Hi, I’m Eve. Given the difficult developments in the news from the Middle East, I thought it might be time to return to the discussion of Modern Monetary Theory to balance the coverage, for both readers familiar with the field and newcomers. The impact of bank loan repayments (and write-offs in loan restructurings) is not sufficiently recognized, as it leads to a contraction of the money supply.
However, monetary easing does little to stimulate economic activity. Companies decide whether to expand or not based on the conditions in their industry or niche. But companies for which interest rates are one of their largest costs of doing business, like financial institutions and leveraged speculators, do well. But monetary tightening can restrict commercial activity and make securing necessary loans costly or impossible.
This asymmetric operation of monetary policy is surprisingly little understood. In the past, the Fed acted as if it did: when they lowered rates during a recession, they kept them low for a quarter, then started tightening. During the dot-bomb era under Greenspan, they took the unprecedented step of keeping rates at negative real rates for nine quarters. Greenspan was obsessed with the stock market and believed (against strong evidence) that a stock market crash would harm the real economy, so he tried to make asset prices soar. They did, but mortgage lending was the biggest beneficiary… and you know how the movie ended.
Richard Murphy produces short videos that provide easy-to-understand introductions to the findings of Modern Monetary Theory and other banking and economics topics. We would appreciate it if you would spread this post widely.
By Richard Murphy, Adjunct Professor of Accounting Practice at the School of Management, University of Sheffield, Director of the Corporate Accountability Network, Member of Finance for the Future LLP, and Director of Tax Research LLP. Originally published in Funding the Future.
By Richard Murphy, Adjunct Professor of Accounting Practice at the School of Management, University of Sheffield, Director of the Corporate Accountability Network, Member of Finance for the Future LLP, and Director of Tax Research LLP. Originally published in Funding the Future
I The following video has been published: In this morning’s Economic Truth series, bank lending moneyOnce you pay off your loan, the money disappears. It literally ceases to exist. This is one of the hardest economic truths for us to comprehend.
of An audio version of this video can be found here.
The records are as follows:
Paying off a bank loan destroys money.
This is one of those economic truths that doesn’t make sense unless you think about it carefully, but it must be true because all the money created by banks in the UK flows into the economy as banks lend money to borrowers.
When a bank lends money to a borrower, an exchange of promises takes place, which we’ve covered in other videos.
The bank says to the borrower, “I’ll lend you £10,000.” And the borrower says, “I’ll pay you back £10,000.” These are the two promises recorded on the keyboard. One is a positive number in your current account. The other is a negative number in your loan account, and when you add them together you get zero, which shows that this new money was created out of thin air.
And as a result of that process, the borrower has new money to spend. And they spend it. And the result, as I explained in another video, is savings. The loan ultimately SavingsBecause the banking system has to be kept in balance.
So what happens as a result of paying back the loan? The money that was created disappears.
I emphasize the word “destroyed.” It doesn’t just quietly disappear. It literally doesn’t exist anymore because the promise that created the money has been fulfilled. If money is about promises, and money is all that it is because it is all debt, then once the debt is paid, the money doesn’t exist anymore. It is as simple and straightforward as that.
The money that existed because the loan was created no longer exists because the loan has been repaid.
But this has huge implications for our economy, because, as we’ll see in a moment, our economy depends on only two kinds of money: money that is created by governments, which we’ll cover in another video, and money that is probably a large part of most economies, including the UK, that is created as a result of commercial banks lending to people like you and me. We are totally dependent on this money that is created through lending, so that once all the loans are paid back, there will be no money left.
This is why we live in a debt economy, because we have no other idea of how to generate the money we need for our daily transactions. Therefore, we depend on people continuing to borrow money from banks to ensure a continuous supply of new money to replace the money that borrowers pay back to the banks every day. As a result, their loans are canceled and the money disappears. Therefore, we must live in a credit economy, an economy in which people borrow.
But this is a real concern, because as we all know, in a recession, people don’t borrow. They lose the confidence to borrow, they don’t go out and spend money, and as a result, the money supply decreases. And that’s why we get recessions.
So what you want in any economy is a balanced system, which means when the economy is doing well and banks are printing a lot of money because people want to borrow, you have a situation where the money supply is strong, so the government doesn’t necessarily need to pump a lot of money into the economy.
When the economy is weak and people don’t want to borrow, when there are fears of a recession, when people feel that it’s too risky to actually pay off their loans, the government has to inject more money to keep the economy running well.
Why does this happen, and what is the evidence? It’s actually quite simple. After the 2008 global financial crisis, people didn’t want to borrow money. Banks were at risk and pretty suspect, people were very anxious about the state of the world, and didn’t want to borrow money to buy anything. So governments had to inject a ton of new government-issued money into the economy to keep it going.
Quantitative Easing That’s what it did. That was its purpose: to fill the shortfall in bank lending and ensure that enough credit was available to keep the economy functioning.
And the same thing happened when COVID-19 hit, because, for the exact same reason, people couldn’t borrow. People couldn’t even go to the stores to borrow or buy or do anything. So the government had to shut down. There was nothing unusual, wrong, sinister or worrying about this process. It was just that commercial banks frankly went bust, and the government just filled in the gaps where people didn’t want to borrow.
And because commercial bank loan repayments were underway, they had to go through the process as it was required by the loan agreement.
This left the economy on the brink of a cash shortage, with the government stepping up to fill the gap.
The reason there was a risk was that when a commercial bank loan is paid off, whether it’s a loan or a mortgage or whatever it is, when it’s paid off, the money that it created is destroyed. The money is gone. It’s gone. It’s as if it never existed, because the promise that created it has been fulfilled. That’s it. The end.
And you have to understand that if you want to understand why we live in an economy where we always have to create credit, or where the government has to finance deficits, and that there’s nothing evil in the government doing that, we just need to make sure that there’s cash in the economy so that we can all get on with our lives.
Negotiate with the government Money Creation I’ll explain that in another video, but the basic point of this video is that paying off a bank loan destroys the money that was created by that loan.
