Monday, July 11, 2011

Modern Monetary Theory meshes nicely with full reserve banking.

Modern Monetary Theory (MMT) consists of several different elements, but for present purposes I’ll take it mean what Abba Lerner (p.39-40) advocated, namely that in a recession, government should simply print extra money and spend it (and/or reduce taxes). And conversely, when inflation looms, government should do the opposite, namely rein in money and “unprint” or extinguish it.

Anyway, it’s nice to see support for the above policy appearing in a paper which advocates full-reserve banking and written by a group (Werner & Co) who do not claim to be MMTers.

As Werner & Co say (p.10), “Under full-reserve banking . . .the Bank of England would control the quantity of money in circulation by increasing or decreasing the money supply which would be allocated through government spending.”

It would be going too far to say that the MMT “print and spend” policy is possible ONLY under full-reserve. But certainly the print and spend policy comes into its own under full-reserve.

This is because under fractional reserve, private banks are more or less in control of the money creation process. Or as Steve Keen put it, “…the credit money dog wags the fiat money tail. Both the actual level of money in the system, and the component of it that is created by the government, are controlled by the commercial system itself, and not by the Federal Reserve.”

In this scenario, the MMT print and spend policy certainly has a finite effect, but it is not dominant.

Also, who decides whether stimulus or deflation should be imposed?

A second reason why full-reserve reasoning meshes with MMT reasoning is thus.

As I pointed out here, the above MMT print and spend policy implies discarding the distinction between monetary and fiscal policy, which in turn raises the question as to who decides whether inflation is sufficiently subdued to warrant extra demand. I suggested that this question was a TECHNICAL one: beyond the competence of politicians, and best left to central banks (or any independent committee of economists).

Of course it is commonly thought that central banks currently DO take the latter decision. But this is not strictly correct in that politicians can also influence aggregate demand by determining the size of the deficit (which has a stimulatory effect). That is, politicians determine matters fiscal.

To have two different bodies both influencing demand is a mess, and this mess is particularly serious in the US right now: members of Congress, precious few of whom have got beyond page one of a basic economics text book are squabbling with each other and with the Fed and the president over deficits, stimulus and so on.

MMT and full-reserve: the two similarities.

So both MMT reasoning and full-reserve reasoning point to the same two conclusions. First, the decision on the stimulus/deflation question is taken by ONE body (the central bank or some other independent committee of economists). And second, if stimulus is deemed to be required, that stimulus should take the form of “print and spend”.

Or as Werner puts it, under the heading "Distributing Newly Created Money", "Rather than lending this money into the economy via the banks.. . .we recommend that the money is spent into circulation via the state.”

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