Saturday, 2 July 2016

Giuseppe Fontana and Malcolm Sawyer’s defective criticisms of full reserve banking.

Giuseppe Fontana and Malcolm Sawyer (F&S) wrote a paper recently criticising full reserve banking (FR). At the time of writing, the paper is due for publication in the Cambridge Journal of Economics. Pre-publication copies are available from the publishers. The paper is entitled “Full Reserve Banking: More ‘Cranks’ Than Brave Heretics”.

F&S actually published a paper making similar points about a year ago which I dealt with here. However, their more recent paper is substantially different, hence the review of it in the paragraphs below.

The review of F&S’s paper in the paragraphs below is unusually long (by the standards of this blog). I’ve done a summary (in green) which is correspondingly long.


Section 1 (Introduction)
.   A flaw which underlies the whole paper and which first becomes evident in the introduction is that the paper purports to be a criticism of FR, whereas in fact it is primarily a criticism of Positive Money (PM), or of the works of PM’s founder, Ben Dyson. F&S do cite other advocates of FR, but they cite a strange collection, which includes two groups whose main concern is matters green or environmental. In contrast, there is no mention of the more heavyweight or authoritative advocates of FR, like the clutch of economics Nobel laurate economists who support FR (or supported it during their lifetimes).

Section 2.1.   This section aims to rebut the claim by PM that the creation of money by private banks yields seigniorage profits for those banks. This is actually a complicated issue. The space devoted to it by F&S is wholly inadequate, as indeed is my rebuttal of F&S’s arguments.

Section 2.2.   F&S claim that PM’s system aims to control inflation by controlling the money supply (as per some versions of monetarism). In fact, when creating and spending new base money (e.g. on infrastructure) there is an INEVITABLE element of FISCAL stimulus. Thus PM’s system is not the same as the latter over-simple forms of monetarism.

Also, in this section, it looks as though F&S haven’t grasped the point that FR involves the abolition of privately issued money.

Section 2.3.    F&S claim that PM think the volume of loans made by banks is determined ONLY by the SUPPLY of same, and not by DEMAND. The idea that the volume of ANYTHING produced is determined just by supply and not demand is very strange idea, and is certainly not one adhered to by the advocates of FR.

Sections 2.4 and 2.5.    2.4 is very unclear, so I have ignored it. As to 2.5, F&S criticise the idea put by PM that there is a distinction between base money which PM claim to be “debt free”, and privately issued money, which PM claim to be debt encumbered. In fact it’s not just PM that make that claim: for example it is generally accepted in Modern Monetary Theory circles that privately issued money nets to nothing in the sense that for each dollar of such money, there is a dollar of debt.

However it CAN BE argued that in a limited sense, base money is a liability of the state, and hence that such money is debt encumbered. Conclusion: when it comes to the “debt based versus debt free” characteristics of different types of money, the distinction between base and privately issued money is not TOTALLY clear. However PM and MMTers are quite right to say that there is a fundamental difference between base money and privately issued money in that connection.

F&S also make the point in this section that base money (e.g. $100 bills) is not REAL WEALTH. I.e. paper money is just bits of paper. That point is so obvious that it goes without saying.

Section 3.    F&S criticise PM for claiming that FR brings financial stability. In fact PM merely claims (as do other advocates of FR) that FR would IMPROVE financial stability.

F&S also claim that FR is deflationary. Well it’s pretty obvious that if privately printed money is banned, that is deflationary. The solution is STIMULUS: in the form of creating and spending an alternative form of money (base money) into the economy.

Next, F&S make an absolutely fundamental mistake which indicates they do not have a basic grasp of FR, or indeed of the existing monetary system. They argue that since it is loans that create deposits under the existing system, it is not clear where deposits come from under a system where loans can no longer create deposits. Well the simple answer is that they come from the base money which is created and spent into the economy under FR. (Indeed, the latter form of deposit creation operates to a limited extent even under the existing system.)

Cheating.   F&S then claim it would be easy for banks to cheat by quickly switching depositors’ money from investment accounts to current / checking accounts (i.e. accounts that are supposed to be totally safe). Well that would be a flagrant breach of the basic rules of FR, and that sort of breach ought to be very easy for any auditor to spot: certainly vastly easier that dealing with one of the alternative forms of bank regulation, Dodd-Frank, which consists of 22,000 pages (fifteen times the length of War and Peace).

Section 5.    F&S claim that under FR, the deficit equals the increase in the private sector’s stock of money, which is correct. They then argue that pitching the deficit at a level that gives the private sector its desired stock of money will not necessarily bring full employment. Well of course! Given excess unemployment, the authorities under FR pitch the deficit a “bit too high” so to speak: they pitch it at a level which gives the private sector a slightly EXCESSIVE stock of money, which in turn induces the private sector to spend more. And something of very much that sort applies both under FR and under the existing system.

Section 6 (Conclusion).   Here, F&S claim that FR would nullify the automatic stabilisers. In fact the automatic stabilisers are not quite all they are cracked up to be. But if it really is thought they are desirable, it would be easy to build them into FR.

Section 1: Introduction.

The first main error in this paper, which underlies the entire paper is that the paper is essentially a criticism of Positive Money (PM), or if you like, a criticism of PM authors: Ben Dyson in particular (who founded PM) and other PM related authors. Just to illustrate that, the majority of passages from other authors’ works quoted by F&S are from Dyson’s works (six out of eleven).

F&S ARE CLEARLY AWARE of other advocates of full reserve banking (FR) and cite a number of these, but the collection they cite in the first section of their paper is a bit odd. In contrast, there is no mention of the more heavyweight or authoritative FR advocates, at least if one judges “authoritativeness” on the basis of Nobel prizes. Economics Nobel laureate backers of FR include:

1. Milton Friedman (1960 & 1948). See list of references at the end below.

2. Merton Miller.

3. Maurice Allais – see Phillips (1992).

4. James Tobin. See Tobin (1987) and Musgrave (2015).

Plus there are various people currently working as professors of economics who also back FR: John Cochrane, Lawrence Kotlikoff and Richard Werner. They aren’t mentioned either. And another household name economist who supported FR was David Hume (see Paganelli (2014)).

In view of large amount of brainpower behind FR, F&S’s description of FR supporters as “cranks” is questionable. Perhaps F&S can at some future date let us know which of the above Nobel laureates and economics professors are “cranks” – I assume it’s all of them.

As to the list of FR supporters that F&S DO CITE, they include two organisations or groups whose main concern is matters GREEN OR ENVIRONMENTAL. That’s the UK’s Green Party and a paper by Farley and co-authors. F&S also cite the prime minister of Iceland, whose FR policies are a straight copy of PM’s ideas. That’s a strange assortment. But of course if you’re trying to rubbish an idea, it pays to keep quiet about the more authoritative advocates of the idea, while drawing attention to the less well qualified advocates.

The abbreviation “PM”.

To repeat, while F&S’s paper claims to be a criticism of FR, it is more a criticism of PM and it’s founder, Ben Dyson. For the sake of brevity below, I won’t distinguish between cases where that is literally the case, and cases where other authors ought to be mentioned. I.e. I’ll cut a corner and say “PM” where I really ought to spell out exactly which authors, including PM authors, are involved.  Readers are of course free to look an F&S’s paper with a view to seeing EXACTLY who advocates which idea. Also, please note that I am NOT an official spokesperson for PM.

Incidentally, PM have given their own answer to F&S which is due to appear alongside F&S’s article, though far as I know, pre-publication versions of THAT are not available.

Section 2 – FRB and endogenous money.

F&S’s second section, entitled “FRB and endogenous money” has five sub-sections, and in the first (2.1) the authors criticise the idea that private banks which create or print money make seigniorage profits. (“FRB” is F&S’s abbreviation for “full reserve banking”).

Unfortunately F&S’s actual REASONS for thinking banks don’t make seigniorage profits are thin on the ground to put it politely. According to F&S, “Graziani (2003, pp. 58–66), among others, has explained that no agent involved in the loans supply process has a seigniorage privilege: not businesses, not households, and certainly not commercial banks.”

As for GRAZINI’S alleged “explanations” they are minimal. In fact  Graziani’s paper mentions the word seigniorage just once. That’s in  this very odd passage (p.3):

“In order for money to exist, three basic conditions must be met….money must not grant privileges of seigniorage to any agent making a payment.”

Well as PM and many others have explained, where the state creates and spends base money it most certainly DOES MAKE seigniorage profits. But that doesn’t matter because the profit is effectively shared by the country as a whole. As for the implication behind the latter passage of Grazini’s namely that base money is not money because it earns seigniorage profits, that is just nonsense. For example the money produced by back-street counterfeiters is money within the dictionary or text book definition of the word money, and that certainly earns seigniorage profits for counterfeiters. Other examples of where private money issuers earn seigniorage profits are given below.

And one of the few other sentences in Grazini’s paper on seigniorage (p.7) reads “A bank cannot buy commodities by means of its own credit (if it did so, it would acquire the market commodities without giving anything in return).”

Well that rather amounts to saying that because obtaining something for nothing (i.e. seigniorage) is undesirable, ergo that cannot happen. I.e. that sentence begs the question as to whether private banks actually do or don’t reap seigniorage profits. As to FULLY EXPLAINING why private banks do enjoy seigniorage profits, that would take far more space that would be suitable here. But here’s a BRIEF explanation.

Seigniorage profit is earned where any entity (e.g. the state, a back-street counterfeiter, or bank) issues an IOU in paper or book-keeping form, buys something with it and the IOU then goes into circulation: i.e. the original issuer is never asked to produce anything of real value in exchange for the inherently worthless bit of paper / IOU. Clearly that is profitable for the IOU issuer.

In the case of private banks, they hire out IOUs (commonly known as “money”) to borrowers. Those borrowers they buy something with the IOUs, and to the extent that (and only to the extent that) that IOU / money stays in circulation, that means profits for banks and borrowers.

As to what constitutes “staying in circulation”, the stock of private bank created money is constantly rising, so in that sense the money stays in circulation. Also in that the money ends up on current or “checking” accounts where no interest is paid, that can legitimately be said to be “in circulation”. In contrast, where the money ends up in term accounts (where account holders demand a decent rate of interest) then effectively those account holders have loaned money to the above borrowers. Clearly that does not involve seigniorage profits.  (And to complicate things still further, there is of course no sharp dividing line between current and term accounts).

Interest rate spreads.

F&S then say, “The profits of commercial banks come from the difference between the rate of interest on loans, with allowance for default, and the costs of deposits, including operating costs and any interest rate payments.”

In the context in which that sentence appears, that sentence is clearly meant to suggest that bank profits come from that interest rate difference RATHER THAN from seigniorage. Well banks clearly do aim to cover their costs and make a profit from that interest rate spread. But that doesn’t prove they don’t ALSO profit from seigniorage.

As Maurice Allais put it, “In reality, the ‘miracles’ performed by credit are fundamentally comparable to the ‘miracles’ an association of counterfeiters could perform for its benefit by lending its forged banknotes in return for interest. In both cases, the stimulus to the economy would be the same, and the only difference is who benefits.”

To summarise, whether and to what extent banks and their customers earn seigniorage profits is complicated. F&S certainly don’t give the subject adequate treatment. In fact I sometimes wonder whether ANYONE has a full grasp of this subject.

Section 2.2 - base and privately created money.

Here, F&S challenge PM’s alleged claim that inflation can be controlled just by controlling the stock of BASE MONEY (i.e. CENTRAL BANK created money). F&S claim that would make that PM claim similar to the more naïve versions of monetarism.

F&S do cite just one sentence by Dyson which suggests that Dyson does support that “naïve” view. However, it’s obvious from a fuller reading of PM’s literature (e.g. Positive Money (2011) that given the WAY extra money is fed into the economy under PM’s proposals there is a FISCAL as well as a purely monetary effect.

That is, under PM’s system, when stimulus is needed, the state creates new money and SPENDS IT (and/or cuts taxes). Indeed, it is widely recognised nowadays that helicopter drops contain an inevitable fiscal element. If you Google “helicopter” and “fiscal” you’ll find enough reading material to keep you occupied for a full month.

To illustrate (and this is a bit of a statement of the obvious), if government decides the create and spend enough new money into the economy to employ one thousand extra bureaucrats, employment will rise by one thousand (all else equal) AS SOON AS job applicants have been interviewed and allotted to their jobs. I.e. the increased employment comes BEFORE the money supply has increased.  As for the strictly MONETARY effect (the increased money supply) that comes later and might be relatively feeble. And if it WAS relatively feeble, that wouldn’t matter one iota.

Incidentally Keynes (1933) also advocated the creation and spending of new base money in a recession. See his para 5, phrase starting “or public authority”. Seems like PM has quite a few “friends in high places” apart from the above mentioned Nobel laureates!

Boyancy and exuberance.

Then in the final paragraph section 2.2, F&S claim, the amount of money is a RESULT of the buoyancy of the economy (or “exuberance” to use a word popularised by Greenspan), rather than the CAUSE of anything.

That claim is a major blunder which indicates F&S don’t basically understand the bank and monetary system.

PM (and other FR advocates, far as I know) do not deny that given “exuberance” the amount of private bank created money will rise. Indeed, that’s one of PM’s main CRITICISMS of the existing bank system: i.e. that given exuberance or extra confidence, private banks create and lend out money like there’s no tomorrow, which is exactly what happened prior to the 2007/8 crisis. Or put another way, as is widely accepted in economics, private banks act in a PRO-CYCLICAL manner. ( Incidentally, that “pro-cyclical” point was spelled out in the first sentence of a recent IMF article (Kumhoff (2016) )

Moreover, PM’s system does not aim to control the amount of private bank created money: indeed, PM advocates the abolition of that type of money! It’s BASE MONEY (aka central bank created money, aka “high powered money”) that PM aims to control or adjust.

Thus F&S’s “buoyancy” or “exuberance” point is flawed.

Section 2.3.

Here, F&S claim FRB advocates think loans are determined SOLELY by the SUPPLY of loans offered by banks rather than DEMAND for loans. And to back this claim, Sawyer quotes a passage of Dyson’s that could be interpreted as saying that.

Well the idea that the amount of anything produced is determined SOLELY by supply rather than demand is clearly absurd. Indeed, F&S would have discovered from a wider reading of PM literature that PM do not claim the DEMAND for loans is totally irrelevant. Moreover, it’s unlikely in the extreme that the numerous other advocates of FRB over the last two hundred years make that “demand is irrelevant” claim.

Section 2.4

I find this section near incomprehensible. I could try to guess what F&S are trying to say, but that would not be a productive use of time.

Section 2.5

F&S start with the claim made by PM that privately created money is “debt based” (i.e. that for every dollar of that sort of money there is a dollar of debt), whereas base money is debt free.

F&S’s first problem here is that it’s not just PM that make that claim: advocates of Modern Monetary Theory often make the same point. For example, as Mitchell (2009) puts it “All financial transactions between non-government players basically net to zero because for every asset created in the currency there is a corresponding and equal liability. Only the government can create deposits in the private banking system without any formal liability being incurred.”

As MMTers often put it, base money (and government debt) are “Private Sector Net Financial Assets” – PSNFA being a specifically MMT phrase. Thus F&S’s opponents are more formidable than they like to think.

Re F&S’s claim that base money is a liability of the central bank or “the state”, there is no 100% clear answer to that question. Certainly PM is right to say that although Bank of England £10 notes say the BoE will pay the holder of the note £10 (in gold presumably), anyone turning up at the BoE and demanding something in exchange for their £10 notes will simply be told to go away.

To that extent, BoE money is clearly not a liability of the BoE.

On the other hand Wray (2014) argues that since base money is used to pay taxes, that constitutes an example of one liability cancelling out another. Ergo, so Wray argues, base money is a liability of the state.

But against that, the state is free to grab any amount of base money off the private sector whenever it wants via tax. That’s like me having the right to raid the bank that granted me a mortgage and grab bundles of $100 bills to help pay off my mortgage. In that scenario, my debt to the bank or “liability” is a strange sort of debt / liability.

To summarise, there are no simple answers to the question as to whether base money is a liability of the state or the central bank. But there is absolutely no doubt that PM (and MMTers) are right to say there is a fundamental difference between privately issued money and state issued money (base money).

Fiat money does not equal wealth.

Next, Sawyer says “It is also readily apparent that a higher amount of (base) money does not constitute a higher level of wealth. There is no increase in the capacity of the economy to produce..”.

Well I think we’ve all gathered that under a fiat money system, money is not real wealth in the same sense as a gold coin is real wealth: $100 bills are just bits of paper. The average teenager has worked that out.

The important point is that base money (e.g. $100 bills) ARE REGARDED as a form of wealth. Thus increasing the private sector’s stock of base money increases its inducement to spend (a point also supported by most MMTers far as I can see).

Section 3 – The FRB goal of financial stability.

Here, the authors accuse PM of claiming that FRB brings financial stability. In fact PM simply claims that FR IMPROVES financial stability.

F&S then trott out the claim (which has been made by many others) that FRB would not improve financial stability because it’s only regular banks rather than shadow banks that would be regulated. Well the simple answer to that is to regulate ANYTHING (larger than some minimum size) which behaves in a bank-like manner, regardless of whether it calls itself a bank or not, as pointed out by Adair Turner: former head of the UK’s Financial Services Authority (see Masters (2012). As Turner put it, “If it looks like a bank and quacks like a bank, it has got to be subject to bank-like safeguards.”

Many of the laws that govern garages take no account of the SIZE OF the garage, and quite right. It would be nice if bank regulators had as much brain as garage regulators!


Next, F&S claim “A second problem with the claimed goal of financial stability is that FRB has an inherent though often ignored deflationary bias…”

Well obviously if lending and borrowing are made more difficult, as indeed they are under FR, then there’ll be a deflationary effect. But that’s easily dealt with via stimulus. Problem solved! Put another way, if privately printed money is to be more or less abolished, it’s pretty obvious that some alternative money has to take its place, and there’s only one alternative: base money. And printing and spending base money into the economy equals stimulus.

Next, F&S claim (para starting “Notwithstanding..”, p.7) that while banning private money printing might reduce instability somewhat, “..herding behaviour could still produce sectoral overinvestment and financial instability.”

Well of course! No doubt F&S are right there. But there is no question but that stopping private banks printing and lending out money like there’s no tomorrow in a boom ought to reduce instability SOMEWHAT. As I said just above, PM does not claim FR abolishes instability: the claim is simply that it improves things a bit.

Loans do not create deposits under full reserve.

Next comes this passage (in the same paragraph): “The second inconsistency is that it is not clear where the prior savings alluded to by Daly and other advocates of FRB have come from. It is technically impossible for banks as a whole to collect deposits without at the same time granting loans for the same amount. Therefore, at least initially there must have been a process of credit creation in the economy, which was completely unconstrained and unrelated to pre-existing resources.”

That passage indicates a complete failure to understand how the monetary system works. Contrary to F&S’s claim, it is not (under FR) “technically impossible for banks as a whole to collect deposits without at the same time granting loans..”. That’s true (or to be accurate, largely true) under the EXISTING BANK SYSTEM. In contrast, under FR, there is almost no money apart from money issued by the central bank.

So how do private banks “collect deposits” under FR? Well they collect them from people or firms which by one means or another have obtained some of the money created and spent into the private sector by the state (e.g. firms who build roads for government, bureaucrats working for government, recipients of state funded social security payments, etc.)

Indeed, the latter point is PARTIALLY true at the moment, particularly since QE. QE has meant that roughly 10% of the money supply is now base money (central bank created money). That contrasts with the 3% (or thereabouts) which used to obtain.  That is, at the time of writing, commercial banks are actually able to “to collect deposits without at the same time granting loans” to quite a significant extent.

(Incidentally, and to be accurate (again), it’s not strictly true to say that under FR every single pound in the UK for example would be state issued money. Reason is that advocates of FR don’t have big objections to various MINOR forms of privately issued money, like local currencies. Plus there might be a small amount of money creation under FR by SMALL shadow banks. But the BASIC aim of FR is to have the LARGE MAJORITY of money in the form of state issued money).

Section 4 – How long would FRB arrangements last?

F&S claim that private banks could easily circumvent the rules of FR. One way banks could do this apparently is:

“For instance, investment accounts with a short notice period for withdrawals could be used as means of payment, i.e. near-money: in the existing electronic age, funds could be switched from an investment account into a transaction account, and then used for the payment of goods and services by two mouse clicks.”

Well that would be a flagrant breach of the basic rules of FR. It should be easy for an auditor to spot that sort of dishonesty. All auditors have to do is look at promotional literature issued by banks for depositors. If it says anything like “We offer you the combined advantages of instant access to your money while you get the decent rate of interest that comes from having your money is loaned out to mortgagors, SMEs etc”, then it’s hefty fines (and even better, prison sentences) for relevant banks or bank staff.

F&S also claim that UK banks could circumvent the rules by denominating bank accounts in dollars rather than pounds. I’m baffled. Again, the important point is to look at the small print as per the paragraph just above. The actual currency in which accounts are denominated is irrelevant.

As to the costs of enforcing the rules of FR, they would not be negligible. But compare that to the costs of enforcing the alternatives, e.g. the Frank-Dodd rules, FR is a walk in the park. Frank-Dodd regulations currently stand at 22,000 pages, fifteen times the length of War and Peace (Grind (2016).

Moreover, FR makes it plain impossible for a bank to go insolvent, a point which F&S do not mention (though a large drop in bank shares are perfectly possible.) In contrast Dodd-Frank which simply makes failure less likely. Given that we had a catastrophic bank crisis in 2007/8, followed by a recession lasting about seven years, you’d think that a paper on FR would mention that FR makes bank failure impossible!!

In contrast to the above 22,000 pages, the rules of FR can basically be written on the back of an envelope. Rule number one is “Deposits which purport to be totally safe must be just that”. Rules number two is: “Where anyone wants their money loaned out, they carry the risk of doing so.”

But that’s not to say auditors would be able to prevent every single instance of liquidity or money creation by the smaller shadow banks. But then auditors are clearly unable to regulate banks under the EXISTING SYSTEM with anything near perfection.

Section 5 – Government budget and the monetary creation process.

The first few paragraphs of this section try to argue that FR would constrain public spending. As F&S put it, “In contrast to present arrangements, under FRB government expenditure would be constrained by a lack of availability of finance.”

On the contrary: as PM literature (and the literature produced by other advocates of FR) makes perfectly clear, there is no constraint WHATEVER on government’s freedom to increase public spending and pay for that with extra tax. Indeed any such constraint would be a totally unacceptable intrusion into an obviously POLITICAL matter, namely the proportion of GDP allocated to public spending.

However, what government CANNOT do under FR (or at least some versions of FR) is to BORROW so as to fund extra spending. Reason is that that would be stimulatory, and under FR, stimulus is under the control of the central bank, or some independent committee of economists. Just to illustrate the latter point that different advocates of FR adopt slightly different policies here, PM's proposals still allow government borrowing under discretion of the Treasury, so would not affect the automatic stabilisers, while Friedman's 1948 proposal would prohibit all government borrowing."

Section 5.1.

This starts by pointing out that that public sector’s deficit ends up as increasing the private sector’s stock of base money (“public sector” equals government and central bank). But apparently there is a problem there: as F&S put it, “Thus, the private sector would have to be willing to absorb any increase in central bank money into their savings but may be (since central bank money and transaction accounts are barren assets yielding zero interest) reluctant to do so over and above any increase in the transactions demand.”

Well the first mistake there is that, as explained in the introductory economics text books, people do not hold money just for the well- known “transaction” motive: there is the equally well known “precautionary” motive. That is most people like having a stock of money against a rainy day.

Next, according to F&S there is a problem here which they explain in this sentence: “The first of the problems comes from asking the question as to what reason there is to think that the pre-specified budget position target is compatible with a high level of employment.”

Well the very simple answer to that is that the authorities under FR pitch the “budget position” (normally a deficit) at whatever level they think will bring “a high level of employment” in exactly the same way as they do under the existing system!!

Next, F&S claim to have spotted another problem, which to quote, is that “the case has not yet been made that a budget deficit equal to the growth of the transactions demand for money (and as indicated above, broadly in line with the nominal growth of the economy) would be compatible with a high level of employment.”

Well the answer to that is that under PM’s system (and the similar systems promoted by other FR advocates) the authorities WOULD NOT aim to pitch the deficit at a level which equaled the change in the demand for money. At least they certainly wouldn’t do that given excess unemployment.

Of course the authorities do not do detailed estimates as to what the transaction and precautionary demand for money is, but IN PRINCIPLE at least, and given excess unemployment, they pitch the deficit at a level they think is likely to result in the private sector having an excess stock of money, which results in the private sector spending more. Indeed (and to repeat) that’s little different to the existing system, under which the authorities increase the deficit given excess unemployment.

As distinct from “in principle”, in practice it would not be easy to pitch the deficit at exactly the right level under FR any more than that is an easy task under the existing system.

Section 6  - Concluding comments.

Here, F&S claim, “Finally, FRB will nullify the automatic stabilisers of fiscal policy and lead to a de facto dominance of monetary policy and un-elected central bankers over fiscal policy and democratic decision making.”

The reason F&S THINK that PM’s proposals lead to a degradation of “democratic decision making” is obvious. Under those proposals, the amount of stimulus is determined by the central bank, or some independent committee of economists. And that induces F&S (and indeed many others) to jump to the conclusion that the latter technicians determine the nature of, and/or total amount of public spending. I fact it does neither.

The basic idea in the PM proposal (supported incidentally by the New Economics Foundation and Prof Richard Werner) is that stimulus comes in the form of having the central bank create new money and then having government / politicians spend it in whatever way they choose (and perhaps also cut taxes). In short, while the AMOUNT of stimulus is decided by the above central bank or other committee, the NATURE of stimulus spending remains entirely under the control of democratically elected politicians – contrary to F&S’s claim.

Moreover, under PM’s system, politicians still have complete control over another obviously political decision, namely what proportion of GDP is allocated to public spending. That is, if politicians want to increase that proportion, there is nothing to stop them increasing public spending and raising taxes so as to pay for it. But what they CANNOT do is raise spending WITHOUT raising taxes. That would be stimulatory, and under PM’s system, stimulus is under the control of the central bank or some committee of economists.

And to add insult to injury, for countries which have independent central banks (that’s the majority of countries nowadays), central banks ALREADY HAVE the last say in how much stimulus there should be because an independent central bank can override fiscal stimulus decisions taken by politicians, and by using interest rate adjustments. Indeed the fact that an independent central bank has the last word when it comes to determining the AMOUNT of stimulus is the basis of the “monetary offset” idea advocated by Sumner (2013).

Another mistake made by F&S make in relation to the “democratic decision making” point is F&S’s assumption that PM’s idea about implementing stimulus via having the state create money and spend it, is an idea shared by most advocates of FR. It just isn't!

In other words, as I pointed out at the outset above, F&S more or less equate PM with FR: that is, F&S are apparently unaware of the fact (to repeat) that a clutch of Nobel laureate economists and other household name economists ALSO support FRB, but those economists DON’T specifically support PM’s “committee of economists” idea (not that they’d necessarily DISAGREE with the idea).

Incidentally, the above “degradation of democratic decision making” mistake was also made by Pettifor (2014) in an article of hers entitled “Why I disagree with Martin Wolf”.

Automatic stabilisers.

F&S also claim that the PM system scuppers automatic stabilisers. Now that’s a better criticism than most of the above criticisms F&S make of PM. But it’s not a brilliant criticism, and that automatic stabiliser problem is easily dealt with.

F&S are right to say that under the existing system, when unemployment rises, government does not need to go running cap in hand to anyone for funds to pay for the increased unemployment benefit burden: government just funds the extra spending via extra borrowing.

However, it really doesn’t take a genius to set up a rule under which government under a PM/NEF system AUTOMATICALLY gets funds from the central bank to pay for a rise in the unemployment benefit bill (or at least a proportion of it). But there’s another problem with the above automatic stabiliser alleged problem which F&S propose, as follows.

As explained above, even under the EXISTING SYSTEM, assuming an independent central bank, the central bank has the final say on the amount of stimulus. Now suppose there’s a rise in the unemployment benefit bill, the CHANCES ARE that that means demand is too low which means the central bank will not raise interest rates, and indeed may even cut them.

On the other hand, it’s always possible that notwithstanding a rise in unemployment, the central bank still thinks demand is too high (or inflation is too high). In that case the central bank is likely to COUNTERACT a rise in demand stemming from the automatic stabilisers kicking in (Sumner’s point, sort of). So even under the EXISTING SYSTEM, central banks can scupper the automatic stabilisers. And a central bank may in fact be right to do that: for example a rise in unemployment in ONE MONTH is not a brilliant reason for thinking a recession is on the way.

So…. the automatic stabilisers only work under the existing system gratis the central bank! And that set up really isn't much different to what would obtain under the PM system where (as F&S suggest) PM’s system scuppers the automatic stabilisers. But if you don’t like that, i.e. if you’re an “automatic stabiliser” enthusiast, then it’s not difficult to incorporate an automatic stabiliser element in the PM system.


P.S. (30th  July 2016).  Re the above inadequate treatment of seignorage, I’ve done a fuller treatment here:


Friedman, Milton. (1948) “A Monetary and Fiscal Framework for Economic Stability”. American Economic Review. (See p.247).

Friedman, Milton. (1960). “Program for Monetary Stability”. Fordham University Press. (See in particular Ch3 under the heading “How 100% reserves would work”.)

Grind, K. & Glazier,E.  “Nuns With Guns: The Strange Day-to-Day Struggles Between Bankers and Regulators”. Wall Street Journal.

Keynes, M. (1933). “An Open Letter to President Roosevelt”.

Kumhoff, Michael and Jakab, Z. (2016) “The Truth About Banks”. IMF

Masters, B. (2012) “FSB seeks to tame shadow banking”. Financial Times.

Mitchell, William. (2009). “Deficit Spending 101  - Part 1”

Musgrave, Ralph. (2015) “James Tobin advocated Full Reserve Banking”.

Paganelli, M.P. (2014)  ‘David Hume on Banking and Hoarding’, Trinity University.

Pettifor, Ann. (2014)  “Why I Disagree with Martin Wolf and Positive Money”. Open Democracy UK.

Phillips, Ronnie. (1992) “Credit Markets and Narrow Banking”.

Positive Money, New Economics Foundation and Werner, Richard. (2011)  “Towards a Twenty First Century Banking and Monetary System”.

Sumner, Scott. (2013) “Why the Fiscal Multiplier is Roughly Zero”. Mercatus Centre.

Tobin, James “Case for Preserving Regulatory Distinctions”

Wray, Randall. (2015)   “Debt Free Money and Banana Republics”. New Economic Perspectives.


  1. Hey Ralph,
    Thanks so much for this, which really ought to be considered part and parcel to the original ‘Journal’ piece – to which I am unable to subscribe … as such I rely upon your, and Ben’s reply comments for any substance(?) being offered.

    A couple of minors here.
    Curious why any list of FR supporters does not include Irving Fisher , who championed this change to central bank operations for many decades, and published more than others on the subject, being considered America’s supreme monetary economist of the last century.

    Then this observation – having correctly established that this is more of a questionably-purposed unfavorable attack on PM’s work than any quasi-academic undertaking, I would even add that this entire modern money discussion is one that suffers from intellectual myopia, where the value of a ratio of reserves takes precedent over the much larger political-economy question of why we have privatized our national money systems THROUGH fractional-reserve banking.
    So, my shortcut there …., it’s NOT about the reserves-ratio, it’s about who is issuing the national money, and WHY(?).
    Bring THAT question to the fore, and the base-money dialogue soon fades to where it belongs.
    Thanks again for all of this.

    Joe Bongiovanni

    1. Re Fisher, Sawyer & Fontana mention him. I ought to have done so as well.

      Re the question as to why we have privatised the money system, I think that's actually the central question being debated. It's just that the answer to that question involves answering an amazing large number of subsidiary questions. So the latter basic question does seem to get lost sometimes.

  2. Hey Ralph,
    I would like to agree.
    But this Post-Keynesian shtick today has morphed into a broad defense of a series of errant MMT constructs, which in turn misinforms the substantive dialogue needed to actually discuss why we have privatized money, and whether we (the public) should take it back from the bankers, or not.

    MMTs problems are not Post-Keynesian, which evolves mostly around that the public sector must fill the GDP-gap when the private sector stalls.
    All well and good there.

    MMTs fails are almost exclusively the Mosler-Wray add-ons, like that (somehow, unexplained) the government actually creates new money (increases the money supply) just by spending.

    Now, I have an actual workable theme on that matter that supports government spending, as relates to monetary velocity, but MMT claims that actual new dollars are added to the money supply, and thus Guv doesn't need either taxes or borrowing for income. False. Can't happen.

    As soon as I first read Bell's "Nuances of Reserve Accounting" chapter, I knew they were either faking it, or incredibly ignorant.

    Because with public money the government WOULD create new money when it spends, the false MMT tenet in this regard, being that they already do it, here puts public reforms off the table ...... there is just no need for discussing public money creation reforms.

    Unfortunately, the P-Ks see MMT as kindred spirits for the most part, when they are seriously damaging the P-K brand.


    1. I can't for the life of me see what's wrong with the idea that states that issue their own money can simply create it and spend it, thus putting more dollars into private hands.


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