Unveiling the Monetary Alchemy: Financing Recovery Beyond Traditional Means

Feb 14


Alex Belsey

Alex Belsey

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In the wake of the COVID-19 pandemic, nations worldwide have grappled with soaring debt levels, prompting a critical debate on sustainable repayment strategies. Traditional approaches often suggest austerity measures or tax hikes, but an alternative path, leveraging the very creation of money, may offer a less conventional solution. This article delves into the mechanics of money creation and its potential role in economic recovery, challenging the orthodox view of fiscal management.


The Post-Pandemic Fiscal Dilemma

As the world gradually emerges from the shadow of COVID-19,Unveiling the Monetary Alchemy: Financing Recovery Beyond Traditional Means Articles economies are left with the daunting task of addressing the financial aftermath. Governments have deployed extensive support measures, such as the UK's furlough scheme and small business grants, to mitigate the pandemic's economic impact. These interventions, while necessary, have significantly increased national debts. The prevailing sentiment, as echoed by former Treasury minister David Gauke in The Observer on July 11th, 2020, and a BBC article on July 9th, 2020, is that the only recourse is to either cut public spending, raise taxes, or increase borrowing. However, this perspective may not account for the full spectrum of possibilities.

The Genesis of Money

Contrary to popular belief, physical currency represents a mere fraction of the money supply. In the UK, for instance, over 97% of money exists as bank deposits created through commercial bank lending, as detailed in a 2014 Bank of England bulletin. This digital creation of money by typing loan amounts into customers' accounts is a cornerstone of modern economies. It implies that the act of borrowing is intrinsically linked to the availability of money, influencing GDP and the broader economic landscape.

The Public's Misconception of Money Creation

The mechanics of money creation remain widely misunderstood. A 2017 survey by Positive Money revealed that even 85% of UK MPs were unaware of how money is created. Recognizing that money can be digitally generated at the push of a button reshapes the conversation on managing pandemic-induced debts.

The Role of Central Banks

Central banks, such as the Bank of England, the Federal Reserve in the US, and the European Central Bank, possess the authority to create money. Unlike commercial banks that lend to individuals and businesses, central banks primarily lend to governments and financial institutions. This power to generate funds for government use is particularly noteworthy.

Dispelling the Myth of the Magic Money Tree

The notion of a "magic money tree" was famously dismissed by former UK Prime Minister Theresa May in 2017. Yet, the reality is that central banks can, and do, create money. For example, the Bank of England introduced £456 billion into the economy through quantitative easing between 2009 and 2017, benefiting financial institutions rather than the broader public. Similarly, the US Federal Reserve injected over $2 trillion into financial markets in early 2020 to avert a recession, with little direct impact on ordinary families.

Direct Monetary Financing: A Historical Precedent

Direct Monetary Financing, where central banks create money to fund government spending, is not a novel concept. It has been endorsed by prominent economists like Milton Friedman and Ben Bernanke. The UK's Ways and Means facility is one such mechanism, which was notably expanded following the 2008 financial crisis and again during the COVID-19 pandemic, as confirmed by a Bank of England press release on April 9th, 2020.

The Inflation Argument and Its Counterpoints

The primary concern against using central bank-created money for public spending is the risk of inflation. However, the relationship between money supply and inflation is not straightforward. The UK's experience with quantitative easing and its modest inflation rates challenges the inflationary fears. Moreover, with the pandemic-induced reduction in bank lending, some economists, like David McWilliams, argue that the greater risk is deflation, necessitating an injection of new money into the economy.

Rethinking Fiscal Recovery Strategies

The traditional triad of tax increases, borrowing, or spending cuts is not exhaustive. Direct Monetary Financing presents an underutilized option for addressing pandemic-related expenditures. While this approach may be contentious, understanding its viability is crucial for informed policy-making.

In conclusion, the exploration of money creation and its potential application in fiscal recovery challenges the conventional wisdom of economic management. As nations seek sustainable paths to financial stability, the acknowledgment of alternative strategies could pave the way for more equitable and effective solutions.

This article was produced by New Frontiers Marketing.