Introduction:
How are you going to pay for it? Seems to be THE question in Political Economy whenever we face a crisis. It has been a major focus of the Covid 19 pandemic, and as a result of the 2008 financial crisis grabbed the attention of politics during the austerity decade. It is also pertinent in the context of climate change and “paying for” a green transition. What crises have in common is their ability to highlight both the importance of money in the modern economy and the widespread confusion about the nature of money by politicians, journalists, the general public and often economics textbooks.
It is important that anyone evaluating the financial system understands money and debt. Modern economies have debt-based money supplies, for example in the UK 3% of money is notes and coins, 97% is debt, mainly from mortgages. Economics textbooks (such as the standard text in the IFoA exams, Economics 10th edition by Sloman, 2018) explain that money is created by the fractional reserve banking system, when central bank money is deposited then lent out by private banks, and that the reserve requirement determines the “money multiplier” which in turn governs the amount of money that is created. This is the “loanable funds” explanation which states that banks are required to take in deposits which they issue as loans.
The Bank of England (in an article in 2014) and many others have explained that the loanable funds model is false and the true explanation of money creation is endogenous money. A consequence of endogenous money is that when a private bank issues a loan it creates money by expanding both sides of its balance sheet at the touch of a computer key. This new money has purchasing power in the economy. The reverse happens when a loan is paid back – money and purchasing power is destroyed. The balance between these activities (which are driven by private demand for taking out vs repaying loans) has implications for aggregate demand. The level of private debt and the balance between private actors cash inflows and cash commitments have important consequences for financial stability.
If we are to face up to the challenges of the 21st Century and move discussion on from this question to “how do we make the monetary system work for people and planet?” we need a proper understanding of that system. How does it work? What are its vulnerabilities? What are its power structures? What is the role of different economic actors in maintaining financial stability? These are crucial questions for actuaries as they work to identify and manage system wide financial risks as well as of considerable public interest.
We will consider topics such as:
The history of money – how are we where we are? How do various economic schools of thought view money and what does this mean for their theories and ideas? Neoclassical vs Keynesian vs Post Keynesian vs MMT (Interacts with economic pluralism work stream).
What constitutes money, what is credit? How is it created and destroyed? Investigating the hierarchical nature of monetary systems and what this means for a globalised capitalist system.
What is the relationship between money and government? How do governments spend? What is the role of different financial institutions – central banks, commercial banks, shadow banks? Fiscal vs monetary policy. (Links with financial stability, economic pluralism & long term investment work streams)
Financial Instability – Minsky’s views on financial stability viewing each economic actor as a series of cash flows and cash commitments. Private vs public debt – why does it matter? The role of public debt in the economy – as a safe asset (Links with financial stability work stream)
How does money influence in the real economy? The impact of bank lending on real economic activity; house prices, productivity growth, climate change, concentrations of risk. What are the implications for inequality? Which elements of financial activity are included in GDP and should they be? (Links with alternative metrics for GDP, Long term investment, sustainability & financial stability work streams)
Resources:
Courses
Explores the history of money and banking and explores the pathway leading up to the 2008 financial crisis. Covers the evolution of central banking (US and UK) through intermittent banking crisis to the shadow banking system and the globalised capital market dollar based financial system we have today. https://www.coursera.org/learn/money-banking/home/welcome
Videos
Josh Ryan Collins
Introduction to money, credit and finance: https://www.youtube.com/watch?v=iUakALXqi7s
Economics of land and housing – covers deregulation of UK banking and the consequences for the wider economy. https://www.youtube.com/watch?v=RX-AzKgUEWk
Stephanie Kelton
An Introduction to Modern Monetary Theory by https://www.youtube.com/watch?v=c6ss3p4jjI4&t=1s
Monetary Finance in the Age of Corona Virus: MMT and the Green New Deal
https://youtu.be/xQFImP5VDrQ
Particularly Randall Wray at 1.32 and Stephanie Kelton at 1.47.
Books
A description of the UK money and banking system: Where Does Money Come From? Josh Ryan-Collins, Tony Greenham, Richard Werner and Andrew Jackson
Rethinking Capitalism, Economics and Policy for Sustainable and Inclusive Growth Edited by Michael Jacobs and Mariana Mazzucato.
Chapter 2 – Rethinking Fiscal Policy (Stephanie Kelton) Introduces sectoral balances and relationship between government and money.
Chapter 3 – Understanding Money and Macroeconomic Policy (L. Randall Wray & Yeva Nersisyan) Gives a modern monetary theory account of banking operations.
Macroeconomics – William Mitchell, L. Randall Wray & Martin Watts – The first textbook written by MMT scholars.
Review of the above textbook from a post Keynesian economist:
https://www.researchgate.net/publication/335883216_Book_Review_Mitchell_William_L_Randall_Wray_and_Martin_Watts_Macroeconomics
5. Ann Pettifor - The Production of Money
Articles
Rethinking Economics have an initiative in this area, see this post:
Yes, Money is Endogenous. Who Cares?
Repeat After Me: Banks Cannot And Do Not “Lend Out” Reserves
Paul Sheard, Chief Global Economist and Head of Global Economics and Research
Modeling the Financial System with a Corn Economy – “misleading and disastrous”
By Peter Bofinger
This is an article published on INET’s website on 3 January 2020. It explains why the description of of the financial system is important for macroeconomics.
Below is a short extract from the introduction:
More than ten years have passed since the outbreak of the Great Financial Crisis. This shock should have led to a fundamental rethink in economics. But how little has changed is illustrated by N. Gregory Mankiw’s textbook on macroeconomics published in its 10th edition in 2019. For the presentation of the financial system, it still relies on the classical model for a corn economy. In the very first paragraph of the General Theory, Keynes criticizes this approach as follows:
“I shall argue that the postulates of the classical theory are applicable to a special case only and not to the general case. […] The characteristics of the special case assumed by the classical theory happen not to be those of the economic society in which we actually live, with the result that its teaching is misleading and disastrous if we attempt to apply it to the facts of experience.” (Keynes 1936, p. 3)
Mankiw’s textbook provides a perfect example of this critique. In the following, we discuss how the book describes the financial system. We use the presentation of “crowding out” to illustrate its economic policy implications. Finally, we discuss Mankiw’s model of the “small open economy.” It is flawed as the author tries to build a monetary superstructure on a model with no role for prices and money.
Critical Macro-finance a theoretical lens: A description of the critical macro finance approach to modern money in particular the capital market based shadow banking system :http://financeandsociety.ed.ac.uk/article/view/4408
Credit Where it’s due: A historical, theoretical and empirical review of 20th century credit guidance policies. Dirk Bezemer, Josh Ryan-Collins, Frank Van Lerven, Lu Zhang. Discusses different forms of credit guidance instruments (both demand and supply side). Includes an empirical analysis of how credit guidance impacts credit allocation by banks. Good for understanding the role of bank lending in economic growth and development across different industrial sectors and lays the foundation for a market shaping approach by governments. https://www.ucl.ac.uk/bartlett/public-purpose/publications/2018/nov/credit-where-its-due
Can the Bank of England Do it? A discussion on the scope of the Bank of England’s monetary operations – Covers the history of the Bank of England from the gold standard through the second world war to its mandate for inflation targeting, Quantitative Easing and argues for an enhanced financial stability mandate through open market operations to target the yield curve as a way forward. https://progressiveeconomyforum.com/publications/can-the-bank-of-england-do-it-the-scope-and-operations-of-the-bank-of-englands-monetary-policy/?preview=true&_thumbnail_id=6910
Managing the UK National Debt 1694–2018: Paper by Professors Martin Ellison of Nuffield and Andrew Scott of London Business School looking at British government borrowing back to 1694. https://pubs.aeaweb.org/doi/pdfplus/10.1257/mac.20180263
Blogs
Critical macro finance – A Group of Economists from Bristol UWE who critically evaluate the Political Economy of finance and money in economic theory and practice. https://criticalfinance.org/about/
Frances Coppola – Good for understanding banking operations, regulation and macroeconomics http://www.coppolacomment.com/
Economics MIG 