The Bank of England released a new working paper on Friday (May 29, 2015) – Banks are not intermediaries of loanable funds – – facts, theory and evidence (updated June 2019) – which further brings the Bank’s public research evidence base into line with Modern Monetary Theory (MMT) and, thus, further distances itself from the myths that are taught by mainstream economists in university courses on money and banking. The paper tells us that the information that students glean from monetary economics courses with respect to the operations of banks and their role in the economy is not knowledge at all but fantasy. They emphatically state that the real world doesn’t operate in the way the textbooks construe it to operate and, that as a consequence, economists have been ill-prepared to make meaningful contributions to the debates about macroeconomic policy.

There was an article in Bloomberg Op Ed yesterday (May 19, 2015) – U.S. Workers Brought the ‘Great Reset’ on Themselves – which argues that those who bemoan the falling standards of living for workers in terms of job stability, real wages growth etc have only themselves to blame because as workers they demand conditions that they are not prepared to sustain as consumers and taxpayers (higher prices, higher taxes). It is an extraordinary argument not because there are not elements of truth in it, but, rather, because it ignores other realities such as the rising income inequalities and the on-going redistribution of national income to profits. It also tallies with what is going on in Australia at present, which is a specific form of the on-going attack on real standards of living for workers and their families through poorly crafted government policy. The policy design reflects ideology rather than any appreciation of what is required to maintain living standards.

In Part 1, I briefly outlined the Sovereign Money System proposal (SMS) advanced by the Icelandic government as a way forward in banking reform. I also demonstrated that the banking collapse in Iceland in 2008 could hardly be seen as being caused by the banks having the capacity to create credit. Much more was in play including the fact that banks had stopped behaving as banks and were serving the doubtful aspirations of their owners rather than any notion of public purpose. While the Icelandic report claims that the commercial bank lending destabilised the growth cycle in Iceland the reality is that it was other factors that led to the explosion of their balance sheets. The money supply did expand faster than “was required to support economic growth” but that is because the financial system was deregulated and the banksters and fraudsters were allowed to serve their own interests and compromise the national interest. As we will see that sort of duplicity can be reigned in with appropriate structural regulation without scrapping the capacity of the private banks to create credit. In this Part 2, I consider some of the mechanics of the SMS and argue that essentially we cannot get away from the fact that a central bank always has to fully fund a monetary system. If it tries to restrict funds yet maintain private bank lending then recession would surely follow and interest rates would rise beyond the control of the central bank. I also provide some ideas on where more fundamental monetary system reform is currently needed.