I pointed out in a previous post that commercial banks create almost all new money, with little regulation. They create money to loan or purchase assets when they think they can profit from it. Money supply growth was allowed to reach 12-13% per annum in the USA, Europe and the UK, far greater than necessary for economic growth (it has now dropped precipitously). This extraordinarily relaxed approach has been a disaster. It lead to asset price inflation, enormous levels of debt, huge inequalities in the distribution of wealth, and eventually the global financial crisis (GFC).
As I have argued, all this could have been avoided if a more balanced approach to increasing the money supply had been used, with governments permitted to deficit spend, supported by central banks.
When the banking system was about to collapse in 2008 because mortgage debt defaults made many large banks insolvent, there was a desperate need to pour money into these banks. The obvious and pain free way to do this would have been for central banks to create the money and use this to recapitalise banks either directly or through governments.
Instead they did nothing. The approach taken was that governments would have to recapitalize banks funding this by cutting spending, raising taxes and increasing borrowing.
The financial system and commercial banks were rescued but this left governments with huge budget deficits. Note that these deficits were also a consequence of the severe recession precipitated by the GFC, which simultaneously reduced tax revenues and increased expenditure on, for example, unemployment benefits.
Soon the alarm was being expressed about the large government deficits and growing debts, leading to pressure for large spending cuts and tax increases, despite the fact that this will further reduce demand.
We are told that this austerity is necessary - that there is no alternative. This is wrong. It is unnecessary. The central banks can easily create the money to fund bank rescues and the budget deficit. They have, after all, created huge amounts of money to spend on quantitative easing (UK and USA) and long-term financing operation (ECB). Fears that this would create inflation, which never made sense given that this just replaced money that the GFC had 'destroyed', have been conclusively proven to be wrong.
Not only is it unnecessary, it is also unfair, particularly in the Eurozone, because the money created is primarily being used to support commercial banks rather than government spending. So the very sector that caused the problems and required rescue by the tax payer are the only ones receiving central bank help. Meanwhile Eurozone governments have been forced to impose fierce austerity and to pay high interest rates, if they can borrow at all (5-8%). That is apparently fine. But when Eurozone banks ran into difficulties late last year the ECB very quickly created and distribute over €1 trillion and loaned it to any bank that wanted it at 1%.
Why is it morally acceptable to create money to lend at low rates to commercial banks, who were the ultimate cause of the problem, but not to Eurozone governments and their voters, who have been forced to bear the costs of commercial bank excesses?
I am not arguing that banks should not be rescued. We need a functioning payment system. What I am saying is that central banks' power to create money should also be used to prevent the misery resulting from commercial bank excesses.
It may well be that central banks, especially the ECB, are constrained by self-imposed rules from doing anything else. But surely it is now obvious that these rules are absurd. In the UK and USA these rules can easily be bypassed or changed. In the Eurozone this is more difficult, especially since Germany is adamant that they be enforced.
In conclusion, I maintain that the approach to the GFC and sovereign debt crisis has been deeply irrational and unfair. The reluctance of central banks to create money to fund government spending is inconsistent with their willingness to create money to support commercial banks directly.
As I have argued, all this could have been avoided if a more balanced approach to increasing the money supply had been used, with governments permitted to deficit spend, supported by central banks.
When the banking system was about to collapse in 2008 because mortgage debt defaults made many large banks insolvent, there was a desperate need to pour money into these banks. The obvious and pain free way to do this would have been for central banks to create the money and use this to recapitalise banks either directly or through governments.
Instead they did nothing. The approach taken was that governments would have to recapitalize banks funding this by cutting spending, raising taxes and increasing borrowing.
The financial system and commercial banks were rescued but this left governments with huge budget deficits. Note that these deficits were also a consequence of the severe recession precipitated by the GFC, which simultaneously reduced tax revenues and increased expenditure on, for example, unemployment benefits.
Soon the alarm was being expressed about the large government deficits and growing debts, leading to pressure for large spending cuts and tax increases, despite the fact that this will further reduce demand.
We are told that this austerity is necessary - that there is no alternative. This is wrong. It is unnecessary. The central banks can easily create the money to fund bank rescues and the budget deficit. They have, after all, created huge amounts of money to spend on quantitative easing (UK and USA) and long-term financing operation (ECB). Fears that this would create inflation, which never made sense given that this just replaced money that the GFC had 'destroyed', have been conclusively proven to be wrong.
Not only is it unnecessary, it is also unfair, particularly in the Eurozone, because the money created is primarily being used to support commercial banks rather than government spending. So the very sector that caused the problems and required rescue by the tax payer are the only ones receiving central bank help. Meanwhile Eurozone governments have been forced to impose fierce austerity and to pay high interest rates, if they can borrow at all (5-8%). That is apparently fine. But when Eurozone banks ran into difficulties late last year the ECB very quickly created and distribute over €1 trillion and loaned it to any bank that wanted it at 1%.
Why is it morally acceptable to create money to lend at low rates to commercial banks, who were the ultimate cause of the problem, but not to Eurozone governments and their voters, who have been forced to bear the costs of commercial bank excesses?
I am not arguing that banks should not be rescued. We need a functioning payment system. What I am saying is that central banks' power to create money should also be used to prevent the misery resulting from commercial bank excesses.
It may well be that central banks, especially the ECB, are constrained by self-imposed rules from doing anything else. But surely it is now obvious that these rules are absurd. In the UK and USA these rules can easily be bypassed or changed. In the Eurozone this is more difficult, especially since Germany is adamant that they be enforced.
In conclusion, I maintain that the approach to the GFC and sovereign debt crisis has been deeply irrational and unfair. The reluctance of central banks to create money to fund government spending is inconsistent with their willingness to create money to support commercial banks directly.
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