First, the power to create all money, both cash and electronic, would be restricted to the state via the central bank (such as the Bank of England or European Central Bank). Changes to the rules governing how banks operate would still permit them to make loans, but would make it impossible for them to create new money in the process.
Banks would then serve two functions:
- The payments function: Administering payment services between members of the public and businesses, and holding funds safe until they need to be spent.
- The lending/saving function: acting as an intermediary (middleman) between savers and borrowers.
Payments via Transaction Accounts
The payments services would consist of Transaction Accounts held by businesses and members of the public. The funds in these accounts would not be deposits created by the banks (an IOU from the bank to a customer), but electronic “sovereign money”, created by the Bank of England. These transaction funds would be “electronically stored” at the Bank of England and would legally belong to the customer. The funds are entirely risk-free, as they cannot be invested or placed at risk by the bank. The bank would provide the payment systems (such as cheque books, debit cards, internet banking, and ATMs) that allow the customer to make payments using the sovereign money that they own. The accounts would be interest free, and banks would charge account fees for providing these services.
Savings via Investment Accounts
The intermediary (middleman) function of banks would take place through Investment Accounts. Customers wishing to make savings or investments in order to earn interest would transfer funds from their Transaction Accounts into an Investment Account. The customer would have to agree to either a notice period required before accessing his/her money, or a maturity date on which the investment will be repaid. There would be no ‘instant-access’ investment accounts.
Banks would perform the function of pooling funds from Investment Account holders, and then lending these funds to a range of borrowers and for a range of purposes, thus diversifying risk on behalf of savers. Investment Accounts would not be guaranteed by the government, and would therefore be risk-bearing, with the risk shared between the bank and the customer according to the type of account chosen by the customer.
Regulators might impose equity requirements and other prudential rules against such accounts to prevent reckless behaviour by banks.
Investment Account balances could not be reassigned to others as a means of payment, to prevent them functioning as a substitute for money. Banks would therefore become true intermediaries in the way that many people currently believe them to be.
Central bank creates all money
Second, the central bank would be exclusively responsible for creating as much new money as was necessary to promote non-inflationary growth. It would manage money creation directly, rather than through the use of interest rates to influence borrowing behaviour and money creation by banks. Decisions on money creation would be taken independently of government, by the Monetary Policy Committee (or a newly formed Money Creation Committee). The Committee would be accountable to the Treasury Select Committee, a cross-party committee of MPs who scrutinise the actions of the Bank of England and Treasury. The Committee would no longer set interest rates, which would now be set in the market.
The central bank would continue to follow the remit set for it by the nation’s finance minister or chancellor. In the UK this remit is currently to deliver “price stability” (defined by an inflation target of 2%), and subject to that, to “support the Government’s economic objectives including those for growth and employment.” The inflation target acts as a limiter to stop the creation of money becoming excessive, but subject to that, the central bank is able to create additional money.
Getting new money into the economy
Any new money the central bank created would be transferred to government and injected into the economy through four possible ways:
- to finance additional government spending
- to finance tax cuts (by substituting for the lost revenue)
- to make direct payments to citizens, with each person able to spend the money as they see fit (or to invest or pay down existing debts)
- to pay down the national debt
A fifth possibility allows the central bank to create money for the express purpose of funding lending to businesses. This money would be lent to banks with the requirement that the funds are used for “productive purposes” (so lending for speculative purposes, or for the purpose of purchasing pre-existing assets, either financial or real, would not be allowed). The central bank could also create and lend funds to other intermediaries, such as business-orientated peer-to-peer lenders or regional or publicly-owned business banks. This ensures that a floor can be placed under the level of lending to businesses, guaranteeing support to the real economy.
All of the above mechanisms should be made as transparent as is feasible.
Transitioning to a Sovereign Money
There are two broad choices for the transition process – either a phased in approach, or an immediate switch. If done right, neither approach need be disruptive to the wider economy.
In the first, phased-in approach, the central bank would start to create money directly, transferring this money to the government for spending into the economy, as described above. However, banks would still be permitted to operate as they currently do, creating money in the process of making loans. Over time, regulations would be tightened to restrict how much money banks could create, and a larger proportion of the growth in the money supply would come from money creation by the central bank. Whilst this hybrid arrangement is in place, this would constitute a partial Sovereign Money system. At a certain point, banks would be required to switch over to the structure of banking described above, and would therefore lose their ability to create money. Further detail on this phased-in approach, in which both the central bank and commercial banks are simultaneously able to create money, is given in Sovereign Money: Paving the way for a sustainable recovery .
A more rapid approach is to transfer the power to create money from banks to the central bank overnight, switching immediately to a full Sovereign Money system. This can be done without changing the level of money supply in the wider economy, and without causing a damaging contraction in the amount of credit available. In this overnight process, the bank-issued demand deposits which make up 97% of the money supply would be converted into state-issued sovereign money held in accounts at the Bank of England. Instead of having a liability to their customers, each bank would now have an equivalent liability to the Bank of England (so that there is no overall impact on the size or nature of their balance sheet). (The state-issued sovereign money would be recorded as an accounting liability of the Bank of England, balanced on the balance sheet by non-interest-bearing zero-coupon bonds.)