Wednesday, 24 May 2017

Top UK Treasury official does not understand deficits.

Nick Macpherson was the top bureaucrat at the UK Treasury 2005-2016. Simon Wren-Lewis (Oxford economics prof) draws attention to the fact that Macpherson claimed in a Tweet that the “Tory pledge to balance budget by 2025 is a disappointment to anybody who wants to break the cycle of deficits, debt and devaluation.” Macpherson then claims in subsequent tweet that, “running a structural current deficit when economy is at full employment is poor economics and poor public finances stewardship.”

I don’t have any big disagreements with Wren-Lewis’s criticisms of Macpherson’s thinking. I’ll set out my own criticisms below which I think are slightly better than Wren-Lewis’s. This is a bit technical: only suitable for people with a serious interest in economics. Here goes.

I’ve actually pointed out the flaw in Macpherson type thinking several times on this blog over the years. But I’ll run thru it yet again.

Assume inflation averages 2% pa over the years. I.e. let’s assume that while inflation may be a bit above 2% in some years, it is below 2% in other years: more or less what has happened in the real world in recent years. Also assume that growth averages about 1% pa in real terms: again, an entirely reasonable assumption – 1% is approximately the actual rate of growth for the UK economy over the last 20 years or so.

The “Macpherson theory” is that in that scenario there should be no deficit over the medium / long term. In fact a deficit is inevitable on the above assumptions and for the following reasons.

The 2% inflation and 1% growth mean that the national debt and monetary base will shrink in REAL TERMS relative to GDP. So on the entirely reasonable assumption that those two will need to remain CONSTANT relative to GDP, then they’ll have to be topped up regularly. And that can only be done via a deficit!

The assumption that the debt and base will remain constant relative to GDP in the long term, or perhaps I should say “very long term” is what has actually happened in the UK over the last 200 years.  That is, while the debt has risen to dramatic levels on some occasions, e.g. after WWII, it has on average hovered around the 50% to 70% of GDP level.

Notice that the sum of the debt and base are what MMTers sometimes refer to as “private sector net financial assets”. PSNFA is an important quantity. It equals or amounts to private sector net financial savings. And it seems (to repeat) that desired PSNFA over the very long term has remained roughly constant.

So, given that a constant deficit is needed, how big will it need to be? Well that’s easy. On the above assumptions, it will need to be (2+1)x50%=1.5% of GDP.!! Macpherson eat your heart out.



The argument put by Wren-Lewis in the above mentioned article is that zero is too low a rate of interest because it means the rate cannot be cut come a recession. Ergo at the zero bound, fiscal stimulus and an increased debt is needed to get the rate of interest up.

Well the slight flaw in that argument is that having got the debt and rate of interest up, the debt will shrink again because of the above mentioned 2% inflation and 1% growth. So Wren-Lewis would need to repeat his “fiscal stimulus so as to get the rate of interest up” process all over again after a few years.

In contrast, I’m advocating a PERMANENT deficit so that the latter “repetition” is not needed. I claim my “model” (for want of a better term) is a bit better.


Artificial interest rates.

Another weakness in the Wren-Lewis model is that under that model, interest rates seem to be simply a device for adjusting aggregate demand. In fact the rate of interest (e.g. for a zero risk loan) is the price of borrowed money, and it is reasonable to assume that GDP is maximised when interest rates are at free market prices, in the same way as it is normally assumed in economics that GDP is maximised when the price of anything else is at free market prices (except where it can be shown that there are good social arguments for the price being artificially low (as is the case with kid’s education) or artificially high (taxes on alcoholic drinks).

I.e. there is merit in the idea that interest rates should be left to find their own level, an idea promoted by Positive Money among others. The only possible flaw in the latter “Positive Money” strategy is that interest rate adjustments might work more quickly than fiscal adjustments. However, it’s far from clear that that is the case.

There is a Bank of England article which claims interest rate adjustments take a year to have their full effect. Plus there is no need to wait for politicians to have lengthy debates on the matter before adjusting fiscal stimulus: an element of variability can easily be built into tax and public spending which DOES NOT require lengthy debates. For example the UK adjusted VAT downwards and then up again during the recent crisis without the say so of politicians (apart from the UK’s finance minister, of course, who implemented those VAT changes.)

Monday, 22 May 2017

Most studies of the economics of immigration are useless.

There’s a very simple reason. Most of them do not consider a HUGE cost that net immigrants impose on host countries, which is the fact that each person requires several tens of thousands of pounds worth of infrastructure and other forms of capital, like housing. (The phrase “net immigrant” refers to the excess of immigration over emigration.)

Thus for each net immigrant, taxes have to be imposed on existing residents of the country to pay for the infrastructure that each net immigrant requires.

Of course the latter point assumes that the host country ACTUALLY DOES create suitable amounts of infrastructure when net immigrants arrive or shortly thereafter. An alternative assumption (one that actually occurs in the real world to some extent no doubt) is that the host country FAILS to create suitable amounts of infrastructure. But the result is still a burden placed on the host country: in the form of overcrowded or inadequate infrastructure.

The above infrastructure point is not to deny that OVER THE LIFE-TIME of each net immigrant, those immigrants will pay, roughly speaking, enough tax to cover their contribution to the country’s infrastructure. But certainly during net immigrants’ first decade or two in the host country, they are “free riders”, thus on balance over their lifetimes, net immigrants do not pay their fair share of infrastructure costs.

As for what the total value of infrastructure and other forms of capital per head is, this study puts the figure at £141,000. The title of the study is “Warning: Immigration Can Seriously Damage Your Wealth” and is published by the Social Affairs Unit. £141,000 is a HUGE AMOUNT.

That is not to suggest that all net immigrants on arrival owe the host country £141k. The issue is more complicated than that. For example the amount of capital that immigrants bring with the must be taken into account. But the size of that figure does mean that to TOTALLY IGNORE the above infrastructure point in any study which purports to measure the costs and benefits of immigration is a huge blunder. And most such studies do in fact ignore the above infrastructure point.

Thus, to quote the title of this article, most such studies are “useless”.

Saturday, 20 May 2017

Pavlina Tcherneva suggests that sales don’t create jobs!*?*!??

If you want to know why the Job Guarantee or “government as employer of last resort” idea is getting nowhere, reason is that the more vociferous advocates of the idea are incompetent  – which is not to say I oppose the JG idea. It’s an idea with definite possibilities, as long as the current leading advocates of the idea are sent to Siberia.

Tcherneva is one of those “leading advocates”. In this article (entitled “Full employment through social entrepreneurship: the non-profit model for implementing a job guarantee” published by the Levy Economics Institute) she starts by questioning whether “expansionary fiscal policy” as she calls it, creates jobs. (I actually referred briefly to this article a few weeks ago, but a closer look at it will do no harm.)

Her first para says (I’ve put her words in green italics), “When it comes to fiscal stimulus, the conventional approach always centers on tax cuts, investment subsidies, accelerated depreciation, contracts to firms with guaranteed profits, and extensions to unemployment insurance and food stamp programs. Though the specific preferences for certain policies may differ from one political party to the next, the objective remains the same: boost private investment and growth by all means possible and jobs will hopefully follow.”

Why “hopefully”? If households are given more money, whether via the above mentioned tax cuts or unemployment insurance, the empirical evidence is that they spend a significant proportion of their newly acquired wealth (gasps of amazement). And that spending creates jobs – how else are relevant goods and services produced other than by people working, at – er – “jobs”?  A large majority of the economics profession believe that fiscal stimulus increases demand and jobs. They are right.

As to the “guaranteed profits” point, that’s irrelevant. Certainly some corporations sign guaranteed profits contracts with government, while other contracts involve a fixed quote for a specific task. In the latter case, relevant firms may then make a profit or loss depending in how well they estimated the cost of the task. But the important point is that when government places orders with firms for goods and services, jobs are created. Or at least a large majority of economists think jobs are created. Tscherneva evidently thinks otherwise.

Modern Monetary Theory.

Another strange aspect of Tcherneva’s above point is that she claims to back Modern Monetary Theory (MMT). But stimulus as proposed by MMT is not much different to stimulus under conventional policies. That is, one of the main forms of stimulus under conventional arrangements is government deficits, while MMTers tend to go for the simpler “just create money and spend it (and/or cut taxes)”. But given that central banks have created money and bought up most of the extra government debt created over the last few years, stimulus over the last few years has in effect taken the above mentioned form that MMT advocates!!!

A total re-think.

Anyway, since sales don’t create, or may not create jobs, Tcherneva claims we need a total re-think here. Her second paragraph reads:

“This way of thinking about the problem, however, is precisely upside down. Growth declines when investment and consumption fall. Investment falls when sales fail. Sales and consumption fall when employment falls. To reverse this vicious cycle, policy must begin by fixing the unemployment situation, which will then lead to a recovery in sales and consumption, which in turn will improve business conditions and profit expectations - all of which will finally boost investment and growth. Growth, in other words, is a by-product of strong employment, not the other way around.”

So apparently if we create lots of JG type jobs – planting trees, picking up litter, charity work, etc – then by some unexplained magic, millions of hi-tech manufacturing jobs, etc will appear from nowhere. This bizarre!

To re-phrase Tcherneva’s argument, she is saying that given a grossly excessive amount of unemployment, instead of giving households money and having government spend money on normal public sector jobs (as per conventional stimulus) we should pay the unemployed to do relatively unproductive and low paid JG type work. There is of course a problem there, and as follows.

If pay for JG work is for the sake of argument half the average wage (and certainly most proponents of JG rightly advocate relatively low pay for such work – e.g. the minimum wage) then there won’t be a huge addition to aggregate demand. Thus relatively few PRODUCTIVE jobs will be created as a result.

In contrast, if demand is boosted in the normal manner, the average job created will be an average sort of public or private sector job paying around the national average wage. More output per job! So why go for the “Tcherneva / JG” option?

In other words, as long as we are talking about a GROSS DEFICIENCY in demand, then normal demand increasing measures (increased deficits, interest rate cuts, etc) are best.

In contrast to GROSS deficiencies in demand, there is the question as to what to do about the 5% or so of the workforce who remain unemployed even at so called “full employment”. Well certainly there is a case there for JG type jobs. To take a crude example, it is theoretically possible to dispose entirely of that “5% unemployment”: just tell the unemployed their unemployment benefit is henceforth conditional on walking up and down their street keeping it free of litter, with pay being equal to unemployment benefit. Anyone refusing the work would no longer be counted as unemployed on the grounds that they had refused work. Hey Presto: unemployment vanishes!

Of course that is a very crude JG system and doubtless we can do better. But it illustrates that the basic role for low paid JG type work is (contrary to Tcherneva’s suggestions) dealing with the above 5%, not dealing with the grossly excessive amounts of unemployment, which we saw for example in the recent recession (which is not to say there isn't a case for expanding JG a bit during recessions).

Tcherneva’s third para.

This reads, “How do we launch a virtuous circIe? One of the most effective ways is through direct job creation in the public sector. John Maynard Keynes spoke of "on-the-spot" employment (Keynes [1982], 171; Tchemeva 20]2b), while Hyman P. Minsky proposed the employer of last resort (ELR) (Minsky 1986). In both cases, the objective is to bring the job contract to the worker in distressed areas and regions with high unemployment, and to attain true full employment over the long run. One modern proposal inspired by Keynes and Minsky is the job guarantee (]G), in which the public sector provides a voluntary job opportunity, in a community project that serves a public purpose, to anyone who is willing and able to work but unable to find private sector employment.”

As regards “distressed areas”, developed countries have had policies in place since the 1930s, if not earlier, to create work in distressed areas!!!! In fact there’s a very large industrial estate covering several square miles just North of where I live in the UK which was started in the 1930s with precisely the latter objective in mind. That’s the “Team Valley” estate, which is now a hive of economic activity. And those efforts to create jobs in high unemployment areas continued after WWII in the UK and elsewhere.

Moreover, if one of the objectives of JG is to deal with distressed areas and ignore the rest of the country, that’s news to me, plus it will be news to most advocates of JG.

If Tcherneva put her “JG / distressed area” idea to the unemployed in distressed areas their response would probably not be couched in entirely diplomatic language. What people in high unemployment areas want primarily is normal, regular private and public sector jobs. No doubt they wouldn’t object to a few “non-profit / charity / JG” type jobs. And no doubt there’s a case for more JG jobs in distressed areas than other areas. But people in distressed areas do not want EVERY JOB or even every other job to be of the “charity / non-profit” type.

Plus the idea that the charity / non-profit sector can absorb a significant proportion of the unemployed in high unemployment areas is plain delusional.


Well that’s the first three paragraphs of Tcherneva’s paper dealt with. Or rather I’ve dealt with SOME OF the flaws in those paragraphs. Any reader with half a brain will have spotted other flaws.

I won’t be wasting time reading any more of this article. Hopefully I’ve gone some way to establishing the point made at the outset above, namely that some of the leading advocates of JG are not too clued up.

However Tcherneva, like many economists, is good at churning out pages of technical sounding text complete  with references to suitably impressive economists like Keynes and Minsky (mentioned above). That sort of stuff fools 99% of the population and about two thirds of fellow academic economists. So doubtless her job and career are safe.

Wednesday, 17 May 2017

The FERI Cognitive Finance Institute have a sense of humour.

I’m reading this work of theirs. I may do a post on it, but meanwhile I’m impressed by their sense of humour. The following two passages illustrate that.


When Lehman Brothers collapsed and subsequently several other banks in several countries in the US and Europe veered on the brink of bankruptcy, it was apparent that events in the   banking system exert a major impact on the rest of the eco-  nomy, including the future path of economic growth. However,   it is less well known that when journalists interviewed leading   experts in ‘economics’ and ‘finance’, namely professors of  economics and finance at major universities, such as Harvard,   Oxford or MIT, their honest response to the questions from the   journalist should have been: ‘I am sorry, but I cannot comment   on the banking crisis.’ An astonished journalist would have   inquired why this was not possible. And an honest academic would have responded: ‘The economic models and theories I use in my work do not include any banks. None of the leading   macroeconomic models and theories include any banks. We   simply do not analyse banks at all.’  


The futility of such a narrow inflation targeting can be illustrated by the European  Central Bank’s official claim that its monetary policy during  its first decade of operation was not interested in and did not monitor bank credit, economic growth nor even inflation in individual Eurozone countries, but was solely focused on  the aggregate Eurozone inflation target of 2%. When asked at a public meeting whether the ECB would thus consider its  monetary policy successful if half of the Eurozone countries  experienced 52% inflation (a disaster), while the other half experienced 50% deflation (an even bigger disaster), resulting in an aggregate inflation rate of 2%, the ECB’s spokesperson responded with a clear ‘Yes’.

Tuesday, 16 May 2017

Random charts - No.23

Text in pink on the charts below was added by me.

Monday, 15 May 2017

Where will the money come from, minister?


Simon Wren-Lewis (Oxford economics prof) asks whether politicians should have to explain where they’ll get £X from if they propose spending £X extra.

A popular answer to that question is that since a proportion of the money in most years for government spending comes from the deficit (i.e. the money comes from thin air, so to speak), a politician does not need to explain where ALL OF the money will come from for the above £X of public spending.

My answer to that is that the fact of increasing the proportion of GDP devoted to public spending DOES NOT mean that the deficit should increase. I.e. if a politician, speaking just on behalf of his own government department or speaking for government as a whole proposes an £X increase in public spending, then he or she needs to explain where they’ll get £X extra tax from.

Of course I’m glossing over the fact that the stimulatory effect of £X public spending exactly counteracts the deflationary effect of £X of extra tax. But for the purposes of this argument, that bit of “glossing” can perhaps be overlooked.

Hopefully I’ve answered SW-L’s question, but I’m not 100% confident I’ve done so..:-)

Sunday, 14 May 2017

We don’t need to save in order to fund investment?

Michael Kumhof and Zoltán Jakab wrote an article, published by the IMF, a year or so ago entitled “The Truth about Banks”.  The article included the following paragraph, which leaves room for improvement.

“Many policy prescriptions aim to encourage physical investment by promoting saving, which is believed to finance investment. The problem with this idea is that saving does not finance investment, financing and money creation do. Bank financing of investment projects does not require prior saving, but the creation of new purchasing power so that investors can buy new plants and equipment. Once purchases have been made and sellers (or those farther down the chain of transactions) deposit the money, they become savers in the national accounts statistics, but this saving is an accounting consequence—not an economic cause—of lending and investment. To argue otherwise is to confuse the respective macroeconomic roles of real resources (saving) and debt-based money (financing). Again, this point is not new; it goes back at least to Keynes (Keynes, 2012). But it seems to have been forgotten by many economists, and as a result is overlooked in many policy debates.”

The truth is actually as follows.

If extra spending is to take place, assuming the economy is already at capacity, then some reduction in spending must take place to balance that increase, else demand and inflation will become excessive. One possible form of “reduction in spending” is extra saving. Thus, contrary to the suggestion in the above IMF article, saving can fund investment.

However there is no absolute need for the saving to precede the investment spending – by one day, or month or any other relatively short period of time. For example if the entity doing the investment just goes ahead with it, after borrowing money from a bank, and subsequently, a reduction in aggregate spending is brought about somehow or other, e.g. via an increase in interest rates, or increased VAT, that would do equally well.

To summarise, extra spending in the form of extra investment requires reduced spending, i.e. extra saving in some other part of the economy. But whether the extra saving takes place just before or just after the investment spending does not matter.

Saturday, 13 May 2017

Random charts - No.22.

I'm getting tired of Roman numerals, and have changed to Arabic numerals for the titles of this series.
Text in pink in the charts below is added by me.

Friday, 12 May 2017

Bundesbank criticises 100% reserve banking.

That’s in an annex starting on p.30 of a Bundesbank article entitled “The role of banks, non-banks and the central bank in the money creation process.”

The article starts by explaining a point set out in a Bank of England article recently namely that money is created when a commercial bank grants a loan. I.e. “loans create deposits” as the saying goes.

Then in the above mentioned annex, the Bundesbank article criticises 100% reserve banking. One of the first points made is that the existing bank system involves economies of scale. It is not entirely clear whether that is supposed to be a criticism of 100% reserves: i.e. it is not clear whether the implication is supposed to be that 100% reserves DOES NOT involve economies of scale. As the article puts it:

“Lending business involves reviewing loan requests, granting the actual loans and, given the information asymmetries that exist between the lender and the borrower, requires monitoring of the projects being funded through the loans. In performing this monitoring task, banks have one particular advantage in that they harness economies of scale and so reduce the monitoring costs.”

But if the latter point is indeed supposed to be a criticism of 100% reserves, then the simple answer is that 100% reserves involves what might be called “large lending organisations” in much the same way as the existing bank system involves such large organisations. Thus there is no loss of economies of scale under 100% reserves. Alternatively if anyone thinks it is worthwhile setting up a small local “lending organisation” under 100% reserve, then the obstacles to doing so are no more under 100% reserves than under the existing system.

Maturity transformation.

The Bundesbank article then praises an apparent merit of the existing bank system, a merit that would not exist under 100% reserves, which is that under the existing system banks can borrow short and lend long or engage in “maturity transformation” as it is called. As the Bundesbank puts it:

“By making sight deposits available while “simultaneously” investing in illiquid projects, banks provide a maturity transformation service. They create liquidity and give depositors the ability to consume intertemporally, whenever they want to.”

Unfortunately the advantages of maturity transformation (MT) are illusory, as I have explained before, e.g. here and here.

But I’ll repeat and summarise the argument against MT.

As the Bundesbank rightly points out, MT “liquifies” (to coin a phrase) relatively illiquid assets. That is, it turns an illiquid investment or asset into money or near money, which all else equal is convenient for the asset holder.

So if MT is banned, the initial effect is deflationary, as the Bundesbank implies, because the private sector then has a smaller stock of money or “near money liquid assets”. But the latter problem is easily dealt with by having government and the central bank print money and spend it into the private sector until the private sector again has the stock of money that induces it to spend at a rate that keeps the economy at capacity. And doing that costs nothing in real terms. 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."

Bank runs and credit crunches.

Then, in reference to the alleged advantages of MT, the Bundesbank says:

“However, this advantage is offset by the risk of a liquidity problem arising in the event that a bank cannot meet demands to repay deposits. If more depositors than anticipated withdraw their sight deposits – not because they need liquidity unexpectedly but because they fear that other depositors may withdraw their money and cause the bank to collapse – this form of coordination among consumers can trigger a run on banks.”

That’s a good point. Indeed, Messers Diamond and Rajan make much the same point in their paper “Liquidity risk, liquidity creation and financial fragility: a theory of banking.”.

As D & R put it in their abstract and in reference to the liquidity creating characteristics of banks under the existing bank system, “We show the bank has to have a fragile capital structure, subject to bank runs, in order to perform these functions.”

So to summarise, what does MT achieve on balance? The answer is “absolutely nothing”. Or to be more accurate, it creates liquidity / money but at the expense of bank runs, credit crunches etc, when liquidity / money can perfectly well be created in whatever amount is needed to keep the economy working at capacity at zero cost and without incurring the risk of bank runs!

Maturity transformation is a farce!

The net effect of 100% reserves on lending.

The next criticism the Bundesbank makes of 100% reserves is that it does not increase lending by banks. For example on p.32 the article says, “The stricter the regulatory requirements regarding the collateral framework are, the likelier it is that a reserve ratio hike to 100% will be accompanied by a corresponding tightening of the provision of credit and liquidity.”

Well the answer to that is that 100% reserves certainly makes lending a bit more difficult for banks, as indeed the UK’s Vickers commission pointed out (sections 3.20-3.21). I.e. speaking as an advocate of 100% reserve, I have never claimed that it increases bank lending, and far as I can see, same applies to other advocates of 100% reserve, though obviously I cannot claim to have read every single sentence ever written on the subject.

But to claim that increased bank lending is necessarily beneficial is to assume that the existing amount of lending is sub-optimal. Well the first point that casts doubt on that claim is the popular idea that the total amount of private debt is excessive. Indeed, all too often people in high places claim that bank lending needs to be increased, and then in the next sentence or shortly after that, the same self-appointed experts claim private debts are excessive. If those self-appointed experts cannot see the glaring self-contradiction there, they should stop expressing opinions on the subject.

As to exactly what the optimum amount of bank lending is, and what the optimum rate of interest is, I argued for a very conventional answer to that question in this article, namely that the optimum is attained in the same way as the optimum amount of apple or steel production is attained: market forces. More specifically the argument in the latter article is that 100% reserves actually amounts to a free market or something nearer a free market than the existing bank system. The title of that article is “Privately Issued Money Reduces GDP”.

Unfortunately, as I’ve pointed out several times before on this blog, the concept “optimum” seems to be too difficult for many self-appointed experts in high places.

Macroeconomic stabilisation.

The final page of the annex in the Bundesbank article claims that 100% reserve would not bring macroeconomic stabilisation. Well certainly the advocates of 100% reserves have never claimed it would bring perfect stabilisation. For example this work entitled “Towards a twenty-first century banking and monetary system” which advocates 100% reserves, makes it perfectly clear that varying degrees of stimulus and “anti-stimulus” would be needed under 100% reserve, just as they are at present.

However, there is one way in which 100% reserves brings a HUGE increase in stability not mentioned by the Bundesbank, and that is that bank failures are all but impossible under 100% reserve. The reason is thus.

Under 100% reserve, the bank industry is split in two. One half accepts deposits but does not lend on those deposits because they are lodged in a totally safe manner at the central bank. That is eminently logical and (unlike the existing system) totally honest. Reason is that a bank deposit is supposed to be totally safe. That is plain incompatible with lending on relevant monies, because borrowers are not totally reliable.

So that half of the bank industry cannot fail.

The other half of the bank industry lends, but is funded by equity or something similar, e.g. bonds that can be bailed in. That half of the industry cannot fail either. Reason is that if loans made turn out to be worth say only half of book value, then all that happens is that shares in the bank approximately halve in value: the bank does not go insolvent.

 Shadow banks.

One of the final criticisms of 100% reserves made by the Bundesbank is one that has been made many times before, and rebutted an approximately equal number of times. That is the claim that if money creation by commercial banks is banned (i.e if MT is banned) small organisations, shadow banks perhaps, will spring up to exploit the newly available gap in the market. As the Bundesbank article puts it, “Moreover, there is a risk of evasive action being taken in that new, non-regulated institutions could be set up to fill the gap.”

Well one answer to that point was given by Adair Turner, former head of the UK’s Financial Services Authority. As he put it, “If it looks like a bank and quacks like a bank, it has got to be subject to bank-like safeguards.”

Much the same applies for example when it comes to safety rules in the construction industry. It does not matter whether a construction firm employs three or three thousand people: all construction firms have to obey the same safety rules.

Second, the idea that banks, small or large will try to evade regulations is not exactly an original observation: it makes no difference what banking laws are put in place, one thing is 100% certain and that is that banks will try to evade those laws. But the big merit there of 100% reserves is the extreme simplicity of the laws or rules. Simple laws are relatively easy to enforce. The basic rules of 100% reserves can be written on the back of a small envelope, unlike Dodd-Frank which occupies a good ten thousand pages. The basic rules are:

1. Loans can only be funded via equity or similar. 2. Deposits must be lodged in a totally safe manner. That’s it!

Third, it is not easy for very small banks to create money or near money. If you were offered a cheque drawn on a bank you’d never heard of, would you accept it? Probably not. Thus if for example the hundred largest banks (regular banks and shadow banks) in a medium or large country are forced to obey the rules of 100% reserve, that probably solves the problem. A few small banks or quasi banks trying to evade the rules is unlikely to be a significant problem.

Monday, 8 May 2017

More support for the “Bernanke / Positive Money” system.

Positive Money has long advocated a system under which stimulus takes the form of simply printing more base money and spending it (and/or cutting taxes) while the total SIZE of the deficit is decided by professional economists (e.g. by the central bank). As for obviously POLITICAL decisions like what proportion of GDP is allocated to public spending and how that is split between health, education, law enforcement and so on, those decisions remain with politicians. E.g. see the submission to Vickers authored by Positive Money, the New Economics Foundation and Prof Richard Werner, entitled “Towards a twenty-first century banking and monetary system”.

Bernanke also recently suggested that arrangement would have merits. See para starting “A possible arrangement…” in this Fortune article entitled “Here’s How Ben Bernanke’s “Helicopter Money” Plan Might Work.”

Note that that system DOES NOT reduce democratic accountability. Reason is that under the EXISTING SYSTEM, the final word on the amount of stimulus is taken by the central bank in that the central bank (at least where the CB is relatively independent) can nullify what it sees as excessive fiscal stimulus implemented by politicians using CB implemented interest rate rises.

Support for a system of the latter sort has recently come from Nobel laureate economist Eric Laskin. See Bloomberg article entitled “A Nobel Winner’s Radical Proposal to Solve the Euro Area’s Woes.”

Note that while the above mentioned work by Positive Money and co-authors advocates full reserve banking, full reserve is not an essential ingredient in a system where central banks (or some other committee of economists) decide the total size of a stimulus package. In fact neither Bernanke nor Laskin mention full reserve.

Apart from the latter full reserve point, there are other small differences between Laskin’s proposal and Positive Money’s. But there are any number of variations on the basic theme here.

It’s nice to see another supporter of the “basic theme”, especially a Nobel laureate.

Sunday, 7 May 2017

What’s the optimum or GDP maximising rate of interest?

Absent any particularly good reason for thinking otherwise, it is reasonable to assume the optimum rate of interest, i.e. the optimum price for borrowed money is determined in the same way as the optimum price for apples or anything else: supply and demand. In fact that is a standard assumption made in economics, i.e. it is normally assumed in economics that absent what economists call “market failure” market forces should prevail.

In the case of apples, apple growers and apple consumers, i.e. households, effectively meet in a market. Consumers buy whatever amount of apples they want at the going price. Producers produce whatever amount they think is profitable, and so on.

So the optimum rate of interest is presumably determined the same way. That is, the optimum rate would obtain where borrowers and savers effectively meet in a market.

Now apples are purchased with money. Nothing wrong with that. But suppose apple wholesalers managed to boost the purchase of apples by printing apple tokens which could be used for the purchase of apples. Those tokens would effectively become a form of money.

Not only would it be possible to use the tokens for the purchase of apples, but the mere fact the tokens being in effect worth a specific number of apples would make the tokens good for the purchase of other goods and services. Exactly the same applies to tokens issued by firms in other industries, e.g. air mile tokens issued by the airline industry.

Air mile tokens and the like CAN BE restricted to the person who has earned the air miles. But equally, if airlines so choose, airline tokens can be good for the purchase of flights with any airline. (Personally I don’t fly much, so I’ve no idea which of those two options the airline industry goes for. And it doesn’t matter for the purposes of this article).

As with apple tokens, if airmile tokens are accepted by every airline or almost every airline, and if almost everyone flies regularly, then airmile tokens become as good as cash.


There is however a problem with specific industries issuing tokens used in the first instance for the purchase of that industry’s products. Suppose the economy is already at capacity (aka full employment). As pointed out above, apple tokens are as good as cash because almost everyone purchases apples. And if the private sector’s stock of cash is increased when the economy is already at capacity, the effect is inflation.

Alternatively, if the economy is NOT AT capacity, the extra tokens / cash may not matter if the volume of tokens issued is not excessive. Indeed, the extra tokens / cash might bring the economy up to capacity without causing excess inflation.

But in either case, one thing is for sure: if extra demand is created by the printing of “apple cash”, the result will be an entirely artificial boost for apple growers: that is, the number of apples sold and bought will be above the GDP maximising level.


Doubtless some readers will have tumbled to where this is leading. But for the benefit of those who haven’t….

Private banks do exactly what apple wholesalers do in the above hypothetical example. That is, private banks print or issue their own tokens which can be used in the first instance for the purchase of the product that banks have to offer, namely loans.

Plus, as with apple tokens, once private bank issued money or “bank tokens” have been spent by the initial users of those tokens (i.e. those who borrow from banks), those tokens go into general circulation and are used as cash.

Private bank issued tokens / cash is not actual cash (in the sense that it is legal tender – i.e. central bank issued cash). Anyone can turn down private bank issued tokens / money on the grounds that it is not legal tender. But that does not happen very often.


Apple tokens, if they were issued, would not be desirable because they would result in an excessive or “non GDP maximising” number of apples being sold and bought.

Exactly the same applies to private bank issued money. It results in an artificially low rate of interest, and hence in an artificially high level of lending of debt.

And finally, this article is dedicated to all Cumbria apple pastie producers and (without his permission) to Nick Rowe who has used apples on dozens of occasions to illustrate various aspects of economics.

Saturday, 6 May 2017

Jo Michell’s criticisms of Positive Money and full reserve banking.

Michell teaches economics at the University of the West of England. I follow him on social media because he is a constant source of ideas.

I agree with some of his criticisms of Positive Money (PM) in this article of his. Title of the article is “Full reserve banking: the wrong cure for the wrong desease”. But on balance he doesn’t seriously dent the case for full reserve banking (FR). Reasons are thus.

1. Michell starts by criticising the popular and fallacious “continuous growth” argument. That’s the idea that when private banks make loans, the economy has to expand otherwise it will not be possible to pay interest on the loan. Ergo, so the argument runs, the existing bank system requires continous growth, which in  turn degrades the environment.

The flaw in that argument is that anyone borrowing from a bank can perfectly well pay interest on a loan, despite their income being constant if they cut down on some other form of spending. Simple.!!! Put another way, if person X saves money and lends it to Y at interest instead of making product Z and selling it to Y, Y will then pay money to X in the form of interest instead of giving money to X as payment for product Z.

However the fact that the continuous growth argument is nonsense is not a good criticism of FR because PM is nowhere near the only advocate of FR: at least four economics Nobel laureate economists have supported the idea, e.g. Milton Friedman and James Tobin. Those economists (and others) do not cite the environmental or continuous growth arguments far as I can see – and I’ve read large amounts of their material.

2. In the para starting “To the average person…” Michell’s accuses PM of using psychological tricks to make people feel uneasy about the existing monetary system. Well fair point: but then PM is a pressure group, not an economics text book. Other pressure groups, political parties etc use psychological tricks.

That’s normal. Plus most supposedly impartial “objective” economists use emotive language. They shouldn’t. But I don’t abstain from emotive language, so I can’t complain.

3. Michell’s then criticises an idea long pushed by PM along the lines that private banks create money when they make loans (on which interest is paid) ergo privately created money forces people to pay interest to private banks for the simple privilege of having money with which to do daily business. (See para starting “The ‘real’ (non-financial)…”)

I agree with  Michell:  i.e. where banks charge interest, they do so in respect of loans. And to the extent that they simply supply customers with money with which to do daily transactions, it would not make sense for them to charge interest, though it does make sense to charge for administration costs. I set out detailed reasons on that point in section 7 of an article of mine entitled "Privately issued money reduces GDP".

4. Michell then deals with PM’s claim that stimulus should come in the form of the state simply printing new money and spending it, and/or cutting taxes. See paragraph starting “Oddly, despite the environmental argument…”.

Michell says, “Further, the conflation of QE with the use of newly printed money for government spending is another example of sleight of hand by Positive Money. QE involves swapping one sort of financial asset for another – the central bank swaps reserves for government bonds. This is a different type of operation to government investment spending – but Positive Money present the case as if it were a straight choice between handing free money to banks and spending money on health and education.  It is not. It should also be emphasised that printing money to pay for government spending is an entirely distinct policy proposal to full reserve banking – which do would nothing in itself to raise infrastructure spending – but this is obfuscated because PM labels both proposals ‘Sovereign Money’.”

I agree with Michell there. About the only excuse I can offer for PM’s error there is that numerous other people have fallen for what might be called the “green / infrastructure QE” illusion. One is Richard Murphy.

5. Give £7,000 to everyone instead of traditional QE?

£7,000 is approximately the total amount of QE done per household, and Michell says “Further, the conflation of QE with the use of newly printed money for government spending is another example of sleight of hand by Positive Money.” I agree. Indeed PM have published material suggesting the average household would have enjoyed spectacular increases in income if the £7,000 (or a significant fraction of it) had been paid direct to households or spent on infrastructure or similar.  Reason why that’s a sleight of hand is that QE has little effect on demand, whereas spending £7,000 for every UK resident on infrastructure or helicopter drops or similar would have a HUGE EFFECT on demand: indeed it would be positively inflationary. I.e. PM should make it clear that the alternative to £7k of QE is not £6k or £5k going straight to households. At a wild guess, it’s probably more like £1k

6. Small banks, shadow banks, etc.

Next, in a para starting “The same is true..”, Michell makes a criticism of FR which has been made dozens times before, and demolished an equal number of times. It’s the idea that FR would deal only with large regular banks, while failing to deal with the smaller unregulated banks or quasi banks.

The answer to that was given by Adair Turner when he said “If it looks like a bank and quacks like a bank, it has got to be subject to bank-like safeguards…”. I.e. no organisation which acts like a bank should be excused obeying bank regulations. Building firms, whether they employ three or three thousand people have to obey similar rules, e.g. as regards health and safety. There is no reason why banks cannot be regulated similarly.

Moreover, even if the smallest shadow banks are not regulated, that does not matter too much: if say the hundred largest banks, regular and shadow, ARE REGULATED, that cracks the problem basically.

7. Seigniorage.

Michell then criticises the claim by PM that money creation by private banks enables them to enjoy seigniorage profits. As he puts it, “There is simply no reason why the act of issuing money generates profits in itself.”

Well strikes me there is a very simple and obvious reason why money creation results in profits: to the extent that banks simply lend out “home made” money, the borrower and the bank obtain a valuable asset (e.g. a house) in exchange for mere bits of paper or book-keeping entries. Nice work if you can get it.

However, the latter is an over-simple view of what banks do. It is more realistic to say that banks’ freedom to create money enables them to lend at an artifically low rate of interest, and that’s where the profit lies. I.e. the latter seignorage profit is actually shared by all mortgagors and by those who fund banks (shareholders, bond-holders, etc).

Joseph Huber in his work “Creating New Money” alluded to the latter interest rate point. As he put it:

“Allowing banks to create new money out of nothing enables them to cream off a special profit. They lend the money to their customers at the full rate of interest, without having to pay any interest on it themselves.”

In short, strikes me that what’s wrong with the existing bank system is the latter point of Huber’s rather than seignorage in the standard sense of the word and I enlarge on that in the above mentioned article of mine.

8. Milton Friedman.

Michell ends with a short discussion of Friedman’s ideas, which is of relevance since Friedman backed FR. But Michell makes the following strange claim about Friedman, “Like PM, he favoured a simple monetary solution: the Fed should print money to counteract the effect of bank failures.”

Well I’ve just looked at Friedman’s 1948 paper “A Monetary and Fiscal Framework for Economic Stability” in which Friedman advocates full reserve and money printing by the state. The phrase “bank failure” does not appear. Moreover, while the word “bank” appears about fifteen times, there is no suggestion that Friedman wants to have the state print money so as to rescue banks.

Indeed Friedman is quite clear that when entities in the half of the bank system which lend make poor lending decisions, shareholders take a hit or get wiped out.
That’s very much in line with Friedman’s pro-free market outlook.  In contrast the ACTUAL PURPOSE of money creation by the state as far as Friedman is concerned is exactly as envisaged by PM: it’s to provide general STIMULUS. Friedman is not bothered about the extent to which banks or “lending entities” benefit from that stimulus, and quite right too. Incidentally Friedman also advocated FR in his book “A Program for Monetary Stability” (mainly in the 2nd half of Ch3).

9. Financial instability.

Finally, there is an omission from Michell’s article as follows.

He says quite rightly that one of PM’s central claims is that FR reduces “financial instability”. But he does not say whether he thinks PM is right or wrong there.

In fact FR brings a HUGE INCREASE in financial stability in that it’s plain impossible for a bank to fail under full reserve. Reasons are simple and as follows.

As regards the half of the bank industry which simply accepts deposits, it cannot go bust because all those deposits are lodged at the central bank. And as to the half of the industry which makes loans, it cannot go bust because it is funded by shareholders (or something similar like bonds which can be bailed in). Thus if (to take an extreme scenario) a bank makes a series of seriously stupid loans, and the bank’s assets (i.e. those loans) become worthless, then the value of its shares and bonds become worthless as well. But the bank is not bust in the sense that its liabilities exceed its assets.

10. Conclusion.

Having set out the flaws in several of PM’s and Michell’s arguments, some readers may be left wondering what, if any, are the arguments for FR. The answer is, basically, the one alluded to in the above quote from Joseph Huber. I.e. the right that commercial banks have to print money is effectively a subsidy of those banks. I go into that point in more detail in the above mentioned article of mine.

Incidentally PM themselves also cite that “subsidy” argument in this short video. Thus PM’s basic error is what might be called their “scattergun” approach. I.e. they cite too many arguments against private money creation. Some of those arguments, as Michell rightly points out, are flawed.

Monday, 1 May 2017

Random charts XXI.

Text in pink on the charts below was added by me.

Sunday, 30 April 2017

World Economic Forum article claims private banks don’t create money.

The article is entitled “Do banks really create money out of thin air?” though the WEF do not officially endorse the arguments in the article.

The article starts with the hypothetical example of person S who sells a house to person B. “S” is obviously short for “seller” and “B” is obviously short for “buyer”.

The initial assumption is that B does not have any cash, so after the sale, B simply becomes indebted to S for the value of the house. And that, as the article rightly points out, is an arrangement which will not suit the vast majority of house sellers. Among other things, it involves S in collecting regular repayments and interest in respect of the debt from B for 20 years or so.

Next, the article explains that banks can help with the latter problem: a bank can open an account for B, credit the account with an amount of money equal to the value of the house (produced from thin air), which B then pays to S. S is now relieved of the inconvenience of collecting the debt from B, plus S has money with which to buy an alternative house.

But despite the obvious admission referred to in the latter paragraph that a bank has in fact created money from thin air, the article in the final paragraph then says:

“But this is only the prima facie appearance and not the truth of the matter because the outside observer has neglected to acknowledge that the deposit value records the value-for-value exchange conducted through an underlying transaction.”

Well the cognoscenti (which includes me needless to say) have always been aware that commercial bank created money nearly always RESULTS FROM the desire of people and firms to do business. I.e. if B did not have any need for a large amount of money, there’d be no point in B going along to a bank and asking for a loan, would there? But the fact that that money creation results from something or other does not stop that money creation being money creation, unless I’ve missed something.

The second flaw in the latter final paragraph, is that in fact banks will create money even where there is no immediate desire to do business. This is unusual, but if a particularly credit worthy bank customer went along to a bank and said “I have no immediate business deals in mind, but please lend me a million so that when a profitable looking deal comes my way I can pounce on it.”, the bank might well go along with that (and of course charge for the service provided). 

Friday, 28 April 2017

Private banks do not charge interest in respect of the money they issue.

There is a popular myth to the effect that the above is the case. The myth is promoted by among others, Positive Money, an organisation I actually support because PM gets many things right. Also Bryan Gould (former member of the UK Labour Party shadow cabinet) seems to lend credence to the myth.

The idea that private banks DO CHARGE interest in respect of the money they issue stems from the “loans create deposits” phenomenon: that is, when a bank makes a loan, it does not need to get the relevant money from depositors or from anywhere else. It can simply open an account for the borrower and credit $X to the account – the money comes from thin air. The bank then charges interest on the loan.

Thus banks do two things there: first, create money, and second, charge interest. Ergo, so it might seem, they charge interest on the money they have created.

The flaw in that argument is that banks either charge for the loan or for the money. They cannot charge for both. I.e. if a bank charges 5% interest, is that for the loan or is it the lucky recipient of the money who is charged?

Take the case of a loan for $X which is granted to Y, who then spends the money, which ends up in the bank account of Z. There is no doubt that Y pays interest to the bank. But Z, the recipient of the money doesn’t.!! If anything, Z charges his or her bank interest (or put another way, Z’s bank will pay interest to Z, particularly if the money is put into a term account.)


Double checking the argument.

By way of double checking the above points, consider an economy where there was no borrowing or lending, but people did (understandably) want a form of money. And let’s say that money is supplied by, or at least supplied almost exclusively by private banks.

Those banks would open their doors for business. Customers would ask to open accounts and would ask for some specific sum of money to be credited to those accounts to enable day to day transactions to be done. Banks would demand collateral as appropriate.

Certainly banks would charge for ADMINISTRATION  costs there (e.g. the cost of checking up on the value of collateral). But there would at that stage be no reason to charge INTEREST because no real resources would at that stage have been transferred by banks to customers.

Moreover, even after customers started spending their money, there would still be no very good reason for banks IN THE AGGREGATE to charge customers in the aggregate for interest. Reason is that money leaving one account must arrive in some other account. (To keep things simple, I’ll assume there is no physical cash – a not totally unrealistic assumption, given that it looks like physical cash will disappear in the near future.)

Of course where specific customers ran down their bank balances, and left them in a “run down” state for extended periods, banks would charge interest to those customers. But in that case, real resources would have been transferred to those customers for an extended period. That is, the only way for that “extended run down” to occur is for relevant customers to buy stuff off other customers and leave it at that. I.e. the latter “buyers” would in effect be borrowing from the latter sellers with banks acting as intermediary. Sellers, would understandably want interest, and that interest would be passed on to buyers.



Banks charge interest on loans. They also charge for administration costs when supplying customers with day to day transaction money. But it would not make any sense for banks to charge interest simply for supplying all and sundry with day to day transaction money.

Monday, 24 April 2017

Random charts XX.

Text in pink on the charts below was added by me.