To meet collective societal challenges, and to respond to future recessions, a different way of thinking about money is required
One particular exchange from the inaugural SPERI conference in 2012 has always stuck in my mind. After Colin Hay’s opening address, Bob Jessop asked him, ‘what is your theory of money?’ At the time I thought this was distractingly abstract, but as I suspect is often the case, Bob was probably two or three steps ahead in his thinking. Nearly a decade on from the financial crash of 2008, the effects of that sequence of events are still being felt, and with a series of turbulent economic and environmental problems looming ahead, a much clearer understanding of the role of money has never been more important.
Text book accounts of money emphasise that it is a unit of account (a way of denominating prices), a medium of exchange (a facilitator of trade and transactions,) and a store of value (a means of protecting or devaluing/ distributing existing wealth). This is a functional and mechanistic conception of money. It may just about be adequate when conditions are benign and economic systems and infrastructures are functioning smoothly (displaying equilibrium properties), none of which apply in an elongated liquidity trap. Unfortunately, the above account also neglects the most important aspect of modern monetary systems and their functioning.
Money is a human creation that reflects, but also acts to protect and promotes particular forms of social and economic system and their underlying values. We should think of money as a utility – a collective resource – created by human agency that can help us realise systemic visions of the future, as a response to the choices, values and priorities of society as a whole. This is what money can be for.
The policies of the last decade demonstrate that money can be thought of in this way, but the choices made and the system they have sought to support, look increasingly questionable. To understand why, we have to ask how money is created? In 2014, the Bank of England’s Quarterly Bulletin published a game-changing acknowledgement. Michael McLeay and his co-authors highlighted that the majority of money in the modern economy is created by private commercial banks making loans.
The paper corrected two popular misconceptions often reproduced in economics textbooks. First, banks do not primarily act as intermediaries, lending out deposits that savers place with them. Savings do not create investment, rather investment creates savings. Whenever a bank makes a loan it makes a matching deposit in the borrower’s account thereby creating new money.
Second, banks do not simply ‘multiply up’ central bank money into more loans and deposits. The central bank does not fix the amount of money in circulation, but sets parameters to private banks’ money creation capacity through monetary policy, setting the interest rate on central bank reserves with the aim of achieving low and stable inflation. Private banks’ money creation powers are also constrained by prudential requirements and their own quest to remain profitable in a competitive private banking system.
All of this is a very elaborate way of saying that the modern monetary system is a privatised system in which the pivotal powers of money creation have been delegated to licensed private banks, who conduct risk calculations. In the UK there are no real attempts to influence that decision making outside of monetary policy and prudential requirements. The primary assumption at the core of the modern monetary system is that rational private institutions’ profit incentives are sufficient to generate and pump credit and money around the economy, producing a system of ‘privatised Keynesianism’.
This system has been under severe duress for the last decade. The crash of 2008 entailed private banks failing in their money creation function, through bad decisions that endangered their very survival and produced a global balance sheet recession. Bailouts and multiple forms of financial assistance duly followed. Since then interest rates have been frozen at close to their lower zero bound for seven years. This has been accompanied by a policy of creating new central bank reserves for financial asset purchases – ‘quantitative easing’ (QE). Both policies have effectively been an attempt to restore the functioning of the system of privatised money creation, but their duration for nearly a decade suggests they have simply kept the ailing system afloat, rather than reigniting it. Conventional monetary policy is consequently close to exhaustion and is effectively immobilised in the face of future recessions. New thinking and conceptions of money are required.
The campaign group Positive Money have claimed that 97% of all money is created electronically by private banks and have argued for these powers to be transferred in their entirety to an independent public authority. One does not need to accept their precise figures, or their exact prescription, to raise the question of whether the proportions of money creation in the current system are desirable, and whether a greater role for public money creation could target long term socially useful projects, currently neglected by market dynamics and investment patterns.
Two particular examples spring immediately to mind. First the UK’s sizable infrastructure deficit could be one target for an increased role for public money creation. Second, a more pressing challenge is climate change, including overcoming the excessive dependence on fossil fuels, by creating a new renewable energy infrastructure. One recent study showed that the capitalisation of the fossil fuel sector was on average 34 times greater than the renewable sector. In other words, the current system of private money creation has generated a huge bet on an unsustainable future. When private systems of money creation and investment are incapable of funding the required technologies of the future, then a greater role for public money creation is likely to become an impending priority.
Such a transition will require a change in our mode of thinking, and is a political as well as an intellectual journey. In particular, it involves asking what money is and what it’s for? Take the Labour Party’s review of the Bank of England’s mandate and role. The admirable trio of David Blanchflower, Simon Wren Lewis and Adam Posen, need to go beyond the narrow technicalities of monetary policy, and enquire into the governance systems that will help realise the social purposes money is likely to have to fulfil in the future. If society and humanity are to meet the collective challenges we face, considering how money creation can be organised to facilitate this, is a pressing question that is going to grow in importance.