Monday, 11 July 2011

Modern Monetary Theory meshes nicely with full reserve banking.

Modern Monetary Theory (MMT) consists of several different elements, but for present purposes I’ll take it mean what Abba Lerner (p.39-40) advocated, namely that in a recession, government should simply print extra money and spend it (and/or reduce taxes). And conversely, when inflation looms, government should do the opposite, namely rein in money and “unprint” or extinguish it.

Anyway, it’s nice to see support for the above policy appearing in a paper which advocates full-reserve banking and written by a group (Werner & Co) who do not claim to be MMTers.

As Werner & Co say (p.10), “Under full-reserve banking . . .the Bank of England would control the quantity of money in circulation by increasing or decreasing the money supply which would be allocated through government spending.”

It would be going too far to say that the MMT “print and spend” policy is possible ONLY under full-reserve. But certainly the print and spend policy comes into its own under full-reserve.

This is because under fractional reserve, private banks are more or less in control of the money creation process. Or as Steve Keen put it, “…the credit money dog wags the fiat money tail. Both the actual level of money in the system, and the component of it that is created by the government, are controlled by the commercial system itself, and not by the Federal Reserve.”

In this scenario, the MMT print and spend policy certainly has a finite effect, but it is not dominant.

Also, who decides whether stimulus or deflation should be imposed?

A second reason why full-reserve reasoning meshes with MMT reasoning is thus.

As I pointed out here, the above MMT print and spend policy implies discarding the distinction between monetary and fiscal policy, which in turn raises the question as to who decides whether inflation is sufficiently subdued to warrant extra demand. I suggested that this question was a TECHNICAL one: beyond the competence of politicians, and best left to central banks (or any independent committee of economists).

Of course it is commonly thought that central banks currently DO take the latter decision. But this is not strictly correct in that politicians can also influence aggregate demand by determining the size of the deficit (which has a stimulatory effect). That is, politicians determine matters fiscal.

To have two different bodies both influencing demand is a mess, and this mess is particularly serious in the US right now: members of Congress, precious few of whom have got beyond page one of a basic economics text book are squabbling with each other and with the Fed and the president over deficits, stimulus and so on.

MMT and full-reserve: the two similarities.

So both MMT reasoning and full-reserve reasoning point to the same two conclusions. First, the decision on the stimulus/deflation question is taken by ONE body (the central bank or some other independent committee of economists). And second, if stimulus is deemed to be required, that stimulus should take the form of “print and spend”.

Or as Werner puts it, under the heading "Distributing Newly Created Money", "Rather than lending this money into the economy via the banks.. . .we recommend that the money is spent into circulation via the state.”


  1. But when you let the bankers out of the bottle, how do you stuff them back in? Forget about coaxing them. It's a political problem that looks pretty intractable right now with the financial sector and neoliberal ideology have captured the apparatus of the state both intellectually and politically.

    Then there is also the question as to how much power the state should have in the first place. Giving it virtually complete control of the money supply puts a lot of control in the hands of politicians, which some people are rightly concerned with in the era of the corporate national security state. This has some ugly antecedents that need to be considered, too.

    1. Look at the positivemoney solution. The main idea is that you should separate the power to create from the power to spend. So something like the central bank will decide how much money should be created and then the government will spend that money.

  2. Tom, Good questions. Re how do you stuff bankers back in the bottle, my answer is thus. Running a full reserve system requires a set of rules, as does the present system (Basle III, etc). Werner & Co set out their ideas as to what the rules should be for a full reserve system, but admit that they probably haven’t got it 100% right. Anyway, whatever the rules are, it shouldn’t be too difficult to require banks to get say half way to adopting the new rules in say two years, and adopting the full 100% reserve rules in say 4 years. Likewise banks do not have to adopt the Basle III requirements on capital for several years, though some countries are enforcing them much quicker.

    The Werner paper doesn’t delve into this point, so I might do a post on this in the near future.

    Re the problem being political and intractable, I think that is more true of the US than Europe. If economists and politicians in Europe understood banks and agreed on how they should be run, banks would have to obey.

    Re giving the state control of the money supply, the alternative is putting the control or some of it into the hands of banks, and look at the results: the credit crunch. Plus banks are a bunch of crooks. So I think giving the state a big say in determining aggregate demand and the money supply is the lesser of two evils.

  3. I don't disagree, Ralph, just playing the devil's advocate. The bankers pretty much have the government in their pocket in the US, and if the government was the money creator, so problem for them, since they control it.

  4. How about keeping the central bank, but giving each citizen a deposit accout at the CB?
    This account would be the only one secured by the state, a full reserve account paying no interest.
    The money supply would be controlled by "printing money" aka crediting these accounts until there is sufficient AD and "buying" from each citizen "taxing rights", which can be used to fight inflation if necessary by selling these "taxing rights" to the treasury.

  5. By doing this, neither the banks nor the state would be in charge. Controlling the money supply would become an intimate affair between you and your CB.

  6. Libertaer, Great minds think alike. Your suggestion is very much what the Werner paper suggests, except that Werner & Co effectively say that commercial banks should act as agents for the Bank of England. And the latter “agent” idea makes sense because the BoE would not want to open accounts for every adult UK citizen. Mervyn King would go apoplectic at the idea. Plus commercial banks already have branches in every High Street ready to do the job.


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