Ecological economics and modern monetary economics need each other
Steven Hail
Here are three things that ecological economists often do not get quite right about money, and I am talking about those who engage positively with modern monetary theory (MMT), so understand MMT basics (i.e. not people who believe we operate fractional reserve banking, or that banks which create money then lend it to their own central banks, or anything like that).
1) You often see people who claim that MMT neglects private bank money. Some people who may have said this a decade ago have since read the literature and know this is incorrect now, but it is still commonly said by some of the most brilliant ecological economists and others.
It is of course not true. As emphasised by one of the originators of MMT, Prof Randall Wray, who was before MMT a leading Post-Keynesian. MMT incorporates the horizontal/endogenous money perspective of Kaldor, Moore and other Post-Keynesians, which is basically the realistic description of how loans create deposits. However, it adds to this a proper description of the role of the government and its central bank.
2) You also often hear people say that 97% of the money supply is created by bank lending. The mistake here is to conflate bank IOUs/deposits with bank lending to customers (the loan is an asset for the bank and the deposit is a liability, and the loan creates the deposit out of nothing when banks lend).
Yes, 97% of some monetary aggregates consists of bank deposits, with the rest being physical currency tokens (notes and coins, while we still have them).
But no, this was not all created by bank lending. Only (a very substantial) part of it. The main other contribution, in most cases, is federal government spending not matched by taxation or bond sales to the non-bank private sector.
If the central government spends $100 and taxes $80, it leaves $20 as bank deposits/IOUs to customers, and at the same time $20 of reserves at the central bank as the offsetting asset for the private banks. If the $20 is then matched by bond sales to non-banks, these deposits and reserves are deleted again. But if the bond sales are to the banks, then while bank reserves fall by $20, to pay for the bonds, bank deposits/bank IOUs DO NOT fall.
In other words, central government deficit spending increases the official money supply in this case, and the 97% of the money supply which is bank deposits has not been wholly created as a result of bank lending. It is a bit more complicated.
As a minimum, I believe bank lending should be much more highly regulated, and I believe in macroprudential and micro/ecological prudential regulation. I would go further and argue that people should be able now to hold their transaction deposits at the central bank itself, and if banks remain in the private sector, they should be largely funded by and closely regulated as to what they are allowed to do by the central bank.
3) There are some people who claim that the existence of compound interest somehow necessitates continuous economic growth. However this is not so, because interest does not normally compound on loans, but is instead a transfer of wealth from those who have to pay interest to those who receive it. The first group might have to create output to make interest payments, but the second group can cut back on what they produce. It is a distributional/social justice issue, but not one which necessarily has to drive limitless expansion.
That said, I am in favour of low or even zero official interest rates, led by the USA and copied internationally, but for distributional reasons.
MMT and ecological economics, in my opinion, very much need each other, which is why I am grateful to Professor Philip Lawn for introducing me to ecological economics over the years, and for introducing so many ecological economists to MMT.
Comments from Prof Philip Lawn
Steven’s last point is important. I used to fall into a trap that I no longer do, thanks to Steven. Most people understand that the repayment of the loan principal destroys credit money. The payment of interest does not. It constitutes a redistribution of spending power from the borrower to the lender.
A lot of people think that the money used to pay the interest on a loan is ‘new’ money and therefore there is always more money in the system following the full repayment of a loan. One can borrow money to pay off any debt owed on an existing loan (‘refinancing’), which might include a little bit of interest owed and a penalty for extinguishing the debt early, which would marginally increase the money supply, however most people use their disposable income to repay the principal and any interest charged. If they do the latter, the borrower may partake in activities to increase real output to earn additional income so they can pay off the loan without having to reduce their spending on other goods and services, but most people don’t do that. They either reduce their fortnightly spending on other stuff (by an amount equal to fortnightly loan repayments) or, if they were previously saving $X out of their fortnightly disposable income (perhaps to build up a deposit on an expensive item), they cease saving $X each fortnight and instead use it to gradually repay the loan principal and pay any interest owed. If they do either of these, they don’t earn additional income and therefore do not engage in activities that increase GDP. The point here is that repayments of loans (where the borrower pays more to the lender over the duration of the loan than they borrow from the lender that is, the borrower receives the principal from the lender but pays back the principal plus interest) do not have to be matched by increases in real output. And consequently it is wrong to say that interest payments on loans necessitates the growth of GDP. It is true that more loans can lead to more spending, which can promote increases in GDP. But we would then be referring to spending levels, not the effect of having to pay interest on a given loan. Interest rates have distributional effects.
One might say that since the payment of interest on loans can lead to some increases in GDP (if the borrower chooses to earn more income to maintain their fortnightly spending and saving levels), then interest payments do promote some growth. And I would respond by saying that it would only promote a desire for more spending. But if natural resource extraction and waste generation are restricted to rates, via caps (as Ecological Economists recommend), that are within the ecosphere’s regenerative and waste assimilative capacities, then without a reduction in the throughput intensity of GDP, the increased desire to spend would manifest as inflation, not as an increase in GDP. If we don’t like the inflation caused by an increased desire to spend beyond sustainable productive capacity, then we can use taxation to reduce the spending power of currency users. In fact, we wouldn’t need to do this if cap-auctiontrade systems were introduced to access natural resources and generate wastes (also recommended by Ecological Economists) because rising permit prices (i.e., permits to access resources and generate wastes) would rise as spending desires rise. The higher permit prices would act like rising taxes by destroying some of the spending power of resource buyers and waste generators.
Caps on the rate of throughput (resource extraction/waste generation) are the only means of guaranteeing throughput targets (simple, not complicated) and, for a given level of government spending, taxation is a simple means of ensuring total spending does not exceed sustainable productive capacity enforced and guaranteed by the caps. Both caps and a form of taxation is part and parcel of well-designed capauction-trade systems.
The inflation issue is important because there is massive cost-push inflationary pressure simmering within the real economy. That pressure is not being reflected in the prices of goods and services because policy makers refuse to impose taxes or introduce cap-auction-trade systems so that natural resource prices better reflect the true value of natural resources and the true costs of waste generation.
Many MMT economists are unaware of this simmering inflationary pressure. How do I know that this pressure exists? Well, apart from the fact that depletion/ pollution taxes are eschewed, the USA, for example, has an ecological footprint that is twice its biocapacity. Sustainability requires the EF to be no greater than biocapacity. Imagine introducing cap-auction-trade systems in the USA with caps to reduce the USA’s rate of throughput to half its current level (necessary to achieve sustainability). The prices of natural resources and the cost of polluting would go through the roof, as would then the prices of newly produced goods and services. Transitioning to sustainability will not be the smooth ride that many people believe. Redistribution is going to be critical, in particular, dramatically reducing the income and wealth of the rich. Without it, we simply won’t be able to fit everyone equitably into a sustainable economy.
Assoc Prof Steven Hail and Prof Philip Lawn are associated with Modern Money Lab, Torrens University, Australia. Steven is a member of the ERA editorial committee and Philip is an ERA patron.
