The Solution - Detailed
The following section contains the detail on how a Positive Money system would be implemented - with worked examples and may be of more interest to economists and financial commentators.
For a general idea refer to the section The Solution - overview.
- Who decides how much new money gets created?
- How will the Monetary Policy Committee make the decisions?
- The mechanics of creating new money
- An improvement on the existing system
We know from the last few decades that granting profit-seeking banks the power to create money leads to lending more money thereby increasing the money supply, regardless of the needs of the economy as a whole.
Elected politicians are unlikely to do much better. The temptation for the government to increase the money supply in order to pay for things such as motorways and university tuition fees is likely to be great, which would result in money being created without any reference to the needs of the wider economy.
What is required is an independent body whose focus is the economy as a whole.
Under our proposals the Monetary Policy Committee will become responsible for making decisions on how much new money should be injected into the economy in each period of time.
They will likely take a 12-month or 2-year view of the economy, and then smooth any increase in the money supply over each month.
The MPC will be politically independent and neutral. This is very important, as it prevents harmful political ‘tinkering’ with the economy. It is important that the MPC cannot be overruled by politicians, whose decisions will be swayed by political matters rather than the long-term health of the economy. It is also important that the MPC is sheltered from conflicts of interest, and also from lobbyists for the financial sector.
The Monetary Policy Committee will also still be subject to all the rules regarding transparency of its decisions, and the amount of the authorised increase in the money supply will be made publicly known.
Note that they will not be creating as much money as the government needs to fulfil its election manifesto promises – the needs of the government will not be considered. As discussed in the section 'Guarding Against Inflation', suggestions that this change would cause a 'Zimbabwe situation' have no basis in reality.
The Monetary Policy Committee (MPC) would authorise the creation of as much new money as they believe the economy (in other words, companies and households) needs to function healthily, and no more.
The Committee will continue to base its decisions on the basis of 'inflation targeting' - the policy of trying to ensure that inflation stays within a small range - such as between 1% and +1% per annum. In other words, they should try to ensure that any change in the money supply is neither inflationary nor deflationary - neither too much nor too little.
Note that for this to be effective, the measure of inflation used must be redesigned to take account of asset price inflation (such as a housing price bubble). It is pointless to attempt to make decisions affecting the whole economy using a measure of inflation that ignores inflation in excess of 10% per annum in house prices when housing is the most expensive item in anyone’s ‘basket of goods’.
Under this requirement, if inflation starts to rise, the MPC will need to stop creating new money until inflation has started to fall again. This makes it impossible for the MPC to create a Zimbabwe-like inflationary spiral.
When the Monetary Policy Committee has authorised the creation of a specified amount of new money, it will be created in the following way:
1. The government will hold an account, known as the 'Central Government Account' with the Reserve Bank.
2. The Reserve Bank will simply increase the balance of this account by the amount authorised by the Monetary Policy Committee. They will not simultaneously reduce the balance of any other account - by making a credit without making a matching debit, they are creating new money.
3. The government can then withdraw the money from its Central Government Account and add it to the pool of tax revenue, and then use it in accordance with the principles discussed in the section 'Distributing the Newly Created Money'.
In contrast to printing physical cash or coin - which costs around 10 cents for every $1 created - the creation of money by the method described is costless. To create $50m or $500m both requires one authorised official with the right passwords and a computer connected to the Reserve Bank's central accounts system.
Of course, it would also require witnesses and statutory formalities to be observed, but all in all, $500m could be added to the economy in a little under 20 minutes, at the cost of just a few hundred dollars.
In the existing monetary system, the total amount of money (defined as 'bank deposits' - the numbers in your bank account) is increased whenever a bank makes a loan. Consequently, the money supply increases as a result of the individual decisions of thousands of loan officers and mortgage advisors, and the lending priorities of bank directors.
Each of these individuals is motivated by a bonus on each mortgage or loan that is issued, and therefore their only incentive is to issue as many loans and mortgages as possible. They have absolutely no conception of how their activities fit into the wider health of the economy.
Post-reform, the health of the whole economy will be considered before a decision is made to increase or decrease the money supply. While there are always issues when decisions are made by small committees of 'wise men', we believe that it would be hard for the MPC to do a worse job of managing the money supply than the banks have done to date.
With a holistic view of the economy, and an incentive to support the economy rather than to maximise their own bonuses, this should lead to a better outcome overall.