Governments, central banks and commercial banks ‘joined at the hip’

Continuing the constant debate about money

Australian-American economist Paul Sheard’s latest book, ‘The Power of Money: How Governments and Banks Create Money and Help Us All Prosper’, is part monetary economics primer, part theoretical disquisition and part manifesto. As a primer, Sheard carefully clarifies many key concepts and misperceptions. As theory, the author rejects the textbook ‘money multiplier’ approach to money creation and highlights the monetary aspects of fiscal policy. As a manifesto, the book calls for reform of policy frameworks that make a sharp distinction between monetary and fiscal policy.

The book is not a graph-laden textbook. Instead, it is an extended analysis that should be of interest to pedagogues, policy-makers and market practitioners alike. Sheard suggests that consideration be given ‘to restructuring the policy framework to clearly make aggregate demand management a joint responsibility of monetary and fiscal policy.’ For Sheard, the careful coordination of fiscal and monetary policy can lead to more effective aggregate demand management.

Sheard has worked as an academic and business economist in both Japan and the US. His detailed knowledge of Japanese monetary policy and his experience as chief economist at S&P Global and Lehman Brothers add granularity to his self-styled ‘explanation’ of money.

The book is an ambitious undertaking covering everything from the accounting entries when money is created to Sheard’s views on the economic implications of income inequality, executive compensation, financial crises, the euro and cryptocurrencies.

This sashay through economic hotspots aims to buttress Sheard’s main policy reflections. First, the conceptual and operational separation of monetary and fiscal policy is suboptimal, and both have distributional consequences. Second, the vocabulary of public policy discourse on monetary and fiscal issues should be refined. Instead of obsessing about a debt to gross domestic product ratio of 100%, why not say ‘debt is equal to one year’s output?’ The relevant economic constraint in society is not money, but real resources and how effectively they can be used.

Third, the deposit (money)-creating function of banks is critical to the orderly functioning of the economy and must be closely regulated. Fourth, the ‘weaponisation’ of the dollar puts its pre-eminent reserve currency status at risk. And finally, the real economy and the monetary economy are ‘inexorably converging, as both become more digital’. A main theme of the book is that governments, central banks and commercial banks are ‘joined at the hip in the creation of money…’.

Sheard’s discussion of where money comes from and of issues arising from the definition, measurement and management of money is insightful. Throughout, the author stresses the importance of viewing the government as a consolidated entity. A useful technical appendix defines in simple algebraic terms the interaction between the central bank and banking system in the reserve and deposit creation process. For Sheard, government bonds are a form of money and it is clearer to think of loans creating deposits, rather than deposits funding loans.

The author evaluates various narratives on the quantitative easing monetary transmission mechanism. He prefers to think of the ‘portfolio rebalance’ channel (banks and investors using extra reserves and deposits to buy higher yielding assets) as an ‘asset price equilibrium’ channel wherein financial asset prices rise such that investors in the aggregate are indifferent between holding cash versus other assets.

In terms of fiscal policy, Sheard makes short shrift of popular narratives about government debt. But his assertion that ‘there are lots of things to worry about in this world, but leaving too much government debt to future generations is not one of them’ is problematic. There are many examples of country defaults, hyperinflation, currency crashes and squandered resources.

There are also examples of monetary and fiscal policy working in opposite directions, as in the first Ronald Reagan administration. Each chapter in Sheard’s compact inquiry could be the subject of a separate book, and one can easily find in this volume propositions to debate. But Sheard succeeds in demonstrating the ‘social construct’ aspects of money, and that fiscal and monetary policy are not as distinct and separate as commonly supposed. This overview is a useful and welcome contribution to the never-ending debate about money.

George Hoguet is Chief Executive Officer of Chesham Investments LLC.

Paul Sheard, ‘The Power of Money: How Governments and Banks Create Money and Help Us All Prosper,’ BenBella Books (2023)

Join Today

Connect with our membership team

Scroll to Top