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If I understand correctly, under the dominant system of fractional reserve banking, many (all?) private banks can create money by lending. See, for example, Implications of abolishing Fractional Reserve Banking on mortgages and interest rates. So, money created when people (or other entities) go in debt, and destroyed when those debts are paid back.

Some organisations, such as Positive Money, advocate there would be considerably advantages if we step away from this system, and only the government could create money. Quoting from their website:

History has shown that when banks have the power to create money, they create too much in the good times, causing financial crises, and then create too little money in the bad times, making recessions and unemployment even worse. They put most of the money that they create into house price bubbles and speculation on financial markets, and only put a small amount into businesses outside the financial sector. We simply don’t think that banks, with all their incentives and need to maximise their profits, can be trusted with something as powerful as the ability to create money. And it’s not enough to regulate them, because regulators have already failed to keep them under control, and there’s no reason why they should get it right this time around. We need to stop banks being able to create money. Instead, we want to see the power to create money transferred to a democratic, accountable and transparent process (...)

My question:

What would be the consequence if only a single institution, accountable to the national government, had the ability to create money? Assume that this institution would use a more or less objective set of criteria to determine how much money to create, for example, in order to meet particular targets.

Edit: A commenter requested more background motivation why this question is specifically about banks. Allegedly, the system leads to increasing house prices and debts, along with other problems. My question here is not whether the issues that Positive Money are correct in attributing those problems the current system of private banks creating money; regardless of their correctness, my question is, as stated above, what the consequences would be of having only a single government-controlled institute create money.

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marked as duplicate by EnergyNumbers, Giskard, Lumi, cc7768, The Almighty Bob Jun 23 '15 at 8:14

This question has been asked before and already has an answer. If those answers do not fully address your question, please ask a new question.

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    $\begingroup$ What if only the government could grow food? How can farms, with all their incentives to maximize profit, be trusted with something as powerful as the ability to create food? If your question is "Why shouldn't the government do everything?", then that's the question you should ask. If your question is specific to the banking sector, then you should have some sort of a story (beyond the vague blather in the quote) about why banking differs from, say, farming. In the absence of such a story, you might as well post 1600 other questions asking about 1600 other industries, one by one. $\endgroup$ – Steven Landsburg Feb 20 '15 at 0:02
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    $\begingroup$ @StevenLandsburg I added a paragraph motivating why I am specifically asking about the ability to create money. (On a side note, I don't know about the rest of the world, but in the EU, farms are very heavily subsidised, so apparently, the private market is not trusted with the ability to create food) $\endgroup$ – gerrit Feb 20 '15 at 0:16
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    $\begingroup$ This is too broad. The main aspect of it is already covered in economics.stackexchange.com/q/444/44 , so this is a dupe . Also, please bear in mind that the Positive Money mob are, errm, let's say at the fringes (of economic thought, of reason, of honesty) $\endgroup$ – EnergyNumbers Feb 20 '15 at 7:32
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    $\begingroup$ This is really an open research question. @gerrit - it might be worth reflecting, or even throwing back at sites like Positive Money the question of on what scientific basis do they advocate making such extreme changes to socially critical infrastructure. This is not to say that banking doesn't need reform, but that such reforms must be well grounded and scientifically otherwise they are quite capable of being incredibly destructive . $\endgroup$ – Lumi Jun 22 '15 at 17:47
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    $\begingroup$ @gerrit - This is my research area, and I'm also from a non-economic but scientific background, so I'm inclined to agree with you on economic research, especially as it applies to the monetary system. I think the key question for Positive Money, and anybody else including regulatory authorities, mainstream economists on the subject of reform, is what is your scientific evidence to back your claim. F.ex. in any other field some kind of simulation, series of experiments under laboratory conditions etc. would be required at a minimum. $\endgroup$ – Lumi Jun 22 '15 at 20:18
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When you dig down, this questions is very nearly a duplicate of this:

Implications of abolishing Fractional Reserve Banking on mortgages and interest rates

but based on the comments, it seems that the connection isn't obvious.

This question asking about what would happen if only a government institution could create money, but equally you say the proposal is not to have a fixed money supply. They are, in practice, the same thing.

The central bank makes the money base, M0, and then the banks create the money supply, with some multiplier to this. In a full reserve system, that multiplier is 1.0, and so the money supply is always equal to the money base.

In your question, we consider having a M0, but also have a state run bank that chooses the money multiplier to some number, that may or may not be 1.0.

From that point on things become almost identical - it doesn't really matter from the point of view of the economy, whether you make M0 ten times larger or smaller, if you offset it with changing multiplier. It should be the total money supply that matters - the money base never leaves the central bank, and so may be thought of as a "construct" onto which the monetary system is hung. The important point is that the government gets to directly control the money supply.

Before the era of quantitative easing, when a central bank wanted to increase the money supply, they lowered rates and that increased the multiplier. With quantitative easing, they simply increase M0 and force the money supply up in a 1:1 ratio. Either works (for a given value of "work").

There is, however, one very important difference:

  • With full reserve banking borrowing money is very expensive - it is economically the same as capital
  • With a state run lending bank, borrowing could be done at any rate the government chooses, including at an economic loss.

So, in your system, you could have a state run bank, that effectively subsidises business and/or people's mortgages using money raised from taxes or elsewhere. This would be like an extreme version of the UK forcing RBS and Lloyds to increase lending.

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  • $\begingroup$ I don't understand why a system where the power to create money is centralised implies that this multiplier is constant. In such a system a central bank can still decide to create money based on incoming loans in a way that private banks do currently. Your last point agrees with my (lay) understanding of what Positive Money proposes, where one of their alternatives is for the central bank to lend money (effectively subsidising) only to economic activity deemed to be valuable (i.e. yes to innovation or infrastructure, no to speculation on existing real estate). $\endgroup$ – gerrit Jun 22 '15 at 9:38
  • $\begingroup$ Also, isn't the contemporary system also effectively subsidising major banks, by guaranteeing that they are not allowed to fail — thus effectively socialising major risks/losses? $\endgroup$ – gerrit Jun 22 '15 at 9:39
  • $\begingroup$ @gerrit I tried to clarify I little bit. Constancy is not an important feature in either case. The point is simply that the multiplier is "set", rather like the central bank base rate is "set" to a constant - it is a constant that changes through time, but it is something that is chosen, rather than just the result of market forces. $\endgroup$ – Corone Jun 22 '15 at 10:49
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    $\begingroup$ Reserve requirements only limit things on one side, and many countries don't bother with them. The UK has a 0% reserve requirement (or rather it is chosen by the banks themselves and signed off). The EU has 2%. By and large most developed nations don't have reserve requirements that banks actually hit. $\endgroup$ – Corone Jun 22 '15 at 13:58
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    $\begingroup$ @gerrit as for capital requirements, they work in a very indirect way on the money multiplication - since it is weighted capital based, so in principle can move almost independently of reserve ratio (but in practice is what limits banks). But yes, ultimately that is exactly the point of all these regulations are for - to control things. The point is controlling things "a bit" is considered better than going whole-hog and making the banking sector part of the state. Positive money people believe the current control is too lax, others disagree and say it is sufficient. $\endgroup$ – Corone Jun 22 '15 at 14:01

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