Author Govert SchullerPosted on Categories Monetary Reform Two economic researchers, van Egmond and de Vries, at the Sustainable Finance Lab (University of Utrecht, the Netherlands) developed a dynamics model in which the financial system is explicitly included. Their working paper is titled “Dynamics of a Sustainable Financial-Economic System”[1] and it also addresses a sovereign monetary system.
After Yamaguchi in 2010 [2] and then Kumhoff & Benes in 2012 [3], this might be the third successful modeling of sovereign monetary reform (SMR) to date.
They also explicitly heeded the call by Richard Werner, who supports SMR, for a new research programme in macroeconomics citing what increasingly looks like his seminal 2012 paper on the Quantity Theory of Credit.[4]
Find below the Abstract of the van Egmond & de Vries paper and the section on the “Legitimacy of money creation by the government”.
Abstract (page 1)
Along the lines of neoclassical theory, a system dynamics model has been developed to describe the most important mechanisms governing the physical output of goods and services in the economy in interaction with the financial system. The model gives a meaningful reconstruction of the overall long-term dynamical behaviour of the financial-economic system, including the endogenously modeled crisis.
The occurrence of the boom- and bust-cycles can be understood and to a reasonable extent predicted from the asset price driven credit cycle. The model confirms Minsky’s instability hypothesis, in which the euphoria over apparently ever increasing (asset) prices, GDP, wages, consumption and loans turn the system into the downward spiral of the bust, when financing cost becomes unbearable for individual households and the economy is no longer stimulated by a continuously decreasing interest rate as soon as the interest rate approaches the zero level. Once the residential quote passes a certain threshold, defaults significantly increase, banks tend to go bust and have to be recapitalized by the government, with substantial macro-economic consequences.
The current financial system appears to be fundamentally unstable. Lacking central coordination, euphoric herd behavior of the many private banks causes the unjustified creation of too much money and subsequent boom-and-bust behavior of the economic system.
The model experiments show that money creation by the government, according to a ‘money creation rule’, for example directed to price stability and / or employment, can stabilize the boom-bust cycles. At a constant price level, both the physical and the monetary production as well as consumption then follow a pathway of stable, continuous growth which reflects the increased productivity resulting from technical progress. Throughout history, money creation by the government is strongly legitimated and advocated by prestigious social, philosophical and economic thinking.
Price stability and the associated positive effects on employment and GDP can be realized by creation of debt free money at a rate corresponding to the growth of the real, physical economy (without inflation); in the model experiment this was about 10 to 15 bn € /year. In case an inflation rate (e.g. 2 %) would be preferred politically, an additional amount over 10 bn € has to be created yearly, increasing over time. Including the saving on interest payments on the declining government debt, the total sum of money which could be spent by the government amounts over 25 bn € / year. This money can be used to lower tax rates and to invest in physical and social infrastructure, for example in the transition to sustainable energy and transport systems.
Legitimacy of money creation by the government (pages 43-44)
Although beyond the scope of this paper, the proposed reform can also be motivated from a more fundamental point of view and in addition to the considerations with respect to system instability as discussed here. As already pointed out by Aristotle in his Ethica Nicomachea (350 BC), ‘money exist by law, not by nature’. Money is not a commodity, but a social construct (Van Dixhoorn 2013). This implies that money has to be created by (groups in) society, in practice usually the State and that the money supply is a government prerogative. . Since Aristotle, numerous philosophers, economists and politicians including Locke, Franklin, Paine, Berkeley, de Montesquieu , Ricardo, Lincoln, Jefferson and Jackson have supported this view.
The current money-as-debt (MaD)system, with money creation by private banks, cannot be considered beforehand as ‘normal’. On the contrary, the system is from a relatively recent date, the end of the 17th century, when in the ‘Glorious Revolution’ the concept of the Bank of Amsterdam was transferred to London and ownership changed from public (the city of Amsterdam) to private. William Paterson, the founder of the Bank of England stated that ‘the bank hath benefit of interest on all moneys which it creates out of nothing’ (Zarlenga, 2002). Since then the struggle for power over the creation of money has caused many conflicts and even wars.
The usual argument in favor of privatized money creation is the alleged assertion that poorly run money systems of the past were under governmental control. In most cases these assertions refer to developing countries and the German hyperinflation of 1923. However, closer examination of the hyperinflation in interwar Germany points to the contrary: it was rather the pressure from the World War I allies (UK, USA) to privatize the German Bank rather than public governmental control that brought he inflation about. After taking control back by the government by Reichskanzler Schacht, the hyperinflation was halted within one year (Zarlenga 2002). It also should be realized, as shown in this paper, that over the last decades private banks and not governments have created the enormous amounts of money that have led to the 2007 / 2008 financial crisis.
From a political point of view, the Central Bank is under full governmental and democratic control, though legally independent in order to prevent interference by short-term oriented political forces. Comparable to the judicial power as the ‘third power’, the Central Bank would be part of a ‘fourth power’, which can act with great independency according to a priori defined rules but, at the end of the day, under full democratic control. (pp. 43-44)
Sources
[1]. Van Egmond, N. D., and B. J. M. de Vries. 2016. “Dynamics of a Sustainable Financial-economic System“. Working Paper of the Sustainable Finance Lab. Version 2. Utrecht University, The Netherlands.
[2]. Yamaguchi, Kaoru. 2010. “On the Liquidation of Government Debt under A Debtfree Money System: Modeling the American Monetary Act”. In Proceedings of the 28th International Conference of the System Dynamics Society, Seoul, Korea, 2010. The System Dynamics Society.
[3]. Kumhof, Michael & Benes, Jaromir. 2012. “The Chicago Plan Revisited“. IMF Working Papers 12/202. Washington: International Monetary Fund.
[4]. Werner, Richard A. 2012 “Towards a New Research Programme on ‘Banking and the Economy’ — Implications of the Quantity Theory of Credit for the Prevention and Resolution of Banking and Debt Crises”. International Review of Financial Analysis, 25/5 (December 2012): 94-105.