The Power of Money

How Governments and Banks Create Money and Help Us All Prosper

Matt Holt Books, 2023

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When it comes to the power of money, facts can be as potent and surprising as fiction.

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The last few financial crises – and now the battle against inflation – have shown how questions about money and government’s control of it can be important and contentious. Economist Paul Sheard explains how the seemingly outlandish claims of Modern Monetary Theory are true to a degree, while at the same time showing how governments refrain from abusing their extraordinary power over fiat money creation. Along with Sheard’s practical reflections on inequality and taxes, the euro, cryptocurrencies and financial crises, this book contains most of what you need to know about “the power of money” today.

Summary

Commercial banks create new money when they advance loans.

In a modern economy, all money begins life in one of three ways: via commercial bank lending, government deficits and central bank open-market purchases. In normal times, most of the annual growth in money, which a growing economy requires, comes from commercial banks creating loans. The old-fashioned textbook model is that commercial banks attract people’s savings and then lend these funds to borrowers.

The reality is that banks don’t need deposits on their balance sheets before they can make a loan. Specific capital adequacy or reserve requirement regulations might constrain their lending, as will the judgment of their management as to their loans’ profitability and risks. Banks make loans based on these and other factors, and then the funds from those loans to individuals and businesses inevitably find their way back into the national banking system. This is because whatever the borrower spends the borrowed money on, someone else gets a payment to put in their bank account. In this way new loans create their own deposits for bank balance sheets. This ability...

About the Author

Paul Sheard is the former vice chairman of S&P Global and a former senior fellow at the Harvard Kennedy School.

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M. R. 9 months ago

In my opinion as an economist (and after only reading this summary), this book confuses many economic concepts around the basics of money and monetary policy. In most countries, central banks are indeed only semi-independent from the government, as claimed in the book. Nevertheless, usually only a country‘s central bank may create new money out of thin air to steer the total money supply. All other economic actors, including commercial banks - and as well the government - are restricted in the form they can create new money. The government for example needs to either issue government bonds to receive money from investors (does not create any new money, only transfers money from private investors to the government as sort of a loan), which it usually does through the central bank‘s money market department or provide collateral in the form of, e.g. government bonds, with the central bank to receive a loan from the central bank (does create new money, but through the central bank). As such, the government itself cannot itself create new money, but it can take up loans (directly as loans from the central bank or indirectly as bonds for private investors) and then use that money for fiscal policy, i.e. for targeted investments into, e.g. the train infrastructure of a country or new roads to boost spending and investments during an economic downturn. The central bank, on the other hand, should not - and is usually prohibited - from any direct investments and only controls the money supply to prevent inflation. Hence, fiscal and monetary policy are two very different instruments - fiscal policy is a targeted investment and does not create any new money, while monetary policy has a general effect on all economic sectors and activity and instead steers the money supply by creating (or removing) money in the economy as a whole to prevent inflation. There is no artificial boundary between fiscal and monetary policy, they are per definition not the same and fiscal policy does not create new money, while monetary policy usually does.

Paul Sheard