N.G.Mankiw’s criticisms of Modern Monetary Theory.

Mankiw, who is a Harvard Economist, recently published a work criticising MMT entitled “A Skeptic’s Guide to Modern Monetary Theory”.

His first criticism is that MMT advocates are not too clear on exactly what it is they are trying to say. While I have supported MMT for several years, I think that’s a fair enough criticism. As he says, advocates of a new idea often come in the form of a group of academics, while MMT advocates are a much more diverse lot (of which I am perhaps typical). That diversity almost inevitably leads to a less clear message than where just one or two academics advocate an idea. Mankiw is generous enough to say that that diversity is not necessarily a flaw.

Mankiw’s first main error comes in the last para of his second page, where he claims there’s a problem with the MMT claim that governments and central banks can  simply create and spend money (and/or cut taxes) up to the point where inflation becomes excessive. The alleged problem is that that new money ends up as bank reserves and that central banks have to pay interest on money. 

Well the obvious flaw in there is that interest on reserves is not inevitable: in fact it’s a very recent development for central banks. Moreover, many MMTers specifically advocate a permanent zero rate of interest policy. (That’s a permanent, or at least more or less permanent zero rate on government and central bank liabilities, which includes reserves. In contrast, the rate of interest on mortgages, pay day loans etc will of course always be well above zero.)


Mankiw’s second criticism.

His second criticism (top of his p.3) is that the latter increase in reserves will increase bank lending, which in turn will further exacerbate inflation.

Well Mankiw apparently hasn’t noticed that quantitative easing resulted in an astronomic and unprecedented increase in reserves, but the effect on bank lending was decidedly muted. And that is not entirely surprising: as J.K.Galbraith famously put it, “Firms invest when they can make money, not when interest rates are low.” I.e. it’s customers coming thru the door that induces firms to borrow and invest.

Of course QE is not exactly the same as cutting interest rates, but it’s near enough the same. Central banks cut interest rates by creating money and buying up government debt. QE is simply a continuation of that “buy up” process when interest rates are near zero and the “buy up” may not actually influence interest rates. 

And another flaw in Mankiw’s above second criticism is that if there is indeed a feed-back mechanism of the type he proposes (i.e. more reserves means more lending, which raises demand), then the solution is simply to go for less of a “reserve increase” (i.e. a smaller deficit) than would otherwise be the case!

Feed-back mechanisms are all over the place in our daily lives. E.g. getting drunk may cause you to behave in an even more irresponsible way and drink even more. Solution: don’t drink so much that the latter feed-back mechanism kicks in!! 



The third criticism.

Mankiw’s third criticism (also at the top of his p.3) is: “Third, the increase in inflation reduces the real quantity of money demanded. This fall in real money balances, in turn, reduces the real resources that the government can claim via money creation.”

Well the simple answer to that is that if there is excess inflation, there is no need for government to “claim more resources via money creation” (i.e. raise public spending)! Indeed there is no need for it to “claim more resources” in any other way!



Conclusion.

I don’t think MMTers need to seriously re-consider their ideas in the light of Mankiw’s criticisms.

Richard Murphy and Colin Hines’s way of funding the Green New Deal.

Murphy & Hines have just published their ideas on this subject in a work entitled “Funding the Green New Deal”.

I’m all for the GND, but Murphy & Hines’s (M&H) way of funding it leaves a bit to be desired. Basically they claim that funds can be nicked from other types of investment: in particular they advocate changing the rules for ISAs and pension funds so that a proportion of the savings currently going to the latter two are diverted to bonds to fund the GND, and certainly that’s possible.

Problem though, is that would starve the banks, firms etc which rely on ISAs and pension funds for money for investment, which would push up interest rates. And that in turn would benefit creditors / the rich while hitting borrowers, e.g. those with mortgages.

That wouldn’t be the end of the world given that in the 1990s UK mortgagors were paying nearly three times the rate of interest they pay nowadays, and strange to relate, the sky did not fall in in the 1990s. But M&H ought to be more open  about that interest raising effect.

The above “rate of interest raising” effect does not actually have anything specifically to do with ISAs or pension funds or any of the many other possible ways of diverting funds to the GND. To illustrate, if government just offered bonds to fund the GND at whatever rate attracted lenders in sufficient quantities, the inevitable effect would be a rise in interest rates and attract funds away from other types of investment.

Put another way, if government decides to borrow and spend an extra £Xbn a year, and assuming the economy is already at capacity (which it more or less is in the case of the UK in 2019), that extra spending is not permissible unless some form of spending cut is implemented so as to balance the extra spending. That cut can be brought about by a rise in interest rates or a rise in tax, for example.

And frankly it does not make a huge difference which one is chosen: if the interest rate rise option is chosen, then in effect it’s mortgagors and other borrowers who are induced to spend less. And mortgagors are pretty much the same collection of individuals as taxpayers, though clearly not exactly the same collection of individuals.

And finally, if the distribution of after tax income is what government thinks is optimum before implementing the GND, then funding the GND via borrowing will disturb that optimum set up (e.g. because mortgagors are worse off). Thus government will have to adjust tax on so called “unearned income” (on the rich) and subsidies for mortgages (if there are any) etc etc. 

Be simpler fund the GND via tax, and in a way to maintains what government thinks is the optimum distribution of after tax income, don’t you think?

Why the IMF was so hesitant about stimulus during the recent recession.

As others have noted, the IMF was positively schizophrenic on the subject of stimulus during the recession that started in 2007/8. In one breath they backed stimulus, while in the next, they warned of the dangers of the alleged increased debt that governments incur when they implement stimulus.

The first obvious flaw in the latter “debt” point is that to a large extent, governments just didn't incur more debt when they implemented stimulus! To be more exact, in the first instance they incurred more debt, but then their central banks did large amounts of QE: i.e. they printed money and bought back that debt.

Thus in effect what many governments did (assisted by their central banks) was simply print money and spend it (and/or cut taxes).

Yet strange to relate, the recently retired chief IMF economist, Olivier Blanchard claims here that low interest rates facilitate fiscal stimulus. His actual words: “…..low interest rates increase the room to use fiscal policy.” (See p.4). (Article title: “Interview with Olivier Blanchard”, published by Goldman Sachs).

To repeat, the going rate of interest has absolutely no bearing on the ease with which government can implement fiscal stimulus because (to repeat) governments and central banks between them can fund fiscal stimulus by simply printing money!!!!!

Keynes pointed out in the early 1930s that stimulus can be funded simply by printing money. You’d think his message would have got thru by now, wouldn’t you?

As Claude Hillinger put it in his paper entitled “The Crisis and Beyond: Thinking Outside the Box”:

“An aspect of the crisis discussions that has irritated me the most is the implicit, or explicit claim that there is no alternative to governmental borrowing to finance the deficits incurred for stabilization purposes. It baffles me how such nonsense can be so universally accepted. Of course, there is a much better alternative: to finance the deficits with fresh money.”

Some popular misconceptions about the debt and deficit.

Scott Wolla and Kaitlyn Frerking, two St Louis Fed authors, try to enlighten us on the deficit and debt. They make some valid points, but also a few mistakes, which I’ll deal with in the paragraphs below. Their article is entitled “Making Sense of the National Debt”.

The first mistake, which appears in the first two paragraphs, is the idea that government, can increase everyone’s consumption by borrowing, just like a household can temporarily bring about a increase in its consumption by borrowing to go on a world cruise or buy an expensive new car, and do that via borrowing. The authors say:

We live in a world of scarcity—which means that our wants exceed the resources required to fulfill them. For many of us, a household budget constrains how many goods and services we can buy. But, what if we want to consume more goods and services than our budget allows? We can borrow against future income to fulfill our wants now. This type of spending—when your spending exceeds your income—is called deficit spending. The downside of borrowing money, of course, is that you must“ repay it with interest, so you will have less money to buy goods and services in the future. Governments face the same dilemma. They too can run a deficit, or borrow against future income, to fulfill more of their citizens' wants now.”

Unfortunately the world of macroeconomics (e.g. the world of government and the economy as a whole) is very different from microeconomics (which is concerned with individual products, households, firms, etc).

Assuming the economy is at capacity, if government spending is $X more than income, excess inflation will ensue unless there’s an $X CUT in spending elsewhere. Unfortunately borrowing $X won't cut spending all that much. In fact it might not cut it at all. Reason is that it’s the rich who lend to government, and the rich don’t change their weekly spending much in reaction to a change in their stock of cash. In fact, given that they won’t lend to government unless they think they’ll make a profit in the long term, they may actually spend that profit before it crystalizes, i.e. raise their weekly spending!!

Thus in the later “borrow and spend” scenario, government and/or central bank has to find some way of supressing demand to balance the increase in demand coming from the “borrow and spend” exercise. Most commonly the central bank, as soon as it spots the above deficit will raise interest rates. Or it may wait till the above mentioned excess demand and inflation actually materialises before raising interest rates. But the exact timing is not of importance to the basic point being made here.

Thus it just isn't possible, in the words of the St Louis Fed article, for government to arrange for the country as a whole to   “consume more goods and services than our budget allows”. For example, in the case of the above interest rate rise, that will dissuade people from buying new or bigger houses, which of course amounts to consuming FEWER goods.


 Borrowing from abroad.

Having said all that, there is one slight reservation that should be made, which is that if a government borrows from abroad rather than from its own citizens, that will enable the relevant country to consume more than it produces for a while. E.g. if China supplies the US with goods, while the US abstains from paying cash on the nail, and borrows from China instead, that will give the US a temporary increase in living standards.

But only a minority of most countries national debt is funded from abroad, so that point is of limited relevance.


Interest on the debt is an opportunity cost?

The authors’ second error is in the passage starting “However, this does not mean that debt is without cost. It is important to understand that debt has an opportunity cost.”

In fact interest on the debt is simply a transfer from one lot of people to another: it’s a transfer from taxpayers (who fund the interest) to holders of government debt. Now why would that have any influence on government’s ability to “finance other projects”?

Clearly the money grabbed off taxpayers is an opportunity cost in the sense that it then becomes more difficult to grab yet more money off those taxpayers. On the other hand, debt holders are better off in that they’ve received the money grabbed of taxpayers, so it is then easier to milk those relatively well off people. All in all, I suggest there is not much of an “opportunity cost” there.

Put another way if government grabbed $Xbn a year off males and gave the money to females (or vice versa), GDP would remain much the same, and hence government’s ability to “finance other projects” would remain much the same.


Growth in the debt is unsustainable.

Next, the St Louis Fed authors trott out a common concern about the debt, namely that if it’s growing faster than GDP in real terms, that is clearly not sustainable in the very long term, which (allegedly) is a problem.

Well now an accelerating car is an “unsustainable” system: it cannot  go on accelerating indefinitely. That’s first because of speed limits on roads, and second, there’s a physical limit to the speed of any car (determined by its engine size and other factors.)

So are accelerating cars a problem? Well clearly not, because there are (to repeat) natural limits to the speed of a car.

And much the same applies to the debt. That is, while the amount of debt that the private sector wants to hold my rise steadily over a period of years or even decades, there must be some sort of limit that the average household wants to hold (either directly or via pension funds and similar).

To illustrate, if someone on average wages discovered they had ten million dollars of government debt, would they just carry on accumulating it, or would they cash it in at the earliest possible opportunity and go on a bit of a spending spree? I think I know the answer to that.

Conclusion: there are natural limits to the amount of debt the private sector will want to hold.

 
Default.

Under the heading “Debt Risks”, the St Louis Fed  authors then worry about the possibility of a government defaulting on its debt when the debt gets sufficiently large and the private sector starts to doubt government’s intention to repay its debt, with the result that debt holders then start demanding a much higher rate of interest for holding debt.

Well the solution to that problem is easy. If interest demand does rise significantly, government can just tell debt holders to get lost when their existing debt matures. In effect, that equals QE.

Of course that would result in former debt holders having a larger stock of cash than previously, which might result in excess inflation (although the actual effect of QE in recent years does not seem to have been inflationary). But if excess inflation does loom, all government has to do is raise taxes. That will produce a deflationary effect to counter the above mentioned inflationary effect.

Nothing difficult in principle there.

Yet another feeble defence of private money printing.

I set out the flaws in many of the excuses proffered for letting private banks create money here recently. (Article title: “Silly excuses for letting private banks print money”)
 
 Another attempt to defend the existing bank system (i.e. allow private money creation) appeared in the Financial Times recently authored by Isabella Kaminiska. To be exact, she tries to argue that Stablecoin comes to the same as full reserve banking, a system under which private money creation is banned. (Article title: “Stablecoins as a euphemism for full-reserve banking.”)

Well Stablecoin (i.e. a central bank issued crypto currency tied to the £ or some other stable unit) is certainly similar to an element of FR. To be exact, under FR, depositors can keep their money in the latter form of totally safe, central bank guaranteed money, or they can choose to have their money loaned on to mortgagors etc, in which case depositors carry relevant risks themselves.

Unfortunately, as Kaminiska makes clear, Stablecoin does not necessarily involve a total abolition of private money creation. Stablecoin thus has similarities to one element of FR, but certainly does not equal FR. 

As for her  final three paras, they are nonsense.Her third last para says, “Love them or hate them, banks -- especially when unconstrained by the need to keep investments liquid -- offer a highly efficient economic service that the government or the central bank cannot emulate. That service is entirely connected to their ability to lend first and fund later, notably by finding appropriate liabilities to match against assets on a so-called “matched book” basis. This allows them to sidestep the economically costly requirement of having to acquire large sums of liquid cash float on an intraday basis to bridge any exchange.”

Well now, the idea that “government or central bank” cannot lend without first attracting funds to lend is a bit of a joke: unless I’m much mistaken the Fed produced around a trillion dollars from nowhere at the height of the recent recession and loaned it to sundry banks.

I suggest Kaminska’s ideas on full reserve can be dismissed until she gets her act together.

A large deficit is OK if it’s spent on investment?

 

Olivier Blanchard (former chief economist at the IMF) made a submission to the US House of Representatives  Committee on the Budget recently. He claimed, “First, deficits, running at more than 5 percent of GDP, are large. Unless they are used to finance an ambitious and credible public investment plan, they should be decreased.”

Well unless I’m much mistaken, the size of the deficit determins the amount of stimulus an economy gets, regardless of whether the deficit is caused by extra capital or current spending. So if a country goes for an excessively large deficit and tries to justify that on the grounds that the deficit arises from extra capital spending, it will find itself with excess demand and excess inflation. 

And what adds strength to the latter point is that there is actually no sharp dividing line between capital and current spending. To illustrate, does something designed to last one year count as capital or current spending? Or should the dividing line be six months or two years or what?

Of course that is not to suggest that a substantial increase in public investment might not be desirable. But the idea that it can be funded via public borrowing is very questionable. At least, if a big increase in public investment is funded via borrowing, that will push up interest rates which will cut private investment, presumably not the effect that those who back more public investment would want.

In short, the world of macroeconomics is very different to the world of microeconomics. That is, borrowing to invest can make sense for a microeconomic entity, e.g. a firm or household. Unfortunately the same does not apply in the world of macroeconomics: a big increase in public investment has to be funded via extra tax, unless we want the extra public investment to be matched by a cut in private investment.  

JFK was an MMTer..!

Seems according to this document* (Appendix A, Note 1) that Kennedy thought the only limit to the size of the deficit and debt was inflation. To be exact, the conversation between Kennedy and James Tobin went as follows.

Kennedy:  “Is there any economic limit to the deficit? I know of course about the political limits. People say you can’t increase the national debt too fast or too much. We’re always answering that the debt isn’t growing relative to national income. But is there any economic limit on the size of the debt in relation to national income? There isn’t, is there? That’s just a political answer, isn’t it? Well, what is the limit?”

Tobin then says (describing the exchange of views) “I said the only limit is really inflation. He grabbed at that.”

Kennedy then says, “That’s right, isn’t it? The deficit can be any size, the debt can be any size, provided they don’t cause inflation. Everything else is just talk.”

The only criticism I’d make of Kenndy’s summary of the debt and deficit there (and indeed, this is a criticism of MMT as well) is that there is actually another limit to the size of the debt, which is that if the deficit is larger than is needed to bring full employment, with a consequent excessive debt piling up in consequence, government and central bank will be forced to raise interest rates unnecessarily so as to damp down the excess demand that stems from the private sector finding itself in possession of more government debt than it wants, and trying to spend away that excess.

Incidentally, those holding government debt cannot of course spend their debt directly on consumer goods or whatever, but they can wait till their particular tranche of debt reaches maturity and then spend the dollars they get at that point rather than reinvest the dollars in more debt.

And finally, I am indebted to “Matthew B” (a Bloomberg journalist) who dug up  and publicised the above points about Kennedy.

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 *Council of Economic AdvisersOral History Interview –JFK#1,08/1/1964

Silly excuses for letting private banks print money.

I did a series of thirty seven Tweets recently demolishing the numerous excuses given for preserving the existing bank system under which private / commercial banks are allowed to create money. I’ve set out those Tweets below.  

A bank system where private banks are barred from that activity has several names: “full reserve” banking, “100% reserve” banking, “Sovereign Money” etc. I use the first of those, which is abbreviated to “FR” below.  

Each Tweet is in two sections. First, the objection to FR is set out in what might be called the “actual Tweet” along with details of which economists put the relevant excuse, then the answer to the objection was set out in a JPEG attached to the Tweet, which starts with the heading “Answer” (i.e. the answer to the latter excuse).

In some cases below I’ve added a few sentences by way of additional clarification – sentences not in the original Tweets. Those additional sentences are prefixed with the heading “Note”.

Silly objection to full reserve No.1.

FR reduces bank lending.

That objection was made Jan Kregel, Frances Coppola & others. See: section 2.1 here for details:

http://books.ksplibrary.org/978-605-2132-59-3/

Answer.    Given the vast expansion in bank lending (or “financialisation” as Grace Blakeley calls it) over the last 50 years, and the “socially useless” nature of much bank activity (to use Adair Turner’s phrase), less lending, i.e. less debt funded economic activity and more non-debt funded activity is probably beneficial.

More non-debt funded activity is easily arranged simply by cutting down on lending by private banks and making up for that by creating more base money and spending it into the economy. That way, households and firms have more money, and thus do not need to go so far into debt.

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Silly objection to full reserve No.2.

Base money (i.e. government / central bank issued money) is not debt free.

That “debt” objection to FR was put by Charlotte Van Dixhoorn in her work “Full Reserve Banking” (p.21).

Answer.   £10 notes (a form of base money) certainly appear to involve a debt (owed by the Bank of England). £10 notes say the BoE “promises to pay the bearer on demand the sum of £10.” But that promise is a farce: the BoE won’t give you £10 worth of gold (or anything else) in exchange for your £10 notes.

The claim that CB money actually is a debt was also made by Messers Fontana & Sawyer in their Cambridge Journal of Economics paper “Full reserve banking: More ‘Cranks’ than’ Brave Heretics’” (p.19). They claim that since CB money can be used to pay taxes, that money is being used “as if” it were a debt. Well a debt is an irrevocable obligation to pay a sum of money or similar to someone. When CBs issue money, there is absolutely no such obligation. The fact that, as Fontana & Sawyer say, CBs may choose to let their money be used “as if” it were a debt is irrelevant. I can “choose” to use a knife as a screwdriver. That does not mean a knife is a screwdriver.

Conclusion: CB money is not a debt.

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Silly objection to full reserve banking No.3.

Bank capital is expensive.

That claim was made by Douglas Elliot: Brookings article, “Higher Bank Capital Requirements…”.

Answer.    Making depositors who want their money loaned on carry relevant risks means those depositors effectively become share-holders. And clearly they’ll want a bigger reward for doing that than depositors under the existing bank system.

The flaw in that argument is that risks under the existing bank system are carried by the deposit insurance system (not to mention trillion dollar loans at a zero rate of interest given to banks in the recent crisis). And the total reward demanded by depositors and the DI system ought in theory to equal the reward demanded by bank equity holders. Moreover, if investor / savers demand a particularly high reward for carrying risk, how come securitization is so popular?? Securitization pretty much equals full reserve.

Note.    Elliot in his article was actually criticising increased bank capital in general, not specifically FR, which of course involves a big increase in bank capital. But I’ve included Elliot’s article here because his points could be used as a criticism of FR.

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Silly objection to full reserve No.4.

FR means the end of banks as we know them.

That objection was put by Frances Coppola in her article, “Martin Wolf proposes the end of banking”, published by Pieria.

Answer.     The fact of ending X, Y or Z “as we currently know them” is not an argument against that “ending”.

Ceasing to send young boys up chimneys to clean them meant the “end of chimney sweeping as we knew it” many years ago. I suggest the effect of that “cessation” or “ending” was beneficial.

Incidentally, I have plenty or respect for Frances Coppola, but she did rather go off the rails in connection with the above “as we know” point.

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Silly objection to full reserve No.5.

Under FR, central banks will still need to lend to commercial / private banks.

That objection was made by Charlotte Van Dixhoorn in “Full Reserve Banking” (p.34).

Answer.     That objection assumes there’s some God given rate of interest which cannot be allowed to vary. To clarify…..

Under FR, interest rates may rise a bit because a bank subsidy is removed. Now assuming the rate of interest that prevails under that subsidised system can be shown to be the optimum or GDP maximising rate, then clearly central banks ought to help private banks by lending to the latter, possibly at a sweetheart rate of interest. But it’s widely accepted that subsidies (of banks or anything else) are not justified, unless the subsidy confers a clear social benefit!! Ergo, unless that benefit is demonstrated, the optimum or GDP maximising rate of interest is the one that prevails under FR, not under the existing bank system. Incidentally, in view of the dodgy environmental effects of GDP increases, I ought to say “output per hour increases” instead, in the hope that people use the additional output to work fewer hours. But I’ll stick with “GDP” in this series even though that’s not quite what I mean.

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Silly objection to full reserve No.6.

A cut in money produced by private banks would mean less money for investment.

That objection was put by Ann Pettifor in “Why I disagree with Positive Money and Martin Wolf”, and Jan Kregel in “Minsky and the narrow banking proposal”.

Answer.     First, there are numerous other sources of funds for investment: equity, bonds, retained earnings, etc. Second, that objection is essentially the same as objection No.5 (the claim that interest rates would rise under FR), and the answer is the same. I.e. while less would be loaned and invested under FR, the important question is: what’s the optimum level of interest rates and investment? The answer is the same as given in answer to “No.5”: i.e. the optimum is not the level that prevails under a subsidised bank system.

Incidentally Kregel (as of 2019) has changed his mind and is now advocating something he admits is very near to FR! See his final section (VI) in Levy Economics Institute working paper 928.

Note.   That’s about the thousandth time I’ve come across an economist who apparently finds the concept “optimum” difficult to grasp.

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Silly objection to full reserve No.7.

Investments under FR might not be viable.

That extremely silly objection to FR was made by Jan Kregel in “Minsky and the narrow banking proposal” (Levy Economics Institute policy brief No 125).

Answer.     The advocates of FR do not claim that under FR the competence of investors (presumably via some sort of magic) suddenly improves!! I.e. incompetent investments would be made under FR just as they are at the moment.

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Silly objection to full reserve No.8.

FR would not reduce pleas by failing industries to be rescued by government.

That daft objection to FR was made by Jan Kregel in his work “Minsky and the narrow banking proposal.”

Answer.   No one ever said such “pleas” would decline under FR!!

I.e. makes no difference what bank system (or other system) you have, one thing is certain: treasuries around the world will always be faced with a queue of apparently worthy supplicants asking for piles of lovely free taxpayers’ money.

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Silly objection to full reserve No.9.

The cost of converting to FR would be high.

That objection to FR was made by Jeremy Warner in “Bankers have done a good job of creating money” (Daily Telegraph) and by Charlotte Van Dixhoorn in “Full Reserve Banking” (p.21).

Answer.    First, US Money Market Mutual Funds have converted to full reserve. I haven’t heard stories about any horrendous costs there.

Second, assuming FR brings benefits, those benefits will continue till the end of time or similar. So even if the upfront costs are high, in the long run they will be worth it.

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Silly objection to full reserve No.10.

Under FR, central banks won’t be politically neutral.

That objection was put by Ann Pettifor in “Why I disagree with Martin Wolf and Positive Money”.

Answer.    As Positive Money has been explaining for ten years, if the size of deficits is determined by central banks under FR, that does not mean CBs need to take strictly political decisions, like what % of GDP is allocated to public spending. Unfortunately that point seems to be too difficult for Ann Pettifor. Incidentally, Ben Bernanke recently gave his blessing to that PM type system, i.e. where CBs decide the size of the deficit, while politicians continue to take strictly political decisions. See para starting “A possible arrangement…” in “Here’s How Ben Bernanke’s “Helicopter Money” Plan Might Work” published by Fortune.

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 Silly objection to full reserve No.11.

The administration costs of FR would be high.

That objection was made by Paul Krugman in his article “Is a banking ban the answer?” (see passage starting “Cochrane’s proposals call for….”).

Answer.    First, I haven’t heard anything about excessive admin costs in the case of US money market mutual funds, which have switched to FR. Second one of the main alternative ways of organising banks, the Dodd-Frank regulations, runs to a good 10,000 pages, while in contrast, the basic rules of FR can be written on the back of an envelope! Thus the idea that the admin costs of FR would be high relative to the existing system is pure lunacy.

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Silly objection to full reserve No.12.

The cost of current / checking accounts would rise under FR.

That objection was put by Charlotte Van Dixhoorn in her “Full Reserve Banking” (p.22).

Answer.    True: they would. But that’s only because under the existing bank system, current accounts are cross subsidised. That is, currently banks are allowed to 1, accept deposits, 2, tell depositors their money is totally safe while lending on that money, which is blatant fraud: reason is that loaned out money is never totally safe, unless backed by a sugar daddy with an infinitely deep pocket, i.e. the taxpayer. But that’s just another form of subsidy. Incidentally, the idea that banks create money rather than lend on deposits is only partially true: if banks don’t need depositors’ money before lending, why have banks dished out billions to depositors by way of interest over the years?

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Silly objection to full reserve No.13.

FR is dependent on demand injections.

That objection was put by Jan Kregel in “Minsky and the narrow banking proposal”. Search for the phrase “chronically dependent on demand injections.”

Answer.    As you should have gathered by now if you’ve been reading this series of Tweets on FR, Jan Kregel, who put the above objection is clueless. Anyway, if FR is dependent on demand injections, one wonders how Kregel would describe the trillion dollar loans at a zero rate of interest made by the Fed to private banks under the existing bank system.!! And then there was the record amount of fiscal and monetary stimulus that had to be implemented in the wake of the 2008 bank crisis.

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Silly objection to full reserve No.14.

The effect of FR on inflation and unemployment is unclear.

That objection to FR was put by Charlotte Van Dixhoorn in her work “Full Reserve Banking”. Look for the phrase “It would be difficult to predict…”.

Answer.    So the effect of the existing bank system on inflation and unemployment is totally clear?? Absolutely hilarious.

Economists failed to predict the 2008 bank crisis, which led to a very sharp rise in unemployment. Plus once the recession hit, a significant proportion of them had no idea what to do about it, despite Keynes having explained what to do almost a century earlier.

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Silly objection to full reserve No.15.

FR would drive business to the unregulated sector.

That objection to FR was made by Paul Krugman in “Is a banking ban the answer?” – passage starting “If we impose 100% reserve…” – and by the Vickers commission final report, section 4.36.

Answer.     First, all forms of regulation (of banks or anything else) tend to drive business to “unregulated sectors”. Second, given the vast expansion of shadow banks over the last 20 years, it looks like banksters are already evading regulations big time!! Third, the basic rule which underpins FR is extremely simple, plus something very close to that rule is already in force in the case of unit trusts / mutual funds (at least in the UK) and I haven’t heard anything about miscreant unit trusts evading that rule. The rule is that those receiving deposits which are less than totally safe must make it very clear that such money is not safe. Ergo that rule is easy to enforce in an effective manner, even in the case of relatively small “unregulated” shadow banks.

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Silly objection to full reserve banking No.16

The state cannot be trusted with peoples’ money.

That objection to FR was made by Charlotte Van Dixhoorn in her “Full Reserve Banking”, section VIII, p.32.

Answer.   Clearly there are some regimes, e.g. Robert Mugabe’s, where people are wary, and rightly so, of entrusting government with their money. But there’s always the option of using something else as money (US dollars were popular in Zimbabwe).

But at the opposite extreme, when was the last time the government of the UK (where I live) reneged on its debts? Frankly I haven’t the faintest idea: it was probably a good two hundred years ago. Same goes no doubt for several other Western countries.

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Silly objection to full reserve banking No.17.

Vested interests would oppose full reserve.

That objection to full reserve was put by The Economist: article entitled “Narrow Minded” (2014).

Answer.   “Vested interests” opposed the abolition of slavery! Presumably The Economist would have opposed the abolition of slavery!! Hilarious, innit?

Ironically, Milton Friedman used the phrase “vested interests” when he explained why there’s been no switch from the existing system to FR. As he said,  "The vested political interests opposing it (i.e. the switch) are too strong…” (That’s in his book, “A Program for Monetary Stability” Ch3.)

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Silly objection to full reserve banking No.18.

FR would reduce innovation by banks.

That objection was made by John Aziz his article “Prohibition didn’t work for liquor….” Published by The Week.

Answer.    It’s very hard to see why innovation would decline, given that there is competition between banks under FR just as there is at present. Certainly Aziz does not explain exactly why innovation might decline.  

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Silly objection to full reserve No.19.

Deposit insurance and lender of last resort solve all problems created by the existing bank system.

That objection was put by John Aziz in “Prohibition didn’t work for liquor….” published by The Week.

Answer.    First, deposit insurance (DI) creates a big problem which is (as the Nobel economist James Tobin explained at length) that it encourages irresponsibility. (See Tobin’s work “The Case for Preserving Regulatory Distinctions”). Second, DI equals preferential treatment for money lenders (aka banks) in that banks’ liabilities are insured, but not those of non-bank corporations. Third, the insurer (i.e. government) has artificially large powers (i.e. it can grab money by force off taxpayers) to meet any and all its needs.

As for lender of last resort, well it’s true that the Fed loaned just over a trillion at a near zero rate of interest to banks in the recent crisis, but that’s a large subsidy of banks!!

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Silly objection to full reserve banking No.20.

Lenders will try to turn their unsafe liabilities into “near monies”.

Charlotte Van Dixhoorn made that objection to FR in “Full Reserve Banking”, p.33.

Answer.    Under FR, the only thing that counts as money is central bank issued money: anything else which purports to be money or is used as money must be advertised as not being entirely safe. It is thus hard to see why many households or small/medium sized firms would want to use “unsafe money”. But clearly there is a finite demand for unsafe money, e.g. Bitcoins which regularly lose a significant % of their value.

But the latter concession to unsafe money does not stop FR achieving its main objectives, namely reducing the possibility of bank failures to near zero (in the case of normal / high street banks used by about 99% of households and small / medium size firms), and secondly removing a bank subsidy.

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Silly objection to full reserve banking No.21.

Anyone can create money, thus trying to limit money creation is futile.

Charlotte Van Dixhoorn made that objection to FR in her work “Full Reserve Banking”, p.34.

Answer.     Clearly anyone can write out an IOU on the back of an envelope and try to use it as money. But with individuals and small/medium size firms their chance of success is negligible. As for relatively large organisations, they stand a better chance, but under FR, any bits of paper or other units purporting to be worth $X, unless they are backed by money at the central bank, must advertise the fact that such “home made” money is not entirely safe. Plus it’s easy for the authorities to keep an eye on what large organisations are doing, and hand out fines to those breaking the rules. That very simple rule disposes of the main cause of bank failures and disposes of one form of bank subsidy. Thus the rule achieves a lot. The fact that a small number of people break the rules is not a flaw in such rules: people ignore speed limits on roads. That’s not an argument against speed limits.

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Silly objection to full reserve No.22.

Advocates of FR are concerned just with retail banking.

Paul Krugman made that objection to FR in his article “Is a banking ban the answer?”

Answer.    Even if they are, then FR would confer big benefits in that banks which are wholly or partly retail and which went bust in the recent crisis (e.g. Northern Rock and RBS), and which cost the taxpayer a fortune to rescue would not have failed.

Note.   Also firms and corporations which deal with non-retail banks, e.g. investment banks, will be astute enough to know what they are doing about 95% of the time. If the latter firms are taken for a ride by some bank, why should taxpayers come to the rescue?

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Silly objection to full reserve No.23.

Government & central bank (CB) will not be better than the market at regulating the amount of money.

See J.Warner - “Bankers have made a good job of creating money” and Frances Coppola - “Full Reserve Banking: the Biggest Bank Bailout...”

Answer.   The glaringly obvious flaw in that objection is that even under the existing bank system, governments and central banks (CBs) play a large role in determining the size of the money supply. E.g. CBs cut interest rates periodically, and that’s done inter alia by the CB creating money and buying government debt, which increases the money supply. Plus the interest rate cut induces private banks to create and lend out more money. Plus QE (implemented by CBs) has given us an astronomic increase in the money supply!!!

Moreover, one of the main purposes of that govt money creation is to counteract  the obviously irresponsible money creation of private banks, e.g. creating and lending out money like there’s no tomorrow during a house price bubble.

“Good job of creating money”? I think not.

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Silly objection to full reserve No.24.

It wasn’t just banks that failed in 2008: also households became over indebted.

Paul Krugman made that objection to FR in his article entitled “Is a banking ban the answer?”

Answer.   Er – who were households indebted to??? Think very hard for two seconds . . . it was B-A-N-K-S!! Or are we to believe that when irresponsible loans are made, that’s entirely the fault of borrowers and not lenders?? The above objection is just a joke. Moreover, the reaction of the authorities in numerous countries to the 2008 has been to adjust bank regulations rather than implement a large program of “borrowing lessons” for those seeking mortgages and other loans, thus it seems those authorities are agreed that the fault lies mainly with banks.

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Silly objection to full reserve banking No.25.

FR cuts down on the amount of money / liquidity creation.

Douglas Diamond made that objection to FR in “Banking Theory, Deposit Insurance and Bank Regulation”, Journal of Business

Answer.   Any fall in the amount of money created as a result of FR is easily made good by expanding the amount of money created by central banks (CBs)!! Plus it costs nothing to have CBs create money, whereas money creation by private banks involves significant real costs (e.g. checking up on the credit worthiness of borrowers, checking on the value of collateral deposited, etc etc). As a result, private banks charge for creating money, while there is no charge to money users in the case of CB money. What’s not to like?

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Silly objection to full reserve No.26.

Funding via commercial paper would be more difficult under FR.

Douglas Diamond made that objection in “Banking Theory, Deposit Insurance and Bank Regulation”, Journal of Business.

Answer.   Probably true, but that’s just part of the overall effect of switching to FR, namely that total debts decline, while the supply of “debt free” money (i.e. central bank created money) rises. Incidentally, as you’ve probably noticed, the people who witter on about excessive debts are often the same people who object to FR, which (to repeat) tends to cut total debts!!

Indeed, Vince Cable, former UK Secretary of State for Business, Innovation and Skills, often complains about high levels of debt, while in the next breath, complaining about tighter regulation of the debt creators, i.e. banks!!!

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Silly objection to full reserve banking No.27.

FR equals monetarism.

Ann Pettifor made that objection in “Why I disagree with Martin Wolf and Positive Money” and Messers Sawyer & Fontana in “Full Reserve Banking: More ‘Cranks’ Than ‘Brave Heretics’” (Cambridge Journal of Economics.)

Answer.   First, the existing system has similarities to monetarism: e.g. stimulus is imparted under the existing system by cutting interest rates and QE, both of which increase the money supply! Second, money financed deficits (supported by Positive Money & many MMTers) works not just because the money supply increases, but also via what might be called the “fiscal effect”. I.e. if base money is created and spent on education, the immediate / fiscal effect is more jobs for teachers, while the “money supply increase” effect comes more slowly.* Third, are we really supposed to think the quantity of money has no effect at all? Doubtless Friedman over-did reliance on simply adjusting the money supply, but the opposite claim, namely that the quantity of money has no effect at all is equally silly.

* Note. Thus the alleged “monetarist” element both in FR and in the existing system is not in fact purely monetarist: i.e., and to repeat, a significant proportion of the allegedly monetarist effect is in fact fiscal. Indeed, that point even applies to Milton Friedman’s version of monetarism!

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Silly objection to full reserve banking No.28.

There’d be no demand for safe / warehouse accounts or banks.

Lawrence White made that objection in “Accounting for Fractional-Reserve Banknotes and Deposits…” publisher: Independent Review.

Answer.   This objection is a joke in that there is a flatly contradictory objection often raised to FR namely that there’d be a stampede to safe accounts (see No.29 in this series).

Anyway, in that there hasn’t been much demand for safe / low interest yielding accounts in the past, that is for the simple reason that there have for a long time been subsidised accounts where risks are carried by taxpayers. Why put your money into a zero interest yielding account when you can put it into one that does yield interest, with the risks involved in having your money loaned out being backed by taxpayers?? There’s no point!! FR abolishes that “taxpayer” subsidy and that would clearly raise the demand for safe / warehouse accounts.

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Silly objection to full reserve banking No.29.

There’d be a stampede to safe accounts.

Kevin Dowd made that objection in “Let’s not ban private money.” Publisher: Free Banking.

Answer.   First, to repeat the point made under objection No.28, Dowd’s objection flatly contradicts the popular objection to FR, namely that there’d be no demand for safe accounts.

Second, if there is a stampede, so what? That is simply part of the process of removing a subsidy, and there’s nothing wrong with removing subsidies unless there’s a good social reason for a subsidy. If taxpayers guaranteed roulette players against loss and that guarantee / subsidy was removed, doubtless there be a “stampede” away from roulette tables and towards other forms of entertainment. What of it?

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Silly objection to full reserve No.30.

FR will not stop boom and bust.

Adair Turner made that objection in “What do Banks Do” in “The Future of Finance” (LSE). See passage starting “..investors would be”.

Answer.    FR advocates never claimed FR would eliminate boom and bust. But they do claim it puts an end to bank failures, which at least helps a bit. Moreover, the “help” could be significant in that as Mervy King said, the pernicious effects of a rash of bank failures, even when banks are rescued by taxpayers, seem to be worse than simple stock market set-backs. See King’s “Banking: From Bagehot to Basel, and Back Again”, 3^rd para.

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Silly objection to full reserve No.31.

Bank shareholders will demand a high return to reflect their uncertainty about what a bank actually does.

Douglas Elliot made that objection in “Higher Bank Capital Requirements Would Come at a Price.” (Brookings).

Answer.   First, are shareholders any more in the dark as to what banks do than non-bank corporations?

Second, there would actually be far more clarity as to what is being done with investors’ / savers’ money under FR than under the existing system. Reason is that under most versions of FR, investors have a choice as to what is done with their money: they might for example be able to put their money into a fund that grants risky 100% mortgages. Alternatively, they might be able to go for a fund that grants mortgages only to those with some minimum equity stake in their house (though under most versions of FR, the exact nature of different funds is left to individual banks to decide.

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Silly objection to full reserve No.32.

Government couldn’t produce enough money under FR.

Randall Wray made that objection in “Modern Monetary Theory: the Basics”. Publisher: Naked Capitalism. See passage starting, “While our governments are large…”.

Answer.   It’s strange that Wray, a leading light of MMT, was unaware that the central bank of a country that issues its own currency can simply press buttons on a keyboard and produce however many billions of dollars it wants. Certainly the Fed produced over a trillion dollars at the drop of a hat by pressing buttons on a keyboard to lend to banks during the recent recession. If the Fed had wanted to press different buttons and produce two or three trillion, it could have. Hopefully Wray has now caught up with the latter point.

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Silly objection to full reserve banking No.33.

FR would raise unemployment.

That objection was made by Ann Pettifor in “Why I disagree with Positive Money and Martin Wolf.”

Answer. FR certainly cuts down on debt based economic activity, i.e. activity based on loans from banks, but it’s easy to compensate for that by having the state create and spend money into the economy, which raises the amount of “non-debt-based” economic activity. I.e. under FR someone buying a house would have more money with which to buy it, and would thus need to borrow less.

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Silly objection to full reserve banking No.34.

FR advocates ignore “established theoretical literatures”.

That objection was made by Messers Sawyer & Fontana (S&F) in their paper “Full Reserve Banking: More ‘Cranks’ Than ‘Brave Heretics’” (Cambridge Journal of Economics.)

Answer.    Well now, a book advocating full reserve by B.Dyson and A.Jackson (D&J) and entitled “Modernising Money”, which is the main target of S&F’s criticisms contains 160 items in its references section, whereas S&F’s own paper contains less than half that number.  Moreover, S&F are apparently unaware of the collection of Noble economists who have advocated full reserve: certainly those Nobels are not mentioned by S&F.  I conclude that if anyone has ignored “established theoretical literatures” it’s S&F rather than D&J. The words “pot”, “kettle” and “black” spring to mind. For details on numerous other errors made by S&F, see my work, “Malcolm Sawyer Claims Advocates of Full Reserve Banking are “Cranks”, (Advances in Social Sciences Research Journal).

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Silly objection to full reserve banking No.35.

The economy shouldn’t be controlled by a committee of economists.

See Ann Pettifor’s article: “Why I disagree with Positive Money and Martin Wolf.”

Answer.     See the sub-heading of her article and her paras starting “This debate exposes…” and “Wolf’s proposal…”.  And the answer to that objection is that the economy ALREADY IS controlled by committees, shock horror! E.g. in the UK there’s the Bank of England Monetary Policy Committee and the Office for Budget Responsibility. Moreover (further shock horror), those committees ALREADY exercise their control to a large extent by adjusting the money supply: e.g. QE raises the money supply, plus an interest rate cut induces commercial banks to create and lend out more money. Thus if Pettifor objects to committees which control stimulus or  influence or control the money supply, she’s up against much more than the advocates of FR.

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Silly objection to full reserve banking No.36.

FR would prevent all lending.

That objection was made by H. De Anglo & R. Stulz in “Liquid-Claim Production, Risk Management, and Bank Capital Structure”, and B. Bossone: “Should Banks be Narrowed.”

Answer.   De Angelo and Stulz clearly don’t have the faintest idea as to what FR actually consists of. Under FR, banks can perfectly well lend: it’s just that depositors who want their money to be loaned out have to carry relevant risks, rather than being protected from risk by a sugar daddy who can lay his hands on near infinitely large amounts of money, i.e. taxpayers’ money, in the event of trouble.

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Silly objection to full reserve banking No.37.

FR equals a huge bank bailout.

Frances Coppola (FC) made that objection in her article “Full Reserve Banking: The Largest Bank Bailout in History.”

Answer.     First, to accuse FR of involving a bailout is rich given the billions of public money used recently to bail out banks under the EXISTING bank system.

Second, FC’s bailout theory is based on the point that to implement FR, a huge amount of base money has to be credited to private banks’ accounts in the books of the central bank, which is a large gift to private banks. Well Positive Money (PM), one of the main butts of FC’s criticisms, actually spotted that problem (big surprise): in the PM “bible”, i.e. Dyson & Jackson’s book Modernising Money (“Step 3”, Ch8, p.228) the authors explain that to match the latter “gift”, an equal amount of money (obtained from repayment of loans made by banks) is eventually paid by private banks to the central bank. Ergo FC’s alleged gift is a myth. Incidentally, since Modernising Money is currently out of print, I’ve reproduced the relevant passage from MM here – article title: “Positive Money’s “Conversion Liability”.