Government Money and Democracy

‘Government money’ takes two forms: cash and reserve balances. Cash comprises notes and coins. Reserve balances are required for final settlement of transactions. Government is the sole issuer of both cash and reserve balances.

Government money is issued in one of two ways: through government spending and government lending.

Government spending adds net financial assets (which are the sum of cash, reserves and outstanding government bonds) because it involves the crediting of reserve accounts. The added reserves may be exchanged for government bonds (if government deficits are to be matched with ‘bond sales to the private sector’) or left as reserves (in the case of ‘interest on reserves’ or ‘overt monetary financing’).

Government lending has no direct impact on net financial assets. It is a swap of one non-government financial asset for another (e.g. a reserve add in exchange for bonds).

Commercial bank deposits are lower in the ‘hierarchy of money’. They are a promise to provide government money at par to the amount of the account holder’s balance. The account holder can demand cash either at any time or after some duration of time. And the account holder is assured that the commercial bank will obtain reserves as necessary for final settlement of purchases made out of the account.

The government’s monetary authority, however, stands ready to provide reserves as required by the commercial banking system, though at a price and on terms of its choosing. So long as it is profitable, commercial banks will lend. If short of reserves, they can obtain these after the fact. In this way, the endogenous creation of ‘private bank money’ (deposits) necessitates an accommodating creation of government money (in the form of reserve balances) by the monetary authority.

The first avenue to government money creation is democratic. The second is undemocratic. In the first case, the decision to issue government money is arrived at collectively through a governmental budgeting process. Any charges applied by government function as taxes, which enrich nobody and function in part to drain government money, income and spending power from the economy. In the second case, a for-profit institution pursuing its own purposes issues private loans, creating commercial bank deposits in the process, and applies private charges (in the form of interest) that enrich the lender. Government money in the form of reserves is created as necessary to accommodate this undemocratic private credit creation in accordance with the monetary authority’s lender-of-last-resort function.

The resistance of a large part of the economics profession to the notion of endogenous money perhaps partly reflects a desire to conceal this second, undemocratic avenue to government money creation.