Dedicated to the reform of economics
"The study of money, above all other fields in economics, is one in which complexity is used to disguise truth or to evade truth, not to reveal it. The process by which banks create money is so simple the mind is repelled. With something so important, a deeper mystery seems only decent."
– John Kenneth Galbraith writing in 'Money: Whence it came, where it went' (1975).
"While a sound monetary system such as our own can, like the sanitation system, be used to promote the interests of society as a whole, the system can also be captured by what is often described as ‘the money interest’ or ‘money power’.
The idea that money matters is not difficult unless you have had an education in economics from an institution of higher learning. In modeling the real economy, the conventional treatment casts money as merely a means of exchange, which facilitates the movement of goods and services.
Real Business Cycle models are "real" only in the narrow economic sense, of being adjusted for inflation. In this view, money is a veil behind which the activity of the economy is essentially barter.
The conventional view is that money simply mechanically multiplies from central bank "printing." This is exogenous, from outside. This in spite of now five years of empirical data showing no such relationship.
"Endogenous" money is key to the correct understanding of economic events. It is the fact that money does not mechanically multiply from central bank action, but arises from credit creation -- debt creation. Money occurs "out of thin air" when banks make loans. Relying on nothing other than the promise of repayment, the bank makes a deposit of money in the creditors account.
The principle of endogenous money gained confirmation from the Bank of England recently.
‘Banks do not act simply as intermediaries, lending out deposits that savers place with them, and nor do they ‘multiply up’ central bank money to create new loans and deposits … Commercial banks create money, in the form of bank deposits, by making new loans.’
‘Money creation in the modern economy’ Bank of England Quarterly Bulletin, 2014 Q1
As Ann Pettifor has said,*
Money creation must be understood within the context of the economy as a whole.... It is important to emphasize that the money for a loan is not in the bank when a firm or an individual applies for a loan. It is the application for a loan that results in the creation of deposits.... Without applications for loans, there would be no deposits.
In other words, while the banker or bank clerk plays a critical risk assessment role in the ‘creation of money out of thin air’, and while the state plays an equally critical role in transforming that private loan into public fiat money, it is the myriad numbers of ... borrowers who are the real spur for the creation of money. When entrepreneurs and other borrowers apply for loans, they help create money (deposits) ‘out of thin air’.
If entrepreneurs and other borrowers do not apply for loans [or if lenders do not extend credit] (because interest rates are too high, terms too tough, confidence low or business slack) the money supply shrinks... and deflation may ensue. If the demand for and supply of loans exceeds the economy’s real potential then the money supply expands and inflation (of assets as well as wages and prices) is an inevitable consequence.
In a well-managed monetary system, private bankers should be regulated by the central bank to ensure that applications for loans are carefully assessed as both affordable and repayable, and that loans are aimed at facilitating transactions between economic actors engaged in productive, income-generating activity. Lending or borrowing for gambling and speculation would be restrained or even prohibited. Speculation, after all, does not increase an economy’s productive capacity, but speculative fevers increase both the risk that borrowers will not make the capital gains needed to repay debts and wider systemic risk.
While a sound monetary system such as our own can, like the sanitation system, be used to promote the interests of society as a whole, the system can also be captured by what is often described as ‘the money interest’ or ‘money power’.
It is the fate of the ... economy presently to be in the grip of a small, wealthy elite who effectively wield ‘despotic power’ over society as a whole.
Wrenching that power away and ensuring the monetary system serves not only the private interests of the wealthy but all of society, including the public sector, is a vital challenge to our democracy. Ensuring that the financial system is the servant, not master, of the economy cannot be achieved on the basis of flawed monetary and economic theory.
Ann Pettifor, "Out of thin air - Why banks must be allowed to create money," 25th June 2014, PRIME