Tax campaigner and writer Richard Murphy outlines his concerns with Positive Money’s proposals to prevent banks from creating money here. This is our response.
When is a bank not a bank?
Richard first point is a semantic argument about the definition of a bank. When is a bank not a bank? In Richard’s view, when it doesn’t create money:
I cannot accept the argument that if you remove the key identifying quality that defines a bank, which is its ability to create and so lend money, that it remains a bank. It does instead become a deposits and loan institution, which is something quite different, whilst its lending function is no longer about the creation and destruction of money but is, instead, more akin to being an outsourced credit committee of the Bank of England.
So if you prefer, call them deposit and loan institutions. From the point of view of the customer they’ll still be institutions that provide payment services, offer savings and investment products, and make loans, so perform all the functions of banks except for creating money. The argument that this is an outsourced credit committee of the Bank of England makes no more sense than arguing that a private equity firm, peer to peer lender or pension fund is an outsourced investment committee of the Bank of England.
The Role of Government Spending and Taxation
Richard points to a fact highlighted by Modern Monetary Theory (MMT) writers: that taxation withdraws money from the economy and in effect ‘destroys’ bank deposits. The government effectively creates new money (in the form of bank deposits) when it spends into the economy, and destroys bank deposits when it taxes money out of the economy. MMT often extends this into a statement that the government can spend whatever it wants, subject to the inflation constraint. It can deal with that inflation constraint by taxing more money out of the economy, in effect making way for its own spending.
“If it is the process of spending government created money into the economy that provides the substance of this money creation process, then the corollary of tax paid must, of course, negate it. I do not recall this issue being addressed in PM’s work.”
But the point that taxes withdraw the money from the economy does not affect the arguments for money creation by the state in place of banks. Firstly, whatever MMT says about how the system could work, the practical reality is that government and HM Treasury aims to limit its spending to what it can collect in taxes, and borrows the difference. It doesn’t finance any of its spending by net creation of bank deposits; it simply uses taxes and borrowing to ‘destroy’ deposits held by tax payers or investors, and then ‘re-creates’ them when it spends. So this is a zero sum exercise.
So MMT’s description of governments creating money when they spend, and destroying money through tax (in order to manage inflation) is a description of how the system could work. But in the current arrangement, it would be more realistic to see taxes/borrowing and spending as redistributing bank deposits from certain bank accounts to others (i.e. from the accounts of taxpayers and investors to the accounts of public sector employees, contractors etc.)
In this environment, governments are not using their power to create additional new money in any sense. Our argument has been that they should be using this power. Even if they don’t immediately prevent banks from creating money, some sovereign money creation would reduce our current dependence on bank-financed debt-fuelled growth. We’ve written about how the state could use money creation in parallel to money creation by banks in this paper from November 2013.
If the state does start to use its power to create additional new money, it would be competing with the money created by the banks. By stopping banks creating money, you ensure that the proceeds of any new money creation go to the state rather than the banks.
Concerns about the shortage of credit
The first of these is that money will, of course, be needed for mortgages and financial speculation. The second is that, as Ann Pettifor has argued, there is no way that a central committee can anticipate the needs of finance system for money in the following month. There will, inevitably, be credit rationing as a result for productive activities. PM’s responses on this issue, including the argument that not all credit is money, are simply not credible: it is not reasonable to argue the businesses should wait to make settlement of commercial obligations because of a shortage of cash created during the course of a month by the MCC, which is what they imply. Like it a lot that will inevitably constrain economic activity.
We’ve just completed a paper, which will be released next week, looking at the supply of credit in a sovereign money system. This paper suggests that the common assertions that there will be ‘inevitably be credit rationing’ don’t stand up when looked at in more detail. Rather than repeating the arguments of that paper here, we’ll comment in more detail next week.
The Democratic Aspect
Richard writes that:
“…there is a suggestion that money creators should not be influenced by those demanding money. That is seriously worrying at two levels. First, this effectively says that this MCC [Money Creation Commitee] will determine the level of government spending without any reference to the need that it might meet. That is monetary policy gone mad, and profoundly undemocratic and surely not what PM mean, in which case they need to make revision.”
This is incorrect. The government is still capable of borrowing or setting its own tax policy, so the government, not the MMC, determines what its spending will be. The money created by the MCC is an addition to its existing tax revenue, and would reduce how much it would need to borrow for any given level of spending. But the purpose of the MCC is not to find a way to finance the government’s operations, but to look at the needs of the wider economy. Instead of trying to influence the economy through the use of interest rates – a very indirect and ineffective tool – they would be able to create money directly. Government is one of the obvious distribution channels for this new money to get into the real economy, although other options, such as a “citizen’s bonus” to every citizen could work well too.
It makes no sense to claim that this is “profoundly undemocratic”. Monetary policy today is not about financing government spending; it’s about setting a rate of interest rate that should filter through the economy and influence wider economic activity. That system is broken now, without doubt, and needs significant reform (obviously we have quite clear ideas of how that reform would work).
More fundamentally, it seems odd to argue that giving a government-appointed committee the responsibility for creating money, and ensuring that all money created benefits the state (and by extension, the public) is ‘profoundly undemocratic’ when it is contrasted against the current system, in which money creation is done on the basis of whether it will be profitable for a bank, with no public interest motive even considered.
“And it is also deeply troubling that the real economic consequences of money creation as indicated by the merit of various spending programme should have no influence upon the decision as to whether to create that money or not. In my opinion the exact reverse should be true, including in the private sector where the precise problem is that money has not been used for appropriate purposes.”
This is a valid point, that we’ll update in a future edition of the book. The Money Creation Committee would need to have an idea of how the government would intend to spend any newly created money before it could assess how much would need to be created, because different uses have different effects on the economy. We’ve written about this issue on page 36-37 of our paper Sovereign Money Creation: Paving the Way to a Sustainable Recovery.
“I could expand all these arguments, of course. But what they suggest are real issues of concern and not petty sniping (in which I have no interest at all). I want banking and monetary reform. I want that to be used as the basis for a better economy. But I am deeply worried about making money creation so much a priority that government and economic activity is subjugated to it, and despite what PM says that seems inevitable to me.
So government has to be in control of its demand for money and the central bank has to meet that need.”
As we’ve explained above, government would still be in control of how much it spends: it still retains full control over how much it taxes or borrows. There are debates about whether the power to create money should be in the hands of independent central banks or under immediate control of the Treasury. I suspect Richard’s faith in politicians not to overuse this capacity to create money, even in the years running up to an election, is stronger than that of most people. Like it or not, the economic convention at this point in time is that central bank independence is necessary to prevent politicians using monetary policy for short-term ends. We can have a wider debate about whether that’s correct or not, but in terms of putting forward ideas that won’t immediately be rejected by the mainstream, we have to accept some of the constraints that already exist. Any campaign to give Gordon Brown or George Osborne the power to decide how much money to create is dead in the water.
So let me assure PM: I want the understanding and reform you do but please address the real concerns that many who have sympathy have with what you’re saying. We’re spending our time on this to make the process work. We’e worried you’re not delivering a workable or democratic or accountable solution, and that’s worrying.”
We’ve spent the last 5 years taking on feedback and concerns from a wide range of people, and adapting the proposals to deal with any valid concerns. We’ve undertaken significant research on issues like the risk of shortage of credit, and are undertaking further research on other potential issues that might arise. But there’s is a real limit on what we can do to address assertions that a proposal that puts money creation in the hands of the state is less democratic than one that leaves it in the hands of profit-seeking companies.