In the modern economy, most money takes the form of bank deposits. But how those bank deposits are created is often misunderstood: the principal way is through commercial banks making loans. Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower’s bank account, thereby creating new money.
Bank of England 2014
Money Creation in the Modern Economy
This is a campaign to transfer the power of money creation from commercial banks to the state.
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Bank of England (Credit: Bank of England, CC BY-ND 2.0)
The Current Situation
While there are regulations and limitations on commercial banks’ ability to create money, the situation is fundamentally dysfunctional, since the interests of commercial banks are generally not the same as those of the general population.
The majority of banks’ lending (money creation) goes into the non-productive real-estate and financial sectors. It is a minority of lending that goes towards productive investment, ie product and service providers in the real (non-financial) economy.
The reason for this is that banks like solid investments. This means that lending for stuff that already exists, such as property or financial products, is preferable for them.
Sir Mervyn King, former governer of the Bank of England (BoE), said in 2010 in a speech in New York:
Of all the many ways of organising banking, the worst is the one we have today.
He is commenting in response to the financial crash of ‘07/08 and the banks’ practices that preceded it.
The nation has payed dearly in recent years for this system. House prices have nearly tripled since 2000, while the average wage has not even doubled. Home ownership is down 10% since 2008. Subsequent to the crisis the Government bailed out the failing banks to the value of £133bn, of which £46bn is still invested. This investment is unlikely to be fully recouped, since the remaining ~£40bn of RBS shares purchased by the state are now worth half that.
The state is capable of creating its own money. This has been demonstrated with Quantitative Easing (QE). The process of QE is that the BoE buys financial assets (mostly government bonds) using newly created central bank reserves, resulting in an inflow of money into the financial markets to cause a ‘trickle-down’ into the real economy. The Treasury authorises the transactions and the Treasury Select Committee of Parliament has oversight of the process.
National Money would differ in how the new money is spent. It would primarily enter the economy through public spending.
If the £445bn created for QE was used to fund public spending the austerity program could have been avoided. In 2016/2017 total public revenue was £730.2bn, so an extra £445bn would be an increase of over 50%. Hardly negligible.
The control structure of National Money would be that the Monetary Policy Committee (MPC) of the BoE would calculate the money supply required to meet any stated policy objectives set by the Government. For example, the Government might want to invest extra funds in the NHS. The MPC would calculate how much new money would be necessary to achieve the desired result, create that money and deposit it in the Government’s bank account.
The MPC would make their calculations based on the inflation target set by the Government to ensure inflation remains closely controlled.
Currently, the MPC sets the base interest rate (the interest rate at which the BoE lends to banks) to influence the money supply and inflation.
Under National Money the role of commercial banks would change. They would become what most people assume they are: Intermediaries between savers and borrowers. They would only be able to loan money that had been deposited by customers in savings accounts. The funds in current accounts would be fully accounted for at all times and earn no interest.
This system would remove the label of too big to fail, since if a bank did fail, the current accounts held with it would be transferred to a healthy bank. Savers would lose a proportion of their savings, dependent on the scale of the failure and the terms of their savings account.
This would make the stability of banks a more immediate issue of public interest, since people would not want to save with unstable banks and risk losing their money. This would force the banks to maintain greater stability.
Currently, the Financial Services Compensation Scheme insures people’s bank balances up to £85,000. This is backed by the Government, and is why the banks were bailed out in 2008; paying the insurance on everyone’s lost bank balances would have been more expensive.
National Money could be implemented overnight, with the accounting changes taking place behind the scenes.
The Free Market
The idea that we operate under a free market system can never be 100% true, since the mechanism that creates the money will have an impact on how it circulates.
However, by transferring the power of money creation from commercial interests to the democratic institutions of state, its entry into circulation will necessarily more reflect the electorate’s funding priorities.
 National Audit Office figures
This proposal is based on Sovereign Money Creation, as developed by Positive Money.