Alvin Hansen, the right amount of money, deficit finance and the search for full employment.

Alvin  Hansen establishes early in his work, Monetary Theory and Fiscal policy that the power to create money is a force to be reckoned with. In the nineteenth century in the U.S.the private banks at the behest of their business clientele and owners arranged for the monetization of the credit notes they had issued to their customers. Privately issued bills of exchange were exchanged for bank notes. By this process Hansen explains the banks were set up to manufacture money. As the American economy expanded and the frontier pushed westward  this private source of money expanded as banks were created  under the free banking movement. As such, it became clear that there was a need to create a supply of money but not to create so much that it would lose most of its value. some degree of regulation was required. however, ‘extreme monetary conservatives (were)as mistaken as the monetary cranks….what (was) required (was) temperance -the pursuit of Aristotle’s golden mean applied to monetary management…. Money is an invaluable , but nonetheless dangerous invention. The trick was to permit enterprise through privately owned banks to manufacture its own money, yet to hold the privilege within bounds.” (p.18) Hansen goes on to explain this is how the right to issue money which was clearly a governmental perogative was delegated in the nineteenth century by the federal government to the private banks.  Still paper money and check book money became the subject of a debate as to how much of it should be issued in order to ensure that the economy could expand but an inflationary bubble could be avoided. Gold and silver coining was not viewed in the same sort of way because of the difficulty of increasing supplies through the mining process.  (p.19)

There was a search on the part of experts including those in the business community for some sort of automatic formula that could control the supply of paper money so that enough was issued but not too much. Over time a formula developed that linked the supply of paper money to that that was necessary to finance current production through bills of exchange and loans for production of goods.”Only the monetization of private credit could supply  the efficient circulating medium needed to effect the transactions arising from an expanding economy.” In such a fashion it was thought the banking or commercial loan system could be self regulating and also supply the right amount of money.

Over time out of the debate between the banking principle school and the currency school the principle of convertibility arose whereby it was considered necessary that the banks stood ready to exchange standard bank notes for bank created money. (p.22) This then evolved with creation of a central bank into the principle that the banks would stand ready to pay out ”currency central bank notes and Treasury currency to any depositer.” Over time a convention arose that the banks could pay out currency in some multiple of their holdings of gold and legal tender on deposit with the central bank.

Until the modern and debatable innovation of capital adequacy and risk rules as a substitute for fractional reserves central banks like the Federal Reserve required commercial banks to maintain a legal ratio of reserves on deposit with the Federal Reserve banks. This ratio imposed a limit upon the expansion of bank credit and money issuance. Hansen then discusses the 100 % money controversy . This was a proposal to prohibit the commercial banks from issuing money. Instead under the scheme only the Federal Reserve would have the power to issue money. Demand deposits would always have to be precisely balanced by member bank reserves and vault cash.Time and savings deposits would no longer be considered cash.

Milton Friedman at one point supported the notion of 100 % money because he believed it would ensure that the Fed and the treasury together could then ensure an adequate supply of currency in the system . But 100 % money is controversial , and clearly not favoured by the banking community.  The  Fed  delegates the power to create money by allowing the banks to loan out deposits which for the overall system leads to a multiple on balance of the deposit base being created as money. The Fed stands at the base of this system.

Hansen acknowleges this fact but his discussion of 100 % money demystifies the process.More importantly he demonstrates that there is ample justification for the Fed to purchase government debt when the circumstances demand it.

”Under the 100 % plan individuals and business firms could not acquire new money by borrowing from commercial banks. But the monetary authorities(meaning both the Federal reserve System and the Treasury) could put new money in their hands (1) by Federal Reserve purchases of U.S. securities in the open market, and (2) by creating a government deficit financed by the Federal Reserve banks.”( P.27) This is an important insight into the evolution of the money creation process and its relationship to fiscal policy  even if we reject the 100 % money system.

The latest numbers on unemployment are disappointing in the U.S. and confirm what I and others have been saying about the foolishness of austerity as a policy choice in the period after a crash and deep recession. Unemployment rose in Europe to 11.9 % in the euro zone but fell in Germany to 5.4 %. In the U.S. it rose by a tenth of a percent as more discouraged workers rejoined the labour force. It now stands at 8.2 % . More on these events tomorrow.


About haroldchorneyeconomist

I am Professor of political economy at Concordia university in Montréal, Québec, Canada. I received my B.A.Hons (econ.&poli sci) from the University of Manitoba. I also completed my M.A. degree in economics there. Went on to spend two years at the London School of Economics as a Ph.D. student in economics and then completed my Ph.D. in political economy at the University of Toronto. Was named a John W.Dafoe fellow, a CMHC fellow and a Canada Council fellow. I also was named a Woodrow Wilson fellow in 1968 after completing my first class honours undergraduate degree. Worked as an economist in the area of education, labour economics and as the senior economist with the Manitoba Housing and Renewal Corporation for the Government of Manitoba from 1972 to 1978. I also have worked as an economic consultant for MDT socio-economic consultants and have been consulted on urban planning, health policy, linguistic duality and public sector finance questions by the governments of Manitoba, Saskatchewan,the cities of Regina and Saskatoon, Ontario and the Federal government of Canada. I have also been consulted by senior leaders of the British Labour party, MPs from the Progressive Conservative party, the Liberal party and the New Democrats on economic policy questions. Members of the Government of France under the Presidency of Francois Mitterand discussed my work on public sector deficits. I have also run for elected office at the municipal level. I first began to write about quantitative easing as a useful policy option during the early 1980s.
This entry was posted in austerity, business cycles, classical economics, deficit hysteria, deficits and debt, Federal Reserve, fiscal policy, full employment, monetary policy, quantitative easing, quantity theory of money, treasury view, U.S., Uncategorized and tagged , , , , . Bookmark the permalink.

4 Responses to Alvin Hansen, the right amount of money, deficit finance and the search for full employment.

  1. romain cansaran says:

    Hi Professor Chorney, I’m Romain Cansaran I was your student back in 2010-2011, I am contacting you through your blog because I wanted to apply to a school in England and I was wondering if you could be my ‘referee’ as they call it, meaning if you could recommend me to them. Thank you in advance and I’ll be waiting for your answer

    • OK just send me the details at my Concordia e mail address. I will send you an e mail from that address shortly. regards Harold Chorney

    • Romain as I explaine I will be glad to send out a reference for you but I need to know the details of where you would like it to go, a copy of your studies proposal i.e. your plan for graduate school and a copy of your transcript so I can write a better letter. just e mail me back with these details and the date you need the letter sent by. Harold Chorney > > New comment on your post “Alvin Hansen, the right amount of money, deficit > finance and the search for full employment.” > Author : romain cansaran (IP: , > > E-mail : > URL : > Whois :

  2. romain cansaran says:

    Apparently the school I’m applying to is just asking for your information and I’m applying to a business program so there is no need for a letter per se but just for your telephone number and your email address. Can I ask you your Concordia email address ? thank you again

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