While many journalists and academics have slated the Bank of England’s ‘Quantitative Easing’ scheme as ‘printing money’ and being inflationary, these same commentators are usually ignorant of the fact that the money supply has been increased by an average of 7.8% per annum for the last 30 years – almost entirely as a result of the money creation within the private banking system. Since this newly created money was all matched by the same amount of debt, it laid the foundation for the recent financial crisis.
Our reform would make it impossible for commercial banks to increase the money supply in order to maximise their own profits. However, that’s not to say that the economy will run smoothly on a fixed amount of money – we may need to increase the money supply in line with rises in population, productivity, or other fundamental changes in the economy. There are also issues as we make the transition from a debt-fuelled economy that requires new money to avoid collapsing under the weight of the debt, to the stable, low-debt economy that this reform would create – like a junkie coming off heroin, our economy might need to be weaned off continual injections of new money over a period of time.
Consequently, in the absence of money creation by commercial banks, we need an alternative source of new money. The following section explains what this source of new money should be, and how it will work.
Who Decides How Much New Money Should Be Created?
The Bank of England’s existing Monetary Policy Committee will become responsible for making decisions on how much new money should be injected into the economy in each period of time.
They will stop making decisions to raise or lower the base interest rate and will instead make a decision to increase or reduce the money supply. They will likely take a 12-month or 2-year view of the economy, and then smooth any increase in the money supply over each month.
The MPC will continue to be politically independent and neutral. This is very important, as it prevents harmful political ‘tinkering’ with the economy. It is important that the MPC cannot be overruled by politicians, whose decisions will be swayed by political matters rather than the long-term health of the economy. It is also important that the MPC is sheltered from conflicts of interest, and lobbyists for the financial sector.
The Monetary Policy Committee will also still be subject to all the rules regarding transparency of its decisions, and the amount of the authorised increase in the money supply will be made publicly known.
Note that they will not be creating as much money as the government needs to fulfil its election manifesto promises – the needs of the government will not be considered. As discussed in the section ‘Guarding Against Inflation’, suggestions that this reform would cause a ‘Zimbabwe situation’ have no basis in reality.
How Will The Monetary Policy Committee Make The Decision?
The Monetary Policy Committee (MPC) would authorise the creation of as much new money as they believe the economy (in other words, companies and households) needs to function healthily, and no more. There are two main measures that they can use to guide their decisions.
Firstly, the Committee will continue to base its decisions partly on the basis of ‘inflation targeting’ – the policy of trying to ensure that inflation stays within a small range – such as between 1.5% and 2.5% per annum. In other words, they should try to ensure that any change in the money supply is neither inflationary nor deflationary – neither too much nor too little. Note that for this to be effective, the measure of inflation used must be redesigned to take account of asset price inflation (such as a housing price bubble). It is pointless to attempt to make decisions affecting the whole economy using a measure of inflation that ignores inflation of 10% per annum in house prices when housing is the most expensive item in anyone’s ‘basket of goods’.
Secondly, the MPC can also refer to changes in the use of overdrafts (see the section on Overdrafts for more detail). If the average overdraft balance was increasing, it may suggest a shortage of circulating money in the economy, and point to the need for more money to be injected into the economy. Alternatively, if the average overdraft balance was decreasing, it may be an indicator that there is ‘enough’ or too much money in the economy and that the Monetary Policy Committee should hold off on increasing the money supply for one or two months.
The Mechanics of Creating New Money
When the Monetary Policy Committee has authorised the creation of a specified amount of new money, it will be created in the following way:
1. The government will hold an account, known as the ‘Central Government Account’ with the Bank of England.
2. The Bank of England’s Issue Department will simply increase the balance of this account by the amount authorised by the Monetary Policy Committee. They will not simultaneously reduce the balance of any other account – by making a credit without making a matching debit, they are creating new money.
3. The government can then withdraw the money from its Central Government Account and add it to the pool of tax revenue, and then use it in accordance with the principles discussed in the section ‘Distributing the Newly Created Money‘.
In contrast to printing physical cash or coin – which costs around 3p for every £1 created -a creation of money by the method is costless. To create £20bn or £200bn both requires one authorised official with the right passwords and a computer connected to the Bank of England’s central accounts system. Of course, it would also require witnesses and formalities to be observed, but all in all, £20bn could be added to the economy in a little under 20 minutes.
An Improvement on the Existing System
In the existing monetary system, the total amount of money (defined as ‘bank deposits’ – the numbers in your bank account) is increased whenever a bank makes a loan. Consequently, the money supply increases as a result of the individual decisions of thousands of loan officers and mortgage advisors, and the lending priorities of bank directors. Each of these individuals is motivated by a bonus on each mortgage or loan that is issued, and therefore their only incentive is to issue as many loans and mortgages as possible. They have absolutely no conception of how their activities fit into the wider health of the economy. As revealed in the financial crisis that started in 2007, this tends to lead to disaster.
Post-reform, the health of the whole economy will be considered before a decision is made to increase or decrease the money supply. While there are always issues when decisions are made by small committees of ‘wise men’, we believe that it would not be hard for the MPC to do a better job of managing the money supply than the banks have done to date. With a holistic view of the economy, and an incentive to support the economy rather than to maximise their own bonus, this should lead to a better outcome overall.
In a steady state condition I do not see why new money is needed. Only if money is lost from the system that new money should be required. Money is lost from the system when there is a major balance of payments in balance with overseas. Also if too much money is accumulated by Mega Rich. Creating new money devalues the money already in circulation. Surely the policy should be to aim at zero inflation.
The MPC can not be independent if the appointments are made by politicians or their lackies. There would need to be several lay persons on the MPC who are selected at random as for a jury.
House inflation is a matter of supply and demand and should treated with caution.. Like “old paintings etc” it creates artificial values. Just because the last house sells for £X it does not mean they all will. If they all go on the market at the same time they would sell for very much less than £X.
Check out the khan academy (on you tube or it’s own website). He has a model economy that produces apples. The bank lends out £ for an irrigation system which leads to the economy producing more apples. This is true growth and it’s valid to have more £ in the system to represent it.
We just have to take care that only true sustainable growth creates more money, and not some of the pernicious things that count in GDP
This proposed reform sounds like a brilliant idea and I’m all for it although I expect the greedy bankers will hate it but its our money so why they should they get rich at our expense!
I shall register my support immediately.
However, I’m having trouble understanding the process of creating new debt-free money. When the Bank of England’s Issue Department increases the balance of the government account but doesn’t simultaneously reduce the balance of any other account it seems to me they are creating money out of thin air which fundamentally doesn’t seem right to me. If it was so easy why doesn’t the Bank of England just magic up enough money to pay off our national debt now?
Apologies if this is a dumb question but I dont have much knowledge about financial matters.
regards
Sara Shepheard
Thanks for your comment Sara. It’s correct that the Bank of England will be creating money out of thin air at this point – within strict limits and under the direction of a politically-neutral Monetary Policy Committee. This is in contrast to the current system, where money is being created out of thin air by the banking system, with the only limit being how much money the public need to borrow.
The Bank of England hasn’t created enough to pay off the national debt up to now because it would be seen as being irresponsible, and paying off the national debt quickly would cause huge problems in the economy (see Clearing the National Debt). Under the current system, they would also have to create money in addition to that created by the banking system. All we do in this proposal is stop the banking creating money, and get the state to create that money in place of the banking system. With the right controls, this would cause less inflation and not burden the economy with a mountain of debt.
Note that even under this reform, it will take years (up to 30 years) to pay off the national debt. We can’t just pay it all of on day one, as doing so would cause economic chaos (again, see Clearing the National Debt).
Excellent reform proposals. I really hope it has success, although I can see the ‘vested interests’ who dominate our politicians, and benefit from this fraudelent money-system fighting tooth and nail against it!
The composition of any Monetary Policy Committee would have to be carefully chosen as to be independent from the machinations of any devious bankers with malevolent intent!
Wishing you the best of luck with this much needed reform!
On point ’2′ of the mechanics of creating money, which account do you propose using to reduce any money created by the MPC?
Hi Tushar, thanks for your comment…
The Bank of England will create the new money on a monthly basis, in the same way that the MPC tinker with interest rates to increase or reduce the level of inflation currently, under our reform the Bank of England will simply create more or less money every month to deal with inflation. Although, as the amount of money in the monetary system will be known exactly at any one time, due to full reserve banking, it is unlikely that this would ever need to happen.
Why is there no reply to Barry Skelcher’s question, above? In particular, his assumption that increasing the money supply must automatically devalue the money already in circulation is a frequent objection to the kind of reforms proposed by the Bill.
The answer to this objection, presumably, is that this is only the case if the amount of goods and services available for trade doesn’t increase in line with the increase in the money supply.
However, another frequent argument against introducing new money into the economy is that it’s unnecessary, as prices would automatically adjust downwards to cover the costs of any new goods and services introduced.
I think it would be useful to deal with this point here, as it’s one which is very commonly held.
I strongly support the monetary reform propsals, but the Money Power will not take kindly to losing its monopoly of credit. In view of this, what effect will the issue of debt free money into our national economy have on the pound on the foreign exchange markets? Is their a defence mechanism in the event of an attack on the pound?
Hi Marsh,
There is likely to be a very short knee-jerk reaction by traders to any discussion on these grounds, but this shouldn’t be a significant threat. Firstly, there will be one year between the legislation being passed into law and the reform actually coming into effect, and this time will allow the financial markets to over-react, calm down, and take a more measured stance on the impact of the reform. Secondly, once the reform has come into effect and the markets have seen that the Monetary Policy Committee is responsibly managing the money supply, and that pound sterling bank accounts will be safer than any other type of account, it’s feasible that the UK could become a competitor to Switzerland in terms of a safe haven for money and investments – this could attract money to the UK and push the pound up. Then, as newly-created money lowers the overall debt burden and level of taxation of the private sector and households, they will be able to afford to import more (since less money will be sucked into the financial sector as interest, or taxed) and this could push the pound back down. So overall, expect a few minor ‘wobbles’ in the exchange rate, but no significant long-term change – certainly nothing as significant as the shifts in the exchange rate caused by the ongoing financial crisis.
We will of course be doing further in-depth research on this front.
the reform will make the pound more attractive. However a strong pound will hurt UK exports. And if domestic demand falls, perhaps because the UK is not producing goods and services competitively, then we will be forced to import a lot more than current levels. In light of this a lot domestic businesses will go bust. How will the monetary reform address this issue?
Hi Fawad,
You’re correct that the reform will make the pound more attractive to foreign investors. However, at the same time it will have the effect of gradually reducing the overall levels of household, corporate and government debt. With lower debt (and lower repayments), people have more disposable income, meaning that they can afford to import more. As foreign investors buy more pounds (because it would be one of the safest currencies in the world) this would push the price of the pound up, but the increased importing by UK consumers would push the pound back down. So, in short, it should all balance out, meaning there would be no real implications for foreign exchange rates – there certainly wouldn’t be a lot of domestic businesses going bust.
Thank you for this wonderful and important initiative.
Currently central banks target 2% inflation rate. This is only needed because
our current money system is debt based. Thus the money supply is constantly being drained by interests. With a non debt based currency we don’t need this, so we should aim for no inflation.
The yearly increase in house prices gives a better view of our real inflation rate
than the consumer prices where the currency devaluation is constantly counteracted by increased productivity. I believe that when the banks stop printing and lending ever more money, we will find that the house prices are actually quite stable.
Having fiat money, we will always run the risk of too much money being produced, even in the new system. This would benefit the state on behalf of it’s citizens.
My suggestion is that we assign a fixed value to the new currency, by connecting it to
something of real value, such as the value of peoples labour. By doing this we would ensure that the value of money could always not only remain constant, but actually increase as productivity increases.
I don’t know the exact procedures of how this could be done, but I think it would be important and beneficial to all to finally establish a tie between money and reality. Any suggestions?
If banks were no longer allowed to lend the majority of money deposited, would this not cause a sudden collapse in the mortgage market as they have only a tiny amount of funds to lend?
Even if the system were to stabilise eventually, house prices would have to collapse initially as nobody would be able to take out a new mortgage, except when old ones are paid off.
I think you would have to increase the ratio the banks are required to hold by a few percent a year, for a few decades until it reached almost 100% and then start producing new money at the bank of england.
The problem here lies in the short-term nature of our politics. I imagine that the policy would never be carried to completion.
Hi Lee,
The transition process (or multiples thereof) are something we are currently putting the final touches to, the method you have suggested is one of the many being analysed and modelled, watch this space!
Thanks for sharing these ideas. In the event that production of goods in the economy should contract (for example, due to a pandemic), how might the money supply be reduced so that significant price inflation does not occur?
Hi Rich, please see 4.5 here….
http://www.bankofenglandact.co.uk/act/part-2-creation-of-currency/
Does this initiative owe anything at all to a similar project launched in 1996 in the US and described in detail at this website: http://www.themoneymasters.com/?
Hi David,
This proposal is based on the proposal by James Robertson and Joseph Huber in Creating New Money (downloadable for free from http://www.jamesrobertson.com/books.htm#creating ), which in turn was a modernisation and development of proposals by Irving Fisher (which was also supported by Milton Friendman).
According to my information it was Marx and Engels who came up with the idea of centrally controlled credit as a means of eventually debauching a nation’s currency and, in time, destroying the middle classes and the entire capitalist system. In what way does your system differ from this?
We are not advocating centrally controlled credit. Let’s simplify banking…
Banks make loans, and they create money. Marx and Engels would have the Government make loans, and create money. We are suggesting the government creates money, but the market is still responsible for loans.
Our idea is categorically not similar to communism, and cannot be classified as a left wing or a right wing idea, we are suggesting that this change in the way money is created can be used to alleviate public and private debt, and provide vastly increased funds for the government to use (or use in the place of taxes), this is an attractive prospect whatever part of the political compass you reside in.
Hi All
In case some of you, either commentators or viewers, are not aware the Coalition Government have launched a site inviting ideas from the Public. http://yourfreedom.hmg.gov.uk/
Generally, it wants suggestions for scrapping laws rather than suggestions for new laws or bills.
I registered and checked in and selected BUSINESS on the right column and inserted BANKING in the search box which brought up the Banking Section which had 45 ideas posted. One entry by gswanson on July 03, 2010 at 12:56PM was entitled Enact the Bank of England (Creation of Currency) Bill 2010 http://yourfreedom.hmg.gov.uk/restoring-civil-liberties/enact-the-bank-of-england-creation-of-currency-bill-2010
It ended with following reference –The Bank of England (Creation of Currency) Bill 2010 is online, with detailed explanations and FAQs, at http://www.bankofenglandact.co.uk/ .
I added a supporting comment H M White July 09, 2010 at 10:43PM
The moderator had not removed G Swanson’s suggested idea although it was suggesting a new Act — perhaps it was viewed as effectively an amendment to the 1844 Bank Charter Act’
Most of you as commentators and viewers like me consider the creation of “money” by commercial banks is iniquitous, applaud the Proposed Bank of England Act and will each take every opportunity to bring it to the attention of as many contacts – including your MPs – as possible. I urge you to use this Government site as a further publicity vehicle by registering and adding a comment and/or vote to G Swanson’s proposal for the Enactment of the Proposed Bank of England Act.
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Am I correct in thinking that bank credit from private banks is created simply from an accounting entry? That all they do is enter your promise to pay principal and interest on one side of the ledger and a matching amount on the other side of the ledger? This is backed typically, I understand, with 10 per cent of bank reserves and with the collaterall the lender puts up as security for the loan? Is it true that absolutely none of this bank credit comes out of money deposited with the bank or out of any of the banks actual earnings and that it is simply money created out of nothing? This appears to be the case although I have read contradictory claims; that the money is 10 per cent reserve of actual deposits and the remaining 90 per cent makes up the loan? If this is the case, surely the private banks create loans from deposits and not out of thin air? I’m inclined to believe the former description, not the latter. Would you explain which is actually the case when banks create a loan please?
Hi Stephen,
We’ll be publishing the definitive guide to how money is created around the 15th August (all referenced back to the Bank of England and Bank for International Settlements) – if you haven’t signed up for email updates, sign up now and we’ll email everyone once it’s published. But essentially, yes, banks do create money (bank deposits) out of nothing when they make loans.
I thought as much, that banks simply conjure loan money out of nothing. Many commentators still stubbornly try to suggest that banks create loans from existing deposits when this is simply not the case.
Thank you very much for your reply.
Stephen Davis.
That’s because they do – you just aren’t able to understand how. They allocate capital. The temporal difference between granting a loan and securing capital is obviously too hard for you to understand.
Hi Harold,
We will be publishing the “technical version” of how banks create money, or broad money to be more specific, shortly. We’ve gone through a number of lengthy documents including the terms and conditions a commercial bank needs to sign up to the Bank of England. You may find this technical version more useful than a simplified version, but it is important to bear in mind that even though broad money is not the same as notes and coins, when there is a bank run, the shortfall is printed up and paid for by the taxpayer, and becomes “real money”, and until such time the broad money can be traded as if it were notes and coins, so, therefore, essentially, the banks do create money.
“The MPC will continue to be politically independent and neutral.” Putting unelected officials in charge is likely to hurt accountability as there is no incentive these people have to do well and act responsibly. Is there a way of creating accountability and reducing the likely lobbying impact by making it for instance possible to vote for the resignation of the committee in the case of bad performance?
There are measures built into the act to make the MPC accountable to a cross-party committee of MPs – See part 2 (Creation of Currency) Section 6
If the demand for ‘new’ money is assessed by looking at the demand for overdrafts, this implies that banks allow customers to overdraw, which is equivalent to allowing them to create money, and interest bearing money at that. But I thought one of the assumptions of your system was that banks are not allowed to create money.
@Jonathan – the overdrafts would serve as a ‘float valve’ to give a little flexibility to the money supply. The money used to fund overdrafts would be borrowed from the central bank, so the central bank would still be the exclusive creator of money. When averaged over millions of accounts, relatively small changes in the average overdraft balance can indicate significant changes in the economy and give us a leading indicator as to what is happening in the economy (rather than inflation, which is a lagging indicator).
What about loans to people who want to buy houses? would this be taken from other accounts? whose accounts? I think this system that you propose is completely unworkable.
The cost of credit would sky rocket as there would be less credit available, thus lowering standards of living for the majority. Companies couldn’t expand, there would be less job creation etc etc.
Who would decide the criteria for lending on a business by business basis? Nationalise the banking industry? Think what other countries/foreign businesses would think of investing in this country? or what they may think of their current investments? (pull them out is my guess) Other countries would not do this and therefore British Nationals would move abroad to be able to obtain credit (i presume you’d stop foreign banks lending in this country too)
Banks serve a very important job of facilitating money movement and allocation. Look what happens when they don’t work properly!
I can understand some of what you’re saying but it simply couldn’t work. People are trying to fill some gaps with credit co-operatives but these are also open to misuse. And again simply don’t supply enough credit because they wouldn’t have enough.
The answer is smaller banks that can fail. If you’re not morally opposed to what banks do then buy shares in them and profit from their expertise too!
Hi Rich,
I think you might’ve misunderstood certain aspects of the reform – if you get chance, have a read through the rest of the site. No banks would be nationalised (we wouldn’t recommend the nationalization of banks and didn’t support the UK government’s purchase of Northern Rock, RBS and so on). Banks would continue to be brokers of credit, borrowing from savers and lending to borrowers.
Foreign businesses would probably appreciate the fact that, post-reform, we would have one of the most stable banking sectors in the world, probably a lower tax burden than most other countries, and a stable currency. So, no, they would have no reason at all to pull out their investments.
Again, I think you’ve misunderstood most of the reform. Have a read through the rest of the ‘How it Works’ section and then get back to us if you still think it wouldn’t work.