Lessons from Mario Draghi

In two successive days last week, two heads of central banks gave speeches on monetary policy.   Graeme Wheeler’s speech was characterized by a rather desperate defensiveness –  attacking nameless critics for views that no one seems to hold, in an attempt to defend his (and the Bank’s) rather poor track record: a CPI inflation rate that hasn’t been at the midpoint of the target range for four years.

A commenter pointed me to ECB head Mario Draghi’s speech, given the following day, “How central banks meet the challenge of low inflation” .   It isn’t a perfect speech by any means –  the claim that “monetary integration in the euro area is both complete and secure” must just be one of those lines he has to use, regardless of the continuing severe stresses on the system.  It is a speech of two halves –  the second half is about the particular challenges of the euro area, but the first half is an excellent and authoritative discussion of how central banks generally should respond to low inflation.

Core inflation in each jurisdiction is quite similar: in 2015 CPI inflation ex food and energy was 1 per cent in the euro-area, and was 0.9 per cent in New Zealand.  If anything, New Zealand’s inflation target is a little higher than that for the euro-area: our Reserve Bank is required to focus on 2 per cent, while the ECB articulates its goal as keeping CPI inflation close to, but below, 2 per cent over the medium-term.

Draghi’s speech is well worth reading.  It is the speech of someone who has a deep belief in the power of monetary policy – that inflation is, over time, a monetary phenomenon, and that if inflation is persistently below whatever goal is set for the central bank it is the central bank’s responsibility to do something about it.    It is a refreshing speech, especially as the ECB is no doubt closer than it would like to the limits of conventional monetary policy (with the policy rate already below zero).    Draghi could have offered excuses, but instead it is robust call for monetary policy to simply do its job.

Draghi draws on the lessons of the 1970s, when central bankers often wanted to shift the responsibility for high inflation onto other structural forces.  He fully recognizes the wide range of shocks than can hit an economy (demography, technology etc), and the way some of them can persist, but  argues that monetary policy authorities are responsible for offsetting the effects of those shocks on inflation –  whether they are pushing upwards (as in the 1970s) or downwards (as at present).

… in a context of prolonged low inflation, monetary policy cannot be relaxed about a succession of supply shocks. Adopting a wait-and-see attitude and extending the policy horizon brings with it risks: namely a lasting de-anchoring of expectations leading to persistently weaker inflation. And if that were to happen, we would need a much more accommodative monetary policy to reverse it. Seen from that perspective, the risks of acting too late outweigh the risks of acting too early.

In sum, even when faced with protracted global shocks, it is still monetary policy that determines medium-term price stability. If we do not “surrender” to low inflation – and we certainly do not – in the steady state it will return to levels consistent with our objective. If on the other hand we capitulate to “inexorable disinflationary forces”, or invoke long periods of transition for inflation to come down, we will in fact only perpetuate disinflation.

This is the clear lesson of monetary history, especially the experience of the 1970s.

Nor does he offer up excuses of the sort that “inflation is low everywhere, so there isn’t much we can –  or perhaps should –  do about it”.

We now have plenty of evidence that, if we have the will to meet our objective, we have the instruments.


So there is no reason for central banks to resign their mandates simply because we are all being affected by global disinflation. In fact, if all central banks submit to that logic then it becomes self-fulfilling. If, on the other hand, we all act to deliver our mandates, then global disinflationary forces can eventually be tamed.

He even deals with the line of argument that easing monetary policy to get inflation back to target may do more harm than good.

Still, there are some that argue that even if central banks can lean against global disinflationary forces, in doing so they do more harm than good. In particular, expansionary monetary policies at home lead to the accumulation of excessive foreign currency debt or asset price bubbles abroad, especially in emerging markets. And when these financial imbalances eventually unwind, it weakens global growth and only adds to global disinflation.

To which his response is:

In fact, when central banks have pursued the alternative course – i.e. an unduly tight monetary policy in a nascent recovery – the track record has not been encouraging. Famously, the Fed began raising reserve requirements in 1936-37, partially due to fear of a renewed stock bubble, but had to reverse course the next year as the economy fell back into recession. That has also been the experience of some central banks in recent years: raising rates to offset financial stability risks has undermined the primary mandate, and ultimately required rates to stay lower for longer.

This suggests that the so-called “assignment problem” between monetary policy and financial stability at the domestic level should also apply at the global level. Monetary policy should not try to balance opposing objectives: it is optimal for all parties if it delivers its mandate. And if that creates financial stability concerns, they need to be addressed by other policies more suited to the task. And in fact there are several policy levers available.

Countries can improve their financial regulation and supervision to make their financial systems more resilient to external shocks. They can adjust their fiscal policies. They can adopt macro-prudential measures.

That is the sort of speech that Graeme Wheeler should have been giving last week – indeed, given how badly inflation has been undershooting the Reserve Bank’s target, he should have been giving it a year or two ago.  Instead, he drove up interest rates –  when his preferred measure of core inflation was even lower than it is now.  And even now that the OCR increases have reluctantly been fully reversed, we are left with real interest rates that are higher than they were two years ago, even as confidence in inflation getting back to target erodes further (and the terms of trade have fallen, the peak impulse from Christchurch has passed, and the global situation has materially worsened).

Chris Green, at First New Zealand Capital, had a commentary out late last week on the Governor’s speech.  I agreed with almost all of it.  But two lines particularly caught my eye:

“My sense is that the Governor is far more focused in defending his current position than objectively attempting to assess the optimal risk-adjusted monetary policy response”


“The perception that they give of a reasonably high hurdle before cutting rates would be more consistent with CPI out-turns around the top of the band, not having been below the midpoint for more than 5 years [I presume he means on the Bank’s preferred core measure] and not projected to get back there until the December quarter of 2017 –  at the earliest”.

Quite.   And one could add that the problem is compounded by the Governor’s reluctance to substantively engage with the issues –  rather than responding to straw men of his own imagining –  or indeed to open himself to sustained scrutiny from the media.

The Governor and his chief economist have been putting a lot of weight on inflation expectations measures recently, and suggesting that there is really nothing to worry about.  We’ll have a new round of inflation expectations data shortly, and I’ll come back to the topic then, but for now consider this chart, drawn from the Bank’s survey of household expectations.

household expecs Feb 16

People are asked whether they expect inflation to rise, fall or stay the same over the coming year.  The survey has been running for over 20 years, and in every single survey a net balance have reported expecting inflation to increase (suggesting that not much weight should be put on the absolute numerical value of the answer).  But what I wanted to highlight is that at present fewer people expect inflation to rise than at any time in the history of the series, with the exception of the depths of the recession in 2008/09.    But in March 2009, when only 20 per cent people expected inflation to rise over the coming year, the last annual inflation rate they’d seen was 3.4 per cent.  Of course –  in the middle of a recession, with plummeting oil prices –  they didn’t expect inflation to rise.  And they were right.  Annual inflation fell sharply.    The most recent observation in the survey was November 2015.  When those respondents completed the survey, the most recent annual inflation rate they’d seen was 0.4 per cent.  And still, not many (by historical standards) expected annual inflation to rise.   There is nothing to be complacent about in the inflation expectations data –  and even among more expert observers, medium-term inflation expectations are lower, relative to the target midpoint, than they have been since inflation targeting began.

It must almost be time for the Minister of Finance’s annual letter of expectations to the Governor.  As I noted last year, the persistent undershoot of the target has had little or no attention in  past year’s letters.  We must hope that this year’s is different.  The primary responsibility for the persistent undershoot of the target rests with the Governor, his chief economist, and his other senior advisers.  But the apparent passivity to date of those charged with holding the Governor to account –  the Minister of Finance, who set the target, and the Bank’s Board, paid to monitor the Governor’s pursuit of the target –  risks making them complicit in the failure.  After all, together they were responsible for the appointment of an individual as Governor who increasingly seems to lack the stature and qualities that the position demands.

58 thoughts on “Lessons from Mario Draghi

  1. Bill English in his ignorance believes that for the RBNZ to create ex nihilo some electronic money and gift it, or lend it interest-free, to the government for spending according to its democratic mandate would be inflationary, but if the government borrowed the same amount of money from a commercial bank (which of course would create it ex nihilo and charge interest on it) would not be inflationary.

    Wheeler has it within his power to create some electronic money and gift it interest-free and debt-free for the government to spend. If he created enough new electronic money, he would have no trouble getting inflation back up to 2%.

    Up until 1974, when the Canadian government was suckered by the Bank for International Settlements and stopped its own Reserve Bank of Canada from doing it, Canada built such infrastructure as the St Lawrence Seaway and the Trans-Canada Highway system with money created ex nihilo by the Reserve Bank of Canada and gifted interest-free and debt-free to the Canadian government. Currently, there is a lawsuit in progress to restore the RBC’s mandate to to do this — as explained in this article:



  2. Hi michael. Interesting piece by draghi which I guess is another version of “whatever it takes” – this time to lift inflation. Good luck with that in the near term.

    as you’ve ventured to Europe I wonder whether you read what I thought was an excellent piece by Axel Weber last year on the weaknesses or limits of inflation targeting frameworks. https://www.project-syndicate.org/commentary/rethinking-inflation-targeting-price-stability-by-axel-weber-1-2015-06

    His main point is that targeting a narrow inflation rate, in the short run, is not sufficient for the central bank to meet their broader objective “of keeping the value of money stable.” He argues, persuasively in my view, that central banks should factor into their near term decisions financial stability factors, asset prices, etc.

    like draghi, he doesnt dismiss that central bankers can influence the inflation rate in the long run – fair. But he does have an issue with the relevant timeframes policymakers should focus on.

    He writes “In short, while price stabilization through inflation targeting is a commendable objective, central banks’ narrow focus on consumer prices – within a relatively short time frame, no less – is inadequate to achieve it. This was highlighted by the surge in many countries’ housing prices in the run-up to the 2008 financial crisis, the steep decline in asset and commodity prices immediately after Lehman Brothers collapsed, the return to asset-price inflation since then, and recent large currency fluctuations. All are inconsistent with a stable value of money.
    Central banks’ exclusive focus on consumer prices may even be counterproductive. By undermining the efficient allocation of capital and fostering mal-investment, CPI-focused monetary policy is distorting economic structures, blocking growth-enhancing creative destruction, creating moral hazard, and sowing the seeds for future instability in the value of money.”

    My take is that if 1) there are non monetary factors bearing down on inflation and 2) so long as we can reasonably expect the inflation rate to return to normal in the years/decades ahead then more economic and financial good (or less harm) will be done by allowing the inflation rate to deviate from target for 1, 2, 3, 4, 5, or even 5 or 6 etc years as opposed to attempting to lift the inflation rate in the near term with ever increasing unorthodoxy and stretching of balance sheets and asst prices. rising household leverage makes me more worried about the long run than a temporarily low inflation rate (due to non-monetary factors) concerns me in the near term.

    Finally, I love his line instructing us that draghi’s and others attempts to lift inflation rates may be futile – at least in the near term. “A more recent indication that inflation targeting has not caused the disinflation seen since the 1990s is the unsuccessful effort by a growing number of central banks to reflate their economies. If central banks are unable to increase inflation, it stands to reason that they may not have been instrumental in reducing it”.

    Apologies this got so long. Peter


    • Thanks Peter

      I had almost as long a reply written, and somewhere lost it. But quickly:

      1. Lets debate what the PTA goals should be, but whatever they are central banks should deliver on them
      2. Weber doesn’t really give a workable practical alternative policy specification. Lists all the imperfect things about infl targeting, but eg the intermediate targets period wasn’t a great success (Bundesbank rarely met its monetary targets, usually for good reasons). So it sounds like an argument for lots of discretion – which means either excess power to unelected offoicials, or handing more choices back to politicians.
      3. He doesn’t stop to analyse why house prices and credit rose – eg what was down to planning regs and population pressures, what to direct US govt interventions in housing credit markets, and what to joining the euro (eg Spain and Ireland)
      4. relatedly, he does not highlight any inflation targeting country, with limited govt involvement in the housing finance market, that had a domestic financial crisis centred on housing loans losses. Consider, for starters, the UK, NZ, and Aus.


      • Yes, Weber seems to be arguing for lots of discretion for the central bank around intermediate targets (like the target inflation rate or monetary target) but no discretion around the central banks broader goal which is a stable value of money – admittedly a lot harder to define and measure than a simple inflation rate. With the right governance that sounds very sensible to me. As you note in your first point, this is not the rbnz’s current objectives. But my comment was not about rbnz policy but more about draghi’s staunch defence of the inflation targeting framework which you summarised as “that if inflation is persistently below whatever goal is set for the central bank it is the central bank’s responsibility to do something about it.” Im no longer sure that is sufficient.

        Liked by 1 person

  3. I wonder how many people would put “deanchoring of inflation expectations” on their worry list? Lower prices for goods and services which reflect positive supply side developments in conjuction with low but positive growth is hardly a toxic situation. Low inflation with high debt seems to be the issue across a number of currecy areas but it appears the former attracts the most attention perhaps because nobody wants to admit some of the debt remains a legacy of questionable ‘capital allocation’ decisions .Which is another way of saying no amount of liquidity will repair insolvency. Inflation targeting was born out of a period of high inflation: time to adjust the framework in light of all that has changed since the early ’90’s.


    • But what alternative model are you proposing? And where are the signs that debt in say NZ or Aus is, to a material extent, a “legacy of questionable capital allocation decisions”. Dairy perhaps, but it doesn’t seem so in housing – far the largest chunk of bank balance sheets.

      “deanchored inflation expectations” don’t matter in their own right, but for what options they limit (ie falling expectations mean rising real interest rates, which may be the last thing the economy needs if there were to be another recession. the lower bound isn’t zero, but it exists.


      • Housing prices is not a product of interest rates. Housing developers in NZ are almost 100% debt businesses. Increase interest rates and you will automatically slow down building. Drop interest rates and builders will build. Build more houses and the prices would fall. The other essential ingrediant is infrastructure. You cannot build large scale when you do not have the infrastructure. Auckland is a elongated city with lots of land on the Waitakere ranges laden with Kauri trees. All we need to do is just cut down hundreds of kauri trees and start building. Nah not happening. Or ignore the viewshaft height limits imposed by 57 sacred mounts, Mt Eden, Mt Albert, Mt Smart, Mt Wellington, 3 Kings, One tree hill etc. Ooops thats most of Auckland.

        We simply cannot build 4 levels buildings.

        1. Beyond 3 levels you need to put in a lift. Thats costly.
        2. You must have carparks which takes out 1 level

        Therefore for the cost of 4 levels you get only 2 levels of building. No one is going to build a 4 level building on a small scale. If you scale up and try and buy a neighbouring property the cost of land would be huge. Also only 50% of a site is building coverage even in a Special Housing Zone.


      • Central banks to stay independent but to my mind, the key policy objective should be skewed more to ‘financial stability’. Granted, not sure how to define and communicate this but the BIS has written plenty on taming the ‘financial cycle’ (e.g. credit-GDP-gap) which would be a good place to start and to an extent, this has already been reflected in the pick up of macro prudential policies across a number of central banks post crisis. I would point to the European banking system as evidence of continuing legacy capital allocation issues: even after the much hailed Asset Quality Review, the Greek banking system just got more capital and the Italian banking system is working on a ‘bad bank’ option?? While capital allocation issues might not apply to NZ’s banking system, as I have rambled on about before, NZ banks fund offshore as do the Australian banks: it might take a major risk event for this to become an issue but as history shows, the major risk event is typically the one no one was talking about?


  4. QC,

    Re Europe, the euro itself has a great deal to answer for, in worsening the health of the banking systems of many of the peripheral countries. You are critiquing inflation targeting, but as I’ve noted I’m not aware of any inflation targeting countries where there has yet been a serious domestic-losses-based financial crisis. Perhaps I’m missing some examples, but while I’m fully on board with the BIS line that price stability isn’t a precondition for macro stability (let alone financial stability), but the examples where a ‘wrong’ monetary policy is to blame for subsequent macro problems seem hard to find among inflation targeters. Perhaps you might nominate the US – which was de facto inflation targeting – in which case we have to turn to the debate about the contribution of various factors to the US financial crisis. JOhn Taylor argues that it was monetary policy – insufficiently adherence to a Taylor rule – but I reckon a much stronger argument can be made for the role of direct regulatory interventions in the housing finance market – which would have led to problems under any conceivable alternative monetary policy.


    • Yip, in broad terms, I am questioning whether monetary policy design is currently ‘wrong’ if the primary objective of central banks remains price stability on the basis that this is the long held consensus view of the best contribution a central bank can make to sustainable economic growth. The inflation targeting framework was devised following a turbulent period in economic & monetary history and I would suggest it is time to rethink/redefine central bank objectives in light of economic/social/institutional developments since the early ’90s. I wouldn’t be surprised if these unconventional policies enacted by inflation targeting central bankers in pursuit of a conventional objective look barking mad ten years hence!!


  5. Blenglish thinks all is well.

    Finance Minister Bill English sees no reason to change Reserve Bank agreement
    Finance Minister Bill English says the Government sees no reason to rewrite its agreement with the Reserve Bank, despite its failure to lift inflation back to its target range under current settings.

    Central bank Governor Graeme Wheeler last week highlighted the bank’s own measure of “core inflation” – which it put at 1.6 per cent. The current consumer price index is running at 0.1 per cent and under its policy targets agreement (PTA) with the Government, targets the mid point of its 1-3 per cent inflation band.

    Wheeler argued that more interest rate cuts wouldn’t necessarily lift inflation and that a flexible approach was necessary “in view of the numerous factors the Bank is required to consider in the PTA – such as asset prices, financial stability and efficiency, volatility in output, interest rates, and the exchange rate”.



    • Certainly agree with him that there is no reason to revise the PTA. As for the rest of the article, I think it says more about politics than economics. The current PTa certainly wasn’t signed up to by Wheeler and English to lower inflation – inflation was already below 2% by the time it was signed (and earlier PTAs, 1996 and 2002) had been explicitly about raising the inflation target.


    • I do agree with Bill English. Sometimes inaction is better than any governmental action. At this stage the NZ economy looks rather resilient and on the right track. Lets not rock the boat when it is sailing nicely.


  6. Michael, you wrote “…. I reckon a much stronger argument can be made for the role of direct regulatory interventions in the housing finance market – which would have led to problems under any conceivable alternative monetary policy.”

    Michael, please explain why it is that to you — and no doubt to many other contributors to your blog — a Sovereign Money banking and financial system is an inconceivable alternative monetary policy?


      • QC, in a Sovereign Money system the government would not be in control of the creation of new money. Rather, an independent Money Creation Committee of the RBNZ would be in control, just as in the current private debt-money system, the governor of the RBNZ is responsible for setting the OCR.


      • There is already too much power given to the RBNZ with decisions and forecasts that are not adequately supported with proper research. Forecasts that are wrong 4 years in a row does not give us any confidence that they do not need oversight. Give them more power to print money freely is a like begging for trouble.


  7. getgreatstuff wrote “Give them (i.e. the RBNZ) more power to print money freely is a like begging for trouble.”

    The Positive Money proposal for a Sovereign Money banking and monetary system does not give the RBNZ the power to ‘print’ money freely — i.e. without constraint.

    Rather, it would give the RBNZ the power to ‘print’ new money only at a rate just sufficient to keep up with economic growth, while at the same time forcing banks to become simply moneylenders that lend existing money that they have borrowed from savers. Incredibly, this is what all our schools and universities knowingly and erroneously teach their students is what banks do now!

    In the present debt-based monetary system, banks are money creators — freely creating money to lend on mortgages at such a rapid rate that they have enabled ‘we the people’ to outbid each other to cause house price bubbles in our major cities.

    The present system is systemically unstable and the sooner we replace it with a Sovereign Money system, the better off ‘we the people’ will all be.


    • In NZ, NZ banks do not create money, they match savers with borrowers and earn a margin. Our problem is that the RBNZ has for decades pitched interest rates too high and keeping the NZD too high allowing the decimation of our local manufacturing. We have become specialist niche marketers with products that are pitched as high value and therefore have a higher margin to be able to sustain a higher NZD. Not necessarily bad but it keeps our industries small.

      As the RBNZ continuosly threatens local businesses with rapid interest rate rises, the risk to businesses in NZ is extremely high. The current system is unstable because the RBNZ has a trigger happy tendency to push interest rates upwards in rapid succession. Slow downwards and fast upwards, that trigger happy attitude is the unstable factor not the current system itself.


    • Contrary to what a lot of people have been told, NZ household savings exceeds NZ household debt which means the banks are under pressure to lend out those savings. People forget that bank deposit savings is a liability to the bank and the interest paid to savers is a cost. Therefore higher savings equate to higher debt. Without that matching taking place the NZ bank makes losses.

      More savings in banks = more lending by banks

      NZ banks are not reliant on foreign currency denominated bonds. Due to global interest rates running close to 1% and in many countries in Europe and Japan negative, our interest rates attract foreign depositors to the NZD, the NZD is one of the 10th most traded currency in the world, I am told $50 billion a day gets traded when our economy is only worth $250 billion a year. Our tax system favours foreign currency denominated bonds giving a zero rated withholding tax in interest earned on those bonds and this attracts foreign savers towards the NZD.


      • Correction, foreign currency purchasing of NZD issued bonds instead of foreign currency denominated bonds


  8. Greatstuff, I don’t know where you studied economics, but the b..s… you are spouting is what is taught in all New Zealand schools and universities — i.e. the “loanable funds’ model of banking. Sorry, but it’s b…s…. The truth was revealed way back in 1956 by the NZ Royal Commission into Monetary, Banking, and Credit Systems.

    In 2014, in its Quarterly Bulletin 1, the Bank of England also revealed the truth in a paper, and in 2015, in another paper. The URLs for these papers are:


    Greatstuff, with the greatest of respect, I suggest that before you write any more responses to this blog you read these papers.

    [Expletives edited – please refrain in future. MHR]


    • PJM, the numbers speak for themselves. If NZ banks were busy creating money then you would see debt exceeding debt by multiples of tens or hundreds. Unfortunately for your pure theorectical approach, that does not happen. NZ household savings is running higher than the NZ household debt. You can read all the hearsay that you like but garbage in is garbage out.


  9. getgreatstuff, the garbage you have written reminds me of the tale about two Sydney taxi drivers leaning out or their car windows when facing each other in a one-way street and the one trying to go the wrong way refused to back up. The one trying to go the right way yelled “You’re not even ‘igorant’!!!!!!!”

    Every time an NZ commercial bank (or an Australian one or an English one or a Canadian one, etc., etc.) grants a loan, it simply types the loan principal into the borrower’s bank account, and thereby creates new money ex nihilo in the act of lending.

    If you don’t believe this, then go to your local library and take out the unanimous report of the 1956 NZ Royal Commission into Monetary, Banking, and Credit Systems, and READ it!

    Maybe even Michael Reddell could spell out for you exactly how the banking system works — and it’s definitely not the way it is taught in schools and universities — which is explained in the two Bank of England papers for which I gave the URLs. What about it, Michael?


    • Michael, with the greatest of respect, please explain why, when my exchange with getgreatstuff began after he wrote “In NZ, NZ banks do not create money, they match savers with borrowers and earn a margin.”, and I responded with my statement that “The truth was revealed way back in 1956 by the NZ Royal Commission into Monetary, Banking, and Credit Systems.”, and went on to quote the two Bank of England papers that repeat the truth that was revealed by the 1956 NZ Royal Commission, that getgreatstuff and I could possibly be “somewhat talking at cross purposes”.

      I am talking the truth, that every time a bank grants a loan, it in effect creates money ex nihilo, and getgreatstuff clearly denies this and evidently has yet to understand how the monetary, banking, and credit systems work.


      • PJM, like I have said, look at NZ household balance sheets. Where is all this debt created by banks that you speak off? NZ household savings exceed NZ household debt. Where is all that so called debt that our NZ banks have created? Why would you create debt when you have more than sufficient savings to lend out and earn a margin on?

        Every indication I look at, 90 bank bill rates, 3 year swap rates all indicate too much savings in our banking system. Interest rates are under severe falling pressure even with the RBNZ trying to keep interest rates on the higher end. NZ Banks are making excess record margins as they try and stem the tide of money going into savings, dropping interest rates on deposits and delaying the reduction of interest rates on their loan books.

        Instead of looking at at something dating back to the vietnam war when most of us were not even alive and telling me I do not have a clue, look at the NZ household balance sheet and tell me where all this created debt resides? It is definitely not in the 1 million plus NZ households. So where is it? In government debt? in commercial debt? Show me the numbers please!!!


  10. getgreatstuff, you are in effect trying to tell all the readers of this blog that whilst in 1956 it was true that banks created money ex nihilo in the act of making loans, as described in the unanimous report of the 1956 Royal Commission, somehow the system has changed and banks don’t do that anymore?

    If that is really your contention, then you really are an ignoramus and should sit down and have a quiet read of at least the first of the two Bank of England papers for which I provided the URLs.

    Michael Reddell has concurred that in New Zealand the banking and monetary system works in almost exactly the same fashion as in the UK. It does in Australia, Canada, and South Africa, too, for that matter.

    Your questions about household balance sheets are irrelevant to the truth about banking and therefore I will continue to ignore them!

    Banks DO NOT lend out their customers’ deposits. Rather, bank loans create customers’ deposits — and hence new money, which is debt.


    • You cannot show me the numbers because you struggle to actually find where all that so called NZ bank created debt is. This is typical of NZ economists, a lot of ivory tower theory but little or no supporting data. I challenge you once again to show me where all this NZ bank created debt is?

      To say that NZ banks created the debt and then created the deposits sounds rather nonsensical. The savings deposits are real. Someone earned that and they are all in individualised bank accounts. The bank records that savings as a liability on their books. To say that loans are just a number on a computer, well, so is everything else these days but we do have armies of accountants their entire job is to verify that those numbers on a computer reflect a real world situation.


      • getgreatstuff, by writing such nonsense you are still refusing to believe both the unanimous report of the 1956 Royal Commission and also two papers published by the Bank of England.

        I have suggested to you before that you make no further comments on this blog until after you have read at least the first of the Bank of England papers.

        Please do your reading sooner rather than later, and then, at last, you will understand how the banking and monetary system actually works.

        By the way, I am a professional mechanical engineer trained in systems analysis. I am self-taught in economics, but sat and passed the two Association of Chartered Accountants’ 3-hour papers in economics in 1973 after I had been teaching Yr 13 economics — from the textbook of the day, written by Paul Samuelson — for almost a year. I taught my students the truth about how banks work — not the nonsense that was in the textbook. My other teaching subjects were mathematics, physics and science. Sometimes one cannot predict what one will have to do to earn a living! The teaching experience engendered in me a desire to learn much more about macroeconomics, and I taught economics again for three years in the 1980s.


      • PJM, you should stick to Mechanical engineering and stop reading too much fiction. Stick to facts. The numbers do not lie.


    • “At $1 billion, these securities are a drop in the ocean of the New Zealand banking system, which has $11.8 billion of subordinated debt, $34 billion of equity and $390 billion of deposits and other borrowings.(Not to mention the more than $400 billion of loans outstanding).”


      PJM, This comment from interest.co.nz gives some indication of the total size of banking deposits around $390 billion including commercial and NZ household activity. Note that the equity provided by shareholders is $34 billion. NOTE carefully that the debt in total is only $400 billion. Therefore savings deposits closely balance the total debt in our banking system plus equity provided by shareholders. There is no reason to be creating debt as there is more than sufficient savings and equity available to lend out to earn a margin. The truth and facts is sometimes more difficult to comprehend than fairy tales. So where is the magical debt created by banks? NZ banks facilitate they do not create.


      • getgreatstuff, by writing “NZ banks facilitate they do not create” you are disagreeing not just with the 1956 Royal Commission and the Bank of England, but also with Michael Reddell.

        Now go and read what I have asked you to and learn the truth about banking!


      • PJM, stick to the facts instead of going on and on about conspiracy theories. I give you factual numbers and in return you give me a number of dated articles of a vietnam era and Bank of England when we actually live in NZ. Gosh I pity your students. You need to rethink your part time teaching endeavour. I hear there is a massive shortage of teachers for high school mathematics. Perhaps that would be a more suitable and honest wage to draw on.


  11. getgreatstuff wrote: “Incidently (sic), my qualifications and experience totally and completely out muscle yours.

    Once again your comment is pathetically irrelevant.

    Incidently? Pity about your poor English!


  12. getgreatstuff wrote: “PJM, stick to the facts instead of going on and on about conspiracy theories. I give you factual numbers and in return you give me a number of dated articles of a vietnam era and Bank of England when we actually live in NZ.”

    getgreatstuff, I have never mentioned a single conspiracy theory, and your factual numbers are irrelevant!

    Michael, I give you my permission to email my mobile number to this fellow so that he may phone me to arrange for us to meet face to face to continue our discussion. As I have unlimited free calling, he may prefer to give you his mobile number for you to give to me so that I may call him.


      • getgreatstuff, your factual numbers may very well be true, but unfortunately for your denial that bank lending creates deposits ex nihilo, they are about as relevant as are the numbers in a telephone book, which are also, by and large, true!

        Here is an excerpt from the Bank of England paper “Money creation in the modern economy:

        Two misconceptions about money creation
        The vast majority of money held by the public takes the form of bank deposits. But where the stock of bank deposits comes from is often misunderstood. One common misconception is that banks act simply as intermediaries, lending out the deposits that savers place with them. In this view deposits are typically ‘created’ by the saving decisions of households, and banks then ‘lend out’ those existing deposits to borrowers, for example to companies looking to finance investment or individuals wanting to purchase houses.
        In fact, when households choose to save more money in bank accounts, those deposits come simply at the expense of deposits that would have otherwise gone to companies in payment for goods and services. Saving does not by itself increase the deposits or ‘funds available’ for banks to lend. Indeed, viewing banks simply as intermediaries ignores the fact that, in reality in the modern economy, commercial banks are the creators of deposit money. This article explains how, rather than banks lending out deposits that are placed with them, the act of lending creates deposits — the reverse of the sequence typically described in textbooks.(3)
        Another common misconception is that the central bank determines the quantity of loans and deposits in the economy by controlling the quantity of central bank money — the so-called ‘money multiplier’ approach. In that view, central banks implement monetary policy by choosing a quantity of reserves. And, because there is assumed to be a constant ratio of broad money to base money, these reserves are then ‘multiplied up’ to a much greater change in bank loans and deposits. For the theory to hold, the amount of reserves must be a binding constraint on lending, and the central bank must directly determine the amount of reserves. While the money multiplier theory can be a useful way of introducing money and banking in economic textbooks, it is not an accurate description of how money is created in reality. Rather than controlling the quantity of reserves, central banks today typically implement monetary policy by setting the price of reserves — that is, interest rates.
        In reality, neither are reserves a binding constraint on lending, nor does the central bank fix the amount of reserves that are available. As with the relationship between deposits and loans, the relationship between reserves and loans typically operates in the reverse way to that described in some economics textbooks. Banks first decide how much to lend depending on the profitable lending opportunities available to them — which will, crucially, depend on the interest rate set by the Bank of England. It is these lending decisions that determine how many bank deposits are created by the banking system. The amount of bank deposits in turn influences how much central bank money banks want to hold in reserve (to meet withdrawals by the public, make payments to other banks, or meet regulatory liquidity requirements), which is then, in normal times, supplied on demand by the Bank of England. The rest of this article discusses these practices in more detail.

        Here is an excerpt from the unanimous report of the 1956 Royal NZ Commission into Monetary, Banking, and Credit Systems:

        Causes of Changes in the Money Supply:
        157. The volume of money (on the Reserve Bank definition) is increased:
        (a) When a customer of the Reserve Bank or a trading bank lodges, to the credit of his account, foreign exchange received from the sale of goods or services beyond New Zealand, from gifts or legacies from persons overseas, or from the proceeds of a loan raised with an overseas lender.
        (b) When the Reserve Bank or a trading bank buys securities or other assets from an individual or firm and the proceeds are lodged to the credit of the seller’s account at a bank.
        (c) When the Reserve Bank makes a loan to the Government or to marketing authorities. At first, the borrower’s deposits at the Reserve Bank are increased, and when this money is spent, the recipients may lodge part of it in their accounts at the trading banks and retain part of it in circulation in the form of notes and coin.
        (d) When the customer of a trading bank draws on an overdraft limit granted by the bank and the recipient of his cheque lodges it to the credit of his account at a bank.
        158. Conversely the volume of money (on the Reserve Bank definition) is reduced:
        (a) When a customer of the Reserve Bank or trading bank buys, with a deposit in his name at the bank concerned, foreign exchange to meet obligations overseas.
        (b) When the Reserve Bank or trading bank sells part of its holdings of securities or other assets to a persons with credit accounts at a bank.
        (c) When the advances of the Reserve Bank are reduced, by the lodgment of notes, coin, or cheques drawn on credit accounts.
        (d) When the advances of the trading banks are reduced, by the lodgment of notes, coin, or cheques drawn on credit accounts.
        159. For the sake of clarity, it has been assumed in each of the transactions in paragraph 157 above that the customer making the lodgment at a bank was making it in a credit account. The position would be different if he were working on a bank overdraft, for if he used the funds to reduce his overdraft (or to buy overseas exchange) there would be no increase in demand deposits and therefore no increase in the volume of money. Similarly, the transactions outlined in paragraph 158 would not result in a reduction of the supply of money if the funds used to buy the exchange, securities, or other assets, or to reduce the advances, had come from an overdraft account or from the lodgment of foreign exchange.
        160. If unexercised overdraft authorities were included in the definition of the supply of money, as we suggest, the supply of money would be increased immediately a customer was granted an overdraft limit, for the customer would then be in a position to draw cheques against the overdraft authority to the amount of the limit granted to him. Again, the transactions outlined in paragraph 157 would increase the volume of money, even if the customer making the lodgment were working on overdraft, as long as his overdraft limit was not reduced. For to the extent that he repaid an advance, the unexercised portion of his overdraft limit would be correspondingly increased. On the other hand, on the suggested definition, the supply of money would be reduced immediately if customers’ overdraft limits were reduced.
        161. It is important to recognise the difference in the effect on the volume of money between lending by or the purchase of assets by a bank on the one hand, and lending by or the purchase of assets by an individual or firm on the other. In the latter case, the individual or firm making the loan or buying the asset parts with his money to the borrower or seller; when a bank lends or buys assets, however, none of those who already held demand deposits before the transaction took place gives up his right to use that deposit when he wishes; i.e., no part of the supply of bank money existing before the transaction is withdrawn, but the borrower, or the seller of the asset bought by the bank, usually receives new bank money in the form of a deposit or of an increase in his unexercised over- draft limit at the bank. An increase in bank lending or purchase of assets therefore normally involves an increase in the total volume of money available to the public.
        162. Thus, during any period, the volume of money is likely to increase
        (a) If the trading banks and/or the Reserve Bank increase their lending, or purchase more assets, during the period; and/or
        (b) If there is an excess of export earnings and other receipts from persons overseas over import and other payments to persons overseas (i.e., if there is surplus in our balance of payments).
        163. Conversely, the volume of money is likely to fall if lending, or purchase of assets, by the Reserve Bank and trading banks declines, or if there is a deficit in our balance of payments.

        Apart from the change to RBNZ monetary controls, when interest rates became the tool of choice, the NZ banking and monetary system still works just as it did in 1956.

        Disagree with these two — at your peril — and remain ignorant!

        My favourite Mark Twain quote is “It’s not what you don’t know that gets you into trouble, it’s what you know for sure, that just ain’t so!”


  13. I do not disagree with any of the above statements. My concern is your personal interpretation of the text. The linkage between the above text and your magical bank created debt is no where in those statements and is no where to be found and is likely drawn from reading a number of other fantasy articles.


      • The planet of dollars and common financial sense. Whatever you do in the world of finance, remember one critical thing in all your hard earned studies. Its a zero sum game, otherwise its called fraud. The fundamentals of business reporting boils down to 2 absolutes. Where there is a debit there must always be a credit. Forget that base principle and they tend to lock you up and throw away the keys.


      • Therefore if you extend that, someone gains then you have someone that pays. Where there are winners, there are losers and so on and on.


  14. getgreatstuff, it seems to me that you still don’t get it that banks create new money ex nihilo in the act of making loans.

    If you still don’t believe that NZ’s banking system mirrors the UK banking system, don’t take my word for it, just ask Michael Reddell to confirm that this is so.

    Here is another excerpt from the Bank of England paper “Money creation in the modern economy”:

    Commercial banks create money, in the form of bank deposits, by making new loans. When a bank makes a loan, for example to someone taking out a mortgage to buy a house, it does not typically do so by giving them thousands of pounds worth of banknotes. Instead, it credits their bank account with a bank deposit of the size of the mortgage. At that moment, new money is created. For this reason, some economists have referred to bank deposits as ‘fountain pen money’, created at the stroke of bankers’ pens when they approve loans.

    Really, you should read the whole paper!


    • You need to be careful how you interpret the article. Economists unfortunately do not fully understand the domain of accountants ie the financial statements. Everything needs to balance and nets to zero.

      You have to look at money as inventory similar in the way that a wholesaler operates. You cannot artificially create debt because at some point you have to deliver. It is finite and is dependent on savings. When a wholesaler buys inventory, he pays a price that is being offered by the seller. In the similar way that is what a saver does, he deposits his savings into a bank. In the similar way you could also look at the sell contract of a wholesaler as having created the sale because the contract with the buyer is independent of the supplier ie the purchase contract. Therefore you can make the same argument that the wholesaler created the sale as the contracts are independent and does not belong to the supplier. This is the gist of the article, that fundamentally the debt is created because the contract is not with the saver but with the bank, ie the bank owns the customer base and there is no direct link between the saver and the borrower in the same way that a wholesaler operates.

      When a wholesaler sells his product to the client he puts in place a markup on the product similar to how a bank puts a interest rate margin on the savings deposit. There is never a direct match. Like a wholesaler he knows he has bought an assortment of products for which his end buyer purchases. There are 2 separate and independent contracts. The purchase contract and the sellers contract. They are independent but is managed by the wholesaler. You can oversell at any time but then at some point you have to deliver on the sale. That’s why sometimes the short term money market interest rates explode, It is because the bank has oversold their trading position and has to cover the shortage. If you can totally magically create debt then you can have interest rates on loans lower than savings and you would not need the short term money market. That never happens because the bank earns a margin. The banks will try and match its loan books with its savings book. Notice how the interest rates margin look very tiny but you may not have noticed that with a fixed loan for say 6 months, interest is charged monthly but if you have a 6 months savings deposits, the interest rate is credited to your account at the end of the 6 months.

      Banks will offer a interest rate to local savers to fund their lending activity. They do this because they do not incur the cost of protecting from exchange rate movements, there is what we call a natural hedge. That is why NZ borrows from overseas savers if the bank does not believe that he can attract enough local savers. If the bank can magically create debt then they do not need savers at all, Why bother paying out to a saver?


      • Sorry, getgreatstuff, your contention that “If the bank can magically create debt then they do not need savers at all, Why bother paying out to a saver?” is awry and not supported by the unanimous Report of the 1956 NZ Royal Commission, nor by the Bank of England, nor by Michael Reddell and innumerable other writers and scholars.

        When an EFTPOS payment or a cheque from a customer of one bank is deposited with a competing bank, not only is money transferred from the payer’s account to the payee’s account, but the payer’s bank owes the payee’s bank an equal amount of RBNZ money, called reserves, which nowadays are either RBNZ electronic digits or notes and coins. Thus “reserves follow deposits”. Each night, a computerised settlement process takes place to net-out these inter-bank debts. So at the end of every day each bank either owes one or more of the other banks, or is owed, some reserves. Banks therefore need to hold some reserves, which they borrow from the RBNZ at an interest rate 50 basis points (= 0.5%) above the Official Cash Rate (OCR), the OCR being the interest rate that the RBNZ pays on deposits of reserves, to banks that have surplus reserves. If a bank doesn’t have enough RBNZ reserves and cannot borrow them from another bank at an interest rate below that which it would have to pay the RBNZ, that bank borrows them “on demand” from the RBNZ at the OCR + 0.5%. In practice, the RBNZ never refuses to lend reserves to a bank, but it may if a bank did not have the pre-specified collateral. Only financial institutions that meet the requirements of the RBNZ can hold electronic reserves – ordinary companies and people cannot. The existing monetary system is therefore a two-tier one – digital bank-debt-money plus RBNZ notes and coins for the people, and digital RBNZ reserves plus RBNZ notes and coins for the banks and selected financial institutions. To satisfy their customers’ needs for them, banks buy notes and coins from the RBNZ, and pay with electronic reserves.

        The major reason that banks pay interest on term deposits and savings accounts is to grow their market share of depositors, to increase the likelihood of the deposits created when they grant new loans being spent with their own customers rather than the customers of competing banks, thus reducing their need for RBNZ reserves and increasing the rate that they can safely lend more. (This follows from the observation that “reserves follow deposits” in the preceding paragraph.) Banks are, however, now subject to RBNZ liquidity (core funding) requirements.

        Also, banks’ paying interest to savers helps to support the illusion that banks are financial intermediaries that take in money from savers, aggregate it, and on-lend it to borrowers, making their living from the margin between the interest rates that they pay savers and the interest rates that they charge borrowers. This is the falsehood that all students of economics in New Zealand’s (and indeed the world’s) schools, polytechnics and universities are taught.

        I have written a four-page article describing exactly how the present debt-based banking and financial system works. If you — or any other reader — email me at pjm.forensic.eng at gmail.com I will email the article to you as a pdf file.


  15. Wow, getgreatsuff, your confidence is not just breathtaking, it’s amazing. You really do believe that the Bank of England and numerous other authors have all got it wrong, and you know for sure that banks don’t create money! I note that you gave no references to support your contentions.

    As Mark Twain so famously said, “It’s not what you don’t know that gets you into trouble, it’s what you know for sure that just ain’t so!”

    Here is a brief article I wrote in December last year on how the banking system actually works:

    A very brief and simplified explanation of Sovereign Money and how it is fundamentally different from Social Credit

    Almost every time there is a TV or newspaper report mentioning money, images of notes and coins are presented to us as representing our money. These images deceive us into thinking that ‘our money’ consists of just notes and coins.

    However, this is very misleading, because notes and coins now make up only 2% of the money we use, and even less as a proportion of the total value of transactions. These days, because of the development of EFTPOS and on-line banking, 98% of our money is electronic, in the form of bank deposits. We all know that notes and coins are printed and minted by the Reserve Bank of New Zealand (RBNZ), which is 100% owned by our government. That is why economists classify notes and coins as sovereign money. The difference between the face value of a note or coin and what it costs the RBNZ to have it manufactured is called seigniorage and in the case of notes and coins, the seigniorage belongs to the government through the RBNZ. It costs only a few cents to manufacture a $5, $10, $20, $50 or $100 note.

    However, few of us know that the electronic money we use is not created by our RBNZ. Actually, new electronic money is created ex nihilo (out of nothing) by banks when they make loans or buy assets.1 That’s right, new electronic money is created by banks, as bank IOUs, i.e. promises to pay, every time they grant a loan. For a mortgage loan, in exchange for signing a contract whereby the bank promises to pay say $500,000 in notes and coins, and credits the borrower’s account with the bank the sum of $500,000, a borrower promises to repay the bank (i.e. the contract legalises both the borrower’s IOU to the bank and the bank’s IOU to the borrower). In our collective ignorance, we the people, and our government, choose to make these electronic bank IOUs spendable money – making payments using our EFTPOS and credit cards, and direct credits through on-line banking – and we accept them as being far more convenient to use than RBNZ notes and coins – even to buy a cup of coffee! We do this in our ignorance of the deleterious effects of this private, debt-based monetary system on the wellbeing of our society. Few of us realise that it is the major cause of ever-growing inequality. When a loan principal or part thereof is repaid, the bank cancels the borrower’s IOU, in effect making the electronic money disappear back into the nothing from whence it came, thus destroying it.1 EFTPOS technology has caused a continuing decline in the use of notes and coins and in New Zealand they now constitute only 2% of the money in circulation (the money supply), which totals about $250 billion. As the Bank of England made perfectly clear in its 2014 papers “Money creation in the modern economy”1, and “Banks are not intermediaries of loanable funds – and why this matters”2, that banks are not financial intermediaries – they DO NOT lend out their deposits. “Rather than banks receiving deposits when households save and then lending them out, bank lending creates deposits.”1 However, this truth is not well known, possibly because practically all secondary schools’ as well as universities’ economics students are erroneously taught that banks are financial intermediaries that take in money from savers, aggregate it, and on-lend it at a margin to borrowers! This is known by economists as the ‘loanable funds’ model of banking.
    A Sovereign Money banking and monetary system would simply modernise the way that electronic money is created, making it sovereign money, just as notes and coins are. All electronic money would be created out of nothing by the RBNZ at a rate to just keep up with the growth of the economy, and gifted to the government, free of debt and free of interest, for the government to spend into permanent circulation according to its democratic mandate. At present, the amount of electronic money in circulation is approximately $250 billion, and at a growth rate of 3% and 2% inflation, about $12.5 billion of new electronic money would need to be created each year by the RBNZ. Taxation could be reduced by the same amount – the seigniorage. The only change that ordinary people would notice is that they had more money to spend, save or invest – it’d be their choice as to which. By law, banks would become mere financial intermediaries, just as taught to practically all economics students.

    This has nothing to do with socialism, capitalism, left-wing or right-wing politics, or the redistribution of wealth. I am sure that if truly informed, New Zealanders would choose to have a completely Sovereign Money banking and monetary system – giving us people’s capitalism. We would be truly free at last, and house prices and inequality would not increase as fast!

    Sovereign Money is now official policy of the NZ First Party, and also the Green Party of England and Wales. In addition, there is a new party in Denmark’s parliament advocating a Sovereign Money policy, and Switzerland is having a referendum.

    Just in case readers imagine that Sovereign Money is similar to, or harks back to, Social Credit, it should be noted that Social Credit did not and does not propose to take back from the banks the power to create new money and give it exclusively to an arm of the state (the Reserve Bank of New Zealand (RBNZ)). Rather, Social Credit has always proposed to have an arm of the state create additional money to fill “The Gap” according to the “A plus B Theorem” as propounded by Major C. H. Douglas, the founder of Social Credit.

    Opponents of Social Credit, including the writer, say that that would be a recipe for increasing inflation. It should also be noted that Social Credit was thoroughly discredited in the unanimous 1956 Report of the New Zealand Royal Commission into Banking, Monetary, and Credit Systems.

    As a Rotarian, I believe that it should become the major mission of Rotary International to work to bring about a switch to a Sovereign Money system in every country. This “gift to the world”, I believe, would do more to improve the lot of ordinary people than all of the other wonderful things that Rotary International has done, and should continue to do.

    1 “Money creation in the modern economy”, a paper in the Bank of England Quarterly Bulletin, Q1 2014: http://www.bankofengland.co.uk/publications/documents/quarterlybulletin/2014/qb14q1prereleasemoneycreation.pdf

    2 “Banks are not intermediaries of loanable funds – and why this matters”, Bank of England Working Paper No. 529, published in May 2015: http://www.bankofengland.co.uk/research/Documents/workingpapers/2015/wp529.pdf

    Readers may learn more at http://www.sovereignmoney.eu and http://www.positivemoney.org and http://www.positivemoney.org.nz


  16. Like I said, fundamentally I do not have a problem with the articles you refer to but what is a problem is your interpretation of them and more than likely many NZ economists interpretation which tends to be one side of the Balance Sheet, debt and forget everything else. I do not need to refer to articles because I deal with the real world. Money in and money out on a day to day basis, audits, checks and balances, control issues, fund management, currency management, debt management, cash management, international reporting and standards each and everyday.


    • getgreatstuff, in writing “I do not need to refer to articles because I deal with the real world.” you have shown all of the readers of this blog just how hopelessly arrogant and ignorant you are!

      It’s just as well that you haven’t given us your real name, because if your employer knew just how arrogant and ignorant you are you might be in a spot of bother.

      It’s true, one can lead a horse to water, but one cannot make it drink!

      Have you considered asking Michael Reddell to let you know, privately, who’s right in all of this, and who’s wrong?


      • PJM, there is no right or wrong, it is what makes financial common sense. There is always more than one view and I happen to think your view is unrealistic and totally one sided(not wrong but out of kilter with the real world) in that you ignore real data and keep on and on about magically created debt without consideration that the savings equate to debt. It is always a balancing act in financial matters but there are always controls that try and match the two sides, thats why we have net creditor nations like the USA and we have net debtor nations like China. Ying and Yang. Zero sum game.


      • getgreatstuff, you are writing about a different topic from what I am writing about.

        Let’s just accept that we can never agree until you understand the topic that I have been writing about.

        Alternatively, I suggest that you ask Michael privately to tell you whether or not my — and the Bank of England’s, and the 1956 Royal Commission’s (all three are identical, apart from a minor change brought in since 1956) — description of the way the banking and financial system works is accurate.

        Personally, I shall not be trying to understand your argument, because it is irrelevant to a discussion about the way in which the banking and monetary system works in the real world!


      • Thats why we get strange decisions, strange comments and fantasy forecasts from the RBNZ. Economists view of the world is strangely not real world.


  17. getgreatstuff — and you seriously believe that you, a mere accountant, have got it all sussed, all on your own!

    WOW — and that stands for “walk on water”.

    Bless you, you’re an absolute genius — NOT!

    That’s it, I shall not be commenting on your weirdness again — you’re simply not worth it!


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