Banks are Special: the Ins & Outs of Money

I was going to drop the back and forth with Paul Krugman, but then he dangled this delicious treat in front of me and like any good little puppy I just had to jump up and bite at it.  So, here I go back to snapping at the big dog.  I apologize to Dr. Krugman’s ankles in advance, but this point is the crux of our entire discussion so I think it’s crucial that we cover this point thoroughly.

Dr. Krugman’s piece yesterday on banking showed a substantial step towards the Post-Keynesian & Monetary Realism position that banks do indeed create money endogenously.   Dr. Krugman says:

“All the points I’ve been trying to make about the non-specialness of banks are there. In particular, the discussion on pp. 412-413 of why the mechanics of lending don’t matter — yes, commercial banks, unlike other financial intermediaries, can make a loan simply by crediting the borrower with new deposits, but there’s no guarantee that the funds stay there — refutes, in one fell swoop, a lot of the nonsense one hears about how said mechanics of bank lending change everything about the role banks play in the economy.”

So we’re now both on the same page that “loans create deposits” and that this can be done simply by marking up the borrowers account.  But we’re still not seeing the importance of banking the same way and I think part of the confusion stems from the Tobinesque view of banks.  In the Tobin world banks are basically just financial intermediaries who act as deposit acceptors in order to satisfy portfolio allocations.  But that view severely downplays the fact that banks are the primary creators of money in our system and this money they create (inside money because it is created inside the private sector) rules the monetary roost.  Stick with me here.

The expansion (and at times contraction) of inside money (money created inside the private sector by banks as a result of a loan that creates a deposit) is one of the key determining factors in how investment is financed, how you buy your home (in most cases) and how the economy expands and contracts.  And its creation is not constrained by central bank reserves or deposit holdings and it does not get “multiplied” as almost all mainstream textbooks theorize (Tobin understood this as previously discussed and the Federal Reserve has recently discussed this point).  This is what the endogenous money view is all about!  And in order to understand it you have to realize that this isn’t the case merely inside of a “liquidity trap”.  It is always the case!  All the crisis did was expose the actual way banks always operate.  It is not a special, unique or temporary event.  Banks always make loans independent of their reserve or “multiplier” position.  Loans always create deposits and this loan creation process is absolutely crucial in understanding how the monetary machine works.  

But what about their role as financial intermediaries?  Well, the Tobin view is somewhat incomplete and puts banks in the wrong perspective.  In Monetary Economics Wynne Godley and Marc Lavoie provide a much more realistic view of banks and explained why the Tobin view was not entirely accurate:

“In other models that attempt to integrate bank behaviour to a full-fledged macroeconomic model, specifically that of Brainard and Tobin (1968) and Tobin (1969), banks are essentially agents operating in financial markets who do nothing but make an asset choice exactly like the asset choice of households and conducted according to the same principles. The role of banks is thus nothing more than to extend the range of asset and liability choice open to households. Tobinesque banks are treated like financial intermediaries. Their main function is not to create loans which make possible the expansion of production and the financing of inventories. Their main role rather is to allocate assets and to decide whether they are prepared to take on any additional liabilities. This view of banks is a rather artificial one, and it leads Tobin (1969: 337) to make some strange constructions, such as a deposit supply function which describes ‘the quantity of deposits banks wish to accept at any given deposit rate’, or to argue that the rate of interest on loans adjusts to clear the credit market…We are proposing something entirely different here. (p. 334).”

“In G&L models, banks are creators of credit-money, and they play an essential systemic role. This must be contrasted to the role of banks in most of Tobin’s models. Banks in his models are presented as a simple veil, that provide households with the opportunity to enhance their choice of assets. As is clear in Brainard and Tobin (1968), banks, like households, are assumed to make portfolio asset choices, based on rates of return, among free reserve assets, loans and government bills. Loans play no special role in this approach – they have no priority – and banks could as well be a non-banking financial institution.2 This impression is reinforced by a reading of Tobin (1982a), where bank loans are omitted altogether from the formal model. When banks are mentioned, it is claimed that the ‘traditional business of commercial banks is to accept deposits…and to acquire assets of less liquidity and maturity….Other intermediaries likewise transform their assets into forms better tailored…to the preferences and circumstances of their creditors’ (1982: 193).3 Backus et al. (1980: 265) also formally describe banks as pure intermediaries, but they do concede that, more realistically, bank loans play.  a special role in monetary production economy, admitting that ‘banks regard business loans as a prior claim on their disposable funds, and meet these demands at the prevailing rate, only later adjusting this rate in the direction that brings loan demand closer to the bank’s desired supply’. This ‘more realistic’ accommodating bank behaviour is more in line with the role of banks in G&L models, which to some extent resemble the banks described by Fair (1984: 72).”

So now I hope we’ve reached a moment of true clarity.  Banks are indeed special.  In fact, they’re beyond special.  They are the oil in our monetary machine.  As I like to say, inside money “rules the monetary roost”. Inside money is the dominant form of money in circulation today and it is the tool that is used at the point of sale in most modern economic transactions.  Outside money, or government money (cash, coins and reserves) is a facilitating form of money.  Cash and coins primarily serves to allow inside money customers to draw down bank accounts for convenient transactions.  And reserves serve primarily to smooth out the interbank settlement process.  The reserve system is a support mechanism designed around the inside money system.  It is not the center of the monetary universe as most economists depict.

When understanding the crisis and why the economy broke down this understanding was central to what was going on because once the engine stopped running due to a lack of oil (the de-leveraging) then the car broke down.  Thus, the IS/LM model which is quantity centric, was never going to help understand the crisis because it couldn’t help us understand how the bank lending mechanism was broken after the credit bust.  But more importantly, this is not a temporary event.  Banks are not temporarily failing to “lend out” reserves.  This is always the case.  All the crisis did was expose the operational reality of the banking system as being unconstrained by reserves.  And perhaps most importantly, banks are not just mere intermediaries in the system who can be removed from a realistic economic model.  They are the oil in the engine and one of the most crucial components of the monetary machine.   And yes, you can omit the oil and its circulation from your economic model, but don’t be shocked when your own model breaks down as a result.

To see this entire back and forth from start to finish please see here:

Cullen Roche: The Failure of the IS/LM Model in Predicting the Crisis

Paul Krugman: Banks and the Monetary Base

Cullen Roche: Banks and the Monetary Base – A Friendly Response to Paul Krugman

Paul Krugman: The Monetary Base, IS-LM, And All That

Cullen Roche: Economath: economics – IS/LM – Krugman Cross = Win

Paul Krugman: Banks as Creators of “Money”

Related:  Understanding the Modern Monetary System

Understanding Inside Money & Outside Money

* Big thanks to Carlos Mucha for the Godley & Lavoie quotes.  

** I should add that outside money can certainly influence the price of inside money, but this does not mean that the creation of new inside money is necessarily dependent on the amount of outside money.  The central bank must accommodate the inside money system’s needs for reserves at all times.  And it must do so in a manner that would not create systemic instability.  After all, the Fed’s primary job is to oversee stability of the payments system. 

—-

-------------------------------------------------------------------------------------------------------------------

Got a comment or question about this post? Feel free to use the Ask Cullen section, leave a comment in the forum or send me a message on Twitter.
Cullen Roche

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services. He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance and Understanding the Modern Monetary System.

More Posts - Website

Follow Me:
TwitterLinkedIn

  • SS

    Epic takedown!

  • beowulf

    Great piece and thanks for the namecheck. For the record, I suggested Cullen title this, “Guess Who Else Had a Beard?” and end it with the video link below, but he declined. Oh well. :o)
    http://www.youtube.com/watch?v=EZD1f9RTEJU

  • http://www.lostoutputclock.com Paul Derpman

    Silly Krugman actually wrote that banks and mutual funds are no different as “financial intermediaries.”

    He won’t be able to talk his way out of this one now. He’s demonstrated once and for all that he just doesn’t get it.

  • Anon

    But … it’s not actually true, is it?

    Cullen’s point is true only as long as “freshly created money” stays inside the originating bank. The moment money is transferred to another bank, the originating bank has to post essentially 100% reserves for that money. Where do those reserves come from? Reserves are not created by private banks – they must come from preexisting, “loanable” funds.

    Consider a simple example: a small bank with $100m in capital creates a large, new loan of $1 billion. It is “out of thin air” only up to the point the depositor transfers this amount to another bank. When that happens the small bank has to come up with a full $1 billion in reserves: either preexisting capital, or time deposits attracted from other banks (I.e. loanable funds).

    The reserves can also be borrowed from another bank, but those reserves are not out of “private thin air” either. It is true that currently, in 2013, the banking system is awash in reserves (the result of Fed easing), so most banks are not reserve constrained as long as they don’t try to expand lending too much. But this is Fed policy, not “operational characteristics of banking”.

    So I think the premise that “loanable funds” do not exist is simply false.

  • A H

    I think you are largely right here, but there is a danger of pushing your case to far. Specifically there if you claim that commerecial banks are not unique, that is not correct. Other financial firms can perfrom the same money creation role as commercial banks, though I am sure you are aware of this. The shadow banking sector is the obvious modern example.

    The problem with all these refernces to Tobin is that he uses different bank models in different papers. In “The Commercial Banking Firm: A Simple Model,” 1982 (this is not the same paper that Godley and Lavoie cite), Tobin does make it clear that making loans is the most important thing that banks do.

  • Phil Dunn

    Anon

    A commercial bank can always get reserves from the central bank. The CB merely credits the commercial bank’s reserve account at the CB with one billion and debits some internal “printing press” account. A commercial bank prefers not to do this because it is cheaper to borrow from another commercial bank and cheaper still to accept deposits.

  • http://internationalmonetary.wordpress.com LXDR1F7

    Im guessing Krugman will just formulate a partial response to Cullen, pretend he was right and ignore this topic from now on.

  • Anon

    Put shortly: banks can create freely transferrable money only if at the end of day someone backs that new money up with some “real” reserves.

    In other words a reserve constraint and a “loanable funds market”.

    The fact that today with ZIRP it’s easier to find loanable funds than to find a viable, low risk debtor should not confuse you into believing that the reserve constraint is not there.

  • Geoff

    Great post, Cullen. Just one small nitpick is that when you hammer home the point that banks aren’t reserve constrained, it always begs the question about what DOES constrain banks. I know this post was already long (not that I’m implying that Dr. K has a short attention span :)), but you probably should have mentioned something about capital constraints.

  • http://jpkoning.blogspot.com JP Koning

    “As I like to say, inside money “rules the monetary roost”. Inside money is the dominant form of money in circulation today and it is the tool that is used at the point of sale in most modern economic transactions. Outside money, or government money (cash, coins and reserves) is a facilitating form of money. Cash and coins primarily serves to allow inside money customers to draw down bank accounts for convenient transactions. And reserves serve primarily to smooth out the interbank settlement process. ”

    You’ve missed an important feature of outside money. All inside money is denominated in terms of outside money. Put differently, a bank deposit is like an option on underlying outside money. This means that any modification in the purchasing power of outside money will be translated 1:1 to a change in the purchasing power of inside money.

    I think its more accurate to say that there are probably several “monetary roosts”. Outside money rules the “price level” roost, inside money doesn’t. This really is a point worth incorporating into one’s monetary mental map — that’s why I keep bringing it up on your blog and at MR. A theory for determining the price level is one of the key pillars of monetary economics.

  • JP Koning

    (which isn’t to say that I disagree with you and agree with Krugman. I think your argument is the correct one).

  • Geoff

    AH, there is a big difference between a true bank and other financial intermediaries. The former creates money out of thin air (when they make a loan) whereas the latter simply shuffles around existing money.

  • Greg

    In order for Krugman and others to be right, they would have to believe that it would be possible for a guy with say 250,000$ in a savings account at Bank A and no debt, to walk over to Bank B, a new small bank that just took in deposits for a day (say, 75,000$), ask for a loan of 100,000$ and be told “Sorry, we just loaned out 50,000$ and we dont have anymore, come back next week cuz we will have more deposits by then!”

  • Johnny Evers

    This debate raises an issue for the layperson, even an educated one, of how do we figure out the science of these types of questions when we don’t have much education in macro economics, all of our practical experience is in microeconomics and we don’t have the time or probably the background to read dissertation papers from 50 years ago.
    Cullen is making a more logical argument, based on mechanics,and is a much better teacher. He actually answers questions.
    On the other hand, Krugman, even though he is a nasty so-and-so who demonizes anybody who disagrees with him, does have a Nobel Prize and seems to be speaking for the establishment.
    Anyway, like I said before, if Cullen wins this argument, he’s going to be writing for the NYTimes and Krugman will be an even more bitter, discredited prof at a minor state school.

  • Greg

    So whats a “real” reserve? Are there some fake ones out there?

  • Greg

    “Anyway, like I said before, if Cullen wins this argument, he’s going to be writing for the NYTimes and Krugman will be an even more bitter, discredited prof at a minor state school.”

    Maybe so, but where would that put Rowe and Sumner? They would be first year students in Pauls classroom…… not on academic scholarship either!

  • Johnny Evers

    Could it be that both parties are right — banks create money in the ‘loans make deposits’ practice, but only because reserves are also available to a bank with capital — either from other banks or from the Fed itself.
    Except how can reserves always be available when the banking system seized up in 2008?
    Hmmm, maybe 2008 wasn’t a liquidity crisis like they want us to believe could be solved with the Fed’s help, but a solvency crisis.

  • Geoff

    Haha, good question! Hey Anon, did you know that some countries (eg Canada) don’t require ANY reserves and their banking systems work just fine?

  • Geoff

    I meant good question, Greg.

  • Greg

    Johnny, I think PKE guys of all stripes would agree that we did not have a liquidity crisis it was a solvency issue.

    But lets look at how we define solvency. You are solvent if;

    1) The total value of your assets is greater than or equal to the value of your debts, if you debts are due at that time.

    2) Your income is large enough to service your debt payments and your not in immediate jeopardy of losing your income.

    3) You have zero debt

    So correcting insolvency issues is always a matter of lowering debt, without lowering incomes, or lowering the value of associated assets. How do you thread that needle? Especially for a bank

  • Johnny Evers

    It was a solvency issue created when banks and financial institutions created levered debt instruments on real estate values.
    The solution we implemented was for the Fed to buy those instruments at full value and lower interest rates in order to make the real estate values go up.
    Better in my view would have been to write off those debt asset values and close down the insolvent banks, leaving a vacuum for smaller or new banks to emerge with sricter rules on lending activity. At the same time you would have had to figure out a way to rescue the retail depositer and investor.
    Very difficult, I know. I don’t even know if there is a precedent for doing that.
    But the actual policy in practicality seems to have bailed out the lender who has the 100k mortgage on the 60k house (levered to the hilt and owned by wealthy investors) while doing nothing for the homeowner. Current policy writes off the working class.
    I think the banking powers want to save the current system, but one more crash will wipe it away.

    And then there are the structural problems with the economy.
    :(

  • Benjamin Cole

    Well…okay, so increasing bank reserves does not mechanically increase bank lending.

    But, is QE effective for other reasons?

    Somebody sold bonds, and now has cash. They have the right to make an immediate claim on output (that is, buy stuff) whereas before they could only spend the interest they received. Or they can invest their cash in real estate, equities, etc. Either result strikes me as stimulative.

    If QE is totally inert, then why not have the Fed buy the entire national debt? Interest payments would flow to the Fed and then through to the Treasury, reducing the tax burden. That would, btw, just about balance the federal budget.

    And really, have we reached a position that says, “Central banks cannot cause inflation”? This strikes me a bit oddly. How did Zimbabwe do it? The USA in the 1970s?

    Do we need to change some mechanics, and have the Fed directly print (digitize) money and finance lotteries that pay our more (in cash) than they take in?

  • Max

    There’s little difference between a bank account and an overnight loan. In both cases you have an investment that can be costlessly liquidated at par.

    Rather than saying “loans create deposits/money”, it would be better to say, “overnight loans create deposits/money”. And it’s mainly financial firms like banks doing the overnight borrowing, because there isn’t enough natural supply of overnight loans (real-economy borrowers prefer longer terms).

  • Auburn Parks

    “The reserves can also be borrowed from another bank, but those reserves are not out of “private thin air” either.”

    Exactly, those reserves were create “out of thin air” by the Fed. And if that small bank can’t get enough reserves through the interbank market, technically they could get them from the Fed if they have enough collateral. Thats why banks are not reserve constrained, they are capital constrained. Thats the difference.

  • Auburn Parks

    I don’t want to get into an argument about the derivative effects of QE (bonds to cash) but I will make one necessary observation. Lets not forget that any positive effects of QE must be weighed against the negative effects to try and surmise its net impact.

    Negative effects of QE:
    1) the Govt is a net payer of interest so, with a ZIRP, the private economy loses that much additional interest income on a macro level

    2) On a smaller level, the Fed has remitted something on the order of ~$80 billion per year in interest income back to the Treasury. Thats effectively a tax increase of ~$80 B. For a sense of scale, the fiscal cliff tax increases were ~$65 billion per year on incomes over $400,000 marginal taxes and over $250,000 on capital gains. And the FICA tax increase is worth roughly ~$120B per year to the private sector. In other words ~$80 billion a year is a lot of “tax increase.”

    Any net positive effects of QE would have to at least over come what I wrote plus any other negative effects that I left out.

  • Auburn Parks

    one only needs 2 graphs to disprove a “loanable funds” model. The monetary base since 1980:
    http://research.stlouisfed.org/fred2/series/BASE

    And the total private debt:
    http://static.seekingalpha.com/uploads/2012/1/9/1066626-132608573651625-marchahead_origin.png.

    If loanable funds were true, you’d think we’d some some increase in base money in concert with the increase in bank deposits = debt. Obviously, there is zero correlation in the way up, so why would we expect there to be on the way down?

  • http://asymptosis.com Steve Roth

    SRW, today (great minds…)

    http://www.interfluidity.com/v2/4522.html

    “we view bank behavior as special and complex. So we find it convenient to model banks specially”

    My comment on that post below. As you say…

    This is the crux. Krugman et al, in assuming that banks are transparent intermediaries between lenders and borrowers, assume that there is a symmetry of incentives between lenders and borrowers based on their intertemporal consumption preferences.

    Or: they assume that even though banks as lenders have very different preferences, incentives, and reaction functions than real-sector lenders (orthogonal to those of real-sector borrowers), Tobin’s portfolio effect means we can model the economy as if lenders’ and borrowers prefs, incentives, and reaction functions were symmetrical.

    Or as you say so succinctly: “Everything that matters is captured by the portfolio preference of nonbanks”

    (I think I find Ramanan giving aid and comfort to this latter view, though I’m not sure I full understand him: http://www.concertedaction.com/2013/08/24/holier-than-tobin/)

    Since “agency problems, political influence, faddishness, and mere error” do exist, however (among many other effects), it’s hard to give credence to the frictionless, agency- and incentive-free pipe dream of intermediation that is characterized in that view — whether that intermediation is seen as being direct between lenders and borrowers, or effected through the complex interactions of portfolio adjustments.

  • http://www.fanbrowser.com/ Cowpoke

    Geoff, I am curious about this being correct because:
    “RBC Capital Markets is part of a leading provider of financial services, Royal Bank of Canada (RBC). Operating since 1869, RBC is one of the top 15 largest banks in the world and the fifth largest in North America, as measured by market capitalisation. With a strong capital base and consistent financial performance, RBC is among a small group of highly rated global banks”
    https://www.rbccm.com/

    Now they have a reserve account with the FED so do they really have a reserve system via proxy the US FED?

  • http://asymptosis.com Steve Roth

    This is just flirting with the common confusion between “required reserves” and “reserve balances.”

    The latter is recorded on balance sheets. The former is just a regulatory ring-fence and could be referencing any safe asset.

    Reserves aren’t the same thing as reserves.

  • http://orcamgroup.com Cullen Roche

    The central bank must accommodate the need for reserves. There is no central bank choice in this matter and yes, the central bank creates those reserves from thin air. The point is that the lending decision comes BEFORE the need for the reserves. And if the reserves aren’t there then the central bank must create them or it will cause a disturbance in the force. :-)

  • http://orcamgroup.com Cullen Roche

    That’s too much. Plus, it makes me Darth Vader, which can’t be right because Dr. K said I am one of the good guys?

  • http://orcamgroup.com Cullen Roche

    Yeah, I should have. I should have also discussed how outside money can influence the cost of inside money. I just didn’t want to run this 20 paragraphs….No one wants to read that much.

  • http://orcamgroup.com Cullen Roche

    I say that the unit of account is determined by the govt. So, $1 is $1 because the govt says so. And the govt determines the banking system as the playing field upon which $1 is good for buying goods and services. But the govt has given the banking system the unique privilege of creating the money thing (deposits in this case) that can be used on its playing field. The govt mostly just plays referee and the banks actually distribute the money. The govt supports the match in all sorts of ways (some might say even disrupts the match), but I still think it’s best to view the monetary system through the lens of inside money first and outside money second.

    No?

  • http://orcamgroup.com Cullen Roche

    Nobody’s banging on my door asking me to write for them. Trust me. :-)

  • http://orcamgroup.com Cullen Roche

    Yeah, I would say QE has other effects. But the one effect it definitely doesn’t do is allow banks to make more loans directly because of the reserve addition.

    But, for instance, there’s side effects. So, when the Fed bought $100B in MBS from the banks you could argue that this resulted in balance sheet improvement and perhaps even helped make some of the banks solvent. In doing so they made the banks more likely to extend loans. So this was a capital transformation story. Not necessarily adding reserves so banks can lend more.

    See the difference?

  • Jussi

    I like to think that the Fed can only set either the price or the quantity. Now if there is no more reserves for the banks (to match deposits), they have to charge more for the use of existing ones which means higher (than targeted) interest rate. Thus the reserves need always to be available to settle the interbank market.

  • http://orcamgroup.com Cullen Roche

    @ anon,

    Well, the Fed must ensure no bank solvent bank is unable to meet a reserve requirement. The Fed is the payment system stabilizer. If it didn’t supply reserves when banks need them then they’d be screwing up their most important job. But the reserves come AFTER the loan. They’re not added before….

  • Geoff

    Anon, Tom Brown is our resident expert at this type of situation. I’m sure he’ll weigh in shortly but in the meantime you may find this example of his helpful:

    http://brown-blog-5.blogspot.ca/2013/03/banking-example-12-loand-deposit.html

    If that wasn’t what you’re looking for, check out the many other examples on his site!

  • http://orcamgroup.com Cullen Roche

    The SRW piece is excellent!

    “Suppose, for example, that banks lend primarily to cash-starved agents, and that cash-starved agents spend primarily to cash-rich agents. (I am including bank deposits as in my definition of “cash” here.) Should the banking system “exogenously” increase lending, the effect would be first a transfer of cash and an increase in debt to the cash-poor, and then a transfer of cash to the cash-rich as borrowers spent their loans. Suppose that the cash-rich then find themselves holding more bank deposits then they prefer to hold. Mechanically, they have absolutely no ability to redeem the deposits for other assets. The only way that deposits in aggregate are reduced is when loans are repaid to the banking system. But the cash-rich have very few loans to repay! Unless they pay off the loans of the cash-poor, taking losses to uphold the collective preferences of a putative nonbank private sector, bank deposits are as inescapable to cash-rich as base money is to the private sector as a whole.

    If the real world looks anything like this, then commercial banks do indeed have something quite analogous to a central bank’s printing press. Net-expansions of the banking system’s balance sheet provoke an inescapable injection of deposits into the aggregate portfolio of the cash-rich. The price of bank deposits, like base money, is pegged to unity. If deposit balances come to exceed the desired allocation in portfolios of the cash-rich, the imbalance cannot be resolved by falling prices. Instead, a “hot potato” effect must take hold: prices of other assets might be bid higher until deposits are restored to their desired small share of the aggregate portfolio. Credit expansion would lead to asset price inflation (much more than to ordinary price inflation, as the consumption plans of the cash-rich need not change in real terms, so there is no impetus to bid up the prices of goods, services, or labor). As a stylized fact about the world, bank-credit-expansion-leads-to-asset-price inflation seems pretty solid. [1, 2]

    This is just one account among a potentially infinite many under which the Tobin/Krugman “banks don’t matter” view would be insufficient, despite its theoretical coherence. It would be nice, from a tractability perspective, if the nonbank private sector could be modeled as a single agent with portfolio preferences independent of the behavior of the banking system. But I think the weight of the evidence suggests that the world is more complicated than that. I think we will need to account explicitly for the behavior of the banking system in order to capture important features of the macroeconomy.”

    http://www.interfluidity.com/v2/4522.html

  • Geoff

    Cowpoke, are you saying that a global bank like RBC could use its special access to the Fed to obtain reserves for use in other countries? Interesting! I don’t know but if RBC needed cash in a pinch for, say, its Singapore sub, I guess it could borrow it from the Fed?

  • Frederick

    The portfolio preference theory reminds me of the cash on the sidelines myth. The nonbank sector can’t destroy deposits or remove them from the system any more so than shareholders can remove stocks from the market. Only the issuing entity can permanently destroy them. Until then, someone holds all the issued assets. Banks are just part of the players in this bigger story and they accommodate client needs by making markets and holding assets at times, but only when it is beneficial to their bottom line. Banks don’t just hold assets that the rest of us don’t want because they’re charitable. They’re making the same portfolio perference the rest of us are making.

  • LVG

    Cullen,

    I’ve been thinking about your scale of moneyness a little bit. Isn’t what Tobin says a bit like saying that share issuance by firms doesn’t matter in the aggregate if the non-corporate sector doesn’t want to hold them?

    Let me explain. If a company issues debt it is issuing a new asset for the non-corporate sector with its own subsequent liability. This will be outstanding until retired by the company. It can’t be used for buying goods and services, but it does comprise part of the overall private sector balance sheet.

    A bank deposit is a security that can be acquired on demand for purchases. If you are creditworthy the bank will make these available to you. They too comprise a big chunk of the private sector’s balance sheet, but they can expand and contract as the private sector needs. This is what makes them special.

  • http://jpkoning.blogspot.com JP Koning

    I don’t doubt that the government selects what item will be the unit of account. But who or what sets the value of that unit?

    For instance, say that it costs $10 worth of Bank of America deposits to see a movie today, but a year from now it takes $10.30 worth of BoA deposits to see a movie. I’d say the Fed was responsible for that change because having reduced the value of Fed money, the Fed simultaneously reduced the purchasing power of all inside money issued by Bank of America.

    You’re right that the reserve multiplier is largely meaningless, but outside money does have some remaining ‘powers’ over inside money worth considering.

  • http://www.fanbrowser.com/ Cowpoke

    Geoff, I am just starting to read up on it. Also the Bank of Nova Scotia is a PD.
    I found this article interesting: http://canadianawareness.org/2012/04/u-s-federal-reserve-controlling-canadian-banks/

    Not sure about the site it’s posted at, could be a Canadian version of Alex Jones type Banking conspiracies.

  • jt26

    Government is very powerful so the unit of account isn’t unique. the government can influence price levels in many many different ways: labor laws, immigration, business regulation, taxation structure, energy policy etc. True, a monetarist would say these have nothing to do with money because “money is involved in all markets” (as Nick Rowe would say), but things like labor laws affects nearly every market. And in an equilibrium arbitrage, even a narrow market can have wide consequences if the ability to substitute is limited (oil).

  • jt26

    Cullen, your next assignment, if you choose to accept it …
    get monetarists to believe that balance sheets matter (now that you’ve convinced them bank BSs matter), and private sector liabilities matter … not just inside money, but “inside liabilities”. There’s a reason the government had to rescue AIG, and there is a reason non-bank CDS backing the credit quality of banking sector assets played a role in the GFC.

  • Anon

    I actually linked to one of Mark Brown’s examples in a short followup comment, which backs up my argument:

    http://brown-blog-5.blogspot.hu/2013/02/banking-example-2.html

    But that comment was deleted for some reason. (It was not abusive in any fashion, and it initially appeared in the comment thread.)

    In that example you can see how, when money transfers from “Bank A” to “Bank B”, bank A has to come up with 100% reserves for the newly created deposit:

    1) either by having enough capital (which are really reserves)

    2) or by having another bank trust this bank for that loan (in which case that other bank’s reserves are transferred over).

    What does not happen: no reserves are created out of thin air by banks, every dollar lent can be traced back to some matching, preexisting fund that secures it.

    This really breaks one of the central assumptions of MMT/MMR, in my opinion.

  • Anon

    The Fed will indeed lend at its “discount window”, if requested, but only if the private bank posts highly liquid collateral such as U.S. treasuries.

    So the small private bank in my example above cannot create the 1 billion transferrable dollars I mentioned, without that loan being secured via some real external money whose (real or proxy) owner really doesn’t want to lose it.

  • Andrew P

    That is because MBS have default risk, at least in principle, and their value can go far below par. Treasuries on the other hand, have no default risk.

  • Anon

    Proof:

    http://www.frbdiscountwindow.org/pledging.cfm?genid=13

    “All Discount Window advances must be secured by collateral acceptable to the Reserve Bank.”

    “The Federal Reserve Discount Window and Payment System Risk Collateral Margins Table includes collateral margins for the most commonly pledged asset types. Assets accepted as collateral are assigned a collateral value (market value or estimate multiplied by the margin) deemed appropriate by the Federal Reserve Bank. The financial condition of an institution may be considered when assigning values.”

    So in the above “can a small private bank create 1 billion dollars out of thin air” the answer from your local Fed will be: “no!”.

    The MMT arrangement of using the loan itself as collateral exists:

    “For qualifying institutions, loans (customer notes) pledged as collateral may also be held on their own premises, under a borrower-in-custody arrangement.”

    Note the qualifier – not all banks can do that, and if you check the collateral haircut XLS table, haircuts are steep and can go to over 50%. And that’s only for “qualifying institutions” – mom and pop banks have to pledge hard assets and the 1 billion dollars heist I outlined above is not actually possible.

  • Andrew P

    The bigger a bank is, the less likely it is to need outside sources of reserves to make payments. The 5 biggest US banks are so big, and have such a large fraction of deposits between them, that most of the settlement payments stay within their own small group. They could collectively be considered as a single big bank, (unless one of them runs into trouble of course).

  • Anon

    I disagree based on what I think are strong factual, “bank operational” grounds: see my other reply above for the detailed argument.

    The Fed requires collateral to be posted before reserves are lent via the Federal Reserve Discount Window:

    http://www.frbdiscountwindow.org/pledging.cfm?genid=13

    See the various haircuts that even high quality collateral gets.

    Regarding your argument that the Fed is forced to create reserves: it isn’t, because in practice Discount Window borrowing is a red flag and a stigma to begin with. The Fed does not have to enforce collateral rules very often, just like it essentially never has to perform open market operations after it announces a new Federal Funds Rate: market participants will flip prices over within a millisecond.

    Not are the Fed’s options binary: “accept this collateral or financial armaggedon”. It can refuse or recategorize a collateral, which the bank will take into account for future loans. Lending does not happen in trillion dollar step over a single day. It happens in small increments, allowing the Fed to shape collateral policy non-disruptively.

  • Anon

    Proof:

    http://m.research.stlouisfed.org/fred/series.php?sid=DISCBORR

    See how seldom banks make use of the Fed Discount Window. They are borrowing reserves from the interbank market, and the banks lending those funds do require high quality collateral as well – which they can use if the originating bank of the 1 billion dollars loan mentioned above (small or mid size) goes under.

    Several hundred (mostly small) banks are in trouble this year alone, twenty went bankrupt already:

    http://www.calculatedriskblog.com/2013/08/bank-failure-20-sunrise-bank-of-arizona.html

    So this is not a theoretical concern for interbank lending.

  • Anon

    That’s a common misconception: Canada uses Tier 1 capital ratio requirements, which are in essence equivalent to reserve ratio requirements. (Since you can pledge Tier 1 capital quality collateral to the Fed the two are functionally one and the same in the U.S. – Fed statistics tend to count reserves and capital together as “reserves”.)

    A quick look suggests that Canadian Tier 1 capital ratios are actually stricter than U.S. ones – and Canadian banks were far less affected by the 2008 financial crash than U.S. banks.

  • http://orcamgroup.com Cullen Roche

    A solvent bank doesn’t have trouble getting sufficient collateral. That’s the point. A well capitalized bank is not constrained by the things you discuss.

  • Geoff

    Anon, capital and reserves are equivalent? Are you serious?

  • http://orcamgroup.com Cullen Roche

    @ anon,

    can you stop inserting html in your comments? It’s messing up the comment format for some reason. Thanks. And sorry!

  • http://highgreely.com John Daschbach

    In general I think the MR view has to be correct at some level. But, when I work through some of the data I find things that are hard to reconcile. It may well be that the data is incomplete in how it is reported.

    To first order, the MR model would indicate that constant dollar GDP should correlate (be roughly proportional) with bank assets. Money creation occurs through banks, and over moderately long periods (a few years to a decade perhaps) GDP has to correlate with money creation or you have inflation or deflation. There are time lags involved, and money flows to or from overseas impact the situation. But, using the FRED data (St. Louis Fed), this isn’t the case at all. The FRED data series for total bank assets, interest earning, all loans and leases shows no meaningful correlation with GDP (all normalized in constant dollars). This FRED series only goes back to 1985, but bank lending/leasing fell relative to GDP from 1985 to 1996 (by 31%). It then rose from 1996 to 2008 (by 60%). It has fallen (by 8%) since then.

    If we include Fed holdings of Tsy (because that is really a loan to the government, not an asset swap) the data only goes back to 2004. For this limited period total lending (banks + Fed [TREAST]) vs GDP increased until 2008, and then fell until almost 2011.

    What is very clear from the data is that fully normalized GDP/(Total consumer + business lending) decreased rapidly from 1950 to 1960 (by a factor of 2) and linearly decreased (with small fluctuations) from 1960 to 1990. It rose until 1994, and then resumed a linear (but steeper decrease) from 1994 to 2009.

    But while I agree with the basics of MR, I find the data hard to reconcile. In the simple view, net changes in bank lending create(destroy) money. This money moves throughout the entire economy (including overseas holdings of dollars) but over long averaging periods real money creation has to be balanced by real productivity or you get inflation or deflation. The data would suggest that the time constant for this balance is closer to centuries than years.

  • http://orcamgroup.com Cullen Roche

    Saying that bank deposits should correlate with GDP is like saying that the amount of workers at a firm should correlate with the growth of the company. That might be true, but it also might miss out on other important variables (like worker productivity). So I would be careful about oversimplifying the view here. The overall economy is much more complex than that.

  • Anon

    But that is my point really: they’ll have no trouble lending, to the extent of their sources of funding, which is all preexisting money such as own capital or outside sources.

    Check this little story for example, a small New Jersey bank expanding lending rapidly, so that it temporarily has to tap the (expensive) Fed Discount Window:

    http://m.us.wsj.com/articles/BL-REB-19380

    Note the specific wording of the bank manager:

    ‘“That was at the height of the refinance market, so we were doing about $350 million in residential mortgages a month,” he said. The Fed was one of several sources that funded that lending “so we would use some short-term borrowing there.”’

    If this bank could create money out of thin air it would not have to find external sources to “fund that lending”, right?

    This example shows how even small banks can connect sources of funds to lenders, I.e. a “loanable funds market”.

  • http://orcamgroup.com Cullen Roche

    The fed does not turn down solvent banks at the discount window. The fed does not constrain solvent banks from making loans. They provide the reserves after the loan has been made if necessary. Banks lend first and find reserves later if necessary. The Fed does not constrain solvent banks from lending. Now sure how else to say it, but the Fed does not have some “loanable funds” market that it doesn’t allow solvent banks to access….The Fed accommodates the banking system’s need for reserves.

  • Benjamin Cole

    Okay..how did inflation arise, USA, 1970s? The Fed can cause inflation, or not?

  • Auburn Parks

    Again, all of this is to say that banks are capital constrained and not reserve restrained. Everyone here agrees with that. You are simply agreeing with us and you don’t seem to realize it. The fact that the Fed has the unlimited authority to create reserves means that the banking system, by definition, can’t be reserve constrained.

  • http://orcamgroup.com Cullen Roche

    Very different environment. You had a labor class with wage negotiating power and an oil crisis. Today, you have a capitalist class with all the wage negotiating power. Today we’ve seen oil shocks, but they ended up being recessionary. So I would argue that the much more powerful of the two is the wage situation.

    And yes, the Fed can crush the banking system if it wants to. For instance, an inverted yield curve always leads to recession. So, if the Fed wants to crush bank margins and seize up the credit system it can do so. But then it’s basically making a mockery of its primary purpose, which is to support the payments system….

  • Benjamin Cole

    Well a “tax increase” of $85 bil is meaningful, but injecting $1.5 trillion of cash into bond holders is not?

    Okay…let mecask this: How would you cause inflation today? Can the Fed cause inflation?

  • Auburn Parks

    Here’s my understanding:

    #1: Oil going from $10 to $40 a barrel. imagine what would happen to input costs and prices if oil rose to $400 a barrel within the next 3 years. Remember, unlike today there were no possible substitutes.

    #2 A much more unionized workforce with wages indexed to inflation.

    #3 Quite possibly the Fed helping drive price increase, 17% interest rates may be net inflationary as thats a lot of interest income. Too many derivatives for me to think about:)

  • Benjamin Cole

    I agree USA more inflation prone 1970s…but how can Fed cause inflation today? Imposible, by your lights?

  • Anon

    That’s true only to a certain degree – the 5 biggest U.S. banks have about 4 trillion in deposits:

    http://www.statisticbrain.com/largest-banks-by-total-deposits/

    Yet total deposits are 9.5 trillion:

    http://m.research.stlouisfed.org/fred/series.php?sid=DPSACBM027NBOG

    So the big five control about 40% of the deposits. That’s large but not complete – it’s not even a majority.

    Also, if any of the big banks expands lending too much, it will still receive an average inflow of reserves – I.e. the increased collateral requirements for increased lending rest mostly on the “first mover” bank.

    I’d mostly agree with you if only a single largest bank existed: it could indeed expand lending rapidly and set the rate of monetary expansion. In all other cases the banks face a prisoner’s dilemma, which can only be resolved slowly, or by the central bank or the Treasury injecting new money into the economy.

  • http://orcamgroup.com Cullen Roche

    I am not saying it’s impossible for the Fed to create inflation today. I just think they have to start doing some rather odd things. For instance, they could start funding state budgets by buying municipal bonds. Or they could set the 10 year interest rate at .5%. Things like that. Things that probably wouldn’t go over all that well with Congress….

  • Auburn Parks

    I don’t know John, you make an interesting point. Maybe my interpretation of the data is wrong but when I see private debt increase by 175% (debt to GDP) between 1980 and 2009:

    http://static.seekingalpha.com/uploads/2012/1/9/1066626-132608573651625-marchahead_origin.png

    Or in nominal terms, we went from $5 trillion in private debt to ~$52 trillion in 2008:

    http://research.stlouisfed.org/fred2/series/TCMDO

    And GDP increase from $3 trillion to $15 trillion during the same period.

    http://alfred.stlouisfed.org/series?seid=GDP

    Those slopes look pretty similar to me.

    And further evidence can be seen on the down side.
    That blip in GDP just so happens to coincide with the blip in the total private debt on the Fed graph and with the decreasing Household sector debt (to GDP) on this graph:

    http://research.stlouisfed.org/fred2/series/HDTGPDUSQ163N

    It should be no surprise that as private debt expands, the economy expands and when it contracts or stagnates, so does the GDP.

  • Auburn Parks

    The Fed is not injecting $1.5 Trillion in cash to bond holders. Its swapping one financial asset for another. This is mostly a net zero besides for maybe a small price premium.

    Here’s an example, say you have a 12 month CD at your bank worth $10,000 paying 5% interest. You already had the initial $10,000 you used to buy the CD in the first place. Then the bank comes along and offers you $11,000 ($500 premium) to exchange your CD. Of course you’d agree, but would you be any wealthier (minus the extra $500)?

    The answer is no, and this is why QE is not the same as Congress running a $1.5 trillion deficit.

  • Anon

    (I’ll stop inserting HTML tags – sorry about that, I didn’t realize it causes trouble!)

    Firstly, if indeed reserves do not matter, why did the loan manager I quoted above say that they needed to “find funding” to expand lending. Why didn’t they just create them out of thin air?

    Secondly, if the Fed always lends reserves, how do you explain that the Fed requires real collateral to be posted before a (temporary, short term) loan of Fed reserves is made:

    http://www.frbdiscountwindow.org/pledging.cfm?genid=13

    Also note how the Fed drains these temporary loans of reserves quickly:

    http://m.research.stlouisfed.org/fred/series.php?sid=DISCBORR

    According to this data the Fed simply does not expand reserves via the Discount Window mid or long term, it mainly does it via government backed debt – not private bank originated loans.

  • http://orcamgroup.com Cullen Roche

    1) I wouldn’t say reserves don’t matter. They just don’t determine the amount of lending that banks do.

    2) A solvent bank doesn’t have a capital constraint, by definition. It might have a liquidity constraint, but that’s different.

    I don’t know how else to explain it. Solvent banks make loans and then find reserves later if they need them. And solvent banks don’t get turned down by the Fed or by anyone else for that matter when they need to alter portfolios for whatever reason.

  • Anon

    Would you be willing to answer a simple probing question? If a small, freshly created bank with $100m in assets requested a $1b loan of reserves at the Fed Discount Window, posting as collateral its self originated loan of $1b to a small customer firm called “la Cosa Nostra”, would the regional Fed bank simply create those reserves?

    I claim they wouldn’t. The bank would possibly not even be eligible to pledge anything else but hard capital, such as government securities or preexisting reserves – so the slightly suspicious name of the debtor wouldn’t even play any factor.

    I.e. a “loanable funds” market: risks taken by those owning funds and delegating control over those funds.

    Can you see a flaw in my argument?

  • Anon

    But that still does not explain why the quoted Grand Bank loan manager said that he needed to “find funding” for new loans created.

    Those words totally make sense if he was out matching incoming funds to outgoing funds in a “loanable funds” world, where aggressively lending banks are constrained by available funds to lend.

    Those statements make little sense in an MMR world though: Grand Bank should have been able to create new loans out of thin air, rubber stamped after the fact, right?

  • Auburn Parks

    In your scenario, youre describing a capital constraint. Capital and reserves are two different things.

  • Anon

    This story seems to suggest something similar:

    http://m.us.wsj.com/articles/BL-REB-19380

    Small bank expanding loans quickly and having to tap Fed emergency lending temporarily until it “finds funding” for the new loans.

    The Fed gave those funds, probably because it judged the pledged collateral adequate.

    20 U.S. banks that went bankrupt this year could not secure funding.

  • http://orcamgroup.com Cullen Roche

    You keep describing a capital constraint. Reserves are an asset for the bank. They are not necessarily the same as capital. Bank lending is capital constrained, not reserve constrained….

  • Anon

    I think the FRED data also includes lending within the financial industry, which probably does not correlate with GDP nearly as well as say a housing loan.

  • Geoff

    Anon, banks are in the spread business and do indeed want to find funding at rates that are lower than the rates on their loans. That funding could come in the form of deposits or perhaps an institutional bond issue. But that Grand Bank story seems to support the MR view in that the bank made loans first and looked for funding later.

  • Geoff

    Cowpoke, I’m pretty sure that story is BS. It isn’t clear what rates were “unilaterally” increased but I assume they are talking about mortgage rates. Canadian mortgage rates aren’t based on the so called Bank of Canada rate (which is like the Fed Funds Rate in the USA). Instead, Canadian mortgage rates are based on bank funding costs, which are mainly a function of the underlying govt yield plus a credit spread. RBC and BNS probably raised rates at the time because one or both of those variables increased.

  • http://www.fanbrowser.com/ Cowpoke

    Geoff, your probably right.
    However, what are your thoughts on the fact that Canada has two primary dealer banks and that they do have a reserve account with the FED?
    Do ya think it’s much a’do about nothing?

  • Iluvatar

    To All (Jesus Christ, en fin!!)

    Do we HAVE TO HEAR THE SAME STORY AD NAUSEUM?

    Well TPC ,
    Looks like you are doing a ‘tete-a-tete’ (French for a head to head) with the Meister Krugman (or maybe not – he doesn’t want to hear from your sorry ass Po’ position). And that’s too bad. But what did you expect? Do you not understand the politics of economics???????????
    But what disturbs me deeply, (and this hails out to ‘Beowulf’ aka Carlos, & JKH, & Mike S.)
    You guys are still not getting what Wynne Godley established for you…
    Not a bit.
    You are absent of a policy recommendation, all you do is explain (over and over again ad nauseaum, ad infinitum!!!).
    Dude we get this already!!!
    And what you most sorely do not get is a PATH FORWARD.
    You guys just don’t fricking get it – PERIOD.
    You have NO PLAN going forward to heal the HH sector – NONE AT ALL.
    But I do & it’s sweet. I have already told it to you 15 times.
    You guys are utterly recalcitrant at formulating policy.
    And there is an excellent reason why!!!
    B/c you CAN’T!
    You have NO expertise in Constitutional Law!
    So Go describe all the things y’all like – knock yourselves out! Go DAWG!
    But until you can formulate policy that is focused on the HH sector, you are OLD NEWS sweet pea.
    You aren’t worth the effort.
    This is a heads-up to Carlos, JKH, and Mike S too (I sure as hell don’t wanna hear another post about the benefits of Social Security again!!!!!!!!!!). And in case you haven’t heard young man – Social Security is actually ILLEGAL! (Go check out Section 1, Article 8 on the Constitution on this – Hoss!). FDR committed legal atrocities during his term at president over and beyond any previous president, except Lincoln. His illegal policies were the highest in ANY presidents term! Wow! Did you actually know that!!! (I am willing to bet that you don’t – you have NO understanding of Constitutional Law!)
    Finally, I object strenuously against your name calling; You have called me an Austrian. I know who they are and have no affiliation with that line of thinking OTHER THAN to realize that ABC Theory as developed by Hayek is very well agreed upon by Minsky’s Instability Hypothesis.
    This is where the Austrians & PKE’ers actually agree – Violently.
    But I ain’t no goddamned Austrian. I ain’t NO Libertarian (although I am a fervent believer in property rights).
    I am a GOD-DAMNED EXISTENTIENLIST!
    Big fucking difference – Hoss!
    And until you know the difference between the 3? Shut the FUCK UP!
    I leave you with this. B/c this is where our society is heading.
    What disturbs me greatly is that you are beyond this – since you have been “bought” by the kleptocracy.
    You have been bought & communicating with you furthermore is a danger beyond that which I wish to absorb.
    Here is what your door prize is:

    Songwriters: FRIPP, ROBERT / GILES, MICHAEL REX / LAKE, GREG / MCDONALD, IAN / SINFIELD, PETER JOHN
    The wall on which the prophets wrote
    Is cracking at the seams.
    Upon the instruments of death
    The sunlight brightly gleams.
    When every man is torn apart
    With nightmares and with dreams,
    Will no one lay the laurel wreath
    When silence drowns the screams.

    Confusion will be my epitaph.
    As I crawl a cracked and broken path
    If we make it we can all sit back
    And laugh.
    But I fear tomorrow I’ll be crying,
    Yes I fear tomorrow I’ll be crying.

    Between the iron gates of fate,
    The seeds of time were sown,
    And watered by the deeds of those
    Who know and who are known;
    Knowledge is a deadly friend
    When no one sets the rules.
    The fate of all mankind I see
    Is in the hands of fools.

    Confusion will be my epitaph.
    As I crawl a cracked and broken path
    If we make it we can all sit back
    And laugh.
    But I fear tomorrow I’ll be crying,
    Yes I fear tomorrow I’ll be crying.
    Send “Epitaph” Ringtone to your Cell
    Epitaph lyrics © Universal Music Publishing Group, Royalty Network

    Lyrics term of use

    Contact Us / Privacy Policy / ToS / LyricsFreak © 2013

    http://www.youtube.com/watch?v=-Jh49xDNbCg

    Cheers, Iluv

  • http://orcamgroup.com Cullen Roche

    Couldn’t stay away, could you? Welcome back. :-)

  • Benjamin Cole

    Auburn-

    Thanks for your comments. In the 1970s-

    1. The US nearly an island economy, much less foreign trade meaning less competition
    2. Big Steel, The Big 3 auto etc dictate prices
    3. Big unions
    4. Huge and stodgy retailers, Sears, Pennys, set prices for the year…no 99 cents stores, Walmart, Craigslist etc
    5. Arthur Burns says tight money only depresses output not prices, so “loose” Fed.

    I lived through this period….

    But…a central bank cannot inflate today?

    I find that hard to believe.

    The Fed buying bonds means sellers have ready cash. They may put it into the bank and do nothing (like David Hume’s gold buried in the backyard), or they may buy goods and services or invest in stocks and property. I understand bond sellers are not richer…but they can spend if they choose. Some fraction must chose to spend, invest…

    The idea is to boost aggregate demand now…the Fed buying bonds, at least enough of them, would do the trick…

    However, I would agree that the Fed would be better off printing money and putting it in grocery bags in lower- middle class neighborhoods…they would spend the money

  • Benjamin Cole

    Seems to me that the Fed buying bonds puts ready cash into seller’s hands…some fraction of that cash is spent, thus boosting aggregate demand, which is what we want…maybe the Fed just needs to up the ante, say to $150 billion a month in bond-buying….

    If that is not true, then the Fed has to print money and buy dirt like you say, or subsidize state lotteries so that there are more winners than losers….

  • http://orcamgroup.com Cullen Roche

    Think about what QE actually does. If you sell your bonds to the Fed then you get cash in exchange for your bonds. Are you really more likely to spend after that? Why? Your net worth is the same. Sure, you’re more liquid, but do you always spend more just because you’re more liquid? Why? I presume, like most of us, you spend more when your income relative to desired saving increases. But QE does not increases incomes and doesn’t increase saving. So why would you spend more?

  • A H

    Highly liquid liabilites are functionally the same as money. So if your firm can create liquid liabilites it can create money “out of thin air”. Money market mutual funds are a prominent example.

  • http://brown-blog-5.blogspot.com/ Tom Brown

    It (the Fed created reserves) doesn’t have to come through the discount window either. Mostly it doesn’t, from what I understand. Mostly it comes via repos. I specifically asked Scott Fullwiler about this and this is what he said:

    “Just quickly as I’m off to class in a minute, but note that the Fed uses open market operations–mostly repos–to manage the fed funds rate as its primary tool. That is, it will provide an overdraft during the day, but it expects that its open market operations will provide sufficient reserve balances for desired overnight holdings to keep the fed funds rate target. The seasonal lending, etc., are not the tools it would use to hit its target. At any rate, included in banks’ “desired overnight holdings” are reserve requirements and any additional excess banks desire to hold as a buffer to guard against overnight overdrafts or so that they don’t have to go to the Fed for an overnight collaterlized loan. And the Fed accommodates (again, mostly through its open market operations) because that’s what it means to set an interest rate target.”

    Scott had said this regarding use of the overnight window to me in an earlier email:

    “(ii) is at a penalty unless collateralized. Even then, it’s at a penalty, just not as high. Also, under the current system, the Fed “frowns” on banks borrowing from it like this, and because of this other banks/investors/lenders view borrowing from the Fed as a sign of trouble (aside from seasonal borrowing and other special programs). In other words, since the Fed doesn’t like to lend to cover payment settlement like this, when it does do it others take it as a sign of weakness on the part of the borrower. To not send that signal to others or to the Fed (since the Fed’s a regulator, too, of course), they prefer not to borrow from the Fed. ”

    So what happen is NOT that banks borrow directly from the discount window (to any great extent), but instead the Fed does repos and reverse repos such that the FFR is hit and banks can borrow from EACH OTHER at the FFR! If they can’t, then the Fed isn’t adding enough reserves to the inter-bank market (or it’s adding too many) via repos and they’ll do more repos or reverse repos such that the market lends at the FFR. Make sense?

    And sure you have to have collateral, but guess what? Loans themselves can function in this regard. Even the Fed accepts MBS for collateral, or in repos. That’s my understanding!

  • A H

    The main tool the Fed uses for monetary policy is open market operations not the discount window. The Fed targets an interest rate in the Fed Funds by using open m arket operations to control supply and demand of reserves in that market.

    This is why the Cullen says the Fed has no choice in the matter. In order to hit it’s interest rate target it must supply a certain amount of reserves.

  • Benjamin Cole

    Well, you raise a good point. I enjoy your commentary btw.

    Still, thanks to the Fed, there is $3 trillion in cash out there, that had been locked up in bonds. Unspendable, before, now spendable.

    If the $3 trillion moves from the sidelines, you get extra demand now, for good and services, equities or property. And we need more aggregate demand now.

    Those bond-sellers could not sell to each other and get the same aggregate result. Someone would go out of cash, and someone into cash.

    Will the Fed QE program work? I think it will, if the Fed makes clear the QE program is open-ended, and they are going to keep doing this, and even taper up, until they get results.

    Then you get a new dynamic going.

    Who wants to be the last guy sitting on the sidelines when trillions of dollars pours into the economy? You would not want to buy property ahead of the stampede? Buy stocks before the boom?

    That said, I still like your idea of the Fed buying bags of dirt. Or pandering to global drug lords to bring their $800 billion in US Benjamin Franklins home to the USA, if they will just spend and live high on the hog for a year or two.

  • JCM

    But if you take that example further and consider two banks doing that, as a proxy for the whole banking sector, those transfers might be netted away to a great extent. So, customer in the bank (A) you though up transfers $1 billion to another bank. Another bank (B) also has a customer who also got a $1 billion deal and transfers that $1 billion to bank A. Those transfers are now cancelling each other out. $2 billion is still created.

    In 2007 average total reserve balances maintained with Federal Reserve Banks was only around 12 billion.

    Between 1981 and 2006 credit market assets rose by over $32 trillion, yet reserves held as deposits at the Fed fell by $6.5 billion during the same period. (Data: Peter Stella at VOX).

  • Bernard King

    I believe this is largely correct. The Fed’s solution was to exchange outside money, i.e. newly created reserves, for the underperforming assets on bank balance sheets. This probably saved some banks, but as you correctly observe, it allowed a lot of malinvestment to remain on the books that should have been written down. The result of this has been to swap out the old punchbowl for a new one, so the party could hobble along into the wee hours of the morning. But the party has to end sometime…

    It also exchanged this money for a big chunk of Federal debt, but I’m still wondering if this was necessary. Maybe the thinking was if bond rates would have risen without these purchases, long term mortgage rates would stay too high. Maybe it was done in light of the increased Federal spending. Maybe both, maybe neither. Still pondering.

  • Joe in Accounting

    @ Anon,

    I think it may be helpful to read JKH’s post “‘Loans Create Deposits’ – in Context”. It drills down into the details of loan creation, funding and asset/liability management, which is the core function of operating a bank.

  • Joe in Accounting
  • Geoff

    Cow, first of all, the Canadians aren’t unique. There are Primary Dealers from around the world like Nomura, HSBC, Barclays and Douche Bank. I believe the purpose of the foreign dealers is to provide a foreign network of Treasury buyers. For example, Nomura would sell to the Japanese and Barclays would sell to the Brits.

    Secondly, these are dealers, not banks. I don’t believe the dealers have the same privileges as the banks in terms of borrowing from the Fed, which is why the Giant Squid converted to a bank during the Financial Crisis.

  • http://dismalecon.blogspot.ca DismalEconomist

    Couldn’t you just as easily argue that additional bank lending creates more inside money and that is what caused the 3% inflation? That seems more plausible to me, seeing as the money being used to transact at the movie theatre is inside, not outside money.

  • erestor

    Anon,

    I’ve been following your comments on this page and I believe you are addressing the very same issue I raised a little while back in the old forum. I had an extremely long exchange with Tom Brown and Cullen over this very issue. The forum post was titled “Money Transmission Process.”

    Cullen, is there a way to access the old forum discussions? Are they in the new “Ask Cullen” webpage anywhere?

  • Nils

    Douche Bank?

  • Phil Dunn

    @Anon

    Loans create deposits but then the deposits fly way from the originating bank. However, for the commercial banking system as a whole loans create their own funding. The funds are there even though a particularl bank could have difficulties obtaining them.

  • Geoff

    Haha, perhaps I shouldn’t make fun of the Germans. I wonder if Deutsche Bank gets along with Goldman Sachs?

  • http://brown-blog-5.blogspot.com Tom Brown

    Sumner DOES mention you this time Cullen:

    “Some might argue that I did the same thing to Cullen Roche that I’m accusing Krugman of doing to Hall.”

    http://www.themoneyillusion.com/?p=23124

    Of course he “mostly” agrees w/ Krugman here, and echos his “nothing special” line.

  • http://brown-blog-5.blogspot.com Tom Brown

    Sumner is also pretty sure that Krugman has a typo here:

    “Banks are just another kind of financial intermediary, and the size of the banking sector — and hence the quantity of outside money — is determined by the same kinds of considerations that determine the size of, say, the mutual fund industry. ” – PK

    He thinks that should read “inside money” not “outside money.”

  • Geoff

    I was wondering about that myself. Not sure if it was a typo, or if he just uses the term differently, or if it was a friendly attempt to use MR language and he just got it backwards by mistake.

  • http://brown-blog-5.blogspot.com Tom Brown

    It’s my understanding that “inside money” and “outside money” are not MR terms, or even PKE terms: they are common terms even used by the Fed itself. Take a look at this:

    http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.148.158&rep=rep1&type=pdf

  • http://orcamgroup.com Cullen Roche

    Yes, I did not invent the terms. They were first used by Gurley and Shaw in the 60’s. They’re not terribly popular ways of describing the system because most economists only focus on outside money. So there’s no need to understand inside money in most modern macro models.

    But I guess you could say I am trying to revive the terms and make them more popular. :-)

  • http://brown-blog-5.blogspot.com Tom Brown

    That’s why it’s possible to define “inside” and “outside” money in different ways, depending on from who’s point of view your are looking at it: like a set of Russian nesting dolls (I still think that should be one of Cullen’s posts… with the graphic being a disassembled Russian nesting doll that looks like Ben Bernanke, with the innermost doll filled with hand written IOUs… if he doesn’t do it, maybe I will, but of course I doubt I’ll be able to find such a picture!)

    What’s my symbolism there? Well you could think of handwritten IOUs as being the most inside of inside “money.” The next layer out would be bank deposits, then paper reserve notes & Fed deposits, then US Notes, and finally coins (which are not formally a liability to anybody… as far as I can tell… I even asked JP Koning if he knew and as far as he can tell, coins are not a formal liability to anybody):

    http://jpkoning.blogspot.com/2012/03/money-as-liability.html?showComment=1377008622528#c7712446343746320628

    (Maybe I’m wrong, but I think of JP as kind of a money expert).

    JKH calls coins a “contingent liability” of the Tsy, and I like that description, but as far as I can tell that’s not an official designation or terminology.

  • http://brown-blog-5.blogspot.com Tom Brown

    “contingent liability” means that practically coins are a liability to Tsy, just not a formal one.

  • http://brown-blog-5.blogspot.com Tom Brown

    “US Notes” are hardly worth mentioning since there’s so few of them “in circulation,” and no new ones are being created, but they are officially still currency and are treated as a direct liability of the Tsy, but one which does NOT contribute to the debt limit. That’s why I’d put them on the layer between coins and reserve notes.

  • http://brown-blog-5.blogspot.com Tom Brown

    Let’s change your scenario slightly and say the bank had $100M in capital rather than assets (it could have for example $100M in assets and $150M in liabilities, which would be very bad indeed).

    Now say it did $1B of lending (over the course of a year) to a well diversified group of low risk borrowers, all of which pledged low risk, independently assessed, collateral for their loans. I don’t see why that isn’t possible: first off, the Fed deposits would come in more or less gradually through the Fed performing repos with the banking system as a whole (not with one giant discount window loan!)… ensuring the liquidity was present for the new bank to borrow the reserves it needed (if any new reserves were actually required) at the FFR. That’s EXACTLY the kind of growth in credit (i.e. inside money) that the Fed is SUPPOSED to be supporting.

    Can you see a flaw in that argument?

  • http://brown-blog-5.blogspot.com Tom Brown

    $100M in captial and no big risky pre-existing assets, so the CAR was >> 10% (for example, if this new bank had $100M in reserves and T-bonds and no other assets or liabilities, the CAR would be infinite since the risk weighted sum of assets in the denominator would amount to 0).

  • Anon

    I’m talking about (and I’m trying to defend) the notion of “loanable funds”.

    In that sense time deposits are “loanable” funds – term matched. They are not bank capital in the traditional sense, yet they act as such.

    A simple deposit on the other hand is not “loanable”, as it could be spent/transferred to another bank anytime.

    Tier 1 bank capital is “loanable” on the other hand, with no term limit.

    In that sense the naive view that people’s deposits are lent out is indeed false, because only a subset of deposits that will stay in place predictably can form a basis for lending.

    But IMO the view that banks create money “out of thin air” is false as well: it’s all collaterized and backed by real reserves, which reserves banks either own by virtue of having attracted deposits from other banks, or rent from other banks at a price.

    So in reality private banks create space for money (preexisting reserves) to flow into.

    The Fed sets the price of the “water” and makes sure that it can always flow to those willing to (and able to) pay the rent.

    Finally, if a bank goes bankrupt then its reserve lending counterparties don’t get the reserves back – they utilize the collateral. There’s no money lost in the aggregate – which really shows that private banks don’t create but reallocate money.

    Does this make sense to you?

  • http://brown-blog-5.blogspot.com Tom Brown

    Auburn, mostly O/T: but you might be interested in this: I’ve changed my Example #11.2 in how it includes G = non-Tsy government held Tsy debt (such as Social Security’s holding). I’m still excluding foreign held Tsy debt (or rather, now in all the series 11 examples, I’m explicitly excluding foreign held Tsy debt). Foreign held will come in a later update. The interesting thing is that G does not contribute to the public’s money stock and is explicitly subtracted from the public’s equity (to remove it as a component of T which now explicitly includes it… i.e. T = F + B + G + public’s Tsy debt). Specifically look for the BS entitled “Public (simplified)” towards the bottom where I set a lot of superfluous variables to 0 to just concentrate on the effects of G.

    http://brown-blog-5.blogspot.com/2013/08/banking-example-112-macro-balance.html

    I’m not certain that I’ve captured the effects of all the MBS variables (M & Mf, etc) correctly, so I’ll review that again next. Set them to zero for safety!

  • Anon

    There’s data on Fed repos:

    http://m.research.stlouisfed.org/fred/series.php?sid=RREPT

    At ~0.090 trillion, mostly constant, it’s still a very small operation.

    The overwhelming majority of reserves were created via deficit spending and the Fed buying government bonds on the open market.

    Those reserves, once controlled by the banks, form the basis of every single checkable depository dollar in existence.

    To create new “bank money” a bank must know that it can profitably borrow backing reserves for the new deposit. (In the ideal case it will already have the reserves, by virtue of having attracted customers from other banks.)

    The cost of reserves is not a constraint today, at 0.25% FFR. But if in the future the FFR hits 5% again then for sure it will matter to a bank’s practical ability whether it controls enough reserves: getting those reserves from other banks will cost +5%, a huge cost that makes a loan probably nonviable.

    So as a practical matter banks can be again reserve constrained, if the Federal Funds Rate is high enough?

    Agreed mostly? Or does MMT define “constrained” in some other way?

  • http://brown-blog-5.blogspot.com Tom Brown

    How about including repos as well as reverse repos and also data prior to 2008 when that method was the primary one for controlling the FFR (again, that’s the implication from Scott Fullwiler’s reponse to me… I’m sure he’s not talking about after QE/LSAP etc.).

    Also, once the FFR is achieved I would imagine it doesn’t take a lot more repos and reverse repos to keep it there. Theoretically the dollar amount should net out to something like just 10% of the change in checkable (demand) deposits in the private sector and no more. Make sense? They don’t have to repo/reverse repo 100% of ALL deposits to keep the FFR on target.

  • Anon

    But why does the order of funding make such a big difference to the argument?

    Most banks expand lending gradually, through hundreds or thousands of customers attracted incrementally.

    With emergency/seasonal fluctuation lending facilities of the Fed such small variations can be smoothed over.

    If the MMT view that banks create money “out of thin air” was true then Grand Bank would not have had been forced to lend reserves from the Fed Discount Window: at penalty rates, also being shamed publicly as a bank that couldn’t borrow from other banks.

    But it was forced to borrow reserves from the Fed – because new money most originate from “old money” – it must originate from sources of money (willing sources of funding).

    To me this story suggests that small banks (which control 50% of all deposits in the U.S.) have more of an “intermediary” role, connecting “lenders” to “borrowers” – not through deposits, but through a subset of capital-equivalent deposits.

    Large, capital-rich banks are less of an intermediary between lenders and borrowers, mostly because through their capital they are assuming a lending source role. That’s not out of “thin air” either: it’s backed by their capital, with every newly created deposit dollar backed up by a preexisting reserve dollar.

  • http://brown-blog-5.blogspot.com/ Tom Brown

    Also note the implication of Fullwiler’s response: the “lending” of the balance of transferred reserves from one bank to another (rather than just the 10% for RR) is accomplished through the overdraft facility, not explicit lending over the discount window or through repo/rev-repo.

    Plus we get back to these reserve transfers being netted out and accomplished in bulk. So for example if there were two commercial banks, A & B and demand deposit levels didn’t change appreciably, then at the end of the day you look at A => B net of B => A transfers in excess of the required reserves & excess reserves (just plain reserves) that A already has, and if more are required A overdrafts its Fed deposit and the Fed makes sure (through repos/rev-repos) that just enough reserves are available for A to borrow on the interbank market enough for A to repay the overdraft in 24 hrs.

    This is a FAR cry from having to borrow 100% of every transfer from the Fed through the discount window.

  • LVG

    @ anon,

    a bank that extends a loan and maintains the deposit has essentially “funded” it own lending. You don’t think that’s important? I think that’s pretty important.

  • http://brown-blog-5.blogspot.com/ Tom Brown

    Anon, you write:

    ” with every newly created deposit dollar backed up by a preexisting reserve dollar.”

    Actually, with 10% of every DEMAND deposit dollar back up with 10 cents of post-existing reserve dollars would be a better way to describe that. Remember that banks build capital through the lending process itself: all those fees and points you pay (i.e. by allowing the bank to debit your deposit) goes straight into building bank equity and capital!

  • http://brown-blog-5.blogspot.com/ Tom Brown

    Could a bank make money doing exclusively cash advances and not even accepting customer deposits? Maybe I’m wrong, but I claim that it’s possible that it could, especially at the ZLB. It would build it’s balance sheet as nothing but cash advance loans (which grow as interest is charged and fees assessed) on the assets side and nothing but reserve borrowing on the liabilities side. It might swap out some of the loans for more reserves or other assets such as Tsy debt to improve it’s CAMELS score. Maybe they have to pay a premium above the FFR because of the risky nature of it’s assets, but as long as there’s still a spread, they could still make money. And the Fed will take care of making sure there’s enough cash in reaction to what the market does. Somebody out there somewhere is probably taking the excess cash and trading it back to banks for more deposits, and the bank in turn send their excess back to the Fed for more Fed deposits.

  • Geoff

    Thanks, Joe. As JKH would say, loans create deposits but deposits fund loans :)

  • http://brown-blog-5.blogspot.com/ Tom Brown

    “Expert!?” … most definitely not! But thanks for the kind sentiment! ;)

  • http://brown-blog-5.blogspot.com/ Tom Brown

    Joe, I read that JKH piece a while back… but how would you respond to Anon in your own words? What does he have right & wrong here? Is there something you’d phrase differently than JKH or that you’re not 100% on there? Thanks.

  • alphaprophets

    lol

  • Anonymous

    Interbank transfers sum during the day so that overnight interbank lending is only a tiny fraction of the total transferred. Thus, the banks can create deposits out of thin air in the knowledge that only a tiny fraction will require reserves for the interbank market / cash withdrawals. Reserves just track transactions between banks so the central bank can act as a clearing house. Interest rates are set via Tsy bonds, which offer risk free rate of return upon which risky lending rates are based.

  • http://brown-blog-5.blogspot.com/ Tom Brown

    Anon, I can assure you the only time I’ve ever deleted a comment was when I thought it was spam! Sorry if I mistook your comment for spam… but I honestly don’t recall such a comment. Usually the spam comments have active links in them and seem to be promoting another commercial website. Did the comment ever post in the first place? There is an automatic spam filter, but I rarely check that. Is it possible it’s stuck in there? Did you use the name “Anon?”

  • http://brown-blog-5.blogspot.com/ Tom Brown

    I hope you didn’t use the name “Anonymous” since 95% of all the spam the filter catches is by that name :(

  • Peter N

    “In that sense the naive view that people’s deposits are lent out is indeed false, because only a subset of deposits that will stay in place predictably can form a basis for lending.”

    Individual banks depend on withdrawals being uncorrelated. The banking system as a whole depends on withdrawals from bank A becoming deposits in bank B.

    A bank can lend until its ratio of assets at risk to capital reaches a certain level. Below this the FDIC will intervene. This is around 10% tier 1 capital to assets.

    In theory a bank can raise money to cover deposit withdrawals exceeding its vault cash and reserves by selling, borrowing against or securitizing assets.

    It would, of course be imprudent to allow the deposits of any single customer to be so large that they can’t be payed off on demand, and the FDIC’s deposit guarantees usually prevent panics. And, a bank can suspend convertibility for a short time.

    If the bank run is unstoppable, the FDIC will usually arrange a takeover by a more liquid bank.

    Terminal bank runs on banks that are properly capitalized, FDIC ensured and solvent are very rare, if the problem is really just a temporary lack of liquidity.

    There’s no magic bullet here. It’s the job of banks to take this sort of risk to the extent considered prudent. That’s one of the things banks get paid for – assuming risk depositors don’t wish to assume.

    See
    http://www.rich.frb.org/publications/research/economic_quarterly/2007/spring/pdf/diamond.pdf

    or a good macro text like

    http://www.amazon.com/Modern-Principles-Macroeconomics-Tyler-Cowen/dp/1429239980/ref=sr_1_1?s=books&ie=UTF8&qid=1377684057&sr=1-1&keywords=macroeconomics+tyler

    or

    http://www.amazon.com/Macroeconomics-6th-Olivier-Blanchard/dp/0133061639/ref=sr_1_1?s=books&ie=UTF8&qid=1377684150&sr=1-1&keywords=macroeconomics+blanchard+6th+edition

    and these are not exactly on point, but well worth reading

    http://www.amazon.com/s/ref=ntt_athr_dp_sr_1?ie=UTF8&field-author=Willem+H+Buiter&search-alias=books&text=Willem+H+Buiter&sort=relevancerank

    And these are wonderful and free!

    http://www.voxeu.org/person/axel-leijonhufvud

    The money multiplier story in any macro text is correct as far as it describes a fractional reserve system. Just substitute the word capital for reserves in the context of limitation and don’t bother calculating a meaningless multiplier.

  • http://asymptosis.com Steve Roth

    @Peter N: “The money multiplier story in any macro text is correct as far as it describes a fractional reserve system. Just substitute the word capital for reserves in the context of limitation and don’t bother calculating a meaningless multiplier.”

    This might be true if they also removed any notion that bank capital — hence lending capacity — has any easily explicable relationship to “saving.”

  • http://brown-blog-5.blogspot.com Tom Brown
  • Geoff

    Wow, thanks for the link, Tom. Looks like he’s lining up with Krugman and Sumner. I don’t think I fully grasp Nick’s argument. I’m going to have to re-read his post a few more times, but when he says that money is “supply determined”, and about “excess demand” for money, it appears that he believes that money is exogenous.

  • http://brown-blog-5.blogspot.com Tom Brown

    Geoff, I don’t think he is lining up with them. He’s writes this in the comments:

    “I think I am contradicting the Tobin view of banks.”

    Plus the point of article is that he thinks the MOE aspect of bank liabilities (deposits) IS special, and thus banks ARE special. I think he’s challenging both sides here: Are there people like Steve Roth (Nick points to this but I haven’t read it yet):

    http://angrybearblog.com/2013/08/why-banks-are-special-the-short-story.html

    that think that the MOE aspect ISN’T important, but that banks still are? According to Rowe, that doesn’t make sense. On first read… I reluctantly agreed… but I don’t know the full implications of what I’m agreeing too… ha! So I may change my mind later! Ha!

    But Rowe clearly thinks MOE is important and in contrast to Sumner, he puts less emphasis on the MOA aspect of base money, therefore banks ARE special. That’s what the title says even.

    Again, in the comments:

    “There’s a side-argument going on as well, because not all MMs think alike on this question. Scott Sumner for example emphasises the MOA aspect of money, and it is central bank money that is the MOA. I put more emphasis on MOE, and both central and commercial bank moneys are MOE.”

  • http://orcamgroup.com Cullen Roche

    Interesting. I actually think Nick is agreeing with me to some degree. I fervently argue that the MOE matters and it’s precisely what makes banks special. The govt has determined the playing field for the payments system. And the payment system we use is the one that banks dominate. And to gain access to that playing field you want access to bank deposits! So yes, the MOE matters because the primary MOE in today’s world is bank deposits. That’s precisely why banks matter. If the govt determined cows as the MOE then cows would matter. And then farms would become the modern equivalent of a banking system where farmers create cows and the govt regulate how they make them and where they make them.

    I think Nick’s validating my point. Unless you guys think I am missing something?

  • http://brown-blog-5.blogspot.com Tom Brown

    Geoff you write:

    “but when he says that money is “supply determined”, and about “excess demand” for money, it appears that he believes that money is exogenous.”

    I need to re-read that too I guess… I completely missed that! However, I’m pretty sure Nick doesn’t think that “money is exogenous” … he has a whole post on that subject (about three of his posts earlier… you have to go up to the top and select “posts by author” to just see his).

    Plus he wrote this on an obscure page in my blog a few days ago. First what I wrote on my “Links” page (just notes to myself really):

    “Nick Rowe’s comments on “The supply of money is demand determined.” … Not even not even wrong, and all that. Also some bits about “perfectly inelastic wrt” and perfectly elastic, etc. Basically one of two talking about money being endogenous in the short term (between six week meetings of the BoC or Fed) but not in the longer term (like two years out) where inflation targeting makes it exogenous. (see Nick Rowe’s 2012.08.22 comment below)
    http://worthwhile.typepad.com/worthwhile_canadian_initi/2012/04/the-supply-of-money-is-demand-determined.html

    Nick’s comment on this:

    “Tom: thanks, but that’s not quite right. Under inflation targeting the quantity of money is endogenous in both the short run and the long run. It’s the nominal rate of interest that is exogenous in the very short run (6 weeks or less, for the Bank of Canada anyway), but endogenous in the long run.”

    Plus there’s more there from him. I was confused at first about how his concepts of “perfectly elastic wrt” and “perfectly inelastic wrt” fit into this endogeneity and exogeneity he speaks of here, but I think I’ve partially resolved that. I still don’t get why he thinks that Glasner is using “endogenous” in a different “sense.” Take a look at our whole convo here:

    http://brown-blog-5.blogspot.com/p/links-to-remember.html

  • http://brown-blog-5.blogspot.com Tom Brown

    I provisionally agree with you Cullen. How’s that for commitment? ;)

    But seriously… I’m about 67% sure of it. Ha!

  • http://brown-blog-5.blogspot.com Tom Brown

    O/T: Just had some fun here… ran outside to see the launch of a Delta IV Heavy from Vandenburg… I understand those rockets are 23 stories tall! … I didn’t stick around long enough to hear the roar, but saw it depart the Earth… you can see the burn and contrail good from here in Santa Barbara. We used to be be able to see them from 4 hours away in the Mojave desert too… in the evenings when the sun would catch the contrails

    http://www.ulalaunch.com/site/pages/Multimedia_Webcast.shtml

  • http://orcamgroup.com Cullen Roche

    Cool.

    On a o/t o/t note – I didn’t know you were in SB. How long have you lived there and how much do you love it? I always talk about moving there every time I visit. Maybe my favorite place in the country….

  • http://brown-blog-5.blogspot.com Tom Brown

    Well, ACTUALLY, I live in Goleta, the far less glamorous neighboring community to the West (yest to the West!) along the ocean (coast runs east-west here… as you probably already know).

    I LOVE IT… I’ve been here since college (UCSB). I’ve been here for permanently since 1991.

  • http://orcamgroup.com Cullen Roche

    I’ve never been. I’ll have to swing through some time so you can teach me about banking. :-)

  • http://brown-blog-5.blogspot.com Tom Brown

    Sure anytime! … I’m not sure about the “teaching about banking” though… you know that everything I learned was online from people like you … well actually mostly you, but other folks too to give credit where it’s due!

  • http://brown-blog-5.blogspot.com Tom Brown

    I just watched the old 1981 remake of “The Postman Always Rings Twice” last night… most of it was shot over the mountains to the North in the Santa Ynez valley, but there’s one brief scene, almost exactly midway through the movie, where they stop at the Rio Grande gas station… that station was not a movie set… it exists although it’s been abandoned for a long time… it’s less than a mile from my house … and within sight of the school I walk to to vote at… which adopted the same blue and white checkboard design: Ellwood elementary. Ellwood (part of Goleta) was a 1930s oil boom town… and one of the few places the Japanese shelled (from a submarine) in the lower 48 during WWII.

    http://www.ellwood.goleta.k12.ca.us/Barnsdall%20Oil/BarnsdallOil.html

    Where all those oil platforms are is were I go for a walk now almost every evening.

  • Geoff

    OK, after re-reading Nick’s post a couple of times, it is beginning to sink in. He is indeed agreeing with Cullen “to some degree”. He does say that banks are special because the MOE is special (right in the title of the post!)

    However, this statement is confusing:

    “The talented artist cannot create an excess supply of his product; banks (in aggregate) can.”

    I don’t believe that banks CAN create an excess supply of their product because it is driven by demand in the first place. You need borrowers in order to lend.

  • http://brown-blog-5.blogspot.com Tom Brown

    Good point. I was confused by that line too. Certainly CENTRAL banks can do that!

    Perhaps what he means is in relation to a PKE style overlending situtaion, requiring a deleveraging phase on the other side. I’d be surprised if that were the cases because MMists in general don’t buy that argument… right? They don’t like the balance sheet recession concept. Sumner says it’s because bubbles don’t exist: the EMH holds so they can’t. But I think that might actually be a point of difference between Sumner and Rowe… Sumner jumped in on Krugman’s side against Rowe a few weeks back, and I think that may have had something to do with it.

  • http://orcamgroup.com Cullen Roche

    You have to understand the MM view. They state that recessions are caused not by a lack of demand for goods and services, but an excess demand for money. So you can create too much money and you can create not enough money to meet the demands of its users thereby causing supply side shortages or excesses. The MM guys presently say there’s not enough money which has led to not enough demand. It’s a sort of version of the MR view, but it solves it differently because we think money is different things and controlled by different entities.

  • Geoff

    Yeah, it seems like there are all sorts of side debates going on! We have monetarists vs monetarists (Sumner vs Rowe), monetarists vs fiscalists (Rowe vs Krugman) , and PKE vs them both.

    BTW, Tom, nice comment over there about how Banks buy everything using MOE.

  • Geoff

    It appears that MM’s are confusing money with wealth, which is clearly not uncommon. If they had said there’s not enough wealth (or perhaps NFA’s) which as led to not enough demand, I would agree.

  • http://orcamgroup.com Cullen Roche

    Or said a little differently, there’s not enough income relative to desired saving. That’s a function of bigger problems and not just an excess demand for money.

  • Geoff

    Right. That is a much better way of saying it. If the goal is to boost Aggregate Demand, you want to boost income relative desired saving. Income is not money!

  • Geoff

    I mean money isn’t income unless the Fed fires cash out their front door with a cannon.

    Did you come up with that analogy? I like it better than the helicopter drop :)

  • http://brown-blog-5.blogspot.com Tom Brown

    that should be “were” rather than “are”… they are LONG gone. Just a few platforms off the coast left and tar on the beach. ;)

  • http://brown-blog-5.blogspot.com Tom Brown

    Thanks… I’ve been saying the same thing over hear for a bit now, but I threw the “MOE” thing in just to make Nick happy. ;)

  • http://brown-blog-5.blogspot.com Tom Brown

    And JP Koning brings this up:

    http://worthwhile.typepad.com/worthwhile_canadian_initi/2013/08/banks-and-the-medium-of-exchange-are-both-special-or-neither-special.html?cid=6a00d83451688169e2019aff0dc8bb970c#comment-6a00d83451688169e2019aff0dc8bb970c

    Basically that Bill Woolsey (another MMist) would be on Nick’s side here… AND Glasner would take Sumner’s… plus they’ve had this debate before it sounds like.

  • http://brown-blog-5.blogspot.com Tom Brown

    Yeah Nils, crazy, eh? Gotta love those Germans… they keep their douche’s in banks! :D …. Ha!… yes I know you’re German, …er.. pardon me, “Deutsch.” Do you know about the Douche Bank? Is it popular there? ;)

  • http://brown-blog-5.blogspot.com Tom Brown

    Cullen, check it out: JP Koning is also getting in on the banking theme (though I haven’t deciphered all of his article here yet):

    http://jpkoning.blogspot.com/2013/08/do-banks-have-widows-cruse.html

    This piece he does here on the “convenience yield” is also interesting:

    http://jpkoning.blogspot.com/2013/08/the-fed-funds-rate-was-never-feds.html

  • http://brown-blog-5.blogspot.com Tom Brown

    Now Sumner links to this Rowe piece about the specialness of banks, and says this (re: recessions):

    “I certainly like the Rovian goods and money story better [about recessions] than the intertemporal substitution story, but I greatly prefer a third approach; labor and money. Indeed I don’t even like the definition of “recessions” that Yichuan starts off with. I don’t see the problem during recessions as being excess supply of goods. Or goods that are not consumed. Rather the goods market seems to be in equilibrium, it’s just that equilibrium output has fallen. I see excess supply of labor as the key characteristic of recessions, at least demand-side recessions. Yes, in theory output could drop while we remained at full employment due to falling productivity, but how often does that occur in the US? In practice, recessions mean excess unemployment.”

    http://www.themoneyillusion.com/?p=23152#comment-271114

  • http://brown-blog-5.blogspot.com Tom Brown

    And Waldman too:
    http://www.interfluidity.com/v2/4522.html

    Shoot, there are a lot of reverberations on this echoing around.

  • http://orcamgroup.com Cullen Roche

    What causes the excess unemployment????

  • http://brown-blog-5.blogspot.com Tom Brown

    OK, let me do my best Sumner impression… ready?

    “A shock to NGDP in relation to sticky wages.” -TB imitating SS

    OK, I’m partially faking my way through that one, but I think that might be about “right” in terms of predicting his response. Ha!

  • Geoff

    Haha, here is my impression of SS explaining unemployment:

    “The Fed failed to either set high enough expectations or provide enough base money to fulfill them”

  • http://brown-blog-5.blogspot.com Tom Brown

    This could turn into a game! I’ve already proposed such a game once for the most interesting of pragcap commentators (I led off by doing a Cullen impersonation — which Cullen got right away… it was pretty easy).

    I can identify certain pragcap commentators even w/ my glasses off simply by how their “sentences” look on the screen. Not a lot, but a few. Most, however, require reading. For example, can you tell who this might be?

    “Cullen, I can’t believe you’re wasting your time with this guy!”

    There’s a couple of contenders, actually. :D

    (and frankly I’m usually glad they pipe up and say what I imagine the bulk of us are thinking!)

  • http://brown-blog-5.blogspot.com Tom Brown

    That’s a pretty good SS, BTW!

  • http://brown-blog-5.blogspot.com Tom Brown

    Hey, I just now realized that “sticky wages” and “sticky prices” are not something you hear a lot about here on pragcap, to my knowledge. Is that more a neo-classical thing?

  • http://brown-blog-5.blogspot.com Tom Brown

    Scott Sumner of course! … Not “SS.”

  • Geoff

    Tom, I can’t identify the poster but I think I can guess who he’s talking about. It’s either Vince or Johnny :)

  • http://brown-blog-5.blogspot.com Tom Brown

    Actually, who he’s talking about could be a WHOLE LOT of people! I don’t want to get specific thought …

    That could be another game: try to identify who Cullen is addressing by his final sentence… or by imitating his final sentence. Sometimes the final sentence is a simple “Thanks.” or “Take care.” which usually means “Please go away and never come back.” On occasion just the final punctuation is sufficient: e.g. “?????????????” … I have a short list of contenders who’ve earned that terminating valediction. :D

    shoot… this is delicious fun, but I should probably quit before I get myself in trouble here!

  • http://orcamgroup.com Cullen Roche

    I read the post. He says: ” monetary shocks cause aggregate nominal income to fall. That leads to less hours worked, and thus less employment. ”

    That’s something I could say if you replaced monetary with debt. Sumner doesn’t understand endogenous money so he doesn’t understand what a money shock is….

  • Dennis

    “In an illuminating series of articles on Seeking Alpha titled “Repoed!”, Colin Lokey argues that the investment arms of large Wall Street banks are using their “excess” deposits – the excess of deposits over loans – as collateral for borrowing in the repo market. …

    “The deposit-to-loan gap for all U.S. banks is now about $2 trillion, and nearly half of this gap is in Bank of America (BAC), JPMorgan Chase (JPM), and Wells Fargo (WFC) alone. It seems that the largest banks are using the majority of their deposits (along with the Federal Reserve’s quantitative easing dollars) not to back loans to individuals and businesses but to borrow for their own trading. Buying assets with borrowed money is called a “leveraged buyout.” The banks are leveraging our money to buy up ports, airports, toll roads, power, and massive stores of commodities.

    “Using these excess deposits directly for their own speculative trading would be blatantly illegal, but the banks have been able to avoid the appearance of impropriety by borrowing from the repo market.” Ellen Brown

    (Sorry for the long quote but she explains something that seems to be “reserve constrained”, but these days the “reserve” bucket is full to an unprecedented degree and the big banks are free to use this as collateral for all sorts of things.)

  • http://orcamgroup.com Cullen Roche

    Oh man. I’ve become too transparent. Time to start mixing it up. :-)

  • Geoff

    Don’t worry, Nils. I’m equal opportunity when it comes to bashing the banks of other countries. In the USA, I have my eye on the Skank of America and Shitibank.