Thursday, March 6, 2014

A flawed objection to the Milton Friedman / Positive Money banking system.

The MF/PM system involves 100% reserves. And that in turn involves loans being funded just by bank shareholders or other types of loss absorber. And that in turn means that depositors who are not prepared to put their money at risk cannot have their money loaned on by a bank and thus earn interest.
Now a possible objection to that system is that we’re failing to use all that lovely money which the latter “no risk” depositors have stored up. So assuming there are viable lending opportunities out there, interest rates would have to be raised in order to attract more shareholder / loss absorber money to fund those loans (boo hoo). Indeed the latter sort of objection was put in section 3.21 of the Independent Commission on Banking’s final report.
But there’s a flaw in that argument, as follows.
Assume to keep things simple that the economy is at capacity. And assume that the above “lovely stored up money” is used to fund loans. That amounts to, or causes an increase in aggregate demand, and that’s no allowable, assuming the economy is already at capacity. Thus to counteract that increase in demand, interest rates would have to rise: just as in the case of where loans are funded just by shareholder / loss absorbers!
So . . . the idea that there is some sort of free lunch to be had from using the money in dormant accounts is a myth.

P.S. (same day).   By way of trying to rebut the above argument, advocates of using dormant accounts could claim that if the economy is NOT AT capacity, then using money in those accounts to fund loans would raise demand which would be beneficial. However, the answer to that is that effecting stimulus by conventional means costs nothing in real terms. E.g. having government / central bank print money and spend it and/or cut taxes would raise demand.  But printing £20 notes (to put it figuratively) costs nothing. So using money in dormant accounts yields no benefits can can’t be obtained for free in other ways.

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