Economic Policies for an Incoming Labour Government (Part 2 of 9)
Sun 1st Mar 2015
If we are to find that better way, we must clearly understand the failures and deficiencies of what has gone before. A major milestone in that quest for understanding was reached earlier this year when the Bank of England, in an article published in its first quarterly bulletin for the year  became the first significant central bank to acknowledge that the vast proportion of money in our economy (calculated by the authors at 97% of the total money supply) is created by the banks. This admission, which has been hotly contested and denied by bankers and economists for decades, if not centuries, casts a whole new light on the meaning of money and its significance for economic policy, and is the key to a new approach - not only as a response to recession - but as the foundation of a successful economic policy.
We need not explore here the mechanisms by which the banks create credit; suffice to say that they are well set out in the Bank of England paper, and in the end amount to the simple fact that the banks are not simply intermediaries, bringing savers and lenders together. They do not lend money deposited with them but instead lend money that they themselves create by making book entries unsupported by anything other than their willingness to lend. But while the mechanisms may be simple, the implications for policy are huge.
The facts that the quantity of money is almost entirely a function of bank policy and that its continuing but regulated growth is the normal and required condition for a well-functioning economy suggest strongly that the conventional treatment of money as a neutral factor in economic policy is completely mistaken. Current monetarist orthodoxy treats the money supply as reflecting more or less automatically the needs of the real economy, and impacting on it only in the sense that, if it is allowed to grow too fast, it will generate inflation. The reality is, however, that the rate of growth in the money supply is not just a function of the level of real economic activity but is, as we shall see and according to the purposes to which it is put, an important determinant of that level.
It is worth registering at this point that the banks’ remarkable monopoly power to create (or “print”) money is exercised entirely in the interests of profits for their own shareholders rather than of the economy as a whole. It might be thought that this private exploitation of such an important power would warrant the most careful public scrutiny, yet it attracts virtually no attention from policymakers, other than in terms of countering inflation; the Coalition government prefers to focus on reducing government spending, as the supposedly essential feature of macro-economic policy.
They thereby totally overlook the fact that it is extraordinarily important for the purposes of economic policy-making as a whole to understand the impact of private money-creation on this scale and, in particular, to analyse the purposes for which that credit is created.
A Labour government should no longer, in other words, accept that credit creation by the banks is benign, and automatically serves - because it is allegedly self-regulating - the public interest; a more effective economic policy depends crucially on an acknowledgment that credit creation (and therefore the whole of monetary policy) is hugely important and impacts directly and substantially on the development of the real economy, and can be made to serve a variety of wider economic interests rather than simply those of private profit-seeking bank shareholders. A Labour government that took this position would surely be encouraged to find that, on this issue, public opinion had got there first.
Keynes was well aware of the fact, and of the almost unlimited potential, of credit creation by the banks and recognised it as an important element in macroeconomic policy. His pre-war contention that “there are no intrinsic reasons for the scarcity of capital” is supported by compelling evidence, not least now by the Bank of England’s recognition that money is created by the banks from nothing. What should now be fully recognised, however, is that the purposes of credit creation could and should extend well beyond the funding of house purchase, which is currently its major feature.
Credit creation at the central bank, if properly directed and managed, can be used to selectively increase the private investment level of the country, as has previously occurred in all very high-growth economies, and as could happen in Britain.
 Bank of England Quarterly Bulletin, 2014, Q1 “Money Creation in the Modern Economy” by Michael McLeay, Amar Radia and Ryland Thomas of the Bank’s Monetary Analysis Directorate.
© Bryan Gould and George Tait Edwards 2015