Monday, 26 February 2018

Extending Warren Mosler’s business card economy.

WM set out a beautiful model of the real economy a few years ago which consisted simply of a family: that is parents and children, with money taking the form of business cards, issued by the parents. Unfortunately I can’t find WM’s original exposition of this analogy / model, but if you Google something like “Warren Mosler, business card, parent, children”, you’ll find several people explaining the basic ideas in the model.

I’ll set out this basic “family economy” first, and then extend the family / economy to incorporate commercial banks and money issued by those banks. Note: I’m setting out the WM business card economy from memory, so I may have some details wrong. That is, if you want the original exposition, you’ll have to find it yourself. Also, the latter “extension” is my own: I’m not suggesting WM would agree with it.

First, this “family model” is realistic in that every family is a mini economy: that is each parent produces various goods and services which are supplied to other members of the family (e.g. the wife does the cooking) and children over the age of about eight normally also have to perform tasks.

In the hypothetical WM family economy, the parents decide one day to issue a form of money, in the form of business cards. There is no good reason, as WM correctly explains, why those cards should have any value, until a day or two later, the parents decide to impose a tax on the children, which must be paid using the cards, else the children are punished.

That’s a very realistic model of the way in which money has been introduced to several civilizations over the last few thousand years. That is, the historical fact is that money has often arisen as a result of kings’ or rulers’ desire to collect tax more efficiently.

Collecting tax in the form of agricultural produce (a common way of collecting tax thru history) is clearly inefficient. Money is much more convenient. So numerous rulers  decided to do exactly what the parents in WM’s model did: issue a form of money with the condition that taxes are paid using that form of money – or else. That immediately creates a demand for that money, and gives the money value.

Next, in the business card economy, the parents realise they cannot issue too many cards, else the cards will lose value (inflation). Nor can they issue too few: that would result in deficient demand for the goods and services available in the household. That is, it would result in unemployment.

Put another way, each child is bound to want to keep a limited stock of cards against a rainy day, but only a limited stock. I.e. the parents (aka the government / central bank / ruler) must issue enough cards to exactly meet the children’s desire to save, and to keep the economy working at full employment.

Next, borrowing and lending would arise in the business card economy, and absent any attempt to parents to influence the rate of interest, some sort of free market rate of interest would establish itself. The parents could artificially raise that rate of interest by offering a rate of interest above the going free market rate and could fund the interest out of taxation. But quite what the point of doing that would be is a bit of a mystery. In particular, it is widely agreed in economics that GDP is maximized where prices (including the price of borrowed money) is at its free market rate, thus any attempt by the parents to artificially raise the rate of interest would seem to be counterproductive.

Put another way, it is always tempting for governments to borrow, as pointed out by David Hume over two hundred years ago (see endnote below), but that borrowing artificially raises interest rates, and reduces GDP.

Indeed, that point ties in very neatly by WM’s claim that there should be a permanent zero rate of interest. I.e. while for example those who offer pay-day loans will always charge way above a zero rate, the rate offered by the state on its liabilities should be zero. (See 2nd last para of WM’s Huffington article “Proposals for the banking system.” and his paper “The Natural Rate of Interest is Zero”).

Commercial banks.

Having set out the basics of the WM family economy, and doubtless having left out some important points that WM made in his original version of that economy, let’s now move on to commercial banks.

As already explained, there’d be nothing to stop the children lending to each other, plus there’d be nothing to stop one or more of the children setting up as a commercial bank, i.e. specialising in safeguarding other childrens’ cards, and lending to other children.

However, that would enable the “banker children” to play a trick which commercial banks play big time in the real world, which is thus. Instead of lending out “parent issued business cards” (base money) at interest, there’d be nothing to stop the banker children issuing promises to pay genuine business cards. And as long as the non banker children trusted the banker children, that commercial bank issued money would serve as well as the real thing, i.e. parent issued cards.

If you have any grasp of banking, you’ll see what is going on here. But in case you don’t, I’ll explain.

The discovery by banker children that they can lend out promises to pay was exactly the discovery that the goldsmith bankers in England in the 1600s and 1700s made: that is, they discovered that when granting a loan, they didn’t need to lend out real gold, or even receipts for real gold.  They could lend out receipts for gold that didn’t exist! They were into money printing, pure and simple.

In short, in the WM business card economy, banker children would be able to supplant the parents, and become the main issuers of money. And indeed that is exactly what has happened in the real world: prior to the 2007/8 crisis, a good 95% of the money in circulation was issued by private banks, not central banks. (That percentage has dropped to roughly 90% as a result of QE, far as I can see. But that’s not of much relevance to the argument here.)

So, does money issuance by banker children (aka “private banks”) make sense? Well the answer is that assuming that money is used purely and solely as money, and not as a long term loan, it makes no sense at all. Reason is that privately issued money is inherently expensive compared to state or “parent” issued money.

Where a commercial / private bank is going to supply a customer with money, the bank has to check up on the customer’s credit-worthiness, allow for bad debts and so on. That involves very real costs. In contrast, there is no need for a central bank (aka parents) to do that.

Incidentally, when I said “use money purely and solely as money, and not as a long term loan”, what I meant was as follows. Where a bank customer (aka child) has no money, and needs money for day to day transactions, the customer might agree with the bank to become overdraw to a maximum of $X, e.g. when short of money just before  pay-day, while having a credit balance at the bank just after pay day of around $X in a typical month. In that scenario, there would be no overall loan by the bank to the customer (or vice versa) over the year as a whole. That is, the $X loan is being used purely as a float, i.e. purely as money.

Genuine loans.

As distinct from using money borrowed from a commercial bank purely as money, there are loans which are genuine long term loans, e.g. mortgages.

Now if a child banker (or a real world commercial bank) simply lends out parent issued cards (or central bank issued base money in the real world), there is little effect on demand. Reason is that in order to obtain the cards to lend out, the child banker has to persuade another child or children to ABSTAIN from spending cards, by offering the latter interest. So the reduced spending by the latter children will approximately equal the INCREASED spending by the former “borrower children”.

In contrast, if the banker children lend out “promises to pay cards”, that is entirely new money. The effect is a rise in demand, and assuming demand was already at the maximum permissible without sparking off inflation, the effect will be inflationary. Thus the parents will have to impose some sort of deflationary measure, like raising taxes and confiscating cards from other children.

In short, the effect of child bankers lending out promises to pay cards (and the effect of commercial banks in the real world lending out their home made money) is very much the same as the effect of traditional back-street counterfeiters who turn out fake $100 bills:  the money printers clean up, while the rest of the community is robbed.

To summarise, where a commercial bank supplies home made money to a customer which is used purely as money, that exercise is pointless, and indeed will not take place if the central bank issues enough base money. Alternatively, where commercial banks lend out money which is used as a genuine long term loan, that activity is subsidised by the community at large.


Endnote – David Hume.

Hume explained why governments incur debt much more succinctly than any 21st century economist. As he put it:

“It is very tempting to a minister to employ such an expedient, as enables him to make a great figure during his administration, without overburdening the people with taxes, or exciting any immediate clamours against himself. The practice, therefore, of contracting debt will almost infallibly be abused, in every government. It would scarcely be more imprudent to give a prodigal son a credit in every banker's shop in London, than to impower a statesman to draw bills, in this manner, upon posterity.”

Thursday, 22 February 2018

The Swiss central bank and Sovereign Money.

Thomas Jordan, Chairman of the Governing Board Swiss National Bank published an article recently entitled “How money is created by the central bank and the banking system”. Actually the article is the transcript of a speech.

“Sovereign Money” is a quite widely used phrase which means the same as “full reserve” banking, or what Milton Friedman called “100% reserve” banking (which Friedman supported).

I have no criticisms of the first half or so of Jordan’s article: it sets out the basics about how central and commercial banks work, and in very clear language. (I’ll refer to commercial banks henceforth simply as “banks”).

But there are several points in the second half I don’t agree with. Under the heading “Why the image of creating money out of thin air is misleading”, Jordan starts by criticising the idea that banks are “privileged” in any way through reason of their ability to create money. The answer to that is that banks, at least under UK law, are very definitely in a privileged position as explained by Richard Werner in his article “How do banks create money, and why can other firms not do the same?” (published by Science Direct, 2014).  That is, banks can lend on money deposited with them, but no other type of firm can do that. And it is precisely that lending on of customers’ money that enables banks to create money.

As to the law in countries other than the UK, I’m no expert on that, but it is bound to be ROUGHLY similar to UK law: for example, I doubt lawyers in other countries are allowed to lend out clients’ money deposited with them (except in as far as depositing money at a reputable bank equals a loan to that bank).

Another way in which the ability to create money puts banks in a privileged position is that that ability enables them to come by money in a costless manner (unlike non-bank corporations) and hence artificially expand the size of the bank industry. That is, non-bank corporations and firms can only obtain money by borrowing it or earning it. Banks have a third and entirely costless way: creating or “printing” money. As Joseph Huber and James Robertson explain on p.31 of their work “Creating New Money”, lending out money you have created yourself at no cost is more profitable than lending out money you have had to earn or borrow. For more on that see my article “The Bank Subsidy No One Mentions”.

Indeed, the proto-bankers in Britain in the 1600s and 1700s discovered that lending out “home made money” in the form of receipts for non existent gold was cheaper than lending out receipts for gold which actually existed.

Next, under the heading “Comments on Sovereign Money” (p.7), Jordan makes three criticisms of Sovereign Money. First he says “the switch to Sovereign Money would be a move away from the historical distribution of responsibilities between the central bank and commercial banks. In this tried and tested two tier system, commercial banks compete with one another to supply households and companies with credit and liquidity, while the central bank acts as the bankers’ bank and conducts monetary policy.”

Well certainly under Sovereign Money, the split of responsibilities as between central banks and governments does change a bit. But the idea that any change in responsibilities is inherently undesirable is not a brilliant argument. Moreover, advocates of full reserve were making it plain some time ago that a change in responsibilities was  involved, e.g. see here. So the “change in responsibilities” point is not news.

As for “tried and tested”, that rather implies that banks have “passed the test” so to speak. In view of the 2007/8 bank crisis, it might be more appropriate to say “tried and found to be severely wanting, as demonstrated in the 2007/8 bank crisis.”

Also it is not true to say banks cease to “compete with one another to supply households and companies with credit…”. The basic change when switching to Sovereign Money is that banks have to fund their loans via equity rather than via debt (e.g. deposits). Apart from that, they compete as they always did.

Monetary policy.

As for the idea that the central bank no longer “conducts monetary policy”, that is not entirely true either. Certainly under Sovereign Money, monetary policy becomes less potent in that interest rate adjustments become less effective.  However, under Sovereign Money, central banks and governments still manage stimulus, which of necessity is at least to some extent monetary in nature.

To be more exact, assuming the sort of stimulus advocated by Positive Money is implemented instead, i.e. having central bank and government create new money and spend it (and/or cut taxes) that form of stimulus has a monetary element. That is when central bank and government create and spend fresh money, there is an initial fiscal effect: jobs are created for example in state schools or via building state owned infrastructure. Second, that spending results in the private sector’s stock of money rising. That’s monetary policy of a sort. (Incidentally Positive Money is a UK based organisation that backs the Sovereign Money idea.)

Next, Jordan says that Sovereign Money , “..calls for the Swiss National Bank to guarantee the supply of credit to the economy by financial services providers. In order to carry out this additional mandate, the SNB could provide banks with credit, probably against securitised loans. Depending on the circumstances, the SNB would have to accept credit risks onto its balance sheet and, in return, would have a more direct influence on lending. Such centralisation is not desirable. The smooth functioning of the economy would be hampered by political interference, false incentives and a lack of competition in banking.”

That idea, namely that the central bank should oversee the total amount of credit offered, and boost it if necessary is actually an OPTIONAL EXTRA, at least under Positive Money’s system.  Moreover, it’s an optional extra I don’t care for, thus I agree with Jordan in a sense there. Put another way, I see nothing wrong with simply insisting that loans are funded via equity, and then leaving it to the market to sort out.

Moreover, the idea that economists, whether working for the central bank or not, have superior judgement to the free market is very debatable. For example is the amount of lending to SMEs under the existing system adequate or not? There are arguments both ways on that one.

Interest rates would rise?

Jordan’s second criticism starts: “…Sovereign Money limits liquidity and maturity transformation as banks would no longer be able to create deposits through lending. Sovereign Money thus restricts the supply of liquidity and credit to households and companies. The financing of investment in equipment and housing would likely become more expensive.”

Well the first problem with that idea is that arguably interest rates are too low, with the result that we have excessive amounts of debt. Certainly if the popular idea that debts are excessive is correct, then a rise in interest rates would do no harm.

Another big potential problem with Jordan’s latter claim is the Modigliani Miller theory. According to the MM, the cost of funding a bank, or indeed any corporation, is not influenced by the method of funding. I.e. according to MM, funding via equity is no more expensive than funding via deposits. MM does have its critics, but I’ve been through the criticisms and I’m not impressed. (See section 1.4g here)

As for the point that Sovereign Money “limits maturity transformation”, I suggest that is an understatement. I.e. the truth is that Sovereign Money means the end of maturity transformation. Reason is that maturity transformation and money creation by private banks are the same thing. So if private money creation is banned, then so too is maturity transformation. Reasons for that are as follows.

Starting with the simplest possible loan, i.e. a loan from Mr A to Ms B, A loses access to his money until B repays it. In theory A can sell the loan, but for a person to person loan like that, A would not get a good price for the loan. That is, there no very effective way for A to transform his long term loan into a short term one (i.e. engage in  maturity transformation).

In contrast, a bank can take deposits from dozens of people, lend the money on to B, at the same time as promising the depositors they can have their money back whenever they want. I.e. the sort of long term loan that is involved where A lends to B, in the case of bank, involves funding a long term loan via loans to the bank (i.e. deposits) which have a time to maturity of zero. And a liability of a bank which has zero maturity is money.

To summarise, the bank lends £X to B, so B has the use of the money, while the depositors who deposited £X with the bank still have access to their £X. Lo and behold £X has been turned into £2X.

Disallowing maturity transformation certainly has a deflationary effect, but that doesn’t matter because the state can print and spend any amount of money it wants into the economy to compensate.

So Jordan’s claim that “Sovereign Money thus restricts the supply of liquidity and credit to households and companies” isn't quite right. That is, the amount of “liquidity” is not affected in that the loss of commercial bank created money is approximately compensated for by an increased supply of state issued money. Secondly, there is less credit creation, i.e. less lending, but that doesn’t matter in that everyone has a larger stock of base money and thus they do not need to borrow so much. In short, Sovereign Money results in less loan based economic activity, and more non-loan-based activity.

The third criticism – financial stability.

Jordan’s third criticism starts “Third, it would be naive to hold out too much hope on the financial stability front Investors and borrowers will always make misjudgements. A switch to Sovereign Money would thus not prevent harmful excesses in lending or in the valuation of stocks, bonds or real estate.”

Well the advocates of Sovereign Money have never claimed that by some magic, creditors’ ability to assess debtors is transformed. In fact that ability will remain much the same.

One of the crucial differences between a Sovereign Money system and the existing system is that however bad those misjudgements, a bank cannot possibly go bust as a result. E.g. if a bank’s loans turn out to be worth say 75% of book value (and that’s far worse than anything that happened to large banks during the recent crisis) all that happens is that the value of the shares that fund the bank drop to about 75% of book value. It is quite common for shares of non-bank  corporations to drop to 75% of the value over a period of weeks or months, either  because of a general fall in stock exchange indices, or because of poor performance by particular corporations. That sort of event does not cause finance crises.

Next, in his third criticism of Sovereign Money, Jordan claims “So the Sovereign Money initiative, with its focus on payment transaction accounts does not resolve the too big to fail issue.” My answer to that is: “yes it does”. As explained just above, under Sovereign Money, banks cannot fail. That solves the too big to fail problem!

Jordan then says, “The initiative (i.e. Sovereign Money) requires that the SNB manage the money supply, an idea we abandoned some 20 years ago. Today, the SNB steers monetary conditions via money market rates, a strategy which has served it well over the years. A switch to monetary targeting would therefore be an unnecessary step backwards from our perspective.”

Well I’m not acquainted with all the details of the Swiss Sovereign Money movement, but in the case of the equivalent movement in the UK, i.e. Positive Money, interest rate adjustments are not replaced SIMPLY with adjustments to the money supply. What happens is that the state, to repeat, creates and spends new money (and/or cuts taxes) when stimulus is needed. And the mere fact of that spending (e.g. on infrastructure, state schools, etc) creates jobs. I.e. there is an immediate fiscal effect there, followed by a longer term monetary effect stemming from the increased money supply. As distinct from increased public spending, government can choose to cut taxes, an option that a relatively right wing government might prefer.


Jordan then queries the reversibility of stimulus, Sovereign Money  style, and certainly that’s a valid point to raise. That’s in his next paragraph, starting “Another problem for monetary policy would arise….”.

There are actually two or three possible forms of reversibility under Sovereign Money. First, all economies have a form of built in and totally automatic form of reversibility via the 2% inflation target. That is, if inflation is running at 2% a year, then the real value of the country’s stock of base money and government debt declines at 2% a year.

At some point that decline is guaranteed to lead to the private sector having what it regards as an inadequate stock of the latter two assets (which are actually so similar that they almost amount to the same thing, as explained by Martin Wolf in the Financial Times). The private sector will then begin to save, and as Keynes pointed out via his “paradox of thrift” metaphor, that leads to deficient demand, at which point, far from reversibility being needed, the opposite, i.e. stimulus is needed.

A second possible form of reversibility is tax. As explained above, under Sovereign Money, stimulus can be implemented by cutting taxes. Likewise, a “reverse” can be implemented by raising taxes (and “unprinting” the money collected).

Third, interest rates can be raised. As explained above,  interest rate adjustments do not have as big an effect under Sovereign Money as under the existing system, but they would nevertheless have a  finite effect.


Jordan’s next objection to Sovereign Money (para starting “Finally, a more general….”) is that there would be “uncertainty” and “turmoil” if Switzerland shifted to a Sovereign Money system while other countries did not.

Certainly it would be better for a significant group of countries, like the EU, to make the switch rather than just one country make the switch. But there are Sovereign Money movements in most countries nowadays, thus if the basic Sovereign Money idea is valid, then hopefully several countries will make the switch at the same time. Put another way, the fact that a solution to a problem is most effective where several countries or all countries adopt the solution at the same time is not a good argument against that solution.

Also Jordan does not spell out exactly what the above “uncertainty” and “turmoil” would consist of. Well here is a suggestion: where one country alone implements Sovereign Money, that could raise interest rates, i.e. make loans more expensive, which would be an artificial advantage for foreign banks.

Well the answer to that is that loans are relatively cheap under the existing system because under the existing system banks are subsidised. First there is the well known TBTF subsidy. The TBTF subsidy derives from the belief that under no circumstances can large banks be allowed to fail, and to that end, the Fed loaned around $600bn at a near zero rate of interest for around 18months to various banks. The $600bn comes from figure 11 here. As to the near zero rate, I have not been able to confirm the average rate, but all the individual loans made by the Fed that I’ve looked at were at either a zero or a near zero rate. That compares to the 10% that Warren Buffet charged Goldman Sachs at the height of the crisis for a $5bn loan, so 10% is presumably the realistic rate approximately.

And for another example of the sort of subsidy that bankers manage to wheedle out of politicians, the UK government has always provided deposit insurance for banks for free till quite recently.

Now if some foreign country wants to provide goods or services at an artificially low rate, why not let them? I.e. if Switzerland or any other country implements Sovereign Money, and finds that foreign owned banks eat into the market in the Switzerland or wherever, what is there to worry about? To take an extreme example, if any country out there wants to sell me a brand new car for $1, please get in touch with me.

Why don’t base money backed accounts already exist?

Finally, in the first paragraph of his conclusion, Jordan asks why banks have not already set up CB money backed accounts if such accounts are so wonderful.

Well the first answer to that is that in some countries, governments (rather than banks) actually have set up such accounts. For example there is National Savings and Investments in the UK. And NSI accounts are quite popular in the UK. NSI does not offer the full range of services offered by a normal bank, but it comes quite close to doing so.

Second, Jordan points to the fact that banks under the existing system offer everything a bank customer could want: interest on deposited money plus total security.

Well the flaw in that argument is that the security only comes thanks to taxpayers standing behind bank accounts. Put another way, taxpayers enable depositors to have their cake and eat it: depositors can have their money fund relatively risky loans, with taxpayers picking up the pieces when that goes wrong. Why should any depositor say no to that arrangement?

If taxpayers compensated me for losses at the local casino, but let me keep the winnings when I won, I’d be in the local casino every other night of the week.

Wednesday, 21 February 2018

You pay extra interest on your mortgage just to enable the central bank to adjust interest rates.

The reason you pay an unnecessarily large amount of interest on your mortgage comes at the end of this article. To explain the reasons, it is necessary to explain something about MMT and interest rates. 

According to Simon Wren-Lewis in an article entitled  “Do Trump’s deficits matter?”, MMTers do no approve of interest rate adjustments. As he says:

“…what MMT actually says is that inflation should determine what the deficit should be. If inflation looks like staying below target you can and should have a larger deficit, and vice versa. The reason they say that is that they think the central bank, in changing interest rates to control inflation, is wasting its time, because they believe rates do not have a predictable impact on demand and inflation.”

Well speaking as someone who reads and leaves more comments on MMT blogs than about 99.999% of the population, that’s not my impression. However, MMTers are a diverse lot, and it’s often not entirely clear what they think as a group.

My impression is that MMTers don’t think much of interest rate adjustments because they tend to believe in a permanent zero interest rate, or at least that a zero rate should always be the objective, with occasional interest rate rises being used only in emergencies. Milton Friedman advocated that policy in his 1948 American Economic Review paper. See para starting “Operation of the proposal…”.

Also, MMT’s founder, Warren Mosler advocated a permanent zero rate in this Huffington article (2nd last para), and here.

One reason for favoring a permanent zero rate is as follows. The private sector and the banking system in particular need a supply of base money. And that need is such that the private sector will willingly hold a stock of that money without being offered any reward for doing so. I.e. no interest needs to be paid.

But if the state issues too much of that money (i.e. runs too large a deficit for too long), then private sector entities will try to spend away the excess, and inflation will ensue, unless the state induces the private sector to hold onto that excess stock by offering interest on it.

But what’s the point of doing that? I.e. what’s the point, to put it figuratively, of inducing people to keep large wads of £10 notes under their mattresses, and inducing them not to spend that money by offering interest on it? This is a farce. It amounts to rewarding hoarders with money extracted from taxpayers.

It also results in everyone with a mortgage paying more interest than they need, just to enable central banks to adjust demand by adjusting interest rates. If monetary policy (i.e. interest rate adjustments) were VASTLY MORE EFFICIENT than fiscal policy when it comes to controlling demand, then there might be an argument for imposing that cost on mortgagers. But the evidence, far as I can see, is that interest rate adjustments do not work in a particularly quick, and predictable way, plus there are some who argue they don’t even have much effect.

Tuesday, 20 February 2018

No housing shortage in Britain?

It seems to be fashionable to argue that high house prices in the UK are not down to a shortage of houses. A quick read thru those sort of arguments normally reveals some nonsense thinking. This article is typical. It’s by Ian Hulheirn, Director of Consulting at Oxford Economics and former HM Treasury economist. (Article title: "Part I: Is there really a housing shortage".

His first argument is that because there are 5% more houses than households now as compared 3% 25 years ago that therefor there is no housing shortage.

Well now real incomes have increased during that period which can reasonably be expected to result in households demanding LARGER houses, and in more people demanding second homes. Plus there are more single person households than 25 years ago, and single people tend to demand more square meters of housing that the typical husband, wife and two kids household.

In short, it is reasonable to assume demand has risen. As to supply, the average value of land with planning permission to build on is £6million per hectare according to this source. That compares to around £20,000 for land without planning permission.  If that doesn’t indicate an artificial shortage of land to build on, then what does?

Sunday, 18 February 2018

Wednesday, 14 February 2018

UK government gets more money via borrowing than from tax??

Well that’s the claim made by Ann Pettifor in an article entitled “Do tax revenues finance government spending? To quote, she says:

“…governments do not finance their investments, or even their activity, from tax revenues. Most of the government’s big expenditures are financed via the issuance of gilts – government bonds.”

Actually it’s the other way round, to put it mildly: i.e. governments get vastly more from tax than they do from borrowing. Reasons and calculations are as follows.

The first slight problem involved in quantifying things in this area is that the amount of borrowing governments do varies hugely depending on whether the economy is in recession, or the opposite, i.e. overheating. Thus to get a rough idea as to how much the UK government gets from borrowing and tax, I’ll take a relatively long period, that is, 1965 to the present: just over 50 years.

I’ve actually chosen that particular period because the debt/GDP ratio was 90% at the start and at the end of that period. (See first and second charts below) I.e. I’ve chosen that period because it keeps things simple. That might seem a cheat, but actually as you see by the end of this article, the actual amount of cheating is negligible. (Charts are taken from this site.)

Next, we need to compare real GDP in 1965 with GDP in 2017. According to this source, UK GDP expanded about two and a half times in real terms between 1965 and 2017.

Thus the increase in government borrowing between 1965 and 2017 was 0.9(2.5-1.0)=1.36x(1965GDP). Thus over that 52 year period, government got an amount of money from borrowing each year which on average equaled 1.36/52 times 1965GDP, which comes to 0.026 times 1965GDP: about 1/40th of GDP.

As to the proportion of GDP allocated to public spending, that’s hovered around 40% for a long time – see chart here.

So to summarise, 40% of GDP is allocated to public spending, and as for the money to fund that that comes from borrowing, that’s about 2.6% of GDP. 40/2.6= about 15. So about 1/15th of public spending is funded via borrowing, with the rest (over 90%) necessarily coming from tax.

Returning to the question as to how much of a cheat is involved in  choosing the period 1965 to 2017, the answer is: “not much”. That’s because one could go back another 50 years or so to around 1918 when the debt was also around 90% of GDP. (See above chart). That would make the total period a century: hardly unrepresentative.

Conclusion: the amount of money government gets from tax is roughly fifteen times what it gets from borrowing – unless I’ve dropped a clanger, which is not impossible...:-)

Tuesday, 13 February 2018

Monday, 12 February 2018

Warren Mosler’s bank reform ideas.


Warren Mosler produced some ideas for bank reform in a Huffington article in 2011. Title of the article is “Proposals for the banking system.”

While I agree with many of WM’s ideas (e.g. I support MMT which I think he founded), I’m not sure about his ideas on bank reform. The basic weakness in his proposals is that they amount to a subsidy of private banks. For example he argues that deposit insurance should be funded by taxpayers, not as at present, by commercial banks. (Incidentally WM spent much of his career working in the financial sector, so that may help explain his sympathetic attitude to that sector.)

Deposit  insurance.

Anyway, the first paragraph reads, “U.S. banks are public/private partnerships, established for the public purpose of providing loans based on credit analysis. Supporting this type of lending on an ongoing, stable basis demands a source of funding that is not market dependent. Hence most of the world’s banking systems include some form of government deposit insurance, as well as a central bank standing by to loan to its member banks.”

The second half of that para suggests that the purpose of deposit insurance is to ensure borrowers’ access to credit is not interrupted. In fact the basic purpose of deposit insurance is as per the description on the tin: it’s to insure deposits.

Indeed the failure of one or two small or medium size banks would not seriously interrupt borrowers’ access to credit: they can simply apply to other banks for loans. Obviously if the bank you normally deal with gets into trouble that may involve a finite interruption to your access to credit, but other banks are not going to turn you away when you apply for credit: no bank or any other business turns down extra sales.

In contrast, there is the possibility of the entire bank system collapsing, as seemed likely in the recent crisis. That clearly would interrupt borrowers’ access to credit. But that problem is not dealt with via deposit insurance in the normal sense of the word: it’s dealt with by central bank “lender of last resort” facilities (mentioned in WM’s above para).

Now the big problem with last resort loans is that while such loans are supposed to be at Walter Bagehot’s famous “penalty rate”, in the real world (no doubt party due to political pressure and bribes paid by banksters to politicians) the actual rate is a sweetheart rate, to put it mildly. The actual rate for the hundreds of billions worth of loans made by the Fed to banks in the recent crisis was near enough zero, which is a MONSTER subsidy for private banks. As it explains in the introductory economics text books, GDP is not maximised where an industry is subsidised, unless there is a good social case for a subsidy, as there is for example in the case of kid’s education.

WM returns to the question as to how to treat large banks in trouble later in his article. I’m dealing with his points in the order in which they appear in his article, so I’ll deal with his other points about large banks in trouble a few paragraphs hence.

100% reserves.

WM’s next para contains a slight mistake where it says “No bank can operate with 100% reserves.” Well that depends on your definition of the word “bank”. If you mean an institution which funds loans via deposits, then WM is correct. On the other hand there is such a thing as “100% reserve banking” (advocated by Milton Friedman and others). Under that system, deposits are all lodged at the central bank, while loans are funded via equity. (That’s “deposits” in the sense of: “money which is supposed to be totally safe”.)

A few sentences later, WM says “The hard lesson of banking history is that the liability side of banking is not the place for market discipline. Therefore, with banks funded without limit by government insured deposits and loans from the central bank, discipline is entirely on the asset side.”

Well the first problem with that idea is that WM does not provide any actual examples of “discipline” being imposed via the liability side and that being a disaster. Moreover, every bank regulator in the World far as I can see believes that some regulation of the liability side of banks’ balance sheets is justified: for example all recent attempts to re-jig bank regulations involve increasing banks’ capital ratios, or at least discuss the possibility of increasing those ratios.

Eight restrictions.

Next, WM lists eight restrictions which he thinks should be imposed on banks, some of which I like and some not. For example he opposes “off balance sheet” stuff and quite right: the purpose of a balance sheet is to give an accurate picture of a corporation’s assets and liabilities at some point in time. Thus off balance sheet items are plain simple deception, far as I can see. I gather off balance sheet stuff is virtually banned in Spain.

In contrast, restriction No.5 is that US banks should not be allowed to lend offshore. That’s a strange idea: banking is very much an international business.

But more important than the merits of individual restrictions suggested by WM is the point that all these restrictions amount to a move in the direction of full reserve banking. Reasons are thus.

Under full reserve (or 100% reserves as Milton Friedman called it), entities which accept deposits cannot take any risks at all with those deposits: an idea which is entirely logical. A deposit is supposed to be totally safe, but that is plain incompatible with lending on deposited money because loaned out money is NEVER entirely safe.

As to risky activities under full reserve, those are funded via equity. Now WM is saying that entities funded by deposits or mainly via deposits should not be allowed to engage in sundry risky activities. That in turn means that those activities will inevitably be funded by other entities which are funded via equity.

So why not go the whole hog and just ban entities funded via deposits from all risky activities? Well the standard answer to that given by supporters of the existing bank system is that that ban would reduce the amount of credit creation: i.e. reduce the amount of money created by commercial banks. But there’s a simple answer to that: have the state supply whatever amount of money is needed to lubricate the economy, which is a job the state (i.e. central bank plus government) already does to some extent. (Roughly 10% of the money supply is currently central bank rather than commercial bank issued money.)

Moreover, as I explain here, the right that commercial banks to fund loans via deposits actually amounts to letting them print or “create” money, and that’s a subsidy of commercial / private banks. (My article is entitled “Taxpayers subsidise private money creation.” (Journal of Economics Bibliography).

Proposals for the FDIC.

The next section of WM’s article is entitled as above, i.e. “Proposals for the FDIC” and it consists of three items.

Item No.2 is odd: WM argues that deposit insurance should not be charged to banks, i.e. he claims that taxpayers in general should fund deposit insurance. There again, I imagine every bank regulator in the world disagrees with that idea.

In short, having taxpayers fund deposit insurance is a blatant subsidy of the bank industry. The shipping industry carries the cost of insuring its ships. Banks should act likewise.

Proposals for the Federal Reserve.

Under the heading “Proposals for the Federal Reserve”, WM says:

“The Fed should lend unsecured to member banks, and in unlimited quantities at its target fed funds rate, by simply trading in the fed funds market. There is no reason to do otherwise. Currently the Fed will only loan to its banks on a fully collateralized basis. However, this is both redundant and disruptive. The Fed demanding collateral when it lends is redundant because all bank assets are already fully regulated by Federal regulators.”

Well the first problem there is the latter sentence: if bank assets really were “fully regulated”, no bank would every make silly loans I assume (thought that depends on exactly what “fully regulated” means).

As to the idea that the Fed should lend at the Fed funds rate, the problem there is that that rate is a sweetheart rate given that the corporations doing the borrowing are in trouble. (Banks themselves charge relatively high rates to any customer which appears to be in  trouble, and quite right.)

For an idea of what would constitute a realistic free market rate for a large loan to a large bank during the recent crisis we need look no further than the $5bn loan made by Warren Buffet to Goldman Sachs in September 2008. The loan involved an interest rate of 10%. In contrast, the Fed funds rate at that date was around 2% and sank to 0% shortly afterwards. To put it mildly, there’s a bit of a difference there!

WM also claims banks should not have to provide collateral in exchange for such loans. In contrast Warren Buffet (as you’d expect) did demand collateral. To summarise, we seem to have three options here. First the ultra-generous treatment of banks advocated by WM. Second, there’s the less generous treatment actually implemented by the Fed during the recent crisis. Third, there is what might be called the “brutal free market” treatment advocated by Walter Bagehot and Warren Buffet.

To repeat, the standard view in economics is that market forces should prevail, unless there are very clear reasons for thinking otherwise. And certainly in the case of large banks, there appears to be a good “reason for thinking otherwise”, namely that if large banks are given the “Buffet” treatment during a crisis, that may drive banks to insolvency.

However that insolvency only arises because of the basic nature of the existing bank system, sometimes called fractional reserve banking. That system allows commercial banks to use debt (deposits and bonds) to fund loans. And that is simply asking for trouble: it involves having liabilities that are fixed in value combined with assets (i.e. loans) which can fall dramatically in value when it turns out that silly loans have been made.

The attraction of using debt to fund a bank (or indeed any business) is that debt holders demand a slightly smaller return on their money than shareholders. But if the corollary is that taxpayers have to rescue large banks periodically, then in effect we have a system where banks are allowed to reap extra profits by taking extra risks, while the taxpayer picks up the pieces when the risks do not pay off. That is a nonsensical arrangement.

A better system is one where banks have to use equity to fund loans: that way it’s impossible for banks to go insolvent. I.e. if a bank makes silly loans and it turns out the value of those loans is only say 80% of book value, all that happens is that the value of the equity falls to about 80% of book value. That bank does not go bust.

At the same time, depositors who want their money to be totally safe are offered accounts where relevant monies really are totally safe: the money is simply lodged with the central bank or government. And that is the 100% reserve system advocated by Milton Friedman and others.

That system may well mean interest rates rise, but assuming they rise to a genuine free market level, then GDP ought to be higher at that higher rate than at the ultra-low rates that have prevailed for the last decade. And as for any deflationary effect of higher interest rates, that is easily dealt with by running a larger deficit.

And finally, low interest rates are not an unmixed blessing. Low rates mean more loans and hence more debt: and every socially concerned do-gooder has been complaining about the excessive amount of debt for the last five years or so. Plus low rates tend to encourage bubbles.

Saturday, 10 February 2018

Cancelling student debt is stimulatory. So what?

A very silly paper has just been published by the Levy Economics Institute entitled “The Macroeconomic Effects of Student Debt Cancellation”. One of the basic points made is that if student debt is  wiped out and government prints loads of money and hands it the universities or banks who lose out because they’re no longer getting money from debt repayment, the effect will be stimulatory: i.e. demand will be raised and jobs created (assuming the economy is not yet at capacity).

The flaw in that idea is that stimulus will occur WHATEVER group of people or organisations government gives money to. Makes no difference whether the money is given to Wall Street bankers, winos and drug addicts or old ladies with blue rinses – the effect will be the same: demand rises. That however is not an argument for handing money to old ladies with blue rinses, or any other group.

Note that that is not, repeat not to say that student debt should not be cancelled. The pros and cons of doing that are quite separate from the very silly and obvious point that handing out loads of money will raise demand.

Even if the above student debt cancellation is funded via a general rise in tax instead of being funded via money printing, there could easily be a rise in demand, but that is still irrelevant. If money is taken off people or organisations with a low propensity to spend and given to people and organisations with a higher propensity to spend, the effect is clearly a rise in demand. An example of that is taxing the rich and giving the money to the poor.

But the same point applies there as made a couple of paragraphs above. That is, while there may well be good reasons for raising taxes on the rich and giving more to the poor, the above “propensity” point is not one of those “good reasons”.

The multiplier.

The Levy paper attaches much importance to the so called “multiplier”: that’s the ratio of increased GDP resulting from some increase in spending compared to the size of the latter increased bout of spending.

To the na├»ve (and that includes the Levy authors) it might seem that the larger the rise in GDP for a given dollop of increased spending the better. The flaw in that argument is that stimulus or if you like “printing money and spending it” costs nothing in real terms. Thus if two dollars have to be created and spent for each dollar increase in GDP rather than one dollar of “print and spend” it really doesn’t matter because printing dollars (or creating them via keyboard strokes) costs nothing. As Milton Friedman put it, "It need cost society essentially nothing in real resources to provide the individual with the current services of an additional dollar in cash balances."

For more on the nonsense that is the multiplier, see my article on that subject: “The Multiplier is Irrelevant.”

Friday, 9 February 2018

Silly arguments against People’s QE.

Let’s start with an argument put by Nick Rowe, associate professor of economics at Carleton University, Ottawa. His claim that Peoples’ QE (PQE) doesn’t work is in this article at the “Canadian Worthwhile Initiative” blog entitled “Fiscal Offset of Silly QE”. The crucial part of his argument is this (his item No.2):

“Suppose the government of Canada normally buys 10 new Canadian bridges at $1 billion each. Then the Bank of Canada prints $3 billion, and instead of lending it to the government (buying government bonds) like it normally does, it buys 3 new Canadian bridges. The government will now buy 7 new bridges instead of 10. The net result on building of bridges, and everything else, is zero. The only difference is that the Bank of Canada is doing part of the government's shopping for it.”

Well now, it just ain’t true to say that the Bank of Canada (or any other central bank) “normally prints $3billion and buys government bonds”. The latter exercise is known as “QE” which is a stimulatory measure only implemented in a recession, i.e. when a large increase in demand is required. So Rowe is not doing the correct comparison, i.e. he is not comparing a “no stimulus” scenario to an “allegedly stimulatory scenario thanks to PQE”. That is, he is comparing two methods of effecting stimulus. His “discovery” that there is not much difference between the two is thus hardly surprising.

Second, (and perhaps I’m just repeating the latter point) Rowe assumes a total spend of $10bn in each case. Well the whole point of PQE is that relevant spending is additional to what would normally have taken place. I.e. come a recession, government says “Instead of building ten bridges, let’s build eleven, plus we’ll spend more on a range of other items, and/or we’ll cut taxes, and that will all  be funded with freshly printed money.”

Tony Yates.

A second anti-PQE argument appears in a Guardian article by Tony Yates (economics prof at Birmingham University). The article is entitled: “Corbyn's QE for the people jeopardises the Bank of England's independence.”

The first answer to his “jeopardises the BoE’s independence” is: “what if it does?”  The BoE was not independent before Gordon Brown gave it independence in 1997. Was the sky constantly falling in prior to 1997? Not that I remember.

I do actually favour central bank independence (or should I say “nominal independence”, because the exact extent of so called “central bank independence” is always debatable). But as intimated above, an independent central bank regime and a non-independent central bank regime do not seem to be Earth shatteringly different.

Second (as explained by Positive Money and co-authors) if keeping politicians away from the printing press is seen as desirable, an independent central bank is not the only way of doing that. An alternative is some sort of independent committee of economists (which may or may not be based at the central bank) who determine the AMOUNT of stimulus (e.g. PQE).

There is plenty more nonsense in Yates’s article and I don’t have time  for all of it. But here’s one more bit of nonsense.

Yates’s third paragraph reads “On the face of it, this (i.e. PQE) appears to get rid of the nasty business of having to finance worthy stuff by running deficits, and later, even worse, paying back the debt with taxation revenue.” Now wait a moment: having the central bank print money with the government then spending that money (or in the Corbyn version, using that money to buy bonds) IS A DEFICIT!!!!!!! I.e. Yates’s claim that PQE Corbyn style might dispose of the deficit is nonsense.

Tim Worstall.

A third anti-PQE argument appears in a Forbes article by Tim Worstall entitled “Peoples' QE Is Also Silly QE And Won't Work”.

Worstall cites an argument which Scott Sumner trots out ad nausiam. Sumner is an economist who teaches at Bentley University in Waltham, Massachusetts. Sumner’s argument is that fiscal stimulus (and PQE is at least to some extent a form of fiscal stimulus) is no use because a central bank will just negate that (with interest rate rises) if it thinks the effects are too inflationary.

Well the simple answer to that is that if the central bank DOESN’T think a dose of fiscal stimulus is excessive, then it won’t negate it! Doh!

I.e. Sumner’s argument is a bit like saying that a following wind won’t help an airliner cross the Atlantic because airliners normally aim for very precisely timed landing slots at their destination airport, so a following wind will just cause the pilot to power down the engines a bit.

For more on the nonsense that is monetary offset, see my article “Monetary offset is a joke”.

X Conclusion.

The moral is that economists often know lots about economics, but that is useless without a firm grasp of common sense.

Thursday, 8 February 2018

The Institute for New Economic Thinking.

I’ve long been puzzled as what the George Soros funded “Institute for New Economic Thinking” has produced which is “new”.  So I’m much amused by this description of an INET conference by Francis Coppola. She says:

“In the last two days we have had panel after panel of old white men discussing economic theories developed by old white men, many of them dead. Economic beliefs that I thought had been comprehensively debunked have reappeared, dressed up as "new thinking".

“It started to go wrong in the very first panel. Six white men and a token woman (this has been the general form of panels throughout the conference) discussing the economic stagnation of the last decade. Steven Fazzari and Adair Turner made some interesting comments, but the rest of the panel was terminally unoriginal. I lost interest quite quickly, turned to Twitter for light relief and got involved in a far more interesting discussion about whether or not banks earn seigniorage from lending, how we could measure this and whether it constitutes a hidden subsidy that should be removed. That discussion on Twitter sparked an even more interesting debate in the foyer of the Edinburgh International Conference Centre about banking reform. As a result, I now have some serious reading, thinking and writing to do, because I really do think banks need radical reform and it seems to have dropped off the agenda. But it didn't come from the INET conference. It came from Twitter.”

As regards “old white men”, doesn't that constitute ageism and sexism? Whether an idea emanates from someone who is old, young, male, female or “dead” is irrelevant. The only important question is whether the the idea is a good one or not.

On the positive side, I’m delighted to see Francis hone in on the question as to “whether or not banks earn seigniorage from lending, how we could measure this and whether it constitutes a hidden subsidy..”. I hope she does some articles on that in the near future.

That’s actually a CRUCIALLY IMPORTANT question. Only seriously clever people like Francis (and me of course – ha ha) have cottoned onto that. In contrast, the duffers charged with regulating banks scarcely know what a bank is.

Sunday, 4 February 2018

Artificial interest rate adjustments do not make sense.

(Stop press: this article is also at the Seeking Alpha site.)


There is a glaring flaw in using artificial interest rate adjustments to regulate demand: the GDP maximising rate of interest is presumably the free market rate, thus in order to maximise GDP, artificial interference with interest rates should be minimised. That in turn means demand is best regulated by fiscal means.

As to “fiscal” in the sense “government borrows money and spends it”, that is defective because the fact of borrowing has a deflationary effect: the opposite of the intended stimulatory effect. Thus the best form of stimulus is one of the forms suggested by Keynes in the early 1930s, namely to have the state print money and spend it, and/or cut taxes.

Under the latter system, treasuries or politicians could be given access to the printing press, i.e. be given control of how large a dose of stimulus the economy gets each year. Alternatively it is not difficult to delegate that “amount of stimulus” decision to a committee of economists, while politicians retain the right to take strictly political decisions, like what proportion of GDP is allocated to public spending.



There is a glaring flaw in using artificial interest rate adjustments to regulate demand. The flaw stems from a principle widely accepted in economics, namely that GDP is maximised where prices are determined by market forces, unless there is an obvious reason for thinking otherwise, i.e. unless “market failure” can be demonstrated, to use the jargon. So on the basis of the latter principle, interest rates ought to be left to find their own level.

It might seem that it can argued that the mere fact of a recession persisting is evidence that interest rates have not fallen far or fast enough and hence that artificial interest rate cuts are justified. However that idea is only valid if it can be shown that there is some sort of obstruction in the way of interest rate reductions, i.e. market failure. And it is far from clear what that obstruction might be. That is, the market for loans and savings would seem on the face of it to be very much of a free market: savers shop around for the best deal as do borrowers.

Artificial interest rate adjustments might be justified if they work much more quickly and/or predictably that fiscal stimulus. But there is not much evidence of that: see for example Dyson (2010) p.10.

Of course it might seem that fiscal adjustments work slowly because of the behaviour of Congress in the US where politicians sometimes spend months haggling over changes to tax or public spending. On the other hand in the UK tax adjustments are sometimes announced by the UK finance minister on budget day and come into effect the very next day. Certainly there is no reason in principle why, given a need for stimulus, a finance minister cannot have some freedom to make instant adjustments to tax or public spending, while politicians retain the right to change those adjustments at their leisure, if  they so wish.

Also in the US, many arguments in Congress about changes to tax and public spending are at root arguments about whether to adjust the deficit and hence the national debt. As is shown below, it is perfectly feasible to have a system where deficit decisions are taken by technocrats, while strictly political decisions remain with politicians. So if the latter idea was implemented, much of the argument that clogs up Congress at the moment would vanish.

Abolishing interest rate adjustments was advocated by Friedman (1948): at least he advocated an end to public borrowing which effectively means an end to interest rate adjustments. That idea was also advocated by Mosler (2011). Or to be more accurate, under Mosler’s “item 3” he advocates a permanent zero interest rate (i.e. government pays no interest on its liabilities). That, to repeat, means an end to interest rate adjustments. See also Mosler (2004) which also advocates a permanent zero rate.

The Pigou effect.

In contrast to interest rates and the above point that there are no obvious obstructions to market forces adjusting interest rates, there is another free market cure for recessions which is quite clearly obstructed. That’s the so called “Pigou effect”: that’s the fact that in a perfectly functioning or almost perfectly functioning free market and given a recession, prices and wages would fall (in terms of dollars, Euros, etc). That in turn would increase the real value of money (base money to be exact), which in turn would encourage spending.

In addition, the real value of government debt would rise, which would also increase the real value of the private sector’s paper wealth, all else equal. However, as explained for example by Wolf (2014, para starting “The purchases of equities…”) government debt and base money are virtually the same thing. So to summarise, in a perfect market and given a recession, the real value of the private sector’s stock of money and near money rises.

Note incidentally that base money is a net asset as far as the private sector is concerned, whereas commercial bank issued money is not: reason is that for every dollar of money created by commercial banks, there is a dollar of debt owed by a private sector entity. Hence the emphasis on base money above.

However, there is an obvious obstruction to the Pigou effect in the real world, namely Keynes’s “wages are sticky downwards” phenomenon. That is, any attempt to cut money wages in the real world is opposed both trade unions and non–unionised workers. However that obstruction should not be a big problem since it is easy to increase the private sector’s stock of base money by having the state (i.e. government and central bank) create new money and spend it and/ or cut taxes. (The word “state” is used here to refer to government and central bank considered as one unit).

Indeed Keynes (1933, 5th para) suggested doing just that. Incidentally, note that the fact of the state printing new money and spending it and/or cutting taxes has a fiscal as well as monetary effect. The fiscal effect arises partly from the fact of the number of public sector employees being increased more or less immediately when extra teachers etc are employed (assuming some of the new money funds extra pubic spending). As to the monetary effect: the latter “print and spend” exercise increases the private sector’s stock of base money which, as noted above, tends to encourage spending. And there is also public spending in the form of direct transfers of money to households (unemployment benefit, state pensions, etc). Incidentally, the above idea of Keynes’s, namely having the state print money and spend it and/or cut taxes amounts to the same as what is often called “QE for the people” nowadays.

It could be argued that an accurate imitation of the Pigou effect would consist of simple cash transfers to households: a helicopter drop. However, a significant proportion of public spending is “helicopter drop” in nature anyway: unemployment benefits, state pensions etc. Plus a cut in taxation amounts to a helicopter drop. Thus it is debatable as to whether setting up an entirely new system, i.e. a helicopter drop in the traditional sense, complete with thousands of bureaucrats is needed.


Returning to Keynes, in the passage mentioned just above, as well as suggesting that the state print and spend money, he also suggested having the state borrow and spend, which raises the question as to which of those two is better.

Well certainly “borrow and spend” is defective in that the object of the exercise is stimulus, but the effect of borrowing is the opposite: that is the effect is deflationary. Indeed, in the real world, central banks have to artificially counter that defective aspect of borrow and spend: that is, the effect of borrow and spend is probably to raise interest rates, thus central banks normally print money and buy back enough government debt to ensure that interest rates do not rise. And normally, given a recession, they go even further and do enough “print and buy back” to bring about a fall in interest rates.

In short, borrow and spend is defective. About the only excuse for it is that it might seem to be easier to reverse than print and spend: that is, so the argument goes, if the central bank has a stock of government debt, it can always impose a deflationary effect by selling that debt at below the going rate, which in turn withdraws base money from the private sector.

However, in an economy where there is no government debt, there would be nothing to stop a central bank wading into the market and offering to borrow at above the going rate. That ploy might not be allowed in various countries at the moment, but there is no good reason for it not to be allowed, where a quick “reversal” was needed.

Another relevant point here is that reversal in the form of raising taxes or cutting public spending is not always needed in order to effect reversal: reason is that inflation constantly eats away at the real value of the stock of base money and government debt, which amounts to reversal of a sort.

What constitutes no government interference with interest rates?

The claim that government should not interfere with interest rates raises a difficult question, as follows.  Given that governments are extremely large borrowers they clearly have a significant effect on interest rates. That raises the question as to what amount of government borrowing constitutes “non-interference” – or put another way, it raises the question as to what the optimum amount of public borrowing is.

A popular answer to that question is the so called “Golden rule”, i.e. that government borrowing should be limited to funding infrastructure investment and similar. But there is a glaring flaw in that idea, namely that education is a huge investment. But no one ever suggests the entire country’s education budget should be funded via borrowing. Thus the “investment justifies borrowing” argument looks questionable.

Indeed, while numerous economists and politicians fall for the “Golden  rule / investment justifies borrowing” argument, most small businesses and households do not. For example if a taxi driver wants a new taxi and happens to have more than enough cash available to buy it, the taxi driver is unlikely to borrow money and pay interest to a bank so as to fund the purchase of the new taxi given that there is no need for the taxi driver to pay interest to anyone.

In short, what justifies borrowing is shortage of cash, not the fact of making an investment. But the state is never short of cash in the sense that it can grab any amount of cash off taxpayers, plus it can print money, though clearly inflation places a limit to the amount of printing it can do.

Indeed, much if not most of the debt incurred via credit cards is for current consumption rather than the purchase of capital investment items. Whether it’s really in anyone’s interest to incur that sort of debt is of course debatable, but there is much to be said for a system where each consumer decides what is in their own interest, and clearly many consumers think the latter “current consumption debt” is in their interests.

Thus the conclusion would seem to be that there should be no government borrowing at all. Indeed, that is exactly the conclusion reached by Friedman (1948) – see second paragraph under the heading “Operation of the proposal”. Mosler (2011) argued likewise, though Friedman did argue that government borrowing would be justified in emergencies, like war time. And that’s very much in line with the conclusion reached a few paragraphs above, that is, that basically the state should borrow nothing, though if a particularly quick bit of reversal is needed, there is a case for the central bank wading into the market and borrowing at above the going rate.

Should politicians have access to the printing press?

To summarise so far, we have reached the conclusion that stimulus is best implemented by having the state print and spend more money and/or cut taxes rather than by interest rate adjustments. But the people who decide matters fiscal are normally politicians and treasuries. And that raises a problem namely that many of us have reservations about giving politicians access to the printing press.

The solution to that problem is not difficult, at least in principle, and is as follows.

The decision as to how much stimulus to impart, i.e. how large the deficit should be, can perfectly well be given to technocrats, i.e. a committee of economists (which could be based at the central bank, or not: it really doesn’t matter). At the same time, strictly political decisions, like what proportion of GDP is allocated to public spending, and how much of that goes to education, defence and so on, can easily be left with politicians. That split of responsibilities as between central banks and politicians is obviously different to the present split, but there is nothing difficult in principle about that new split.

The way the new system would work would be approximately as follows. The committee of economists would tell politicians what the deficit for the next year or so ought to be. Politicians would then decide what combination of tax and public spending put that deficit into effect. For example if the committee said that the deficit should be 5% of GDP over the next year, politicians could meet that objective by having tax equal to 20% of GDP and public spending equal to 25%. Or they could go for 30% and 35%.

Indeed Bernanke (2016) said such a system would be workable. His exact words were as follows.

“A possible arrangement, set up in advance, might work as follows: Ask Congress to create, by statute, a special Treasury account at the Fed, and to give the Fed . . . the sole authority to “fill” the account, perhaps up to some pre-specified limit. At almost all times, the account would be empty; the Fed would use its authority to add funds to the account only when the [Fed] assessed that a [helicopter drop] of specified size was needed to achieve the Fed’s employment and inflation goals.

Should the Fed act, under this proposal, the next step would be for the Congress and the Administration—through the usual, but possibly expedited, legislative process—to determine how to spend the funds (for example, on a tax rebate or on public works).”

That sort of system was also advocated by Dyson (2010) p.10-12. Note that Dyson and co-authors devoted much of their work to advocating full reserve banking. That’s not actually relevant for the purposes of the present discussion in that full reserve is perfectly compatible with the new split of responsibilities advocated here, as is the existing bank system.

Disposing of government debt is easy in principle.

Having advocated a “zero government debt” regime above, some readers may claim that is not too realistic and on the grounds that disposing of government debt is difficult. Certainly there are plenty of self-styled “economics professors” out there who have no idea as to how to drastically reduce the debt. Actually it is very easily done, at least in principle. That is there are no strictly economic or technical difficulties here, though possibly there are political difficulties.

The debt can be made to vanish in a very short space of time by simply printing money and buying it back (i.e. continuing with QE). As to any inflationary effect of that, that is easily dealt with by raising taxes and “unprinting” the money collected. Job done.

The only real difficulty is political: the population clearly objects to raised taxes. Though note that that rise in taxation would have no effect at all on living standards. That is, the sole purpose of the tax is to prevent excess demand, so there is no reason for real wages to fall.

Print money and buy non-government debt assets?

One way of imparting stimulus which could be argued to be an imitation of the Pigou effect is to have the central bank print money and buy assets other than government debt (i.e. private sector assets like corporate bonds): a ploy favoured by Scott Sumner.

The policy advocated in this article, namely printing money and boosting public spending plus cutting taxes is actually nearer to the Pigou effect. Printing money and buying up private sector assets will boost the market price of those assets relative to the price of consumer goods, whereas the policy advocated in this article simply leaves the choice between buying private sector assets versus buying consumer goods to households, employers and government spending departments. Thus the latter policy is presumably the better of the two.



Bernanke, B. (2016). “Here's How Ben Bernanke's "Helicopter Money" Plan Might Work”. Fortune Magazine.

Dyson, B., Greenham, T., Ryan-Collins, J. and Werner R.A. (2010).
“Towards a twenty-first century banking and monetary system.”

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

Keynes, J.M. (1933) “An open letter to President Roosevelt”.

Mosler, W. and Forstater, M. (2004)  “The Natural Rate of Interest is Zero”.

Mosler, Warren. (2011)    “Proposals for the banking system”. Huffington.

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