Would the Green Party’s monetary policies crash the economy?

Much of UK Green Party economic policy can be applauded. The Green Party rightly prioritises ecological sustainability and dealing with climate change. There is a central commitment to a more equitable distribution of wealth, opportunity and power. Political devolution is emphasised. Personal autonomy would be  enhanced by the establishment of a universal basic income. These policies would make a positive difference.

It is primarily with monetary policy that things go radically wrong. Their monetary policies are untested and, according to some expert opinion, they would lead to an economic crash. Consider these proposals in the official Green Party policy document:

• “EC661 The Green Party believes that, as the means of exchanging goods and services, the stock of money is a vital common resource which should be managed in the public interest.”

• “EC663 The Green Party believes that the power to create money must be removed from private banks. The supply of our national currency must be fully restored to democratic and public control so that it can be issued free of debt and directed to environmentally and socially beneficial areas such as renewable energy, social housing, or support for community businesses.”

Let us start with the claim that “the stock of money is a vital common resource which should be managed in the public interest”. This seriously misunderstands the nature of money. Modern money is not a stock. It is not material stuff – like oil, water or wheat – that can be physically hoarded and distributed. Money is relational.[1]

Money is essentially a type of promise. Monetary promises are debts. Such promises can be made by the state, or by a private entities or agencies. If we issue an IOU, then it is a promise to pay, which could in the right circumstances be treated as money. The state plays a vital role in establishing the unit of account and regulating the banking system.[2]

Why should a note (or IOU) saying “I promise to pay you £1000” be treated as “a vital common resource which should be managed in the public interest”? Green Party policy would make all such agreed interpersonal financial obligations subject to the control of a “National Monetary Authority”. So much for the Green Party’s commitment to individual autonomy. A national committee would decide whether anyone can borrow or lend. This implies a massive centralisation of power.

Green Party clauses EC662 and EC663 complain that the “existing banking system is undemocratic” and the “supply of our national currency must be fully restored to democratic and public control”. Several questions arise. Why should it be democratic? And, if it should, at what level? National or local? And how would “democratic control” work?

Here exposed is a major contradiction in the Green Party’s approach. On other matters, they want to advance autonomy and decentralisation. But this means that higher-level (democratic) bodies have less power to interfere with (some) local decisions. Otherwise, power is not devolved. You cannot have it both ways. Power is not decentralised if higher authorities always vet local decisions.

Allowing lending and borrowing between individuals and businesses would mean that money is created at a local level, and it is not subject to “democratic control” by a national body. The Green Party has ruled this out. They want to centralise the control of money.

How would “democratic control” work? Here the Green Party emulates many on the left who see some vague notion of “democratic control” as the obvious solution to almost every economic problem. Sometimes the slogan of “democratic control” covers up the deeper motive of control by the state. Generally, the practicalities and pitfalls of “democratic control” are ignored.[3]

What the Green Party means by “democratic control” is rather tame, in terms of democracy. Their policy is to create a “National Monetary Authority (NMA) that is accountable to Parliament” (EC663 (a)). The NMA would be in charge of issuing all money. But experience shows that accountability to Parliament, while important, offers only limited opportunity for democratic involvement. Parliament itself is always overwhelmed by detailed decisions. Technically trained advisors then play a crucial role. Parliamentary scrutiny is important, but its democratic features are constrained by complexity and information overload.

Responsible lending and borrowing depends on decision makers that have access to relevant detailed information and can make informed decisions about potential benefits and risks. Much of this should be done at a local level, where banks are involved in communities, have a deeper knowledge of community needs, and of potential returns on investments.

But the Green Party has an objection in principle to such decentralisation of lending decisions to private banks. With a note of outrage, they point out that

• “only 3% of our money supply currently exists in the form of notes and coins issued by the Government or the Bank of England. 97% of the money circulating in the economy takes the form of credit that is created electronically by private banks … when they make loans.”

But it is not necessarily a misfortune. The statement seems to suggest that we need more notes and coin and less bank deposits. But why? There is nothing intrinsically wrong or dysfunctional in using electronic deposits. And there is nothing intrinsically wrong or dysfunctional in having those deposits in private banks. The knee-jerk reaction of the Green Party is against private banks. But no clear reason is given.

From a rival perspective, we can imagine a reformed banking system with many more local banks. In such a case their decentralised powers to issue loans would be an advantage. It would make banking (and the consequent money creation) more sensitive to local conditions and needs. Instead, at least when it comes to monetary policy, the Green Party wants massive state centralisation.

“The Green Party believes that the power to create money must be removed from private banks.” Let is consider what this means. Public or private banks create money whenever they lend to clients. The bank issues a loan and receives the debtor’s obligation to repay. The loan entry (in the name of the customer) appears on the asset side of the bank’s balance sheet, and the bank simultaneously creates a new and equal-sized deposit entry (in the name of customer) on the liability side of its balance sheet. Hence the bank simultaneously expands both sides of its balance sheet by equal amounts. By these devices, commercial bank money is created endogenously. In modern monetary systems, banks can create money, subject to their own solvency and credibility.

The Green Party wants to end this. There will be legislation “to prohibit banks from creating national currency in the form of electronic credit … banks will have to borrow or raise the necessary national currency from savers and investors” (EC663 (b)). This suggests that banks can only lend money they have already received from depositors.
The Green Party approach seems similar to proposals by Frederick Soddy in 1926, Irving Fisher in 1935 and Milton Friedman in 1948, whereby a 100 per cent liquid reserve requirement would be applied to all deposits. This was known as the “Chicago Plan”. Similar proposals are put forward today by the Positive Money movement.

To give credit where it is due, the Green Party states: “In the longer term the banking system should be largely brought under democratic control, preferably at a local level” (EC675). Indeed, a meaningful democratic voice is more viable at the local level, because of the numbers of people and layers of hierarchy involved are both reduced. Presumably, EC675 means that the National Monetary Authority would eventually be wound down or abolished. But in the meantime, the local banks would have been hobbled and the huge contractions of available credit would have damaged the economy.

The Green Party imagines a future decentralised utopia, while in the meantime bringing massive centralisation of financial power. This is reminiscent of Karl Marx’s prediction of the eventual “withering away of the state” in the communist future. Of course, we shall never get there. We are always stuck in the interim, where the state has immense political and economic power. If the state obtains such powers, then it is very difficult to remove them. The state machinery creates its own vested interests.

The Positive Money or the Green Party monetary proposals have the support of influential thinkers including Adair Turner and Martin Wolf. But they are criticised by some leading economists. These critics claim that such policies are based on faulty theoretical analyses, and they would not lead to the results that are expected and desired. Influential critics today include prominent Keynesian economists such as Ann Pettifor, Malcolm Sawyer and Randall Wray. 

Critics of Positive Money or full-reserve banking agree that there many serious problems with financial systems in developed countries, including in the UK, US and the European Union. But they offer alternative diagnoses and different remedies.

There is not the space here to give an adequate account of the debate. Instead I will touch on a selection of concerns and criticisms. Ann Pettifor noted:

• “Because of the finance sector’s despotic power, about which I have been very vocal, many readers would expect me to support a proposal that prevents private banks from creating money, and to enthusiastically back the nationalization of money issuance. I do not however, and want to explain why.”     
  

She argued that Martin Wolf’s Positive Money proposals would lead to “a shortage of money, high unemployment and low economic activity”.

While concurring that “there is something rotten” in the current financial system, Yeva Nersisyan and Randall Wary criticised proposals for “full reserve banking” and the supply of “debt-free money” by a sovereign monetary authority. As money is credit, it is consequently  a liability for the issuer, therefore “debt-free” money cannot exist. “If we really did limit our finance to saving and our loans to deposits, then we would run our economy into the ground.”

Giuseppe Fontana and Malcolm Sawyer argued that “full reserve banking” is likely to exacerbate financial instability. The policy “has an inherent … deflationary bias which is likely to produce instability in the financial system.” For them, “the creation of money through the lending activity of banks is essential in order to accommodate the financing needs of capitalist economies, and to generate the cash flows which will prevent the occurrence of real and financial instabilities.” A full reserve banking system “could well lead to an exacerbation of instability for several reasons, including … the obsessive focus on commercial banks, while ignoring non-bank financial intermediaries and ‘shadow banking’”.

With their words quoted at the end of the previous paragraph, Fontana and Sawyer allude to the “boundary problem” that besets all financial regulation. Regulation applies to entities that are defined in the regulatory legislation. If it applies principally to conventional banks, then investors will shift their money to “shadow banks” (such as pension funds or hedge funds) that are free of regulatory constraints. As Charles Goodhart has pointed out, this is not an argument against financial regulation as such, but it is a problem that any regulatory legislation must address.

The boundary problem is entirely ignored in the Green Party’s proposals. Their draconian restrictions on the local issue of money would lead to inventive attempts to circumvent the rules. These could include IOUs, cryptocurrencies, money in foreign bank accounts, and so on. These problems are neglected.

There is a need for major reforms of the financial systems in most countries. Globally, finance is dominated by large banks that have immense power. They operate in international financial markets, seeking out gains in that arena, rather than serving the needs of local communities and small or medium sized businesses. The system needs radical reform and more effective regulation to avoid another financial crash.

As I argued in my 2023 book, The Wealth of a Nation, local banking played a crucial role in the British Industrial Revolution. Subsequently, these small country banks were mostly gobbled up by the big banks in the City of London.

Today, among the radical reforms required are the re-creation of local banks that can issue loans to support people and businesses. By having greater local knowledge, they would have more sensitivity to local needs and possibilities. This need for community-oriented banking was dramatized in the 2023 comedy movie Bank of Dave. Leading characters in the movie argued for banking decentralisation, to enable more loans to local communities.

The Green Party proposes a big step in the opposite direction. It wants to centralise money issue by placing it exclusively in the hands of a National Monetary Authority. Virtue is signalled by the words “under democratic control”. This would mean little more than the National Monetary Authority reporting to Parliament, its members being elected by the same body.

Members of Parliament are overwhelmed by other responsibilities, and precious few of them are experts in finance. The chances of ordinary people having any say on the crucial central decisions of money issue would be zilch. By contrast, a decentralised banking system would provide much more opportunities for local voices to be heard.

As John Maynard Keynes and many others have emphasised, financial systems are extremely complex. They are subject to uncertainty and waves of speculative sentiment. Complexity and uncertainty mean that any reform of the system has to be careful and experimental, learning from experiences elsewhere. Radical changes can easily have adverse unintended consequences.

On monetary policy, the Green Party has abandoned its commitment to decentralisation. It promotes dramatic changes that are entirely untested. Although the issues involved are subject to further debate, there is enough authoritative criticism to worry about the adverse outcomes. While the Green Party have rightly rejected policies of fiscal austerity, they promote policies of monetary austerity that could be even more damaging. Green Party monetary policy could inflict unprecedented financial and economic damage.

19 June 2023

Minor edits: 28 June 2023.

1. There are other misunderstandings of basic economic ideas. I have noted previously that Green Party leaders (along with former Labour Leader Jeremy Corbyn) have misinterpreted the economic concept of a “public good”.

2. See Bank of England economists McLeay et al. (2014) for an excellent exposition. See also Ingham (2004, 2020), Kelton (2020) and Keen (2022) on the nature and creation of money.

3. On the practicalities and pitfalls of “democratic control” see Hodgson (2021, ch. 9; 2023a).

References

Fisher, Irving (1935) 100% Money (New York: Adelphi).

Fontana, Giuseppe and Sawyer, Malcolm (2016) ‘Full Reserve Banking: More “Cranks” than “Brave Heretics”’, Cambridge Journal of Economics, 40(5), September, 1333-50.

Friedman, Milton (1948) ‘A monetary and fiscal framework for economic stability’, American Economic Review, 38(3), June, pp. 245-64.

Goodhart, Charles A. E. (2008) ‘The Boundary Problem in Financial Regulation’, National Institute Economic Review, 206(1), October, pp. 48-55.

Green Party (2019) Our Policies: The Economy. https://policy.greenparty.org.uk/our-policies/long-term-goals/economy/.

Hodgson, Geoffrey M. (2021) Liberal Solidarity: The Political Economy of Social Democratic Liberalism (Cheltenham UK and Northampton MA: Edward Elgar).

Hodgson, Geoffrey M. (2023a) ‘The Institutional Impossibility of Guild Socialism’, Cambridge Journal of Economics, published online.

Hodgson, Geoffrey M. (2023b) The Wealth of a Nation: Institutional Foundations of English Capitalism (Princeton and Oxford: Princeton University Press).

Ingham, Geoffrey (2004) The Nature of Money (Cambridge: Polity Press).

Ingham, Geoffrey (2020) Money: Ideology, History, Politics (Cambridge: Polity Press).

Keen, Steve (2022) The New Economics: A Manifesto (Cambridge UK and Medford MA: Polity).

Kelton, Stephanie (2020) The Deficit Myth: Modern Monetary Theory and How to Build a Better Economy (London: John Murray).

McLeay, Michael, Radia, Amar and Thomas, Ryland (2014) ‘Money Creation in the Modern Economy’, Bank of England Quarterly Bulletin, Q1, pp. 14-27.

Nersisyan, Yeva and Wray, L. Randall (2016) ‘Modern Money Theory and the facts of experience’, Cambridge Journal of Economics, 40(5), September, pp. 1297-1316.

Pettifor, Ann (2014) /Why I Disagree with Martin Wolf and Positive Money’. Available at: https://www.primeeconomics.org/articles/why-i-disagree-with-martin-wolf-and-positive-money/.

Soddy, Frederick (1926) Wealth, Virtual Wealth and Debt (London: George Allen and Unwin).