Money. Doing it Right this Time.

I'm agnostic on whether tax breaks for the wealthy stimulate an economy well, but it seems rather pointless to do it when the federal funds rate is hugging zero, considering any additional savings aren't going to bring it any further down.


Look at Integral's post above and his work explaining Aggregate Demand. Now his approach and my approach to AD have some differences, but if I'm understanding him right, we both have AD in a critical spot in dealing with economic growth. In short, you need AD to grow in order for the economy to grow.

Now how that relates to the tangent of supply side theory is that SST does nothing for AD in the short run, and is harmful to AD in the long run. It does not boost purchasing power now, and it cuts into purchasing power in the long run the deficits it causes now.

What SST proponents ignore is that, first, business people and investors act self-interestedly, within the bounds of what they know. What this means is that you never get business investment except with the reasonable expectation of being able to make a profit on it down the road in the term of sales. No expectation of sales equals no business investment. In order to justify SST, it was necessary to rehabilitate Say's Law. Under Say's Law, it is assumed that there will be the purchasing power to buy whatever is produced. However we know from Keynes that Say's Law is bunk. It does not apply in the real world. Hell, in the dozen econ textbooks I have remaining from when I was in school, over the whole dozen there's about 1 paragraph on Say's Law, and that is only to explain why it fails. It is not just that it is that far out of the mainstream, but that it really is on the ash heap of history. But SST doesn't work without it, and so it had to be rehabilitated. The second major point that SST proponents have wrong is the concept that Savings = Investments. Now here they are on at least conventional economic ground. S=I is pretty much taken as a given. However, it is wrong. Why? Because in an open economy that S can go overseas as easily as it can be spent or invested here. And it can also be used to bid up the price of existing assets rather than create new ones. So in a world where money can flow across national borders, and one in which the prices of assets can be bid up to create bubbles, S=/=I. And so SST fails on that regard as well.

So SST requires that two failed theories must be true for SST to be true. Real world evidence? Zero net new private business investment in 8 years that Reagan was president. Zero private sector job creation in 8 years that Bush was president. Exploding federal debt. Destabilized financial system. Bubbles, bubbles, everywhere. So you decide.
 
You need aggregate demand to grow an economy, but it needn't be in your country's economy ;) For the US and other top earning nations, it does, but for nations playing catch up, supply side, wage suppressing techniques tend to work perhaps better.
 
Modern economics uses Walrasian equations, which are basically a reformulation of Say's Law so if Say is bunk there is a lot of economics to be re-written. Of course, if you want to see that process of rewriting fold itself out, read Steve Keen. The attack on Walras' Law is one of the centerpieces of his work. But I should point out that a rejection of Walras' law only really makes sense within Keen's framework.

Cutlass said:
Now how that relates to the tangent of supply side theory is that SST does nothing for AD in the short run, and is harmful to AD in the long run. It does not boost purchasing power now, and it cuts into purchasing power in the long run the deficits it causes now.

The untaxed money is either spent on consumption, invested or saved. If it is saved, it is borrowed by another party and invested (after all, they want a return so they can repay the loan). Consumption and investment spending are both demand, so there is no harm done to AD. This holds only up to the point when the federal funds rate has farther to go down (i.e. when not in "liquidity trap").

Endogenous money theory might throw a monkey wrench in that story, though. I'm having trouble wrapping my head around the fact that any saving can/needs to happen in an endogenous money system at all. Why do banks need savers' deposits when they can create deposit entries at will?

Cutlass said:
So SST requires that two failed theories must be true for SST to be true. Real world evidence? Zero net new private business investment in 8 years that Reagan was president. Zero private sector job creation in 8 years that Bush was president. Exploding federal debt. Destabilized financial system. Bubbles, bubbles, everywhere. So you decide.

I'm sympathetic to your argument, but are you saying there is no truth to the idea that the private sector has more of an incentive to invest profitably than the public sector? I don't think we should just throw insights like these out of the window:


Link to video.
 
Modern economics uses Walrasian equations, which are basically a reformulation of Say's Law so if Say is bunk there is a lot of economics to be re-written. Of course, if you want to see that process of rewriting fold itself out, read Steve Keen. The attack on Walras' Law is one of the centerpieces of his work. But I should point out that a rejection of Walras' law only really makes sense within Keen's framework.


Say's Law, to get a bit deeper into it, is based on the concept that supply = demand, and so there can never be a general glut. Does that hold true in the real world? Well clearly it does not. On every business day product is thrown away, wastage, because there is no buyer for it. That is every single day.

What happens? Well take the periodical publishing industry. The publishers have expected demand X, but in the knowledge that it will most often be X either plus or minus some unknown amount. And so they print X+Y and send it to the sellers. Now in most cases the actual sales will fall short of X+Y. And so the retailer strips the cover from the excess periodicals and sends it back to publisher for a credit. This happens every day.

Consider the food retail industry. Stores stock their shelves such that they try to meet demand, but they always overstock because nothing is worse for their long term customer base than frequently having to tell the customer that they ran out. People will go elsewhere. And so, since their product is largely perishable, they build into their business model costs for unsold and destroyed merchandise above and beyond what is damaged in transit. This happens every day.

Now consider the rest of retail. They do the same thing as grocery, overstocking in the full knowledge that it will not be all sold. Much of that merchandise ends up in the hands of the second run retail stores. But much of it also ends up being destroyed. This happens every day.

Now the theory says that these little gluts are just general business mistakes, and they don't matter because the successful businesses will adjust and the others fail.

But the truth is that this is the business model of successful businesses.

There is a general glut every day. That is, there is more supply then there is demand every day. So where the theory claims that there is no general glut, the business models of the private sector tells you that they believe that there is, and it is integral to their business plan that all supply will not meet demand. They plan for this at all times.

If the theory does not take this into account, then the theory is wrong and needs to get the hell out of people's way.


The untaxed money is either spent on consumption, invested or saved. If it is saved, it is borrowed by another party and invested (after all, they want a return so they can repay the loan). Consumption and investment spending are both demand, so there is no harm done to AD. This holds only up to the point when the federal funds rate has farther to go down (i.e. when not in "liquidity trap").


S=I is conventional wisdom. However, it fails when considering an open economy, and it fails when considering speculation. Only by using a closed economy model can you make the case that it holds true. And only by assuming that no money goes to speculation that raises the price of existing assets can you make the case that it holds true.

However, that tells you nothing about whether business investment will take place. We had huge increases in the volume of wealth that went to the top income earners, those who have the lowest marginal propensity to consume, and we had no increase in business investment. None.

You cannot explain bubble after bubble and no increase in investment if you simply say S=I and do not look any further. You cannot explain the real world that way.


Endogenous money theory might throw a monkey wrench in that story, though. I'm having trouble wrapping my head around the fact that any saving can/needs to happen in an endogenous money system at all. Why do banks need savers' deposits when they can create deposit entries at will?


We've been over this. Perhaps I wasn't clear enough. Banks do not and can not create deposit entries at will. The money has to come from someplace in the beginning. And that place that it comes from is not just an accounting entry. The money is either borrowed from depositors, or it is borrowed on the open capital markets. It came from someplace outside the banks. And not the central bank. The CB has no obligation to supply the money under normal circumstances. In the US, we have the Federal Funds Rate, which is one of the monetary tools that you often hear talked about. The Federal Reserve is setting the interest rate, but the loans are from bank to bank, not from the fed to the banks. Another thing you often hear of is LIBOR, the London Interbank Offered Rate. What that is is the rate at which banks borrow from one another. That is where the money comes from if a bank needs more money than is deposited, it does not come from the central bank, and it does not come out of thin air.



I'm sympathetic to your argument, but are you saying there is no truth to the idea that the private sector has more of an incentive to invest profitably than the public sector? I don't think we should just throw insights like these out of the window:


Link to video.


You missed my point. The private sector invests when it sees the potential to make sales. That is the only time when the private sector invests. If the belief is that consumer demand will be weak, then the private sector will not invest until things look better. The private sector does not invest just because they can, but rather for what they expect to get in return out of it. And that is very situationally dependent. Sometimes the private incentive is very high. Other times there is no private incentive.

It is a mistake to think that the incentive is always there and high under all conditions.

One thing that many conservatives and libertarians are getting horrendously wrong now it in forgetting that is in forgetting just how completely the investment in the US economy has been a public-private partnership from day one. Both are necessary. Both have to happen. The lolbertarian party line now is to end public investment. However private investment will not pick up the slack. And so the country's long term economic prospects will be crippled. The telegraph would not have been built without government investment. The railroads would not have been built without government investment. The internet would not have been built without government investment. The whole of the US would not have been electrified without government investment.

When someone tries to tell you that government investment has no economic value, they're flat out talking out of their ass and have no concept of economics or the economic history of the US.
 
Modern economics uses Walrasian equations, which are basically a reformulation of Say's Law so if Say is bunk there is a lot of economics to be re-written. Of course, if you want to see that process of rewriting fold itself out, read Steve Keen. The attack on Walras' Law is one of the centerpieces of his work. But I should point out that a rejection of Walras' law only really makes sense within Keen's framework.

Micro yes macro no.

MIcro is the study of general equilibrium and relative prices, and hence barter economies, and hence invokes Say implicitly.

Macro studies nominal prices and breaks from Say.

I will go into detail if requested.
 
Cutlass said:
We've been over this. Perhaps I wasn't clear enough. Banks do not and can not create deposit entries at will. The money has to come from someplace in the beginning. And that place that it comes from is not just an accounting entry. The money is either borrowed from depositors, or it is borrowed on the open capital markets. It came from someplace outside the banks. And not the central bank. The CB has no obligation to supply the money under normal circumstances. In the US, we have the Federal Funds Rate, which is one of the monetary tools that you often hear talked about. The Federal Reserve is setting the interest rate, but the loans are from bank to bank, not from the fed to the banks. Another thing you often hear of is LIBOR, the London Interbank Offered Rate. What that is is the rate at which banks borrow from one another. That is where the money comes from if a bank needs more money than is deposited, it does not come from the central bank, and it does not come out of thin air.

This is simply not how it's been explained to me. Deposit entries are definitely created ex nihilo and reserves are only drawn in to settle net interbank payments, including tax payments to the government's account at the central bank. I posted the explanation of two credentialed post-keynesian economists (Neil Wilson and Merijn Knibbe) earlier in this thread. I invite you to read them again.
 
This is simply not how it's been explained to me. Deposit entries are definitely created ex nihilo and reserves are only drawn in to settle net interbank payments, including tax payments to the government's account at the central bank. I posted the explanation of two credentialed post-keynesian economists (Neil Wilson and Merijn Knibbe) earlier in this thread. I invite you to read them again.




Having scanned back over what we have been talking about, it still circles around to the fact that a bank cannot create a loan without acquiring the base money from someplace. The base money either has to come from deposits, or the bank has to borrow the money someplace. And that someplace in all ordinary circumstances is the existing capital markets, including the stock and bond markets, other banks, or other financial firms. Not the central bank.

If someone is telling you otherwise, then I have no reason to believe that that person knows what they are talking about. It would be strictly illegal under any accounting standards.
 
You must have missed this part, which is unusual because I bolded it specifically and asked you to read back the passage it is in:

Merijn Knibbe said:
The bank and you proclaim: “Let there be money”, somebody types “10.000,–” on your account – and then there is money.

A bank "deposit" does not represent "base money" per se, rather than paper that can at any time be exchanged for base money when a tax payment or net interbank payment is due. This makes it a store of value even when that ability is not made use of. Many transactions between bank clients can take place before any reserves are involved, hence why the deposits are themselves money (a store of value, medium of exchange and unit of account) even when not backed by existing reserves yet. There can be a long lag between the creation of the "deposit" and the "base money". When reserves are needed, they are borrowed from other banks until the banking system as a whole is out of reserves, at which point the central bank has to provide them in order to prevent the deflation and instability that would result from banks going under. Their mandate necessitates that they accommodate the system as a whole.

The fact that broad money creation leads base money creation rather than follows it is an empirical fact: http://www.debtdeflation.com/blogs/2009/01/31/therovingcavaliersofcredit/ (scroll down to "The Data versus The Money Multiplier Model")

So I ask you, if it is illegal, why is it happening?
 
I don't think that it is. And you're going to have to find someone with a lot more credibility than a blogger to convince me that it is. :dunno: It just does not make sense in terms of anything that I have ever learned unless some banks in LDCs are running outright fraud. Iceland, Ireland, maybe. The G7, no.
 
how do you explain that broad money expansion leads narrow money expansion in the US data, then?
 
I don't know enough to say with certainty. But you'd have to look at measurement lags.
 
@Monsterzuma: do note that the money multiplier is not often binding. That alone goes far in explaining the "oddity" you describe.

i.e., expanded economic activity -> expanded broad money -> the Fed expands base money (endogenously) to accommodate.
 
@Monsterzuma: do note that the money multiplier is not often binding. That alone goes far in explaining the "oddity" you describe.

i.e., expanded economic activity -> expanded broad money -> the Fed expands base money (endogenously) to accommodate.


Do you think you could do that with a bit more depth?
 
Sure. Suppose banks are at their lending constraint: every loan they want to make has a buyer. Then the normal money multiplier goes through, and a $1 expansion in base money causes a $1/r expansion in the broad money supply, were r is the reserve ratio.

But suppose that banks can't always find a buyer for their loans; suppose there is excess supply of loans. Then a $1 expansion in base money will cause a smaller than $1/r increase in the broad money supply, because again not all the possible loans were taken out. You can think of $1/r as the "upper limit" to the expansion in the broad money supply.

So suppose economic activity increases for whatever reason (a good shock to AD or something), then people start taking out more loans, so we see broad money expand. The Fed notices this, and they try to accommodate the increased AD (and hence increased aggregate demand for money) by increasing the base money supply.

That's my intuition, anyway.
 
According to Keen, reserve requirements are hardly a factor any more in modern banking including the US banking system:

there are two factors needed to make manipulating reserves a control mechanism over bank lending:

- Reserves themselves; and
- A mandated ratio between deposits at banks and reserves

Paul doesn’t seem to have caught up with the fact that this mandated ratio no longer exists, for all practical purposes, in the USA and much of the rest of the OECD. Six countries have no reserve requirements whatsoever; the USA still has one, but for household deposits only. Figure 3 shows the actual rules for reserves in the USA—taken from an OECD paper in 2007 (Yueh-Yun June C. O’Brien, 2007). The reserve ratio of 10% only applies to household deposits; corporate deposits have no reserve requirement. And the reserves are required with a 30 day lag after lending has occurred—by which time the deposits created by the lending are percolating through the banking system.

http://www.debtdeflation.com/blogs/2009/01/31/therovingcavaliersofcredit/

So what you're describing is likely not just a possible condition, but a very common one, if not ubiquitous.
 
Heck, if the Fed didn't want economic activity to expand (say, we were already at the Fed's ideal AD or something), then you might see the perverse effect that expansions in broad money reduce base money (as the Fed counteracts the rise in AD)!

I agree that reserve requirements almost never bind and hence aren't particularly useful in understanding the stock of money anymore.
 
The fact that broad money creation leads base money creation rather than follows it is an empirical fact: http://www.debtdeflation.com/blogs/2009/01/31/therovingcavaliersofcredit/ (scroll down to "The Data versus The Money Multiplier Model")

Hmm. Empiricism is usually a good sign ...

Thus rather than credit money being created with a lag after government money, the data shows that credit money is created first, up to a year before there are changes in base money. This contradicts the money multiplier model of how credit and debt are created: rather than fiat money being needed to “seed” the credit creation process, credit is created first and then after that, base money changes.

So Integral responds by agreeing that reserve requirements don't bind. Hence(?) money multiplier model is out. So ... what model is in?
 
Bit unfair to compare a model without banks to real-world banking. It'd be like asking the neoclassical model questions about monetary policy: it makes as much sense as asking a music major about evolutionary biology.

(Note: we do have decent real models of banks. Diamond-Dybvig is the standard undergraduate one.)

(Note2: To explain Monsterzuma's graph. In the standard neoclassical model, there are no banks. Instead, people lend and borrow directly from another. This is an analytical shortcut and allows us to talk about financial flows without having to model banks explicitly. Medium-scale and large-scale models do include a banking sector.)
 
Can I ask what may be a silly question?

Where does inflation fit in to the picture from the initial equation?

I understand MV=PQ (extremely helpful to an economic dullard like me, that alone was quite illuminating, thanks), but from that it seems that inflation simply means someone is not putting the correct amount of M in to the system to maintain P at a static level - also wouldn't that be more efficient?
 
Top Bottom