by Philip Pilkington
Article of the Week from Fixing the Economists
Well, the Bank of England has finally come out and said it: loans create deposits; banks create money and don’t simply lend out savings, and the money multiplier in the economics textbooks is false. Actually, we’ve known this for a long, long time. While the BoE report references much Post-Keynesian work — including early work by Nicholas Kaldor and Basil Moore’s path-breaking 1988 book Horizontalists and Verticalists — they would have done well to look up the findings of the Radcliffe Commission in the UK in 1957 (I have written about this extensively here).
It is fantastic that the BoE has finally decided to lay its cards on the table and be honest with the public about how money is created. Unfortunately, though, the report is not willing to make certain concessions. For example, it largely paints the Quantitative Easing programs as being effective — which they were not — and it also claims that the BoE still sets the variable that has the most influence on money creation; that is, the interest rate. This latter point ties into the whole debate surrounding the so-called ‘natural rate of interest’ (which I have dealt with extensively here).
With regards to the central bank’s power to control lending, the BoE authors insist that the “ultimate constraint on lending†is monetary policy. They explain how this functions as such,
The interest rate that commercial banks can obtain on money placed at the central bank influences the rate at which they are willing to lend on similar terms in sterling money markets — the markets in which the Bank and commercial banks lend to each other and other financial institutions… Changes in interbank interest rates then feed through to a wider range of interest rates in different markets and at different maturities, including the interest rates that banks charge borrowers for loans and offer savers for deposits. By influencing the price of credit in this way, monetary policy affects the creation of broad money. (p8)
