The Bank of England's latest edition of its Quarterly Bulletin features an article entitled 'Money creation in the modern economy'. It's pretty revolutionary stuff.
A week ago the IMF said that inequality is harmful and redistribution is helpful to economies. We were a little bit surprised. Now the Bank of England is going out of its way to say that conventional teaching on money in economics textbooks is wrong. Take these examples:
The reality of how money is created today differs from the description found in some economics textbooks:
- Rather than banks receiving deposits when households save and then lending them out, bank lending creates deposits.
- In normal times, the central bank does not fix the amount of money in circulation, nor is central bank money ‘multiplied up' into more loans and deposits.
and
While the money multiplier theory can be a useful way of introducing money and banking in economic textbooks, it is not an accurate description of how money is created in reality.
and this one:
This article explains how, rather than banks lending out deposits that are placed with them, the act of lending creates deposits – the reverse of the sequence typically described in textbooks.
That doesn't say the textbooks got it a bit wrong; it says they got it absolutely the wrong way round. In case you weren't sure they meant it they add:
As with the relationship between deposits and loans, the relationship between reserves and loans typically operates in the reverse way to that described in some economics textbooks.
And there are more in addition to these.
That does though lead to a question: if standard economic textbooks get something as basic as money and banking so spectacularly wrong, what else are they wrong about? As you can imagine, my list is very long.
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Now all they have to say is that taxes and “borrowing” do not fund the State’s expenditure (Levy Institute Working Paper 244).
And if economics textbooks are wrong, what about history books? What about chemistry, physics? What else are we being lied to about? I’ve said for a long time school is where you to go to be misinformed and made conceited about it. The evidence for that is beginning to emerge into the mainstream. This will upset a lot of people. One bases one’s self-esteem at least in part on how much you know, what you’re confident of, and you won’t want to be told what you know is wrong and you’ve been made a mug of. Cue controversy, disorder. It has to be done though.
Bill, your education did not seem to have taught you something very commonplace:
All knowledge is provisional.
There may be a lot of conspiracies in the world, but this is not one of them.
As a historian, I know and work with the knowledge that all writing about the past is changeable, flexible, mutable, disputable as soon as we get away from the basic facts we can all agree upon: e.g. The Allied landings in Normandy began on June 6th 1944.
Geedon
Research student of History
Bill – Physics and chemistry are essentially testable by experiment although peer review takes on fashions and has bias. There is a dumbing down as autodidacticism is replaced with marketised expectation of students and providers, “it does what it says on the tin” mindset.
Scientists understand that Science is not about finding a set of immutable truths, but determine the applicability of a theory, how well it applies. Scientists work to understand, test and measure the “uncertainty” of the model. As models improve uncertainty reduces (until a revised theory arises). Whilst economics and social sciences are differently testable, if so, and can be subject to corruption. When “Information is King” its clear misinformation is powerful.
An interesting point I recently discussed off-line is the huge decline of workers education in all its forms (Chomsky http://www.youtube.com/watch?v=-7ADdBAT7h0 is worth watching), and the negative impact of the lack of workers awareness. The late Bob Crow was no-one’s fool (Paxman’s dinosaur) although popularly marginalised by the media as a communist dinosaur “Unionsaurus”.
I seem to recall it was once considered testable both that the earth was flat and the sun went round it. Why did WW1 start? ‘Sarajevo’, you cry in unision, yet there are those, sober, informed individuals, who suggest it was just an excuse and the real reason war was brought about was economic necessity, the end game to preserve the financial status of whomever. I have not yet read an account of this I can absorb and retain but the knowledge’s out there. War – (uh!) what is it good for? It’s good for bankers as they happily create credit for both sides knowing they’ll be paid back in spendable money. Newtonian physics tells us there can be no action without an equal or opposite reaction, yet in banking we seem to have a functioning genuine horn of plenty, with the plenty springing from nowhere. Maybe we’ve been discouraged to consider zero point energy because accepting the theory behind it could lead us to stumble over the secret of banking. You read Post-War Banking Policy by former Coalition Chancellor Sir Reginald McKenna and see what he says in the about the need to discourage what he called ‘unorthodox’ thinking. Well, unorthodox thinking threatens to become the mainstream now, and all sorts of shibboleths may come tumbling down.
We agree on natural philosophy – “it was once considered testable both that the earth was flat and the sun went round it”. It was testable and failed [1]; natural philosophers paid a hefty price e.g. Galileo and Copernicus. Similarly we test economics and the current orthodoxy fails – the high priests of modern economics are comparable to the Inquisitors.
In 1616 Cardinal Bellarmine delivered the Inquisitors findings to Galileo — translates today as – Ben Bernanke delivers the Feds findings.
[1] B. Ryden and BM Paterson “Foundations of astrophysics”, gives a readable account of the historical roots of astronomy from its religious origins to a science. http://www.goodreads.com/book/show/7282684-foundations-of-astrophysics
AS economists like Richard Werner point out, the tail is wagging the dog:
” In reality, the tail wags the dog: rather than the BoE determining how much credit banks can issue, one could argue that it is the banks that determine how much central bank reserves and cash the BoE must lend to them.”
Where does Money Come From (Werner et al.) p.103
It says that ‘some’ textbooks.
What they describe is hardly revolutionary. It describes the operation of central and commercial banks as all economists (as far as I am aware) recognise as objectively true. And although it talks about the ‘modern’ economy, nothing much has changed conceptually except the link back to gold has been completely severed and that was quite some time ago now.
Where there may be controversy is how different economists then draw lessons or policy recommendations from this reality. But the BoEarticle itself doesn’t go into this.
For some read ‘most’ because this is absolutely conventional neoclassical economics they are challenging
And to say otherwise is just wrong
It is certainly a big step forward to see these facts covered by BoE in plain English. I know you have spent much effort trying to explain this process, Richard, to many doubters.
It is not easy to persuade those who have achieved degrees in economics that their thinking is wrong – believe me, I have tried as well. To be fair, Lord Adair Turner, when he was head of FSA and a member of the Court of Directors of BoE, did on occasions explain the process fully and this has been covered by Positive Money.
Neoclassical economics (by far the dominant school of several) is riddled with epic fallacies – for instance it has no real understanding of people (rational expectations nonsense), no proper theory of money (seen as just a way of lubricating barter) and claims that the supply curve has a positive slope (whereas most firms experience economies of scale – a negative slope).
In fact it’s so comprehensively nonsense and so immune to observed facts that the only conclusion is that its real purpose is to provide a pseudo-intellectual fig-leaf for banker and elite looting. “So sorry I took all your money, the market MADE me do it”.
Quite so
I always find its absence of a theory of money quite astonishing
But then, it also has no theory of government, because it assumes it is a bad thing
As a theory goes, it’s utterly bankrupt
Hear, hear.
No proper account of externalities – people or environment (can not be remedied by public bailout).
Modern Monetary Theory -seems to offer better explanations of Money and offers an effective critique of the Austrian ‘goldbugs’ and debt hysteria. Perhaps this will replace the neoclassical stuff that bears only a tangential relationship to reality.
The world of big finance is happy to maintain this cognitive dissonance for obvious reasons – a revolution in education is required.
“What about chemistry, physics? What else are we being lied to about?”
Well, I suppose you could say the facts work against that concern for most practical purposes. You can drive in a car, over suspension bridges or in tunnels, or fly over to Paris or Rome, with the high expectation you will survive and return. Nuclear bombs, as much as mobile phones, rely on some “laws” of physics which as far as we know don’t get broken, except in Dr Who or Star Trek.
And I doubt if there is any economics theory that can really take account of the wide range of human behaviours, which I think just shows there is more to this world than you can put down in a theory.
Even today, many will deny that banks create money and lend it to you at interest; that the amount “loaned” is simply written into an account along with a liability for the same amount.
The so-called “fractional reserve” went out of the window, along with some other apparent banking restraints, around 1981. Apart from a capital adequacy ratio, there is no restraint of the fractional reserve in the UK. In theory, banks in the UK can legally lend at 1000:1 if they wanted to. Banks can even lend without reserves and seek reserves to cover the gap later. Yes – when credit leaves the bank and when cheques are cashed, this has to be covered, but as money is coming in and going out of a bank all the time, these gaps are mostly netted out. Those that are not can be taken care of by overnight loans.
The fact that it is very rare that people will want to withdraw their money at the same time is the very thing that keeps the Ponzi scheme of modern banking going. Once that does happen, as in a bank run, then the jig is up and the system collapses.