Is 97% of money created by commercial banks?

Positive Money claims it is. But I beg to differ.

Positive Money has done a good job in some respects, as pointed out by Victoria Chick. (See first two minutes of this video clip.) PM has stirred things up, and made everyone think about money. Plus some of PM’s critics are intellectual pigmies, who have no grasp of economics at all, e.g. UK Column and  Detlev Schlichter (who never uses one word when a hundred will do).

Indeed, Schlichter wrote an entire book predicting that hyperinflation would result from QE, and has now gone into hiding perhaps out of embarrassment at the failure of hyperinflation to materialise.

Anyway, PM does make some mistakes (as indeed we all do). In particular, the argument behind their much publicised claim that 97% of money in circulation is commercial bank created isn’t quite right. Their argument goes as follows.

3% of money is physical cash (£10 notes, etc), ergo the rest must be commercial bank created. Now the flaw in that argument is that it leaves out central bank created money (monetary base) which is not physical cash. That’s central bank created money (which like most money) takes the form of a book-keeping entry (done on computers nowadays).

The ACTUAL AMOUNT of the latter “central bank book-keeping” money is normally no large compared to the other above mentioned types of money, thus the 97% figure won’t be far out – NORMALLY. However, we aren’t in normal times at the moment: in particular, central banks have created large amounts of money recently so as to effect QE.

So, at a wild guess, the proportion of money which is not commercial bank created might be about 90% at the moment, rather than 97%.


Are reserves a form of money?

Doubtless some readers will claim there’s a flaw in the above argument, namely that bank reserves (or monetary base in the books of the central bank) is not a form of money available to bog standard bank depositors like you and me. Well it’s true that standard depositors don’t have DIRECT access to central banks. But they do have access using their commercial bank as an agent.

To illustrate, if person X is paid money by the central bank as a result of the above QE (i.e. X sells government debt to the central bank), then X’s account at their commercial bank is credited. Plus the latter bank’s account at the central bank is credited.

But X has complete freedom to do whatever they want with that central bank money. If X wants the money in the form of physical cash, then X’s commercial bank just has to get that money, and sharpish, from the central bank, and give it to X.






Public investment again.


OMG. Another economist, Ashoka Mody, calls for more public investment as a way out of the recession. See his last paragraph.

The flaw in that argument is that investments should take place if they are VIABLE, not just because extra aggregate demand is needed. And if you don’t understand that, I’ll illustrate with some examples. Here goes.

If all worthwhile public investments that could be made have already been made, and given a need for more extra demand, the extra demand should come in the form of extra consumer spending and extra CURRENT public spending (as opposed to extra CAPITAL public spending). The extra spending should not come in the form of non-viable public sector investments.

Conversely, if there are worthwhile public investments that can be made, and NO EXTRA DEMAND is needed, then those investments SHOULD BE MADE. As to how to make them without causing excessive demand, the answer is to damp down consumer and public current spending. I.e. raise taxes on the private sector (or damp down private sector spending by having government borrow from the private sector).

As for the claim by Ashoka Mody that more public investment might “shake the world out of its stupor”, that’s a great new bit of economics. Where pray do we find learned papers by leading economists in “stupor” and “shaking the world out of it”? I long to know.

If, as Ashoka Mody claims, the central problem is an excess desire to save (i.e. Keynes’s paradox of thrift) then that problem won’t be ameliorated one iota by more public sector investment. Or if there is any “amelioration” likely to take place, then Ashoka Mody really needs to explain how and why.


The multiplier.

There’s an article in today’s Wall Street Journal which argues against extending unemployment benefits in the US. The article claims in connection with the multiplier that “This is the theory that you can increase employment by paying more people not to work…”.

No it’s not. If those writing for the WSJ studied basic economics, they’d discover that the multiplier is the idea that an initial bout of additional spending ultimately produces an amount of spending which is NOT THE SAME AS the initial bout. The ultimate addition to spending or aggregate demand may be more than or less than the additional bout.

Moreover, the ACTUAL NATURE of that initial bout of spending is near immaterial. That is, the multiplier works (or doesn’t) regardless of whether the initial bout of spending goes on unemployment benefit, law enforcement, new roads, you name it.

Or put another way, the first sentence of the Oxford Dictionary of Economics’s definition of “multiplier” is: “A formula relating and initial change in spending to the total change in activity which will result.”

For example, if recipients of the initial bout of spending save all the money they receive, there’ll be little or no ultimate increase in spending or demand. Conversely, recipients may spend all that additional money, and recipients of the latter spending may spend it all, and recipients of the latter spending may spend it all. You get the picture. And in that case the ultimate increase in demand will be far more than the initial bout.

The moral is: don’t believe anything you real in the Wall Street Journal or Financial Times.

Kenneth Rogoff advocates infrastructure spending as a cure for recessions.

Every time there is a recession, a crowd of well meaning folk pipe up and suggest that infrastructure spending is a cure.

The first problem there is that it just ain’t possible to implement BIG INCREASES infrastructure spending at the drop of a hat: the skilled labour and machinery are unlikely to be there. Some infrastructure projects are “shovel ready”, but most are not.

But Rogoff manages to make an entirely new mistake in connection with the “infrastructure cures recessions” myth: in a recent Financial Times article  he claimed that it’s a good idea for government to incur debt in a recession so as to fund what he calls “high return projects”. Well that sounds good, doesn’t it? Unfortunately, there are problems there, as follows.

“High return projects” should go ahead REGARDLESS of whether there’s a recession or not. Indeed, same goes for a project which produces a standard return!!! “Doh” (as Homer Simpson would say).

But Rogoff has a habit of putting his foot in it, as this recent Naked Capitalism article points out.

Another argument put by Rogoff is that during recessions “resources are cheaper”. Well that’s no more an argument for INVESTMENT projects than any other form of spending – “current” spending, in particular. That is, if the cost of all “resources” drop by X%, that does not of itself make a capital intensive way of doing something viable relative to labour intensive ways of doing the same thing.

But even that doesn’t do justice to the fallacious nature of Rogoff’s ideas: in particular, what does it mean to say that “resources are cheaper”? It’s actually meaningless.

To illustrate, if the cost of absolutely everything (in terms of dollars or Euros) drops by X%, then we’re all back where we started: except that the real value of money will have risen.

Interest rates.

One particular “resource” is capital, and the cost of capital does drop a bit in recessions in that interest rates drop.

The first problem with that argument, is that central banks normally aim to cut just SHORT TERM borrowing rates in recessions. After all, the average recession lasts very roughly three years, so rates do not want to be cut for MORE THAN about three years. (Plus even without central bank intervention, rates would probably rise come the end of a recession.)

But infrastructure projects last DECADES!!!  That is, anyone looking to fund an infrastructure project will have to borrow LONG TERM, and long term rates normally do not drop much in a recession.


The “infrastructure spending cures recessions” idea is as defective as it ever was. It’s the sort of idea that attracts those with little understanding of economics. And given Rogoff’s – er – bright new ideas on the subject, it seems that Rogoff himself comes into the category of people who do not understand economics.