Saturday, January 27, 2018

Diamid - The Production of Money: How to Break the Power of Bankers – by Ann Pettifor

An interesting article on Ann Pettifor's book, The Production of Money: How to Break the Power of the Bankers 
Ann Pettifor is a director of Prime Economics, which advocates for a more Keynesian view of macroeconomics, and has been involved in development and environmental economics for many years. In The Production of Money: How to Break the Power of the Bankers (Verso, 2017) she correctly identifies that ‘money enables us to do what we can within our limited natural and human resources’, and so ‘creates economic activity’ rather than being a result of it. It does this by creating the finance needed for productive employment and investment. Bank finance ensures that there is never a ‘shortage of money’ and so we are only limited by humanity’s capacity and the physical ecosystem. Yet when 95% of the money in existence has been created by the commercial banking system, whose aim (quoting Michael Hudson) ‘is not to minimise the cost of roads, electric power, transportation, water or education, but to maximise what can be charged as monopoly rent’, this power must be rigorously regulated. So much should be uncontroversial today and I have written about this here.

The second main part of Pettifor’s argument is that because money is a social construct, then so are interest rates. ‘Savings are not necessary to fund purchases or investment’ because banks can create money along with debt. Saving in the sense of obtaining a financial claim, whether a banknote, deposit, bond or share, always requires the prior issue of a debt from a process that involves time – an investment. The saving flow is a consequence of the investment flow rather than the reverse. This financial sense of saving is contrasted with the physical sense of saving a commodity for later use rather than consuming it now. If saving follows automatically from investment, interest rates do not derive from a supply and demand nexus for savings and investment but from the costs of issuing the debt that sets the whole process off.
But Diamid has some criticisms of Ann Pettifor's book -
I find some issue with her discussion of interest rates. Since ‘credit is essentially a free good’ if prior savings are not required, then interest rates charged to borrowers are ‘socially constructed’ just as money is, she argues. Yet this seems incorrect – banks may not be providing a scarce commodity when they create money, but they are providing a service for which the required resources such as monitoring attention, the capacity to make good the losses of debt default and the infrastructure required to attract deposits are all limited. Even if access to central bank reserves is cheap, the cost of acquiring these and other resources needs to be set off against the interest rate revenue received. The puzzle then becomes why banks have so often miscalculated the default risk element of their lending costs – an element which has no direct connection to the level of the bank rate. Interestingly the critique of the free-market Austrian school of economists, while ignorant of the workings of the finance system and mistakenly clinging to the idea that there is a ‘natural’ rate of interest that matches supply and demand for savings, also blame interest rates for the Great Financial Crisis. In their case, however, they believe that central banks set rates too low in the run-up – creating a demand for investment that exceeded the savings available. But the same critique applies – the cost of reserves alters the potential gains on a risky loan, but should not make the calculation of that risk more prone to error.
Another doubtful issue raised by Pettifor is the apparent exponential nature of debt growth linked to the compounding of interest. Interest only compounds if it is unpaid. If it is paid as it comes due it is recirculated as purchasing power by the recipient bank. A loan created where compounding is anticipated is recklessly risky for both parties – why should it be contemplated under normal business incentives? A productive loan (and this may mean various things, including the welfare benefit of time-shifted consumption) creates an income flow that exceeds outlay, allowing profit for the borrower and interest revenue for the lender along with debt repayment. There is no inevitability of the exponential rise in debt – it is not driven intrinsically by the way money and credit are created by banks.


Ralph Musgrave said...

"Savings are not necessary to fund purchases or investment because banks can create money along with debt." Absolutely hilarious.

So we can have billions of dollars worth of new investment in infrastructure or new machinery, and no one needs to save in the form of consuming less beer, clothing, housing, holidays, etc. This is wondrous news. Why hasn't Pettifor been given a Nobel Prize for her amazing method of creating instant riches at no cost? Because she's talking BS.

Matt Franko said...

"How to Break the Power of the Bankers "

1. Set rates to 0.25%

2. Have Fed do $Ts of "QE" asset purchases...

3. Have Treasury put surplus USD balances into the Depository Accounts instead of the General Account...

Ralph Musgrave said...


I agree with zero or near zero interest on base money / government debt. Warren Mosler and Milton Friedman advocated that.

But why have the Fed do $Ts of asset purchases. Is the Fed better at running Microsoft or General Motors than the existing management?

The main thing that private banks do at the moment which is wrong is that they print or “issue” most of the dollars in circulation. That amounts to a subsidy of those banks, a subsidy that needs removing.

Kaivey said...

Ann Pettifor and Positive Money disagree. PM injury want only the government to be able to issue money.

NeilW said...

"So we can have billions of dollars worth of new investment in infrastructure or new machinery, and no one needs to save in the form of consuming less beer, clothing, housing, holidays, etc."


You have a stock/flow mismatch error. What pays for new loans, is old loans being repaid. That's the private tax paid that matches the spending of the banks on loan advances. Savings just creates a 'deficit' (change in savings) on that amount in the same way as it does with the government spending/taxation cycle.

It's just a privatised version of the same process. Taking a loan is just agreeing to be taxed by a private entity.

NeilW said...

"PM injury want only the government to be able to issue money"

PM want only unelected wonks in a central bank to be able to issue money, not government. Essentially they think the way the ECB is running the show in the Eurozone is how things should be done.

MMT on the other hands wants rid of both wonks and politicians from the issue money cycle, and replaces the whole lot with a 'pull' from the Job Guarantee. Money is then issued where it is needed, automatically, spatially and instantly. No unreliable clueless humans required.

NeilW said...

The critique of Ann is justified I think. She doesn't seem to quite get the institutional nature of banks, how they work and the job bankers actually do (or should be doing), nor does she seem to get the dynamics - even though people like Steve Keen have had circular models of it for a long time now.

IMV the simplest construction is just to see interest as the wages of bankers - paid for assessing the risk on loans. Repayment of loans (capital and interest) is then just a tax to offset the loans issued and wages paid to bankers.

But the commenter makes a mistake as well. Reserves are not really costly to a bank. They are more of a subsidy since they are a deposit with the central bank on which they receive interest. The higher the interest rate, the more subsidy the bank receives on those reserves.

Ralph Musgrave said...

Neil objects to (in his words) the fact that “PM want only unelected wonks in a central bank to be able to issue money, not government.”

Er – the “unelected wonks” at central banks ALREADY control how much money is created. First, it’s central banks that print money and buy back government debt when they implement QE or interest rate cuts. So to that extent PM’s proposal is not particularly outlandish. Moreover, it’s those interest rate changes that determine or at least have a big influence on how much money COMMERCIAL banks create and lend out.

Second, the idea that politicians should not have access to the printing press is a widely accepted idea: one which continues under PM’s proposals. So PM’s proposals are not particularly outlandish in that regard either. Though I accept that giving politicians access to the press would probably not be a disaster – except perhaps in inflation prone countries, e.g. in South America.

Next, Neil’s claim that under MMT, the money creation process is determined entirely by JG is a new one on me, and the first time I’ve know Neil put that idea. The idea has a couple of flaws.

First, JG is not an ESSENTIAL part of MMT, as Warren Mosler pointed out. The clue is in second “M”: it stands for “monetary”. I.e. MMT is essentially about – wait for it – “monetary theory”.

Second, assuming a large scale JG system is in place, it is perfectly possible that the non-JG sector of the economy would require stimulus (or the opposite) from time to time. In fact booms and recessions are guaranteed to happen even after JG is implemented. Dealing with recessions JUST BY expanding JG would not make any more sense than dealing with a recession by boosting JUST car manufacturing or the military. Put another way, if the economy can create extra viable / normal / regular / productive jobs, why create relatively unproductive JG jobs?

If one concentrates just on JG jobs, no doubt the stimulus from that would trickle down to the rest of the economy sooner or later, but it doesn’t strike me as the best option.

NeilW said...

It's very simple Ralph. If you're not doing the JG, then you're not doing MMT. You're doing something else that will likely result in a wage/price spiral - 1970s stagflation.

Warren is in perfect agreement with the JG and you have utterly misunderstood him - as you have most of MMT. That's why he has a paper out explaining how the labour buffer stock is a superior anchor to the gold standard.

The JG is central to the inflation management of the MMT proposals, and offers a superior system to the unemployment buffer stock you support.

Under the full MMT proposals, money is largely created and destroyed by the JG operating as a spend-side automatic stabiliser. That means all other discretionary proposals can be simple 'balanced budget' tax and spend in roughly the traditional fashion.

That makes the politics nice and simple, and the central bank management nice and simple so that even idiots can understand it. The politicians redistribute via tax and spend, and the central bankers clear cheques and stop the commercial banks being idiots.

Once the JG is in place, traditional rules can apply. Because funnily enough you are at full employment.

Matt Franko said...


"But why have the Fed do $Ts of asset purchases.?"

I'm not advocating for it .... I'm just saying if you want to F over the banks that is what you should do...

Matt Franko said...

btw Ralph you may want to check out these crypto things as they are basically full reserve...

Tom Hickey said...

Cryptos are an alternative currency that is a substitute for government-issued currency but not a replacement for it unless the currency issuer accepts an alternative currency in payment of obligations government imposes, like taxes, tariffs, fees, fines, etc.

MMT economists are fine with the use of alternative "currencies" to supplement government currency to promote commerce.

Yes!@ Magazine [Mentions Scott Fullwiler]
Alternative Currencies Are Bigger Than Bitcoin: How They’re Building Prosperity From London to Kenya
Raul Carillo

The downside of crypto is in saving and finance rather than use as a supplemental medium of exchange.

Bitcoin's Real Value Could Be Zero, Morgan Stanley Analyst Says
John Patrick Pullen

New Economic Perspectives
The Fair Price of a Bitcoin is Zero
Eric Tymoigne | Associate Professor of Economics at Lewis and Clark College, Portland, Oregon; and Research Associate at the Levy Economics Institute of Bard College

On the other hand, with the governmental push to track, limit and even eliminate cash, the anonymity provided by crypto has "extraordinary" value that is non-zero and may not be trivial.

On the other hand, tech warnings are appearing that crypto may not be as anonymous or secure as many assume.

Ralph Musgrave said...

I get involved in a heated debate (as is my wont) after that "Production of money" article, if anyone is interested.