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Sunday, November 24, 2019

Banks And Money (Sigh)

The article "Are banks really magic money trees?" by Thomas Hale (link to FT Alphaville; article is free, but you may need to create an account to access) attracted a lot of chatter on my Twitter timeline. This article is a worst case scenario from my perspective for online economics wrangling -- it's an argument between two views that I disagree with.

My argument is that this is yet another example of why money as a concept needs to be abolished from economic theory (as argued in my tome "Abolish Money (From Economics)!"). As far as I can tell, if everyone involved read my book, this debate would not have happened.

The Hale piece starts picking apart an earlier David Graeber article, which contained some generalisations about "mainstream" economists that said economists dislike. Although I am a definite critic of neoclassical economics, I do not see much value in mis-characterising it. The pre-Financial Crisis neoclassical theoretical consensus embraced a lot of dodgy stuff (which various segments of the profession disagreed with, for varying reasons), but a lot of that was abandoned post-crisis. My concern right now with neoclassical macro is not so much that it is wrong, rather it is a haphazard, internally inconsistent mess. Given that the various post-Keynesians do not spend a whole amount of time agreeing with each other, that just means that the neoclassicals and post-Keynesians have converged in at least one sense.

The Debate

If we want to look at the big picture debate, Hale summarises it as:
Graeber, reviewing a new book from Robert Skidelsky, goes on to cite a Positive Money poll showing most politicians "don't know" where money comes from. The think-tank, which has generally spearheaded a view of the economy predicated on the above observation about money creation, also drew on this precise reference to the May speech in 2017, here.

We’re not saying May is right on government spending. But is the magic money tree meme, which has circulated widely, a useful or insightful way to think about banks? The answer is straightforwardly no, irrespective of your politics.
I agree that the Positive Money view is the wrong way to go about things, as I discuss in my book. So in a certain sense, I would have to agree with Hale. Where I disagree is how well the "mainstream" comported itself, as well as some his arguments about the limits of bank lending.

How Well Did the Mainstream Understand Money?

Hale refers to the heavily cited BoE paper on money creation, and argues:
The seemingly radical and counterintuitive points contained in the paper, regarding commercial bank money creation, are by no means new (nor are they the thing wrong on the internet here). Economist Joseph Schumpeter, in his 1954 tome the History of Economic Analysis, stated that by 1930, the “large majority” of economists had been converted to the view that bank lending creates deposits, though he does add that it had proved hard for them to come round.
One point that David Andolfatto keeps making on Twitter is that we need to cite what individuals actually, and not impute views to vague "schools of thought." So yes, members of the "mainstream" probably believed a lot of things about money, and the majority obviously understood that deposits are part of the broad money numbers. That said, we can point to influential people who really messed things up.

  • Milton Friedman and his "k% money growth target," which is nonsense on stilts from the endogenous money perspective. Friedman's views picked up a lot of followers within the mainstream.
  • Neoclassical "Econ 101" textbooks with "money multipliers" (I don't cite any, since I have zero desire to buy a copy of said textbooks.)
  • The Krugman/Keen online debate which literally started over that topic (before I started my website). (My feeling is that Krugman wrote something he realised was wrong, but refused to back down.)
All of these episodes happened after 1930. Furthermore, one can point to the various "workhorse" DSGE models in which "money" was important, but was purely "government money."

Limits on Lending

I objected (slightly) to the following passage.

[...] To be as fair as possible to the Magic Money Tree school of thought, the BoE paper thereafter points out that, despite this constraint on individual banks, the banking system as a whole can still create money in a manner effectively unconstrained by reserves if they all increase lending together. Is there perhaps a magic money forest, if not one single tree?

The answer is still no. Many other factors constrain bank money creation, and they are also mentioned in the same Bank of England paper. [...]
None of the factors that Hale lists as constraining growth of bank lending are novel from the perspective of endogenous money. Although I disagree with the sensationalist claims about the banking system, Hale's article does not draw a clear enough distinction from serious endogenous money theories and the Positive Money crowd.

The issue is straightforward: there are tons of limits on bank lending in the short term. But if we lengthen the horizon, there is no magic numerical limit on lending growth. Loan volumes will move in line with growth in nominal incomes, and if they speed up, so will lending.

The interesting argument is the following: what about the central bank? Can the central bank determine the inflation rate, and hence act as a barrier on bank lending growth? (Working from memory, that was Krugman's argument in the Keen/Krugman Kerfuffle, which I have seen echoed elsewhere.) I would argue that this is only true if the central government decides it wants to play along. A sufficiently loose fiscal policy along with policy framework changes to ensure that central bank has to play along, will blow through any alleged limits on inflation. Right now, the political consensus is in favour of tight inflation control. However, there are no laws of nature preventing that consensus from changing.

Concluding Remark

"Abolish Money (From Economics)!"

Post-script: Go Bombers!

(c) Brian Romanchuk 2019


  1. It is surprising (to me) to see academia so willing to cite and pick. They repeatedly cite a source and then pick the source apart. What they don't do is to reverse engineer the system.

    On the battle field, if a new weapon is discovered post-use, the surviving victims pick up all the clues available and try to figure out how the weapon was made. They reverse engineer, learning from example how to build a workable device.

    My website, Mechanical Money , is dedicated to examining the economic system as we find it, trying to find subsystems/parts that create the effects we see. The monetary economy is treated as if it were a machine.

    Without describing how I got here, there is no question in my mind that money should be treated as if it were a coupon, very similar to coupons issued by private entities. The vast differences between money and private coupons are evolutionary and logically consistent. We do need money in this mechanical-economic formulation.

    So Brian, what formulation of the economic system do you like?

    1. Hi, I just saw this. Watching the Grey Cup, so I will have to get back to you...

    2. Yay, Bombers won!

      I use SFC modelling. The technique captures monetary flows in the economy, and gives a good intuition for the mechanisms being growth.

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  2. On the subject of coupons, here's a view of our economy from a retired engineer & hi-tech entrepreneur. I keep looking for flaws in this view (it seems too simple) but have found none.

    GDP is the measure of our productive economy. GDP is the sum of household, business and government spending (and likewise the income of those sectors equals that spending, because ALL spending is someone else's income). Our economy depends on household spending (2/3 of GDP). That spending is limited by household income (which comes only from those three sectors). Business provides that income to the extent demand (business opportunity) exists, and government provides the rest (by way of bookkeeping entries to household bank accounts). All that's important to the economy is maintaining this flow, and with a fiat currency (whose value, by definition, depends ONLY on currency-users perception), there are no limits other than that perception.

    If this is factually correct, maybe I'm reading more into it than is warranted. It appears that government is perfectly capable of providing sufficient tokens to its citizens to ensure their welfare (food, housing, education, transportation, healthcare...), even if a good deal of that spending is for imports.

    It appears that government could rationally manage the economy just as one would manage a business - set expectations on it's GDP/GDI earnings statement & when the economy deviates from those expectations, drill down into the earnings statement to explore the options for correcting the deviations.

    It appears that the portion of the economy not represented in GDP is just one big casino, not essential to the economy & not capable of destroying the economy given proper NGDP management. My only use for banks was as a depository (& I'd like to see the central bank given that role).

    Now this is probably very naive - but I'd appreciate any comments as to where.

  3. It does seem like they could, doesn't it Ed? I am part of a group that thinks so and wants to somehow get them to do it. We're thinking we need to help people get the issue with money and organize to change it. Come join us.

  4. I follow the Seattle Seahawks, who also won. Yay.

    Once money has been created, like you, I like SFC modelling. The caveat is "once money has been created".

    The 'creation of money' is the event that prompts me to liken money to coupons. The event always follows a decision by either owners or managers. In my judgement, the creation event is a starting point for a chain of future events that continues until the created money is uncreated.

    Of course, this idea would apply to MMT.

    I hope the Bombers (and Seahawks) continue to win.

    [corrects a grammar typo in the third paragraph]

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