Modern monetary theory (MMT) says the government creates all our money - either itself through its own spending, or indirectly through the banks that it licences.
In both cases the money is made by making a loan - and repayment of the loan cancels the money that is created.
The Bank of England currently manages the government's money creation programme. It does part of this through what is called the quantitative easing (QE) programme.
QE does, in effect, let the Bank of England lend money to the government. It can do so interest free. However, the problem is that the government ends up with little effective control of the money created for it by the Bank of England.
MMT argues that this is inefficient, and not just because of the cumbersome nature of the QE process described below. It says that the process in question is not required: if the government wants funding from the Bank of England it just has to ask for it (as it did until 2008 when it chose to use QE instead, but which it could still do on what is called its Ways and Means Account). Then the government could use the newly created funds any way they wished instead of relying on third parties to decide on their use.
Despite this the government persists with QE, supposedly to comply with international law. The arrangements are cumbersome. This is what happens:
a) The Bank of England lends money to a company it owns - the Bank of England Asset Purchase Facility Fund Limited - which is known as the APF;
b) The APF is owned by the Bank of England, but that is misleading: every aspect of its activities is undertaken for and on behalf of the Treasury, who provide a complete indemnity for its activities to the Bank of England. The Treasury is, of course, a part of the government, of which the APF is an effective part as a result. This interaction makes a mockery of Bank of England independence as a result;
c) The APF buys bonds that the government has issued. It does not do so directly from the government. It buys them from financial markets instead. Banks, buildings societies, pension funds and others sell them to the APF. It is very likely that they profit from doing so.
d) The money paid for the bonds is - by and large, but not entirely - used by the banks and building societies to whom it is paid to increase their own liquidity. This means that they actually deposit it back with the Bank of England on what are called their central bank reserve accounts. It is likely that these organisations hold more than £600bn in such accounts at present, which is most of the funds created via the QE process.
e) The Bank of England pays interest at its bank base rate of 0.1% on these balances. The advantage of this arrangement to the government is that it means it has considerable control over the short-term interest rates in use in the UK economy: if such large sums are subject to the Bank's chosen rate all other rates follow suit.
f) In effect, by using QE the gilts the government issues to collect money from the private sector are replaced by private sector bank deposit accounts held with the Bank of England of roughly equivalent amount. There is an approximate substitution of one form of government liability for another;
g) The advantage for the government of this arrangement include that fact that:
-
- their gilts are effectively cancelled because of their ownership by the Treasury, which also issued them in the first place (even if this cancellation is publicly denied);
- the government still secures the cash funding that they want, but now through deposits from banks and building societies instead of via bonds;
- the overall interest cost of these funds is, however, reduced because bank base rate is paid upon them rather than the higher rates at which most reacquired gilts were originally issued;
- interest rates in the economy are controlled through this payment of bank base rate on deposits of more than £600bn;
- the central bank reserve accounts that are held by UK banks and building societies with the Bank of England are, in practice, very hard for them to redeem even if they are, in theory, repayable on demand. That is because if the government refuses to accept additional payment from the banks and buildings societies who hold these accounts in the form of either higher taxes of new bond sales not covered by additional quantitative easing activity (and neither looks likely at present) the banks and building societies have little chance to make any significant new payments to the government over and above the flows of new money that come to them as a result of government spending on a regular basis, meaning that these balances are likely to remain broadly static. The balances can, admittedly, be reallocated between those banks and building societies at their choosing, but redemption is effectively entirely under government control, meaning that questions of so-called ‘repayment' do not arise unless at the government's choice; and
- banks and other organisations hold greater quantities of funds that may encourage them to lend or invest more, which may stimulate the economy and so improve its performance.
h) The advantage for the banks is that they tend to have enlarged balanced sheets with significantly more cash holdings on them, which makes them appear more robust. With luck, some money might also reach the real economy as a result, although the amounts in question are in doubt, and much that has been used seems to have flowed towards asset speculation.
The problems with this policy should be apparent. Firstly, it is a game of smoke and mirrors. It is fundamentally dishonest with the public as to its intention. The permission it gives to the government to claim that there is still debt in place, as they do in national debt calculations, when in practice that has been substituted with newly created money is intended to mislead, and does. That deception is part of the austerity narrative, long used to claim that the government cannot spend as it is suggested that it has not got the means to do so, when that is obviously untrue.
Secondly, the same cash injection could be achieved more effectively by the Bank of England lending newly created money directly to the Treasury for the latter to spend as it wished on whatever it thought might best stimulate the economy instead of relying on commercial banks to achieve this goal.
For these reasons MMT does not embrace QE, which it thinks unnecessary, and instead suggests direct lending from central banks to government. This could, however, be structured in the form of QE if that was really desired. But in that case the logical way to do this would be to use the funding in question for specific government directed purposes. So, for example:
- The government could create a National Investment Bank (NIB);
- The NIB could issue bonds;
- The APF could use Bank of England created money to buy these NIB bonds;
- The NIB could then invest directly into the economic transformation that the UK requires;
- The holding of bonds in the NIB would, via the APF, be under the directs control of the Treasury, as would be appropriate;
- The Bank of England would have then used its power to create money for specific rather than random purpose;
- Government borrowing through the NIB would still have been replaced by newly created money on the national balance sheet;
- There would be no loss of control of interest rates: there are more than enough conventional QE funds in existence already to achieve that goal.
In 2010 Colin Hines and I described such an arrangement as Green QE because it would fund a Green New Deal. It still could, and is the use of a form of QE that is consistent with modern monetary theory that we still require.
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Ah.
I need to get my head around this again.
I thought that the money the pension funds (etc) had from the sale of their bonds, was used to buy more government bonds.
The new bond purchases, effectively giving the BoE created money to the government (via the bond market)
I’m struggling with why the reserves stay with the pension funds (etc) and not get passed onto the government to spend into the economy?
Just when I thought I had it sussed!!!!! Doh!!!!!
It just sits there…
If a pension fund sells its bonds to get reserves it will likely only be able to buy new bonds at a lower rate. So there’s be no point in selling them ,unless they really need the reserves to pay investors. As it stands the BoE is actually buying up all the new bonds the Treasury is issuing, so in effect “the market” has been taken out of the equation.
It might help if Richard did a post on what reserves actually are. There are 3 types of money we use.
1 Bank deposits,(held by private banks)
2 Reserves.(held by banks at the BoE)
3 Cash and coins(which are in effect reserves as well)
Only banks can use reserves, no non-bank institution or individual can use or touch reserves. So the pension funds can only swap their bonds for reserves or vice versa. It can in that way give the govt reserves to spend in normal times. However this is not really happening enough to fund the sheer scale of gov spending right now. So the BoE has now resorting to just buying all the bonds the govt is creating by just creating the reserves itself.
So the pension funds are not buying these new bonds. Unless they are replacing old ones that have expired and been cashed in.
Vince Richardson.
Thanks for that.
I think I get it now.
So…… The bonds that the BoE are buying from the market, aren’t existing bonds, but new ones that the Treasury have issued.
I’m guessing the primary dealers have no choice but to purchase the bonds the Treasury issues?
They are then sold onto the secondary market, from where the BoE purchases them?
How long does this process take. Is it seconds or do the primary dealers and secondary market hold onto them for days/weeks?
So in effect the BoE is buying new bonds from the Treasury by proxy, through the bond market.
Keeps the public off the scent.
No, the bonds a5re of varying ages
They are not usually new ones
They are bought in auctions at current market price – they gave always been offered for sale as the sums required push up prices – and so lower interest rates which is the BoE aim
But quite emphatically this is not new bond churning
Richard.
Sorry. Still missing a trick here.
If the BoE are buying up EXISTING bonds through the APF and the reserves used to buy those bonds are staying in the reserve accounts of the Pension Funds (etc), how does this create money for the Treasury?
The reserves that purchased the bonds originally, has already been accounted for.
Where are the new reserves coming from for the Treasury to spend into the economy?
I’m missing a trick here.
The process does not create money for the Treasury
The BoE creates money for the treasury to spend – as MMT says
Then the Debt Management Office try to sell debt
But it is assumed that debt purchases at the current level are beyond the capacity of the market to absorb so rates would have to increase to sell them
There is no desire for increased rates
So separately to the original spend by the Treasury the BoE creates more money to buy the debt back – substituting money for debt on bank balance sheets
QE does not fund the spend
It cancels the aftermarket effect of the spend top control rates and (maybe) encourage investment by greater liquidity – but we know that this is a bogus claim as banks can lend without deposits
Sorry Richard. Still don’t get it!!!???
You say
“The BoE creates money for the treasury to spend — as MMT says”.
What is the mechanism that transfers the BoE created reserves to the Treasury to spend into the economy?
I’m not getting how QE, as explained, finances the Treasury spending?
If the bonds the BoE buys through APF are existing bonds and the reserves used to buy the bonds sits in the reserve accounts of the banks/pension funds etc. How are reserves getting into the Treasury accounts held at the private banks?
QE does not directly fund the Treasury
It not permitted to
The Treasury is initially funded by the BoE that pays what it is told to
By convention the Treasury clears its overdraft – actual or potential – at the BoE by issuing bonds
QE repurchases those bonds. Officially that is to control interest rates, but what is said and what actually is the case are nit always the same
Actually QE has made sure that people will still buy bonds because a) there aren’t too many of them and b) the price is rising
So QE still let’s the government apparently fund its activities with debt by buying up old debt to make sure new debt can be sold
So indirectly QE funds the Treasury – but it is indirect, but nonetheless real. The BoE QE operation permits the pretence of new bond sales to supposedly fund the Treasury – effectively funding it in reality
Good summary. My only criticism is the suggestion that in an ideal world, if government want’s more money “Â it just has to ask for it”. In effect that means politicians control the printing press, which is dodgy.
Strikes me the set up proposed by Positive Money and the New Economics Foundation in their submission to the Vickers Commission would be better (a set up also backed by Ben Bernanke). Under that system, the CENTRAL BANK decides how much additional “print and spend” is suitable, while politicians retain control of strictly political matters, like what the money is spent on, or whether the extra money funds tax cuts, etc.
NO!!!!
I am a democrat
And what exactly is “undemocratic” about the PoMo / NEF proposal? Technocrats at the central bank decide how much stimulus there is to be over the next six months or whatever, just as is the case now in that under the EXISTING system, the CB can over-rule excess fiscal stimulus with an interest rate rise.
As is absolutely apparent today the BoE does what the Treasury wants
That is right
For heaven’s sake, let’s not give bankers control of the economy
Richard,
And what if that democracy decides that austerity is the remedy? Who can protect us from that?
We just have to change the narrative
Vince Richardson.
“And what if that democracy decides that austerity is the remedy? Who can protect us from that?”
I guess it depends on which type of democracy that get us to that decision!?
FPTP no thank you.
STV and a well informed public, why not?! Better than unelected bankers.
[…] From my Twitter account this morning, I admit overlapping with comments already made here: […]
I am not sure……
QE was originally conceived as a logical extension of interest rate policy. First you cut the overnight (policy rate) to zero…. and when that fails you try to reduce longer term rates by “forward guidance” and eventually intervention (buying gilts) in the open market…. which is QE. All of this is designed in the hope that lower rates across the curve will stimulate investment and economic activity more generally. It was this way of thinking that led to the construction of the rather complicated way of managing QE and if you see QE through this very narrow neo-liberal lens of interest rate policy management then it makes reasonable sense.
Unfortunately, it doesn’t work. Driving long rates lower (from already low levels) has some benefit but it is tiny.
You and I know that massive government spending (without borrowing or taxing) is required and I think QE is the only way to institute the policy “without frightening the horses”. Aggressive long term use of the Ways and Means account would scare some and would (arguably) be illegal under the Maastricht Treaty….. so let’s use the tool that is available.
And we are…. to the tune of £300bn and counting. MMT by accident!!
The problem is that Government refuses to acknowledge what QE can do for them – they have been handed an axe but insist that it can only be used as a hammer. How do we get them to turn the axe round and start cutting to the heart of the matter?
So, going back to my first line (“I am not sure”)….. if your suggestion for an NIB allows QE to used “properly” then I approve. But, I fear that until the government realises that it is holding an axe rather than a hammer there will be little progress.
Noted!
Thanks for this exposition Richard. Could I ask for clarification of some points?
1. Para g (2). How do these deposits in banks and building societies , owned by the private sector, “secure the cash funding the government wants”? since as you say, the govmt has no control over them.
2.Your para g(5), I find difficult to follow.
3.”For these reasons MMT does not embrace QE, which it thinks unnecessary, and instead suggests direct lending from central banks to government. ” But one of the main points I take away from your blogs is that it is “smoke and mirrors” to talk about one government office “lending” or “borrowing” from another government office. If the central bank “lends” to government, is this not the “Direct Monetary Financing” which MMT advocates? in which case why do you use the term “lending” again?
1. Cash deposits with the government substitute for gilts: there is an asset swap, although it is partial (I stress)
2. I’ll have a look again
3. DMF is still lending – it is between two entities within government – and has to be as all money is debt
I still don’t see how the private bank deposits created when the BOE buys back bonds provides the government with spending money. Unless maybe it is being used to buy new bonds again.
It doesn’t
The deficit did that in the first place
QE monetises the resulting debt
And money does not require repayment
Jeff,
It’s easy to get bogged down in this.
If the BoE buys back the bonds from the banks (the usual primary dealers) using QE, it plants newly created reserves into the accounts of those banks. Who then have to make a payment to HM Treasury for the gilts they were given and told to sell to the market….except those in the know, know that never was going to happen, there is no market in effect now.
The reserves the BoE created are thus then transferred to the Govt’s. own commercially held bank accounts, who will be invariably be spread across the same banks. Net effect is that the govt banks accounts with private banks are awash with new money which the govt can now spend into the economy, paying for all the things it needs.
So QE creates a pile of new deposits in the hands of the private banks, which can now circulates in the bank reserve base and at the same time the gov gets the use of the new deposit creations to spend. Which then allows the recipients of that money to spend themselves…and so on.
I don’t agree with that
See what I just said to Vinnie
Article 123 of the TFEU bans member states’ central banks from making loans to governments for general expenditure, hence the QE deception with smoke and mirrors.
I have to disagree with you over your words: “In both cases [I refer here to banks not BoE] the money is made by making a loan – and repayment of the loan cancels the money that is created.”
I posted a few days ago the NEF report, “Making Money from Money,” which not only made it clear that money created by bank loans did not disappear when the loans are repaid – and the historical growth in money supply supports this assertion – but that jointly, the banks actually benefit to the tune of £23 billion a year.
I really would appreciate if you could explain why you appear to disagree with the NEF version.
I disagree with them on cancellation – and do not think their data proves their point
And seignorage is a different issue
Thanks for your reply, I am content to let the “cancellation” issue pass as I suspect that it is a matter of semantics. Even the BoE says that most growth in money supply is created by commercial banks.
However, it is the issue of seigniorage which really interests me, an apparent gift of perhaps £23 billion a year to the banks might explain the close relationship between bankers and politicians and deserves scrutiny.
I would be grateful if you could explain your views or at least say whether you think the NEF estimate is reasonable or not.
Many thanks.
It’s not semantics on cancellation
It’s fact
And £895bn is not most money creation being in the private sector
I’m happy with the idea of seignorage – whether it is £23bn I do not know
What are you suggesting we do about it? An excess tax? I’d be happy with that
Personally I think stuff like this that explains the mechanics of beneficial money creation is needed more out here in the real world. I for one much appreciate the effort.
Thank you again, Richard. I won’t labour the point now, but perhaps when you have a quiet day, you could explain why the question of cancellation of bank created debt seems to contradict the recorded money growth figures. And how the money is actually cancelled. I can see how this might happen if the banks were making huge loans each year that overwhelmed the cancelled money, but I would expect to see a reduction in money supply during recessions when banks were not making so many loans. I hope my problem with this is clearer.
The BoE stated that “banks create the most money” before this latest round of QE.
Finally, yes, I did suggest a 50% excess tax in my earlier post.
“the government persists with QE, supposedly to comply with international law”. Is this the TFEU? After 1st Jan, will we be free to use direct monetary financing? A very important step for MMT is it not?
Depends if we want any relationship with the EU – which we will, by February I suspect
Are you not concerned? Isnt this vital to monetary sovereignty?
Sorry – because I can’t see what you are responding to when moderating I can’t answer your question
Jeffrey Lucas says:
November 6 2020 at 1:00 pm
“the government persists with QE, supposedly to comply with international law”. Is this the TFEU? After 1st Jan, will we be free to use direct monetary financing? A very important step for MMT is it not?
Reply
Richard Murphy says:
November 6 2020 at 1:43 pm
Depends if we want any relationship with the EU — which we will, by February I suspect
Reply
Jeff lucas says:
November 6 2020 at 4:58 pm
Are you not concerned? Isnt this vital to monetary sovereignty?
No I am not concerned – it’s now clear that no one is
No one is arguing about direct monetary funding now that everyone is effectively doing it
You say
“No I am not concerned [about DMF] — it’s now clear that no one is
No one is arguing about direct monetary funding now that everyone is effectively doing it”
But above you explain why QE is a bad way of “effectively” doing this. Are you expecting that in any Brexit deal , the EU will not want to prohibit the UK using DMF? In which case then, QE it must be?
DMF can be dressed as QE
This needs updating but addresses much of it
https://www.google.co.uk/url?sa=t&rct=j&q=&esrc=s&source=web&cd=&ved=2ahUKEwjmj4yVpvHsAhWPa8AKHVbvDM8QFjADegQIARAC&url=http%3A%2F%2Fwww.financeforthefuture.com%2FGreenQuEasing.pdf&usg=AOvVaw3x1wzQYpEmEgcs2nuQq7G2
Thanks – will read and digest – a lot there to take in. Ordinary QE is bad, as above, GreenQE as per this doc is OK, and if need be, for the sake of a Brexit deal, can hide Direct Monetary Financing from the EU. I might get back to you on this. In the meantime, if you don’t say anything to Ursula von dr Leyen, I won’t either. Deal.
🙂
So what is the “international law” that prevents the Gov. from borrowing directly from the BOE? You mention the Maastrict treaty.. is that it for the UK? In Canada it was the Basel Committee established by the central bank governors of the 10 country members of the Bank for International Settlements in 1974 supposedly to “maintain monetary and financial stability” It was in that year that our relatively low/stable debt of about $29B began to rise because of interest payments to its current level of about $600B. Prior to that Canada did actually borrow interest free from its own central bank since 1938 when it was nationalized. During that time Canada funded major public projects; war funding, education for returning soldiers, family allowances, old age pensions, Trans Canada Hwy, St Lawrence Seaway and universal health care among other things so it can be demonstrated that self financing by Gov as imagined by MMT works.. because it has worked! And I don’t remember (not that I was alive then or particularly interested in economics) any bouts of economic stress or inflation. Check out; “Oh Canada! Imposing austerity of the worlds most resource rich country”: by ellen Brown 2012 or anything by the Qualicum Institute. There is a group here;( the Committee on Monetary and Economic Reform COMER) who brought a court case to the Canadian Supreme court challenging the stifling of the BoC mandate to create money for the public good. The case was not thrown out because it was frivolous but because it was deemed to be political! This was back in 2015 and received no media coverage. Case covered in “Liberate the Bank of Canada, Intrepid think tank urges” by Murray Dobbin, The Tyee april 2015
Fundamentally it’s been Masstricht here – but that is backed by a web of international conventions that back this in turn backed by all the major international financial institutions that back this plus a neoliberal economics elite who have not a clue what this means in accounting terms who claim as am consequence that it is justified