The Myth of Neutral Money

Conventional economic theory purports that money is neutral: that is, changes in the money supply do not affect the ‘real’ economy (patterns of trade, production and consumption). Instead, the only interaction between the monetary and the real economy is thought to be through the determination of nominal quantities such as prices, wages, exchange rates and so forth. Though a change in the quantity of money may create short term disruptions, the economy eventually will settle at the same long term equilibrium as before.

An extreme interpretation of the neutrality of money would lead to absurd conclusions, such as the idea that the ‘real’ economy would operate the same whether it had a gold standard or hyperinflation. I’d therefore interpret the ‘neutral money’ view as the claim that, at ‘normal’ levels of money, a change in the money supply will not alter the long term economic equilibrium. This viewpoint was described well by Milton Friedman in his famous ‘helicopter drop’ story, which I will use as the basis for my critique.

Friedman began his story by imagining a community in economic equilibrium:

Let us suppose, then, that one day a helicopter flies over our hypothetical long-stationary community and drops additional money from the sky equal to the amount already in circulation-say, $2,000 per representative individual who earns $20,000 a year in income. The money will, of course, be hastily collected by members of the community. Let us suppose further that everyone is convinced this event is unique and will never be repeated….

…People’s attempts to spend more than they receive will be frustrated, but in the process these attempts will bid up the nominal value of goods and services. The additional pieces of paper do not alter the basic conditions of the community. They make no additional productive capacity available. They alter no tastes….the final equilibrium will be a nominal income of $40,000 per representative individual instead of $20,000, with precisely the same flow of real goods and services as before.

It is first worth noting that the ‘real’ benchmark for Friedman’s equilibrium is somewhat hard to define – after all, the real economy is an artificial construct with no real world counterpart. Economic agents must necessarily negotiate with and act on the nominal: as John Maynard Keynes pointed out, workers do not have control over the general price level, and hence can only impact their nominal wages. Clearly, nobody has control over the ‘general price level’ (itself surely a problematic concept), so Keynes’ argument also applies to prices, exchange rates and other variables (sorry, economists, no ‘as if‘ arguments allowed). Nominal variables are actually observable, while proponents of money neutrality have no moneyless baseline by which they can judge real activity, despite repeatedly appealing to the idea.

More generally, I find the idea expressed by Friedman – that the economy will tend toward a stable, long term equilibrium, perhaps oscillating in the short term – is often used by economists, but is rarely fully justified. It is merely assumed that the economy will behave this way, and any erratic behaviour – such as money illusion, and sticky wages/prices – can be dismissed as short term ‘noise’. However, seems to me that such an idea can only be sustained by sweeping potential problems under the rug. Indeed, this supposed ‘noise’ (a) could be more relevant to understanding the system than the equilibrium and (b) could have a permanent impact on the economy and therefore equilibrium itself.

It is entirely possible – common, even – for a system’s behaviour to differ markedly from its equilibrium value(s). This is true even if the system has some tendency toward the equilibrium**. In examples such as Friedman’s, a monetary disturbance will surely alter people’s perceptions (something Friedman acknowledges), and they will engage in economic activity based on these altered perceptions, continually adjusting as they overshoot or undershoot their plans. Hence, a monetary shock could push the economy out of equilibrium and into a long term trajectory that has little relation to its initial position. Furthermore, if there are constant changes in the money supply, any tendency toward equilibrium will be continually thwarted. As Irving Fisher put it, “equilibrium is seldom reached and never long maintained”.

In fact, monetary disruptions can have even more fundamental effects than this. Due to path dependence, a monetary disturbance could change not only the immediate behaviour of the system but also the long term equilibrium itself. If money is invested based on people’s altered perceptions, long term capital goods can be created that otherwise would not have been. This phenomenon is all the more pronounced if new money is not evenly distributed but injected at specific points, something known as Cantillion effects. Friedman considers this possibility, but dismisses it without must justification (“during the transition some people will consume more, others less. But the ultimate position will be the same”. Erm, why?). The fact is that a company, individual or government who finds themselves with a relatively higher income due to a monetary injection could make important investments, altering long term patterns of production and consumption.

The role of finance

All of these effects would be important even in Friedman’s imaginary world. But it only becomes clear quite how important they are when we consider the nature of the modern banking system is particularly important, something entirely absent from Friedman’s example. This is because in neoclassical theory, banks are generally assumed to be ‘intermediaries’ who take money from Peter and loan it to Paul. The result is that banks only really ‘smooth things out’ by matching borrowers and lenders, and hence can be assumed away, perhaps save for one or two ‘frictions’ (transaction costs, interest rate mark ups). Effectively, we model the economy as if Peter is loaning directly to Paul, and from there we suppose that the nominal amount of money lent & borrowed is arbitrary, having no impact on Paul’s ‘real’ activity.

However, as has been comprehensively discussed in the blogosphere, this is not how banks work in the real world. Rather than taking money from Peter and loaning it to Paul, banks simply create a loan for Paul out of nothing. The ‘other side’ of the loan is not Peter’s deposit; it is a deposit that belongs to Paul, created at the same time as his loan, at an amount equal to the loan itself. At the moment the loan is issued, the money supply expands, and when the loan is repaid, the money supply will contract. Hence, the real economic activity Paul engages in is inextricably intertwined with the change in the money supply. The goods and services Paul buys, or the business he starts, or the assets whose price he bids up are a direct consequence of the same decision that expands the money supply. We cannot say that only prices will be affected, as the loan has a clear impact on production and consumption patterns in the real economy.

Furthermore, the constant extending and repaying of credit means the money supply is always expanding and contracting, with no discernible regularity. This is in stark contrast to the idea that the quantity of money simply moves from one long-term quantity to another, or increases at a constant rate. The idea of an underlying ‘real’ equilibrium simply becomes irrelevant when the nominal economy is constantly shifting like this, as irrelevant as discussing a surf board on calm waters if we want to understand its motion when it’s riding a wave.

Lastly, I previously noted that nominal variables are the variables which are actually observed and used in the real world, and nowhere is this more important than in the financial sector*. It is clear that by doubling the quantity of money in circulation, the relative value debts and assets would halve, which would have a big impact on the economy – imagine waking up to find your savings and mortgage were now worth half as much! Plans would be thwarted; firms, households and the government would find themselves in dramatically different financial situations: better or worse depending on whether they were a debtor or creditor. Bankruptcies and spending sprees would surely ensue. Likely, it would be a highly chaotic situation.

The constant interaction between the real and nominal – whether due to people’s perceptions, the financial sector, Cantillion effects, or what have you – means that they are impossible to separate. This leads me to question how useful the idea of real variables is, and whether theories should use nominal variables instead. This is especially important when trying to understand the role of assets and the financial sector – in fact, economist’s ‘real’ benchmark, and their adherence to the neutrality of money, which allowed them to gloss over the role of money and finance, surely helped blind them to the financial crisis. Perhaps further acknowledging the importance of money and the nominal could be a positive step forward for economic theory.

*I have seen people suggest that such variables should be made real to ‘correct’ the problem. Well, this was tried in Iceland, and it didn’t work. You simply cannot force the world to behave like theories; you have to do things the other way round.

**This is easy to show using difference or differential equations. Try, for example, plugging values into y(t+1) = y(t)*(1 – a*(y(t) – y’), where 0 < y < 1, a is some constant, and y’ is the equilibrium value of y. There is a negative feedback loop, yet depending on the value of a, and the initial values, the average can be far from y’ for long periods of time.

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  1. #1 by Min on July 1, 2013 - 8:51 pm

    “I’d therefore interpret the ‘neutral money’ view as the claim that, at ‘normal’ levels of money, a change in the money supply will not alter the long term economic equilibrium. This viewpoint was described well by Milton Friedman in his famous ‘helicopter drop’ story, which I will use as the basis for my critique.

    “Friedman began his story by imagining a community in economic equilibrium”

    Assumes the answer, if there is a unique equilibrium. OC, if you start in a unique equilibrium, a perturbation will return to the equilibrium. That’s what we mean by an equilibrium. Big Duh!

    But if there is another equilibrium, a helicopter drop might just be the shock that will shift the system to that equilibrium.

    • #2 by Unlearningecon on July 3, 2013 - 1:34 pm

      Assumes the answer, if there is a unique equilibrium. OC, if you start in a unique equilibrium, a perturbation will return to the equilibrium.

      Is this necessarily the case? If the equilibrium is not stable, surely the system will not return to the equilibrium? Friedman merely assumes it is stable.

  2. #3 by Rob Rawlings on July 1, 2013 - 8:55 pm

    You talk about the role of the banking system as a contributor to the non-neutrality of money. I’m not convinced this is accurate. Monetary theorists argue that money will be neutral if over time its value is kept constant (or more accurately if its value can be kept in line with people’s expectations). I think that what you call “endogenous money” (in theory at least) contributes to achieving this.

    In the example you give new loans made by banks lead to an increase in the money supply. This will undoubtedly have real effects on the economy. However this needs to be seen in the context of a bigger picture. The monetary authorities normally target interest rates as a means to hitting another more fundamental target – most commonly an inflation target (but if could be an NGDP target).

    So: If in a given period the demand for loans increases then this may cause the money supply to increase too fast and the target to be missed. The monetary authorities will wish to reduce the number of loans (and the money supply) in the next period and so will increase the interest rate target. The long term effects will mean that despite short term variations monetary equilibrium will be maintained over time as people’s inflation expectations will be met.

    Compare this with the situation under a fixed money supply (such as might exists under a 100% reserve banking system) . If demand for money decreases then interest rates will fall and loans will increase. If this happens faster than prices can adjust then this type of banking regime can be shown to be more vulnerable to money-supply shocks that an “endogenous” one operating to a target.

    Of course this system doesn’t seem to have worked very well over the past few years. I can see a few reasons for this. 1) When demand for money increased dramatically no attempt was made to hit the inflation target leading to ZLB conditions 2) The banking system was compromised not by inflation targeting but by moral hazard and govt policies which encouraged reckless lending

    • #4 by Unlearningecon on July 3, 2013 - 1:41 pm

      The question is how much control the CB can actually exert over the growth of wider measures of the money supply. I googled the behaviour of M4 and found this for the UK, which suggests M4 can be highly volatile. Money also grew very fast in the run up to the crisis despite few excess reserves and increasing interest rates. I just remain unconvinced anything like an equilibrium can be sustained with the kind of volatility exhibited by the endogenous financial system.

      • #5 by Rob Rawlings on July 4, 2013 - 3:29 am

        I sort of agree.

        I think a CB can hit a monetary target (various types,of money supply, inflation , NGDP etc) with a fair degree of precision. But this tends to cause non-targeted variables to start to fluctuate in an unpredictable manner and the target tis eventually abandoned either before or as the result of a crisis.

        I’m not sure this proves endogenous money is correct but it does mean that monetary theory is probably more complex than some bloggers claim.

  3. #6 by Min on July 1, 2013 - 10:48 pm

    Typo: “Rather than taking money from Peter and loaning it to Paul, banks simply create a loan for Paul out of nothing. The ‘other side’ of the loan is not Peter’s deposit; it is a deposit that belongs to Peter, created at the same time as his loan, at an amount equal to the loan itself.”

    Should be “it is a deposit that belongs to Paul, . . .”

  4. #7 by Boatwright on July 2, 2013 - 2:36 am

    Epistemology here:

    All of the talk about the “real economy” belies the fact that what is being posited is whether this or that level of economic abstraction represents the basic, “real” level of economic activity. Lines of argument start with idealized barter, gold based money, helicopters dropping money, etc., etc..

    As many have pointed out on these pages, human economic activity is complex, chaotic, and intractable when analyzed with as-if, assumed equilibrium beginning assumptions. The clockwork universe of Newton lives on in such theories.

    If by “real economy” we mean the fundamental and if we are ever to find it, surely it will be in the three hundred years of scientific progress since Newton. If there is such a thing as a real economy in the world, its laws will necessarily apply to the whole world — all of nature. These laws are open to being discovered. Their fundamental character will be thermodynamic, ecological, physical, and REAL.

    It seems obvious that for any economic activity to happen there must be flows of energy and matter. I stuns me that economists show so little interest in looking for the fundamentals where they must be. It also stuns me that they waste so much time with non-negatable, as-if monetary theories.

    • #8 by Boatwright on July 2, 2013 - 11:59 am

      To make myself clear: By non-negatable, I mean that such “theories” fail the test of falsifiability. This is a key concept in science. For an hypothesis or theory to be scientific it must allow for evidence which falsifies it.

      This is the reason creationism, relying on the assumption that scripture is infallible, is not science. It is the reason that many so called economic theories, relying on idealized as-if assumptions, are also not scientific. It is also the reason that much monetary theory stands on a foundation of sand.

      It seems that many economists want to skip over this fundamental problem, and get busy with the fun stuff of broad theorizing, advising politicians, and appearing as all-knowing experts on TV. I am tempted regularly to throw a shoe when I hear that the economy went this way or that because of the Fed’s fine-tuning of the money supply. Equally, we must be very skeptical of those who propose money neutrality because it is a necessary corollary to their original, unproven assumptions.

    • #9 by Unlearningecon on July 3, 2013 - 1:52 pm

      If by “real economy” we mean the fundamental and if we are ever to find it, surely it will be in the three hundred years of scientific progress since Newton. If there is such a thing as a real economy in the world, its laws will necessarily apply to the whole world — all of nature. These laws are open to being discovered. Their fundamental character will be thermodynamic, ecological, physical, and REAL.

      It seems obvious that for any economic activity to happen there must be flows of energy and matter. I stuns me that economists show so little interest in looking for the fundamentals where they must be. It also stuns me that they waste so much time with non-negatable, as-if monetary theories.

      This is a crucial point and I wonder if you have read this post. Economists do express concern about environmental issues, but it’s often superficial. They need to pay attention to the fundamental relationship between the environment and the economy.

      • #10 by Boatwright on July 16, 2013 - 1:54 pm

        I just came around to reading Hawkeye’s post @ Golem XIV. Thanks for the link. Perhaps you could do a follow up here? The subject certainly needs a wider discussion. The interchangeability and replaceability of physical inputs (with the implicit assumption that technology will always find a way) is a bedrock assumption of the mainstream. Examined, this assumes an infinity where in the physical world none exists or can ever exist.

      • #11 by Unlearningecon on July 17, 2013 - 8:17 pm

        Unfortunately I’m simply not that knowledgable on ecology or environmental economics. I may do a post on it at some point, but I wouldn’t hold your breath.

  5. #12 by Luis Enrique on July 2, 2013 - 10:54 am

    Rather than taking money from Peter and loaning it to Paul, banks simply create a loan for Paul out of nothing. The ‘other side’ of the loan is not Peter’s deposit; it is a deposit that belongs to Peter, created at the same time as his loan, at an amount equal to the loan itself.

    I am assuming there’s a typo there, otherwise you have just written the other side of the loan is not Peter’s deposit, it is Peter’s deposit.

    more substantively, I think you are wrong about this, as are many of those other MMT internet warriors who like to explain how banking “really works” to dumb economists.

    Why do you think banks go to the trouble of attracting depositors? It costs them an awful lot – they pay interest on savings and provide costly services. What’s in it for them? According to your account here, if a bank wants to create a loan it has no need of them. OK they can make some money from overdraft fees etc. but there’s no way that turns deposit taking into a profit centre.

    I could loan some money to you. I could tell you that you now have £100 on deposit at the bank of Luis Enrique. So I have “created a deposit” at the time of agreeing a loan with you equal to the loan itself. What happens if you want to withdraw that £100? Does the “deposit” I have created help me fund it? No. I need to go find £100 from somewhere.

    Banks need to fund their loans. They can use retail deposits, wholesale funds, they can borrow from the central bank, there are lots of ways of doing it, but using money deposited by Peter to fund lending to Paul is still very important.

    How much difference is there between taking a deposit and then looking for somebody to lend it to, or finding somebody to lend to tan then looking for a deposit to fund it? Not much when you talk about a bank making countless loans and taking countless deposits each day. Yes it’s true bank lending is never really reserve constrained (although the cost of funding is important).

    We’ve been round this topic before, but I think you are getting it wrong again. Even if you think of banks as intermediaries between savers and borrowers, the standard money multiplier story explains how credit expansion expands the money supply. The question is what does a credit boom (expansion of the money supply) do to real economic activity? I agree with you to the extent that I don’t think it would be neutral either, although you have to be careful here. You could say standard econ would say without a supply side response, money expansion would just be inflationary leaving real activity unchanged, but if we have a credit boom that could as much be a symptom of supply side expansion as a cause. I think causation runs in both directions.

    • #13 by Roman P. on July 2, 2013 - 12:23 pm

      Fullwiller 2013 answers all of your objections, actually.

      • #14 by Luis Enrique on July 2, 2013 - 12:55 pm

        oh yeah? well Bandersnatch 2013 refutes all of his points, answers all of your objections and solves the P or NP problem. Actually.

      • #15 by Roman P. on July 2, 2013 - 1:32 pm

        I am amazed at the quality of your argument/snark. What are you, a middle-schooler? Jesus…

      • #16 by Luis Enrique on July 2, 2013 - 1:57 pm

        well how about providing a link to the paper or maybe explaining which objections he answers and how, rather than just dumping a useless “so and so says you’re wrong so there” comment?

      • #17 by Roman P. on July 2, 2013 - 2:42 pm

        You were banned by Google? Tough luck.

        The article answers ALL of your objections in a way that is too lengthy to cram into a blog comment. Want to read it, read it, if not it’s your loss.

      • #18 by Luis Enrique on July 2, 2013 - 2:45 pm

  6. #19 by Roman P. on July 2, 2013 - 12:33 pm

    Unlearningecon,

    If I may have such a question, do you/ did you learn accounting as a part of your education in economics?
    I did have a full-year course in accounting, but it was sadly taught by an insane teacher and we didn’t learn bank accounting – a shame, really, but it is rather different from general accounting in Russian accounting standards. Still, it was rather useful in the end.

    • #20 by Unlearningecon on July 2, 2013 - 2:28 pm

      I actually have not done formal accounting and am largely blogosphere educated on endogenous money. I tried to avoid finance as it is both boring and inevitably filled with wannabe investment bankers.

      Nevertheless, perhaps it would have been sensible to take an intro module. Should probably be compulsory for economists IMO.

      • #21 by Roman P. on July 2, 2013 - 2:59 pm

        It is worth it, considering that accounting is the language of business and SFC models are one of the latest breakthroughs of heterodox economists. It is difficult to understand the technicalities of Lavoie/Fullwiller papers without understanding how bank accounting works, for example.

        I think that the insufficient grasp of accounting is a source of many confusions in economics, for example some MMT’ers sometimes claim that only government could introduce new money because all money lent out by the banks is balanced by their liabilities (so it nets out to zero). My humble opinion is that this view hinges on the misunderstanding of the accounting balance.

  7. #22 by Boatwright on July 2, 2013 - 12:35 pm

    Evidence vs Theory:

    Perhaps we should look to the evidence as we debate the functions of banks. I see two sides in the debate: Those who believe that banks are simple intermediaries – taking a deposit from Peter and lending same to Paul. And those who believe that banks create money out of thin air.

    The smoking gun is the cascade of failure in a bank run. If banks were merely intermediaries, they should generally have much less problem meeting the withdrawal demands of depositors in times of crisis, those deposits being limited to the communities money supply in the first place. However, in the real world we see depositors demanding cash — and here is the key — including those deposits that were created out of thin air in the form of soon to be noncollectable loans. EVERYBODY wants “their” money, Peter and Paul, and the bank is quickly insolvent, having no way to meet the cash demands for what were originally merely computer entries.

    Those who cling to the classic view of banking would do well to consider the 100’s of billions Congress and the Fed were forced to pump into the system a few years ago to restore solvency.

    • #23 by Luis Enrique on July 2, 2013 - 1:10 pm

      for God’s sake, you think the “classic” mainstream econ accounts of banking are unable to explain bank runs? Get a clue. The banks-as-intermediaries story includes bank money creation, and explains why there’s no money there if everybody turns up at once to ask for it (a bank run). Also learn the difference between a liquidity crisis (being unable to honour demands for cash) and insolvency.

      • #24 by kkalev on July 2, 2013 - 1:51 pm

        The Fed, the ECB and BIS are quite clear that the money multiplier does not exist.

        You could also read Urlich Bindseil, head of monetary operations at the ECB for an even more detailed analysis of monetary policy and central bank operations.

      • #25 by Luis Enrique on July 2, 2013 - 2:07 pm

        kkalev

        if you mean the idea, roughly, that creating more high powered money (H) will increase the money supply (M) in some reasonably fixed proportion as H is multiplied by bank lending, then yes of course, that idea is crock. You can print the money but you can’t make banks lend it.

        But that is not saying “the money multiplier does not exist” it is saying that is there no stable relationship between H and M that policy makers can exploit.

        As that Fed piece you link to puts it “the normal money multiplier process has broken down” which suggests there is a reasonably stable relationship in normal times, but not now.

        There is a difference between H and M, and that difference represents money created by bank lending, and that process is reasonably well described by the money multiplier story, even if, and I quite agree about this – the story in which the central bank makes M go up by increasing H, ain’t true, except perhaps within a narrow corridor of normality, so long as increases in H are small. Or something.

      • #26 by Unlearningecon on July 2, 2013 - 2:25 pm

        2 things:

        (1) The issue as I see it is really one of causality. Exogenous money teaches that H moves first, then banks are able to lend (though they may choose not to). Endogenous money teaches that M moves first, which is empirically verified.

        (2) Phrases such as ‘in normal times’ remind me of Alan Greenspan’s ‘with notably rare exceptions, the financial system has performed well’. The fact that the relationship randomly breaks down is potentially symptomatic of an issue with the theory.

      • #27 by Luis Enrique on July 2, 2013 - 2:11 pm

        Here is a Bindseil paper – should be ungated I think – which models bank intermediation between lenders and borrowers.

        http://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp1312.pdf

      • #28 by Boatwright on July 2, 2013 - 2:21 pm

        Is it possible that a liquidity crisis can lead to insolvency? Remember Lehman Bros.? Note that I said: “If banks were merely intermediaries, they should generally have MUCH LESS problem meeting the withdrawal demands of depositors in times of crisis” Also note that neo-classical “mainstream econ accounts of banking” do in fact assume that banks are merely intermediaries, and the money creation of banks is of no practical consequence.

        Please explain the $700 billion liquidity infusion if it wasn’t to fill the hole created by wanton money creation in the form of real-estate and bond speculation, financed by out-of-control banks. Perhaps I could have been more precise to describe this as the bank run that would have happened…….

        How about addressing the issues, instead of splitting hairs, and firing ad-hominem at those with whom you disagree?

      • #29 by Luis Enrique on July 2, 2013 - 2:31 pm

        boatwright

        I’m not splitting hairs I am claiming your “two sides of the debate” view is completely wrong. Why should “mere” intermediaries have much less problem meeting withdrawal demands if they’ve lent out all the money and have very low cash reserves? I’m not denying money creation happens, I am saying it’s done by mere intermediaries. So yes you can say massive liquidity infusions were needed to fill the hole created by wanton money creation if you like; my point is that’s consistent with the simple intermediaries view.

        n.b. if banking didn’t involve taking money from some people and doing something else with it (lending it out, speculating like crazy whatever) then banks wouldn’t go bust because going bust means being unable to repay the people you owe money, with rather presumes the existence of people you have taken money from.

      • #30 by Boatwright on July 2, 2013 - 5:03 pm

        Bank A: Let’s call this the Hometown Bank, which takes a deposit from Peter, loans same to Paul. Paul opens an account and deposit same money. In a crisis, Paul’s demands for withdrawal cannot exceed the amount originally deposited by Peter. (This is of course simplified, and takes no account of the multipliers in real-world banking, but it is nevertheless the neo-classical view.)

        Bank B: Let’s call this the Greenspan Bank and Trust, which churns out loans like butter. Times are good. The curve steepens. And, as kkalev has pointed out here “In any case, even reserve requirements are satisfied ex-post and not ex-ante. They are backwards looking (back several months in the case of the ECB).”

        It seems obvious that Bank B is much more vulnerable in a crisis. Recent history proves the point.

      • #31 by luis enirque on July 2, 2013 - 8:38 pm

        boatwright

        bank A, where has Paul deposited the money? Anyway, I guess you have in mind the usual fractional reserve case whereby if too many depositors want their money back, the bank won’t have the money to hand. A standard liquidity crisis.

        bank B has churned out loans like butter, but you haven’t said how it has funded them. If you believe something silly like “by creating money out of thin air” then contrary to your claims, it cannot get into trouble, there is nobody to come and ask for their money back, all that could happens is loans funded by magic money are not repaid. But so what? You have invented a bank with assets but no liabilities. But back in the real world those loans need to be funded somehow. the bank’s balance sheet must balance.

        of course a bank can make itself vulnerable by lending rashly, keeping insufficient reserves etc. but your supposed alternatives, intermediaries versus thin air magicians, is bogus.

      • #32 by Unlearningecon on July 3, 2013 - 2:51 pm

        On B: banks can always find reserves at some price, as the CB is forced by the nature of the system to. Hence, by ‘creating credit’, they are efefctively creating money. They do, however, create this as debt so the power is not infinite: it depends on whether the debt is ‘good’ or not.

        I basically think about reserves as just another cost decision. Banks settle them ex post, for a price roughly set by the CB. So the CB has some influence but it’s nowhere near as direct as economics textbooks suggest.

      • #33 by Luis Enrique on July 3, 2013 - 5:08 pm

        unlearning.

        what do you mean it can “always find reserves at some price”? Boatwright and I are discussing bank runs, and he is trying to claim that type B (supposedly a money creating out of thin air bank as opposed to a money creating by intermediation bank A) is more at risk of runs. Now you say it can always find reserves, so are you saying it would always be able to meet demands for cash in the event of a run, the opposite of what BW is claiming?

        What do you think bank B’s liabilities look like? I am always being told economists need to learn accounting (funnily enough, I did learn some accounting before moving to economics late in life) so go on then, show me the power of understanding bank accounts Describe a simple balance sheet of a type A and type B bank.

        let’s keep it simple and just say there its only assets are loans and cash on reserve at the CB. I say there is no type A and type B, both banks have liabilities say 5% equity and 95% deposits from savers (retail, wholesale, bonds it doesn’t matter).

      • #34 by Unlearningecon on July 4, 2013 - 2:21 pm

        @Luis, It can always find reserves in normal times from the CB or other banks. In the case of a bank run, the CB is again responsible, though obviously the sudden nature of the event creates problems.

        @Boatwright, I have to say I agree with Luis on your original point. It seems to me that in both the endogenous and exogenous money cases the bank will have trouble in a run.

      • #35 by Luis Enrique on July 3, 2013 - 5:14 pm

        further …. and type A banks are also creating money, remember the basic money multiplier model in which banks intermediate between borrowers and savers is a model of money creation.

  8. #36 by kkalev on July 2, 2013 - 2:29 pm

    @Luis Enrique on July 2, 2013 – 2:07 pm

    The money multiplier framework mainly stipulates that money quantity is exogenously set by the central bank with commercial banks using high powered money to create deposits and increase the money supply. High powered money (bank reserves and banknotes) are the ‘independent’ variable while the money supply is the dependent variable. How large and stable the money multiplier is, is not as important.

    The problem is that bank reserves are not only used for satisfying reserve requirements but also for final settlement of transactions. As lenders of last resort, central banks always stand ready to provide enough bank reserves (at some price) for transactions to settle successfully. They more or less always provide daylight and overnight standing facilities to give banks as many reserves as they need (on a secured loan basis).

    Since central banks target an overnight interbank interest rate there’s really no other way to carry out their policy. You either target quantity and let the price (interest rate) float or the other way around. As a result, banks are always confident they can acquire the necessary reserves to settle their transactions by borrowing at the interbank market or (as a last resort) at the central bank. In any other case, the interbank interest rate would increase (up to the marginal lending facility) and signal to the central bank that it needs to ‘defend’ its interest rate target by increasing the available reserves in the system.

    In any case, even reserve requirements are satisfied ex-post and not ex-ante. They are backwards looking (back several months in the case of the ECB).

    Deposits are always a liability of commercial banks. How much high powered money is needed at any time (not counting reserve requirements) depends on transactions flows, habits and hoarding and it is not a stable variable in any shape or form. In countries like Canada reserve requirements are zero yet the monetary system is extremely stable (and of course the money multiplier is not infinite).

    • #37 by Luis Enrique on July 2, 2013 - 2:43 pm

      kkalev

      yes yes I understand all that. You are just saying that H is not exogenous in contemporary central banking that’s well understood by everybody including lecturers on econ 101 courses.

      But going back to the non-existent pedagogic world in which we think about the CB choosing H, of course stability is important. If the were no stable relationship between H and M, the CB would have no ability at all to influence M, in that world.

      And back in the existing world, it still makes sense to talk about how high powered money is “multiplied” by bank lending, so that M>H.

      • #38 by kkalev on July 2, 2013 - 2:47 pm

        The Central Bank does not influence M, it influences the price of M by being able to influence the price of H (which is used for clearing purposes) with every other rate being determined through arbitrage and credit spreads. The central bank cannot influence the quantity of M, that is the point stressed by every post-Keynesian writer on the endogenous money debate.

      • #39 by Luis Enrique on July 2, 2013 - 2:56 pm

        right. but we weren’t arguing about that though were we.

        thus far I think I’ve just been arguing that the standard money multiplier story explains the difference between H and M, even it”s quite wrong to think the central bank controls M by moving H.

        I reckon those post-keynesians are overstating their case somewhat. You really think the CB could not influence the quantity of money no matter what it did and what it was prepared to see happen as a consequence?

  9. #40 by Luis Enrique on July 2, 2013 - 2:48 pm

    UE your two things

    1. “H moves first then banks are able to lend”. I have said many times that bank lending is not constrained by H in that fashion.

    2. I’m surprised the corridor of normality did not remind you have Axel Leijonhufvud

    http://cje.oxfordjournals.org/content/33/4/741.abstract

  10. #41 by kkalev on July 2, 2013 - 3:05 pm

    @ Luis Enrique on July 2, 2013 – 2:56 pm

    As long as demand for excess reserves is zero (or stable), the money multiplier will track aggregate data of M and H fairly accurately since the central bank would need to cover any demand for reserves (used to cover reserve requirements) in order to achieve its interbank interest rate target. Otherwise, the interbank rate will just move upwards until it reaches the rate of the marginal lending facility (how quickly that will happen will depend on the length of the reserve maintenance period). Banks will be able to meet their reserve requirements anyhow by just borrowing at the discount window (marginal lending facility).

    The central bank is not prepared to see the interbank payment system dis-functioning, that is its primary goal and one of the main reasons central banks where established. It is prepared to move the interbank rate at levels consistent with its target but usually with small steps and during quite a length of time. It will not try to harm the banking system (something which can be done if it moves the interbank rate at large lengths very quickly since it will harm bank balance sheets).

    • #42 by Luis Enrique on July 2, 2013 - 3:12 pm

      right. again I’ve rather lost track of why you are making these points to me.

      • #43 by kkalev on July 2, 2013 - 3:31 pm

        Because you are trying to derive explanatory power from something that is nothing more than roughly an ex-post accounting identity.

        In a reserve requirements regime with stable demand for excess reserves, bank liabilities (deposits) used in calculating reserve requirements will be a multiple of required reserves. The multiplier will be determined by the reserve requirements set by the central bank, subject to allowances (such as the fact that vault cash is counted in required reserves in the US while the same does not happen for the Eurosystem).

        The quantity of reserves (required + excess) will be demand driven and out of control of the central bank (except at the margin through collateral requirements, haircuts etc). The latter is only able to loosely determine the price of money by targeting the overnight interbank rate (while operating in the repo market).

        The central bank cannot determine ex ante the quantity of the money supply with any level of precision.

      • #44 by Luis Enrique on July 2, 2013 - 3:44 pm

        yes, I also think the best way to think about the money multiplier is as an accounting identity! and a pedagogical tool.

        I also think it’s useful for thinking about the process of money creation by banks, for example, we had seen a big increase in H recent, but not M, because banks haven’t “multiplied” H via expanded lending.

        I am not sure what explanatory power you think I have tried to derive from it – as far as I recall the only references I have made to it on this thread have been talking about how standard econ with banks as intermediaries accounts for money creation by banks. Which it does. It’s there in the money multiplier story of how fractional reserve banking works.

        To reiterate for the Nth time, this does not mean the central bank could control M by setting H.

  11. #45 by thehobbesian on July 2, 2013 - 7:23 pm

    “Furthermore, the constant extending and repaying of credit means the money supply is always expanding and contracting, with no discernible regularity.”

    Exactly! I find myself again and again getting into arguments with gold standard/freebanking advocates about Fed policy. They seem to believe in the idea of either a “steady state” monetary system or even deflationary growth, both of which I really see no observable fact in either history or logic which gives those theories a logical basis. From what I see, economic history seems to indicate that the money supply is usually either going one direction or another, and never actually staying put at equilibrium, and given that, the most prudent way to go forward is a long term slow rate of inflation which gives short term price stability and enough money in the economy to make deflationary retractions less likely.

    Monetary economics is a lot like conflicts of law in that it is a topic which can be so prohibitively complex that even many experts (like Friedman) don’t know what the hell they are talking about. Surely no one can actually believe that money is truly “neutral” at the very least due to Cantillon effects, since price volatility in and of itself would create costs for firms who constantly have to readjust and recalculate due to changing prices. Thus by making firms have to do extra work to deal with price changes, they are creating real costs which obviously would be having a real effect (and consequentially price stability is reducing those costs and perhaps allowing for more robust growth).

    But the really interesting question is whether changes in the money supply has an effect on the real economy which goes beyond the mere effect which price changes has on individuals. If that’s the case then the old adage by Hume that if everyone woke up with $20 more in their pocket one morning they would be none the richer may be false, and we may actually be denying ourselves unique strategies for growth. For example, and people have mentioned this before, but if new money is created, the first people to spend it would in fact be enjoying the benefit of the price levels from before that new money was created, and even if prices subsequently rises that still doesn’t change their initial benefits from this. Now I believe people like Mises acknowledge this effect but essentially say that it is those individuals stealing from the rest of society based on the neoclassical logic that all costs and benefits are being equally transferred across the economy, almost akin to matter being created or destroyed. Very similar to Bernanke’s ridiculous analysis of Fisherian debt deflation where he said that people defaulting on debts had that money being transferred to some other part of the economy rather than simply being erased. Though, if one is to believe Fisher and reject equilibrium economics as I do, and say that in debt deflation money and wealth are simply being destroyed, then perhaps money and wealth can be created too. And through effects like the one with the first person to use new money, as well as things like price stickiness, perhaps you could say that you can in fact produce new wealth simply from printing money, which, even with inflation stays one step ahead and builds upon itself like a snowball effect (throw the snowball effect is usually something that evokes negative imagery). Thus introducing new money can in fact create new wealth. And even if subsequent inflation does result in those first buyers transferring SOME of the costs to others, I would argue that the Equilibrium based neoclassical idea that you are transferring the EXACT same amount of costs to others is wrong. In other words, while they are transferring some costs elsewhere, they are not transferring costs which are completely equal to the wealth created, therefore, some of this new wealth is left over and feeds into the total value of the economy. And because money, as a representation of capital and can help compel and create new production, there is actually some real value being created in the economy. Also, inflation over time can in fact decrease the costs of debts if interest rates are being controlled (like what many central banks do). Anyways, maybe I’m just crazy, but this is why I love monetary economics, it is a crazy subject for crazy people.

    So when people try to complain about all the inflation of the past century, I do try to point out that there has been great wealth creation which has coincided with that money creation. And perhaps that wealth creation is either from a simple Cantillon-esque opportunity cost effect whereby price stability allows capital to be reinvested back into production, or from a far more mysterious and exciting process like the one I just described.

    • #46 by Unlearningecon on July 3, 2013 - 2:39 pm

      Completely true. The idea that money is neutral lends itself to the idea that giving (poor) people money will not actually improve anything, but it’s obvious that how money is distributed and how the economy works are intertwined, and who exactly gets to partake in ‘real’ activity is a political choice.

      I am still ambivalent about the answer to the question ‘is money wealth’? Money is probably not wealth, but it is the key to wealth in the same way a ticket to sports game is effectively the sports game for the ticket’s owner. We (obviously) could reach a stage where supply was the constraint and so more money was worthless, but the idea that capitalism is any way near this with any regularity is ridiculous.

      • #47 by thehobbesian on July 3, 2013 - 5:11 pm

        “I am still ambivalent about the answer to the question ‘is money wealth’? Money is probably not wealth, but it is the key to wealth in the same way a ticket to sports game is effectively the sports game for the ticket’s owner.”

        I am rather ambivalent too, one obviously cannot say that money “is” wealth or “is” capital in a holistic sense. However, in many ways it can be treated as such by market actors in many situations.

        And of course since money can be used as capital in the capitalist economy, it can be used as a factor in production. So if those “first users of new money” i mentioned use that money to invest in some kind of productive operation, they could be said to be creating more economic activity, and perhaps new value or wealth. Which could explain the rise in stock markets over the 20th century and the use of equities in investment. Now of course people like Mises realized that people put more money into things like stocks when the money supply is increasing, but they seem to dismiss it as a bad thing or “malinvestment”. Of course I don’t agree with that assertion, if anything I think its better for more people to be invested in productive assets which can boost employment and increase competition and create incentives for innovation. I don’t know why they would think that people hoarding commodities and such would actually be preferable to investing in production, other than it coming from some very strange and un-provable assumptions about normative economics. If you look at the bulk of history, inflationary events like the price revolution of Europe (http://en.wikipedia.org/wiki/Price_revolution) and the inflation of the 20th century seemed to have been good things for both markets and society, rather than bad things.

  12. #48 by kkalev on July 3, 2013 - 8:44 am

    @ Luis Enrique on July 2, 2013 – 3:44 pm

    Honestly I have a hard time following your argument. You seem to accept most part of the endogenous money post-Keynesian view yet you insist on calling banks as intermediaries. By definition, such an entity will only expand its assets if it first increases its liabilities. That is true for the shadow banking sector (MMMFs and pre-2008 investment banks) but not for banks.

    They increase their claims (loans) and expand their liabilities (deposits) in the process. The form of their liabilities (central bank loans, deposits, interbank liabilities, CP, long-term securities) will depend on the cost of funds of every alternative funding source and the term structure of their assets. Banks look for deposits because they tend to be a very stable and low-cost liability, not because they need funding to expand their balance sheets.

    The spread and stability of their liability side will play a major role in extending loans but that does not mean that they first need to expand their liabilities in order to acquire more assets (as is the case for a MMMF for example).

    • #49 by Luis Enrique on July 3, 2013 - 10:24 am

      first, I am only very vaguely familiar with post-Keynsian theories. Basic mainstream econ says that interest rate targeting central banks let the stock of high powered money move about as required to hit the target. But claims they retain some form of “exogenous” control over the money supply because the central bank decided it wanted to influence it (perhaps thinking money is too loose/tight) it can change its interest rate target.

      second, I think I have said repeatedly that I don’t think banks first need to expand their liabilities to acquire more assets. From my first comment on this thread: “How much difference is there between taking a deposit and then looking for somebody to lend it to, or finding somebody to lend to and then looking for a deposit to fund it?”.

      However I do think banks need funding to expand their balance sheets, in the following sense. The bank of Luis Enrique agrees a £100 loan with kkalev. We start by you having £100 in a deposit account at the bank of Luis Enrique plus a £100 debt to it. My bank’s balance sheet has expanded, but so far nothing has really happened, there are just some offsetting entries on a ledger. If the bank actually lends the money to you – i.e. something actually happens, you withdraw the money and spend it somewhere else (so it ends up in another bank or as cash in hand somewhere) then I need to fund it. Mainstream econ accounts tend to ignore the intermediate step where there are some entries on accounting ledgers but nothing interesting has occurred. Sensibly so, in my opinion.

      Of course there are countless transactions occurring simultaneously, and banks only need to fund net balances, and they don’t have to do it immediately and can mix short and long term sources of funding etc.

      What I can’t understand about your account is that you describe a bank increasing its assets, you right say there needs to be an equal increase in liabilities, yet you seem to be saying the bank doesn’t “need” this increase in liabilities in order to increase its assets.

      • #50 by Unlearningecon on July 3, 2013 - 2:14 pm

        I’m not going to get bogged down in the details, as kkalev has already done a great job of explaining it, and all I can really see from you, Luis, is that he’s right but it doesn’t really matter. So, here are a few reasons why I think it matters:

        – With endogenous money, money is created and destroyed as debt, which implies all sort of Keensian things about the role of private debt that I’m sure most here are familiar with. This is contrary to the neoclassical idea that the level of private debt does not matter as it is owed by everyone to everyone else.

        – There is no ‘hot potato’ phenomenon in an endogenous framework: the CB has little control over broad monetary aggregates, so something like NGDPT will not work, especially at the ZLB. Neither will the expectations fairy save it, because expectations require some concrete phenomenon on which they can be anchored.

        – The purported ‘junker fallacy’, eg whether money is lent to speculators or put into real investment, is not a fallacy at all but one of the most important regulatory questions we must ask if we want to avoid financial crises. Credit can move around bank accounts, inflating asset prices, getting speculators into debt, and compromising bank’s financial positions in a way that investing in ‘real’ productive investments wouldn’t.

      • #51 by kkalev on July 3, 2013 - 2:17 pm

        “What I can’t understand about your account is that you describe a bank increasing its assets, you right say there needs to be an equal increase in liabilities, yet you seem to be saying the bank doesn’t “need” this increase in liabilities in order to increase its assets”

        The bank only needs to register a new claim and liability, nothing more. In order to find clearing balances to settle payments what it does is to discount assets. All central bank payments systems are overdraft systems, even if a bank has zero reserves in its account it can happily settle payments by going overdraft (and posting collateral if these overdrafts are not cleared within each minute). There are numerous regimes where banks end the day with zero balances in their reserve accounts (all payments are overdraft payments in this case).

        The only issue is that different asset classes have higher or lower ‘money’ properties. A positive reserve account balance is 100% money and so is a T-bill. A T-Note is relatively close to money while a credit claim will incur a large haircut if it is transformed into money (with quite a lot of limitations in the form of credit claims accepted as collateral depending on the central bank in question).

      • #52 by Luis Enrique on July 3, 2013 - 4:21 pm

        unlearning …

        he’s right but it doesn’t matter about what? I don’t think he’s right about banks not acting as intermediaries between savers and borrowers and not needing to fund loans with deposits, and the way in which you characterising banking in the OP remains erroneous. Nobody has written anything to convince me otherwise (although I think that’s what kkalev is now addressing). The other stuff may or may not be right but it isn’t relevant to the topic I thought was under discussion here. The same goes for the three points you go on to make here.

        kkalev,

        well why do you think banks go to the great expense of offering savings accounts then? What explains the composition of their liabilities? It’s not 100% equity is it? Banks choose to take deposits from savers. I say they do so because they need to fund their loans, and it still makes sense to think of banks acting as intermediaries between saves and borrowers. I am a net saver, my money is in a bank account. What is it doing there? Some other people are net borrowers, and have taken out loans from my bank. But you don’t want to say my bank is acting as an intermediary between me and them.

        I’m not sure I understand your second para, but it’s not as if banks fund their all their assets by borrowing from the central bank. I am claiming that if a bank wants to expand its balance sheet in a meaningful way (i.e. have loans that are drawn down, not just sat on deposit) it needs to fund those loans, and retail and wholesale deposits (and various other ways in which banks borrow money from savers) constitute the bulk of that funding.

  13. #53 by Luis Enrique on July 3, 2013 - 10:12 am

    back to the topic of the post. what does this mean?

    “It is first worth noting that the ‘real’ benchmark for Friedman’s equilibrium is somewhat hard to define – after all, the real economy is an artificial construct with no real world counterpart”

    real means the quantity of goods and services produced. 10 apples, 1 hour of therapy, etc. What’s artificial about counting apples? Friedman is suggesting the real quantity of goods and service won’t change.

    I think he’s not quite right because I think when people start spending their helicoptered money some firms will exploit un-utilized capacity, labour supply might increase and some extra investment might happen and that might have some lasting effect. But he is surely mainly right. Economies that experience high rates of money growth don’t tend to experience proportionate increases in real production.

    • #54 by Unlearningecon on July 3, 2013 - 2:05 pm

      Badly worded, perhaps: what I mean is that it’s difficult to say what the real benchmark would be completely independent of the existence of money. Yet this sort of moneyless barter economy seems implicit in many theories such as, say, Walrasian equilibrium.

      • #55 by Luis Enrique on July 3, 2013 - 4:24 pm

        he’s just claiming that if you doubled the money supply the quantity of goods and services produced wouldn’t change. That benchmark seems clear enough to me. I don’t completely agree with him, but that’s another matter.

      • #56 by thehobbesian on July 3, 2013 - 7:04 pm

        “Yet this sort of moneyless barter economy seems implicit in many theories such as, say, Walrasian equilibrium”

        Never mind the fact that it is rather strange to make the assumption that bartered for exchange would even be producing something like an economic equilibrium that would be reflected by a perfectly functioning money stock. I wrote about inequity aversion the other day and how people’s perception of what is equitable will determine whether they decide to engage in a transaction or not. However, the concept of what is equitable is not necessarily universal or objective, a transaction that may be equitable in one culture is not perceived as equitable in another. So while trying to keep all economic exchanges to be in line with the culture’s perception of equity may help to create cohesion and a social equilibrium of sorts, there is really no basis that it is creating some kind equilibrium or resource movement that exists outside of mere social cohesion. I like to think that if all exchanges were as close to a 50/50 exchange of real value as possible it would be ideal for optimum functioning, but then again that might just be a result of my primitive ape brain liking neatness, conformity and even numbers.

  14. #57 by kkalev on July 3, 2013 - 5:12 pm

    @ Luis Enrique on July 3, 2013 – 4:21 pm

    “well why do you think banks go to the great expense of offering savings accounts then?”

    Deposits are unsecured liabilities yet they exhibit extreme stability and usually carry very low (and sometimes zero or even negative) rates. They allow banks to carry non-traded assets (credit claims) yet fund them with unsecured liabilities. That’s a huge advantage.

    The alternative is basically investment banking which requires that most funding happens in the secured (repo) market with haircuts and daily mark-to-market. That means that all assets are securitized and adds short-term liquidity risk.

    • #58 by Luis Enrique on July 3, 2013 - 5:18 pm

      right … so I am claiming that banks need to fund their loans and choose to do so, in great part, by attracting deposits from savers. Hence they intermediate between savers and borrowers and the characterization of banking under the heading “The role of finance” in the OP is gubbins .

      and you are saying this is somehow wrong, but here now extolling the virtues of using deposits to fund loans?

      Umm, aren’t I the one arguing that banks fund their loans by taking deposits?

      • #59 by kkalev on July 3, 2013 - 5:33 pm

        The fact that by accounting identity A = L + C does not mean that L funds A. Funding means a specific sequence of events: I increase my clearing balances by attracting deposits which allows me to ‘fund’ an increase in assets (loans) because I now have a clearing balance large enough to settle any withdrawal of the new loaned funds.

        What banks actually do is that they increase their balance sheet (in the first step) and correspondingly increase the risk of larger withdrawals of funds. They can always cover withdrawals by borrowing from the central bank yet that is short-term borrowing and relatively expensive. As a result they do their best to keep their liabilities in forms with lower cost and more long-term with deposits being the best candidate.

        They are not a source of funding but of a low cost ‘hedge’ for withdrawals. The alternatives (repo, CP, securities) are just usually more expensive (at least for regular loans carried on bank balance sheets).

      • #60 by Luis Enrique on July 3, 2013 - 5:53 pm

        for God’s sake, I have said countless times that I agree the first step is not obtain deposits to fund an increase in assets, I have repeatedly told you I have been quite clear I am not using the word funding in that sense. I have said that they can make the loans first and find the deposit later.

        You have just written that whilst they could tap the central bank, that’s unattractive so they look for deposits instead. That’s exactly what I have been saying all along. And – this is the important bit – it’s what is completely absent from the description of banking in the OP which is where all this started, which stops at the point at which a loan is agreed, but before it is drawn down and requires funding. UE will say the CB is “always prepared to providing funding” but the bloody banks don’t want to use the CB for anything other than short-term stop-gaps, as you ably explain above. Maybe you could explain this to UE rather than me because I frigging knew all this all along.

    • #61 by Unlearningecon on July 5, 2013 - 1:25 pm

      Luis I don’t even disagree about the workings of the banks; it’s the fact that you seem to think this stuff has no implications for mainstream theory. The money multiplier is simply a false description of how banks go about their business, and this alone should be enough for you to say ‘yeah, fair enough – they should change how they teach it’.

      On the role of deposits, see eg here.

  15. #62 by kkalev on July 3, 2013 - 6:08 pm

    @ Luis Enrique on July 3, 2013 – 5:53 pm

    “And – this is the important bit – it’s what is completely absent from the description of banking in the OP which is where all this started, which stops at the point at which a loan is agreed, but before it is drawn down and requires funding.”

    Yet you continue to use the word ‘funding’ in this context. Funding of withdrawals will always be provided by the central bank at the aggregate (since withdrawals can only happen in the form of banknotes on reserves) in order for the latter to be able to hit its interest rate target. Anything else is just liability management by banks, not funding.

    What is important is the endogenous nature of the money supply, not how you call bank liabilities. Liability management is one thing, endogenous money is another.

  16. #63 by Luis Enrique on July 3, 2013 - 8:02 pm

    Kkalev

    Yes that’s right. Because we’re not talking about the aggregate, we’re talking about a bank. And I’m trying to kill this silly depiction of banking in the OP which talks about loans created out of thin air the “other side” of which is the deposit created at the same time, and does not continue to think about what happens when loans are drawn down, and how depositors do form the “other side” of the loan, via a process you choose to call liabilities management.

    Yes endogenous money is another thing.

    • #64 by Unlearningecon on July 4, 2013 - 2:26 pm

      That is how banks actually work, though. Deposits are not drawn down; reserves are. And banks find these when they need them, quite separate from the lending decisions they make.

      • #65 by Luis Enrique on July 4, 2013 - 2:53 pm

        by “drawing down a loan” I mean – in simplest form – turning up and asking for cash. Loans certainly are drawn down, in that sense. And when that happens the deposit that is created at the same time the loans is agreed, is no help to you. When a bank has to hand some money out, it has to get some money in to fund it, and although that might be borrowing from the central bank or interbank market or whatever in the short run, the point, which I am still not confident you yet recognise, is that as a bank expands its balance sheet it wants liabilities in the form of retail depositors and similar (other savers), so it ends up intermediating between savers and borrowers.

        here’s one story. Peter walks into a bank deposits £100 cash, bank now thinks hooray I can make a loan, calls up Paul says you know that £80 you wanted to borrow, I have it here for you. And Paul takes the £80 and puts it in his wallet. This is the supposed dumb econ story. End result: liabilities £100 owed to Peter, assets £20 cash reserves, £80 loaned to Paul.

        Now here’s the other story. Paul wants to borrow £80. Does our bank have £80 lying around? Hell no, making sure you have the funds in advance to lend is the dumb econ story! no, our bank agrees the loan with Paul, then when Paul comes to collect the cash our bank borrows from the central bank or wherever. There you silly economists, that’s how banking really works. Then over time, via “liabilities management” our bank replaces that short-term funding with a retail deposit of £100 from this chap called Peter. End result: liabilities £100 owed to Peter, assets £20 cash reserves, £80 loaned to Paul.

        Now unless you can describe to me how the balance sheet of the dumb economist intermediating between savers and borrowers bank ends up differing from the balance sheet of the realistic MMT/Post-Keynesian whatever bank, I would like you to concede my point here.

      • #66 by Luis Enrique on July 4, 2013 - 3:04 pm

        and how many f-ing times do I have to say that I agree lending decisions are not made by first seeing if the bank has surplus reserves lying around?

  17. #67 by Jan on July 3, 2013 - 8:36 pm

    @ Luis Enrique and kkalev:

    Isn’t your discussion a bit beside the point? I think the endogenous money view, as I understand it has two basic components:

    – First, if a bank makes it loan it isn’t going to check if it has sufficient reserves before it loans the money. The bank credits the account of the client: it creates a deposit. If the client then withdrawals this money, and if the bank doesn’t have enough reserves to facilitate this withdrawal, its account at the central bank goes in the red. It then has to clear this debt to the central bank and borrows the needed reserves on the interbank market, wich brings me to the second component:
    – If there is an increasing demand for loans at a certain targeted interest rate, reserves will become scarcer, so the central bank has to add reserves to the system to prevent the interest rate from rising. So if the central bank targets a certain interest rate, it has no control over the monetary base. So it is the money supply that moves first and causes the monetary base to expand, and not the opposite like in the exogenous money view. This is important in my view and not the discussion about ‘funding’.

    Is this correct, or do I miss something?

    • #68 by Luis Enrique on July 4, 2013 - 10:24 am

      Jan

      beside whose point? I started by pointing out the depiction of banking in the OP is erroneous and I have been trying to defend that position ever since. You might think endogenous money is more important, I wasn’t writing about it.

      on that topic, I think the words endogenous and exogenous have some subtleties that often gets missed. You can “endogenize” the central banks behaviour by giving it an objective, defining its instruments, and then saying if it wants to do this, it has to do that. And yes if it wants to hit an inflation target via interest rate targeting then the quantity of base money moves around as required. As far as I know this is absolutely mainstream econ, not some exotic post-keynesian theory. But in another sense, the central bank still has some exogenous influence (never *control* because everything is mediated by the financial sector) over the money supply because if it wanted to influence it (hence changing its objectives), it could. For instance it could just decide to sell as many bonds as it can at whatever price and disregard the interest rate, inflation and GDP/employment.

  18. #69 by James Reade on July 4, 2013 - 5:16 am

    “In fact, economist’s ‘real’ benchmark, and their adherence to the neutrality of money, which allowed them to gloss over the role of money and finance, surely helped blind them to the financial crisis. Perhaps further acknowledging the importance of money and the nominal could be a positive step forward for economic theory.”

    Who are these economists who blindly hold to the neutrality of money? Could you please identify them for me? Could you tell me how many of us blindly hold to it? Could you point me to all the macroeconomic models (since you talk about the financial crisis) that assume money is neutral?

    Now I don’t doubt there are some, possibly many. But you haven’t cited a single economist since Friedman in this entire blog. Maybe, as some of your allusions point to, you’re talking about maybe some right leaning libertarian economists – in which case, just fine, but please point this out.

    I wonder whether this theory paper, published in 1999 in JET, blindly adheres to the neutrality of money? http://chwe.net/michael/mm.pdf

    I haven’t even started looking at the number of papers that test the neutrality of money that can be found on Google Scholar.

    As with our extensive twitter debate, I marvel at how absent any reference to any of the literature since some famous economist decades ago is in your posts. As in, again you make wonderfully unsubstantiated claims, and conclude telling economists how best they might move forward. Just one paper, found with a simple Google Scholar search, suggests that economists are actually decades ahead of you.

    I suggest you start reading the blog Economic Logic. He begins with a reference to what economists are actually doing with each post.

    • #70 by Unlearningecon on July 4, 2013 - 2:17 pm

      (1) At no point did I claim all economists adhere to the neutrality of money; I said conventional economic theory does. This includes models of supply and demand, labour markets, Walrasian Equilibrium etc, where everything is expressed in ‘real’ terms. Almost all of UG economics assumes money doesn’t matter (in the long run), while even DSGE models have a questionable treatment of money (eg there may be no room for it at all).

      (2) Suggesting Friedman – a very public spokesperson for the discipline, responsible for a number of theories and viewpoints, as well as popular interpretations, somehow does not ‘count’ is an exercise in special pleading. The neutrality of money viewpoint influences NGDPT, a popular viewpoint on the blogosphere which seems to be gaining some traction with the world’s central banks. Think they’re wrong? Take it up with Scott Sumner or Mark Carney, not me.

      (3) That paper you linked does indeed discuss how numerous ‘deviations’ – such as lack of information, which the paper focuses on – may ‘disrupt’ the neutrality of money. This is fine, as it goes, but I am presenting a very different perspective here. I do not think money is not neutral because of real world ‘frictions'; I think it is so due to the disequilibrium nature of the economy and the financial sector. This is the fundamental difference between mainstream and heterodox economics – conventional economics, no matter how complex it gets, implies that if only markets, knowledge etc. were ‘perfect’, things would function smoothly. Heterodox economics doesn’t.

      (4) EL is OK but most of it falls under what I discuss above – papers discussing various ‘quirks’ and ‘frictions’. These may be interesting in a sense, but they aren’t the fundamental changes I’m interested in.

      • #71 by James Reade on July 4, 2013 - 2:35 pm

        (1) But if conventional theory does, as you assert (which I’m not at all convinced about), then that implies most economists, if not all, adhere to it. You didn’t actually answer my question though. How about as a challenge you link me up 10 papers published in the last 10 years that assume money neutrality. I’m sure you can do it – it’s not that I think it’s impossible or that ur wrong. I’d just like to see you actually bother to substantiate your points for a change.

        (2) When did I say it didn’t count? What I said was where’s the evidence that this is a mainstream view in this day and age. It may well be – all I’m asking is you substantiate your point – if ur criticising econ today, cite some economists today! Seriously, you could do with actually reading what I write – a criticism you seem happy to dish out to others.

        (3) So essentially what ur saying is: If economists study deviations from something absent of frictions, rather than starting from a mess, they are somehow wrong/deluded/irrelevant? We then have to simply disagree – if you don’t have some fixed point to start your analysis from, even if it’s hypothetical and unachievable, how can you know people are biased and what those biases are? The bigger point is – this approach is not futile, does not stop us uncovering the ways in which individual agents function and networks operate.

        (4) If you think these fundamental changes are needed, then why haven’t you got on and published a few papers discussing them in the literature?

      • #72 by Unlearningecon on July 4, 2013 - 11:26 pm

        (1) Actually, it doesn’t. Many economists will swear by their theories when challenged, but only view them as tools which are at best imperfect representations of the real world, or even one aspect of it. I’m critiquing the theories on the grounds that they aren’t even good for this. I have some articles attacking economists and their way of thinking directly, but this isn’t one of them.

        (2) These theories are widely taught and variants of them are used by policymakers. Once this isn’t the case, I’ll lay off them.

        (3) You can have a fixed point from which to start without assuming everything is somehow ‘perfect’. See my comment to Luis – Marx, Keen, Schumpeter, Sraffa and Keynes did this, as do econophysicists & evolutionary economists.

        (4) Because I’m an undergraduate. Don’t worry though, I’ll get there.

      • #73 by Luis Enrique on July 4, 2013 - 3:01 pm

        hold up, just become lots of “conventional economic theory” does not include a role for money, does not mean “conventional economic theory” says money is neutral, it just tells us that in those particular contexts money is on the long list of things that have been excluded. And often for very sensibly so, on the basis it’s not important to the question in hand.

        what we need to find are mainstream macro models that have money in, and see whether money is neutral in those models. I recall Blanchard’s Lectures on Macroeconomics has models with money in, as does everybody’s favourite, Ljungqvist and Sargent. But I am not about to read them now!

      • #74 by Luis Enrique on July 4, 2013 - 3:08 pm

        even then we may learn that mainstream macro models with money in tend to assume money is neutral, but that too may be for the sake of simplicity because the model in question is about something else, rather than telling us the modeller actually believes money is neutral.

        by the way, mainly macro has a new post up that includes talking about money neutrality.

        fwiw my guess is UE is correct that most mainstream macro do not say that long-run real outcomes are determined by changes in the nominal supply of money. i.e. money neutrality.

      • #75 by Luis Enrique on July 4, 2013 - 3:12 pm

        “conventional economics, no matter how complex it gets, implies that if only markets, knowledge etc. were ‘perfect’, things would function smoothly. Heterodox economics doesn’t”

        citation please! I want to see a heterodox model with well defined preferences, no information problems, matching frictions etc. etc. in which markets don’t function smoothly. I suspect what you are going to show me is heterodox models that include what in mainstream parlance would be called frictions.

      • #76 by Unlearningecon on July 4, 2013 - 6:18 pm

        Keen’s model. He doesn’t even have sticky wages or prices, yet it produces a cycle due to the expansion of credit.

      • #77 by James Reade on July 8, 2013 - 10:48 am

        (1) I’m not going to defend economists (if they exist – again I want evidence and u need it if ur going to be convincing in your critique!) who cling to models in that manner. But you haven’t given me the 10 links from the last 10 years I requested.

        (2) Again – no evidence. How do you know these things are widely taught? You need an evidence section of your blog with all the links to places and syllabuses and economists that commit all these crimes you allege. Until then I’m just not convinced. And I asked you about economists engaged in research, not those teaching.

        (3) I wasn’t necessarily saying you’re wrong in this – was just noting that we’ve got to the core or where you object to neoclassical economics. The one thing going for the neoclassical approach is that it enables us to point out all the ways in which it falls short, and hopefully give enough evidence to help better theories to replace it, in time.

        (4) Great – I genuinely look forward to it. I’m not hostile to criticism, to reiterate my earlier point (ur DSGE post), but I am hostile to unsubstantiated and vague comments. Substantiate with evidence beyond a few bloggers – draw papers from Ideas/repec, and link up lecturers (other than Mankiw – he’s about as popular as DSGE models these days) who commit the offences you allege. I genuinely would like your blog to do better on this – without it, it just reads like an undergraduate rant ;-)

  19. #78 by Luis Enrique on July 4, 2013 - 11:00 am

    another thing to consider is that the distinction between short-run non-neutrality and long-run neutrality breaks down as soon as you allow for hysteresis, which is an idea mainstream econ is perfectly comfortable with.

  20. #79 by Luis Enrique on July 4, 2013 - 7:40 pm

    Keen’s model? Oh dear, sometimes I despair of you. 

    Here is the Lotka Volterra predator-prey model

    http://en.wikipedia.org/wiki/Lotka–Volterra_equation

    It can exhibit cyclical or chaotic dynamics. If I relabel predators “the financial sector” and prey “the real economy” have I produced a model that shows even frictionless markets may be dysfunctional? I haven’t even assumed sticky prices! My point is just because you have a model with cyclical behaviour doesn’t mean you’ve shown us anything about markets. 

    A market has to consist of people with things to buy and sell coming together and deciding what prices and quantities to trade at. 

    Now I could model agents being randomly matched and being offered the following choices: trade at a randomly drawn price, decline and look for another match, or throw yourself of a cliff. If I impose the rule “always throw yourself off a cliff” have I demonstrated that even frictionless markets may be dysfunctional because in my model everybody dies? No. Introducing a rule that market participants have to follow means you have introduced an extreme “friction”.

    Can you show me where the market is in Keen’s model consisting of people choosing prices and quantities in the absence of any constraints, incomplete markets, etc.? If not you have not shown me a heterodox model of a market with no imperfections exhibiting dysfunctional behaviour. 

    Minsky’s ideas are a great example of market dysfunctionality, but I don’t think you’ve got much chance of seeing that behaviour emerge from a model of a perfect market. 

    • #80 by Unlearningecon on July 4, 2013 - 11:13 pm

      Keen’s model? Oh dear, sometimes I despair of you.

      Likewise.

      A market has to consist of people with things to buy and sell coming together and deciding what prices and quantities to trade at.

      This really begs the question. I’m not looking for a model of ‘the market'; I’m looking for a model of capitalism as a whole. In Keen’s model the capitalist sector pays the workers, who consume, and the financial sector provides the funds for either investment or asset speculation. Although this doesn’t represent the optimising agents that you are predisposed to believe is the only possible approach, this involves people ‘coming together’, in an aggregate sense. The investment decisions of firms, the speculative decisions of investors, and the lending of the banks come together to create business cycles.

      But if you aren’t satisfied with Keen, how about Schumpeterian business cycles, driven by a rational reaction of entrepreneurs to technological breakthroughs? Or Marx? In a TSSI model, the use of labour saving technology causes the rate of profit to fall, which leads to crises. How about the general theory, where a high rate of interest causes speculation and business cycles?

      Can you show me where the market is in Keen’s model consisting of people choosing prices and quantities in the absence of any constraints, incomplete markets, etc.?

      I cannot show you a heterodox model that follows neoclassical methodology, no.

      Minsky’s ideas are a great example of market dysfunctionality, but I don’t think you’ve got much chance of seeing that behaviour emerge from a model of a perfect market.

      This was one of my primary examples in the post I linked. Minsky does not require imperfect information or irrationality at all: in fact, the decisions made by investors to up their leverage repeatedly are pretty rational when taken on their own. They lead to an irrational outcome.

  21. #81 by Luis Enrique on July 5, 2013 - 9:28 am

    Oh UE, you are giving me an ulcer again.

    Having a definition of a market as (roughly) people trading and choosing prices and quantities is not begging the question – you need a definition of “market” before you can say whether “if only markets, knowledge etc. were ‘perfect’, things would function smoothly.” as you put it.

    I asked you to show me where Keen has a perfect market, thus defined, behaving badly, and you respond: “I cannot show you a heterodox model that follows neoclassical methodology” but I didn’t say anything at all about neoclassical methodology. You could have a decidedly heterodox model of people choosing prices and quantities and trading in a market, such as a computable agent based model, for example. The fact that you think modelling a market is “neoclassical methodology” … well maybe you just wrote too hastily.

    You now write “I’m looking for a model of capitalism as a whole” but that’s moving the goalposts, you made a claim about perfect markets, that non-existent theoretical construct that if actually manifested you said mainstream economists think would function smoothly but heterodox would not, and “capitalism as a whole” certainly isn’t the manifestation of a perfect market.

    You could have written that heterodox economists aren’t interested in trying to model markets like that, and prefer to take a reduced form approach to modelling “capitalism as a whole” where they try to capture the behaviour of decidedly non-perfect markets going awry. Which is what Keen has. His model doesn’t say anything at all about whether markets are perfect or not.

    You may think the behaviour of agents in Minsky’s (informal) model is “pretty rational” and I’d probably agree, but that doesn’t mean they are operating in a perfect frictionless market, which is what your original claim concerned and is what I was asking you about.

    I asked you to back up your claim that heterodox economics does not think that “if only markets, knowledge etc. were ‘perfect’, things would function smoothly” and the fact you think Keen’s model has anything to say about that … well I think you haven’t quite grasped the issue at hand.

    • #82 by Unlearningecon on July 5, 2013 - 9:13 pm

      We are talking past each other, which perhaps explains your ulcer.

      Neoclassical economics must invoke some departure from this perfectly competitive benchmark, such as a behavioural quirk, financial friction, or whatever else, in order to exhibit ‘undesirable’ behaviour. This is what economists do – they say that if x is present, it could lead to y. Patient versus impatient agents lead to debt deflation, for example. Without this, the economy would function nicely.

      Heterodox economics does not resemble perfectly competitive models – that’s the point. The model cannot blame any volatile behaviour on something ‘getting in the way’. For example, both Keynes and Marx assume perfect competition in a sense, but the various rational actions of different agents lead to problems. The problem is systemic; there is no implied baseline theory where there would be no problems.

      With Keynes, you might say ‘liquidity preference’ is the culprit, but is it really? If individuals did not hold cash so that they could respond quickly to changes in circumstances – their own or the whole economy’s – then that would surely create a lot of rigidities and problems, both in the financial sector and in people’s lives.

      Similarly, with Marx, you might say the adoption of labour saving technology is the problem. But surely, without this, productivity would hardly ever increase, leaving capitalism in stagnation. Again, the problem is simply a symptom of the way the system works, not something that can be blamed on a collection of key institutions or behaviours.

      • #83 by Luis Enrique on July 8, 2013 - 10:36 am

        Heterodox economics does not resemble perfectly competitive models – that’s the point

        ok, but it’s quite a different point from saying heterodox economists disagree with the idea ” “if only markets, knowledge etc. were ‘perfect’, things would function smoothly”. I think you should abandon that formulation, it doesn’t make sense.

        perfect markets are a theoretical construct, and they function “smoothly” or not in theory only.

        Here is an alternative claim you could have made:

        1. mainstream economists think real world markets would function more smoothly if various frictions, distortions were removed.

        this idea has some obviously sensible applications – it’s easy to think of markets that could be improved by, say, reducing information asymmetries. But it”s not generally true. Are you familiar with the theory of second best? this says removing one distortion can make matters worse.

        “Neoclassical economics must invoke some departure from this perfectly competitive benchmark, such as a behavioural quirk, financial friction, or whatever else, in order to exhibit ‘undesirable’ behaviour. “

        but just because heterodox models don’t explicitly couch things on those terms, does not mean they are not also relying to the existence of quirks, frictions etc. etc. If you asked a het economist “why do you think this happens?” they may very well appeal to some “departure from perfect markets”. Take Minsky’s ideas. When everybody enters the Ponzi finance stage, do you think investors in bank equity are fully informed that the bank has now got itself into a position whereby a fall in asset prices will render it insolvent? I don’t know whether Minsky himself discussed that, but my guess is that there are information asymmetries all over this story. In some senses heterodox economists must invoke departures from perfect markets, otherwise they’d be using a model of a perfect market. Which they are not.

  22. #84 by Luis Enrique on July 5, 2013 - 11:20 am

    Christ I have just seen this! ” This leads me to question how useful the idea of real variables is, and whether theories should use nominal variables instead. ”

    nominal median wages have increased greatly in the UK since 1970. Because of inflation.

    real median wages have barely increased in the UK since 1970.

    which do you think is more important to explain?

    real consumption per capita in Zimbabwe is one twentieth of what it is in the USA, nominal consumption per capita is 100000 times higher in Zimbabwe, measured in local currency, than US consumption measured in measured in local currency. Nominal variables are all measured in local currencies, that’s what it means. Which do you think matters, real or nominal incomes?

    I’m thinking real incomes are more important than nominal .

    • #85 by Jan on July 5, 2013 - 12:16 pm

      `Market Monetarist` Lars Christensen had a post with real GDP for certain South American economies to show that Venezuela did not do so well under Chavez. UE disagrees and posts a chart with GDP per capita in current US$ where it seems that Venezuela is doing better. Strange reasoning, we would think that real GDP is the better indicator, not?

      http://marketmonetarist.com/2013/03/06/hugo-chavezs-economic-legacy-the-two-graph-version/

      • #86 by Unlearningecon on July 5, 2013 - 12:21 pm

        @jan I was taking issue with the use of an index, not the nature of how GDP was expressed.

        @luis I think I overstated my case – obviously, the real is a useful concept. I do, however, think that key variables in the economy are nominal, in the sense that nominal variables are the only ones people can control and act on.

      • #87 by Luis Enrique on July 5, 2013 - 1:02 pm

        “nominal variables are the only ones people can control and act on.”

        that is not true. real prices are ratios of nominal prices. You know that if you have £10 and Mars Bars cost 50p and Jaffa Cakes £1 you can act on real prices.

        If I get a job up North for a given nominal wage my real wage will be higher because housing costs and other prices are lower and I can act on that.

        I am deciding whether to work some voluntary overtime or play with my children, that’s not a choice between nominal variables because my children aren’t denominated in a currency. But I can think about what the wage from the overtime would buy me, perhaps a holiday with my children, another real variable.

      • #88 by Unlearningecon on July 5, 2013 - 9:03 pm

        that is not true. real prices are ratios of nominal prices. You know that if you have £10 and Mars Bars cost 50p and Jaffa Cakes £1 you can act on real prices.

        In a narrow example where you have only Jaffa cakes and mars bars, yes, maybe. But if you are talking about all the potential consumption decisions you can make, this kind of decision is computationally impossible. It’s only at non-normal levels of inflation that people stop thinking nominally, and even then they hardly follow neoclassical theory; it’s generally more chaotic than that.

      • #89 by Jan on July 5, 2013 - 1:12 pm

        What´s the issue with the index? Chavez started in 99. Whether you use an index or the values (real GDP or PPP) themselves, the GDP performance (I am not talking about poverty, there you are correct) of Venezuela is not so good compared with the other countries in his graph.

      • #90 by Unlearningecon on July 5, 2013 - 1:19 pm

        It’s not as extreme as the index suggests, however, and the oil strikes probably had something to do with the first dip, after which growth was at a similar trend to the rest of LA.

      • #91 by Jan on July 5, 2013 - 2:20 pm

        Yes, I think you are right. I was confused by you posting a graph with GDP per capita in current US$, this distracted a bit from your argument.

  23. #92 by Blue Aurora on July 6, 2013 - 10:46 am

    I agree with you that the non-neutrality of money is very much a real phenomenon, UE. However, I do have a question that may seem unrelated and off-topic at first, but please bear with me.

    What do you know of the Real Bills Doctrine?

    I haven’t read any primary source texts like Thomas Tooke, but it seems to me that the RBD and Post-Keynesian formulations of “Endogenous Money” have an uncanny resemblance to each other. I pointed this out in a comment on a post by Daniel Kuehn not too long ago, and I had a discussion with Current and a few others about this.

    http://factsandotherstubbornthings.blogspot.com/2013/05/a-thought-on-minsky-and-rothbard-that.html?showComment=1369905368141#c6106101841211835453

    J.P. Koning also pointed me to an interesting article by Gillian Hewitson published in the History of Economics Review a couple of decades ago, when I asked him about this.

    http://jpkoning.blogspot.com/2013/06/real-or-unreal-sorting-out-various-real.html?showComment=1371330011332#c7777514137357271883

    It seems that there have been acknowledgements by Post-Keynesian economists and scholars sympathetic to their school of economic thought that the RBD and “Endogenous Money” have some sort of connection, but nothing in depth. The following piece may be something in depth, but I can’t access the whole piece.

    http://www.elgaronline.com/abstract/1840648295.00011.xml

    Finally, for more information on the RBD, I recommend people take a look at these papers by Michael N. Sproul.

    http://www.csun.edu/~hceco008/realbills.htm

    • #93 by Unlearningecon on July 7, 2013 - 3:40 pm

      RBD is definitely a theory that has a lot of appeal to me, but after reading through a few of those and also Wikipedia, I am left with the question: what asset determines the value of fiat currency? The answer ‘government bonds’ seems to be circular, since their value is determined by the value of the currency. So I am drawn back to an MMT-style answer: the value of money is determined by its ability to extinguish obligations such as tax and debt. But I am not sure how this could be quantified.

      Maybe I’m completely off the mark.

      • #94 by Blue Aurora on July 8, 2013 - 10:47 am

        So you’ve heard of the RBD before I mentioned here, right?

        There are a lot of misunderstandings about the Real Bills Doctrine floating around. The fact that the Quantity Theory of Money has overcome it in monetary theory through the passage of time and the fact that most in the economics profession lack a deep interest in the history of economics has led to a lot of misunderstandings and what not by those opposed to the RBD and what few people left today that advocate it or at least sympathise with it.

        Have you read any primary source writings by thinkers who have been classified as advocates of the RBD? Like say, John Law, or Thomas Tooke? I have read practically little-to-no primary source writings by thinkers who have been classified as advocates of the RBD, unless you count Adam Smith. (There *appears* to be some sort of dispute in the literature on whether Adam Smith was an advocate of the RBD, but I haven’t reached the parts of The Wealth of Nations which are about monetary economics and the financial system, so don’t take my word on it completely. I strongly suggest e-mailing Michael N. Sproul, who has spent a lot of time reading about the RBD and written papers on the subject…he has a better understanding of the subject than I do.)

        My hunch that the RBD and Post-Keynesian formulations of “Endogenous Money” are connected were based on inferences from readings of secondary sources and my noticing of the thinkers cited as forerunners of “Endogenous Money” like Thomas Tooke of the 19th Century Currency School and Banking School Controversy apparently had some sort of connection with the RBD historically.

        Do you see where I’m coming from with regard to the parallels between the RBD and Post-Keynesian formulations of “Endogenous Money”?

        It seems even Matias Vernengo does seem some sort of resemblance between the two.

        http://nakedkeynesianism.blogspot.com/2013/06/the-real-bills-doctrine-and-persistence.html

      • #95 by Unlearningecon on July 13, 2013 - 12:30 pm

        I have not read nay primary thinkers although I have heard of it before – I’ve seen that naked keynes article, for example.

        RBD does seem to add something to endogenous money. I’d be interested to see what empirical research on the value of money looks like.

        Interestingly, RBD seems to be consistent with Krugman’s famous ‘babysitting story‘. New money was issued, yet it was still worth 1 babysit (or whatever it was worth).

      • #96 by Blue Aurora on July 15, 2013 - 1:38 pm

        Great, Unlearningecon. It seems that both of us are up a river without a paddle on this matter until one of us manages to read the primary source works of thinkers that apparently advocated the Real Bills Doctrine (which have included John Law, Adam Smith, Thomas Tooke, and John Fullarton). I hope to read at least one primary source work by a thinker who supposedly advocated the RBD eventually and in the near-future.

        Nevertheless…did you read Michael N. Sproul’s writings on the RBD?

  24. #97 by Boatwright on July 8, 2013 - 5:53 pm

    Yikes! There is nothing like the smell of MONEY to get folks worked up.

    Group A: Those who see money as “real” in the sense that a kilowatt-hour of power or a bushel of corn is real (this is not to say that money doesn’t have real effects). Group A seems most reluctant to give up the idea that somehow economists can fine tune the value and creation of money in both idealized theory and real world economic policy. In theory they tend to see banks as autonomous institutions that must always balance their books. They seem disposed to hard (or at least firm) money theories and policy. Led by theorists such as Milton Friedman they propose that a firm hand on the “money supply” is the be all and end all of theory and policy.

    Group B: Those who see money as an abstraction. Group B believes that the economy is complex and chaotic, and that the value and creation of money is non-neutral — that it subject to the whims of policy, the fever of speculative bubbles, the effects of new technologies, etc., etc.. — that its economic and social effects are anything BUT neutral. They see banks as a large interconnected system which includes regular commercial banks, investment banks, issuers of stocks, bonds, mortgages, and other financial instruments, and central banks — all with the power to create and destroy “money”.

    For group A, it should be noted that in the same way that idealized supply/demand/price models break down when confronted with the shopping cart problem, theories of neutral money are unable to deal with the real world, multi-variable conditions under which money is created and destroyed, and inflations, deflations, bubbles, and crashes actually occur.

    Although these systems may be deterministic, meaning that their future is dependent on their initial conditions, even with no random elements involved, the deterministic nature of these systems does not make them predictable. This behavior is known as deterministic chaos, or simply chaos.
    The intractable problem for classical economic theory is the need to resort to idealized, fixed starting assumption, when in fact no such things exist in the real economy. In truth, at best we have approximations. We want to believe that we can predict and control our future, that money can be neutral, and controllable, that markets will clear, that equilibrium is the “normal” state of things, but in fact NONE of these things is provable.

    Edward Lorenz, defining mathematical chaos:

    When the present determines the future, but the approximate present does not approximately determine the future. That is, there are causes but outcomes will be unknowable to the degree that we lack knowledge about the fine details of the starting conditions. Knowledge is always imperfect, and any theory that relies on idealized starting conditions (such as “let us assume neutral money”) is flawed from the beginning.

    • #98 by Unlearningecon on July 9, 2013 - 12:13 pm

      It strikes me that group B have really won the debate empirically, as its obvious from the evidence, the way banks work and the many crises of capitalism that money can’t be more or less assumed away. But I think the way for group B to win over the public and academia is really to generate models that emulate the behaviour you have described. Many of these already exist, but a definitive model of the economy, with network effects and chaotic behaviour, would surely attract people’s attention, and be more plausible, than the neoclassical models.

      • #99 by Boatwright on July 9, 2013 - 1:23 pm

        Exactly.

        This will require a revolution in the way economies are studied, and in the way economics is taught. Standard textbooks present models as if they are self-evident. Public economic speakers too often begin an explanation of events or criticism of policy by resorting to unproven truisms.

        I am skeptical that a “definitive model” can ever be created. There will always be something new, something unseen. At best we can hope for a model that is robust and open to new information — a model that can evolve as the complexities of human behavior and the natural world demand.

        Revolutions are never easy. We can hope that young academics such as yourself will lead the way.

    • #100 by Luis Enrique on July 10, 2013 - 3:09 pm

      Group A is a ridiculous fabrication. Absolutely nobody thinks money is as “real” in the sense that a kilowatt-hour of power or a bushel of corn is real. Nobody. Not Friedman. Nobody. If by fine tuning the value of money you mean keeping inflation reasonably close to target, people still believe that. For good reasons. I don’t think anybody believes policy makers can fine tune the quantity of money.

      • #101 by Boatwright on July 10, 2013 - 4:53 pm

        “Absolutely nobody” ??? Except the legions of goldbugs. As to not thinking “anybody believes policy makers can fine tune the quantity of money”, you will have to leave out legions of politicians and public economic and financial commentators who tell us every day that that is what we need to do.

        What you say may be true among academics, but nevertheless powerful men, the Greenspans of the real world, believing they can fine tune inflation, are regularly surprised by events.

      • #102 by Unlearningecon on July 10, 2013 - 8:20 pm

        Luis you seem to make the mistake of thinking that people are attacking the economics profession as a whole, when they may well be attacking Internet Austrians or the ‘free market’ frontmen that so often represent the profession.

  25. #103 by Dinero on July 10, 2013 - 6:53 pm

    > Unlearningecon

    I agree with your comments about endogenous money , but I don’t see why it is seen as a new idea. It has been known since the time of the first paper money banks and merchant bill clearing houses of the 18th century that money is created at the time that a loan or line of credit is made.

    • #104 by Unlearningecon on July 10, 2013 - 6:54 pm

      It’s not a new idea but it’s certainly not what is taught in mainstream economics. Even moreso, economists who agree with it seem to think that their method is virtually the same somehow. See, for example, Nick Rowe go through all kinds of contortions to show the money multiplier and endogenous money are the same.

  26. #105 by Dinero on July 10, 2013 - 7:47 pm

    Yes , what he is saying there is that Banks will only go to depositors for clearing transactions when the central bank is to pricey. So he is agreeing that the idea of banks as conduit between savers and borrowers is tangental to loan creation.
    In your understanding of the banking system, do you concur that a bank can issue a cheque , to be spent by a borrower, and then owe the funds to the bank at which it is ultimately deposited, and funding it from the borrowers repayment, and so the Central Bank and savers do not feature at all.

    • #106 by Unlearningecon on July 13, 2013 - 12:13 pm

      Yes, I do!

      Though I’m a little confused as to what your overarching point is?

      • #107 by Dinero on July 15, 2013 - 12:28 pm

        I was just getting catching up with the thread here and confirming that bank transferable credit, what people call “money” does not fundamentally involve savers and deposit accounts. Which is agreement with your original post of , and critique of the text book erouneouse money multiplier concept, of course. Banks are a not a conduit between saves and borrowers thay are more so a conduit between buers and sellers.

  27. #108 by Blue Aurora on July 12, 2013 - 12:28 pm

    Perhaps I might be suffering under confirmation bias, but it seems to me that Dinero has affirmed my point – there is an uncanny resemblance between Post-Keynesian formulations of “Endogenous Money” and the Real Bills Doctrine.

    • #109 by Dinero on July 15, 2013 - 1:34 pm

      Yes true. The Historical Real bills Doctrine is a good way to start understanding what modern credit money is. Money created by loans is backed up by the value of the goods and services generated by the borrower in earning the money to fulfil their loan contract.

      • #110 by Unlearningecon on July 15, 2013 - 5:30 pm

        That’s an interesting idea, as it suggests that the value of money in an FRB system is inherently speculative. This goes nicely with endogenous money theory.

  28. #111 by Dinero on July 15, 2013 - 8:02 pm

    Yes, all human exchange is speculative.

    • #112 by Dinero on July 15, 2013 - 8:12 pm

      except barter for imediate consumtion.

      • #113 by Boatwright on July 16, 2013 - 12:24 am

        Another way to approach this concept may be in the way anthropologists look at the role of “economic surplus” in money-less cultures. The role of the “big man” in the pig economies of Papua New Guinea, the Potlatch, etc. all involve complex social interactions, debts and obligations

        Could it be that all money functioning as a claim on future surplus is by nature speculative — that is money can never be neutral — simply because a surplus may or may not actually exist in the real future, and all economic activity necessarily exists in a web of often arbitrary social values. One man holds a pig as his standard of wealth and another an entry in a bank ledger..

      • #114 by Unlearningecon on July 17, 2013 - 8:19 pm

        This topic definitely needs some more attention. I’ll look into it.

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  4. Brief Thoughts on the Real Bills Doctrine | Unlearning Economics
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