Last night, the Chancellor sought to consolidate the political landscape through fiscal means, binding future governments by law to maintaining a budget surplus in ‘normal’ economic conditions. Less noticed was his claim that he has near-resolved a very British dilemma, ‘of being a host for global finance without exposing our taxpayers again to the calamitous cost of financial firms failing.’

His case for the latter rests on a number of significant reforms – some international in origin – that have improved the security of the UK’s financial system since the crisis. For example, the new Basel III agreements on equity requirements, the creation of ‘living wills’ for major banks, and the introduction of the Prudential Regulation Authority have all increased the resilience of the financial sector.

Nonetheless, the reforms have done little to reanchor finance in the real economy, reduce the build-up of debt in society, or lessen its distortive and inegalitarian social effects. This is because present policy orthodoxies fail to address the central dynamic that underpinned the financial crisis and continues to give the sector its immense, if unstable, economic power: financial institutions create and allocate private credit and money. As Ann Pettifor memorably put it, they have the ‘power to create money out of thin air’.

As the Bank of England recently made clear then, banks are not intermediaries of loanable funds based on savings, but rather ‘provide financing through money creation. That is they create deposits of new money through lending.’ This matters hugely and yet is almost wholly absent from present public policy debates. Private financial institutions have a unique economic privilege in our economy, in that they create and allocate between 95 to 97 per cent of the money supply. Financial institutions can therefore bring forward future resources as debt by the elastic production of money, giving finance capitalism its power and productive potential. However, given a free rein, too often they create money that does little to increase the productive potential of the economy, nor increase its capacity to repay mounting debt obligations.

For example, between 2000 and 2007, financial institutions doubled the amount of money and debt in the economy. Critically, just 8% went to businesses outside of the financial sector, with much of the newly created credit going into either real estate or financial transactions. This explosive growth in credit and debt led to an unsustainable rise in asset prices, which eventually tipped over into the financial crisis in a classic Minskyian cycle: credit-driven boom, euphoria, profit taking, and then finally, panic as a Ponzi-like pyramid collapses.

Yet the post-crisis reforms have done little to ensure banks better discharge their role as custodians of the money supply. For example, in the UK nearly 90 per cent of outstanding domestic loans continue go to fund either financial companies or property deals. Of course, some of this credit will trickle into productive purposes, but too much circulates to achieve ‘accumulation for accumulation’s sake.’ In other words, our financial system continues creates too much of the wrong sort of debt, fuelling asset bubbles and financial instability, unbalancing the economy, and constraining the productive potential of the economy.

If the Chancellor – and politicians more generally – are therefore serious about resolving the British dilemma of a financial sector too distant from the society that underwrites it, public policy must regain control over the growth and allocation of credit creation in society. This will require institutional innovation and new models of economic governance to reassert democratic authority over the financial system, particularly those privileged institutions that create and allocate credit within the economy in order to reanchor finance in the real economy. Only then can we begin to address the UK’s productivity and investment challenges and lessen the systemic riskiness of our financial sector.

IPPR, for example, has recommended introducing a system of credit guidance, to ensure new credit growth is focused on generating sustainable returns based on productive capital formation in the non-financial economy and not on driving the growth of asset bubbles through new credit flowing to property or financial transactions. Alongside an overarching guidance regime led by the Bank, we also recommend developing a tighter regulatory system that leans against the over-accumulation of private debt, removes the tax bias in favour of debt over equity finance, increases equity ratios over time, and multiplies and diversifies forms of public banking and more patient sources of capital. We also argue for innovative new forms of collective ownership of assets and financial equity to ensure the process of financial accumulation works for public benefit.

Such an agenda would help reassert democratic authority over the financial system, re-orientating it back towards its essential, if more modest, purpose: managing the payment system, providing appropriate levels of liquidity, and directing credit to productive and socially useful activity to create sustainable value. This is, of course, an ambitious agenda, particularly in light of the current debate.

Perhaps as a start then, we should begin by taking seriously the creation and circulation of money and credit within our economy as dynamic agents rather than neutral pawns, placing credit, money and their allocative institutions at the heart of debates about what a post-crash progressive political economy should actually look like (something PERC has begun to explore). For as Geoffrey Ingham argues, the money system has a dual nature: it ‘is not only infrastructural power, it is also despotic power.’[1] Democracy should rein in this power, so that finance can in time better serve the common good.

[1] Geoffrey Ingham, The Nature of Money, 2004.


Mathew Lawrence is a Research Fellow at IPPR, and author of the report ‘Definancialisation: a democratic reformation of finance’  He tweets at @dantonshead