\t\t\t\tLawrence Summers is a New Keynesian economist. That means something. While there are nuances that exist between members of that school of thought, mostly to do with policy sensitivities and speeds of adjustment, the New Keynesian paradigm has demonstrated clearly that it is incapable of capturing the macroeconomic dynamics in any consistent manner, despite it being the dominant approach in the profession. So, it is no wonder when Summers provides opinions the underlying logic he demonstrates is similarly flawed. Unfortunately, he keeps getting important platforms to express these opinions, which continues to blight the public policy debate. He was at it again when he started lecturing the US Federal Reserve Bank on the conduct of its asset-purchasing program.
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Recall that Lawrence Summers, signed a memorandum in December 1991, when he worked at the World Bank, that indicated that it would be economically efficient to send toxic waste from advanced countries to the lowest wage countries in Africa.<\/p>\n
Recall during his time as a bureaucrat in the Clinton Administration that that he was directly involved in a number of highly questionable matters.<\/p>\n
Don’t forget that he and Rubin when they ran the US Treasury were resistant to the idea that the US should participate in the Kyto protocol – see the National Archive documents accompanying this briefing – Kyoto Redux? Obama’s Challenges at Copenhagen Echo Clinton’s at Kyoto<\/a> (December 18, 2009).<\/p>\n And during this period, think about Summers and his role, with Robert Rubin and Alan Greenspan before the GFC to promote increasing financial market deregulation and his demonisation of Brooksley Born, who became the head of the US federal Commodity Futures Trading Commission.<\/p>\n She tried to warn the US government of the increasing dangers of unregulated financial markets and was undermined by Summers.<\/p>\n I wrote about that in this blog post – Being shamed and disgraced is not enough<\/a> (December 18, 2009). <\/p>\n And, the Enron scandal – Larry Summers’ Enron Problem<\/a> (November 12, 2008).<\/p>\n Recall that Lawrence Summers was warning the US government that it was dangerous to continue to be ‘dependent’ on China to fund the US deficits by purchasing government bonds.<\/p>\n And don’t forget that he has coveted the position as boss of the Federal Reserve (to succeed Ben Bernanke)<\/p>\n And many more instances of flawed analysis and judgements.<\/p>\n Most recently, Summers and his New Keynesian mates (such as, Kenneth Rogoff) have been beating up the inflation mania story – which I addressed in this two-part series:<\/p>\n 1. Is the $US900 billion stimulus in the US likely to overheat the economy – Part 1?<\/a> (December 30, 2020).<\/p>\n 2. Is the $US900 billion stimulus in the US likely to overheat the economy – Part 2?<\/a> (December 31, 2020).<\/p>\n I have made this point before, but the public debate is biased against progress because characters like Summers can continue to command a platform and are given elite access to the public via the mainstream media, even when there is a litany of failed steps and poor predictions.<\/p>\n Anyway, onto the recent Op Ed, which appeared in the The Washington Post (August 26, 2021) – Opinion: It’s time for the Fed to rethink quantitative easing<\/a>.<\/p>\n There we learn about a number of key differences between the way a New Keynesian economist thinks and the way an Modern Monetary Theory (MMT) economist understands reality.<\/p>\n Summers starts by drawing an analogy between Vietnam and Afghanistan and economic policy.<\/p>\n I won’t pursue that, but, I don’t think any American that has been close to policy has anything much to say about either US war defeat.<\/p>\n Both were disastrous choices from the outset and were always doomed to failure.<\/p>\n Yes, I know that the US could have nuked both countries and claimed victory. I have been told that before. But that doesn’t get us very far.<\/p>\n The point Summers is making in terms of economic policy is that one should have a long-term vision of where the policy will take us rather than adjust it “incrementally … to avoid near-term pain”.<\/p>\n I agree with that statement.<\/p>\n Knee-jerk adjustments to policies that are well thought out, just to appease the uninformed media etc is poor practice.<\/p>\n But I disagree with his conclusion that:<\/p>\n \n… continuing quantitative easing … has gone on for too long … [and] … cannot be justified and presents its own danger.\n<\/p><\/blockquote>\n My disagreement goes under the conclusion to his logic – the New Keynesian logic.<\/p>\n First, he claims that:<\/p>\n \nQuantitative easing is a policy of creating money in the form of providing interest-paying reserves to banks and buying up Treasury bonds and other government-guaranteed securities.\n<\/p><\/blockquote>\n Which is highly misleading.<\/p>\n Usually, we consider money to be a means of payment.<\/p>\n Commercial banks, operating under government license, are typically required to hold accounts with the relevant central bank, which contain balances that are used as part of the ‘settlement’ process to reconcile daily transactions across banks.<\/p>\n Banks don’t loan out reserves and do not need reserves to make loans.<\/p>\n Loans create deposits, which, in turn, are liquid funds that can be spent to purchase things.<\/p>\n Say Bank A makes a loan to Customer A who buys something from Seller A who also banks with Bank A. All the transactions are dealt with within the accounting system of Bank A and no reserve transactions are involved.<\/p>\n If Customer A buys off Seller B who banks with Bank B, then Banks A and Banks B reconcile the transaction through electronic accounting adjustments to their respective reserve balances at the central bank.<\/p>\n Reserve accounts are also adjusted if a customer asks their bank for actual ‘cash’ (physical notes and coins).<\/p>\n While only the central bank can create reserves, any individual bank can acquire them from another bank, which might have an excess, relative to their expected ‘clearance’ needs on any one day.<\/p>\n But, if there is an overall shortage of reserves in the banking system, then the central bank is the only source and it, historically, has provided those reserves through open market operations (buying government debt instruments, usually, from the banks).<\/p>\n Similarly, an excess reserve situation can only be resolved if the central bank drains them by selling government debt (usually).<\/p>\n I explain in this early introductory suite of blog posts why central banks will mop up excesses or provide in the case of shortages:<\/p>\n 1. Deficit spending 101 – Part 1<\/a> (February 21, 2009).<\/p>\n 2. Deficit spending 101 – Part 2<\/a> (February 23, 2009)<\/p>\n