Why is this still taught at UK unis?
3/3/2016
Economics schools at UK universities are where a huge swathe of the future employees and civil servants in the business and economic sector will be found. Why is it then that UK universities are teaching grossly outdated economic material? In particular how ‘money creation’ occurs, the very heart of the economic system.
What is taught in economic textbooks as of 2016, a position that can be backed up by asking any current economics student, is that money is created in the UK via what is known as ‘fractional reserve banking’. While sounding complex ‘fractional-reserve banking’ it is not really, here is an extremely simplified outline:
Central banks (Bank of England) lend out say £100 million to a commercial bank (banks with which most businesses and individuals interact with).
The Central Bank also sets a ‘fractional-reserve rate’ of say 20%. What this means is that commercial banks must hold 20% of all deposits in money available to them to lend out. Therefore if a commercial bank has £100 million it can lend out 80% (£80 million).
Now when this money is lent out (£80 million) this become the deposits in the commercial banks of lenders. These commercial banks can also now lend out that £80 million with 20% held in reserve. This means this second commercial bank can lend out £64 million.
Over time this process continues until the initial £100 million money created by the central bank has been lent out many times by different commercial banks each obeying the 20% reserve ratio.
To save you working this out a £100 million initial deposit at a 20% reserve ration results a total of £100 million being held in deposit and a total of£357 million has been lent out into the economy.
In UK universities this process is taught as the way in which money is created. In this scenario the central bank can affect the monetary system by changing the reserve ratio (e.g. it may be 10% or 30% and not 20%) to fit the needs of the economy. For instance a £100 million deposit with reserve requirement of 10% leads to £900 million being lent out, not £357 million as under the 20% ratio.
There is ONE big problem with teaching this at UK Universities – IT IS TOTALLY FALSE!
This system for money creation DID exist in the UK but no longer –
Between 1971 and 1980 the reserve requirement was 1.5% but in 1981 this mandatory requirement was halted.
From 1981 this mandatory reserve was eliminated.
Professor Charles Goodheart of the London School of Economics says in his 1984 book “Monetary Policy in Theory and Practice” that fractional reserve banking is “such an incomplete way of describing the process of the determination of the stock of money that it amounts to mis-instruction” – a huge 22 years ago!
You need not take our word for it – The Bank of England itself in its 1st Quarterly Bulletin of 2014 states:
(Screenshots from:
http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q1prereleasemoneycreation.pdf)
Bank of England Q1 2014
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Bank of England Q1 2014
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The problem here is that one:
Economics students are being taught false information and then take that information into the workplace and into economic debate.
And two:
It is claimed by many, and critics include former Bank of England Governor Mervyn King (Governor from 2003 to 2013), that such a system leads to disastrous knock on effects on the wider economy. Namely that unlimited money creation (even if there are other mechanisms in place) leads to a system whereby money becomes debt due to the fact that interest must be paid on all loans, and in order to clear that debt money must be destroyed, thereby leading to economic contraction.
While the debate as to whether the elimination of fractional-reserve banking may lead to economic instability is a matter for another day, surely though it must be argued that those that will soon be at the heart of policy and business must surely be taught the correct material – particularly as these changes occurred almost 25 years ago!
For more information on this subject, including the proposed negative effects of eliminating fractional reserve banking please visit www.positivemoney.org – an excellent UK based site and campaign group with in-depth easily understandable videos, articles and presentations.
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