by Russel Norman
In the debate around monetary policy, it is often forgotten that the default position is that the private banks create most of the money and lead the increase in the monetary supply. They then charge interest to the users of the money that they have created.
The public authorities create very little money. The notes and coins created by the Reserve Bank are only a small fraction of the ‘money’. See this interesting Seven Sharp story if you want to see a MSM story about how this works – essentially banks can lend out far more money than they have as deposits.
So quantitative easing, or as John Key likes to call it “money printing”, is simply government extending to itself the right that it has given to the private banks to increase the money supply – except doing it for public purposes rather than simply private gain.
So what is happening with money supply in NZ?
We can measure the increase in the money supply by looking at two indices produced by the Reserve Bank – M3 and M1. M3 is the broad definition of money and M1 is the narrow definition (official definitons at the end of the post). They are graphed here (also CPI):
The first point to note is that all of this huge increase in the money supply, what Key would call ‘money printing’, happened without the government engaging in any kind of government led increase in the money supply. It was private led increase in money supply.
Secondly, as you can see there was a huge increase in money supply through the early 2000s – it peaked at an annual 17% increase in the 2006 year alone! Presumably the big increase in bank lending into the housing market (partly funded offshore) through the early 2000s let to this surge in money supply This lending was grossly irresponsible by the banks and led to a doubling of house prices in 5 years.
Thirdly, this growth in M3 dropped off as the GFC hit and it shrank through 2009.
And fourthly it has now taken off again and has been increasing at an annualised rate of around 7%, linked to the new housing bubble as the banks create money to expand the bubble.
So the debate shouldn’t be whether NZ should be ‘printing’ money, in fact the private banks are increasing the money supply dramatically (partly funded offshore) – our money supply (M3) has increased by $28.5 billion in the 2 years to March 2013.
The debate should be: what constraints should apply to the private creation of money given the banks’ irresponsible behaviour in the past; and should the public institutions be expanding money supply as a policy tool, to what extent, and to what purpose? Should the state be allowed to also increase the money supply for public purposes such as refilling the Natural Disaster Fund and to see what effect it can have on reducing the very damaging high NZ dollar?
The answers to these questions aren’t black and white but for my pick I think we need to restrain the banks lending into the housing bubble and use a trial public creation of money to restock the Natural Disaster Fund – both to be prepared for future disasters and to see what impact it would have on the dollar.
It is of course difficult to have a rational conversation around these issues in the current political context (ie Key’s scaremongering) but it is an important conversation for rational adults to have. We do have an out of control current account deficit and if we want to be masters of our own destiny we need to change policy settings as under Key’s plan our deficit and debt increase dramatically.
M1 – Includes notes and coin held by the public plus chequeable deposits, minus inter-institutional chequeable deposits, and minus central government deposits.
M3 -The broadest monetary aggregate. It represents all New Zealand dollar funding of M3 institutions and any Reserve Bank repos with non-M3 institutions. M3 consists of notes & coin held by the public plus NZ dollar funding minus inter-M3 institutional claims and minus central government deposits.