (in a general way) for creating the right amount of money, but are responsible (in a specific way) for spending it in such a way that is most beneficial for society as a whole.

    Richard Werner, in “Princes of the Yen” talks about how successful Japan was in the first three decades or more after 1945, with its policy of “window guidance”. This consisted essentially of the BoJ telling the commercial banks what sectors, and in some cases what individual large borrowers to lend to. At this time, it was under political control (i.e. their Ministry of Finance), so their specific guidance was under a more general political guidance, and this was towards growth-oriented (not profit-oriented) development, led by exports.

    This was very successful until the BoJ more or less reversed this policy in the 1990s, and caused a very long-running recession. By then, they had escaped democratic control.

    This underlines the need for democratic control of the central bank (or any money-creating entity).

    I’m sorry, but you can’t write off politicians as “vote-seeking”.

    If we don’t have a democracy we believe in, then there is no hope for us.

    This is my single biggest disagreement with Positive Money, although I agree with their general aims.

    We need to reform our money system – yes, of course. But we don’t just leave it to the unaccountable technocrats. We need to improve our democracy at the same time.

    Bankers need to be accountable.

    And so do money-creators (or destroyers).


    • http://ralphanomics.blogspot.com/ Ralph Musgrave


      Re your point about “where that money is directed towards”, that’s taken care of under PM’s proposals. That is, the decision as to what proportion of GDP is allocated to the public sector, and how that is split between education, law enforcement, etc is left with the electorate and politicians.

      In contrast, stimulus, i.e. the excess of government spending over govt’s income is in the hands of MCC, with (to repeat) the decision as to HOW TO spend that money being left with politicians.

      Re your claim that money creators or destroyers should be democratically accountable, you are asking politicians to do a job which 99.9% are totally unqualified for: measuring inflation, working out whether it’s rising or falling, and thus whether a bit of stimulus is required, and if so, how much.

      Why not have politicians design nuclear power stations? That would be more democratic than leaving the job to qualified nuclear engineers.

  • http://www.facebook.com/virginiahammon Virginia Hammon

    (I posted this elsewhere, but since this is a more current discussion, I’m hoping it will get your attention :-)) Your proposal suggest using an inflation rate of 2% as a criteria for
    new money creation. I’ve read both your books (excellent! and VERY well
    written) and did not find a rationale for planning for steady
    inflation. How about using population and productivity to maintain a
    stable money supply, without inflation? If the inflation issue is about
    encouraging innovation—I can’t think of any other reason that would
    weigh more than the disadvantages of continuing a system of exponential
    growth—, couldn’t that be addressed directly with a 1% for innovation ?

  • Ian Duncan

    The article says banks are scared to lend during recessions/busts – why? If he money they create t lend out isn’t theirs and doesn’t actually exist then even if the borrower defaults on the loan, the bank has not, technically, lost anything, right?

    And, to drag morality into it, what moral right does a bank have to repossess a house bought by someone who defaulted on the mortgage from that bank? The bank hasn’t lost anything as the mortgage money wasn’t there til the borrower asked for it.

    Another question I have is why do we let bankers create money, in effect, for themselves? To enrich themselves for doing nothing of real worth?

    Can anyone help?

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