My model for an economy is now complete. It is described below. All of the control systems are described. All it needs is the management team to make the decisions.

The management is so tight that it can be automated by a computer programme. 

The economy will perform at its optimum output indefinitely.

Edited and re-posted a few times - the latest being on 8th June 2018.

The whole idea of managing interest rates is wrong. It is not how an economy ought to be managed.

For a start it wastes the credit that is on offer because the market clearing price is never used.

To have a market clearing price means that only those who can afford the interest cost are going to borrow money. They will have a better and more productive use, a more profitable use, a more useful use, or a critical use such a the need for a home, for the money than the rest. So, they pay the highest interest rates. To get that market clearing price there must be competition for a limited supply of credit.

Currently, banks do not lend their clients’ deposits, they create new money and lend that, using the deposits as collateral. This new lending creates new deposits (new money), that can be used as collateral and so more deposits, more new money, is created and lent. Supply is unlimited. To manage the stock of money in this case, interest rates must be managed to choke off demand, which is a wrong way to do things. It wastes credit by making it too cheap or too expensive.

To arrange a limited supply of credit, lenders must be prevented from lending a deposit which they have to lend, more than once at a time. This can be done using a spreadsheet to identify which money has been lent and which has not. Will lenders cheat? They will be found out in an instant because their banker is the central bank.

Now only the central bank can create new deposits. Money in circulation is just a number on a spreadsheet / a bank balance. All it takes to create new money, (new deposits), is a few keystrokes at the central bank. To get the market clearing price, the market rate for the base interest rate, and so avoid waste, there must be auctions of new deposits at interest. Lending intermediaries, including banks, will bid for these and on-lend them to their customers. Customers with the best use for credit will cause lenders to bid high enough to obtain the money at aution needed to service them. That is how the auction price will become the market clearing price. It is through end-user pressure.

When all that is in place, this basic rate of interest will never fall close to zero.

The problem then will be to manage the stock of money in circulation, not 'M0, M1, M2' or any other 'M' - money supply - but the part of 'M' that is circulating - being spent - 'MC'. There must be enough spending to sustain the demand for the output of the economy.

Trump’s tax cuts have not entered 'MC' because the companies getting them have left that saved money on deposit. That, and people putting money on standby, is just one way that money can lie idle. Reserves for lenders and Foreign Exchange Reserves are other places where money can be standing by.


#1 One way to increase ‘MC’ is for the government to run a budget deficit and then for the central bank to create new money to add to the government's Treasury account. The central bank, the government’s banker, just changes the bank balance - a few keystrokes.

#2 A good way to help a slowing economy is to create new money for the Treasury and have them reduce VAT or the USA equivalent, sales taxes; and to subsidise untaxed payments by an equal percentage – regular savings and donations for example.

#3 Another way that can be used is to protect people’s savings and other deposits at banks. By creating new money and adding that to a failed bank’s assets, the deposits will be protected and some of the new money needed by the economy will be injected. This does not protect the failed board of directors or the bank’s shareholders.

This costs next to nothing and insures all deposit accounts nationwide. An economy always needs more 'MC' for one reason or another, so this is another way to supply some ‘MC’.

All the above will increase deposits for lending at banks because all new ‘MC’ only exists as deposits.

#4 Auctioning more deposits to lend will reduce the interest rate and boost lending. Lent money is spending money. It is ‘MC’ money.

#5 Trading partner nations also need enough 'M', enough Foreign Exchange Reserves,  just like nations need enough 'M'. When that 'M' gets spent on imports it becomes extra 'MC' in the economy of the exporting nation. Creating more Forex Reserves when needed to prevent a slowdown in trade or to allow international trade to increase, makes sense to both nations. It is cost free. A few keystrokes.

What happens when people switch mindsets and start to over-spend and / or borrow to spend? There is a risk of there being too much spending and too much ‘MC’ drawn down from where it was previously parked as ‘M’ – available but not circulating. Then ‘MC’ increases. The surplus spending and the surplus 'MC' can be mopped up. Here are three ways to do that:

a) As lenders get their loans repaid, the central bank does not have to re-auction that money; or it can label it as not to be lent. 'MC' will reduce. Interest rates will rise. Borrowing to spend will reduce.

b) A tax increase on sales (VAT for example), will remove a lot of 'MC' very quickly. The government does not have to spend it. The central bank can delete it from the Treasury account.

c) As an alternative, the whole financial framework of the economy can be re-designed in a way that mops up the extra ‘MC’ in higher prices and higher costs without upsetting the economy. Think of it this way: if more hours were worked every time National Average Earnings, NAE, increased, after a decade or two, a day's work would last for two days. Since we know that does not happen, we also know that much of the increases in NAE is just inflation. It creates extra spending without creating extra output. Extra output does not come from increased NAE. It comes from other things. Prices and costs must compensate for that increased spending / demand coming from more NAE and sustained by more 'MC'. That is basic economics. Prices must adjust to keep supply and demand in balance. The alternative of reducing NAE and other costs and prices leads to recession.

Here are the three changes that must be made because as things stand that law of economics is being broken. The costs and prices listed below do not adjust smoothly to rising NAE or to the associated increased spending. Policy makers struggle to manage the consequences. It is an impossible task because every wrong price creates many complications that need attention. It would be better to address the real problem.  

Remember, rising 'MC' allows all prices, including NAE, to rise. NAE is a price / cost like everything else. It is the price / cost of the human resource. Here are the changes to be made:

#1 We redesign Treasuries. As National Average Earnings, NAE, rise somewhat faster because of the extra 'MC', and as all prices inflate, the value of treasuries, now re-designed and now being index-linked to NAE, does not drop or crash, as it would do normally. The new Treasuries may be called 'Wealth Bonds' as they store wealth. The value of pension funds, annuities, and reserves invested in them will not crash, nor will the value of savings invested in them. Annuities invested in Wealth Bonds will rise as if retirees were still working, as will savings, reserves, and pension funds invested in them. The rising liabilities of the private sector, as more is lent and more is insured, will have a reserve asset that also rises. People that save 10 NAE in their pension fund over a lifetime can have 10 NAE in their fund when they retire. Their pension can be 0.5 NAE for 20 years or a different number for life, rising as if they were still working. Governments can pay say 1% p.a. interest, saving money, because there is no risk premium to pay. That is enough to pay for the administration costs of pension funds and other managed funds.

#2 As NAE rises faster, a re-designed, new 'ILS' Lending and Savings Model for housing finance, will not jump up the level of repayments because nominal interest rates have risen. Instead under this new repayments system, as used by this model, the borrowers’ repayments will rise a little faster than they did before, just like rentals do when NAE is rising faster. The law of supply and demand will work. The extra NAE will be mopped up in proportionately higher costs. No leverage. The amount that must be repaid every year starts at say 30% of income (for a single borrower) as usual, and the number of NAE that this represents as a payment is calculated by the lender. Using that figure, the lender demands that 4% less NAE is paid every year. This simulates inflation and reduces the burden to avoid pyments fatigue and to make space for the cost of a growing family or variations in perssonal income. For example, if NAE does not rise, next year’s monthly payments will fall by 4%. If NAE rises by 6% the following year’s repayments will rise by 2%. It is still 4% less compared to NAE. After three years that is almost 12% less. In this way lenders and borrowers are kept safe. The aggregate demand / level of spending in the sector on repayments is not changed. New borrowers still pay more and older ones still pay less. Arrears rates are low. Lending costs are low.  

The amount (income multiple) that can be lent safely in this way does not vary much, so property values will be stable, rising like everything else, not rising and falling faster than other prices as happens today. Not inflating loan sizes when inflation and interest rates are low. Not reducing loan sizes when interest and inflation rates are higher.

#3 There is need to alter the currency markets so that they also play into this scenario, raising the price of imports a little faster in response to the higher NAE. This is a regulatory matter not an intervention matter. Tricky but possible. Around half of world GDP has a price element in currency due to the growth of international trade. Volatility here can smash billion dollar investments.

All this is as it should have been in the first place. The basic law of economics says that as spending increases for no greater level of supply, prices should rise proportionately. It is because that does not happen that economies crash or go into a recession or behave in crazy ways.

When prices and asset values move in the other direction or at a geared rate, it is like having an aircraft with the elevators put on upside down and other controls doing stupid things.

When all of the price and repayment cost rises happen correctly in the finances of the nation, then as NAE and 'MC' rise, and spending increases, so do all the financial costs alongside extra price increases of goods and services. Unlike what happens today, all prices will behave in the classic ways that they should, all being that much higher than they would have been if 'MC' and NAE, had not risen. People will not be working more hours, they just get more pay; and because prices will then rise proportionately they will hardly be affected. Higher prices and higher earnings will cancel. The first law of economics will be obeyed for the first time in economic history since banks lent money and nations traded with each other.

To sustain the new price and income levels, more 'MC' is needed permanently. So, the surplus 'MC' gets mopped up by the higher prices of everything including the higher NAE. The exception is that some goods and services change in price as supply and demand figures alter, which is how we all get to be better off over time. The supply side increases and prices fall. That is a second component of prices.

Without the central bank creating more new money, the rate of inflation comes under control or stops. Only the central bank can create new money. We already stopped the banks from doing that.

Now we do not have to forecast the economy. We can just steer it. Now it is behaving in the way that it should do, we can just 'fly' the economy. The ailerons are on the right way up. The demand comes from people always wanting more, the restraint comes from the price of credit at auction and the limited supply of it, and from taxation. The injection of new money and more credit at lower interest can boost spending when necessary to avoid any significant slowdown. That can happen without people always having to borrow more. It can happen through the other ways listed above.

When people get free new money, they get free goods and services. If everyone gets free new money as sales taxes reduce, everyone supplies some free goods and services. And they all then have enough ‘MC’. If only borrowers get new money, it gives them an advantage. But the important thing is to keep the balance of demand in all sectors in balance.

Do not have a large government spending stimulus aimed at one big sector. It takes too long for the extra spending to 'trickle down' to everyone else. Small businesses need to be kept afloat. Keep all sectors afloat with the right mix of new 'MC'. Let people spend on what people like to spend and let government spend on what they like to spend. Any forced change hits some sectors and wastes those resources until normal spending resumes.

Do not balance a budget deficit with cut-backs on spending, with tax increases, or with government borrowing that may crowd out commerce. The only time to increase taxes is when a government must spend more permanently; and there are limits to how much a government can tax without greatly slowing the economy. The main reason for government borrowing is to provide a risk free investment for the private sector.

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