“vintage brown equipment” by Agê Barros on Unsplash

Before answering the question posed in the title, we need to consider how money is created and flows through the economy.

It is a common misconception that banks lend other people’s money. But they don’t!

Banks create money ‘out of thin air’ when they make loans.

This Bank of England paper explains the money creation process.

In simple terms, when a bank makes a loan they create money by writing two balancing entries in their own books: Debit loan to Borrower and Credit deposit to Borrower. The credit entry creates the deposit that allows the borrower to draw down the funds, while the debit establishes the obligation of the borrower to repay the money.

This works because each person (and society in general) accounts ‘deposits’ as ‘money’, so a shift in ‘numbers’ from one account to another constitutes payment as good as cash.

Normally, when we lend money to someone, we no longer have it to use. That’s not the case with our deposits. Think when was the last time the bank took money out of your account, or froze it, because they had to on-lend it to someone else!

As noted, instead of taking anyone’s deposit, banks simply write a new deposit for the borrower; which gives the borrower new money to draw on, and balances the loan entry.

As the banks make loans, they ‘pump money’ into the economy. This new money does not send the economy into an inflationary spiral simply because, as the loans are repaid, the entries are reversed and the money is written back into the thin air from which it came. Effectively taking money out of the economy.

The reason the repayments don’t usually send the economy into recession is because year on year net lending increases — driving economic growth as borrowers spend the newly created money into the economy at a ‘sustainable rate’. Recessions and depressions do ensue when the rate at which loans are called in exceeds new issues. As was most dramatically evidenced in the 1930’s Great Depression.

The Central Banks key objectives are to keep inflation and unemployment low by managing demand for new money through the use of the cash rate. Increasing it to damp demand, and dropping it to lift spending.

As an aside, the banks only get to keep the interest paid on the loan to cover their operating costs, interest on deposits, inflation, a provision for default and… profit (which represents the value added in marshaling resources to provide the ‘lending service and ensuring repayment’). This is a very valuable service for the community — if done with the right intent.

The purpose of any bank ought to be to ensure that ‘new money’ is only provided for socially acceptable purposes to people/organizations with the capacity to ‘add-value’ via work and/or investment (which provides the means to repay the loan). Once, the local bank manager took this duty very seriously and, as a result, was a highly respected member of the community. Can we say as much today?

The problem with ‘growing demand via the issue of new money as debt’ is two fold.

First, if bank lending (new money creation) outpaces the capacity of the (global) economy to produce, we get inflation.

Not all bank lending has this effect. Borrowing to buy existing assets largely inflates asset prices, with little impact on the real economy — as evidenced by ‘Quantitative Easing’ where the money paid to acquire existing bonds was largely reinvested in securities and property.

Secondly, there are limits to how much people can borrow. Effectively, borrowing just pulls forward demand that is (in part) destroyed when debt burdens become too great, leading to defaults and recession.

As to the flow of money, it is important to recognise that money flows up much faster than it trickles down.

Most people spend their money on goods and services as soon as they get it to satisfy unmet needs.

This money circulates through the economy as businesses pay employees and suppliers.

Over time, the money flows into the hands of higher paid executives and owners as higher salaries, bonuses and profits.

Beyond a certain level, the extra income ceases to circulate in the ‘real economy’. Instead, it is invested in securities and property within the ‘financial economy’, bidding up prices. Once the money is drawn into the financial economy it generally stays there as people build their wealth… very little ‘trickles back down to the real economy’.

Given this flow and the money creation process, how can the Central Bank use monetary policy to affect aggregate demand?

There are two answers. The first is familiar. The second is not.

As is commonly understood, Central Banks can increase aggregate demand by lowering the cash rate at which commercial banks lend to and borrow from it.

This reduces the commercial banks operating cost, allowing them to reduce interest on loans to customers.

This enables customers to borrow more for cars, homes, furnishings, consumer goods and travel — boosting aggregate demand as the borrowers spend the new money into the economy.

However, the borrower must repay the loan… for good reason. The loan gives them the ability to acquire resources they have not earned. Once the borrower works/invests to repay the loan, they and society are square. The borrower will have put in (via work/investment) what they took out when they spent the proceeds of the loan.

Which brings us to the second way Central Banks can promote aggregate demand.

Given money is created by banks as they make loans, we can as easily give Central Banks the power to create it to pay everyone a Universal Basic Income (UBI).

Most people will spend the extra on what they need — boosting demand, and ultimately boosting the wealth of higher paid executives and business owners as a result of the increased turnover. In the process, increasing tax revenue, without increasing tax rates.

Everyone wins!

Unlike individual loans sourced from newly created money, the UBI would be paid equally to everyone — so there would be no need to repay it, as no one would get an advantage over anyone else.

The problems of course are inflation and employment.

If we just pump money in, it will inevitably outpace the capacity of the economy to produce, leading to inflation. As well, given enough Basic Income, people will just stop working!

Fortunately, the propensity of people to work differs person to person, based on their drives, needs, and economic status.

These differences can be leveraged to create a UBI that is set ‘in the market’… a Market-oriented UBI (MUBI)

Starting small (say $10/week/person) the Central Bank can issue new money to everyone into their nominated bank account… and see what happens.

Most people will spend the money immediately on food and energy and transport and furnishing and consumer goods and perhaps towards the cost of cars and travel and housing.

This will boost demand for capital and labour to produce the extra goods and services demanded. At first, this extra demand can be met from ‘idle resources’ (under utilized equipment and labour across the globe).

At some point, people will start to drop out of work in the local economy, leading to a shortage of labour, which then pushes up wages. In the first instance, this will provide even more income to further increase demand.

Demand driven price rises may be held in check in a number ways:

  • As the money is pumped into the real economy at the ‘bottom’, it will naturally flow up into the financial economy… effectively taking it out of circulation in the real economy — reducing ongoing inflationary pressures.
  • Technology continues to enable us to make and do more and more with less and less inputs, keeping down prices.
  • The Central Bank can increase interest rates, just as they now do when inflation starts to bite. In this case, the higher rates will reduce the demand for loans to buy goods and services.

Under these circumstances, the MUBI simply replaces the new money that otherwise would have been created via bank loans.

By eliminating the debt, while maintaining demand, we ensure the continued growth of the economy, without the trauma associated with the increasing debt burden on consumers… and without inflation —using ‘trial and error’ to match the increase in money to the growth in productive capacity, by monitoring the MUBI’s impact as it is issued.

Of course, people would still borrow for cars and homes and to create productive assets, but the pressures on individuals caused by debt fueled consumer demand would be much less.

  • Instead of upping the cash rate to damp demand across the board, perhaps an even better way to moderate inflationary pressures, would be for the Central Bank to levy an additional interest charge on top of the interest payable by each borrower to their lender.

By using a targeted interest charge, the Central Bank could hone in on specific sectors — without damaging those that are not over heating.

It could, for example, put an extra charge on borrowing for existing homes in one city alone, while allowing borrowers to access cheaper funds (without the extra charge) to buy new homes... encouraging new supply where there are shortages. Or, it could just put the charge on borrowing for, say, consumer goods and services if there was widespread demand-pull inflation as a result of the MUBI.

This extra charge could be simply written back into thin air by the Central Bank when received, to offset (in part) the injection of new money via the MUBI… again reducing inflationary pressures.

The main impact on inflation would come from the fact that the additional interest charge would be payable by the borrower. This increases their cost of borrowing, damping demand for the specific types of loans targeted which damps demand for goods and services. The charge would be collected by the lender who would be required to on forward it to the Central Bank. (Though the system could be set up to facilitate direct payment of the charge by the borrower to the Central Bank).

As with interest rates in general, the Central Bank could apply the additional charge in small increments and watch what happens — until the specific market began to cool — without sending the whole economy into recession.

Importantly, the interest charge could be levied on new borrowing only, to limit new spending… which is what we want. It means, that existing borrowers who borrowed at a lower rate don’t suddenly find they are faced with increased costs, just to damp new demand either across the economy, or within specific sectors.

  • If all these ways of damping demand are not sufficient to stem inflation in the real economy, the Central Bank could also be given the power to levy a flat % tax on all spending.

This tax would be used to mitigate demand pressures across the board. It would impact more widely and more directly than any increase in interest rates (that only impacts borrowing)… effectively increasing the price of goods and services directly.

The tax raised, would not go to the Central Bank or the Government. It would simply be written back into the thin air from which the MUBI came. It’s sole purpose would be to mitigate inflationary pressures resulting from the MUBI.

The combined effect of the flat amount MUBI and flat % tax is ‘progressive’.

Which is to say, though everyone is treated the same, the combination of the MUBI and flat % tax would put proportionally more of the ‘new money’ into the hands of the lower paid — which is what we want.

Without money, no one can signal their needs to the market, so the market can never respond. This is never a problem for those on high incomes.

The sole purpose of the MUBI is to provide the money people require to express their basic unmet needs.

By giving the Central Bank the power to create money via a MUBI; and to levy a targeted interest charge on new borrowing and flat % tax on spending in general to take the money back out, we give the Central Bank additional tools to achieve their twin objectives.

The Central Bank can then go on gradually increasing the MUBI and levying the interest charge and % tax (as required) to ensure both ‘low unemployment’ and ‘low inflation’ to a point where everyone can meet their basic needs.

The actual ‘minimum standard of living’ to be achieved will be a matter of policy. It will have to be determined by the electorate based on hard evidence of what it takes to live a reasonable life in a modern city that requires access to transport and communications, as well as food, clothing and shelter. This minimum can be continually raised as our capacity to produce more with less grows, subject to a re-engineering of our supply chains to limit destruction on the natural world.

This leaves people free to work as hard as they like to earn a lifestyle above the base.

Since everyone would have the same opportunity to both live on the base, or to work to earn more, who can complain?

As for those choosing not to work, by definition, the labour market would be in balance under this proposal (as that is the objective of the Central Bank). In these circumstances, there would be no jobs available in the ‘paid economy’ for those choosing not to take extra work for money. This is not to say such people would be without work. It is reckoned that at least 50% of all work is done outside the paid economy in the form of ‘volunteer’ services in the home and local community. Imagine the benefits for the family (and society in general) if one parent (or both sharing) could spend more time caring for their children, free from the worry of how to meet their basic needs for housing, clothes, food and other necessities in a modern economy.

If people still wanted ‘paid work’, this would signal ongoing ‘unemployment’, requiring the Central Bank to raise the MUBI. At some point, it would be sufficient for someone in work to drop out, leaving a place for those still looking for a job… bringing the job market back into balance.

Importantly, over time, as the MUBI met everyone’s ‘basic needs’, employers would only have to pay the marginal rate required to attract people to do the work on offer. Employers would no longer need to pay a ‘living wage’. This ensures resources are directed to their most productive use, while breaking the current nexus between work and the need for money to signal our basic needs. Of course, the nexus would remain above that level. The higher the value added by the worker the more money they should earn, enabling them to take out an equivalent amount of value as they spend their extra income.

Of course, it would never be perfect. There would be inconsistencies and failings, with the Central Bank having to make continual adjustments in an endeavour to achieve a dynamic balance in both inflation and employment… just like the current system.

The difference is that the Central Bank would have a whole new set of targeted tools to achieve their objectives, in addition to the cash rate.

We don’t have to change anything else.

People would still borrow, but the pressures to borrow for living expenses would be much less.

Nor would we have to change any welfare. The MUBI would simply count as income. Over the long term, as the MUBI increased, it would push people up the income scale, reducing their entitlements — but still leaving them ahead, as any other income they earn would not reduce their MUBI. This helps remove the poverty trap created by the existing system that reduces benefits as income increases. The MUBI would never replace all support payments, as those with special needs (disabled and sick) face higher costs that require additional funding.

Overall, this is a market driven approach that helps people to meet their basic needs without labeling anyone as ‘second-class citizens on welfare’, mitigating the fear of job loss, making it easier to transition into new roles as the economy automates (including more time doing rewarding non-paid work for family and community), all while increasing aggregate demand (that boosts business, and hence the incomes of executives and owners and tax revenues without increasing tax rates) — while also providing a range of tools to mitigate inflation.

It also enhances the incentive to take work (when it is available) to lift yourself off the base, as the MUBI is paid regardless of other earnings.

In the process, history shows, less money stress will improve health outcomes (physical and mental), reduce crime and enhance community safety — gradually reducing the call on government and community support services.

As for employers, they may ultimately only have to pay marginal wages above the MUBI to attract workers.

And we don’t have to theorise about its impacts. By starting small, we can see what happens with little risk. The worst that may happen is people get a bit more in their pocket and inflation starts to kick in. At which point, the MUBI can be re-assessed

What’s not to like? :)

Though a MUBI is necessary to give everyone the means they require to signal their basic need to the market, it is not sufficient when it comes to housing. To solve the housing problem… we need houses! This requires specific actions to promote the construction of appropriate housing for those who lack it. This does not mean building massive ‘community blocks to shove our poor into’.. but that’s a topic for another day.



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