Friday, March 23, 2012

JKH writes a really long post

JKH has written a really long post on "S = I + (S – I)". Cool! Even after the really long comment threads written on the topic here, I still cannot figure out why this is important (although I agree that it is true).

I'm not very bright, so I use simple models to try and understand things.

Let's imagine a brand new world. T=0.

It has one entity with a monopoly on violence who can create demand for a currency only it can create. Therefore a monopoly on violence extends to a monopoly in issuing currency.

The non-currency issuers have no currency to spend unless the currency-issuer firsts prints some currency into existence, gives it to the non-currency issuers, and then doesn't take all of it back again as taxes.

G-T.

Suppose the currency issuer sells debt to "fund" the printing. The people to buy the debt are the non-currency issuers, and the only money they have to buy the debt with is the currency that was just issued to them (and not taxed back). If the currency issuer sells debt equal to every unit they issued, then all the non-currency issuers will be left holding is the debt.

There are many non-currency issuers. Some are companies. Some are households. Some are foreigners. They trade the currency between themselves. Or not. Or partially. They can issue debt, but that doesn't change net currency in the non-currency issuer sector.

By consolidating the three different types of non-currency issuers into one, the model becomes a two sector model (currency issuer, non-currency issuer).

I do not understand what S=I+(S-I) adds to or changes this, but I hope to be enlightened on this soon.

37 Comments:

Blogger JW Mason said...

You can really see the homology between MMT and market monetarism in parables like this. It is possible you could find a handful of colonial situations where something like this story would apply, but in the real economies that we are interested in, money is created by, and evolves out of, private debt contracts.

All banks are currency issuers. Historically, though rarely today, non-bank private units are also currency issuers. Money is not defined by its ability to satisfy tax liabilities, it is defined by its ability to satisfy liabilities full stop.

1:40 PM  
Blogger paul said...

"If the currency issuer sells debt equal to every unit they issued, then all the non-currency issuers will be left holding is the debt."

Actually, they will be left holding the "debt" (treasuries) plus the original units (dollars) which are spent back into the non-government.

Unless that's what you meant in which case, nevermind.

2:46 PM  
Blogger Lars said...

Mason makes a good point. I see MMTers creating a world they want and not a world we live in. Market Monetarists do this also. It makes no sense.

I seem to be seeing mistake in MMT over and over again. You seem to think that banks are not money issuers just because they're not issuers of net new financial assets. This is confusing of the real world in which we live. Banks are issuers of credit, which in the real world is just as good and just as liquid and useful as the money spent by the government into the economy. Downplaying this reality by saying the banks don't create net new financial assets is missing the forest for the tress.

The issue you all are worried about comes down to interest and sustainability. Theoretically, if the banks issued money at 0% it would be no different than the government spending money into the economy. This was basically how money system once worked. Private banks could issue as much money as they pleased. But the problem arises from the fact that interest means the borrowers have to find money that may or may not be in the system. This leads to default and unstable credit cycles. Debtors can either borrow from Peter to pay Paul or the government can ensure that enough liquidity is in the system to make this repayment possible. That's all the government does. They allow the credit system and payment system to operate smoothly by monitoring the credit system appropriately. But this doesn't change the fact that the banks are issuers of their own form of currency. And it certainly doesn't give the government a monopoly on money or violence or any of the things mentioned in this post. The real power is still with the private banking system.

This has vast and important implications for MMT as a theory. It means that the government is not the monopolist. And it means taxes don't drive money as JW Mason noted. I believe some of the MMRists have started to pinpoint some of these problems that are becoming obvious in the MMT works and I presume it has to do with JKH's long paper.

4:01 PM  
Blogger winterspeak said...

LOL! Serves me right -- I try to be clear and simple, but still mess up.

I say specifically that agents in the non-currency issuing sector "...can issue debt, but that doesn't change net currency in the non-currency issuer sector."

This is true not just for banks, but also for corporations and anyone who can create a trade-able IOU. But this creates gross in-sector currency, not net in-sector currency.

The question is, does the non currency-issuing sector want net currency holdings? Or, do we beleive that specific agents within the non currency issuing sector are comfortable running positive or negative currency holdings, comfortably netting out to zero, and happily using gross holdings for everything else?

Also, there was credit long before banks. There are elements to banks which are special, but the question here is not a sectors ability to extend credit within itself, it is whether the non-issuing sector wants to hold a net positive balance of the issuing-sector's currency.

4:16 PM  
Blogger winterspeak said...

JW Mason:

I agree with what you say. But "money" is a vague term, and banks can issue a certain kind of "money" but not all kinds of "money".

There is one kind of "money" that can only be issued by a Government. This type of "money" may certainly exist in a mixed currency regime, and these are common. Nevertheless, the question is whether the non-issuing sector wishes to run a net positive balance of this type of currency.

The ability for there to be local or supra-national currencies, or real assets (which can be used to settle liabilities too!) is begging the question. Sure, all of these things can and do happen. Not my question.

Lars: I'm still unclear as to what the real functional beefs are between MMT and MMR. I've spent time on this, but I'm still at the "OK, so what?" stage? I agree with MMR on the technical points they have raised, but fail to see the consequences.

Maybe MMR believes that MMT thinks private credit is unimportant. That was not my interpretation of MMT, but maybe it's true. I certainly believe that private credit is important, both from banks, but other entities as well. I embrace mixed currency regimes, non-bank private sector balance sheet expansion, and real assets. I have found no tension between this and MMT. But maybe I'm just missing something.

4:25 PM  
Blogger Lars said...

Your statement is still confused because banks are issuers of money also. But they issue money with the intent to make a profit. So they need net money in return for the money they create. This is where the government comes in to satisfy that need. I think trying to find a "monopolist" in this story is a chicken and egg development.

I believe the statement that set all of this off was a comment by Randall Wray claiming "Without a government deficit, there would be no private saving." This is not correct and JKH clarified that in his paper. Are you still confused by that or maybe you agree with the Wray statement?

4:36 PM  
Blogger winterspeak said...

Lars:

"Money" is vague. Banks are issuers of some kind of money, but not others. I can think of reasons other than the one you suggest for why a Government needs to step in.

(By the way, why do you believe only banks might want net money? Some non-bank corporations want to make a profit too. Won't they need net money? What about individuals -- might they also desire net money?)

The Wray statement is vague as well. I don't agree with it, although I understand what he's trying to say. If he said "without a government deficit, the non-government sector would not be able to increase its stock of net financial assets (equity)" then I would agree with it.

Would you agree with the revised statement?

4:47 PM  
Blogger The J said...

I'm also struggling to understand the importance of S=I+(S-I). It's a doubly difficult task, my being an economics neophyte :) But the best I've been able to gather is that the MMR folks desire to emphasize private *gross* saving (S) (rather than net saving (S-I)) as some kind of argument against the *necessary* role of government in maintaing a healthy economy. For example:

'Actually, MMT’s design to bring the state back to “center stage” is wrong. There’s no “money monopolist”. There’s no “Without a government deficit, there would be no private saving.” There’s no rationale for setting prices. There’s no rationale for the job guarantee. That’s the whole point. When you visualize the picture correctly...MMT’s desire to bring the state “back to center stage” is wrong.'
--Cullen Roche, bit.ly/GJyjRt

4:53 PM  
Blogger paul said...

"…Theoretically, if the banks issued money at 0% it would be no different than the government spending money into the economy…"

This is not an accurate statement. Even at zero interest the borrower still has to repay the principal. This is in no way similar to net government spending.

If dollars are accumulated (saved) as wealth by other agents in the non-government, the dollars necessary to repay debts is effectively unobtainable. Instability ensues when the ability to "borrow from Peter to pay Paul" is constrained when agents reach the limit of their ability to service debt (income limits).

Net government spending is the only other source for dollars needed to satisfy liabilities, unless you advocate severe constarints on wealth accumulation (high taxation).

When the government sells treasuries, there is no principal to repay, the holder still has his "principal", and it's "money good" for pretty much anything but consumer spending.

5:15 PM  
Blogger Lars said...

WS:

Let's keep it simple. If the banks issued credit without interest then that would be the equivalent of government spending. The fact there is an asset and liability doesn't change this. Net new credit is always being added to the monetary system (or at least 99% of the time). The only thing that makes this process unsustainable is the fact that interest is paid on loans so you need to deliver more money than you were loaned. This means the credit system is like a game of musical chairs. And the government is there to supply the extra chair when the music stops. This doesn't mean the government has a money monopoly or that taxes drive money or many of the things you've mentioned in this post.

5:18 PM  
Blogger paul said...

"…If the banks issued credit without interest then that would be the equivalent of government spending…"

Wrong.

This statement ignores the known laws of arithmetic.

5:21 PM  
Blogger Greg said...

Lars,

You cant be serious. If you got a $10,000 transfer from the govt, say from the SS administration, you are saying that is equivalent to getting a 0% 10,000$ loan from BOA? Tell you what, you trade me your 10,000$ transfer for my 10,000$ loan....... OK!

6:39 PM  
Blogger Dan Kervick said...

Following up on Greg's comment, suppose that a bank did simply "issue" $10,000 in new money by giving some customer a $10,000 demand deposit without requiring the customer to pay it back, even at 0%.

Then that bank just lost $10,000.

But when the government issues $10,000 there is no meaningful sense in which it has lost $10,000.

9:58 PM  
Blogger Neil Wilson said...

"The only thing that makes this process unsustainable is the fact that interest is paid on loans so you need to deliver more money than you were loaned"

Classic static thinking.

I know WS doesn't like Steve Keen's work, but this is one belief he has clearly debunked time and time again.

Loans are denominated in the unit of account $ and are a stock.

Interest is denominated in units over time $/year and is a flow.

Interest is funded from the stock turn and is clearly sustainable - since it is merely a sub component of the profit share.

A particular amount of loan is turned numerous times by entrepreneurial activity into a greater amount of sales.

The dynamic models Steve constructs in the horizontal circuit demonstrate clearly that interest is not only sustainable but can generate a stable system.

12:00 AM  
Blogger Lars said...

Its only static if you don't consider the full duration of the loan.

Lets assume not gov, no foreign. Bank A makes a $100 loan at 10% for 1 year to Co A. Where does Co A get the $10 to repay the loan? Someone else must borrow or dissave.

2:03 AM  
OpenID lsvensen said...

It's only static if you don't consider the duration of the loan, which is what you're doing.

Consider a closed economy with no gov sector. Bank A makes a $100 loan to Co A at 10% for duration of 1 year. Where does Co A get the $10 to repay the loan + principal? Someone else must dissave or borrow.

2:11 AM  
Blogger Dan Kervick said...

Someone else must dissave or borrow.

Yes, but someone always is borrowing. Banks are continually creating new loans in the form of demand deposit balances "out of thin air". The total amount of these balances can continually increase so long as the total value of goods and services for sale continually increases as well. If there is increasing production, then some bank will be willing to finance that production.

The only thing that needs to be added about sustainability is that these ever-expanding quantities of demand deposit balances in a growing economy correspond to an ever-expanding quantity of interbank payments. So, in our system, there must be a growing supply of central bank money in the form mainly of reserve balances to keep pace with the expansion of demand deposit balances.

6:03 AM  
Blogger Госбанк said...

The dynamic models Steve constructs in the horizontal circuit demonstrate clearly that interest is not only sustainable but can generate a stable system.

If you mean this: http://www.debtdeflation.com/blogs/2010/11/05/solving-the-paradox-of-monetary-profits-2/
then Table 1 does not make much accounting sense starting with Line 1 ("Lend money") which supposedly comes from the bank's vault -- a strange statement indeed for an endogenist in whose world loans, not cash in vault, make deposits.

Line 3 is especially suspicious: what is "compound debt" ? There in no ledger entry like that on the bank books in reality. It seems like a trick helping to solve his equations.

He needs to re-write his exposition according to accepted accounting norms to make it correspond to what happens in real world.

I doubt he can though and tend to agree with Someone else must dissave or borrow above.

7:43 AM  
OpenID lsvensen said...

DK,

You're proving my point. The banking system is self sustaining assuming a few unreliable trends (increasing asset values and increasing lending). I've seen some MMTers say that loans get "destroyed", but this is not true in the aggregate or long-term sense. It is only true in a micro sense.

The government plays a supporting role in all of this. I think MMRists like the word "facilitator". The government supplies reserves IF needed and support to the payment system IF needed. But as I mentioned above, MMT gets the causation backwards here and makes false conclusions about monopolist this and monopolist that (see the WS post). Loans create deposits and the government oversees smooth payment IF needed. Not vice versa. There is no monopolist in this story. There is no "taxes drive money" in this story as Mason rightly mentions.

I believe these are some of the points MMR is trying to say to MMT, but are meeting resistance against.

8:58 AM  
OpenID lsvensen said...

DK,

You're proving my point. The banking system is self sustaining assuming a few unreliable trends (increasing asset values and increasing lending). I've seen some MMTers say that loans get "destroyed", but this is not true in the aggregate or long-term sense. It is only true in a micro sense.

The government plays a supporting role in all of this. I think MMRists like the word "facilitator". The government supplies reserves IF needed and support to the payment system IF needed. But as I mentioned above, MMT gets the causation backwards here and makes false conclusions about monopolist this and monopolist that (see the WS post). Loans create deposits and the government oversees smooth payment IF needed. Not vice versa. There is no monopolist in this story. There is no "taxes drive money" in this story as Mason rightly mentions.

I believe these are some of the points MMR is trying to say to MMT, but are meeting resistance against.

9:02 AM  
OpenID lsvensen said...

The point I am trying to make is that the horizontal system is perfectly sustaining by itself. As a circuit theorist it doesn't surprise me that Keen also understands this. It is why he is so focused on Minsky and instability. We must create a more stable banking system because it is the most important structure we have in our monetary system.

9:16 AM  
OpenID lsvensen said...

The problem though, as we're now seeing is that the banking system does run into a typical boom bust cycle which requires a stabilizing force at times. I think MMR and MMT agree on this. I just think they disagree on the causation. Perhaps I am wrong. I have cross posted this at MMR in case.

9:18 AM  
Blogger paul said...

"…the horizontal system is perfectly sustaining by itself…"

This can only be true with ideal conditions under certain assumptions:

1. No demand leakages can occur (such as trade deficits).

2. No significant savings or wealth accumulation can occur.

3. High taxation and subsequent government spending is necessary to maintain a flow of funds to "excite" the system.

The natural flow of money is towards wealth accumulation. How does policy deal with that dynamic?

9:49 AM  
Blogger winterspeak said...

Guys

You are assuming that the non govt sector has no desire to net hold net financial assets (equity)

Do you really believe this is true? Do banks and non- bank corporations really have no wish to retain earnings in aggregate? Do households really have no desire to build up a nest egg in their bank account (to supplement other things of course?)

10:04 AM  
OpenID lsvensen said...

WS,

Total credit market debt to GDP is 360%. So it appears the answer to your question is "no". You might WANT a positive net financial balance, but we don't reside in a system where that necessarily occurs in the aggregate.

10:32 AM  
Blogger paul said...

"…You might WANT a positive net financial balance, but we don't reside in a system where that necessarily occurs in the aggregate…"

We do reside in such a system - we've had a positive net financial balance for many decades, nearly since day 1. Everytime we run a deficit greater than the trade deficit that balance increases (for the domestic non-government).

11:01 AM  
Blogger winterspeak said...

US gross public debt is over ten trillion dollars. So there is that quantity of nfa equity out there

What is it doing? Does it play a function different from a bank loan?

11:07 AM  
Blogger Dan Kervick said...

lsvenson,

When you say that the government only supplies reserves if needed and supports the payments system if needed, it sounds to me like you are thinking of the government role here as just some kind of backup system that is only deployed in a crisis or a pinch.

But I don't believe that is correct. The Federal Reserve banking system is a hierarchical system, and so long as the economy is growing and commercial bank liabilities are growing in turn, then the ongoing government provision of reserves is essential to the everyday, routine functioning of the system. Additional reserves are always needed. Only the quantity varies.

Unless people are taking out loans but not using the money they are borrowing, an increased volume of liabilities on the loan books will be almost always be accompanied by an increased volume of payments between banks. And banks pay each other with government-issued reserves. That's just how they do it. Just like you and I issue payment orders on our commercial bank accounts to pay each other, banks issue payment orders on their reserve accounts at the Fed to pay each other. When those payments occur, some quantity of dollars is deducted from one banks's reserve balance and credited to another bank's reserve balance. And reserve balances come from the government only. They cannot be created from some other source.

On the "direction of causation", as far as I can tell there is not now, nor has there ever been, a disagreement between MMT and MMR on what drives the provision of government reserves through the banking channel. Commercial banks drive the process by issuing loans and creating demand deposit balances in response to market demand. The Fed accommodates this expansion of commercial bank balance sheets, and maintains its target interbank interest rate, through an ongoing provision of additional reserves. If bank loans are growing rapidly, its provision of reserves needs to be equivalently rapid. If bank loans are growing more slowly, the provision of additional reserves will occur more slowly as well. This basis picture is central in all of the well-known MMT books and papers. It is not a new addition by MMR.

The MMR guys argue, though, that these facts about the direction of causation and the functioning of the payments system mean that the government is not a currency monopolist. But I don't see what the issue is here. The US government is the sole producer of physical currency and reserve balances. And the net volume of private sector financial assets cannot increase unless the government provides additional quantities of physical currency and/or reserve balances.

The idea that the commercial banking system is "self-sustaining" without the ongoing, routine government provision of additional reserve balances is very misleading - and I think basically wrong. If banks expanded their balance sheets but the Fed did not accommodate that expansion by increasing reserve balances, then the Fed Funds rate would shoot up and the payments system would freeze up. Since the economy can't grow without a growth in financing, then the economy can't grow unless the Fed accommodates that growth.

That doesn't mean that the Fed's decision to boosts reserves causes the growth, but that the growth can't occur without the Fed's provision of additional reserves.

Think of it with a Star Trek analogy. The central bank is Scotty and his engines. The banks are the Captain and the helm. The engine room doesn't make the ship go to Rigel-7 or wherever. Scotty can fire up the dilithium crystal plant and charge up the ships batteries all he wants, but unless they chart a course and flip the right switches in the helm, the ship goes nowhere. But if Scotty doesn't run the fuel plant, then the ship rapidly runs down its batteries.

11:37 AM  
Blogger Dan Kervick said...

Total credit market debt to GDP is 360%.

This doesn't entail there is not a net positive domestic private sector balance.

If GDP was $1 trillion, and the total amount of outstanding private sector debt obligations was $4 trillion, then the credit market debt to GDP ratio would be 4 to 1. But each of those private sector loans is a lender's asset and a borrower's liability. So if there is no net government obligation to the private sector and and no net foreign obligation to the domestic private sector, the domestic private sector's net balance is zero.

The private sector's debt to itself is not the private sector's balance.

11:48 AM  
Blogger Geoff said...

I agree with Greg about the preference for the transfer rather than a loan. Sure, my bank account might read $10,000 in both cases, but there is a big difference. One belongs to me outright while the other does not. I've only borrowed it for a while. This whole idea of banks "creating" money is highly misleading in my opinion.

12:44 PM  
Blogger Geoff said...

Another way to look at is that my net worth is $10,000 greater in the former case while it remains unchanged in the latter.

12:55 PM  
Blogger Michael Sankowski said...

WS,

They do want to hold NFA and it's a huge boon to be able to hold them. Yes, it's stupid to advocate for a world with no NFA, and that NFA-less world is prone to massive booms and busts. But NFA are not necessary in the sense the world can't work unless NFA are available. It's just a world that (usually) doesn't work very well.

The point of all of this (for me at least) is to move the role of the private sector back to one which accurately reflects its place in the world. MMT doesn't talk enough about private banking, Saving, Investment, and how the private sector interacts with itself in the presence of government.

lsvensen, this is so true:

"We must create a more stable banking system because it is the most important structure we have in our monetary system."

How can we do this? MMT does not provide us with much, because it focuses on the pubic sector.

Keen is great and has demonstrated many times the horizontal circuit can be stable and self sustaining. I think he's missing the fact NFA management can and should be a huge stabilizing factor for private banking. It's not the H circuit can't be stable, but rather it should be easier to manage bank stability if you get the govt issuing NFA.

Plus, we should be all real world richer if we can use the government to add effective demand. MMR and MMT do agree on this point, but just perhaps not in the exact mechanism for bringing this demand to the economy.

Steve Waldman called us "diagonalists", and that's about right.

9:42 PM  
Blogger Neil Wilson said...

"Consider a closed economy with no gov sector. Bank A makes a $100 loan to Co A at 10% for duration of 1 year. Where does Co A get the $10 to repay the loan + principal? Someone else must dissave or borrow."

Bankers eat as well.

By spending the money during the weeks in that year, which then circulates round as income for the products produced earning profits week by week.

So that $100 generates, say, $300 of sales during the year.

That's what I mean by 'turn'. In quantity terms it is 'MV' that matters for interest payment, not 'M'.

If you want a picture of the dynamic system, I have one here

1:07 AM  
Blogger Neil Wilson said...

"How can we do this? MMT does not provide us with much, because it focuses on the pubic sector. "

The little white lies have started I see.

How is "Full FICA suspension" public sector?

"Plus, we should be all real world richer if we can use the government to add effective demand. MMR and MMT do agree on this point, but just perhaps not in the exact mechanism for bringing this demand to the economy. "

MMR is a neo-classical synthesis theory in the same vein as monetarism. It leaves full employment to the fairies.

Suggesting that MMR and MMT are in anyway equivalent is once again to ignore the three million people MMR is prepared to sacrifice Aztec style that MMT is not.

1:45 AM  
Blogger Greg said...

Michael

Certainly you are aware of Warrens proposals on banking. He talks about banking a lot. Maybe you mean he doesnt talk as "nicely" about banking as some in the MMR camp. Thats probably true....... but I must say I mostly agree with Warrens and Bill Blacks views of banking.

Not wanting to take sides really but I do think the early MMR work cedes much too much to banking which is all run by monetarist ideologies and therefore mostly wrong....... but I know you guys have taken on monetarism in the past and I think this is one of the needles you will have to thread with MMR........ How to examine and reform a monetarist dominated system (private banking) using the MMT/Chartalist realities you DONT disagree with. I'm not saying it cant be done but I think it will be hard. I hope you are successful.

I see it as essentially telling bankers they cant have it both ways all the time. They want to run the worlds money systems until they near collapse and then have govts save them (since they are all using govts money ultimately!) while at the same time they want to appear as having saved the world them selves (think of Bernanke on latest Bloomberg Mag cover) and perpetuate claims that govts are simply the problem with their excessive debts and all.

One more thought...

I still say the only coherent way to see banking is not as part of the horizontal system but as outside the system just like govt is. They are better understood as a another type of vertical system.. (say V* with the govt being V). I say this because banks are not restricted on the amount of money they can print. They have full "currency issuing power" so to speak..... but it is a fundamentally different currency and it is issued for different purpose. Govt currency is simply a token, taxcredit,...... whatever. This in theory never has to be paid back. The govt can have a zero tax on its currency....... and just give it away. The banking system ALWAYS has a tax on its currency, in fact it uses the taxes for profits (we know it as interest) But even if there were no interest the bank currency is still expected to be returned IN FULL at some later date........ (and of course we USE the govt to enforce all this!!) Maybe this is one of the ways to attack the monetarist myths of the banking system which is to point out that the banks are outside the system just as the govt is and therefore they are equally inflationary. As I understand monetarism, one of their claims is that only govt spending (fiscal policy) can be inflationary, the banking system, to them is zero sum game of balancing borrowers and savers and simply affects distribution not total amount.

Just some thoughts on a Sunday morning

4:50 AM  
Blogger Michael Sankowski said...

I like to think abou this study every now and then.

"Some literally stepped over the victim on their way to the next building!"

http://faculty.babson.edu/krollag/org_site/soc_psych/darley_samarit.html

4:35 PM  
Blogger Dan Kervick said...

In addition to Warren Mosler's proposals for banking reform, here is another essay by MMTer L. Randall Wray on financial reform, covering most aspects of financial services:

http://www.levyinstitute.org/pubs/wp_655.pdf

Wray is on the program for the upcoming 21st Annual Hyman P. Minsky Conference: Debt, Deficits, and Financial Instability at the Levy Institute.

http://www.levyinstitute.org/conferences/minsky2012/

7:37 PM  

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