Ptole­maic Eco­nom­ics in the Age of Ein­stein

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Jet­lag has me up and at the key­board at 5.54am here in Lon­don, 43 min­utes before sun­rise, which today is at 6.37am.

Only it’s not “sun­rise”, is it? As we all know, it’s really “Earth Axial Rotate” at the point in its 24 hour axial rota­tion when the Sun—around which the Earth rotates once each year—becomes vis­i­ble from Lon­don.

Click here for this post in PDF

We still call it “sun­rise” because it’s a lot less awkward—and a lot more romantic—than say­ing “Earth Axial Rotate Earth-Sun Radial Align­ment”, which is what it really is. We all know that it’s not really the Sun “ris­ing” at all: that implies that the Earth is fixed while the Sun rotates around it, whereas ever since Coper­ni­cus we have known that, though it looks that way to a naïve observer on Earth, that’s not what really hap­pens.

How­ever, not merely before Coper­ni­cus, but for a very long time after him, many peo­ple con­tin­ued to believe that that was how it really is: that the Sun does rotate around the Earth, that the Earth is not merely fixed, but fixed at the Cen­tre of the Uni­verse, and not merely the Sun but all Celes­tial bod­ies rotate around it in per­fect spheres.

What broke us from that belief was the empir­i­cal fail­ure of the the­ory which encap­su­lated it and still made sense—as much as it could—of the anom­alies between the pre­dic­tions of that the­ory, and actual real­ity. Claudius Ptolemy’s trea­tise the “Math­e­matike Syn­taxis” (or Math­e­mat­i­cal Com­po­si­tion), which became known as the Almagest (mean­ing “The Great Trea­tise”), was pub­lished in about 150 BC, and it pro­vided a plau­si­ble model for earth-cen­tric beliefs about the nature of the Uni­verse that dated back mil­len­nia. It held sway not merely until Coper­ni­cus wrote his De rev­o­lu­tion­ibus orbium coelestium in 1543, but for many decades after, as not only the Church but also incensed Ptole­maic astronomers fought to sup­press the new, more accu­rate, but to them hereti­cal and false model of the Uni­verse.

Why the brief dis­course on Astron­omy? Because read­ing what Paul Krug­man is say­ing about bank­ing feels like read­ing a Ptole­maic Astronomer describ­ing sun­rise today as if that’s actu­ally what’s hap­pen­ing. He is dis­mis­sive of the view that banks can “cre­ate credit out of thin air”—so dis­mis­sive in fact, that any­one unac­quainted with the empir­i­cal evi­dence might be fooled into believ­ing that his case is so strongly sup­ported by the facts that it’s not even worth the bother of cit­ing the empir­i­cal data that backs it up.

That is so NOT the case: the empir­i­cal evi­dence over­whelm­ingly sup­ports the case Krug­man is try­ing to dis­miss out of hand, that banks can and do “cre­ate credit out of thin air”, with the sup­posed reg­u­la­tory con­trols over their capac­ity to do so being largely inef­fec­tive.

Fig­ure 1: Krugman’s 3rd post on bank­ing and money cre­ation

In fact the evi­dence is so strongly in favour of the case that Krug­man blithely dis­misses that it’s dif­fi­cult to decide where to begin in refut­ing his Ptole­maic fan­tasies to the con­trary. I’ll lead with his “gotcha!” argu­ment in this post, but before that I’ll return to the Ptole­maic Astron­omy-Neo­clas­si­cal Eco­nom­ics analogy—because it’s quite a strong one that deserves fur­ther elu­ci­da­tion.

Ptolemy and Walras—Brothers in Arcs

The Geo­cen­tric mod­els of the uni­verse, of which Ptolemy’s sys­tem was a vari­a­tion, had 3 guid­ing prin­ci­ples, which Cardall describes as fol­lows:

  1. All motion in the heav­ens is uni­form cir­cu­lar motion.
  2. The objects in the heav­ens are made from per­fect mate­r­ial, and can­not change their intrin­sic prop­er­ties (e.g., their bright­ness).
  3. The Earth is at the cen­ter of the Uni­verse. (Cardall, 2000)

The key prob­lem with this base the­ory is that it man­i­festly didn’t fit the facts, because of the behav­iour of celes­tial bod­ies that we now call Planets—which is the ancient Greek word for “wan­der­ers”. Far from obey­ing uni­form cir­cu­lar motion, these Wan­der­ers lit­er­ally did wan­der all over the sky. We’re gen­er­ally not aware of this today because it’s no big deal from our bet­ter-informed Helio­cen­tric model of the solar sys­tem, but for the ancients it was a big deal. A sim­u­la­tion by David Colarusso indi­cates how much the appar­ent behav­iour of the Wan­der­ers vio­lated the three core tenets of the Geo­cen­tric model.

Ptolemy’s con­tri­bu­tion was to pro­vide “tweaks” to this core vision, which main­tained its over­all integrity while fit­ting it much more closely to the data. He stuck with most of propo­si­tion (1) and all of (2), but mod­i­fied (3) to “The Earth is near the cen­ter of the Uni­verse”. With the Earth slightly off-cen­ter, the gen­er­ally ellip­ti­cal motion of The Wan­der­ers could now be explained by what was called The Eccen­tric. But their habit of “ret­ro­grade” motion—the fact that they would occa­sion­ally reverse direc­tion in the night sky—was still an anom­aly.

To solve that, Ptolemy added cir­cu­lar motion on cir­cu­lar motion. All celes­tial bod­ies still fol­lowed a great circle—called the Deferent—but the plan­ets also did their own rota­tions on the Def­er­ent on mini-cir­cles called Epicy­cles.

But even that wasn’t enough, because the plan­ets also appeared to speed up on part of their motion through the heav­ens, and slow down on oth­ers (today we know this is just because some­times they are closer to the earth on their ellip­ti­cal orbits around the earth, and there­fore appear to move more rapidly). So Ptolemy added “Equant” motion: the big “Def­er­ent” cir­cle each planet moved on was divided into seg­ments by lines through a point which was not its cen­ter, and the planet moved through each dif­fer­ently sized slice in the same time—thus speed­ing up in the big slices and slow­ing down in the small ones.

By these tweaks, a par­a­digm which was utterly unlike the real world was actu­ally able to mimic it to a tol­er­a­ble level of accu­racy. But the sys­tem was extremely com­pli­cated, and it took an enor­mous amount of brain power to be a Ptole­maic astronomer. Look­ing back on this once dom­i­nant the­ory, Cardall tellingly observes how the very com­plex­ity of this absolutely false men­tal con­struct helped pre­serve it despite mount­ing evi­dence that it did not describe real­ity:

That ancient astronomers could con­vince them­selves that this elab­o­rate scheme still cor­re­sponded to “uni­form cir­cu­lar motion” is tes­ta­ment to the power of three ideas that we now know to be com­pletely wrong, but that were so ingrained in the astronomers of an ear­lier age that they were essen­tially never ques­tioned. (Cardall, 2000)

Why am I reminded of Neo­clas­si­cal Eco­nom­ics? Let me count the ways…

Firstly, there are sim­i­lar under­ly­ing prin­ci­ples to the DSGE mod­els that now dom­i­nate Neo­clas­si­cal macro­eco­nom­ics, and as with Ptole­maic Astron­omy, these under­ly­ing prin­ci­ples clearly fail to describe the real world. They are:

  1. All mar­kets are barter sys­tems which are in equi­lib­rium at all times in the absence of exoge­nous shocks—even dur­ing recessions—and after a shock they will rapidly return to equi­lib­rium via instan­ta­neous adjust­ments to rel­a­tive prices;
  2. The pref­er­ences of con­sumers and the tech­nol­ogy employed by firms are the “deep para­me­ters” of the econ­omy, which are unal­tered by any poli­cies set by eco­nomic pol­icy mak­ers; and
  3. Per­fect com­pe­ti­tion is uni­ver­sal, ensur­ing that the equi­lib­rium described in (1) is socially opti­mal.

If that were actu­ally the real world, then not only would there not be a cri­sis now, there would never have been a Great Depres­sion either—and reces­sions would sim­ply be minor sta­tis­ti­cally unpre­dictable but inevitable events when the major­ity of shocks hit­ting the econ­omy were neg­a­tive, and they would rapidly be resolved by adjust­ments to rel­a­tive prices (wages included, of course).

So econ­o­mists like Krugman—who describe them­selves as “New Keynesians”—have tweaked the base case to derive mod­els that “ape” real-world data, with “sticky” prices rather than per­fectly flex­i­ble ones, “fric­tions” that slow down quan­tity adjust­ments, and imper­fect com­pe­ti­tion to gen­er­ate less-than-opti­mal social out­comes.

This is Ptole­maic Eco­nom­ics: take a model that is utterly unlike the real world, and which in its pure form can’t pos­si­bly fit real world data, and then add “imper­fec­tions” so that it can appear to do so.

Fig­ure 2: Krugman’s 3rd post on bank­ing and money cre­ation

Walk like a Ptolemain

Krugman’s rejec­tion of the propo­si­tion that banks can cre­ate money—in the sense that “their abil­ity to cre­ate money is not con­strained by the mon­e­tary base” as he puts it in an update—is also a vin­tage Ptole­main manoeu­vre. A sci­en­tific response to this propo­si­tion would be to dis­prove it via empir­i­cal evi­dence. Krug­man instead appeals to his own author­ity, relies on deduc­tive logic—which I’ll return to shortly—and derides those who believe that banks and credit growth mat­ter in macro­eco­nom­ics as “Bank­ing Mys­tics”.

What Krug­man dis­plays here is not greater insight but blind igno­rance. A recent addi­tion to the over­whelm­ing evi­dence that credit growth is a cru­cial fac­tor in macro­eco­nom­ics is an empir­i­cal paper by those well-known bas­tions of Bank­ing Mys­ti­cism, the National Bureau of Eco­nomic Research and the Fed­eral Reserve Bank of San Fran­cisco. The paper analy­ses 200 reces­sions in 14 coun­tries over 140 years, and sum­marises its results as fol­lows:

This paper stud­ies the role of lever­age in the busi­ness cycle. Based on a study of nearly 200 reces­sion episodes in 14 advanced coun­tries between 1870 and 2008, we doc­u­ment a new styl­ized fact of the mod­ern busi­ness cycle: more credit-inten­sive booms tend to be fol­lowed by deeper reces­sions and slower recov­er­ies. We find a close rela­tion­ship between the rate of credit growth rel­a­tive to GDP in the expan­sion phase and the sever­ity of the sub­se­quent reces­sion. We use local pro­jec­tion meth­ods to study how lever­age impacts the behav­ior of key macro­eco­nomic vari­ables such as invest­ment, end­ing, inter­est rates, and infla­tion. The effects of lever­age are par­tic­u­larly pro­nounced in reces­sions that coin­cide with finan­cial crises, but are also dis­tinctly present in nor­mal cycles. The styl­ized facts we uncover lend sup­port to the idea that finan­cial fac­tors play an impor­tant role in the mod­ern busi­ness cycle. (Oscar Jorda et al., 2011a, Oscar Jorda et al., 2011b)

That emphat­i­cally decides the key empir­i­cal dispute—whether the level and rate of growth of aggre­gate pri­vate debt has macro­eco­nomic effects—in favour of the case I put.

Unreserved Lending

There is also a wealth of stud­ies to sup­port the con­tention that reserves don’t con­strain lending—that if any­thing, the causal link runs from lend­ing to reserves, and not the other way around. I referred to some of these in my last blog post, so I won’t repeat that issue here. Instead I’ll take up Paul’s “gotcha” argu­ment to the con­trary:

Yes, a loan nor­mally gets deposited in another bank — but the recip­i­ent of the loan can and some­times does quickly with­draw the funds, not as a check, but in cur­rency. And cur­rency is in lim­ited sup­ply — with the limit set by Fed deci­sions. So there is in fact no auto­matic process by which an increase in bank loans pro­duces a suf­fi­cient rise in deposits to back those loans, and a key lim­it­ing fac­tor in the size of bank bal­ance sheets is the amount of mon­e­tary base the Fed cre­ates — even if banks hold no reserves.

Sigh. The level of cur­rency retrains lend­ing? So banks stop lend­ing as they approach the lim­its to cur­rency set by the Fed’s print­ing of notes?

I can’t improve on the com­ments of Neil Wil­son on Krugman’s argu­ment here:

Krug­man needs to start attend­ing the real world. The lat­est argu­ment is utter tosh. For there to be a con­straint in the real world, you have to have the actual power to stop another entity from doing some­thing.

What Krug­man is sug­gest­ing is that the Fed has the power to limit the amount of cur­rency in issue. In other words he’s sug­gest that to con­trol the econ­omy the ATMs will be left to run dry and you will be told ‘no’ when you go and try and draw cash at the bank counter.

Sweep­stake on how many attosec­onds it would take to cause gen­eral pan­de­mo­nium if that every hap­pened. Here in the UK there has been a sug­ges­tion that the fuel pumps might be short of fuel if the tanker dri­vers did decide to go on strike. It has caused com­plete chaos even though noth­ing is dif­fer­ent this week­end than last. Krug­man is beyond grasp­ing at straws now.

And even if the Fed could do that—even if it did attempt to con­trol bank lend­ing by manip­u­lat­ing reserves (some­thing it gave up on doing about 30 years ago)—there are two fac­tors needed to make manip­u­lat­ing reserves a con­trol mech­a­nism over bank lend­ing:

  1. Reserves them­selves; and
  2. 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.


Fig­ure 3: USA Reserve Require­ments

This, and the bank­ing cri­sis we are now in, finally inspired the Fed­eral Reserve’s research depart­ment to con­clude that, effec­tively, the “money mul­ti­plier” doesn’t exist. Car­pen­ter and Demi­ralp note that today reserve require­ments “are assessed on only about one-tenth of M2”, and con­clude that

the nar­row, text­book money mul­ti­plier does not appear to be a use­ful means of assess­ing the impli­ca­tions of mon­e­tary pol­icy for future money growth or bank lend­ing. (Seth B. Car­pen­ter and Selva Demi­ralp, 2010, p. 29)

So Paul’s “gotcha” lacks at least one of the blades needed to make it work—and if he cares to con­sult the exten­sive aca­d­e­mic lit­er­a­ture on the role of reserves post the failed Mon­e­tarist exper­i­ment of the 1970s, he will see that the other blade doesn’t exist either: Cen­tral Banks now sup­ply what­ever level of reserves is needed to main­tain their short-run inter­est rate tar­get.

Who’s the Mystic then?

Krugman’s claim that those who argue banks play an essen­tial role in macro­eco­nom­ics are “Bank­ing Mys­tics” has a nat­ural riposte: Neo­clas­si­cal econ­o­mists like Krug­man who believe that cap­i­tal­ism can be mod­elled with­out either money or banks are Barter Mys­tics (David Grae­ber, 2011). How on earth can some­one believe that the man­i­fest real­ity that trans­ac­tions involve money being exchanged for goods can be ignored, and pre­tend instead that goods are exchanged for goods? How on earth can the insti­tu­tional real­ity of banks be ignored by those who claim to be macro­econ­o­mists?

How on earth indeed. It’s because they’re still liv­ing in a pre-Coper­ni­can uni­verse, deluded by the imag­ined per­fec­tion of the Spheres.


Cardall. 2000. “The Uni­verse of Aris­to­tle and Ptolemy,”

Car­pen­ter, Seth B. and Selva Demi­ralp. 2010. “Money, Reserves, and the Trans­mis­sion of Mon­e­tary Pol­icy: Does the Money Mul­ti­plier Exist?,” Finance and Eco­nom­ics Dis­cus­sion Series. Wash­ing­ton: Fed­eral Reserve Board,

Grae­ber, David. 2011. Debt: The First 5,000 Years. New York: Melville House.

Jorda, Oscar; Moritz H. P. Schu­lar­ick and Alan M. Tay­lor. 2011a. “When Credit Bites Back: Lever­age, Busi­ness Cycles, and Crises,” National Bureau of Eco­nomic Research, Inc, NBER Work­ing Papers: 17621,

Jorda, Oscar; Moritz Schu­lar­ick and Alan M. Tay­lor. 2011b. “When Credit Bites Back: Lever­age, Busi­ness Cycles, and Crises,” Fed­eral Reserve Bank of San Fran­cisco, Work­ing Paper Series: 2011–27,

O’Brien, Yueh-Yun June C. 2007. “Reserve Require­ment Sys­tems in Oecd Coun­tries.” SSRN eLi­brary.


About Steve Keen

I am Professor of Economics and Head of Economics, History and Politics at Kingston University London, and a long time critic of conventional economic thought. As well as attacking mainstream thought in Debunking Economics, I am also developing an alternative dynamic approach to economic modelling. The key issue I am tackling here is the prospect for a debt-deflation on the back of the enormous private debts accumulated globally, and our very low rate of inflation.
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  • steve allder

    Dear steve, this debate makes me think of Chris ary­gris. Even though he has stud­ied tens of thou­sands inter­ac­tions between peo­ple and found vir­tu­ally all are con­sis­tent with defen­sive reasoning,this data always has an unbe­liev­abil­ity about it. But here is a Nobel prize win­ning econ­o­mist using it in pub­lic! Keep going with your testable data. It is mak­ing his responses almost too embar­rass­ing to read

  • bar­ry­thomp­son

    @ Steve Allder. Great point. Our brains evolved rea­son mainly as a tool for use in argu­ments. Krug­man is defend­ing his own argu­ments (and doing so very poorly) rather than being open-minded and exam­in­ing the evi­dence. But at least he is engag­ing in the dis­cus­sion.

  • steve allder

    Have just read his (PK) lat­est com­ment. Clas­sic. Mis­us­ing term ‘ratio­nal’ and then quot­ing a 1963 paper but not jus­ti­fy­ing why it is actu­ally an authen­tic reposte to the points and assim­i­lat­ing another mem­ber of his ‘team’ to cre­ate some appear­ance of a united front. None of this is teat­able data unless you have a really deep grip of both source. My incli­na­tion is that SK will be able to pro­vide us with plenty of well rea­soned data so we can make an informed choice for our­selves about the rel­a­tive mer­its of the argu­ments pre­sented. And of course, this is not a ster­ile aca­d­e­mic debate amongst econ­o­mists. I am doc­tor really wor­ried about aus­ter­ity on pub­lic ser­vice pro­vi­sion, this stuff has very real impli­ca­tions in the real world.…..

  • alain­ton

    Wel­come to Lon­don Steve

    I hope peo­ple have spot­ted that Krug­man isnt sim­ply propos­ing a loan­able funds approach to banks, where loans are based on the inflow and out­flow of sav­ings by say­ing that banks ‘must buy assets with funds they have on hand’ he is going back to a mid 19th cen­tury wages fund the­ory. Krug­mans world inst even ptole­maic, the world doesn’t even turn and time doesn’t exist.

    In such doc­trines trans­ac­tions are all paid out of a pot of money ‘on hand’. A stock. But this doc­trine was dis­proven as early ago as the 1870s by Krug­mans equiv­a­lent as Amer­i­cas most famous econ­o­mist Fran­cis Amasa Walker

    Walker proved that it is future antic­i­pated cash flows rather than ini­tial stocks of cash which form the basis for eco­nomic deci­sions. Invest­ment deci­sions are based on antic­i­pated prof­its. Fur­ther­more invest­ment allows for the cre­ation of addi­tional employ­ment to be employed in activ­i­ties which gen­er­ate growth. Ratio­nal eco­nomic deci­sions there­fore are not con­strained by cash on hand but by the abil­ity to see cash advanced to be repaid by growth and future cash flows to the investor and his cred­i­tors.

    This led to his suc­ces­sor FW Taus­sig Devel­op­ing the mod­ern the­ory of credit money ( inde­pen­dently of Hawtry in the same year 1919) —
    Page 357 ‘Money Means are cre­ated, and the com­mand of cap­i­tal is sup­plied, with­out cost or sac­ri­fice on the part of any saver’ 

    It is pre­cisely because of the pay­ment of inter­est from future cash flows that bankers can credit credit with account­ing oper­a­tions only, all a bank needs to do is ensure that overnight it remains net cash pos­i­tive, and if it would not be var­i­ous inter­bank and cen­tral bank means are avail­able.

    It is if Krug­man had regressed to the mid 19th Cen­tury for­get­ting most of the advances since. Even the most basic bank­ing 101 book pub­lished in the last cen­tury has this bal­ance sheet model of bank­ing. Some with sophis­ti­cated math­e­mat­ics, and yet since the 60s most main­stream eco­nomic text­book dont even have a chap­ter on bank­ing.

    The ver­sion of the mul­ti­plier so vocif­er­ously defended by Krug­man is known as the Fried­man-Swartz-Cagan Model — it is a mon­e­tarist idea and if you read Richard Koo you will see that the research that caused econ­o­mists to use it — the claim that gov­ern­ment high pow­ered money dri­ves the money sup­ply is bunkum. Fried­man-Swartz-Cagan is based on a math­e­mat­i­cal iden­tity, but makes a false assump­tion about the direc­tion of cau­sa­tion. It became pop­u­lar pre­cisely because it enabled sim­pli­fied treat­ment of money in macro. Indeed it could sim­ply be assumed away by being folded into the IS/LM model. Thats why Krug­man loves it it is sim­ple but dan­ger­ous and wrong. 

    Iron­i­cally Phillip Cagan, who per­fected the math of the model later esti­mated that 91% of US money was endoge­nous rather than gov­ern­ment cre­ated.

    What Krug­man doesnt like his his favourite macro tools being slagged. But if he could be pre­sented with new tools, or demon­stra­tions of how old ones such as the Cagan iden­tity could be recast he might be less grumpy. Steve needs to con­front Krug­man on his own ground, not Steves, Krug­man aint going to go there.

  • End­less


    You raise a very good point in your last para re meet­ing Krug­man on his ground. I think this is also an issue for Steve in light of mov­ing from an out­cast con­trar­ian to more main­stream — at some point, peo­ple don’t want you to sound like a con­trar­ian even if you are one!

    At what point do you shift from a Jere­miah sound­ing the dire warn­ing, to a more per­sua­sive approach, shift­ing argu­ments so that they don’t sound so extreme to the pre­vail­ing view? Assum­ing, of course this is pos­si­ble, but the key here might not be to per­suade Krug­man, but those that too read­ily accept what he has merely because he says it.

    Not that I have any con­struc­tive sug­ges­tion as to how to go about this…

  • RickW

    This cur­rent debate is receiv­ing con­sid­er­able atten­tion and PK needs to be respected for engag­ing with the fringe. There is wide recog­ni­tion that the present finan­cial sys­tem has seri­ous flaws so there is inter­est in seek­ing new ideas. 

    The clar­ity, pre­ci­sion and sci­en­tific merit of SK argu­ments has gained con­sid­er­able favour despite the appar­ent author­ity of a “Nobel Prize” win­ning econ­o­mist. The vast major­ity of peo­ple com­ment­ing on the debate see the naivety in the PK argu­ments.

    It seems Steve’s time has come — hope­fully not too soon. He still needs to get Min­sky fin­ished to the point where it is effec­tive in guid­ing pol­icy. He can high­light the present flaws with great clar­ity but other than mod­el­ing the indi­vid­ual stim­u­lus pack­age that Aus­tralia offered I have not seen other pro­posed ideas mod­eled.

    Steve Keen gets 2.69M google hits; Paul Krug­man 8.18M. So Steve’s star will rise due to PK engag­ing.

    I think the “Oh Shit” moment is in process with macro­eco­nom­ics. That said Steve needs to be care­ful about get­ting pushed into mak­ing calls that he has not done suf­fi­cient home­work on while con­tin­u­ing the edu­ca­tion of those will­ing to learn. As Christo­pher Joye con­tin­u­ally reminds us he lost the hous­ing price bet. 

    It is hard to be hum­ble when a life­time of work begins to get the recog­ni­tion it deserves. I believe Steve has more pas­sion for his work than the need for recog­ni­tion but pri­ori­tis­ing time will be even more chal­leng­ing.

  • alain­ton

    Krug­man seems to be back­ing down — in an update to his lat­est post.

    So now he seems to be say­ing that banks do cre­ate money — it is sim­ply ‘con­strained’ by mon­e­tary base — which is just about as weak assed an attempt to res­cue some­thing from exoge­nous the­ory as can be attempted. The ‘con­straint’ is sim­ply that with coins and notes you cant trans­fer it as quickly to other bank accounts as through a cheque — mon­e­tary base sim­ply acts as as a drag on veloc­ity. So this is his new view of pol­icy eh — con­trol the money sup­ply by lim­it­ing the amount of nick­els in cir­cu­la­tion.

    Quite seri­ously there are peo­ple who have advo­cated this — its called mon­e­tary base con­trol. –it was fash­ion­able around 1980 (it sur­vived longer in Ger­many and Switzer­land) — some now advo­cate it as a sec­ond best to the gold stan­dard

    Inter­est­ingly the whole huge Trea­sury file on the failed exper­i­ment has been dumped as an FOI — they show that by 1985 though Alan Wal­ters Thatch­ers eco­nomic guru wanted to still use this to restrict bank lend­ing — the Trea­sury view by then that this was impos­si­ble because of the increase in gross pri­vate sec­tor debt — which of cop­urse had increased at a time of struct base con­trol.

    The the­ory was pretty much sunk by Charles Good­hart put sim­ply sea­son­able and unpre­dictable demand for money means the cen­tral bank has to oper­ate an acco­mo­da­tion­ist pol­icy.

    Of course these days if nick­els and dimes were scarce every­one would just use debit and credit cards.

  • alain­ton

    Woops that went wrong here’s what PK said that got lost in the HTML above

    Update: It’s obvi­ous that many com­menters don’t get the dis­tinc­tion between the propo­si­tion that banks cre­ate money — which every eco­nom­ics text­book, mine included, says they do (that’s what the money mul­ti­plier is all about) — and the propo­si­tion that their abil­ity to cre­ate money is not con­strained by the mon­e­tary base. Sigh.’

  • TruthIs­ThereIs­NoTruth

    From the per­spec­tive of earth (earth cen­tric per­spec­tive) the sun orbits around the earth. From the per­spec­tive of the sun the earth ort­bits around the sun and rotates on it’s axis. From the per­spec­tive of our solar sys­tem we have the helio­cen­tric model. So there is noth­ing wrong with the sun ris­ing and set­ting from the per­spec­tive of a non-astro­nom­i­cal earth­ling and it is a reminder of humanity’s self-cen­tred nature.

    From the per­spec­tive of a skep­ti­cal out­side observer, it looks like there is a bit of a log­i­cal leap in this post. As a foun­da­tion you present the most com­monly known sci­en­tific mis­con­cep­tion. It is strictly true that the geo­cen­tric model was incor­rect and could not explain the empir­i­cal data. It is strictly true that the helio­cen­tric model does a bet­ter job of explain­ing the empir­i­cal data and is there­fore as close as we can get in explain­ing our empir­i­cal obser­va­tion of our­so­lar sys­tem. Clearly in terms of under­stand­ing the uni­verse it does not stop there. It is strictly true that the gen­eral brand of neo-clas­si­cal eco­nom­ics does not explain empir­i­cal evi­dence. HOWEVER it is not strictly true that the view that ‘banks cre­ate money out of thin air’ is sup­ported by empir­i­cal evi­dence. There is some evi­dence from a spe­cific per­spec­tive that banks cre­ate money. But to make the much stronger state­ment ‘out of thin air’ to an observer who has a fairly good idea of how things work at the coal face, this is sim­ply reflec­tive of a too nar­row per­spec­tive.

    I would like to see the empir­i­cal evi­dence which allows you to make the full state­ment. How would you even empir­i­cally prove the ‘thin air’ com­po­nent. In fact to make this state­ment you need to implic­itly assume a whole bunch of empri­cal facts away. It’s not good replac­ing one mis­con­cep­tion with another.

  • Dra­gunov

    Krugman’s responses have been a com­plete mess but at least Nick Rowe is engag­ing with Steves ideas here:

  • RickW

    There is a chart in a recent RBA paper that shows the increas­ing role of bank deposits in Aus­tralian Bank fund­ing. With respect to the cur­rent debate on where loans come from the deposits still pro­vide less than 50% of total lia­bil­i­ties despite ris­ing strongly since 2009. 

    I was look­ing for sim­i­lar chart for the USA but only found tables that I did not take time to chart:
    I notice that as at March 21 total com­mer­cial bank assets is 10.807tr and lia­bil­i­ties are 11.165tr! What does that mean?

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  • mahaish

    well put alain­ton,

    one of richard koo’s famous pre­sen­ta­tions below

  • Lyon­wiss

    Propo­si­tion: Debt is not money.

    Proof: Money is “legal ten­der” and debt is not; there­fore debt can­not always set­tle trans­ac­tions (not a “medium of exchange”). Debt is not a “store of value”, because of credit defaults. QED.

  • ken

    RickW, I think you’ve mis­read some­thing, line 43 assets-lia­bil­i­ties is always pos­i­tive.

    Domes­tics deposits in Aus­tralia are ris­ing sim­ply because pub­lic debt is ris­ing, which is essen­tially a result of giv­ing money to the peo­ple, and they are deposit­ing it in banks.

  • Money is “legal ten­der” and debt is not”

    If the debt is handed back to the bearer of the debt instru­ment it cancel’s it. 

    So it very much can clear trans­ac­tions within its own sphere of influ­ence.

    What you call money is just a lia­bil­ity with a large sphere of influ­ence — but ulti­mately you hand it back to the issuer to set­tle a debt.

  • Mary-Ellen Large

    Scott Full­wiler has writ­ten a good arti­cle on this debate between Keen and Krug­man on naked cap­i­tal­ism.

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  • alain­ton

    I think Nick Rowes inter­ven­tions on this issue are much more sub­stan­tive here and here

    The first much more than the sec­ond. He seems to be argu­ing from the mon­e­tarist the­ory of endoge­nous money of Yea­ger and Lai­dler — and argu­ing that money is a dis­e­qui­lib­rium process with occa­sional mis­matches between real goods in cir­cu­la­tion (GIS) and money — now that makes sense- my own think­ing on the rela­tion­ship between asset mar­kets and mon­e­tary expan­sion is mov­ing in that direc­tion. It also brings liq­uid­ity pref­er­ence into the frame.

    but he goes on

    An indi­vid­ual com­mer­cial bank can cre­ate money out of thin air sim­ply by buy­ing some­thing. But the money it cre­ates may not be its own. Its money may sub­se­quently be redeemed for the money of another bank, or the cen­tral bank. The indi­vid­ual com­mer­cial bank that wants a per­ma­nent increase in its stock of money may need to per­suade peo­ple not to redeem its money. Whether or not it needs to do any­thing to per­suade them all depends on how the other banks, espe­cially the cen­tral bank, react.’

    Which is a bet­ter way of putting the point Krug­man was strug­gling to. 

    But you don’t redeem money for money at another bank, you either redeem money for goods and then other peo­ple who sup­plied those goods deposit that money in banks — which is noth­ing to do with liq­uid­ity pref­er­ence. Profits/receipts must either be deposited in banks or stuffed under the bed — in the lat­ter case it takes no part in trans­ac­tions and adds noth­ing to demand. If that money is them used as col­lat­eral for another loan thats then another mat­ter — then you get an exposte veloc­ity mul­ti­plier.

    ’ If the Bank of Canada wants to increase the sup­ply of Bank of Canada money, it just does it. It doesn’t need to per­suade peo­ple to want to hold more. ’

    Yes but thats inside money not endoge­nous money — the two exist side by side (im going to stop using the term ‘high pow­ered money’ its a relic from Fred­i­man and wrong — if cau­sa­tion is reversed then its low pow­ered).

  • TruthIs­ThereIs­NoTruth

    From the Scott Full­willer arti­cle:

    But this means that the man­ner in which a cen­tral bank can exert con­trol over credit expan­sion is indi­rectly through its inter­est rate tar­get, not through direct con­trol over the quan­tity of reserve bal­ances.”

    My under­stand­ing is that the inter­est rate tar­get is actu­ally met via quan­ti­ta­tive con­trol. The cen­tral bank esti­mates the demand for cash at a par­tic­u­lar inter­est rate level and sets the quan­tity to tar­get a par­tic­u­lar inter­est rate, this is why it never usu­ally exactly hits the tar­get and that is why it is called a tar­get.

    The arti­cle sug­gests that all the banks liq­uid­ity related to loans is met through the cen­tral bank overnight facil­ity. If this is what the ‘banks cre­ate money out of thin air’ hinges on than it’s sim­ply wrong and is a very good exam­ple that the actual behav­iour of banks does not match this assump­tion.

    On an indi­vid­ual level banks acquire assets well ahead of the time they expect to lend them out. In fact a banks fund­ing require­ment is esti­mated by fore­casts of demand for lend­ing. Stay­ing ahead of the fund­ing require­ment is the most impor­tant oper­a­tional aspect of a bank’s trea­sury. The notion that banks stay on the edge of liq­uid­ity so that they could cre­ate deposits out of thin air, to a prac­ti­tioner is ridi­coulus and laugh­able.

    It does not work at an indi­vid­ual entity level because it does not match the behav­iour at entity level. Why would an indi­vid­ual bank need exter­nal fund­ing if it could just cre­ate deposits. So maybe the answer must be taht it works at some aggre­gated level. 

    But at the aggre­gate level you have things like credit risk, inter­est rates, basis cost, for­eign exchange to name a few fac­tors. Dur­ing the GFC Aus­tralian banks became selec­tive about who they lend to because they became cap­i­tal con­strained, investors pref­fered the appar­ent safety of trea­sury bills and gold over bank paper, how does this fit into the banks cre­ate deposits notion? Where are these fac­tors, which are most impor­tant at a prac­ti­cal level con­sid­ered? They’re not, they do not fit the model so are implic­itly assumed away, ie ignored. 

    I have no idea why Krug­man got his noble prize, I trust Steve Keen’s work in debunk­ing that brand of eco­nom­ics. But the alter­na­tive the­o­ries and ideas that I see are still a very long way from explain­ing real­ity.

  • Lyon­wiss

    @ TruthIs­ThereIs­NoTruth April 2, 2012 at 11:54 pm

    You said: “But the alter­na­tive the­o­ries and ideas that I see are still a very long way from explain­ing real­ity.” Totally agree. It amazes me how sim­ple things can be made so con­fus­ing and com­pli­cated, includ­ing works of Adam Smith, Schum­peter, Keynes, let­ting alone those of con­tem­po­rary econ­o­mists… prob­a­bly because the arm­chairs are too com­fort­able.

  • Derek R

    Whoah! Too many ital­ics.

  • Derek R

    Let’s try switch­ing them off

  • alain­ton

    A close em should do it try it