Tuesday, 26 August 2014

The New Money Creation Process

The focus of Chapter 7 (Jackson & Dyson 2012) is on the issues surrounding the new money creation process. The first question is who should have the authority to create money (pp. 203-204). Under the current system, only the Bank of England can create physical currency (i.e. notes and coins) but digital money is created by commercial banks or the Bank of England. Under this system, no one group controls the amount of money in the system. Is this a good process? Who should have the authority to create money?

Jackson and Dyson argue that those responsible for the creation of money should not be able to benefit personally from the creation of money. To do so would mean that there is a conflict of interest. In the current system, bankers are rewarded for issuing loans and in the process of issuing loans, they create money. Indirectly, there is personal benefit to the bankers and therefore a conflict of interest.

The proposed system

Giving the responsibility to politicians could see them sanctioning the creation of money in order to buy votes. The proposal is therefore to have a money creation committee (MCC) as part of the Bank of England that has responsibility for the creation of money and to leave the politicians with the decision on how the money is used. This provides a separation of responsibilities and reduces the possibility of personal gain (p 206). It also aims to avoid influence from bank lobbyists.

Jackson & Dyson propose that appointments to the MCC should be ratified by a cross party group of MPs. This avoids the chancellor or government having too much control over appointments and thus gaining a committee that favours government policies. The objective of the proposed method of selecting members of the MCC is to try an avoid influence on their selection however, in my view, there is no way to be totally independent. The selection will be influenced by what are perceived to be the current desirable skills for committee members. This is most likely to include appointing bankers. economists, and business people who are likely to maintain the current direction in the economy. From my perspective, all humans are biased in their decision making and I would expect the committee members to be influenced in some way in their decision making. The issue is how to minimise the opportunity for this to provide personal gain or be influenced by a specific interest group in the economy.

The operation of the committee also needs to be designed to ensure that members of the committee have no personal chance of gain from money creation. It is proposed that the committee be responsible for maintaining an inflation target in the same way as the current monetary policy committee (p 207). As well, they should consider how to maintain an appropriate amount of new business lending and to prevent price bubbles in markets like the property market.

How much money to create?

Estimating how much money is needed in the economy is a difficult task. The proposal is that rather than the MCC trying to estimate how much money needs to be in the economy, they should try to determine how much change is required. Jackson and Dyson say, the MCC needs to “take a view on the likely future path of the economy in addition to reacting to economic events” (p 208). They acknowledge that it is not possible for the MCC to predict perfectly the growth needed in the money supply. What is important is “Who is likely to supply the economy with the 'correct' amount of money”? (p 208). The MCC needs to consider the interests of the national economy.

Accounting and mechanics for money creation (pp 210-211)

This section describes the general principles that should be applied for the accounting for money creation. Jackson and Dyson contend that cash and bank deposits should not be recored as liabilities nor held as assets against liabilities. They argue that “electronic, state-issued money will be an asset of the holder but not a liability of the central bank or the Treasury” (p 210). They argue that there is no need for an asset backing for the currency. The value comes from the willingness of people to exchange it for goods and services.

Money should simply be “a number in an account at the Bank of England” (p 211) and should be electronic tokens held in custody for the owners. Newly created money is a non-repayable grant that is placed into the Central Government Account at the Bank of England.

How money should be spent into the economy (pp 211-216)

The decision of how newly created money is spent should be seen as a government decision and it is expected that it would increase government spending. The government could decide to cut taxes, make a direct payment to citizens, or pay down the national debt. Jackson and Dyson contend that paying down national debt is placing the money into the financial sector when it really should be targeted at the real economy.

As part of the Bank of England's responsibilities is ensuring that the economy does not suffer through a lack of credit. Rather than the bank lending directly to businesses, it would lend the money to commercial banks and it would be recirculated on repayment back into the economy through government spending.

Reducing the money supply (pp 216-218)

Although Jackson and Dyson contend that this is unlikely in a growing economy, any proposal has to consider the possibility that there is a need to reduce the money supply. This is most likely to occur when the growth is limited or nearing zero. In such situations, there is likely to be excess money in the economy causing inflation. It is proposed that the Bank of England could remove money from the government account, sell securities and remove the money gained, not rollover loans to the banking system, or not recirculate the 'conversion liability'.

Conclusion

This chapter has focussed on the mechanisms for money creation and distribution. Under the current system, the Bank of England endeavours to control how much money is in the economy by setting the base interest rate. This is an indirect control over the amount of the money in the system (I am inclined to argue that this can be seen in recessions where the interest rate is dropped but it doesn't immediately stimulate borrowing and economic growth.

References

Andrew Jackson and Ben Dyson (2012) Modernising Money: Why our monetary system is broken and how it can be fixed. London: Positive Money.