American Monetary Institute Conference 2012
Sep22
on September 22, 2012
at 7:43 am
This is the presentation I gave today at the American Monetary Institute 2012 annual conference in Chicago.
Presentations were also given by Michael Kumhof of the IMF, who has incorporated endogenous money into a Neoclassical DSGE framework (a world first), Kaoru Yamaguchi with an endogenous money version of his Vensim dynamic model of an economy, and Michael Hudson presenting a paper based on “The Bubble and Beyond” and a joint paper he’s working on with Dirk Bezemer and me.
If you are interested in more discussions about this and similar subjects, check out my site, Debunking Economics here. SK
I was really enjoying that until it got to the bit about banks creating credit and putting in reserves a month later.
It’s a preconceived misinterpretation of the ECB statement. There is a big difference between reporting reserves in a buerocratic sense, and managing liquidity in a real sense. In fact allowing a month delay in reporting presumes the funding is done in advance rather than implying that the funding is done to meet reserve requirements.
The statement shows a poor understanding of how banks operate. Where is this kind of information coming from, other than the very selective and misinterpreted snippets? It’s not even really necessary for the whole argument anyway, endogoneus money creation does is not hinged on this causality.
Happy to invest some time in explain this to you if you wish.
It’s good that Steve criticizes mainstream economists for wrongly ignores private debt and for making other assumptions, but it’s still only economists talking to economists. Their discourse is still not based on an understanding of how the real world works now. The world of Schumpeter and Minsky is not exactly the world of today. Financial regulation has made attempts, even if it turned to be unsuccessful so far, to curb unconstrained private debt e.g. The comments by economists are simply inaccurate, because their comments are based on history, some aspects of which are no longer relevant today. The problem of economics goes much deeper than just a wrong model, because it is based on a futile illusion, which will take much more space to explain here.
The point of that comment TININT is that reserves can’t be a control mechanism for lending, which is how they are perceived by most economists. I agree that endogenous money does not depend on that causality, but that false causality is used by economists to dismiss endogenous money out of hand–as you can see from Krugman’s exchange with me some months back:
They then stick with a Loanable Funds model of lending, in which banks cannot create money, apart from the money multiplier process that the Federal Reserve controls. Remember this desperate nonsense from Krugman?:
The most parsimonious way to model Loanable Funds is to argue that “Patient” lends to “Impatient” as a transfer from one deposit account in a bank to another. The equally parsimonious way to model endogenous money is that lending involves an increase in loans on the asset side of the banking system, and an increase in deposits on the liabilities side.
I can accept that individual banks arrange much of their finance through the liabilities side, by borrowing to lend, etc. But ultimately the systemic outcome is an increase in loans on the assets side, matched by an increase in deposits on the liabilities side.
If you would like to provide an explanation of that much more detailed process, I would be very pleased to see it.
You’re getting close, very, very close to recognizing where the real problem lies. Banks are businesses also after all. And they are also subject to the necessity of “keeping the books” and hence of every dollar being subject to the effects of…..cost accounting…..which are scarcity of individual incomes compared to prices…..which cooks price inflation “into the books.”
Krugman is right to say that banks do not lend money they don’t have. You have to think of the settlements process. Say a bank lends you money to buy a car say 20k. That 20k has to end up in the account of the car dealer. Sure if there was 1 bank in the universe, the car dealers account gets deposited with 20k which automatically balances the transaction. The bank does not need to have that money on the presumption that no matter what they do the book balances out as money lent = deposits. That’s a pretty big presumption on which to be risking your bank’s liquidity position.
Bank’s will always be funded ahead of time this is just an operational reality. This happens via the treasury process, where the amount and cost of funds is determined for all banking operations. The surplus money sits as most liquid assets first before being distributed, those most liquid assets count as top tier capital, so in reality ‘reserve’ is met first except its not reserve its capital requirements. In fact, in anticipation of Basel III banks are already shifting their capital positions. In Australia we will have an interesting situation where banks will need to hold more government bonds at a time when the government is going into surplus.
For a bank the advantage to this causality is operational convenience, from being able to set the price on loans knowing exactly what the funding costs are, to having a liquidity buffer and the flexibiility to adjust capital position, most importantly banks need to keep margin, if they lend first how can they control funding cost. Funding cost is dependant on market forces, lending rates is what a bank can control. You can’t run this motor backwards, it really does not make sense at any level. Even if they could lend first and get deposits later, they wouldn’t because it does not make sense. A bank’s purpose is to make money, the money is made on a pretty tight margin, I thnk this is the key point, how does a bank make margin if doesn’t know funding cost in advance? That’s the main reason the proposition does not make any sense.
At a systemic level it’s a slightly different story. The endogenous money mechanism has already happenned, I think a long time ago. And indeed most money in the system is endogenous money. But the system is always at a marginal point of saturation, where a multitude of factors drive both the demand and supply side of money. Probably the most important factor not covered by either side of the debate is risk.
Risk is ultimately what drives lending decisions. Why do banks lend so much money to households and less to businesses? Because as it happens in Australia people are in love with real estate and are very good at paying their mortgages, at least better than business. From a bank’s perspective they will lend at a lower rate to households because they lose less money on default. The moment that starts changing banks adapt their behaviour. Australia has a very high foreign investment, this in part explains some of the economic behaviour. The entrepeneurship comes from outside the country as a result the household earns a high income without huge incentive to be entrepenuering, instead the government has provided incentive to both invest in and purchase real estate. So we are earning a foreign wage, and also borrowing from overseas to compete at auctions. Whether that is sustainable or not has nothing to do with endogenous or not endogenous money.
Hope this helps, not sure I’ve convinced anyone. Happy to provide more details, but I think as far as a blog entry is concerned, that’s as far as I can take it.
I know the AMI conference context, and I’d guess that you shot over the heads most of the people there, though I am also certain that you certainly dazzaled most of the people there. There tends to be a large contingent of popular level monetary reformers there, since that was the center of AMI’s concept. I am certain that you dazzled most of the attendees. For that crowd there was likely to be a massive uptake issue in going well out side of the NEED legislative initiative. I believe that the impact of your presentation is like to take months to express itself. AMI needs to join together with the MMT/FF discourse and the endogenous money discourse. I expect that your participation as well as Michael Hudson’s pried open that context in a constructive manner. This particular presentation seems particularly technical, and I know that your are still in an uptake mode due to your engagement with the Fied Institute. I doubt that any real damage was done in terms of massively swamping uptake capacities. More precisely what you gave them was well beyond a lot of the pop-level material that they have primarily heard, and that’s a positive. I expect that you will receive an invitation to next year’s AMI conference to speak as well. fast forward, Tadit Anderson
Isn’t it possible that the main role of assets is outside the equations, simply as collateral for loans? Without such collateral, the lenders would not lend so much. There is huge potential leverage here, since a small number of transactions can revalue a whole class of assets, enabling a large increase in total lending.
Also, I am curious about the definition of Y and GDP in your equations. In the conventional system, they are made equal by construction with, for example, GDP counting inventories and work-in-process rather than final sales. I suppose that is a way of finessing the time delays inherent in production. However, for there to be room for other terms in the equation, presumably Y and/or GDP must be defined a little differently or evaluated at different times?
“Risk is ultimately what drives lending decisions. ”
Risk and its mistaken attempted elimination by the Banks is what got us into this mess. Risk is inherent in business, but on top of that because in the current system there is an enforced scarcity of individual incomes in comparison to prices that must be paid in order to remain in business that risk is greatly increased. The humanly inevitable results of that onerousness and ever present fact combined with greed lead Banks to create CDS, MBS, etc…..and the rest is history.
THAT SCARCITY IS ENFORCED BY COST ACCOUNTING’S CONVENTIONS. LIKEWISE THIS ENFORCED SCARCITY OF INCOME CHAINS THE INDIVIDUAL.
The elimination of this ENFORCED monetary scarcity FOR THE INDIVIDUAL is the key to making the system ACTUALLY AND FINALLY free for BOTH businesses AND the individual.
The current system is NOT free AT ALL. The one thing that Austrian theorists have in their advantage is their realization of the significance of the individual. HUMAN ACTION. But then they turn right around and ignore the effects of the system on the individual by worshiping something that is impossible under the current RULES of the system, namely AN ACTUALLY FREE MARKET.
The whole problem with economic theory is it either starts with the abstraction of the system and never actually gets down to the effects on the individual, or like with Austrians it begins with the individual and then promptly jumps to market worship thus ignoring the flaws of the system and the 800 lb. gorilla forces of Finance capitalism and corporatism….both of which are as much reactions to the onerousness of the scarcity of effective demand enforced by cost accounting’s conventions as it is to the human frailties of greed and domination.
Start with the individual, and never take your focus off of his/her freedom…..and you’ll be able to craft a system that is free for both.
Thanks TININT,
From an economic modeling point of view, the ultimate question is does the increase in debt turn up on the liability or asset side of the banking system as a whole.
If on the liability side–so hat there was no change in bank-issued debt–then “Loanable Funds” would be the correct model and changes in the level of debt would have no macroeconomic significance. If however it turns up on the asset side of the aggregate banking system’s ledger, then the change in debt adds to the sum of bank liabilities in circulation and thus to both the money supply and aggregate demand.
The empirical data is clearly that bank debt changes, and is recorded on the asset side of the ledger. Hence endogenous money is the rule. A simple model that shows loans and deposits growing simultaneously certainly does not describe the complexity of actual banking operations. But it is a parsimonious model tht captures the ultimate outcome that rising debt means rising bank assets and liabilities, and the latter adds to aggregate demand.
Doesn’t the “Loanable Funds” model also suffer from a start-up problem? Where did the initial funds come from and how do they grow with the economy? There needs to be an endowment of money (given – not lent) underlying the whole system. Endowment was assumed in Eggertson and Krugman’s paper, for example, but they did not say where the endowment could have come from, since banks, including central banks, give money out only as loans or for purchases.
Precisely. We’re still thinking primarily “inside the box” about the nature of the system and for our solutions. Society, no matter what anyone prefers to think, is primarily metaphysical. In other words, its based on ideas. We’ve got to change the consumer financial paradigm from loan ONLY to citizen’s dividend and loan, if desired and creditable. You don’t change society by appealing to economists, financiers or politicians, however respectable that effort may be, you change society by raising the awareness of THE GENERAL POPULACE. Self interest, intellectual stubbornness and lethargy and ignorance can only be changed by a mass movement. Time is running out.
SH – time does not run out, we run out of time.
That I have to agree with. The problem I’ve always had with this is that the parsimonous model incorrectly implies individual bank behaviour, which earlier on had the pitch fork crew up in arms chanting slogans that bankers wake up in the morning and switch on the money machine.
The question is how do you reconcile a systemic outcom from the outcome of individuals who act in the opposite way. This is not impossible actually and I think it is an advancement in thinking to understand that individual banks funding first can collectively create a system of endogenous money creation. This type of model is worthy of the complexity of the financial system, as opposed to the simple notion that individual banks behaviour is directly translated to systemic outcomes.
Thanks TININT. I’m pleased-very pleased–that we’re in agreement.
One interesting avenue would be to explore what the “microstructure” is behind endogenous money. It’s obvious that, ultimately, the additional debt turns up on the asset side of the aggregate banking system’s ledger; it’s also true, as you emphasize, that banks procure their funding before lending–which implies entries on the liabilities side of the ledger (as well as the asset side). It could start from a bank issuing bonds to raise funds for lending, for example.
For the meantime though, I’ll leave that issue and work on building a monetary macro model where the ultimate outcome is shown in a parsimonious way.
Now if you wanted to give it a try in your spare time…
Hi Prof Keen,
Not sure if I have this right. Looking at your model of profit creation through new technology and how that advantage is eroded as more adopters do the same, could you say the same of women entering the workforce. I’ve often wondered how my parents could comfortably own a home on a single Blue-Collar income when twin White-Collar incomes now would struggle (bubble aside). Have the initial benefits of women entering the workforce in increasing numbers effectively led to the devaluation of total household income in relative terms to the previous single income level?