Since the financial crisis there is a far greater public awareness about the nature of money. Most importantly the idea is getting across that private banks are able effortlessly to create money from nothing. This ability is a very big deal, not least a massive privilege – pretty much a licence to print money and to reap very rich rewards.
This awareness is in large part thanks to ‘civil society’ (CS) campaigners who have worked tirelessly to de-mystify matters that are of the greatest importance to economics and political debate.
As far as I am aware, the vast majority of the economics profession has chosen to ignore this work.
But a couple of weeks ago, academic economics from the ‘post-keynesian’ tradition responded (see end note for clarification). The title of Giuseppe Fontana and Malcolm Sawyer’s (FS) review essay says it all: “Full Reserve Banking: More ‘Cranks’ Than ‘Brave Heretics’” (it is published in the Cambridge Journal of Economics, the link has been updated to one with free public access).
Their targets are works by the NGOs ‘Positive Money’ (notably Modernising Money by Andrew Jackson and Ben Dyson) and the new economics foundation (e.g. Where Does Money Come From? by Josh Ryan-Collins, Tony Greenham, Richard Werner and Jackson again). Another target is a contribution from the IMF (The Chicago Plan Revisited, by Benes, J. and Michael Kumhof – the latter now ‘senior research advisor’ at the Bank of England).
As the title suggests, Fontana and Sawyer object specifically to the idea of ‘full reserve banking’ (FRB). FRB is common to many (though I am not sure whether it is all) of civil society’s initiatives. The logic runs (very crudely):
- private banks create credit
- private banks act recklessly and over-lend to disastrous effect – causing e.g. the financial crisis
- so private banks should not be allowed to create credit. They should be allowed only to loan what has been deposited with them (that’s the full reserve bit)
- any expansion (or contraction) of the money supply should instead be the responsibility of the central bank.
Much of Fontana and Sawyer’s argument is technical, but there are some key points. They reject the idea that any such system would be more stable (given presumably that it is even possible to control money in this way). They claim that civil society organisations ignore non-banks, “deemed to have been the main cause of the Great Financial Crisis of 2007” (p. 6). They also argue that the civil society proposals have an inherently deflationary bias, “quite likely to produce recessions and financial instability” (p. 7). They object strongly that the proposed systems are very close to monetarism in spirit, given that under their schemes the authorities are responsible for the supply of money and the apparent acceptance of the monetarist relation between money and inflation. They explain in some detail how government spending could be unnecessarily restrained under FRB proposals. I will leave it to the targets of the Fontana and Sawyer critique to defend themselves against these charges.
For me the key point concerns the baby and the bathwater.
As the authors of this journal review write: “one of the main lessons from the work of Minsky and other Post Keynesian economists is that the demand for, and supply of bank loans via the financing of the production of goods and services (investment) are an integral aspect of the operation of real-world economies” (p. 8).
I agree with very much of this. For me, economic and social advance and an effective monetary system have gone hand in hand through 5000 years of history. To discard the system because it has malfunctioned – no matter how disastrously and inequitably – is to throw the baby out with the bathwater. We do not ban fire because fire can get disastrously out of control. Money, with its awesome but sometimes terrible properties, is still one of humankind’s great inventions or social technologies.
But while Fontana and Sawyer celebrate the positives of money, they barely touch on the negatives – beyond remarking almost incidentally “the creation of money also opens the door to fraud and unsafe banking procedures and the use of loans to fuel asset price bubbles” (p. 8).
Civil society organisations have been motivated by crises; by the realisation that the financial system has failed disastrously. And that is surely fair enough. In Fontana and Sawyer’s review there is no sense of the scale of the failure of the system, and of whether there is need for fundamental reform (recognising this is only a review essay, not a statement of their perspective in full). At one point they seem to be at the other extreme to civil society, with the credit system a vital protection against financial crisis: “Therefore, the creation of money through the lending activity of banks is essential in order to accommodate the financing needs of capitalist economies, and to generate the cash flows which will prevent the occurrence of real and financial instabilities” (p. 8).
It seems both Fontana and Sawyer and civil society organisations think these crises are inherent to capitalism: “Advocates of FRB seem to agree with Keynes that capitalist economies are monetary economies and as such prone to crises and instabilities” (p. 8).
For me there is a middle ground, which – contrary to the preceding statement – is where Keynes stood. This middle ground was defined by his liquidity preference theory of interest. Higher employment and financial and economic stability depended on managing money at a low rate of interest (the latter involving debt management policy, capital control and the rest). Interest rates seem scarcely to feature in either Fontana and Sawyer’s review, or indeed in the narratives of civil society.
There are very legitimate concerns about the prominence of FRB proposals in public debate around money, and of the associated dangers of discrediting all variants of monetary theory and proposals for monetary reform. I presume it is for this reason that Fontana and Sawyer have gone in so hard. They fear, in their language, the misleading doctrine of the ‘cranks’ overwhelming the rightness of the ‘heretics’.
But as noted at the start, civil society organisations are raising questions in the public mind that academia has not managed to raise. Indeed they have seemingly provoked the Bank of England to publicly concede that banks create money and point out that mainstream textbooks are generally wrong on this fundamental point. This is a very non-trivial admission (the first time in history?), serving somehow to vindicate the work of all of us.
I like to hope that the debate around monetary reform has barely begun. It is right that differences are in the open. We will be best placed in the future if the various factions listen and learn from each other.
FS classify ‘modern’ Post Keynesian economists as embracing the ‘endogeneity of money’, and list the following variants:
French and Italian circuitists – Graziani, Parguez and Seccareccia
Horizontalists – Lavoie, Moore, Rochon
Structuralists – Wray, Palley, Dow
Fundamentalists – Davidson
Sraffians – Pivetti, Brancaccio and Fontana
Kaleckians – Sawyer
I wonder if this is not exhaustive and, though already complicated, over-simplifies the positions of all scholars of Keynes and post-Keynesian economics. Plainly these complexities are not an advantage in setting out a coherent challenge to the mainstream. “The only people we hate more than the Romans are the f*****g Judean People's Front” and all that.