Interview with Martin Wolf on Monetary Reform, Part 1

Martin Wolf wrote an excellent article earlier this year on monetary reform, which can be found here .

Martin’s new book, “The Shifts and the Shocks: What we’ve learned – and have still to learn – from the financial crisis“, is available now. Martin Wolf is Chief Economics Commentator at the Financial Times. He has been visiting professor at Oxford and Nottingham universities, a fellow of the World Economic Forum in Davos, and a member of the UK’s Vickers Commission on Banking, which reported in 2011. His books include Why Globalization Works and Fixing Global Finance. In 2000, he was awarded the CBE for services to financial journalism, and in 2012 he received the Ischia International Journalism Award.

How long has monetary reform been an interest of yours?

I cover more or less everything in a strange sort of way, its a slightly weird job. At least everything, predominately macro-economics to global trade development, those sort of things rather than more strictly micro-economics things. I’ve obviously always been interested in macro-economic policy and as long as I’ve done this job, anyway which is now, I’ve been at the FT for 27 years so I’ve obviously been interested.

But I suppose I was one of those people who thought by and large, and I wouldn’t wish to exaggerate this, that the system we had evolved, though very peculiar in many respects, was stable enough that one didn’t need to worry about it, and therefore didn’t need to think through the possibility of radical change. So I’ve always– I’ve been interested ever since I was a student of economics back in the ’60s, but I didn’t think that we had to go back to first principles at all. And of course, the crisis of 2007 to 12, which is still ongoing to some degree – well, it’s still ongoing – has obviously made one, almost everybody I think, ask questions about the right way to manage the economy and therefore inevitably to start thinking about monetary economics. And that’s what happened to me, along with many others.

And in your experience, is this an area that central bankers take seriously?

Most central bankers are, to the extent that they’re economists, and there are only a limited number, though far more than used to be the case, (that’s one of the big changes by the way, without much notice, they’ve increasingly– the top central bankers are actually professional economists. That wouldn’t have been true 30 years ago. It’s a very big change.) The professional economists, so we’re thinking people like Ben Bernanke and Janet Yellen and Mervyn King before that in the UK, Draghi now. They are all quite academic economists, though they have of course also some practical experience. They tend still largely to work within standard models so their radicalism is limited. However, it’s well known that at least one or two of them, Mervyn King most notably in his speeches was profoundly critical of the modern monetary and financial system.

Though there are people in the academic end who think about these things more academically, who are more radical. Another person – who actually was never a professional academic as far as I know, I am sure he wasn’t – who was also very very interested in this set of questions is Adair Turner, Chairman of the Financial Services Authority, although never a central banker. So there is some interest, but still the orthodoxy – or what I call the new orthodoxy in my new book – is still dominant. You also have to remember so that sort of discussion of intellectual background and thinking among academics. You also have to remember that most central bankers are more or less practical people, who are forced rightly to deal with the problems in front of them. Most of them have been – well, mostly in the west, or all of them – have been dealing with exceptional and unexpected problems for seven years now.

So that doesn’t allow them a great deal of time for philosophical discussion of what a completely different world might look like. And so, on the whole, they don’t do that and if they did publicly of course it would be quite destabilising because they would be suggesting that what they’re doing, they don’t believe in. Well, that is not a very sensible thing for a policy maker to say, even if they should think it. So, by and large of course, they are bound to carry out their tasks, they’re public servants, within the framework of institutions and ideas that their masters – as it were, the public, the politicians – have set for them, rather than ask these rather fundamental questions.

In your article you mentioned positive money as a possible model for monetary reform. Are there risks in giving seigniorage powers to government agencies? Do you think that the temptations to overprint may become too much for them if they were given these powers?

There are a number of dangers. And one of the lessons I’ve learned and I think it’s a fundamental lesson, it’s the way I think at the moment is a modern monetary economy, and in a way I think it’s probably the most important lesson I now think one should now draw from Keynes’ work. But it goes back further in the history, back to Wicksell I think. Is that the modern monetary economy is a very complicated animal. It cannot be seen I think just as a sort of barter economy which is the way the orthodox economics tended to think about it. Money enters into it in very complicated and difficult ways. And it’s always– I think money exists because we live in an inherently uncertain world and money is the stuff you hold because the world is uncertain. It’s a reserve of absolutely reliable purchasing power that you need beyond just transaction – it’s not just about transactions – it’s stuff you can buy things with whatever happens as it were. Money is inherently linked I think to uncertainty, the fact the we don’t know what’s going to happen.

This is, therefore, a very imperfect world compared with the sort of complete market neo-classical paradigm which is of course an artificial and non existing world. In this situation, it’s always about choosing between imperfect solutions. Highly imperfect solutions. And I think there are a number of problems with reallocating seigniorage to the Government and I think there are two fundamental ones. One is the one you mentioned that the Government will be irresponsible, and the Government irresponsibility will be bigger than the private sector’s irresponsibility which we’ve already seen. The private sector can also, as we know, push back fundamentals, create credit and debt essentially without limit as long as it’s backed by the state. And that’s exactly what has happened all across the west before the crisis. We had this giant explosion in the private sector driven leverage and it created huge problems. And I’ve argued frequently but unfortunately it tends to end up with the public sector and indeed pressure on the public sector to inflate. It’s extremely likely that in the very long run, we will end up with inflation in the developed world. To get out of the debt that the private sector ultimately created, which then became public sector debt when the private sector and financial sector imploded and the economy collapsed. So, it’s very difficult to separate out what the private sector does and what the public sector does, when you have such an interlinked, interconnected public private monetary partnership which is what we’ve had now for a long time and it’s become greater.

But there is a risk of course as you said, in handing over the power to government to create money and that’s why, I would hand – if I would do this – I would hand over the authority to create money to the central bank as defenders of government given a mandate by government to create money in a non-inflatory way. The second problem which I actually think is more important than this first one, is what happens to the financial sector in this world, and there are two problems about that. First, which is perhaps later, the first is – and they’re related – is that the private sector, financial sector which would not now be creating money narrowly, might still create, well not might but certainly would try to create near money or money substitutes. As indeed happened in the 19th century, how we got bank money and not just gold money, as it were. We got bank notes and then bank deposits as near money because what Wicksell noticed in the late 19th century and that’s because the private sector just created it.

So the question is, if the private sector creates it, won’t you just re-establish the fragility we’ve seen, likened that the huge question or problem. The second question is and I think Charles Goodhart – a very distinguished scholar in these matters at the LSE – has stressed, the second really big problem is of course private sector money, particularly the ability of banks to create advances for people to create money as it were and credit it simultaneously, gives people flexibility in the economy. It means that if they need money temporarily, they can borrow at once and offset the bank and just create it for them. Well of course, the state isn’t flexible in that way. And it allows people to economise on their money holdings. It allows people to have much less money then they might need in the course of their business activities.

So there are, I think quite profound questions about what would happen and that’s why in my book, I’ve recommended that I would like to see countries experiment with it. I’m not suggesting and indeed experimentation is – in my view – one of the most important lessons of this crisis. We don’t know what the optimal monetary and financial system is, we simply don’t. Nobody can say with confidence that they do know how it should be structured and what are the laws and regulations it should have. So I actually think instead of promoting one side of banking model fits all, that sort of Basel approach, that we should encourage countries to experiment and perhaps, a few small countries to try this sort of model and see what happens.


  • joe bongiovanni says:

    Thanks to Cobden on this important aspect as we prepare to discuss money-creation and issuance anew.

    I took my hat off to Martin Wolf’s earlier call to end fractional reserve banking, and give that money-creation power to governmental authority, as had Lord Adair Turner earlier, but today his proposals for reform don’t quite seem as adequately thought through. Are these perhaps Cobden-friendly responses, like that given to the OBVIOUS ‘can’t trust government’ with money issuance question?

    His textbook ‘government MAY overprint’ reply actually extends the traditional ‘public money’ taboo, and shows to me his inability to fully appreciate the mechanics of true systemic money reform.

    There should be no power given to any government to overprint, if the systemic reform is properly done, and Wolf seems quite unaware, for instance, of the benefits of the Kucinich proposal to the 111th and 112th U.S. Congress, before K was redistricted out.

    The primary relevant benefit here is the legal structure where the ‘money-quantity’ question is resolved outside the partisan-political structure, and our politicians are left with the same budgeting priorities of public spending they possess today.

    I know the Positive Money proposal also includes a ‘public monetary authority’ structure, and Wolf seems here to eschew its benefits.

    In Irving Fisher’s (et al) 1939 Program for Monetary Reform, the problem we face today was spelled out in the “Intent” of the Program, ‘to end the “”lawless”” variability in the quantity of our circulating medium’.

    Ending the problem of media quantity cannot be left to politicians, it must be legally set in a publicly accountable authority free from political influence, and that structure is best laid out in the Kucinich Bill.

    Wolf needs to buck-up on the available systemic reform structures, esp. where this question of money-quantity can be readily transparent in real-time politics.

    For the Money System Common.

  • I agree with Joe.

    One weakness in Wolf’s suggestion that government might go wild with money creation is that it has had that power for decades, and for the most part, has used the power sparingly. That is, a part of the government machine, i.e. the Bank of England Monetary Policy Committee or similar committees, could at any time over the last century have given in to popular demands for more stimulus and pitched interest rates too low, or gone wild with QE. But they haven’t done that (except perhaps in the 1970s, but that episode was arguably caused by political problems, i.e. excess union power).

    In short what might be called the “direct money creation” advocated by Turner, Irving Fisher, Positive Money and others is only a minor variation on what central bank committees already do.

    Wolf’s second criticism is equally debatable. He says “..the second really big problem is of course private sector money, particularly the ability of banks to create advances for people to create money as it were and credit it simultaneously, gives people flexibility in the economy…”.

    The answer to that is that under full reserve banking (as advocated by Irving Fisher, Milton Friedman, Positive Money etc), the fact that banks do not create money when they lend does not stop them lending. Thus where a borrower wants the “flexibility” to which Wolf refers, i.e. wants access to funds, the borrower shouldn’t have much more difficulty than under the existing system.

    Moreover, far from using their freedom to create money under the existing system in a constructive manner, what commercial banks actually do is to create money out of thin air and lend it out in a pro-cyclical manner. I.e. they stoke booms and exacerbate recessions.

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