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The biggest intellectual scandal of our time

John Hermann

If mainstream economists had thought and behaved differently after 1980, then arguably the world would not be in its current state of disarray, and much of the social and environmental dislocation that we have witnessed over that time-span would not have occurred. In a nutshell, these economists uncritically accepted as true the false analyses, promises and prescriptions of neoliberal ideology. The destructive outcomes of their attempts to implement those  prescriptions were greatly enhanced by their profound ignorance of the operational dynamics of finance, banking and credit money creation. To this day they continue to hold to barter-based models of economic activity, to the extent that money, credit and banking are missing from their considerations.

Mainstreamers possess several major blind spots. Firstly a failure to recognise the important role that the creation and flow of bank credit money plays in the evolution and development of every modern economy, through its essential contribution to income, aggregate demand, employment and economic performance. Secondly, they think that private debt growth does not affect economic performance. Thirdly, they think that every economy tends towards a stable equilibrium configuration. Fourthly, they think that private borrowing, spending and saving are always driven by “rational expectations”. Fifthly, they think that public debt (i.e. deficit spending) should be minimised, consistent with what they imagine is the universal validity of  the “crowding out” hypothesis – which falsely asserts that public borrowing always crowds out private borrowing, leading to rising inflation and rising interest rates.

And lastly, they hold to the idea that commercial banks do not create the money they lend and spend into the economy. But rather, they hold to the “loanable funds” hypothesis, which asserts that banks are able to on-lend their depositors’ funds. The reality however is that neither bank credit money nor reserves are ever loaned out to a bank’s retail customers. Moreover bank credit money creation occurs endogenously, meaning that banks lend or spend first and look for the regulatory reserves they might happen to need later. Central banks are always able and willing to provide the reserves that the aggregate of commercial banks require for their business operations. Flying in the face of this reality is the belief of mainstream economists that reserves are created proactively – under the discretionary control of the central bank – rather than reactively in association with their open market operations.

It seems that central bankers know a good deal more about these matters than do mainstream economists. This is evident from a 2017 monthly report on the dynamics of bank money creation produced by the Deutsche Bundesbank and also a similar 2014 report produced by the Bank of England The BoE report referred to here was discussed in a previous issue of ERA Review [v7, n4, 2015; p15]. The  findings of these reports are quite inconsistent with the false beliefs held by mainstream economists that we have listed above. Unfortunately, if their past history is anything to go by, that is unlikely to change the views of many of the (neoclassical) mainstreamers, who will simply adopt the tactic of ignoring the existence of these reports.

John Hermann


  1. Dario

    “Reserves” appears in the 3rd para but it’s not defined, and a google search gives descriptions that generally relate to cash on hand. You go on to say they’re never loaned out but you don’t give a reason for their existance. We need a thumbnail sketch of how it all hangs together.

    • Economic Reform

      Hi Dario, banking reserves are usually comprised of currency reserves (coins and banknotes held in bank tills and vaults) and creditary reserves (bank deposits in the central bank, which in Australia are called exchange settlement funds). These two forms are generally interchangeable, on demand.

      The main reason creditary reserves exist is to allow banks to settle between themselves every day – as a result of the many financial transactions involving banks – in a convenient electronic manner, so that they don’t have to go to the inconvenience of trucking large amounts of currency under guard between banking institutions every day.

      Currency reserves exist in order to meet the ongoing cash requirements of bank depositors.

      Reserves also exist in order to meet any existing statutory reserve requirements and any existing statutory liquidity requirements. In Australia there are almost no statutory reserve requirements (unlike the United States), apart from the requirement that banks should maintain positive balances in their Central Bank (RBA) account – as a condition for having an ongoing operational account.

      Creditary reserves also currently form the basis of implementing monetary policy, which the Central Bank performs via the buying/selling of Treasury securities from/to the private sector. When it sells securities from its assets portfolio to a bond dealer or large institutional investor, the buyer’s bank loses reserves. And when it buys securities from the same sources, the seller’s bank gains reserves.

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