I was asked the following question on People's QE on the blog this morning:
Richard, if you use printed money to pay for investment, who is actually paying for the investment? Are you suggesting that no one is paying for it? As an economist, you should explain who is paying for that extra investment.
That's a fair question. This is my expanded response:
The investment is paid for with money created out of thin air. I stress there is nothing unusual about this: all bank loans are created out of thin air in exactly the same way and the investment those bank loans permit are not paid for by anyone as a result.
In both cases you can, of course, ask that those using the asset created pay for that use: that is how banks hope (and only hope) to cancel the money they have created (and I stress, bank loan repayment cancels money, it does not return it to anyone else). This is how bank loans are paid for.
In the case of People's QE you can also choose not to charge: the cost then is a subsidy in future years. Governments can choose to make such subsidies, if they wish. There are very good reasons why on occasion they choose to do so. But in that case it would be possible for tax to be used to cancel the PQE if desired, or it could simply be left in place. That is a choice for the future depending on the state of finances at the time.
But let's be clear banks also face the risk of not being paid. Bad debt happens: it is normal and means that loans are never repaid.
The processes are in fact so similar a Martian would have difficulty spotting the difference.
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The creation of money is not an inherently inflationary act, and you bring some light to the discussion by mentioning the role of fractional reserve banking.
It *can* be inflationary, but it is not necessarily so; and it definitely isn’t when there’s a shortage of money.
There is a converse to that argument: is the collapse of an asset bubble necessarily deflationary? Or worse, contractionary, and the inevitable route to a recession?
You should ask that question now, because large-scale housebuilding will collapse the house price bubble; and, perhaps, other asset bubbles too.
Critics – all of them asset-rich proprty owners – will point to this as a massive destruction of value; doubtless they will find economists who agree.
Other economists will point out, correctly, that this is not the destruction of value, but a transfer of wealth: a collapse in house prices can be a paper loss to house-owners accompanied by a *gain* in housing by those who are priced-out (or spending far too much of their income on it, and would choose otherwise if it was a free choice in an unconstrained market).
It depends how it’s managed: but any deflationary effect in the wider economy has a countervailing force in the massive creation of money intrinsic to green or peoples’ QE.
And the recessionary risk of a collapsing bubble – if it exists at all – runs into the release of all that disposable income from excessive rents, in the medium term; and in the short term, any tendency to recession runs into the direct effects of the money being pumped into the economy by QE.
It’ll need careful management; but we got here, in the state we’re in, by mismanagement of the economy, and it won’t get better with more of the same.
Meanwhile, this will illuminate the motivations of your critics.
There are *no* reserve requirements in the UK. Banks are not limited by reserves.
http://www.bankofengland.co.uk/publications/Pages/quarterlybulletin/2014/qb14q1.aspx
Is it a gross simplification (or just wrong) to think: inflation is the money supply growing more quickly than real value, and that deflation is the converse?
And, if inflation is zero, and the money supply is growing, then “real value” is growing at the same rate?
It’s a buit simplistic
But it’s not a bad way of looking at it
A quick note: it is extremely impolitic to say what I just said in that comment, and you may choose not to release it from moderation.
Stating it out loud will raise a storm of protest from Middle England and the Daily Mail, and this might not be the best time for it.
I can live with storms of protest
And they need to realise what is likely to be happening, soon
Isn’t the investment paid for by the labour worked on whichever project the QE has invested in as opposed to such labour being worked on something else such as call centres for example?
What is PWE and why could that ‘simply be left in place?
Early morning typo
PQE = People’s Quantitative Easing
In my analysis all modern money – being returnable & cancellable in payment for taxation – is in practice a Treasury credit instrument created and issued by banks as fiscal agents.
When created by private banks, this modern money is essentially a clone or look-alike of that created by the Bank of England as the Treasury’s direct fiscal agent (not banking counterparty – a very different accounting relationship).
Banks either spend this money into existence – eg when they buy assets, or pay costs or dividends – or they create it when they lend. The point here is that this ersatz Treasury credit is not the bank loan – it is the OBJECT of the bank loan and is effectively created, sold and repurchased at a discount.
So the reality is that when bank loans are repaid this modern money is NOT extinguished but remains in circulation. Only the Central Bank, as fiscal agent of the Treasury, can destroy this modern money.
A simple thought experiment backs this up. Imagine Little Bank is about to wind itself up, and has £1m in share capital, £1m in reserves held with the Bank of England and a £10m term loan to Borrower A repayable today, balanced by £10m in short term deposits from Investor B repayable today.
What happens is that Borrower A’s bank credits Little Bank’s reserve account with £10m and thereby repays his loan. Little Bank then credits Investor B’s reserve account with £10m and these term deposits (interest-bearing loans to Little Bank) are also extinguished.
Little Bank then credits the reserve accounts of the banks where its shareholders maintain their accounts with £1m in aggregate, cancels its shares and liquidates.
The point is that no modern money is created or destroyed when Little Bank’s loan is repaid or when it liquidates.
This article of mine in the Scottish Sunday Herald covered the Myth of Debt, and has yet to be refuted
https://blogs.ucl.ac.uk/resilience/2013/03/11/the-myth-of-debt/
The reality is that existing National Debt is not debt at all, but equivalent to interest-bearing preference shares in UK Incorporated. If the Debt is ‘paid down’ the result is either the liquidation of UK Inc productive assets, or productive assets overseas held by UK Inc.
Chris
I might differ slightly – but only a bit
What I do agree is that debt is not debt at all
Richard
Chris Cook-your ideas need to reach more people, why is your ‘light’ still hidden under a bushel? We need to hear more from you! Thank heavens Richard’s voice is getting out there more via Corbyn.
Kind of you to say so. The phrase Inconvenient Truth comes to mind. As the man said, it’s difficult to get someone to understand something when his job depends upon him not understanding.
Here’s how I think about it at the moment. I’d really like to head if people think this is nonsense, or sorely lacking.
“Money” isn’t a commodity, it’s an accounting mechanism. As such, it doesn’t have real value. “Things” have real value. Land, property, food, energy, people’s time — all sorts of things have real value.
When the money supply expands, circulating money is in some way “diluted”. Likewise when the money supply contracts, the remaining money becomes a little more concentrated.
This doesn’t cause any transfer of actual real value, but does cause an effective transfer of money. At an extreme, this can become noticeable as capital effectively becomes diluted.
However, many of the resources we have to hand have untapped potential value. We can only free up that value for beneficial use by investment of some form.
As stated, loans increase the money supply and hopefully they also allow some untapped value to be released, so overall, things balance.
We’re comfortable about allowing private management of this process by banks in the form of loans (and companies in the form of debt instruments).
So, there’s nothing really very radical in _also_ (not instead) having public access to this mechanism, with the released money being directly used to realise latent potential value.
… The risk (I think it’s good to be clear and open and state at what point it becomes a risk — I believe the point to be a very long way from where we are now) is if created money is systematically (ie — a few mistakes are not a disaster) used in a way that does not actually realise latent real value. This does lead to inflation.
This might happen, for example, if an industry’s output is simply not required at the level it produces, perhaps due to saturation, or due to changes in habit making it unwanted. At this point the real value of its output diminishes.
After watching “The Spirit of ’45” (splendid film) last night, this was very briefly touched on (unwanted steel from UK manufacture). I wonder if it really was a significant problem during the 70s, and what we might do to more rapidly and compassionately adjust to such shifts in future. Or perhaps there wasn’t really a problem of overcapacity?
… a more pithy statement of this would be good, though!
You are spot on about releasing value
This is why I propose PQE and not helicopter money
The latter sucks in imports for a quick junky fix
PQE creates long term value using currently under-utilised resources in our economy -mainly called under-employed people
Thanks to Benjohn and Chris Cook for their useful simplifications and clarifications. These types of discussion create a subtly different perspective from Richard. Taken together, they provide the kind of every-day vocabulary that campaigners (including non-economists) can use to push for a financial system that works for the many rather than the few.
Richard, I hope that you can put into the equation the effect that a proper LVT would have on such QE. As you know, all good public investment increases local land values. So once you have set in motion the QE + LVT (with annual revaluation) you get a virtuous cycle of increasing investment => increasing land values => increasing LVT => increasing investment.
Agreed!
Indeed-why can’t people see that the real ‘scrounging’ are property and land bubbles?
We need a big neon sign in Picadilly Circus proclaiming this -though the populace, realising the swindles played out on the majority of them might feel angry as the myth evaporates.
I don’t feel you have answered the original question.
The question “Who is actually paying for the investment” needs to be clarified. If you build a hospital, then the people on the building site are doing it with their own labour. The result will be more hospitals than you would have if these people were unemployed. It is people, not money, that build hospitals.
If, on the other hand, unemployment is fixed, then printing extra money will cause inflation, which acts as a tax on everyone with deposits that earn less than the inflation rate.
I have always agreed that when under employment is fixed PQE does not have a role
isn’t the real issue the TYPE of employment? We could clearly get nearly full employment with crap jobs as we incrementally approach slave labour conditions-so full employment without inflation risk is quite possible, indeed, this is what the Tories were aiming for by hammering people into poorly paid work via sanctions.
I agree
Well paid
Skilled
Secure
With prospects
Those are the jobs I would like
Could we be at some sort of tipping point? A sudden flip, just as with Keynes, where Corbynomics (more properly Murphynomics) goes mainstream and is the new orthodoxy?
It would be nice to think so
I suspect not
And nor is this a fully fledged economic theory although I have dealt with some of that in the Courageous State and more in the Joy of Tax (forthcoming)
I would also like to comment on the concept of “creating money”. When a bank makes a loan, the *money supply* has increased, measured as M1 etc. Any bank can do this.
On the other hand, only the Central Bank can create money out of thin air, by lending or giving money that didn’t exist before. Unfortunately there is no word for this process, which is completely different from just “creating money”. That is why the phrase “inventing money out of thin air” is not a simplification for the ignorant, but an accurate technical term. Of course you could use a more latinate phrase, like “creating fiat money”.
Private banks create clones of the ‘modern money’ (Treasury credit) created and spent by the Central Bank as fiscal agent (not counterparty) of the Treasury.
A £1.00 Treasury credit instrument/note is precisely the same in effect as a Bank of England £1.00 credit instrument/note. cf the £1.00 ‘Bradbury’ notes issued by the Treasury during the First World War.
So private banks conjure from thin air look-alikes of £ denominated central bank credits (which are completely indistinguishable from them) in exactly the same way the Central Bank does. Banks THEN spend or lend this modern money by crediting title to these instruments to bank reserve accounts either with an additional agreement to return them (a loan), or not.
I know it’s a very popular idea but the notion that bank lending creates money out of thin air seems very dubious to me. In reality bank loans are created from a legally enforceable contract which gives the bank a claim on the borrower’s assets if the debt is not repaid voluntarily. It may be abstract but it’s certainly not creating money from nothing and it’s very different from a government creating money with no expectation that it will subsequently be destroyed.
I also have doubts about your view that there is currently a shortage of money (though my focus is on general principles so my view isn’t based on data). My impression is that there is in fact plenty of money; it’s just not circulating within the productive economy. In our current system, liquidity can be locked up in speculative activity and, to my mind, the asset price inflation that has resulted from previous rounds of QE should be regarded as latent consumer price inflation. I think it’s possible that the prospect of Jeremy Corbyn as Prime Minister might well trigger a bursting of the asset price bubble which could lead to real-world inflation even before PQE got underway.
For the record, I’m one of the many people who has written to him with policy suggestions. The reforms I’m advocating are both more radical and more cautious than most people are suggesting and he’s the first prominent politician I’ve seen who looks like he might be thoughtful enough to appreciate the need for them and bold enough to implement them – so I am keen to see him win the leadership contest and I’ve registered as a supporter, intending to vote for him. At the moment, however, what he’s proposing simply looks like a swing back of the same old pendulum.
I can see that, within the constraints of the existing monetary system, PQE might be the best way to proceed even with the danger of inflation. It’s certainly better than the previous model of QE but I’m doubtful it would have the multiplier effect you’re hoping for without significant structural reform of the real-world economy. As things stand I think the new money would quickly be drawn into the same pattern that dominates existing flows of money; in other words it would flow towards the wealthy (who currently seem to be more interested in storing it than in productive investment).
The Bank of England do confirm all bank loans are made from newly created money
Admittedly they only did so in 2014 but that is what they now agree
And it is precisely because liquidity can be used for speculation that I propose what Jeremy calls People’s QE
I wasn’t suggesting that bank loans are not newly created money, Richard. I’m simply pointing out that they’re not created from thin air. And although, technically, bank loans create new money, they are essentially just a mechanism for increasing the velocity of existing base money rather than a mechanism for increasing the stock of it. But when governments create new money without any clear strategy for cancelling it they are adding to the stock of base money. The two processes are not equivalent.
And my point about liquidity being tied up in speculation is that there might be less scope for safely increasing the money supply than you seem to think. The liquidity created over the last few years by QE hasn’t gone away but it hasn’t yet fed into headline inflation. It’s like having a block of ice suspended above a bowl of water; you can’t judge how much water can safely be added to the bowl simply by looking at the level of the water, you have to take into account how far it will rise when the ice melts. If you want to convince people that PQE can be done without creating inflation I think you need to show that the shortage of money that you’re relying on is a genuine shortage of base money rather than just an artefact of maldistribution.
I do not agree
Bank loans create new money identical to bank money
And both can be cancelled
Just burn £5 notes….
As for 2009 QE and inflation, sorry: that’s just paranoia
Look at total money supply data: we are well down on 2008
And I am not relying on a shortage of money for PQE: I am relying on a shortage of funding for essential investment
Yes, I know both *can* be cancelled in principle – it’s a question of whether or not there is an established process for doing so. The government can’t burn the £5 note while it’s under the mattress of some unknown hoarder, whereas the banks can generally enforce repayment of loans. If you want to satisfy people that PQE won’t cause inflation, the money it creates either has to be one side of a clearly repayable loan or there will have to be an explicit strategy for eliminating it through taxation. Simply saying that the newly-printed money *can* be destroyed, if we ever feel like doing so, isn’t likely to reassure people.
I don’t think “that’s just paranoia” will reassure many people either, even if it’s true. It’s especially not going to reassure them if your point of comparison is the time just before the biggest crash in living memory.
Perhaps I misunderstood what you wrote elsewhere. I assumed, when you said “printing money is not inflationary when there is a shortage of money in the economy” – http://www.taxresearch.org.uk/Blog/2015/08/03/chris-leslie-has-got-corbynomics-wrong/ – that you were acknowledging the fact that printing money when there is no shortage *would* be inflationary. In fact you’ve explicitly said that it would have to be stopped once the economy is functioning at full capacity.
The problem is that, where significant amounts of money are trapped in non-productive areas of the economy, (whether stuck under a mattress or circulating in a loop of speculative buying and selling of financial assets) the only way to reach full capacity is by injecting too much money. As long as it stays under the mattress, that £5 which the government has no means of destroying doesn’t contribute anything to price inflation or to productive economic activity – but that doesn’t mean it can be ignored, because it can come back into circulation at any time. If hoarded or speculative money only trickles back into the productive economy it’s not a problem, because then it can be mopped up, but if it comes back into circulation in a flood it will drive up prices and at that point turning off the tap is too late.
I agree that functionally, in circulation, all money is the same – but that includes what you call ‘funding for essential investment’. The new money created by PQE will have a one-off benefit in the creation of whatever bit of infrastructure it’s aimed at but, without reform of the structural features of the economy which cause money to flow towards the wealthy, it is mostly going to end up in the hands of the same people who effectively control the money supply today. It would be defensible as a temporary strategy to help us through the transition to a new monetary system but PQE looks to me more like a short-term fix which is quite clearly inflationary than a cornerstone of a long-term strategy.
The underlying problem is that money in its current form conflates functions which are governed by different forces and needs: to fulfil its function as a medium of exchange, money has to keep circulating, but as a store of wealth it has to stop circulating. How on earth can we expect to have a stable economy in those circumstances? A mature society would not base its economy around a medium of exchange which, in its base form, can be taken out of circulation by anyone who happens to have a surplus of it, nor would it operate with a unit of account whose value is essentially arbitrary and effectively controlled by diverse private interests. It would be relatively easy to introduce a parallel monetary system which didn’t have those obvious flaws but unfortunately people seem to find short-term fixes so much easier to grasp.
Who pays for it? I would argue it means the REAL RESOURCES that are used in the spending can not be used elsewhere. Now if resources are being underutilized it expands the pie and everyone gains.
What happens to the people’s QE money? It will be spent and respent. Now the money will create an amount of tax and an amount of saving. That saving can be “borrowed” by swapping with gilts but the point is this ALWAYS happens. Bond issuance is borrowing the money AFTER. It just drains excess reserves.
And we can see the “deficit” will depend on the private sector’s decision to save and spend.
You won’t reduce the “deficit” by cutting a teacher’s wage, because you will get less back in income tax and NI, less 20% VAT when the teacher spends and so on.
If it were up to me I would QE the entire “national debt” to show up what a load of nonsense it is.
QE doesn’t even exist on the Consolidated Accounts/Whole of Government Accounts:
https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/221560/whole_of_government_accounts_31-03-2011.pdf
ALL government spending is “printing money” because it makes no sense to have an account with your own IOUs. Gilts are Money with a “welfare” payment and you can view the govt as spending taxpayer’s money or burning taxpayer’s money and printing new money when it spends.
So both tax and borrowing are “printing money.” Gilts are Money.
The “deficit crisis” is a total scam.
Richard, as the person who posted this question thank you for taking the time to respond.
The reason I asked the question is because I felt the entire debate around money printing/PQE was ignoring some fundamental principles. Principles which, in my opinion, are precisely what economics as a field are supposed to answer. I have to say that I think your answer is that of an accountant rather than as an economist. Although I can’t see that you’ve actually answered my question to be honest. If PQE is not cancelled, who has paid for it? The job of the economist is to explain that which is unseen in the economic activity. The seen is very easy. If the government prints money out of thin air then it appears as if no one pays. But this cannot be true, the laws of physics preclude it. Building a hospital must impose costs on people. It would only be costless if it fell from heaven, a gift from the gods. There simply cannot be a free lunch. That would defy the laws of physics and no accounting can change that. You would do your cause more of a service if you explained what that cost was and who bears it. The argument that it is no different to normal credit creation by banks, whilst an argument, still doesn’t address the question of what are the costs of the action and who bears it. Answering that question is what differentiates economists from pundits. If you are interested I will tell you who I think pays the cost, but this post is long already. Best.
Money is a facilitator
PQE is designed to bring under utilised resources into use
They’re called people
Who pays for it? That’s the wrong question, surely? Why not ask who benefits from it? And then realise that the benefit will provide the return – including tax – that pays for it
That’s the right question
Asking who benefits may be a better question. But answering who pays is still important. If you suggest an unconventional and untested policy, you really have a duty to explain it fully. Including the cost bit. Imagine an accountant saying, actually the costs bit is unimportant, just look at the income and trust me that overall there is a profit. It needs to be better explained if you are to sell it as an economist.
I have explained it
Money is created to release capacity in the economy
That is what credit does
I raised a question, which you thought was significant enough to make the heading of one of your blogs, saying it is a fair question. When I challenged that you hadn’t answered it, you said it’s the wrong question. And now you say the answer is money releases capacity in the economy. Which is a roundabout answer. Who pays? Is it no one?
The government pays
It creates the money
Next
Who funds the government? The taxpayer? In order to sell PQE you must have a clear answer, that the public can understand, on who pays for it. Saying it is paid for by creating money is a cop out.
All lending that pays for investment is paid for by creating money
That’s how money works
What do you want me to do?
Lie like most politicians do?
I want you to be an economist and explain the second order effects. Printing pieces of paper does not suspend the laws of physics. Doing anything involves costs and benefits. With money printing the costs appear hidden. But they must exist. There is no free lunch. You should explain what these are if you want to be considered an economist rather than a politician.
Money enables greater employment
That yields a return
That pays for th investment
Next?
How does it pay for it at the time though? At the start? Time runs in one direction. The return from an investment can’t pay for the investment, unless you have a time machine. Someone must pay at the start. That is how the physical world works.
No one pays at the start
That is capital
In the private sector that is stored claim on value
In the public sector it is released value
My answer to your question, James, is that it is society at large which pays the cost. The people who actually do the work creating the new infrastructure are paid with the newly-created money, which is then dispersed into the wider economy. As long as the new money and/or the new infrastructure stimulates further productive economic activity which would not otherwise have happened, the extra liquidity in the system will be necessary and will generate extra tax in the future – which can, in principle, be written off when the extra money is no longer needed.
Personally, I think it relies on a degree of wishful thinking. I certainly see that it can work in theory – and may possibly work in practice – but in reality I think it’s only likely to work reasonably well in a less integrated global economy, where the new money will circulate mostly within the communities where it’s initially injected. But the way the world works currently I’d guess that the new money will quickly be sucked into the financial asset vortex rather than stimulating significant amounts of new productive activity. In that case I think the cost will be paid, eventually, in the form of inflation.
My view is that it would be sensible as a transitional process if there was a strategy to move to a more rational monetary system* but on it’s own I think the best that can be said for it is that it would reverse a pendulum that has swung too far to the right.
* I think the core of a more rational monetary system would be the one I advocated in the LSE’s recent project to crowdsource a new constitution – https://constitutionuk.com/post/85294 – which would establish a unit of account based on labour, and a basic medium of exchange which could not be hoarded.
I think the idea that money stimulates activity is one way of looking at it. The other way is that productive ideas chase the money, and the absolute amount of money doesn’t matter, it is all about relative pricing. If there are 200 as many Yen in the world as pounds what does it matter? Essentially the argument boils down to those given printed money can make better use of the resources they then command as a result.
Yes, James, I agree that the absolute amount of money doesn’t matter but there obviously needs to be a certain minimum, and the economy will only function properly if it keeps circulating. In my view, there is a significant problem that stagnant money – money which is not circulating productively – doesn’t contribute to healthy economic activity but does constrain the government’s ability to safely stimulate it.
Richard plays down the difference between base money and bank-created money, but the fact that they’re functionally identical doesn’t mean the consequences of increasing them are the same. Bank money is eliminated as soon as the loan which created it is paid off but base money can only be eliminated when it comes into the hands of the government. When there are huge disparities in wealth that’s a big problem because, if the rich decide to just sit on their money, the government only has a couple of options, both of which are unpalatable; either it imposes swingeing taxes on the rich (“taxing wealth creators!”) or it prints money and risks causing inflation.
In a fundamentally healthy economy PQE would probably be quite safe but I can’t see that pumping additional money into a pathologically unequal system will do anything to make it better. The best it will do, to my mind, is temporarily mitigate some of the worst effects of the inequality – at the cost of undermining money’s function as a standard of value. It’s no substitute for establishing a monetary system which properly reflects the real world.
Michael
I really do not think we will get total monetary reform overnight
PQE rebalances some worrying elements
Richard
I quite agree that we won’t get total monetary reform overnight, Richard – that’s why I advocate reforms which would allow it to happen relatively smoothly, over a period of years, by removing barriers which inhibit the emergence of parallel currencies. (Similarly, the reforms I mentioned in a comment to another of your posts, to allow everyone to inherit a fair share of the nation’s natural resources, are designed to be introduced over the course of a generation or so.)
The fact that fundamental reforms have to be introduced slowly isn’t a reason to neglect doing them; as far as I’m concerned, it makes them more urgent. And, in fact, PQE would be more clearly worthwhile if fundamental reform of the money system was underway: firstly, the government would be fulfilling its responsibility to maintain a stable medium of exchange, through the newly-introduced currency; and secondly, by printing more of the old currency it would encourage the private economy to migrate to the new currency.
But on its own PQE is no more than a temporary fix. The new money will quickly find its way into the hands of the same people who already have more than is healthy but are not spending it. Even if the first round of PQE doesn’t trigger any obvious inflation, it will have to be repeated over and over again. Sooner or later, the people who are hoarding money will realise that there is latent inflation and it will come flooding back into the productive economy much faster than it can be mopped up.
In conjunction with steps to reform the fundamentals PQE would be an eminently sensible strategy. But on its own I’d expect it to lead to rampant inflation.
Malcolm
I have already shown why it would not lead to inflation
MMT would support that view, strongly
Sorry: I think you are wrong on that
In Modern Money Theory, taxation takes excess money out of circulation and is one of its main functions. I think Richard has pointed out clearly that Tax is more about redistribution than paying for services even though we are lead to believe by our ideologues that this is not so which then leads to the “there’s no money” myth .
Chris Cook puts it well in his article he referred to above: ” The reality is that taxation acts to remove money from circulation and to prevent inflation: it does not fund and never has funded public spending.” let’s hope Corbyn with Richards help can release more of this cat out of the bag.