Monday, 18 July 2011

Summary of the Werner / Positive Money / New Economics Foundation paper.

This paper was submitted to the UK’s Independent Banking Commission. Here is my ultra brief summary. Hope it’s a fair summary.

1. Fractional reserve banking promotes instability. A major reason is that during an economic upturn, fractional reserve enables commercial banks to create money out of thin air and lend it to nit wits who see asset prices rising and want to invest in those assets. That raises asset prices still further, creating more collateral to be used for yet further borrowing.

Conversely, during a downturn, everyone deleverages, that is pays money back to banks, which involves the extinguishing of money: just what is not needed in a downturn. Thus fractional reserve should be banned.

2. Another fundamental flaw in the existing banking system is that money from bank accounts which are 100% safe and taxpayer backed is used for commercial purposes. This amounts to a subsidy for commerce, which is wrong. Hence those depositing money in banks must be presented with a clear choice, as follows. 1. put money into 100% safe accounts where the money will be lodged in a 100% safe fashion – i.e. at the central bank, where it will earn little or no interest. Or 2, put money into a “commercial” or “investment” account, which will probably earn some interest, but there is no taxpayer backing if it all goes wrong.

3. Re the systemic risks that derive from the latter commercial or investment accounts, these can be minimised by banning maturity transformation.

4. Banning fractional reserve and maturity transformation involves leaving more money idle in bank accounts. The idea that this equals failure to use real stored wealth is nonsense, because in a fiat money system, money is simply a book keeping entry.

5. The idea that the above, or any form of restriction on bank activity will harm economic growth is nonsense in that the government / central bank machine can perfectly well make up for such restrictions by creating new central bank money (monetary base) and spending it into the economy. (The latter policy incidentally is also advocated by most followers of Modern Monetary Theory).

Indeed, the latter "create money and spend it into the economy" is a better way of regulating aggregate demand than interest rate adjustments. Thus creating (or extinguishing) money should be the prime method of regulating demand, with interest rates being left to find their own value.


Stop press. The Fed’s Edward Nelson mentions Modern Monetary Theory.



  1. Great post Ralph! I would love to see MMT folks address each one of these points to help me solidify my understanding. Great opportunity to respond by outline MMT's view of the role, function, and problems of the banking sector versus the mainstream. Anyway you want to lead up that effort? it would be very helpful to many of us laymen.

  2. I looked into the paper, but couldn't find a concrete mechanism how to exstinguish money.

  3. Craig, Strangely enough, the points I made above don’t have anything much to do with MMT (except where I mentioned a connection in “5” above). Bill Mitchell actually made a similar point a few months ago in that he said that MMT is indifferent as between fractional and full reserve banking.

    libertaer3000, I think you are right: there is nothing in the Werner paper about extinguishing money. But when dealing with the “print and spend” idea I always like to mention that when inflation looms it is appropriate for the government / central bank machine to rein in money and extinguish it. The reason I do this is that there are a large number of folk out there who start chanting “Mugabwe, Weimar” a soon as they hear the phrase “print money”. To keep this lot happy, I like to mention money extinguishing. Warren Mosler and Bill Mitchell, two of the leading lights of MMT have made this point a hundred times, namely that under the above policy, governments will NORMALLY run deficits, but occasionally it will be appropriate to run a surplus: i.e. rein in money.

    Re the actual mechanism for extinguishing money, both central banks and commercial banks do this all the time. Commercial bank created money is simply a debt, which passes from hand to hand. When the debt is repaid (e.g. repayments of the capital sum in the case of a mortgage) the money is by definition extinguished.

    As to central banks, the receipt of £X by a central bank does not make the bank “better off” because it can produce any amount of money any time it wants. So effectively, the £X disappears when paid to the central bank. As I understand it, central banks don’t even keep a record of their total receipts.

  4. My point is: today central banks exstinguish money by selling government debt to their primary dealers, which shrinks their balance sheet. If you change to a regime, where you don't buy or sell anything, only crediting accounts without getting something in exchange, then how do you contract the money supply?
    I think, you need to give the new central bank some taxing rights.

  5. Libertaer, Yes, giving central banks taxing powers is one option, but I don’t like that option because it gets the central bank involved in politics. I prefer the arrangement I set out here:

    This involves making politicians work on the assumption that the budget must balance, and leaving it to the central bank (or any committee of independent ecnomists) to work out what size deficit is permissible given the threat posed by inflation,etc. The central bank would then issue the relevant money to politicians (or demand that they run a surplus, and collect money and hand it to the central bank). In the latter case, the money is extinguished.

    The central bank could “put the money into an account” if it liked, but “central bank money in the hands of a central bank” is a meaningless concept because a central bank can create as much of the stuff anytime.

  6. "(or demand that they run a surplus, and collect money and hand it to the central bank)"

    Okay, but this is fiscal policy in the hands of the central bank. If the cb or some other committee could demand a surplus, then the government has to spend less and/or to tax more.

    I like the idea, but it would give the cb "taxing rights" in the sense of being able to take tax money from the government. It's not a political tax, cause the money gets exstinguished. You could call it monetary policy by fiscal means.

  7. Libertaer,

    I’m not too bothered about the exact distinction between fiscal and monetary. In fact in an earlier post I suggested the distinction was a bit of a nonsense:

    What I’m really after is separating political decisions (e.g. what proportion of GDP should be allocated to the public sector, a question which is rightly in the political arena) from those economic decisions which have no obvious political implications and which are best left to economists. I suggested a way of doing this separation in another post:


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