The logical connection between overt money creation and full reserve banking.

The phrase “overt money creation” (OMC) is often taken to mean a system where government and central bank implement stimulus by running a deficit by simply creating base money and spending it  (and/or cutting taxes with public spending remaining approximately constant). And that is the meaning attached to the phrase here. Effectively that means merging fiscal and monetary policy: i.e. there is clearly a fiscal effect there, for example if the additional money is spent on more education, there is an immediate effect in the form of more teachers being employed. Plus there is a monetary effect (a somewhat delayed effect) in that the additional money increases the private sector’s stock of base money.

OMC is advocated by a variety of economists and groups of economists. For example it is advocated by Modern Monetary Theory and these authors, plus Ben Bernanke and Adair Turner gave the idea an approving nod. (For Bernanke, see para starting “A possible arrangement…” here, and for Turner, see his article entitled “Adair Turner in defence of helicopter money”).

Merging fiscal and monetary policy has some logic, in that the purpose of both is to adjust stimulus, and normally (both in economics and other areas) there is one best method of achieving any given objective, rather than two, three or more. I.e. having two, three or more smells of duplication of effort.

As for increasing the private sector’s stock of base money, that also has some logic, as follows. Inflation is constantly eroding the real value of the existing stock of base money, plus economic growth is constantly eroding the value of that stock relative to real GDP. Plus it is reasonable to assume that the stock of base money that the private sector wants to hold relative to GDP will remain approximately constant in the long term. Ergo that stock will, over the long term, have to be steadily increased in both nominal and real terms.

Incidentally I’m treating base money and government debt as the same thing, which is arguably what they are. That is, both of them are liabilities of the state (government and/or central bank). Certainly base money and government debt merge into each other in that base money is a liability (or at least an ostensible liability) of the central bank which pays no interest, whereas a tranche of government debt which matures in say one week’s time, and which pays a very low rate of interest amounts to all intents and purposes as the same thing as pointed out by Martin Wolf. (See Wolf’s para starting “The purchases of equities…” in his article entitled “Warnings from Japan for the eurozone.”)

That is why advocates of Modern Monetary Theory sometimes treat base money and government debt as being the same thing and refer to the sum of the two as “Private Sector Net Financial Assets”.

To summarise so far, OMC has a certain logic behind it, and it effectively amounts to saying that given a need for stimulus, that stimulus should come in the form of increasing the private sector’s stock of base money.


Full reserve banking.

Full reserve banking is the idea that the only form of money should be state created money (i.e. base money): that is, that commercial banks should not be allowed to print / create money as well.

Now that meshes rather nicely with OMC, doesn’t it? OMC says that stimulus should come in the form of the state creating and spending more state created money (rather than cut interest rates and thus enabling commercial banks to create and lend out more of their own home made money).

Just to expand on that “mesh” a bit, take a hypothetical economy which switches from barter to using money for the first time (or if you like, a hypothetical Eurozone country which quits the Eurozone and reinstates its pre-EZ currency (say the Drachma in Greece)). The advocates of full reserve would recommend issuing just state issued money and OMCers would advocate the same. It would of course be possible to do what the existing bank system in most countries involves, namely have the state stand behind those “promises to pay” which are issued by commercial banks and which constitute money. But if the state does that, it is subsidising the money lending activities of commercial banks. And subsidies do not make sense, unless there is a very good social case for a subsidy.

That above claim that there is a connection between OMC and full reserve banking certainly needs fleshing out, but the above is my first stab at the idea.