The Positive Money proposal in balance sheets

Clearing up some confusion

The monetary system is complicated, as are the various proposals for reforming it. Unfortunately, it is often not possible to describe complex systems in words without leaving some ambiguity in the mind of the reader (hence the usefulness of maths in science). Worse still, these ambiguities can be amplified by preconceived ideas as to what it is one is advocating in the first place.

Consequently, we thought it might be a good idea to attempt to remove as much ambiguity as possible, by presenting our proposals in a closed economy, stock-flow consistent*, balance sheet framework. The framework consists of three sectors: the central bank, the commercial banking sector, and a non-bank private sector (incorporating households and businesses). (A government sector is not included but could be, if desired).

The presentation starts with three interlocking balance sheets, showing a stylised version of the UK economy. A transition to the PM system is then outlined. Various scenarios are run through and their balance sheets implications presented.

The downloadable PowerPoint file is best watched as a slideshow, as there are animations.

Positive Money Reforms Transition Presentation (ppt)

Positive Money Reforms Transition Presentation (pdf)

It is probably worth referring to the paper ‘The Positive Money Proposal’  if anything is unclear. One should also read the bullet points outlining the reform proposal below before running through the PowerPoint.

*by stock flow consistent, we mean that the flows from sector to sector create the corresponding sized stocks, within the balance sheet framework. That is, there is no cheating – every change in a stock is reflected with appropriate changes elsewhere in the balance sheets – satisfying double entry bookkeeping requirements and the quadruple entry accounting principle. We do not mean, by stock flow consistent, that the presentation will use the transaction and accounting matrices framework pioneered by Wynne Godley, although the principles that “everything must come from somewhere and go to somewhere”, and that there are no ‘black holes’ remains.

The Positive Money proposal in brief:

1. Commercial banks’ demand deposits would be removed from their balance sheets and converted into state-issued currency held at the central bank (by a legal restriction on the types of short term liabilities banks could issue).

• Banks would be prohibited from holding or creating new demand deposits on their balance sheets

2. Commercial banks’ time deposits would be converted into illiquid, non-transferable bank liabilities.

3. Thus, unlike in the current system where two types of money circulate separately – reserves created by the central bank and deposits created by commercial banks – in the reformed system there would be just one integrated quantity of central bank money used by banks, businesses and members of the public alike.

4. Individuals would then be faced with two choices with regards to where they could place their money:

• In a ‘Transaction Account’ (similar to a current account today.) Although these accounts would be administered by commercial banks, they would be owned by the customer, with the funds in them held at the Bank of England. They would therefore be 100% safe, regardless of the financial position of the commercial bank that administered them. These accounts would collectively make up the payments system. No interest would be paid on these accounts.

• In an ‘Investment Account’. These accounts would remain on the commercial banks’ balance sheets, would pay interest and would not be guaranteed by the government (i.e. they would be risk- bearing). They would be non-transferable, and illiquid, with either maturity dates or minimum notice periods.

5. In the conversion period, banks’ demand deposits would be converted into Transaction Accounts holding funds at the central bank. The demand deposit liability that banks presently hold to their customers (and which would be extinguished in the conversion process) would be replaced with an equal ‘Conversion Liability’ to the Bank of England, which would be repaid as the banks’ assets mature.

• The Bank of England would gain an asset, in the form of a conversion liability from the commercial banks.

6. In order to maintain the money supply, repayments to the Bank of England would be automatically circulated to the Treasury’s account, from where they would be spent back into circulation, funding one or more of:

• Tax cuts

• Spending increase

• A citizens’ dividend

• The repayment of the national debt (perhaps the least desirable)

7. With banks no longer able to create deposits through lending, the Bank of England would be the only institution able to alter the money supply.

8. The decision on whether to increase or decrease the money supply would be taken by a democratically accountable, independent and transparent body, the Monetary Creation Committee, in line with a democratically mandated target set by government.

9. The Bank of England would increase the money supply by either:

• Granting money to the government to be spent into circulation, as above, or

• Lending money to the banks to on-lend to businesses (to ensure an adequate supply of money for businesses to borrow).

10. The Bank of England would decrease the money supply by one or more of the following:

• Issuing/selling financial assets.

• Not re-circulating some of the Conversion Liability (during the transitional period).

• Not rolling over loans it made to banks to on-lend to businesses.

• Removing from circulation taxes collected by the government (with the government’s permission).

The objectives of the Positive Money proposal:

1. To prevent banks from being able to create new money, in the form of bank deposits, in the process of making loans (or buying assets). As bank lending would no longer increase the amount of money in the economy, the money supply would be stable and permanent regardless of any over or underlending by banks. This would limit:

• Asset price bubbles caused by bank credit creation.

• Financial instability caused by asset price bubbles.

• Business cycles caused by bank credit creation.

2. To separate the payments system from the lending/investing side of a bank’s balance sheet.

3. To turn banks into true financial intermediaries: Banks would become money brokers, rather than money creators.

4. Banks would lend by borrowing state-issued currency from savers/investors (via Investment Accounts), and lending it to borrowers. New lending would not create new money, but simply transfer existing money (and purchasing power) from one entity to another.

5. To align risk and reward:

• Those individuals who did not want to take a risk with their money could place their money in a Transaction Account, where it would be 100% risk-free.

• Those individuals who wanted to earn a return on their money could place their money in an Investment Account. They would earn an interest rate, but also take some risk.

• There would be different Investment Accounts for different types of loan. This would prevent banks from taking large risks with funds from customers who wanted a low level of risk.

• There would therefore be a clear distinction between truly risk-free money in a bank account, and a risk-bearing investment that could lose value.

• Moral hazard would therefore be removed.

• The subsidy to the banking sector would thereby be removed (which occurs due to some banks being ‘too big to fail’ and because of deposit insurance).

6. To allow banks to fail:

• Without large macroeconomic effects, and at no cost to the taxpayer

• The failure of a bank would no longer affect the broad money supply or the payments system

• While protecting depositors who had opted to keep their money safe:

  • Since funds in Transaction Accounts would never be placed at risk and would not sit on the bank’s balance sheet, when a bank failed due to insolvency its customers’ Transaction Accounts could easily be transferred across to another bank.

• Thus solvency and liquidity issues affect the lending side of the bank’s business only – the Investment Accounts, the owners of which would become bank creditors in the event of an insolvency.

7. To return the power of money creation to the state. Newly created money would be spent into circulation by the government, allowing the private sector to pay down its debt without sparking a recession:

• During the transition, when bank customers repay their loans to their banks, their banks would then repay their ‘Conversion Liability’ to the Bank of England. The Bank of England would then credit the government account with the value of the money repaid, and from there this money would be spent by the government, back into circulation.

• In effect, the equality between money, in the form of bank deposits, and private debt, would be broken.

Positive Money Reforms Transition Presentation (ppt)

Positive Money Reforms Transition Presentation (pdf)