PQE solves – it evenly divides fiscal and monetary policy while revitalizing the economy

An Alternative Policy: Sovereign Money Creation Monetary policy can be thought of as an attempt by the authorities to influence the amount of money creation and spending in the economy. By creating new money, bank lending enables spending in excess of what would otherwise be possible, which results in an increase in aggregate demand.27 Monetary policy was primarily unsuccessful at increasing GDP following the financial crisis because banks didn’t want to lend and individuals didn’t want to borrow. Rather, individuals wanted to save and repay debt, whilst banks wanted to reduce their leverage by lowering the rate at which they made new loans. Consequently, new money creation by banks, and with it spending, was lower than would have normally been expected (given the reduction in interest rates). Although QE did lead to a modest increase in spending, this occurred indirectly through QE’s affect on wealth.

In contrast, fiscal policy can be looked at as an attempt to change the level and composition of spending in an economy. Because the government is able to buy goods and services from the private sector, fiscal policy can be used to directly increase demand. However, since 2009 the government’s commitment to reducing the national debt has restricted the use of fiscal policy for this purpose. This has led to the policy dilemma outlined earlier: conventional monetary policy is ineffective and fiscal policy could be effective but is politically infeasible.

Fortunately there is a way out of this ‘Catch-22’ situation. Consider the following:

• The central bank can create money at will. Yet given current conventions, it cannot spend this money in a way that directly adds to aggregate demand. Therefore, without a willing partner (the private sector) the central bank is unable to directly influence GDP.

• The government can spend money and so directly affect GDP. But it cannot create money (at least given current conventions) and therefore its ability to spend and increase GDP is limited by the extent to which it is willing to tax and issue bonds. Given the government’s focus on reducing the national debt, the government will not deliberately adopt a policy that leads to an increase in government borrowing.

However, if an increase in spending is desirable, the government and central bank can work together to increase spending and therefore GDP. Rather than attempting to get the private sector to increase its spending, the Bank of England could instead partner with the government and use its capacity to create money to attempt to increase the government’s spending instead. The Bank of England can do this by creating money and, rather than using it to buy pre-existing financial assets (as was the case with QE), instead grant it to the government. Because this process involves the creation of money by the state (rather than by commercial banks), we can name this process “Sovereign Money Creation” (SMC).

The government could then use the money for several purposes:

• It could use the newly created money to directly increase its spending

• It could temporarily reduce taxes, using the money to compensate for the lower tax revenue (keeping its total income constant)

• It could distribute the money directly to citizens in the form of a “citizen’s dividend”.

However, it is important that politicians are not directly given control over money creation, because of the risk that political pressures could lead the government to abuse this power to create money. Therefore, the decision over how much new money to create should be taken, as it is now, by the Monetary Policy Committee (MPC) at the central bank in line with their democratically mandated targets. Likewise, the process should be designed so that the central bank is not able to gain influence over government policy. In practice this means that the MPC and the Bank of England should not have any say over what the new money should be used for (this is a decision to be taken solely by the government) whilst the government should have no say over how much money is created (which is a decision for the MPC).

With these two factors in mind, the procedure for the central bank and the government cooperating to increase spending is relatively simple. First the central bank would take a decision over how much money to create and grant to the government. Once in possession of the money, the government could use it to increase spending or lower taxes.28

This increase in government spending would directly increase demand and therefore output and GDP, without increasing private or public debt. By increasing spending and lowering the private sector’s debt-to-income ratio, this creates the possibility of a sustainable and robust recovery.