{"id":34292,"date":"2016-08-31T17:52:13","date_gmt":"2016-08-31T07:52:13","guid":{"rendered":"https:\/\/billmitchell.org\/blog\/?p=34292"},"modified":"2016-08-31T17:52:13","modified_gmt":"2016-08-31T07:52:13","slug":"indexed-bank-reserve-support-schemes-will-not-expand-credit","status":"publish","type":"post","link":"https:\/\/billmitchell.org\/blog\/?p=34292","title":{"rendered":"Indexed bank reserve support schemes will not expand credit"},"content":{"rendered":"

\t\t\t\tOn the Wikipedia page for economist Ricardo Reis<\/a> we learn he was “Influenced by: Greg Mankiw”, which basically should tell you everything. Everything that is that would lead to the conclusion that his macroeconomics is plain wrong. Yet his connections in the profession are strong and has prestigious academic appointments, is ensconced in senior editorial positions on influential economics journals, advises central banks in the US and has regular Op Ed space in a leading Portuguese newspaper (his homenation). These facts tell you what is wrong with my profession. That someone can write articles that are just so off the mark yet have significant influence in the profession and be held out in the public debate as to be someone who is worth listening to and being reported on. I have received many E-mails in the last few days about the proposal offered by Reis at Jackson Hole last week. Many readers are still confused and actually thought the proposal had credibility. Let me be clear – bank lending is not influenced by the reserve positions of the banks. Without credit-worthy borrowers lining up to access loans, the banks could have all the reserves in the world and the central bank could invoke any number of nifty ‘indexing’ or other support payment schemes on those reserves, and the banks would still not lend. And with those credit-worthy borrowers lining up to access loans, the banks will always lend irrespective of their current reserve position or the nifty support schemes the central bank might dream up. Core Modern Monetary Theory (MMT) 101!
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The paper – Funding Quantitative Easing to Target Inflation<\/a> – was presented to the Jackson Hole Economic Policy Symposium<\/a>, hosted by the Federal Reserve Bank of Kansas City, which was held last week (August 25-27, 2016).<\/p>\n

The theme for the Symposium was “Designing Resilient Monetary Policy Frameworks for the Future”.<\/p>\n

Apparently “Some 100 economists and Fed officials – each one able to fill a room if they gave a speech in New York or Washington – attend the two-day event” (Source<\/a>).<\/p>\n

It just goes to show that the neo-liberal Groupthink is alive and well if the ideas that are presented in the Reis paper are taken as worthy of filling a room of high-paid officials.<\/p>\n

We shouldn’t be surprised though.<\/p>\n

His influence – Greg Mankiw – still teaches students that central banks can control the money supply and that the textbook money multiplier is still a valid concept to learn.<\/p>\n

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.<\/p>\n

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.<\/p>\n

The second “and more important job”:<\/p>\n

\n… is to control the quantity of money that is made available to the economy, called the money supply<\/strong>. Decisions by policymakers concerning the money supply constitute monetary policy<\/strong> (emphasis in original).\n<\/p><\/blockquote>\n

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:<\/p>\n

\nFed’s primary tool is open-market operations<\/em> – 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.\n<\/p><\/blockquote>\n

This is the influence that Mankiw dishes out.<\/p>\n

It is completely fictitious account of the way central banks operate.<\/p>\n

Central banks cannot control the “money supply”.<\/p>\n

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<\/a>.<\/p>\n

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.<\/p>\n

The FRBNY article states clearly that:<\/p>\n

\nIn 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.\n<\/p><\/blockquote>\n

This is practice is not confined to the US.<\/p>\n

In reality, in a credit money system, this ability to control the stock of “money” is undermined by the demand for credit. The overall broad money aggregate (‘the money supply’) is determined as the outcomes that follow 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).<\/p>\n

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<\/a> – for more discussion on this point.<\/p>\n

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

And that brings me to the Reis paper, which was reported on by Reuters (August 27, 2016) – Fed could use reserves payments to stimulate U.S. economy: paper<\/a> – as if it contained an ingenious new idea.<\/p>\n

It is, in fact hard to know where to start discussing this sort of paper, which, sadly, represents the standard understandings in the mainstream of my profession.<\/p>\n

There are so many clangers – like:<\/p>\n

1. “The interest on reserves controls inflation” – how?<\/p>\n

2. In relation to the growing reserves in the banking system, Reis claims “The main risk is that the central bank becomes insolvent … central bank insolvency is equivalent to hyperinflation, which happens often, all over the world.”<\/p>\n

To learn why this is such a stupid claim, please read my blogs:<\/p>\n