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What causes changes and fluctuations in the volume of money?

A New Zealand colleague recently drew my attention to the NZ Royal Commission into Monetary, Banking and Credit Systems (1956) [1], and in particular to clause 157:

” 157. The volume of money (on the Reserve Bank definition) is increased:

(a) When a customer of the Reserve Bank or a trading bank lodges, to the credit of his account, foreign exchange received from the sale of goods or services beyond New Zealand, from gifts or legacies from persons overseas, or from the proceeds of a loan raised with an overseas lender.

(b) When the Reserve Bank or a trading bank buys securities or other assets from an individual or firm and the proceeds are lodged to the credit of the seller’s account at a bank.

(c) When the Reserve Bank makes a loan to the Government or to marketing authorities. At first, the borrower’s deposits at the Reserve Bank are increased, and when this money is spent, the recipients may lodge part of it in their accounts at the trading banks and retain part of it in circulation in the form of notes and coin.

(d) When the customer of a trading bank draws on an overdraft limit granted by the bank and the recipient of his cheque lodges it to the credit of his account at a bank. ”

Clause 157 remains valid for modern world economies, however it does not discuss the dynamic nature of the money supply.  In particular, bank credit money is temporarily reduced from the money supply M1 whenever a non-bank makes a payment to a bank (including a loan payment, of principal or interest), and bank credit money is temporarily added to M1 whenever a bank spends into the real economy or purchases a financial asset from a non-bank.

In addition to the four modes of money increase listed above, M1 temporarily increases whenever a bank spends or buys assets from non-banks, and when the central government spends into the real economy.  And M1 is reduced temporarily when a central government receives tax receipts from non-banks and when it borrows from non-banks.

Moreover, we need to consider deficit spending by a sovereign government, which spending is directly associated with increases in liquid funds available to the private sector, and in particular to non-banks. It will be recalled that liquidity is defined as the conjunction of accessible money and financial assets which are readily convertible into accessible money. Much of the liquidity held by the private sector takes the form of risk-free financial assets, embracing both short-term and long-term Treasury securities. An increase in liquidity has profound economic consequences, contributing to aggregate demand, private sector income and savings, and employment.

So we have a complicated dynamical picture of money and liquidity being created and destroyed, the full import of which may be assessed by setting up a dynamic model of the entire economy, including most importantly the financial and banking sector. Prof Steve Keen’s models attempt to do this, in marked contrast with the economic modelling of mainstream economists.

John Hermann

  1. Reference




Does the federal government’s “credit rating” need protecting?

Has everyone forgotten the role played by the ratings agencies in the global financial crisis? Have any of those responsible for the wrongdoing of those agencies been punished for their destructive activities? Absolutely not! They have been protected from prosecution for their crimes. The ratings agencies in question have no useful or constructive role to play in the world and should, at the very least, be closed down.

The very idea that a monetarily sovereign government (meaning one that issues its own independent currency and has a floating currency exchange rate) is at risk of default on the securities issued by its Treasury is quite absurd. The contrary examples that are provided by those who do not understand this reality are always of governments that are not monetary sovereigns.


John Hermann

Governments ‘too focused on budget cuts’ says Bernanke

An interview on 26 October by BBC economics editor Robert Peston with former Fed chairman Ben Bernanke [1] has revealed that the latter thinks there should have been a stronger fiscal response to the global financial crisis in most countries, rather than their obsession with budget cuts, which left central banks with the primary responsibility of trying to pick up the pieces and keep their economies functioning — despite the moral hazard attached to bailing out the banks with public money.

As chairman of the U.S. Fed during the crash and its aftermath, Bernanke is the most influential central banker of our age, and so his opinions on economic policy should be taken seriously.

What was not discussed in this brief interview was the alternative — which would be anathema to most main-stream economists — of allowing the failed U.S. banks to go to the wall with their shareholders wiped out, and nationalising those banks with the application of government guarantees for all existing bank liabilities and assets.

The money directed to recapitalizing the newly nationalised banks could be repaid to the central government Treasury over time from the banks’ profits, after which time some consideration could be given to re-privatising them.

The response of governments, and especially the U.S. government, to the next financial crisis will demonstrate whether any lessons have been learnt. We might not have much longer to wait, in order to find out.

1. Source:

John Hermann

Could anything be more insane than for the human race to die out because we “couldn’t afford” to save ourselves? *

During the past year ERA Review has published various articles highlighting the possibility and desirability of funding essential public services and utilities entirely by government spending, rather than through market operations dedicated only to achieving corporate profits. This alternative to the current system used to be described as a mixed economy, long before major political parties succumbed to the pressure of neoliberal spin and decided to uncritically accept the self-interested recommendations of business and banking economists. The latter groups have never wasted an opportunity to inform us that there is no alternative to state support for corporations combined with austerity for the majority of our citizens (the TINA principle) at a time when corporate profits and corporate tax evasion have ballooned to record levels.

At present there exists, in Australia and other countries, considerable unused capacity for the production of goods and services. In such circumstances a monetarily sovereign government can make use of deficit spending in order to fund essential projects, without needing to worry about the possibility of inflation. Such spending always adds new financial assets to those held by the private sector as a whole, thereby boosting its ability to spend, save and invest, which in consequence exerts downward pressure on unemployment. Public borrowing is the conventional route, however direct funding from the central bank is entirely possible and the latter route has been employed in the past, especially during times of crisis.

There is no shortage of useful projects to which such funding can be directed. Topical and important examples include (a) the provision of government grants to research bodies concerned with developing alternative methods for electrical power generation to those which depend upon burning fossil fuels; (b) increased grants to citizens for the purpose of assisting them to install solar panels on their houses; (c) making education affordable at all levels to those who desire it and are qualified to undertake it, without obliging those at the start of their working life to service crippling education debt – in other words, recognising that education is an investment in the future of our country; and (d) grants to local governments for justified projects.

All of these things, and much more, are possible. What needs to change is the mindset of those who have not understood that the dysfunctionalities in the prevailing economic system can be successfully tackled and eliminated. The first line of attack must include educating the average citizen and the journalists who write for them, who continue to misunderstand the nature of the forces which are moulding and controlling their lives, and also the groupthink of those in positions of power and influence in our society who – in many cases – have been led unwittingly to believe that there is no alternative.

* Quote from the late Prof John Hotson (cofounder of COMER, the sister Canadian organisation to ERA)

John Hermann

Federal government spending is different from household spending

It is not unusual to hear from politicians that government spending and household spending operate according to the same overall principles. This narrative usually states that households and governments must both “live within their means”.

And although many astute commentators recognise that attempts to draw an analogy between government and household financing are fallacious, they fail to recognise that the reason for this fallacy runs much deeper than their commonly expressed observation that government expenditure leads to some return in the form of revenue for the government.
For several decades now, currency-issuing countries around the world have been operating without a gold standard to back their respective currencies. Modern currencies are based on pure state fiat money, backed only by the ability and willingness of each central government to tax its citizens.

Unfortunately mainstream economists have largely not yet caught up with the implications of this relatively new situation, and consequently they do not understand the significance of the development of modern monetary theory (MMT) and what it is all about.

Amongst other things, MMT proposes that monetarily sovereign governments (this includes our federal government but not our state or municipal governments) do not need to rely on taxation revenue in order to effectively spend into the economy without having to worry about inflationary pressures or potential rises in interest rates.
Deficit spending, whether accommodated by issuing Treasury bonds to the private sector or more directly to the central bank, allows the central government to inject new net financial assets into the private sector, as deemed appropriate for the purpose of enhancing aggregate demand, boosting the ability of the private sector to save and invest, and reducing the overall level of unemployment. Only central government has the ability to create net financial assets in this way; it never needs to “balance” its budget, and can never go broke.
Putting it another way, a central government which is monetarily sovereign will always live within its means, because it has a bottomless pit of financial assets (denominated in dollars, and easily convertible into actual dollars if this is required) at its disposal. There is no risk of inflationary pressure from deficit spending in circumstances where the economy is operating below its capacity to produce goods and services (such as right now!). None of this applies to a household, or to household budgeting.

John Hermann

Austerity is wrecking the global economy

In a recent article in the New York Times [1,2], economist Paul Krugman made the point that “the widespread demand for austerity serves a political agenda, with panic over the alleged risks of deficits providing an excuse for cuts in social spending”. However considering the current state of the global economy, the budget deficits of sovereign governments present no risk of unacceptable inflationary pressures or rising interest rates whatsoever. Indeed, many heterodox economists would go further, by saying that for any economy operating below full capacity its central government has nothing to fear by allowing its budget deficits and spending into the real economy to rise to whatever levels are necessary in order to secure healthy levels of aggregate demand and employment.

Krugman also made the point that in a non-inflationary environment budget deficits and government spending may be easily accommodated by allowing the central bank to make use of its ability to manufacture banking reserves (a form of state fiat money, or base money) out of nothing. This process is sometimes described as “printing money”, even though it is fully recognized that no printing presses are involved in the manufacture of reserves. Here is his account:

“… there actually is a sure-fire way to fight deflation: When you print money, don’t use it to buy [financial] assets; use it to buy stuff. That is, run budget deficits paid for with the printing press.

” Deficit finance can be laundered, if you like, by issuing new debt while the central bank buys up old debt; in economic terms it makes no difference. ”

One of the implications of this is that in a depressed, deflationary economy, conventional fiscal prudence is dangerous folly. In particular, the simplistic and misconceived notion that all surpluses are good and all deficits are bad must be abandoned. This is relevant to the Australian economy, because some informed commentators are now predicting [3-7] that Australia will soon move into recession. In such circumstances, to continue with austerity and the objective of cutting federal budget deficits in order to achieve a surplus at some future time would be to apply a wrecking ball to the Australian economy, at a time when the opposite fiscal trajectory is needed.

It is to be hoped that the new Turnbull government is aware of what is required for ameliorating the effects of any recessionary tendency, as was the Rudd government in the wake of the global financial crisis — as evidenced by its program of fiscal stimulus during 2008-10, which (notwithstanding inadequate monitoring of some spending projects) served to keep recession away from Australia’s doorstep.

John Hermann


Differing viewpoints on the role of debt in the economy

The following appeared within an article in the Jul-Aug 2014 issue of the ERA Review

The respective positions of the orthodox (neoclassical) and heterodox (mainly postKeyensian and MMT) viewpoints as they pertain to the role of debt in the modern economy differ profoundly, and may be summarised as follows:

Orthodox viewpoint

  1. The economy tends towards a stable equilibrium configuration.
  2. Private borrowing, spending and saving decisions are always driven by “rational expectations”.
  3. Banking and money flows don’t affect economic performance.
  4. Private debt growth does not affect economic performance.
  5. Public debt (deficit spending) must be minimised since it leads to rising inflation and rising interest rates. 

Heterodox viewpoint 

  1. The economy generally operates far from equilibrium.
  2. The idea of rational expectations is a fiction unsupported by evidence.
  3. Banking and the creation of new money by banks matter because they contribute to purchasing power and economic performance.
  4. Private debt growth (relative to GDP or a genuine progress indicator) must be restrained, because if excessive it will set the economy up for a crash.
  5. Sovereign government debt (aka Treasury securities) should be allowed to rise to whatever level is required for the operation of a healthy economy.


John Hermann