Thursday, 19 January 2017

Criticisms of Positive Money by “Critical Macro Finance”.

Summary / introduction.

An organisaton called “Critical Macro Finance” recently published an article entitled “Full Reserve Banking: The Wrong Cure for the Wrong Disease”, which is basically a criticism of Positive Money’s ideas on full reserve banking.  Critical Macro Finance is a group of economists based at the University of the West of England.

No authors are given for this article, so I’ll refer to the authors as “the authors”. The authors have done plenty of homework, and the article contains plenty of references.

While I support Positive Money, the authors’ arguments are among the best criticisms of PM I’ve seen and I agree with several of those criticisms. I’ve always thought PM was skating on thin ice with some of its claims and I’ve been amazed at how slow the economics profession has been to identify the weaknesses in PM’s arguments. However, the authors do not manage to demolish the case for full reserve. But the reasons for saying that are many and complicated and are as follows. I’ll take the authors’ points in turn.

Continuous economic growth and the environment.

First, the authors attack the idea put by Positive Money (or at least by PM supporters, like the Green Party) that the existing monetary system requires continuous economic growth and that for that or other reasons, the existing system harms the environment.

I fully agree with the authors there: indeed I have debunked the “continuous economic growth” and the “environment” idea on this blog.

The human race demands continuous economic growth because of its insatiable desire for ever more consumer goodies. That desire will be there regardless of what monetary or banking system we have.


Next, (para starting “To the average person…”) the authors accuse PM of using psychological tricks to make people feel uneasy about the existing monetary system. Well fair enough: PM is a pressure group, not an economics text book. Other pressure groups, political parties etc use psychological tricks. That’s normal.

The Chicago Plan.

The authors then correctly trace PM’s ideas back to a group of economists based in Chicago in the 1930s (para starting “The original blueprint..”). In fact PM makes no secret about those origins of PM’s ideas.

Loans create deposits.

The authors then make the following false assertion: “When a bank lends £100 to a customer, both ‘loans’ and ‘deposits’ increase by £100.” Well that is true where the money loaned out is paid to someone who banks at the same bank, but not otherwise. I.e. the latter sentence of the authors’ should have been something like, “When the private bank SYSTEM lends £100 to a customer, ‘loans’ and ‘deposits’ of the aggregate private banks system increase by £100”. But that’s not a crucial error, so lets continue.

Full reserve prevents bank lending?

The authors then claim that banks do not lend under full reserve banking. To quote, he says “Under the proposal, banks would not be allowed to make loans.”

Well as PM literature makes clear (and indeed as other advocates of full reserve like Milton Friedman and Lawrence Kotlikoff make equally clear) banks ARE ALLOWED to lend under full reserve: it’s just that the bank industry under full reserve is split into two halves, one of which lends and is funded by equity or something similar, while the second half simply accepts and stores deposits and is not  allowed to lend.

But possibly that point is a bit semantic: i.e. if what one means by the word “bank” is something like “an entity that accepts deposits”, then it is true to say that under full reserve, banks cannot lend.

Privately issued money increases debts?

The authors then attack an idea long pushed by PM (specifically here) which is along the lines that private banks create money when they make loans (on which interest is paid) ergo privately created money forces people to pay interest to private banks, or an unnecessarily large amount of interest to private banks.

I agree with the authors there: i.e. that that argument of PM’s is flawed. However, the authors explanation of where the flaw in PM’s argument lies is unnecessarily long and convoluted.  As I’ve explained in earlier articles on this blog, the ACTUAL REASON why PM are wrong there is actually quite simple, and is thus (skip to the next heading if you are not interested in where I think PM have gone wrong here).

First, the above PM argument is actually false logic: that is, the fact that in the case of private banks some money is created as a by product of loans (on which interest is paid) does not mean that private banks are unable to create money WITHOUT charging interest.  The fact that rain makes roofs wet does not prove that the fact that a roof or roofs are wet proves it must have been raining. And in fact private banks do to some extent create money without charging interest. Reasons are as follows.

There are actually two quite different types of “loan” granted by banks. First, banks to some extent are into the business of supplying customers with a form of money or “float” to enable customers to do daily transactions. But in as far as that is ALL THAT banks do, there is no reason for the bank to charge anyone any interest. To illustrate, a private bank, having supplied person A,B,C, etc with say £1,000 floats, the balance on A, B  & C’s account will bob up and down over the year, above and below £1,000, thus there is no reason, over the year as a whole for the bank to charge anyone any interest: simply crediting £1,000 to someone’s account does not involve transferring any REAL RESOURCES to that person. Thus there is no reason to charge interest.

In contrast, there certainly IS A REASON for banks to charge for ADMINISTRATION COSTS: that is, there are very real costs involved in checking up on the creditworthiness of A, B, C, etc, and taking collateral off them. Indeed, that is a strong argument against privately issued money: it’s costly to issue. In contrast, issuing state created money (base money) is virtually costless (as pointed out by Milton Friedman).

In contrast to simply supplying customers with a float, banks are also into the business of supplying customers with LONG TERM loans like mortgages. That's the second type of loan. In that case, and having supplied a customer with say £100k worth of mortgage, the balance on that customers account very definitely DOES NOT bob up and down above and below the £100k mark. Quite the contrary: the customer will spend nearly all the £100k and not pay it back for years or decades. In that case, the bank certainly will charge what might be called “genuine interest” (in addition to administration costs). Plus it will have to pay interest to some set of depositors who have put money into term accounts at the relevant bank. In that case, real resources certainly ARE TRANSFERRED  to the borrower: about £100k worth of house, to be exact.

Should government print money or borrow it?

The authors then deal with PM’s claim that stimulus should come in the form of the state simply printing new money and spending it, and/or cutting taxes. See paragraph starting “Oddly, despite the environmental argument…”.
Unbeknown to the authors, and possibly also unbeknown to PM, that idea is actually quite separate from the arguments for and against full reserve. E.g. we could perfectly well continue with the existing “fractional reserve” bank system while abolishing all government borrowing.

On the latter grounds, I could simply ignore the “borrow versus print” argument. However, I’ll say a bit about it.

The authors say,

 “Oddly, despite the environmental argument, we can also find arguments from PM about ways that monetary mechanisms can be used to induce higher output and employment. These proposals, which go by titles such as ‘Green QE’ and ‘People’s QE’, argue that the government should issue new money and use it to pay for infrastructure spending.”

The authors continue,

“An increase in government infrastructure spending is undoubtedly a good idea. But we don’t need to change the monetary system to achieve it. The public sector can do what it has always done and issue bonds to finance expenditures. (This sentence will inevitably raise the ire of the Modern Money Theory crowd, but I don’t want to get sidetracked by that debate here.)”

Well the answer to that is that PM, far as I know, does not argue that “we need to change the monetary system” in order to implement spending on infrastructure. Indeed, it’s blindingly obvious that we have spent billions on infrastructure over the last century without implementing totally new monetary systems. PM (and indeed the many other organisations and individual economists who back full reserve) argue that a system where only the state issues money is OVERALL a better system. Infrastructure in particular has nothing much to do with it.

Moreover, the very idea that a government which can print money should borrow money is odd, as Friedman (1948) said. Why borrow money at interest when you can print the stuff?

Also Keynes (1933, 5th para) said that having the state print and spend money in a recession was a perfectly acceptable alternative to having the state borrow and spend. Thus contrary to the authors’ suggestions, there’s a fair amount of brain power behind the idea that government borrowing is a nonsense, and that government should be funded just via tax and money printing.

Incidentally, the fact that Keynes advocated money printing without at the same time advocating full reserve nicely illustrates my above point that the “print versus borrow” argument is separate from the “full versus fractional reserve” argument.

And there’s another glaring anomoly with government borrowing which is thus. The purpose of having government borrow and spend is often stimulus, but the fact of borrowing considered in isolation is DEFLATIONARY!! I.e. the effect of borrowing is the opposite of the desired effect. Thus to have the state borrow and spend with a view to stimulus is a bit like throwing dirt over your car before washing it: barmy!

And if you want to know why government borrowing has proved so popular over the centuries despite its obvious defects, I suggest a big part of the answer was given by David Hume writing about 250 years ago. As Hume said, politicians borrow money rather than raise taxes so as to ingratiate themselves with voters (Hume 1742, II.IX.5).

Yet another nail in the “government borrowing” coffin was set out by Kellerman (2006). She demolished the popular claim that it makes sense for governments to borrow to fund INVESTMENTS: the so called “golden rule”.

Also Warren Mosler opposes government borrowing (Mosler (2010), 2nd last para).

Give £7,000 to everyone instead of traditonal QE?

The authors then say “Further, the conflation of QE with the use of newly printed money for government spending is another example of sleight of hand by Positive Money.” That’s a valid criticism. Indeed PM have been publishing tweets recently (see below) to the effect that the average household would have enjoyed spectacular increases in income if the £7,000 or so of new money created per head to enable QE had instead been paid direct to households or spent on increastructure or similar.  Reason why that’s a sleight of hand is that QE has little effect on demand, whereas spending £7,000 for every UK resident on infrastructure or similar would have a HUGE EFFECT on demand: indeed it would be positively inflationary.

Small banks, shadow banks, etc.

Next, in a para starting “The same is true..” the authors trott out a criticism of full reserve banking which has been made a dozen times before, and demolished an equal number of times. It’s the idea that full reserve would deal only with large regular banks, while failing to deal with the smaller unregulated banks or quasi banks.

The answer to that was given by Adair Turner when he said “If it looks like a bank and quacks like a bank, it has got to be subject to bank-like safeguards…”. I.e. no organisation which acts like a bank should be excused obeying bank regulations. Building firms, whether they employ three or three thousand people have to obey similar rules, e.g. as regards health and safety. There is no reason why banks cannot be regulated similarly.

Moreover, even if the smallest shadow banks manage to escape regulation that does not matter too much: if say the hundred largest banks, regular and shadow, ARE REGULATED, that cracks the problem basically.


The authors then criticise the claim by PM that the freedom private banks have to print or create money enables them to enjoy seigniorage profits. As the authors put it, “There is simply no reason why the act of issuing money generates profits in itself.” Well a quick answer to that is: “tell that to a backstreet counterfeiter”.

However, that’s a flippant answer to the authors’  point. I.e. the exact way and extent to which private banks enjoy seingiorage profits is complicated and the authors are probably right to say PM overestimate the size of seigniorage profits.

But to say private banks make no seigniorage profits at all is equally wide of the mark. Joseph Huber in his work “Creating New Money” illustrated how seigniorate profits arise. As he put it,

“Allowing banks to create new money out of nothing enables them to cream off a special profit. They lend the money to their customers at the full rate of interest, without having to pay any interest on it themselves. So their profit on this part of their business is not, say, 9% credit-interest less 4% debit-interest = 5% normal profit; it is 9% credit-interest less 0% debit-interest = 9% profit = 5% normal profit plus 4% additional special profit.”

That can be put another way, as follows.

Some of the money created by the state comes in the form of PHYSICAL money like £10 notes. But holders of that money (you and me) get no interest whatever on that money. But the state obtains various assets (e.g. schools and hospitals) in exchange for the money it prints (both in physical form and digital form). And that’s a nice little earner for the state. That’s seigniorate profit.

But in additon to zero interest earning physical money, there is also zero interest earning digital money: the money that you and I have in our current accounts (“checking accounts” in US parlance). Certainly my high street bank pays me a derisory rate of interest (0.1%) while making a specific charge for each cheque, debit card or other transaction.

In short, the authors’ claim that private banks simply intermediate between lenders (i.e. depositors) and borrowers is not entirely true: to some extent, private banks (along with those they lend to) simply print money, which is happily held by depositors without their getting any interest, as long as they have instant access to that money. I.e. in effect, private banks and those they lend to obtain real assets (e.g. houses) in exchange for inherently worthless bits of paper. That’s seigniorage profit.

Milton Friedman.

The authors end with a short discussion of Friedman’s ideas, which is of relevance since Friedman backed full reserve banking. But the authors make the following strange claim about Friedman, “Like PM, he favoured a simple monetary solution: the Fed should print money to counteract the effect of bank failures.”

Well I’ve just looked at Friedman’s 1948 paper “A Monetary and Fiscal Framework for Economic Stability” in which Friedman advocates full reserve and money printing by the state. The phrase “bank failure” does not appear. Moreover, while the word “bank” appears about fifteen times, there is no suggestion that Friedman wants to have the state print money so as to rescue banks.

Indeed Friedman is quite clear that when entities in the half of the bank system which lend make poor lending decisions, shareholders take a hit. That’s very much in line with Friedman’s pro-free market outlook.  In contrast the ACTUAL PURPOSE of money creation by the state as far as Friedman is concerned is exactly as envisaged by PM: it’s to provide general STIMULUS. Friedman is not bothered about the extent to which banks or “lending entities” benefit from that stimulus.

Financial instability.

Finally, there is an important omission from the article as follows.

It says quite rightly that one of PM’s central claims is that full reserve reduces “financial instability”.  The authors however do not say whether they think PM is right or wrong there.

In fact full reserve brings a HUGE INCREASE in financial stability in that it’s plain impossible for a bank to fail under full reserve. Reasons are simple and as follows.

As regards the half of the bank industry which simply accepts deposits, it cannot go bust because all those deposits are lodged at the central bank. And as to the half of the industry which makes loans, it cannot go bust because it is funded by shareholders (or something similar like bonds which can be bailed in). Thus if (to take an extreme scenario) a bank makes a series of seriously stupid loans, and the bank’s assets (i.e. those loans) become worthless, then the value of its shares and bonds become worthless as well. But the bank is not bust in the sense that its liabilities exceed its assets.


Indeed, if there’s a criticism to be made of full reserve as a solution to bank instability: it’s that full reserve constitutes overkill. It involves using a sledge hammer to crack a nut. That is, under full reserve, lending entities have 100% capital ratios, and as is widely accepted, a significant rise in capital ratios is certainly needed, but 100% is way too much as far as bank stability is concerned. (For example Martin Wolf and Anat Admati (professor of economic at Stanford) want far higher capital ratios than the UK government or Vickers commission want, but even Wolf and Admati only advocate a ratio of around 25%.)

So what’s the argument for full reserve?

Astute readers will now be wondering what the arguments for full reserve are, given that so many of the authors’ criticisms of pro full reserve arguments seem to be valid.

My answer (very briefly) to that is there is pretty obviously a difference between two systems: 1. Full reserve, under which just the state issues money while private banks cannot, and 2, the existing or “fractional reserve” system under which private banks are allowed to issue money. One of those systems must be better than the other.

Now there is no reason to suppose that under full reserve, interest rates do not settle down to some sort of GDP maximising free market rate. Nor is there any reason why, under full reserve, full employment is not attainable: all the state has to do is issue enough money to the private sector to induce the private sector to spend at a rate that brings full employment.

But if private banks are to start issuing money, they have to offer loans at below the above free market rate, which you might think means they’d make a loss. Well the answer is “Oh no they wouldn’t”: reason is those banks do not need to pay anything for the  money the lend out (as Joseph Huber explained – see above).

But that new lending increases demand, which means the state has to rein in demand, e.g. by raising taxes and confiscating some of the private sector’s stock of base money. Net result: interest rates fall to below their free market level and debts rise to above their free market level. And given the usual assumption in economics, namely that GDP is maximised when prices (including the price of borrowed money) are at their free market levels (unless market failure can be demonstrated), it follows that GDP will be larger under full reserve than under the existing or “fractional reserve” bank system.



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

Hume, David (1742) ‘Of Public Credit’.

Kellerman, Kersten, (2006)    ‘Debt financing of public investment: On a popular misinterpretation of “the golden rule of public sector borrowing.”’ Published by Science Direct and the European Journal of Political Economy.

Keynes, M. (1933) ‘An Open Letter to President Roosevelt’.

Mosler, Warren (2010). ‘Proposals for the Banking System’. Huffington Post Business.


  1. Thanks for your appraisal of this article,personally I think they mipsrepresent quite a bit of what Positive Money actualy say,but that is usually the case in most critiques.It was on the whole a reasonably fair attempt though.
    My only beef is that they say a couple of times that there is no doubt a strong argument that the banking system has some major flaws and that it needs reforming...but they offer no alternative solution.At least PM have gone into consierable depth on this and over many years,it will take more tha one short article to deter me from believing what they propose is for the best....namley Full reserve AND sovereign money.The authors here seem a bit shakey on actually understanding that point right from the beginning,and do get rather tangled up trying to unravel it all.
    Only thing I might add is that the need for economic growth is quite simple,the stateresigned itself just to paying off the interest on its borrowings.If GDP does not grow fast enough, revenues will fail to cover the interest....and we fall further behind as we need to borrow even more.As long as increase in revenue exceeds the interest the economy is OK.We are in other words trapped in this cycle.

    1. Strikes me the national debt is one huge non-problem. Basically we can just print money and buy it back: exactly what we’ve done with almost all the new debt incurred for the last 3 years or so, and under the guise of QE. Granted it’s not QUITE that simple, but it’s very nearly that simple, and for reasons I set out here:

    2. Totally agree, it is a manmade trap we have inflicted in ourslelves.


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