# Money multiplier – missing feared dead

I know I said I was not going to write a blog today but I changed my mind. It will be a short blog only. I was considering the continued dogmatic assertions that mainstream economists make that the central bank still controls the money supply and that money multiplier is alive and well but has just disappeared for a while. This recent mainstream post is typical of these on-going erroneous assertions by mainstream macroeconomists about the way the monetary system and the institutions within it operate. The fact is that the monetary multiplier is not dead – I can say that confidently because I know it was never alive!

The mainstream theory alleges that the money multiplier m transmits changes in the so-called monetary base (MB) (the sum of bank reserves and currency at issue) into changes in the money supply (M). Students then labour through algebra of varying complexity depending on their level of study (they get bombarded with this nonsense several times throughout a typical economics degree) to derive the m, which is most simply expressed as the inverse of the required reserve ratio. So if the central bank told private banks that they had to keep 10 per cent of total deposits as reserves then the required reserve ratio (RRR) would be 0.10 and m would equal 1/0.10 = 10. More complicated formulae are derived when you consider that people also will want to hold some of their deposits as cash. But these complications do not add anything to the story.

The formula for the determination of the money supply is: M = m x MB. So if a \$1 is newly deposited in a bank, the money supply will rise (be multiplied) by \$10 (if the RRR = 0.10). The way this multiplier is alleged to work is explained as follows (assuming the bank is required to hold 10 per cent of all deposits as reserves):

• A person deposits say \$100 in a bank.
• To make money, the bank then loans the remaining \$90 to a customer.
• They spend the money and the recipient of the funds deposits it with their bank.
• That bank then lends 0.9 times \$90 = \$81 (keeping 0.10 in reserve as required).
• And so on until the loans become so small that they dissolve to zero.

So you should expect a fairly constant relationship between the monetary base and the measures of the money supply. Indeed, mainstream theory claims that the central bank uses this relationship to control the money supply.

In his Principles of Economics (I have the first edition), Mankiw’s Chapter 27 is about “the monetary system”. In the latest edition it is Chapter 29. Either way, you won’t learn very much at all from reading it.

In the section of the Federal Reserve (the US central bank), Mankiw claims it has “two related jobs”. The first is to “regulate the banks and ensure the health of the financial system”. So I suppose on that front he would be calling for the sacking of all the senior Federal Reserve officials given the massive collapse that occurred under their watch.

The second “and more important job”:

… is to control the quantity of money that is made available to the economy, called the money supply. Decisions by policymakers concerning the money supply constitute monetary policy (emphasis in original).

And in case you haven’t guessed he then describes how the central bank goes about fulfilling this most important role. He says that the:

Fed’s primary tool is open-market operations – the purchase and sale of U.S government bonds … If the FOMC decides to increase the money supply, the Fed creates dollars and uses them buy government bonds from the public in the nation’s bond markets. After the purchase, these dollars are in the hands of the public. Thus an open market purchase of bonds by the Fed increases the money supply. Conversely, if the FOMC decides to decrease the money supply, the Fed sells government bonds from its portfolio to the public in the nation’s bond markets. After the sale, the dollars it receives for the bonds are out of the hands of the public. Thus an open market sale of bonds by the Fed decreases the money supply.

More recently, our polite friend Mark Thoma wrote, under the heading “The Fed’s Control of the Money Supply” that:

To control the money supply, the Fed takes the multiplier as given, and then sets the MB at a level that gives it the Ms it desires.

In the September 2008 edition of the Federal Reserve Bank of New York Economic Policy Review there was an interesting article published entitled – Divorcing Money from Monetary Policy.

It demonstrated why the account of monetary policy in mainstream macroeconomics textbooks (such as Mankiw etc) from which the overwhelming majority of economics students get their understandings about how the monetary system operates is totally flawed. This is the stuff that Mark Thoma also pumps out into cyber space as some sort of truth.

The FRBNY article states clearly that:

In recent decades, however, central banks have moved away from a direct focus on measures of the money supply. The primary focus of monetary policy has instead become the value of a short-term interest rate. In the United States, for example, the Federal Reserve’s Federal Open Market Committee (FOMC) announces a rate that it wishes to prevail in the federal funds market, where overnight loans are made among commercial banks. The tools of monetary policy are then used to guide the market interest rate toward the chosen target.

This is practice is not confined to the US. All central banks operate in this way and I have shown in other blogs that central banks cannot control the “money supply”.

However, the FRBNY try to build a bridge between the two viewpoints by claiming that “the quantity of money and monetary policy remain fundamentally linked”.

How do they construct that argument?

They say that because commercial banks hold “reserve balances at the central bank” and demand “reserve balances – inversely …. [to] … the short-term interest rate”, which is the “the opportunity cost of holding reserves” then the central bank can “manipulate the supply of reserve balances” by exchanging “reserve balances for bond” (open market operations) to ensure that the “marginal value of a unit of reserves to the banking sector equals the target interest rate”.

This allows the interbank market (for overnight funds) to clear and maintain the policy rate.

The FRBNY say that “(i)n other words, the quantity of money (especially reserve balances) is chosen by the central bank in order to achieve its interest rate target”. This is, in fact, fairly loose language. It is clear that the level of reserve balances in the system are chosen by the central bank to maintain the policy rate. But using terminology like the “quantity of money” is misleading and doesn’t match the concept of the “money supply” that the likes of Friedman and Mankiw were referring to. They were in fact referring to a close relationship between the monetary base and broad money as captured by the money multiplier model.

However, that construction of banking dynamics is false. There is in fact no unique relationship of the sort characterised by the erroneous money multiplier model in mainstream economics textbooks between bank reserves and the “stock of money”.

You will note that in Modern Monetary Theory (MMT) there is very little spoken about the money supply. In an endogenous money world there is very little meaning in the aggregate concept of the “money supply”.

Central banks do still publish data on various measures of “money”. The RBA, for example, provides data for:

• Currency – Private non-bank sector’s holdings of notes and coins.
• Current deposits with banks (which exclude Australian and State Government and inter-bank deposits).
• The M1 measure – Currency plus bank current deposits of the private non-bank sector.
• The M3 measure – M1 plus all other Australian Deposit-taking Institutions’ deposits of the private non-ADI sector. So a broader measure than M1.
• Broad money – M3 plus non-deposit borrowings from the private sector by AFIs, less the holdings of currency and bank deposits by RFCs and cash management trusts.
• Money base – Holdings of notes and coins by the private sector, plus central bank reserves (deposits of banks with the Reserve Bank and other Reserve Bank liabilities to the private non-bank sector.

The US Federal Reserve no longer publish M3 time series. In the US, M2 is the M1` plus saving deposits, small time-deposits, money market mutual funds and some other small components.

To some extent the idea that the central banks controls the money supply is a residual from the commodity money systems where the central bank could clearly control the stock of gold, for example. But in a credit money system, this ability to control the stock of “money” is undermined by the demand for credit.

The theory of endogenous money is central to the horizontal analysis in MMT. When we talk about endogenous money we are referring to the outcomes that are arrived at after market participants respond to their own market prospects and central bank policy settings and make decisions about the liquid assets they will hold (deposits) and new liquid assets they will seek (loans).

The essential idea is that the “money supply” in an “entrepreneurial economy” is demand-determined – as the demand for credit expands so does the money supply. As credit is repaid the money supply shrinks. These flows are going on all the time and the stock measure we choose to call the money supply, say M3 is just an arbitrary reflection of the credit circuit. Please read my blog – Understanding central bank operations – for more discussion on this point.

So the supply of money is determined endogenously by the level of GDP, which means it is a dynamic (rather than a static) concept. Central banks clearly do not determine the volume of deposits held each day. These arise from decisions by commercial banks to make loans. The central bank can determine the price of “money” by setting the interest rate on bank reserves.

Further expanding the monetary base (bank reserves) as I argued in these blogs – Building bank reserves will not expand credit and Building bank reserves is not inflationary – does not lead to an expansion of credit.

The following graph uses US Federal Reserve data for Money Stock Measures and plots the ratio between M1 and the monetary base since 1959. M1 is the sum of issued currency, traveller cheques, demand deposits and other cheque deposits.

The ratio which is the estimated “multiplier” is clearly not constant.

The behaviour of this ratio led our favourite macroeconomics textbook writer to write in January 2009 that the Money multiplier had disappeared. He of-course didn’t realise that it never existed.

The next graph shows the relationship between the monetary base, M1 and M2 from January 1959 to May 2010. The sharp spike is the base (bank reserves) which occurred in December 2008 after a major Federal Reserve intervention is clear and drives the behaviour of the other series (\$-for-\$ virtually).

To see the more recent behaviour more clearly, this graph is constructed for the sample January 2007 to May 2010.

And finally, here is the movement in the monetary base over the same period (January 2007 and May 2010).

Obviously missing the security blanket that the money multiplier provides (what else would you write on the blackboard?), our friend Mark Thoma has offered the following explanation by way of reassurance:

The multiplier falls when excess reserves increase, and the dramatic increase in excess reserves during the crisis has caused the multiplier to fall substantially, enough to offset the increase in MB. The result is that the quantity of money actually circulating in the economy, (mult)(MB), has remained relatively constant.

So for all you addicts who need to know there “is” a money multiplier, Mark assures us that its absence is only temporary and it will be back around 2 before we get too uncomfortable. Just adopt a meditative pose and as your mantra recite “m will return”.

The problem with the current explanations of the “disappearing” money multiplier is that they are just made up. These sham-type defences of a flawed theory, remind me of the message that David M. Gordon (in his great book from 1972 – Theories of poverty and underemployment, Lexington, Mass: Heath, Lexington Books) wrote about in relation to neoclassical human capital theory. My copy of the book is in another office at present so I cannot quote from it. But the message that Gordon provided was one of continual ad hoc response to anomaly by the mainstream economists.

So whenever the mainstream paradigm is confronted with empirical evidence that appears to refute its basic predictions it creates an exception by way of response to the anomaly and continues on as if nothing had happened.

This is very notable in the way the NAIRU literature evolved. The NAIRU literature began (in the mid-1970s) with the position that the NAIRU was constant and cyclically-invariant despite early challenges from the theories of hysteresis. My early published work (from my PhD) was part of this challenge. Influenced by this literature, governments deflated their economies and pushed unemployment up.

Empirical (econometric) tests soon found that the estimates of the NAIRU were anything but constant and seemed to vary with the cycle – so rose when unemployment rose. Faced with mounting criticism, the NAIRU theorists progressively moved to a position where time variation in the steady-state was allowed but this variation is seemingly not driven by the state of demand – the so-called TV-NAIRUs.

This intermediate phase has spawned a frenetic period of estimation using a range of technical methodologies including state space techniques (Kalman filter); univariate extrapolation methods (filters and smoothers), and spline estimation.

Like the original concept, the attempts to model the time variation have been based on shaky theoretical grounds. The theory that generated the NAIRU in the first place provides no guidance about its evolution. Presumably, the evolution of unspecified structural factors have played a role, if we are to be faithful to the original (flawed) idea.

In this theoretical void, econometricians have assumed that a smooth evolution is plausible but these slowly evolving NAIRUs bear little relation to actual economic factors. The extrapolation and smoothing approaches are particularly blighted here. Some authors have the temerity to merely run a smoothing filter through the actual series and assert that this captures the NAIRU.

Most of the research output confidently asserted that the NAIRU had changed over time but very few authors dared to publish the confidence intervals around their point estimates (Staiger, Stock and Watson, 1997 were exceptions). The evidence is illuminating. Some models yield 95 percent confidence intervals of 2.9 percent to 8.3 percent which makes the range of NAIRU estimates too large to be useful.

We cover these developments in detail in my recent book with Joan Muysken – Full Employment abandoned.

The point is that the response to the anomaly was ad hoc and could not be guided by theory. The basic theory failed and so layers of fudges were added.

We are now seeing that sort of ad hocery when it comes to trying to defend the money multiplier. The bottom line is that there is nothing in the theory that tells you what is happening at present. The reason is that the theory is simply inapplicable.

Even the Federal Reserve reluctantly admits this. In a July 2009 paper, they answer their question – Why Are Banks Holding So Many Excess Reserves? in this way:

The total level of reserves in the banking system is determined almost entirely by the actions of the central bank and is not affected by private banks’ lending decisions. The liquidity facilities introduced by the Federal Reserve in response to the crisis have created a large quantity of reserves. While changes in bank lending behavior may lead to small changes in the level of required reserves, the vast majority of the newly-created reserves will end up
being held as excess reserves almost no matter how banks react. In other words, the quantity of excess reserves depicted in Figure 1 reflects the size of the Federal Reserve’s policy initiatives, but says little or nothing about their effects on bank lending or on the economy more broadly.

This conclusion may seem strange, at first glance, to readers familiar with textbook presentations of the money multiplier … we discuss the traditional view of the money multiplier and why it does not apply in the current environment …

Their conclusion is based on the decision of the central bank to pay the target policy rate on excess reserves. In fact, the inapplicability of the money multiplier is not dependent on whether the central bank does have a support rate in place.

Why is that?

As I have indicated several times the depiction of the fractional reserve-money multiplier process in textbooks like Mankiw exemplifies the mainstream misunderstanding of banking operations. Please read my blog – Money multiplier and other myths – for more discussion on this point.

The idea that the monetary base (the sum of bank reserves and currency) leads to a change in the money supply via some multiple is not a valid representation of the way the monetary system operates even though it appears in all mainstream macroeconomics textbooks and is relentlessly rammed down the throats of unsuspecting economic students.

The money multiplier myth leads students to think that as the central bank can control the monetary base then it can control the money supply. Further, given that inflation is allegedly the result of the money supply growing too fast then the blame is sheeted home to the “government” (the central bank in this case).

The reality is that the central bank does not have the capacity to control the money supply. In the world we live in, bank loans create deposits and are made without reference to the reserve positions of the banks. The bank then ensures its reserve positions are legally compliant as a separate process knowing that it can always get the reserves from the central bank.

The only way that the central bank can influence credit creation in this setting is via the price of the reserves it provides on demand to the commercial banks.

The mainstream view is based on the erroneous belief that the banks need reserves before they can lend and that quantitative easing provides those reserves. That is a major misrepresentation of the way the banking system actually operates. But the mainstream position asserts (wrongly) that banks only lend if they have prior reserves.

The illusion is that a bank is an institution that accepts deposits to build up reserves and then on-lends them at a margin to make money. The conceptualisation suggests that if it doesn’t have adequate reserves then it cannot lend. So the presupposition is that by adding to bank reserves, quantitative easing will help lending.

But banks do not operate like this. Bank lending is not “reserve constrained”. Banks lend to any credit worthy customer they can find and then worry about their reserve positions afterwards. If they are short of reserves (their reserve accounts have to be in positive balance each day and in some countries central banks require certain ratios to be maintained) then they borrow from each other in the interbank market or, ultimately, they will borrow from the central bank through the so-called discount window. They are reluctant to use the latter facility because it carries a penalty (higher interest cost).

The point is that building bank reserves will not increase the bank’s capacity to lend. Loans create deposits which generate reserves.

The reason that the commercial banks are currently not lending much is because they are not convinced there are credit worthy customers on their doorstep. In the current climate the assessment of what is credit worthy has become very strict compared to the lax days as the top of the boom approached.

Modern monetary theorists consider the credit creation process by banks to be the “leveraging of high powered money”. The only way you can understand why all this non-government leveraging activity (borrowing, repaying etc) can take place is to consider the role of the Government initially – that is, as the centrepiece of the macroeconomic theory.

Banks clearly do expand the money supply endogenously – that is, without the ability of the central bank to control it. But all this activity is leveraging the high powered money (HPM) created by the interaction between the government and non-government sectors.

HPM or the monetary base is the sum of the currency issued by the State (notes and coins) and bank reserves (which are liabilities of the central bank). HPM is an IOU of the sovereign government – it promises to pay you \$A10 for every \$A10 you give them! All Government spending involves the same process – the reserve accounts that the commercial banks keep with the central bank are credited in HPM (an IOU is created). This is why the “printing money” claims are so ignorant.

The reverse happens when taxes are paid – the reserves are debited in HPM and the assets are drained from the system (an IOU is destroyed). Keep this in mind.
HPM enters the economy via so-called vertical transactions. Please refer back to Deficit spending 101 – Part 1; Deficit spending 101 – Part 2 and Deficit spending 101 – Part 3 for the details and supporting diagrams.

So HPM enters the system through government spending and exits via taxation. When the government is running a budget deficit, net financial assets (HPM) are entering the banking system. Fiscal policy therefore directly influences the supply of HPM. The central bank also creates and drains HPM through its dealings with the commercial banks which are designed to ensure the reserve positions are commensurate with the interest rate target the central bank desires. They also create and destroy HPM in other ways including foreign exchange transactions and gold sales.

We can think of the accumulated sum of the vertical transactions as being reflected in an accounting sense in the store of wealth that the non-government sector has. When the government runs a deficit there is a build up of wealth (in \$A) in the non-government sector and vice-versa. Budget surpluses force the private sector to “run down” the wealth they accumulated from previous deficits.

One we understand the transactions between the government and non-government then we can consider the non-government credit creation process. The important point though is that all transactions at the non-government level balance out – they “net to zero”. For every asset that is created so there is a corresponding liability – \$-for-\$. So credit expansion always nets to zero! In previous blogs I have called the credit creation process the “horizontal” level of analysis to distinguish it from the vertical transactions that mark the relationship between the government and non-government sectors.

The vertical transactions introduce the currency into the economy while the horizontal transactions “leverage” this vertical component. Private capitalist firms (including banks) try to profit from taking so-called asset positions through the creation of liabilities denominated in the unit of account that defines the HPM (\$A for us). So for banks, these activities – the so-called credit creation – is leveraging the HPM created by the vertical transactions because when a bank issues a liability it can readily be exchanged on demand for HPM.

When a bank makes a \$A-denominated loan it simultaneously creates an equal \$A-denominated deposit. So it buys an asset (the borrower’s IOU) and creates a deposit (bank liability). For the borrower, the IOU is a liability and the deposit is an asset (money). The bank does this in the expectation that the borrower will demand HPM (withdraw the deposit) and spend it. The act of spending then shifts reserves between banks. These bank liabilities (deposits) become “money” within the non-government sector. But you can see that nothing net has been created.

Only vertical transactions create/destroy assets that do not have corresponding liabilities.

But what gives the unit of account chosen by the Government its primacy. Why do all the banks and customers demand it? The answer is that state money (in our case the \$A) is demanded because the Government will only allow it to be used to extinguish tax liabilities. So the tax liability can only be met by getting hold of the Governments own IOU – the \$A. Further, the only way that we can get hold of that unit of account is by offering to supply goods and services to the Government in return for their spending. The Government spending provides the funds that allow us to pay our taxes! That is the reverse of what most people think.

This process is how the Government ensures it can get private resources in sufficient quantities to conduct its own socio-economic policy mandate. It buys labour and other resources and creates public infrastructure and services. We are eager to supply our goods and services in return for the spending because we can get hold of \$A.

So the private money creation activity that is central to many progressive models misses the essential point – that the credit creation activity is leveraging of the HPM – and is acceptable for clearing private liabilities (repaying loans) only because it is the only vehicle for extinguishing one’s tax liabilities to the state.

Conclusion

It was meant to be a short blog. Sorry!

The Saturday Quiz will appear tomorrow (EAST) and the answers and discussion will appear Sunday.

I am off for 2 days to have fun – haunt some bookshops, drink cups of tea beside Sydney Harbour, and see some films etc.

That is enough for today!

### This Post Has 53 Comments

1. Ken says:

Interesting. The money multiplier is starting to remind me of Russell’s teapot.

Ken

2. Davif Schulz says:

Do I understand this correctly? The gov’t creates money, or wealth/GDP, by buying labor, by creating desire to produce via monetary incentive. Thus truly it is the people supplying labor who create wealth. What about the people getting welfare and unemployment money, and the vast majority of gov’t employees that are vastly underworked & overpaid? Thanks.

3. Ken says:

All Government spending involves the same process – the reserve accounts that the commercial banks keep with the central bank are credited in HPM (an IOU is created). This is why the “printing money” claims are so ignorant.

To be fair … when “informed” people speak of “printing money” in this context I don’t think they mean it literally … it’s pretty much understood that these are mostly electronic bookkeeping entries. Even if they don’t understand this, I’m not sure it matters, since any money thus created can be swapped on demand for paper notes.

Rather than spending energy ridiculing the metaphor, I think it would be more effective for MMT advocates to explain to the public why government spending via fresh money creation is the necessary and appropriate policy in the present circumstance. Neutralize the “printing money” bogeyman by tackling it head-on. When somebody retorts with “inflation”, simply explain that we are currently struggling with deflation, and an “inflationary” policy is just what the doctor ordered.

Ken

4. Ken says:

One more thing … I’ve had other people try to explain this, but it would be interesting to hear Bill’s take: why do governments not include their own bonds when measuring broad money aggregates, like M2, M3? One thing I’ve gathered from reading here is that government bonds are rather close to being “money”, to be point where we lump them together as “net financial assets”, and regard the ultimate mix of these entities that result from government spending to be largely a matter of indifference (except for the control of the overnight interest rate).

Does the exclusion of these bonds from the aggregates in some way reflect differences between the MMT and mainstream views of the world?

Ken

5. Ramanan says:

That is the reverse of what most people think

Lets imagine a country running persistent current account deficits. The foreign reserves do not earn enough to compensate for the leakages through the current account. Faced with dwindling losses of foreign reserves both in the central bank and the Treasury’s balance sheets, the government needs to do something. There is an oil purchase to be made by a state-run corporation and the government needs to finance its purchases. The international money markets which holds a lot of bills and bonds are figuring out what to do with the upcoming debt maturity. The State is facing issues with the bid/cover ratios and rising yields. …

The State funds the citizens who fund the government. The State doesn’t fund the international money markets or the currency markets. The State has to fund its purchases by hook or crook and agree to the currency markets’ demands. The currency market is under no compulsion. The State can ask the Treasury to ask the central bank to allow an overdraft or monetize the debt. If debt monetization is a non-sequiter, I don’t mind changing the wording to say that the State issues less securities than the deficit. Doesn’t help. The currency markets which is invested in the near-maturity debt makes a capital flight when its bank account is credited.

The currency market is the Creditor. The State is the Debtor. The State is the Debtor.

6. Regarding Mark Thoma’s ‘victory lap’ response:

1. I believe that Charles Goodhart has also contributed to the literature (if I recall correctly he criticised the money multiplier in one of his early books ‘Money, Information and uncertainty’. There is also mention of the history of Chartalism in medieval kingdoms). Anyway, I think you’ll find the following quote from Goodhart supports the heretic position:

…simple observation of the way that central banks and money markets actually behaved would reveal that this was the exact reversal of the truth. The process started with the Central Bank determining its official short-term interest rate, in pursuit of its current policy objectives. The demand for bank borrowing, at the chosen policy rate, was the main determinate of the growth of monetary aggregates. Given M, the multiplier worked effectively in reserves, to determine the amount of base money that the authorities had to make available to the banking system to sustain their initially chosen interest rate (Goodhart, 2004, p.3)

This behaviour of Central banks – setting the interest rate and meeting the demand for reserves at to maintain that rate – is consistent with the Reserve Bank of Australia’s position:

The Reserve Bank has no prescribed target for the level of settlement balances [reserves], supplying whatever amount is needed to keep the cash rate near the target (RBA, 2003, p.4)

The previous governor of the Reserve Bank of Australia has this to say regarding the money multiplier:

When the dust has settled and statistics collected, it will be seen that there is a reasonable relationship between the cash base … and bank deposits. IT is this relationship that has traditionally been referred to as the multiplier between money base and money supply, but as the forgoing suggests, causality between the two variables is a complicated process and not a mechanical one, as estimated equations for the multiplier would imply. The main channel of causality runs from interest rate to deposit growth and then cash or bank reserves. The multiplier shows a simple supply relationship but that is because it leaves out the chain of causality (Macfarlane, 1984, p.116)

2.Regarding the ‘reserve effect’ that Bill describes in his post is something which I believe the RBA would not find difficult to accept:

In a world where the Reserve Bank was undertaking no open market operations, the amount of cash that underpins the market [exchange settlements or reserves] would depend on the Government’s fiscal balance. And it is not hard to see that this would be likely to result in monetary instability. Any government deficits not financed by an exactly coincident issue of debt to the public… would mean a rise in cash and a fall in interest rates. Similarly, a surplus not exactly matched by debt retirement would lead to a shrinkage of the amount of cash and an escalation of interest rates. (Macfarlane, 2001, pp. 15-16)

3.As to Mark Thoma’s assertion that because the Post Keynesian theory of endogenous money is absent from mainstream literature and therefore not credible, this works both ways. It might also be because like any field of thought there will exist different and sometimes contradictory paradigms. If there is a dominant paradigm and if you reject the hard core believes of that paradigm (e.g. ontological and methodological) then you are essentially an outsider and communication with the paradigm from the outside is difficult to impossible – that is if they have even heard of you. This has consequences for heterodox economists and heterodox journals, as the former will be forced to publish in non-mainstream journals and the latter will be ranked poorly – the ranking of journals also has a self reinforcing effect: establishing and defining common belief and influencing the development of economic students towards these ‘prestigious’ journals. With this in mind, I find it hard to accept assurances that because the endogenous theory of money is not in mainstream textbooks or journals it is somehow a ‘second-rate’ theory. To accept this would be to ignore the sociological factors mentioned. (see for more detail: History of heterodox economics : challenging the mainstream in the twentieth century – Frederic Lee).

Here’s hoping that some debate will come of this. Personally, I also hope that Mark Thoma is right. As a student currently studying economics it would be a relief to know that what I am learning from the textbooks actually reflects reality and not the logically constructed fantasy land that I suspect mainstream economics is.

Sources:
Goodhart, C.A.E. 2004. “Monetary and Social relationships” presented at: Eighth Annual Conference of the European Society for the History of Economic Thought, Venezia and Treviso. [Accessed from a thesis paper]
Macfarlane, I. 1984 Methods of Monetary Control in Australia. Reserve Bank of Australia Bulletin, 110-23 [Accessed from a thesis paper].
RBA. 2003. The Reserve Bank’s Open Market Operations”. Reserve Bank of Australia Bulletin, June 1-7.

7. Ramanan says:

Plus the processes provoking rapid currency falls in the exchange markets and a threat to the acceptability of the State’s currency in international markets.

8. >It will be a short blog only

Seriously .. Is this metric or imperial ?

9. Motu says:

“For every asset that is created so there is a corresponding liability – \$-for-\$”

Sorry but can someone explain this to me? If I borrow \$100 (asset to me, liability to the bank) from a bank and they demand \$120 (asset to the bank, liability to me) back how do the asset and liability correspond exactly? Aren’t there only 2 places that the excess \$20 can come from; other credit that has been created or net financial assets?

Surely if banks en masse are demanding more than they lend the only way this can occur is if they end up with all the net financial assets created (which does indeed seem to be what happens!)?

Thanks

10. Ken says:

Exactly how does the mainstream account for the behavior of the money supply in countries with no reserve requirement … presumably the “multiplier” in this case would approach infinity …

Ken

11. Motu,

I may be wrong but this is my take:

Why is the bank demanding the extra \$20 if you borrowed \$100? Are you including interest that needs to be repaid? Because interest is not a balance sheet item, it’s in the income statement (correct me if I am wrong).
The creation of all financial assets must create a financial liability that is exactly equal. So in the aggregate when the private sector expands its balance sheet (all else equal) this must net to zero, as all financial assets have a matching liability \$ for \$.

12. Richard says:

Bill

You wrote: “The point is that building bank reserves will not increase the bank’s capacity to lend. Loans create deposits which generate reserves.”

OK, but do the bankers realise this? Is there any evidence available?

I know it is a very simplistic question (I’m a beginner in all this) but, as Bill says economic text books and University courses teach otherwise, why should students believe anything other than they are taught? They have the answer that will get them a degree in most Universities. (Clearly, there are exceptions).

You can then continue the thought by asking ‘do the politicians, regulators and lawmakers have the same misconceptions?’ and ‘What about the general public?’

I enjoy flying kites:-
So, does 40 years of misleading information need to be undone? Probably and its a big task. Where to start? The educators won’t willingly admit that they are teaching incorrectly, so maybe we need to try to educate the general public [those that care] to ask the right questions – in the UK, this might be Members of Parliament, particularly those involved with committees with a financial affairs interest. (US and AUS too). Perhaps a cheap, small primer using the material spread throughout Billy Blog would start some questions being asked? An MP showing up and shaming a banker in front of a house of Commons committee might just start useful publicity that mainstream economists don’t have a clue!

Could it be done and made freely available on the web? I’d willingly download it, print it and send it to my MP. I cannot force it to be read though.

Regards

Richard

13. Can anybody answer me these questions, because I’m obviously missing a piece of the puzzle here.

You say:

“If they are short of reserves … then they borrow from each other in the interbank market or, ultimately, they will borrow from the central bank through the so-called discount window. They are reluctant to use the latter facility because it carries a penalty (higher interest cost).”

– If this is the case, why do credit checking? Why not simply lend to everybody who will take a loan at a rate greater than the cost in the discount window.

– In this sort of setup how do banks go bust? Surely they could just lend and continue drawing via the discount window regardless for the quality of loans or default. Who or what calls time on a bank behaving badly? If that is a regulatory body, then surely then can constrain access to reserves that way (by saying that they will withdraw access to the discount window).

– Is it the regulatory threat of withdrawal of access to the discount window that causes banks to come up with a rational lending criteria?

So isn’t it the case that the driver is follows: discount window access regulations leads to rational lending criteria which leads to a limit on loans made and therefore a restriction on the use of the discount window and it is this that caps reserves.

Or am I completely confused here?

14. CharlesJ says:

Bill et al.
Motu wrote: “Surely if banks en masse are demanding more than they lend the only way this can occur is if they end up with all the net financial assets created (which does indeed seem to be what happens!)?”

I’m confused about this too. There is alot of talk about “debt money”, and I think this is what they are getting at. Those that see this as a problem see “sovereign money” as the solution. I’d like to know if (in MMT) there is some kind of fundamental problem with this debt-money arrangement.

Kind Regards
Charlie

15. anon says:

The MMT group might consider getting a LOT more aggressive on the issue of the multiplier. It’s fundamental. To use Randall Wray’s colourful language, there is a population of blogosphere economist offenders that require “bitch slapping” on this issue. The usual suspects, in order of frequency/intensity of egregiousness, are:

Sumner, Thoma, Beckworth, and Rowe

Feel free to add to the list.

16. Dear Bill

I hope you don’t mind a little monetarist heresy thrown in here – a monetarist by my definition is someone who believes a simple maxim: It’s The Money System……I never call people stupid.

My reading of this yet another excellent post is that it provides proof positive that the ‘money-multiplier-mechanism’ is flawed by the concept of pushing on a string – the result being a lack of adequate circulating medium given humongous quantities of excess reserves.

The last time I raised some basic monetary reform principles with you, the dialogue got a little confused by your presentation (oft-repeated) that monetarists are proven failures and casting most of them in the Austrian camp. I have tried several times to get you ready for the attack from the left-flank and that s why I’m here today.

The so-called fractional-reserve banking system, more correctly the private system of public-servitude using debt-based money, is the cause of both the deficit-mania you often challenge here and the evolving recession-soon-to-be-depression.

I very much appreciate your realism that a sovereign national monetary system is capable of creating the money needed for public purposed economic objectives like full-employment and the rest. Sorry, Bill, but you guys are missing the boat. It’s the Money System.

Pete and I at economicstability.org have begun posting discussions around what my Dad always said was the best piece of monetary-economic works of his lifetime, a 40-pager by Douglas, Graham, Fisher, et al, titled A Program for Monetary Reform.
We have an electronic version of the document thanks to some help from our friends and it is available here:

with apologies for my linking skills.

Whereas you prove by research the fallacy behind one of the neo-liberal monetary economists tenets regarding the money-multiplier, it was painfully self-evident to the authors back in 1939 and they wrote the purpose of the Program as:
“It is intended to eliminate one recognized cause of great depressions, the lawless variability in our supply
of circulating medium.”

Lawless-variability equates with a broken multiplier.

Their solution has many of the elements I have advocated for here occasionally.
They have this to say relative to fractional-reserve banking:

The Fractional Reserve System
(9) A chief loose screw in our present American money and
banking system is the requirement of only fractional
reserves behind demand deposits. Fractional reserves give
our thousands of commercial banks power to increase or
decrease the volume of our circulating medium by increasing
or decreasing bank loans and investments. The banks thus
exercise what has always, and justly, been considered a
prerogative of sovereign power. As each bank exercises
this power independently without any centralized control,
the resulting changes in the volume of the circulating
medium are largely haphazard. This situation is a most
important factor in booms and depressions.

Bill, and other progs, please note – “what has always, and justly, been considered a prerogative of sovereign power”.
Of course, this creates two imperatives for those noted economists – one is with what do we replace the fractional system?

The 100% Reserve System
(10) Since the fractional reserve system hampers effective
control by the Monetary Authority over the volume of our
circulating medium it is desirable that any bank or other agency
holding deposits subject to check (demand deposits) be required
to keep on hand a dollar of reserve for every dollar of such
deposit, so that, in effect, deposits subject to check actually
represent money held by the bank in trust for the depositor.

And then, having removed the ability of private bankers to create the nation’s circulating medium, they address the replacement mechanism of monetary sovereignty (hint above in Monetary Authority).

Government Creation of Money
(12) Under a 100% requirement, the Monetary Authority
would replace the banks as the manufacturer of our
circulating medium. As long as our population and trade
continue to increase, there will, in general, be a need for
increasing the volume of money in circulation. The
Monetary Authority might satisfy this need by purchasing
and retiring Government bonds with new money. This process
would operate to reduce the Government debt. This means
that the Government would profit by manufacturing the
necessary increment of money, much as the banks have
profited in times past, though, they do not and cannot
profit greatly now because of the costly depression,
largely a result of their uncoordinated activities. That
is, the governmental creation of money would now be
profitable where the bankers’ creation of money can no
longer be profitable, for lack of unified control.

And then finally, they address the matter obviously before us, the inevitability of failed monetary policy under fractional-reserve banking.

The 100% Reserve System May Be Inevitable
(17) There are two forces now at work which are tending
silently but powerfully to compel the adoption of the 100%
reserve plan:
(a) Short-term commercial loans and liquid bankable
investments other than Government bonds are no longer
adequate to furnish a basis for our chief medium of
exchange (demand deposits) under the fractional reserve
system. Capital loans are inappropriate for this purpose.
As time goes on this inadequacy will grow far worse. Under
the present fractional reserve system, the only way to
provide the nation with circulating medium for its growing
needs is to add continually to our Government’s huge bonded
debt. Under the 100% reserve system the needed increase in
circulating medium can be accomplished without increasing
the interest bearing debt of the Government.

You, and we, are here.

So, Bill, there you have it. A friendly address from the social science school of Frederick Soddy, recalling that the result of his original scientific finding was that fractional reserve banking is a confidence game.

Games up.
With my apologies for the length to all of Bill’s readers.
All the best.

17. Do I understand this correctly? The gov’t creates money, or wealth/GDP, by buying labor, by creating desire to produce via monetary incentive. Thus truly it is the people supplying labor who create wealth. What about the people getting welfare and unemployment money, and the vast majority of gov’t employees that are vastly underworked & overpaid? Thanks.

The government creates money, which is not wealth/GDP which is used to buy goods and services. The goods and services are produced with resources – labor, equipment, infrastructure, and natural resources. Just as commercial banks create money when they lend, which is used to purchase goods and services.

It is truly people working with tools and supporting infrastructure and materials provided from natural resources the produces wealth. Splitting off the contribution of labor alone from the contribution of wealth harvested from natural systems is like asking with blade of the scissors does the cutting, which is why in mainstream microeconomics the default model abstracts out natural resources. Neoclassical economics in its early years, after all, was driven by a desire to squeeze land out of classical value theory to undermine George and the Land Tax crowd.

And if we want to find the premier examples of “massively high” pay/effort, we would not look to government workers, but rather to the corporate boardroom and the speculators in financial markets. Indeed, under the Fordist regime before the Neoliberal regime took over, the trade-off that government workers normally made was a bit lower pay than their private sector equivalents, but better job security and good pensions.

If the inequalities have been reversing, it seems more accurate to characterize that as private sector pay at lower levels in the hierarchy being squeezed down in order to raise both profit income and senior executive income,

18. nmtdoc says:

Add to the above list all the morons engaged in hyperbole over at ZeroHedge, Mish Shedlock, and Minyanville. As of late I have been spending time trying to cross pollinate the financial media with Bill’s work, and have been sending e-mails to everyone I can think of at the Huffington Post, Robert Reich etc. If more of us do this we may get a foot hold.

19. f this is the case, why do credit checking? Why not simply lend to everybody who will take a loan at a rate greater than the cost in the discount window.

Because the banks do no generate income at the time that they lend for most loans, and only a small fraction of the income in mortgage lending. However, they generate liabilities equal to the size of the loan: they have to be able to clear the loan check. The liabilities are backed by the loan contract, and only covered with the income generated when the loan is paid back.

This is why the collateralized mortgage instruments had such massive moral hazard … the income generated for the originator with these was the origination fee, with the financial assets at risk covered as soon as when the instruments were first sold in capital markets. If some idiot would believe a false rating and buy the instrument, then they would obviously be happy to originate a loan to NINJA borrowers … No Income, No Job or Assets.

The job of mainstream economists in this was to provide mainstream models that systematically undervalue systemic risks, to be used as CYA to pretend that the whole process was not making bad loans in pursuit of middleman income.

20. As with any multiplier, the money multiplier is a model of a positive feedback loop where the feedback is at a relatively stable fractional rate. However, in the real world, the feedback is not relatively stable, but is subject to active management by commercial banks as they balance higher rates of return versus higher risks of default and underperformance for lending versus holding sovereign bonds.

21. Motu says:

MDM; however the bank accounts for it they are creating \$100 and asking for say \$120 (\$20 interest) back. That \$20 has to come from somewhere and as far as I can see there are only 2 places… other peoples/businesses bank created money or net financial assets. If you put 10 people in a room and lend them all \$100 and ask them all for \$120 back the only way this is possible without net financial assets already being in circulation is if at least 2 people end up with \$0 and are unable to pay the bank back. However, if there are net financial assets in circulation it *is* possible to pay back \$120 each but only by draining \$200 of net financial assets from circulation.

So either people end up broke or the banks end up with the net financial assets. Either way we lose.

22. markg says:

Motu,
William Hummel has an excellent site “Money, what is it, how it works”. He answers your question on interest in the article “The Interest Time Bomb”.
I agree with Ken on his comment about countries with no reserve requirements. Surely Ben B must have at sometime in his career stumbled onto this fact. Why did he think flooding the banks with reserves would increase bank lending?

23. Min says:

“Students then labour through algebra of varying complexity depending on their level of study (they get bombarded with this nonsense several times throughout a typical economics degree) to derive the m, which is most simply expressed as the inverse of the required reserve ratio. . . .

“The formula for the determination of the money supply is: M = m x MB.”

Pardon me, but this the kind of thing that drives me batty about economists. According to the derivation, that should be

M < m x MB

That's high school math.

24. Min says:

Ramanan: “There is an oil purchase to be made by a state-run corporation and the government needs to finance its purchases. The international money markets which holds a lot of bills and bonds are figuring out what to do with the upcoming debt maturity. The State is facing issues with the bid/cover ratios and rising yields. …

“The State funds the citizens who fund the government. The State doesn’t fund the international money markets or the currency markets. The State has to fund its purchases by hook or crook and agree to the currency markets’ demands.”

I take it that you are talking about a state that needs U. S. dollars in order to purchase oil. Right?

25. In attacking NAIRU, Bill throws a baby out with the bathwater.

Like Bill, I’ve always been irritated by the simpletons who think that the NAIRU relationship can be measured accurately. On the other hand, all other things being strictly equal, there has to be SOME relationship between employment levels and inflation. If not, then abolishing unemployment is easy: just bump demand up to astronomic levels with a helicopter drop. What are we waiting for?

If find NAIRU an indispensible theoretical concept or piece of shorthand, and will continue to use it. The fact that it cannot be measured or quantified is irrelevant. The square root of minus one is indispensible in maths, but no one knows what it is.

26. Min says:

Ralph Musgrave: “Like Bill, I’ve always been irritated by the simpletons who think that the NAIRU relationship can be measured accurately. On the other hand, all other things being strictly equal, there has to be SOME relationship between employment levels and inflation.”

Perhaps I have misunderstood, but I thought that NAIRU did not mean that there was some relationship between employment levels and inflation, but that there exists a level of employment above which there is a hyperinflationary spiral. That is a rather strong claim.

27. Ken says:

markg ….

Interesting that you mention Hummel …. I learned a lot from his online material.

Although he clearly understands the MMT viewpoint, he is somewhat critical of it. For example, see:

http://tinyurl.com/29fsynk

Hummel is an engineer by training, not an economist. However, I would find a debate/discussion between him and Bill very interesting….

Ken

28. Ken,

I would disagree with your statement that “he clearly understands the MMT viewpoint.” He gets a lot closer than most other critics, but he doesn’t completely understand. The fact that he goes back to the founding of the nation to critique the “spending precedes taxes” point demonstrates this, as it’s always been acknowledged that the US was not originally a sovereign currency issuer.

29. Motu says on Saturday, July 17, 2010 at 1:46

however the bank accounts for it they are creating \$100 and asking for say \$120 (\$20 interest) back. That \$20 has to come from somewhere

That \$20 is income, it comes by taking a slice of income flows. If it is not spent again but instead is retained (as when a bank must make good losses), then it is a leakage and essential comes from an equal amount of injection, after having recirculated the average amount of times for that nation’s income/expenditure loop … but if it goes out to wages and salaries and operating expenses, any of it that is spent on newly produced goods and services takes another kick around the income expenditure loop.

The \$100 in principal that is created is either retained in circulation as money by rolling over into new loans, or is destroyed as money by not relending. The interest is paid out of funds in circulation and often continues in circulation as the bank spends or distributes it.

30. Min says on Saturday, July 17, 2010 at 7:24

Ralph Musgrave: “Like Bill, I’ve always been irritated by the simpletons who think that the NAIRU relationship can be measured accurately. On the other hand, all other things being strictly equal, there has to be SOME relationship between employment levels and inflation.”

Perhaps I have misunderstood, but I thought that NAIRU did not mean that there was some relationship between employment levels and inflation, but that there exists a level of employment above which there is a hyperinflationary spiral. That is a rather strong claim.

Yes, the formal models have inflation acceleration operating as a proportion of the existing rate of inflation, so there is no way to express a position that raises inflation a notch but not in an ongoing way. Bear in mind that the mainstream models are typically closed in a way that assumes or introduces an automatic tendency to full employment. That leaves full employment as an long-run equilibrium of the system. And so turning that around, any increase in inflation is symptomatic of being above “true” full employment … and pressing aggregate demand up beyond actual full employment is indeed the launching pad for hyperinflation within the logic of the model.

Historically, hyperinflationary episodes have normally come from foreign exchange rate meltdowns in economies that are structurally dependent on imports … without the option to simply not purchase imports and rely on domestic production in its stead, more and more domestic currency is required to obtain the necessary imports, and that contributes to the ongoing meltdown in FX markets. The Confederate States in the 1860’s, the Weimar Republic, Brazil in the 1980’s, Argentina at the turn of the century, Zimbabwe … the hyperinflation leads to a breakdown of the ability of the sovereign currency to act as a store of value, and with its loss of status as full fledged money, an important economic policy tool of a national government is undermined.

And, the assumption that the system tends toward full employment is false, and so in the real world it is quite possible to have a level of employment that an economy has not adapted to and which generates higher inflation without necessarily being economic conditions that risk accelerating rates of inflation.

However, it is quite handy for rentiers to conflate some modest increase in the rate of inflation with entering the early stages of hyperinflation, since otherwise the risk of slightly higher rates if inflation in return for broad based strong employment conditions and broadly distributed rising real incomes would be a trade lots of people would gladly accept … including the large majority of small business owners earning well below the top few percent of the income ladder. And keeping a false model of their personal financial interests in the minds of those small business owners is important for maintaining the neoliberal political economy.

31. Davif Schulz says:

Ken/anyone, why on earth do ‘we’ not want deflation? I worked hard and saved my money, and I bought a home in ’01 and sold it to someone this year for far more than I paid (including real costs) and far more than it’s worth (to me). I have cash in hand, and worked to ensure I’m up-to-date in my field and always employable with a rainy day fund that’d last decades, so I can only benefit from deflation. If others suffer it, so what? I say f–k ’em. They had a field day buying things they couldn’t afford, and it’s high time I get to buy things at a reasonable non-bubble price.

32. Min says:

@BruceMcF

Many thanks for the explanation. ๐

33. Min says:

@David Shulz

Why not deflation? This is not a very informed opinion, but let me take a stab at it.

Money has at least two functions, as a medium of exchange, and as a store of value. As BruceMcF pointed out, with hyperinflation you lose the function of being a store of value. OTOH, deflation reduces the function of being a medium of exchange. That means a stagnant economy, as money does not circulate freely enough. It is not true that if you have savings you can only benefit from deflation. While you will do better than those who have not saved, you will lose through economic stagnation. There will be goods and services that are not available to you that would have been available without deflation.

History seems to show that a moderate rate of inflation strikes the happy medium. And when inflation is stable, you can invest your savings safely to keep up with inflation, or even to grow faster than inflation. ๐

34. Punchy says:

If I and every other borrower cant find productive things to do with borrowed money we dont borrow so we dont create deposits (or jobs).
If the private side cant find profitable things to do with the money then the State should step in and fill the gap until the private sector starts to pick up profit for risk again. But what will happen when the existing (not new) borrowings are not producing as we expected at the same time new opportunities are negative. We sit arround doing nothing or worse retrench existing borrowings. Add a Gov that is determined to spend less not more and we will not just have a doubble dip we will have stagnation or worse.
A question then. What causes inflation or deflation? (anyone) Point me to the right reading material if you cant explain it here. Thanks Punchy

35. Greg says:

David

You exemplify the problem, as I see it, perfectly. Why as a saver should you have a guarantee to forgo buying something today and be guaranteed to get it next year or the year after that? If you want something, get it now. If there is nothing you want….. fine. Dont expect anyone or anything to reward you later for either 1) choosing not to purchase something earlier or 2) not needing something earlier. There is nothing more virtuous about forgoing consumption that you dont need. Our obsession with providing hoarders with a continuous store of monetary value has put a strong deflationary bias on our economy.

36. Davif Schulz says:

Greg, don’t expect to steal my tax money to create gov’t waste-fuelled inflation to bail you out of your unaffordable debt purchases, malinvesments, and need for instant gratification. All I see among inflation proponents is people who want a free ride at the expense of those with sense and self-discipline.

37. Greg says:

First off David, you know NOTHING about my personal spending and saving habits. I’ll bet my debt load is a lot lower than yours. That being said, I dont expect that everything I decided not to buy yesterday will be as affordable to me next year. I dont think Im exhibiting any more virtuous behavior by NOT buying a BMW and going with a ’99 Altima, I’m not a better person because I have a mortgage that can de serviced with less then 12% of my take home pay. I’m also not sitting here DEMANDING that my savings get some arbitrary level of return that insures me todays living standards in 20 yrs. My saving is no more important to the economy than someone elses, or even my own, consumption. I do believe in not needlessly wasting resources but I also believe that letting savers hold consumers hostage is wrong headed. Germans are not more virtuous because they produce more than they consume and it is not a model of “proper” economic behavior to do so. For every Germany there must be someone consuming more than they produce or you have excess.

38. Gamma says:

People who suggest that the increase in excess reserves does not have the POTENTIAL to be highly inflationary have not really thought about it too much. The analysis I see here and elsewhere is superficial.

How did the large increases in excess reserves come about? It happened because the Federal Reserve bought large amounts of financial assets (mortgage-backed bonds and agency bonds) mainly from US commercial banks.

So now instead of holding somewhat toxic MB securities, these banks now hold balances with the Federal Reserve. Which position is more conducive to lending? As Bill says, banks are not “reserve constrained”, but they are capital constrained, and having switched some of their mortgage portfolio for fed funds, the banks have a better capital position than they did before.

39. anon says:

Gamma. That’s correct. Their lending position is better because of their improved capital position. But that’s got nothing to do with replacing nominal reserves with loans because of some multiplier process, which is the nature of the erroneous argument that’s typically made by those who don’t understand this. The banks don’t need the reserves to make loans anymore than they need treasury bills to make loans.

40. Bill: “But the message that Gordon provided was one of continual ad hoc response to anomaly by the mainstream economists.
So whenever the mainstream paradigm is confronted with empirical evidence that appears to refute its basic predictions it creates an exception by way of response to the anomaly and continues on as if nothing had happened.”

This is the situation that Thomas Kuhn observes as the chief precursor to a paradigm shift in science. Ad hoc patches are added to a theory to resolve anomalies as they arise in the course of doing normal science, until it is clear that the explanatory power of the old paradigm is insufficient, and it gets replaced by a new one with greater explanatory power. Kuhn provides historical evidence for this in The Structure of Scientific Revolution.

41. Sergei says:

There is a quite prominent though very hysterical Russian blogger (to the tunes of zerohedge) which has been rolling out for quite some time already a non-sense along these lines:

– Fed stopped publishing M3
– There are some “shadow” estimates and they look ugly
– Debt is increasing extremely fast
– Debt is approaching shadow estimates of M3
– Crisis is coming since there will be not enough money to purchase new debt
– Shop gets closed

And a lot of people listen. Moreover they come to him (his blog) and say “Sensei, what do you think about this and that and meaning of life and whether I should get pregnant and maybe from you”. Well, last part is exaggeration but in Europe we can still afford some harsh jokes ๐

I tried to engage this guy several times into discussion but his standard approach is arrogance and banning account from commenting on this blog. So much different from Thoma guy.

42. David Schultz,

If governments run persistent surpluses peoples have the choice of either lowering their standards of living or indeed maintaing it through credit.

In many cases living on credit is not an example of greed but one of sheer survival in a society that benefits some at the peril of others.

I’m glad that you are doing well but I am also saddened by the fact that many others are not as fortunate and through no fault of their own.

43. Obrigado Bill, it’s a great post.

44. cityeyrie says:

@David shultz and @Greg: whether individual Joe Bloggs are spending or not spending is kind of beside the point – although it might help if Joe at least demanded better products than the piles of Chinese crap on offer at WalMart. More than the amount of it or even who or what actually creates it, the main problem to my mind is that most of this credit/money is not going towards facilitating the infrastructure and jobs which actually need doing, it’s going towards empty speculation in non-products like derivatives. Your hard-earned tax dollars are going towards keeping bankers in yachts after they’ve gambled their own credit line away. Rampant consumer debt spending has merely been a convenient smoke-screen for the trillions they’ve been moving around piling bet upon bet, and collecting fees for doing so. As long as we’re addicted to debt for plastic nonsense or the latest gizmo, how can we complain?

I’m afraid Mother Nature will call in the final debts anyway.

Great post, Bill.

45. Punchy says:

Bill Said :Further expanding the monetary base (bank reserves) as I argued in these blogs – Building bank reserves will not expand credit and Building bank reserves is not inflationary – does not lead to an expansion of credit.
If I have my understanding right now an expansion of money suply is not inflationary at all. But a substantial increase in borrowings (which is real money suply increase) would be inflationary at least for assets classes.
So all the talk about the FED printing money does nothing if the Gov of the day cant get borrowers to take the money and use it.
It follows then that if current borrowings stay the same and no new borrowers want to borrow more money we have stagnation.
If borrowing is negative then we will have real negative GDP and unemployment will result.
So in a way Keen is right to focus on borrowing? He goes on and on about it being the most important thing to watch.
Anyway in the end I am finding MMT quite understandable and even a bit obvious. Hope it catches on.

46. Punchy says:

Bill Said in an earlyer post.
Inflation occurs when there is chronic excess demand relative to the real capacity of the economy to produce.

I think this clears it up for me now. The key is inflation has to be cronic or trending before its a real problem. Interesting though how inflation is most obvious and easy to track in asset classes as opposed to goods and services. The Australian Reserve Bank seems to have descovered recently that inflation in asset clases especially Real Estate cant be ignored the way it has been. The RBA must now hope the Real Estate bubble deflates over the next 10 years or so because if to goes with a pop the RBA will get the blame for ignoring it for years.

47. flow5 says:

The expansion coefficient doubled from 1947 to 1975 (28 years). It doubled again from 1975 to 2003 (28 years). From 2003 until today (8 years), it has almost doubled again (.88%). I.e., contrary to the pundits, the money multiplier hasn’t contracted, it has expanded (i.e., the denominator has fallen).

48. flow5 says:

“as the demand for credit expands so does the money supply. As credit is repaid the money supply shrinks”

No, you confuse the supply of money with the supply of loan-funds.

49. jess says:

Iยดm very confused on this top…i need to understand commercial banking practise has an impact upon the money multiplier and you seem to understand it, could you please enlighten me as the more i read the more confused i get!! Thank you

50. Boris says:

This is such a good post.
The last 13 or so paragraphs before the Conclusion (starting around “Modern monetary theorists consider…”) are MMT so greatly distilled that it’s almost a shame that in 2020 this is burried so deep in the blog and then again in the post. It’s the core of MMT in a nutshell. Sentence after sentence of the facts without a single word of fat. Beautiful writing.
Will probably end up using these paragraphs as my main “executive summary” reference from now on. Thank you.