Policy Research in Macroeconomics

The power to create money ‘out of thin air’

By Ann Pettifor

Happy New Year to all PRIME readers, and welcome to my latest PRIME publication, The power to create money out of thin air.  At first sight, this is a long-delayed review of Geoffrey Ingham’s book, Capitalism (Polity Press, first published 2008).  However like all the best reviews, it has become a hook on which to hang discussion of the author’s contemporary pet themes. Here, these include primarily, capitalism’s ‘elastic production of money’. However, I also take the opportunity of explaining why misunderstanding about the creation of money out of thin air is so widespread, and why orthodox economists are mainly responsible for the confusion.

Out of this discussion arises a further one about ‘fractional reserve banking’ – currently at the heart of debate surrounding an IMF Working Paper by Kumhof and Benes. Then I take a pop at the theory and policy frameworks that prevent (or claim to prevent) co-ordination between monetary and fiscal authorities.

The review challenges, too, the widespread assumption (long promulgated by the enemies of labour, but also held by others) that wage claims by trade unionists caused, or led to, the inflation of the 1970s.

But Ingham’s book raises important issues which are and will be at the heart of politics and economics in 2013: with a deeper understanding of capitalism’s ability to create ever expanding amounts of credit-money, how does a democratic society once again rein in, regulate and subordinate the private finance sector to the wider public interest? How does society regain control over the public good that is credit and a sound banking system, and use both for financing society’s most important needs – including the need to tackle the threat of climate change?

And finally, how can public goods (including liquidity) avoid being confiscated by the finance economy? And how can they be restored to public accountability?

All of this should of course have been drafted as a series of short, readable blogs. Instead I offer only a long ‘review essay’ – for which I beg forbearance, but welcome readers’ own comments and ideas on the issues raised.

To download the pdf, click on:


14 Responses

  1. Brilliant essay. I found it to be hilariously funny in many places, although I do not think you would appreciate the humor the way I did. While I must insist that the conclusions to which you are drawn are mistaken, it is the best description of the financial system I have read to date.
    Yes, fractional banking IS a myth, as is the notion a gold backed dollar (which you did not mention) to which many of the great masses still subscribe. Your explanation of the real cause of the collapse of the economy; i.e. massive fraud and collusion between the banks and the regulators was spot on. This is the reason why more regulation is never the answer. You can’t regulate a snow ball rolling down a hill, which is what all credit bubbles become eventually.

    “If the system is to remain stable and work well, then it is essential that credit
    creation is part of a virtuous economic circle. One in which carefully regulated credit drives sound investment in economic activity, which in turn generates income in the form of wages/salaries/profits and tax revenues, used in part to repay debt.”

    This is utopian musings at best and naivety or disingenuous at its worst. It is almost neo-marxist to believe that economic needs can be anticipated effectively enough to carefully regulate anything. Only an individual can determine what they may need at any given moment. Why would anyone care enough to look beyond their own interests to build and sustain such an enterprise? What type of feedback system would be needed to control such a rubric?

    Without the heavy hand of government driving the economy away from the shoals, the unseen hand of the market place would have long ago drove the Keynesian model onto the rocks. The costs of doing this have been enormous.

    The banks should be allowed to offer any loan arrangement they desire, banking is by its nature a risky business. People who deposit their money in banks do so for many reasons. Historically, it has been for safety and gain. The problem, of course is that the fraud perpetuated on its customers by the banks isn’t prosecuted by the courts.

    While it is true the banks don’t need depositors money, sound banking does require it. What we have today is a criminal banking system that robs the nation and its people of not only their principle, in the form of a debased money supply but pays them no interest on money “loaned” to the bank.

    It is the economic theorist such as Keynes that gave the banks the fig leaves needed to cover the crime.

  2. You lot ought to take a little time out and look at this letter to the Queen by a sixteen year old Londoner called Sonny Green. He’s got more idea about what’s what than most of you accountant types whose perverse tunnel view of the world makes the economics of a madhouse make sense to you but to no one with their feet on the ground, whether in a job or on the dole. REAL people.

    Excuse me Ann please for sparking off. We need people like you in the driving seat.

  3. The following is a response to one aspect of Ann’s review… sent to her by Geoffrey Ingham, the author of the book “Capitalism” which was the catalyst for her essay:
    “Re your question of why no inflation 1945-71, perhaps I should have expanded on why the ‘fragile compromise’ between the classes prevailed during this period. There is evidence (Runciman, ‘Relative Deprivation and Social Justice’ and Goldthorpe’s essays) to suggest that during this period – in VERY general terms – workers compared their position with their own class and this favourably with their position in the recent past. During the 1960s this changed as capitalism and consumerism picked up speed. Comparisons were now made with other classes and the reference point was the future and not the past.

    Strangely, this was not widely understood by the ruling elites (Keynes believed that workers would be relatively satisfied when fully employed and not become ‘aspirational’ (to use the current voguish term) – the first M1 motorway was ludicrously small because it was believed that car ownership would not penetrate far down the class structure; the disintegration of traditional status hierarchies in the 1960s (I lived through this!!); ….on so on. I could go on (as I used to in my lectures) to the shifting patterns of industrial relations and the structure of industry that led to the exercise of the power that Kalecki (1944) said would occur (in his LEFT socialist critique) of Keynes.”

  4. “My point was that money creation is restricted THE THE GOVERNMENT / CENTRAL BANK. The fact that under the present system, money creation is restricted by capital ratios is a separate and unrelated point. The latter is simply saying that money creation BY COMMERCIAL BANKS is restricted.”
    No those are identical in accounting terms.

    One is ‘in specie’ and the other is ‘insured’. That’s the only difference.

    But I appreciate you won’t see that. You’re having a ‘watchtower moment’.

  5. Dear Ann,
    I read your piece with great interest – it was enlightening. I am one of your uninformed citizens with no education (expelled at 14) who has tried to understand the crazy situation we find ourselves in today.I have only been paying attention for the last few months when I chanced upon Modern Monetary Theory (I think that is what MMT refers to) and was blown away by it. This led me onto Marx, Hayek and Keynes and I started to understand a bit more. So, have faith. If someone as uneducated as me can start to critically evaluate our current circumstances, then there must be hope for everyone.

    If you have time, please look at my blog today http://crustyoldcodger.blogspot.co.uk/ where I seem, more by accident than design, to have come to roughly the same conclusions as you. It lacks the rigour of your analysis and is very weak on the way forward but, hey, at least there is some good coming out of the Great Depression – a more aware populace.

  6. “What it does do is to restrict money creation to the government / central bank.”
    That’s what we have in the current system. You just haven’t done the accounting to spot it.

    Money creation is limited by the capital ratios on the bank, and the willingness of the regulators to enforce that limit.

    Once you hit capital limits, you need to convert deposits into bank capital investments to continue lending.

    Or nick capital from another bank, and force them into insolvency.

    And its the same however you organise the accounting. There is no difference between an ‘in specie’ system and an ‘insured’ system other than the notional size of the balance sheets.

    1. Wrong yet again.
      We are all perfectly well aware that “Money creation is limited by the capital ratios…”. That has no bearing on the point of mine you attempt to contradict, namely that “What it does do is to restrict money creation to the government / central bank.”

      I’ll repeat that using as short words and sentences as I can.

      My point was that money creation is restricted THE THE GOVERNMENT / CENTRAL BANK. The fact that under the present system, money creation is restricted by capital ratios is a separate and unrelated point. The latter is simply saying that money creation BY COMMERCIAL BANKS is restricted.

  7. Ralph Musgrave: you’ve missed the whole point. The Bank of England most certainly does not try to determine the right amount of credit for the economy. It reacts to the credit created by the de-regulated private, commercial banking sector.
    It’s not the quantity of credit that is the issue. It’s the quality.

  8. My work is not based on Modern Monetary Theory. It’s based on old monetary theory…Keynes’s monetary theory which evolved in the 1930s. That’s all. So because MMT is about that too, fine. Don’t shout at me.

  9. Hi Ann,
    Re your claim that wage claims did not cause or substantially contribute to the 1970s, strikes me that the figures for the % of GDP taken by wages casts doubt on your claim. Wages took 65% of GDP in the mid 70s, which is an unprecedented figure. The average figure for the 50s and 60s was about 59% and the average over the last 20 years even less: about 55%.

    You claim that “Limiting the quantity of credit creation to a fixed sum to be decided by civil servants would impose deflationary forces on the economy….” I’m always irritated by the word “credit” because it does not distinguish between a debt, and in contrast a debt which is easily transferable (which equals money).

    Full reserve does not, as you seem to imply, restrict debts (e.g. normal trade debts). What it does do is to restrict money creation to the government / central bank.

    You say “Limiting the quantity of credit creation to a fixed sum to be decided by civil servants would impose deflationary forces on the economy…” Well no it wouldn’t: not if “civil servants” (or to be more realistic the BoE Monetary Policy Committee and Treasury) made the “fixed sum” the right size – which is actually something (roughly speaking) that the BoE tries to do ANYWAY.

    You say “But limiting the quantity of credit is also a hopeless endeavour in a world of innovative and subversive finance…”. If by “subversive finance” you mean “shadow banks”, I don’t see a problem in regulating these in the same way as normal banks are regulated (with the possible exception of the smallest shadow banks).

    As Adair Turner put it, “If it looks like a bank and quacks like a bank, it has got to be subject to bank-like safe-guards.” There is an FT article that makes the same point:


  10. You’re not “advocating MMT.” What the hell does that mean? MMT is simply a description of how fiat money/sovereign currency systems function. It’s like saying you’re close to the view that the earth revolves around the sun, but you’re not advocating it.

  11. Andi, thanks for your query. First, this analysis is mine, and does not represent the views of all the network of economists linked to PRIME. Indeed we disagree on some points. Second, as a network we have many good friends in the MMT community, have great respect for their work, and many of our approaches are aligned. But cannot say that PRIME as a network of economists is ‘advocating MMT’. But we sure are closer to them than to the orthodox community…

    1. Thanks Ann. I’d be interested to see where the points of difference are. There seem to be several some groups advocating similar things under various banners and to my (simple) mind, it’s just the stuff round the edges stopping joint action tackling “the enemy”.
      Divide and be conquered!

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