Now is the time for complacency: RBA v Bank of England edition – Part Two

Image result for money and bankingCross-posted on The Mandarin: To quote Bank of England Governor, Mervyn King in 2010 “of all the many ways of organising banking, the worst is the one we have today.” As I documented in part one, the Bank of England continues as a thoughtful critic to this day. And as we’ve seen there, but will see further below, that’s not so true of our central bank the Reserve Bank of Australia (RBA).

But first, let’s have a quick tour of the horror show to which King was referring.

The fatal flaw in banking is that, although the money in our economy is a classic public good, like the air we breathe or the radio spectrum, it’s privately created. Commercial banks like NAB or Westpac create money whenever they advance a loan. This private licence to print money produces four huge problems.

First the banking system – and with it the economy – seizes up if private banks take excessive risks and go bust. In bailouts governments typically socialise the losses long after shareholders and executives have privatised the profits in hefty dividends and bonuses. And when you hear people say Australia didn’t bail out the banks – don’t believe them. None went under because the banks lobbied for emergency guarantees for hundreds of millions of dollars and, with all hell breaking loose around the world, the government capitulated over a weekend.

Second, public officials manipulate the banks’ creation of money by influencing the appetite for bank lending (through the overnight cash rate). But borrowing and lending reflect ‘animal spirits’ which strongly reinforce the economic cycle. And manipulating animal spirits is notoriously tricky. We often watch repeated interest hikes or cuts fail to turn things around. This happened as rate rises failed to moderate the exuberance of the boom in the late 1980s – until they overdid it. It’s been happening ever since the financial crisis as we’ve been shown that, until confidence returns, interest rate cuts can ‘push on a string’ and are ineffective in increasing credit and investment.

Third, with surging surpluses from saving countries like China, Germany and the Middle East for decades now, other countries have been relieving themselves of the discomfort of sluggish growth by increasing debt at the risk of even greater trouble ahead. Are you feeling lucky?

Fourth: if private banks creating money sounds a bit dodgy, it is. Economic reform reins in these kinds of privilege in other areas. Thus where it was once allocated to the lucky few, much radio spectrum is now auctioned, generating billions in government revenue. But here’s the thing. If governments created the money supply it would bring in tens of billions, perhaps a hundred billion in revenue.

What created money really funds

Indeed, in 1933 at the nadir of the Great Depression, economists from the University of Chicago proposed that governments monopolise money creation. A young Milton Friedman championed the ‘Chicago Plan’ after WWII and for the rest of his professional life.

The textbook concern with this approach is that preventing private money creation will starve business of credit for working capital and for investment.  Yet today, banks focus mostly on secured lending against mortgages, which for whatever benefits it generates, also underwrites an arms race in property prices and that does nothing for house buyers in aggregate and indeed imposes substantial costs once one takes into account the increasing financialisation of housing – the increasing payments to banks.

In fact only around 10% of bank lending finances business operations. As the Great British economic journalist Martin Wolf explains, if we’re worried about this “we could find other ways of funding this”. Wolf goes on to outline the upside. If money growth was held to just 5% annually, the ‘seigniorage’ from government money issue would be around 4% of GDP. Leaving aside my own rough figuring which suggests Wolf’s numbers are excessively conservative – 4% of Australia GDP is 70 odd billion dollars of government revenue per annum!

When a government competes

I’ve proposed a less radical plan – Chicago Lite if you will. You know how government agencies shouldn’t use their special advantages of being government agencies – like tax and planning exemptions – to compete unfairly with private firms? This principle of ‘competitive neutrality’ has been a staple of economic reform for decades.

But it cuts both ways. To prevent bank runs and stabilise liquidity in the system, the government-backed central bank goes banker to the banks. They can borrow or lend from the central bank at the cash rate and use central bank ‘exchange settlement accounts’ to make payments between themselves. If they get those services from the central bank why can’t we all?

This was a moot point before the internet made it cheap to do.

But Australia’s Reserve Bank Governor Philip Lowe recently dismissed such ideas. Given the remaining problems in banking – of price gouging and instability – and the magnitude of the possible upside, you’d think he might have quoted some research: Research like the Bank of England’s which released research on a different Chicago Plan Lite.

Modelling the central bank creating a third of the money supply by issuing its own ‘bitcoin’ style crypto-currency, their simulations suggested huge economic gains of 3% of GDP – more than the PC’s estimated gains from national competition policy throughout the 1990s.

Regarding my proposal for ‘central banking for all’, Lowe was dismissive, claiming that it would put the RBA in competition with the banks. For me, that’s a feature, not a bug. Genuine economic reformers might see it that way too. They should. Especially in a sector saturated with excessive profits and bonuses – shouldn’t we at least consider levelling the playing field between banks and their customers? They bank with a ‘people’s bank’ – the RBA – but we can’t.

Of course, as the Bank of England paper noted, there are plenty of issues to be worked through. But none that can’t be managed using standard principles like everyone meeting the full, unsubsidised costs of services they receive. The Governor’s other concern – which extends also the issue of central bank digital currency – is that anything that makes it easier for people to avoid depositing money with commercial banks threatens financial stability. Again I see this as a feature, not a bug – or perhaps an opportunity dressed as a problem. If the little people are still fleeing for safety while the smart money has long since departed, shouldn’t we be asking why rather than lament their refusal to keep pretending?

Let’s debate reform’s winners and losers

Of course, Lowe’s concerns shouldn’t be ignored. But they should be the beginning, not the end of our exploration for the best options. As I read Lowe’s speech I thought of the old Tariff Board of the early 1960s which would have been reluctant to countenance tariff cuts to our highly protected car industry (It recommended a local content plan in 1965). Why? Well because it would make life difficult for car manufacturers. Later it came to understand that the whole point of a level playing field was that you can’t make things better for the best without making them tougher for the worst).

Or our Tax Office, which opposed Australia’s pioneering use of the tax system in administering HECS because using its infrastructure to facilitate student loans would interfere with the Tax Office’s real purpose.

If the Bank of England’s research is to be believed, reforming our monetary system offers economic reform with benefits on a grand scale. Is it really asking too much of our own central bank, replete with substantial research capacity, protected with independence other civil servants could only dream of, to deliberate on such important matters with its lodestars being reason, evidence and the public interest rather than the interest and comfort of the sector it regulates?

Postscript – Complacency, what complacency?

In an earlier version of this column, I suggested that the Productivity Commission might be sympathetic to my argument that RBA competition with the banks was a feature, not a bug. In any event, in that spirit, Lateral Economics made a submission to the Productivity Commission’s recent inquiry into competition in financial services outlining the proposal. Silly me. The Commission has just released its draft report. It is over 600 pages so I can’t claim to have read it all. But there’s no sign of it that I can see and, on subjecting it to a word search, “Lateral Economics” turns up only in the list of submissions. I’m hoping to attend the public hearings on the draft report in the hope that the commissioners might be able to help me better understand why these ideas are not worth considering.

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16 Responses to Now is the time for complacency: RBA v Bank of England edition – Part Two

  1. paul frijters says:

    there’s a related problem, related to the dual role of money.

    Money as a means of exchange is a classic public good. But money as a holder of value, ie purchasing power, is a classic private good. It is both rival and excludable. Yet if a bank creates money, it creates both the public good and the private good.

    When money is created, someone gets the purchasing power they did not have before. And that someone, in the first place, is the bank. The bank lends it out and gets and interest rate in return (or not, if it just creates it to pay the CEO), but crucially the bank is the initial beneficiary of the private good that is purchasing power. So the power of banks rises with the amount of money. They don’t just take an extra cut on the rest via cartel-interest rates and too-big-to-fail-risk-privilege, they get first dibs on economic growth and debt. It’s a very poorly understood aspect of modern banking, but it becomes crucial when thinking about things like quantitative easing. Then it matters an awful lot who gets the purchasing power.

    • Nicholas Gruen says:


      Here’s an interesting attempt to estimate the implicit subsidy to banks from money creation.

      I’m not sure I’d say that money in its role as a store of value is a private good. The money supply is a public good and how much of it you hold is a private good. And if you hold it on its first entry to the world, it’s a private good alright, but that’s because it’s not entered the world as it should it seems to me – as a public good – to then be allocated as a private good to someone who pays for it.

    • Ravi Smith says:

      This might be a dumb question (I’m taking monetary economics next semester). But isn’t the Government the only entity that benefits from the new money in the form of seignorage. The first people to get the money have simply exchanged T-bonds for money at market prices.

  2. Technology and the Internet of Things now allows us to simplify money so there is no need for it to undertake multiple and conflicting roles. Money no longer needs to be complicated by also being a store of value or a unit of value. It can just become a medium of exchange.
    Neither Blockchain money nor official money is fit for the purpose of sustaining life on earth. We need to define a unit of value independently of the financial system. A unit of value that will sustain life on the planet for eternity. One way of achieving this was presented in my paper last December at the UNSW conference of the Society for Heterodox economics. My paper on “Is a stable financial system possible?” is posted at: . Also refer to my forthcoming book chapters: ‘Sustainable Value Money: Why it’s needed, how to get it?’ In: Boubaker, S. and Nguyen, D. (eds.), Ethics, ESG and Sustainable Prosperity, World Scientific Publishing: Singapore, .
    ‘’Renewable Energy: Stabilising Money and Society’, in: Droege, P. (ed.), Urban Energy Transition, 2nd Edition – Handbook for cities and regions, Elsevier Science Publishers: Oxford, .

    • Shann
      Would guess that because financial systems involve many, intertwined layers of representation, of representation(s) that some degree of instability is probably intrinsic to them.

  3. Nicholas
    This is not my area , forgive me if this is a dumb question. Re ‘central banking for all’ does that mean recreating some sort of ‘ commonwealth peoples bank’ ?

    • Nicholas Gruen says:

      It means doing what I’ve proposed.

      The RBA provides utility banking services to the banks. We should be able to do the same. There need be no branches or any of that malarky – it can all be outsourced. The RBA should make its savings, lending and exchange settlement services available to all comers, though this could be done with a major investment in its IT system with APIs (application programming interfaces) to enable others – banks, Google, Apple, Woolies, whomever can meet the relevant technical and compliance requirements – to resell its services.

      • Thanks
        ,apart from the absence of bricks and mortar ,how else would that differ from the old commonwealth bank?

      • Diogenesed says:

        What value would goog, appl or any other intermediary confer?

        “The RBA should make its savings, lending and exchange settlement services available to all comers”

        All it needs to do is offer every AUS citizen a basic transaction account with customer access provided by the Internet. Let the RBA invest these savings in Australian Treasuries, and offer a nominal rate of interest based upon these. If you recall, this is why Ahmed Fahour was employed by APost.

        Why didn’t APost do it? The Big Four, and its lobbying arm, the ABA, complained to the government!

  4. Ingolf says:

    Nicholas, much as I admire your long-term efforts on this front, I’m sympathetic to Lowe’s concerns.

    Granting everyone access to RBA accounts is a radical proposal and I suspect there would be many unintended consequences, not all of them necessarily good. You see Lowe’s concerns about financial stability and putting the RBA in competition with the banks as pluses and it’s tempting to agree with you. Banks have hardly covered themselves in glory. Still, it seems to me he’s right, for example, in suggesting that the easy availability of a bombproof bolthole at moments of perceived crisis would increase destabilising flows out of whatever remains of the private banking system.

    What interests me more is that this proposed solution doesn’t seem to properly consider the deeper causes of our dysfunctional banking system. To my mind, the fatal flaw isn’t that “money” is created privately, it’s that under a deregulated fiat system underwritten by a central bank this endogenous process becomes a one-way street, inherently given to excess and, eventually, destabilising imbalances. These in turn provide the rationale for more aggressive official efforts, mounting capital markets confusion and reflexive speculation.

    If a financial system is to be deregulated, which I favour, then participants must not be protected from their foolishness. If the political decision is made that the system must be backstopped in various ways, then stringent regulation ought to continue. What we’ve ended up with post the 70s is the worst of both worlds.

    It seems to me political imperatives, together with bureaucratic careerism and groupthink in the central banking world mean that errors are rarely caught whilst small and manageable. The incentives mostly point the other way. Giving the RBA a greatly increased role in our financial system strikes me as heading in the wrong direction.

  5. paul frijters says:


    great to see you in this debate. As you might know, I’m with Nick on this matter.

    The essence of Nick’s proposal is to separate investment banking from retail banking, and for a new Commonwealth bank to offer deposit accounts to everyone and minimal lending services. This effectively is taking away the most profitable and sensitive parts of the banking system, which uses its cartel position to overcharge on lending for mortgages and business loans. That overcharging is a huge drain on the economy and on growth whilst depriving us of tax revenue. So that bit is on its own a no-brainer. Only if you think it is better to have low growth and money in the hands of the owners of banks rather than the general population would you oppose it on the first-round implications. If one opposes it, it would have to be on system effects.

    In terms of those system effects, I have you have the basic story wrong. The basic story of the systemic problem with current banking is that banks have too much of an incentive to gamble big because they can blackmail the government with the deposit holding side of their operation. So separating the two should decrease systemic risks, not increase them! On this part, I think Lowe is just wrong.

    There is a related, more tricky issue, which is the tendency of individuals to over-borrow to keep up with others. That tendency is independent of how the banking system is organised though: people want to keep up with each other and are prone to over-borrowing when given easy access to credit and faced with credit card marketing.

    With or without a new Commonwealth bank, the loan-shark side of the financial industry will remain a worry and in need of regulation that in turn will be gamed and politically manipulated. The main instrument on that issue is interest rate policy and taxation on the luxury goods that people want to borrow for (big houses and expensive cars).

    When you say you do not want an increased government role in the financial system, I think you miss the point that the current situation is one where the role is just as large, but is indirect, more destructive and less visible.

  6. Ingolf says:

    Thanks Paul. As usual, you make a good argument. Nevertheless, as you’d probably expect (!), I’m not yet quite won over . . .

    It seems to me granting open access to RBA accounts is far more radical than simply creating a Commonwealth Bank II. Wouldn’t it, for example, greatly increase the amount of base money, indeed blur the distinction between base money and “money” as it’s currently understood? Perhaps this needn’t be a bad thing but at a minimum it needs to be meticulously thought through. This is after all playing with the very foundations of our monetary system. I have a suspicion that “controlling” monetary affairs would end up being even more complicated (as if they weren’t difficult enough already).

    I think the proposal also prompts questions about how the two “systems” would interact. Nicholas may have answered many of these elsewhere; if so, apologies for my ignorance. Still, to note just a few: how, on a continuing basis, would the RBA decide where and how aggressively to lend; what would be their basis for setting lending rates given they’re a major determinant in setting base rates; would banks and other financial institutions be allowed to freely compete with the RBA, both in lending activities and in trying to attract deposits; if, as seems quite likely, the “private” financial system evolves new and interesting responses to the RBA’s initiatives, is that whole area to be caveat emptor for participants, large and small; and, if so and if it stays (or gets) big enough, will governments and the RBA really be able to wash their hands of its problems in any future crisis? And so on.

    Part of our difficulty in discussing this issue is that I see the existing banking and monetary system as fundamentally flawed. In my view, properly rooting out those flaws would ameliorate (or in some cases perhaps entirely eradicate) the sort of problems that prompted Nicholas to put together his proposal. In other words, we don’t so much disagree about the manifest failings of what is but rather about the most efficacious and safest solution. While that’s arguably a separate (or at least parallel) topic, it tends to constantly bleed into my thinking about any additions or changes to the existing system.

    Anyway, to finish just a quick response to some of your other principal points.

    First, no argument, overborrowing is a problem and not only for individuals. Although it’s true that Australian households are medal winners in this category, I think it’s fair to say that progressively increasing relative indebtedness is the single most notable feature of recent decades pretty much everywhere. I’m not in the least convinced, however, that this is independent of how the banking system is organised. Quite the contrary as touched on in my initial comment. Fiat based, central bank backed monetary systems intrinsically and powerfully lean that way.

    As for those “system effects”, we’re probably slightly at cross purposes. I don’t think Lowe would argue that banks aren’t still in effect “too big to fail” and that their vast deposit holdings give them unhealthy political leverage. Certainly I wouldn’t. As you say, this is a critically important flaw in the current system. His concern, as I understood it, was a narrower one; namely that a ubiquitously available RBA based safe haven might produce destabilising flows out of the reduced “private” banking system at the first sign of crisis. Probably not a big deal but a valid concern.

  7. Nicholas Gruen says:

    Thanks Ingolf and nice to see you around these parts. Always welcome :)

    I didn’t see your comments and so haven’t responded till now. In any event Paul seems to have done a good job.

    I have had a crack at answering your questions below.

    Still, to note just a few: how, on a continuing basis, would the RBA decide where and how aggressively to lend.

    It lends of right to anyone with a super-collateralised asset which on prime residential property is up to 60% of the value of the property. It’s as ‘aggressive’ in doing this as it is in its supply of banknotes to the monetary system. It just meets demand for the right to the extent that it manifests itself.

    what would be their basis for setting lending rates given they’re a major determinant in setting base rates

    The rate they set is the same as the rate for the banks – the overnight cash rate plus or minus any charges or margins to fully meet the costs of account keeping.

    Would banks and other financial institutions be allowed to freely compete with the RBA, both in lending activities and in trying to attract deposits


    If, as seems quite likely, the “private” financial system evolves new and interesting responses to the RBA’s initiatives, is that whole area to be caveat emptor for participants, large and small

    As Martin Wolf pointed out when he was discussing it with me, this could easily lead to a ‘caveat emptor’ world for the rest of banking given that utility banking is accessible through the central bank. Still, if you think some prudential regulation should remain, you should provide some.

    And, if so and if it stays (or gets) big enough, will governments and the RBA really be able to wash their hands of its problems in any future crisis? And so on.

    If you think private banking might compete unsustainably with the central bank and that this could be destabilising, you’re suggesting that some prudential regulation should remain – which is fine with me. But because the commercial banking system is now dealing with riskier assets, I think it’s likely that they’ll charge higher margins and do less lending – that is if you’re marketing loans against property, and you only have the second mortgage after the central bank has a first mortgage against 60% of the value, they’ll probably cut back the aggressiveness of their higher LVR lending.

    • Ingolf says:

      Yes Nicholas, I don’t drop in often enough and when I do, I’m therefore almost invariably late to whatever conversation is underway . . .

      Anyway, thanks for the responses. At one level, it all seems straightforward enough. At another, there’s much that I’m uncertain about. Borrowing by “right”, for example, seems a very interesting concept. Isn’t there a danger that credit creation might at some point and to some degree slip out of the RBA’s control? Particularly if the rate at which it lends is close to the cash rate. Or did you mean by “charges or margins” that the RBA would add a substantial amount to the cash rate to bring it closer to “market” rates?

      As for private banking and the rest of the financial sector, it obviously would be much reduced if the RBA took the meat of mortgage (and other plain vanilla?) lending. Still, as we well know, humans are infinitely creative and animal spirits will continue to pop up from time to time. It’s not that I favour regulation but rather that I fear this separation of core retail banking and the rest might not truly deal with the underlying systemic problems. I’m inclined to agree with Mervyn King who emphasised in that talk you cited that the only really workable solution he could see was much, much higher levels of capital, as in multiples of any currently proposed levels.

      As Paul said in the more recent thread, “money is bloody complicated”!

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