Tuesday, 24 November 2015

Full reserve banking equals monetarism?

I dealt with one paper by Malcolm Sawyer and a co-author here recently. He actually published another paper at much the same time (June of this year) on the same topic. That topic was full reserve banking (FRB), and the title of the second paper is “The Scourge of Green Monetarism”.  The latter is examined in the paragraphs below.

The word “green” is a reference to the fact that the UK’s Green Party has adopted the FRB ideas of Positive Money. Some points are common to both papers, so I’ll ignore those, as I have already dealt with them.

There is nothing wrong with Sawyer’s p.1, where among other things he introduces two terms: exogenous and endogenous money. The former is central bank created money or “base money” as it is sometimes called, while endogenous money is commercial bank created money.

Demand for and supply of money wouldn’t match?

At the top of p.2 Sawyer says that under FRB (i.e. an economy where only government or central bank created money is allowed) there’d be “..a mismatch between the amount of money which the central bank creates and the amount of money which the public is willing to hold.”

Well I have news: the above sort of mismatch arises under the existing system.

For example market monetarists like David Beckworth often claim (I think correctly) that the recent recession arose to a significant extent out an excess desire by the private sector to save money. But that in turn is just a repetition of Keynes’s “paradox of thrift” point.

So to the extent that the last seven years or so of excess unemployment are attributable to the above mismatch, FRB could hardly be worse than the EXISTING SYSTEM.

FRB resembles monetarism?

The second part of p.2 is the start of Sawyer’s claim that FRB closely resembles monetarism. As he puts it, “FRB shares many similarities with the ill-fated proposals of Friedman (1960) and others for the achievement of a specified growth rate of the stock of money.”

Well one problem with the latter claim is that if the state creates new money and spends it, and/or cuts taxes, there is an obvious monetary effect: the money supply rises. But there is also a fiscal effect: public spending rises and/or taxes are cut. Thus Sawyer’s claim that PM’s ideas amount to pure monetarism is very questionable.

Annual money supply increases.

A second problem is that a basic element of monetarism, at least a la Milton Friedman, was that it envisaged a small and fixed annual increase in the money supply. In contrast, PM advocates nothing of the sort. PM advocates that (much as under the existing system) stimulus should be varied from year to year dependent on the circumstances: e.g. whether there is excess inflation or whether the economy is in recession.

Mild monetarism is widely accepted.

Third, as distinct from monetarism a la Friedman, monetarism in a milder form is widely accepted in economics. That is, it’s widely accepted that the size of the monetary base has some sort of effect on inflation and output, as Robert Mugabe so ably demonstrated.

Why was QE implemented? Because the authorities thought that if the holders of government debt were given base money instead, there’d be some sort of stimulatory effect. Thus in that PM claims the amount of base money in private sector hands has some sort of stimulatory effect, that claim is completely uncontroversial. 

FRBers ignore cost push inflation?

Page 6 of Sawyer’s paper then makes this bizarre claim:

“The FRB approach retains the monetarist perspective that the growth of the money supply (however defined) can control the rate of inflation, and that inflation is a money demand phenomenon which is to be controlled through manipulation of demand (and in the monetarist perspective through control of the money supply). Hence it ignores any role for cost-push inflation and imported inflation, and is willing to accept, if required, the reduction of employment in order to constrain inflation.”

The first of the latter two sentences just repeats the idea that there’s something wrong with the idea that the money supply has some sort of effect. To repeat, that idea is entirely uncontroversial.

As for the idea that because you think the money supply has some sort of effect that therefore you are ignoring “cost push” and “imported” inflation, that’s just nonsense. The Bank of England clearly thinks the size of the money supply has an effect: that’s why it implemented QE.  Plus the BoE, as is widely appreciated, has paid careful attention in recent years to the extent to which inflation is cost push. Indeed, it would be a dereliction of duty on the part of the BoE if it ignored the possibility that inflation is partially cost push.

As for the idea that about “willing to accept, if required, the reduction of employment in order to constrain inflation”, it’s widely accepted that there is a trade-off between inflation and unemployment: i.e. that idea is not peculiar to FRB.

Central banks.

Next, Sawyer says “The full reserve proposals are designed to place the stock of money under the direct control of the central bank.”

Not strictly true. Under FR (at least as proposed by Positive Money), the stock of money is controlled by SOME SORT OF committee of independent economists. That COULD BE an existing central bank committee. But it might just as well be an entirely new committee, or some committee in the Treasury.

Of course that’s a minor blemish in Sawyer’s paper, but there seem to rather a large number of blemishes, large and small, in Sawyer’s paper.

Transaction accounts.

Next, Sawyer says, “The purpose of the control of central bank issued money is to influence, if not set, inflation and output. This assumes that the central bank is indeed able to control its issue of money, and that the money issued by the central bank will be placed in transactions accounts…”. Wrong again.

It is extremely unlikely, given a money supply increase, that every single person in the country with a bank account would put all of their share of a money supply increase into either their transaction account or their investment account. Likewise it is extremely unlikely that given an increase in the money supply under the EXISTING SYSTEM, the whole of that increase would be put into current/checking accounts rather than deposit/term accounts. (The latter two types of account, incidentally are very roughly the equivalent of the transaction and investment accounts under PM’s FRB system).

But even if 100% of a particular money supply increase did go into investment accounts, that would not, contrary to Sawyer’s suggestions, destroy the stimulus effect of the extra money. Reason is that more money in investment accounts would tend to cut interest rates which would encourage more investment, and that is stimulatory.

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