Should private banks be allowed to create / print money?

This is a 400 word summary of this work (see top of the column just to the left).

There’s no question but that private banks create or print money under present arrangements. See the opening sentences of this Bank of England article for confirmation of that point.

To answer the question in the above heading, let’s consider an economy where the only form of money is base money, i.e. government / central bank issued money. I’ll refer to government and central bank combined as “the state”.

The more base money the state spends into the economy, the bigger the private sector’s stock of base money. Given that the more money people have, the more they are likely to spend, at some point, giving a rising stock of base money, that will at some point induce the private sector to spend at a rate that brings full employment. Moreover, that arrangement will result in some sort of natural or free market rate of interest.

Assume also that private banks can act as intermediaries between lenders and borrowers, but they can't actually CREATE money.

Assume also that the state does not borrow anything. Given the large amounts that states or governments currently borrow, that might seem an unrealistic assumption. In fact several economists have advocated a “zero borrowing” regime: e.g. Milton Friedman (see para starting “Under the proposal..”). Also see the final two paras of this article by Warren Mosler.

Now suppose private banks are allowed to create money out of thin air and lend it out. Those private banks can easily undercut the going or free market rate of interest for the simple reason that it costs nothing to create / print money. (In contrast, to the extent that banks INTERMEDIATE, lenders have to endure the pain of actually EARNING money and then abstain from spending it so as to transfer that money to borrowers.)

The result of that extra lending will be excess demand, thus the state will have to curtail demand somehow. One option is to raise taxes and “unprint” the base money collected. In that case, households and firms are robbed of money in order to enable private banks to create the stuff.

Alternatively, and given that interest rates will have been reduced by the above lending out of freshly produced money, the state can raise interest rates again. It can do that by offering interest to base money holders with a view to inducing them to deposit money with the state. That money is then no longer in circulation, hence the deflationary effect.

But that involves robbery again: that is, taxpayers are robbed in order to pay interest to those with an excessive stock of base money.

Conclusion: a system under which private banks create money is a defective system.