destabilizing stable economics

Recent Posts

Taxes and Turmoil in Lebanese Politics

Taxes and Turmoil in Lebanese Politics

A series of protests have begun to rock Lebanon as of mid-March 2017. Protesters are taking to the streets to denounce the Lebanese government’s plan to introduce or increase 22 new taxes on citizens, most notably increasing the VAT tax from 10-11%, as well as various other taxes on food, drink, public […]

Community Currencies: A Ray of Light in the Rust Belt

Community Currencies: A Ray of Light in the Rust Belt

In times of severe recession, cash can be hard to come by. To somewhat maintain their standard of living and avoid being further driven into poverty, some communities developed their own alternative currencies. These community currencies are parallel systems of exchange. They are growing in popularity in countries such as Greece, which […]

The Shortage of Money:  A Fallacious Problem

The Shortage of Money: A Fallacious Problem

Whether they are implemented in Latin America (1970-90s), in the UK (under Thatcher) or in Greece (since 2012), austerity measures are all justified by the fact that “there is not enough money.” People are told that “there is no alternative,” and that the state needs to implement structural adjustment programs—usually including across-the-board spending cuts—to restore investors’ confidence and to hope for a better future.

What if this shortage of money could be overcome? What if this problem was ultimately the wrong one? What if we could have money for everything we needed?

In her latest book, The Production of Money: how to break the power of Bankers, Ann Pettifor argues that:

  • YES the society can afford everything that it needs,
  • YES we are able to ensure enough money for education, healthcare, sustainable development and the well-being of our communities, 
  • YES we can discard money shortage, contrary to the human or physical (land and resources) ones.

However, one condition needs to be fulfilled: our monetary system should be well-regulated and managed.

To understand how and why, Ann Pettifor takes us back to basics. She starts by defining money as a “social construct based primarily and ultimately on trust”. One of the  reasons why we use money in the first place is because we know that others will accept it in the future; it is the means “not for which we use to exchange goods and services, but by which we undertake this exchange” (Law). Your 100-dollar bill would be worthless if others didn’t accept it. The value of money depends on the “acceptance” of money, i.e. on the trust you and others have in money.

Contrary to popular belief, 95% of (broad) money (i.e. cash and coins + bank deposits) is created by private banks and not by the central bank. When a bank makes a loan to a firm, it creates simultaneously a deposit account from which the firm withdraws the loan. Money is therefore created “out of thin air” when the account of the borrower is credited—i.e. when loans are made. This has two implications:


  1. When money is created, so is debt. This debt needs to be repaid. Ann Pettifor uses the example of a credit card  which allows you to purchase goods and services today. The spending (= purchasing power) on a credit card “is created out of thin air”. You will ultimately need to pay back the amount spent plus a pre-agreed interest rate. Money is therefore a promise of a future productive value.
  2. The money supply depends on private borrowers and their demand for loans. Central banks influence (but do not control) the money supply by increasing or decreasing the cost of borrowing with their policy interest rate. Money creation is therefore a bottom-up process rather than a top-down one.

Does this mean that we should create as much money as people want loans?  Of course not. According to Ann Pettifor, there are constraints that make unlimited borrowing impossible: inflation (and deflation). Indeed, if money is not channeled toward productive purposes, the claim associated to it might not be reimbursed. In other words, the promise of a future productive value might not be fulfilled. When there is too much money “chasing too few goods and services”, reflecting over-confidence in the economy, it results in inflation, eroding the value of assets (such as pensions). Similarly, when there is not enough borrowing (either because borrowers need to repay their debts, as it has been the case in Japan and the US right after the last recession, or because the cost of borrowing is effectively too high), reflecting distrust in the ability to repay debt, deflation steps in.

Therefore, as money can be created “out of thin air”, there is no reason to have a shortage of money as long as it is channeled towards productive purposes. An unlimited amount of money can be created for projects that will ultimately result in the production of value, which will allow the repayment of debt. However, the author does not define what “value” or “productive purposes” are, which in my opinion is the main drawback of the book.

Although Pettifor does give some hints by opposing “productive purposes” to “speculative” ones and by associating “value” to the notion of “income, employment and sustainability”, her approach is rather imprecise and in this sense disappointing. To her credit, defining value is a difficult task, especially if we want to define what is valuable to the society as a whole. Pinning down the definition of value is, in my opinion, ultimately a political debate. If one considers that democracies reflect “collective preferences”, it can be said that societies decide through elections on what is most valuable to them at a given point in time.

Unfortunately, the current monetary system does neither enable nor guarantee that money and credit are used for productive purposes. It is characterized by “easy” and “dear” money; the former refers to unregulated and easy access to borrowing, while the latter conveys the idea of expensive borrowing, i.e. with loans charged at high interest rate. The issue with this system is that (1) with unregulated borrowing, money will be used for unproductive purposes, (2) with high interests, debtors will meet difficulties reimbursing their loans. 

Such a system is harmful to society. In the words of Ann Pettifor:

“If rates of interest are too high, debtors have to raise the funds of debt repayment by increasing rates of profits, and by the further extraction of value. These pressures to increase income at exponential rates for the repayment of debt implies that both labor and the land (defined broadly) must be exploited at ever-rising rates. Those who labor by hand or brain work harder and longer to repay rising, real levels of mortgage or credit card debt. It is no accident therefore that the deregulation of finance led to the deregulation of working hours.”

A sound financial and monetary system would precisely have opposite features, with “tight but cheap credit” (Keynes), in which loans are regulated but cheap. “Tight credit” would ensure the soundness and creditworthiness of loans, while “cheap credit”, secures the affordability and thus the repayment of loans.  

Hence, Ann Pettifor makes a remarkable argument by providing an in-depth but accessible insight into the workings of the monetary system and the debates surrounding it. Both economists and non-economists should give it a read.

It is indeed quite astonishing that money, ever-present in our lives, is so poorly understood; even by many economic experts themselves. According to Ann Pettifor, this incomprehension stems from the deliberate efforts of the financial sector to “obscure its activities” in order to maintain its omnipotence. The Production of Money aims at addressing this “crisis of ignorance” by providing an intelligible and comprehensive overview of money in the hope of empowering people against finance’s grip over society.

By Céline Tcheng
Disclaimer: views are my own.

About the Author

Céline grew up between Paris, China and Singapore. After graduating in a Master’s degree in Economics and Public Policy,  she now works for a public policy institution in France. In her free time, she coordinates INET (Institute for New Economic Thinking) YSI (Young Scholars Initiative)’s Financial Stability Working Group and performs with her dance crew “Slash Art”. Her main interests are: macroprudential policy, financial stability, monetary policy. Follow her on Twitter: @celine_tcheng

In Defense of Dodd-Frank

In Defense of Dodd-Frank

It’s been nearly a decade since we first felt effects of the Great Recession. While the recession officially ended, its consequences still affect us. Some are beneficial, others (like sluggish growth and the number of people leaving the labor market) not so much. One of the better side effects of the 2007-2008 […]

The Borrowed Science of Neoclassical Economics

The Borrowed Science of Neoclassical Economics

Another “Econ 101” story we hear in microeconomics classes is that, as consumers, individuals are always involved in a rational, hedonistic competition trying to maximize their own utility. The utility principle was brought to the forefront of the economics profession with the Marginal Revolution of the 1870s. The Marginal Revolution, the story […]

The Tragedy of “The Tragedy of the Commons”

The Tragedy of “The Tragedy of the Commons”

How should a society manage its common-pool resources like fisheries, forests, and grasslands? The problem, as presented in an Econ 101 course, is that these systems lack the proper incentives for sustainable use. Without private property or government regulation, people inevitably overuse and exploit them. This is the “tragedy of the commons” —famously formulated in a seminal 1968 paper by ecologist Garrett Hardin, and taught to thousands of economics undergraduates every year. There’s just one problem: it fails to explain real world behavior.

Hardin’s argument runs something like this. First, he invites us to “picture a pasture open to all.” In this scenario, herdsmen of the pasture, if they are rational, self-interested agents, will figure that the benefits they receive from adding one additional cattle to the pasture outweighs the costs from overgrazing that are shared by all the other users. Each herdsman continues to add cattle to the pasture, but in this way, the resource is inevitably depleted. For this reason, Hardin argued that “ruin is t he destination toward which all men rush.”

Scholars—many outside the economics discipline—have attacked this argument for its unrealistic assumptions and lack of evidence. One prominent critic is Elinor Ostrom, a lifelong researcher of the commons and Nobel Laureate in economics. Ostrom said that Hardin confused a joint property commons with an “open-access regime,” where restrictions on use are completely absent. Open-access regimes sometimes do exist (e.g., fishing on the high seas), but in the real world, common-pool resources are often governed by rules and norms that its users develop. This means Hardin’s “pasture open to all” does not accurately map how the commons operate in practice.

There is ample empirical evidence for the sustainability of commons regimes—as defined by Ostrom. The very existence of the commons, particularly where resources are scarce, proves neither private property nor state coercion is a prerequisite for their viability. In the words of Ostrom and her colleagues: “although tragedies have undoubtedly occurred, it is also obvious that for thousands of years people have self-organized to manage common-pool resources, and users often do devise long-term, sustainable institutions for governing these resources.” Commons are not always successful, but they are far from doomed to a tragic fate.

Take for instance, the grasslands in northern China, Mongolia, and Southern Siberia. State-run and private methods of resource management implemented in Russia and China are not nearly as effective in conservation as the traditional Mongolian group-property institutions. Around three-fourths of grassland in Russia, and more than one-third in China, has shown signs of degradation, compared to just one-tenth of grasslands in Mongolia.

The water commons in Bali provides another example. Subak, the traditional institution for irrigation management, has been sustainable for centuries without state regulation or private ownership. With water flowing downhill, the position of upstream farmers seemingly puts them in a prime position to free-ride, diverting more water for their own crops, but in reality, the opposite occurs. Farmers, upstream and downstream, are able to create a synchronized cropping arrangement in which damage from pests is minimized and downstream farmers retain access to water. In the end, crop yields are increased while water is used sustainably by all.

The voluminous literature on the commons documents countless similar examples. In the West, these include the cod fishery in Newfoundland (before it collapsed due to government mismanagement) and the lobster fishery in Maine. Digital and intellectual domains can fall under commons management as well. Wikipedia and the Creative Commons license exist only because people are able to cooperate and discourage free-riding.

Policy makers, unfortunately, sometimes fail to see the nuances of these sustainable systems. Under “tragedy of the commons” assumptions (no communication, self-interested, rational agents, etc.), arrangements like those found in Mongolia and Bali simply can’t exist. As a result, technocrats, looking to promote sustainability and growth, have often designed policies that backfire because they fail to take into account the complexity of local conditions.

Case in point: Bali in the 1970s. On advice from the Asian Development Bank, the Indonesian government, in an attempt to boost crop yields, instructed farmers to plant rice as often as they could—disrupting the synchronized cropping schedule. Pest populations exploded as a result, and crop losses were massive. In this example, simplistic and detached development policy had disastrous consequences for the Balinese farmers.

Thus we see a genuine understanding of the commons is imperative for coherent policy making. Scholars have long shown that Hardin’s “tragedy of the commons” is an  inaccurate representation of reality. Policy makers ought to adopt a more realistic view of the commons, and professors should jettison this fallacious model from their Econ 101 courses. A failure to do this and embrace the real world would, indeed, be the real tragedy.

Written by Jimmy Chin
Jimmy is an undergraduate studying economics and Asian studies at UNC Chapel Hill. He hopes to continue his studies in graduate school and has interests in economic development, political economy and China. Other sources of enjoyment for him include reading philosophy, writing, and hiking.

Economics: An Illustrated Timeline

Economics: An Illustrated Timeline

Do you keep getting confused about the different schools of thought in economics? Do you always forget what Walras was about, and when Marx was around? This timeline has your back. It provides an overview of historic events, schools of thought, and the people involved.CLICK IMAGE TO VIEW FULL SIZE:                       Sources  The Economics Book […]

Hidden in Plain Sight: Illicit Financial Flows

Hidden in Plain Sight: Illicit Financial Flows

The importance of Illicit Financial Flows (IFFs) in the context of economic development has slowly come to grasp people’s attention. The World Bank defines IFFs as “money illegally earned, transferred, or used that crosses borders.” Since 2006, the Global Financial Integrity (GFI), a Washington, DC-based think tank, has done extensive research on […]