I promised I wouldn’t do any more political posts, and I came close to breaking that promise in my last post, on the UK Parliament debate on money creation. According to my stats, only 7 people read it. So I don’t think the damage is significant. It was useful, anyway, because it drew my attention to an interesting philosophical question.
Here it is: Sometimes the generally accepted theory about how some social institution works is at odds with the practical reality. This entails a failure of democracy: how are people meant to make informed decisions about something they understand incorrectly? The philosophical question is: When this occurs, should practice change to be brought in line with theory, or should theory change to be brought in line with practice? Which is easier to achieve? Which makes more sense?
The general understanding of banking seems to be a good case study for this question. Positive Money are exercised over the fact that what banks actually do is so different from what people generally think that banks do. This is a real problem when it comes to the democratic process guiding policy where it concerns banking. Their solution is to make the way that banks work more like the way that people think they work: to tailor the practice to the theory. Modern Monetary Theorists take, I think, the opposite line: they’d rather adapt the theory to match the practice.
What is the theory? Positive Money draw upon some polling conducted by the Cobden Centre, on public awareness of banking. Many people, apparently, think that banks are like safe deposit boxes: you put your money in the bank, and the bank keeps it safe for you. Maggie Gee, as I mentioned at the time, was on the radio once expressing indignation at the suggestion that depositors in the bank take a risk; all they do, she insisted, was trust another human being to keep their money for them.
That really is quite silly. If it is what depositors do, then they are chumps. Does it not occur to them that it makes no sense for the bank to pay you for the service it provides in keeping your money for you? Why on earth should a bank pay interest on your savings account if it’s doing you the favour? Maggie Gee goes on to rant about how greedy bankers are; but if they’re so greedy why should anybody expect them to pay us to provide a service to us?
I don’t think it’s really accurate, anyway; if all people wanted was a safe place to put their savings, they wouldn’t trust bankers over their own friends and family. What people want, of course, is access to the payments system, and the banks administer the payments system. It costs them a great deal to do it. The theory that their primary business is to store our money for us, administer the payments system on our behalf, and then pay us for the privilege is not even worth listening to. It is too nonsensical to be put into practice.
Positive Money, therefore, settle for a kind of halfway house. Their aim is to make banking work as much like this nonsensical system as possible. The banks should, they think, provide safe deposit accounts linked to a payments system jointly administered by the banks. But of course we should pay them fees for this. It is absurd to imagine that they would continue paying us interest on deposits.
The other thing that people think that banks do, of course, is take deposits from some people and lend them out to others, for profits that they share with the depositors. What this view overlooks is central banking. Central banks can loan as much money as they like into existence, and this power is directly transferred to commercial banks that can borrow from the central bank. PM reason that because people don’t generally know that banks have the power to create money, banks shouldn’t have such power. Unfortunately, the reforms they propose wouldn’t actually take away banks’ power to create money.
This leaves open the question of how money creation should happen. Here it’s impossible to tailor practice to theory. The general public have no identifiable theory of how money creation occurs; even undergraduate economics textbooks are reduced to silly stories about government helicopters dropping cash on cities. So PM simply stipulate that money creation should be conducted by a panel of experts at the central bank. That is the Achilles heel of their position, as it was for the Chicago Plan of decades past and as it is for the New Chicago Plan outlined in a recent IMF working paper.
The MMT perspective, as I said, seems to look in the opposite direction. Instead of making banks work the way we think they work, let’s adapt our theories to correctly represent the ways that banks do work. Chartered commercial banks are certainly not safe deposit boxes. Nor are they private outfits in the maturity transformation business. They are agents of the state, providing the public services of money creation and maintenance of the payments system. The state employs them to underwrite loans of state-created money. The reason the state doesn’t administer money creation itself, through some panel of experts, is because the knowledge of where money would be most profitably introduced into the economy is inherently diffuse. It’s the kind of knowledge that Hayek argued a central planner could never have. Thus banks should be seen as employees of the state, using their diffuse expertise in underwriting to efficiently provide public services. They should be regulated according to this role and function.
Both the MMT position and the PM position involve some compromise in adapting practice to theory or vice-versa. PM don’t believe that banks should work exactly as they are perceived to work since, as I said, that would be impossible. And MMTers don’t think that banks should continue to work exactly the way that they do, since that has proven to be disastrous. Banks should be narrower and subject to strict punishment if their underwriting goes wrong, since their whole purpose is to use diffuse knowledge to underwrite loans of state-issued money. But although the PM view and the MMT view both admit that both theory and practice must change for the two to be brought in line, the views differ on which should change the most. On one view, it is theory that should make compromises to practice; on the other view, it is the reverse.
Keynes is supposed to have said ‘When the facts change, I change my mind. What do you do?’ I don’t think it’s a rhetorical question. It’s philosophically interesting. When people generally think that a certain institution works in a certain way, should we change the institution to match our understanding? Or should we change our understanding to fit the institution? Obviously, we’ll end up settling for some compromise between the two. But at which point in between? I think it’s an interesting question. I have my own answer in this particular case, but I wonder if there are any principles that should apply in answering the general question?