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Bank of England recognizes Endogenous Money

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  • Registered Users Posts: 515 ✭✭✭SupaNova2


    Well I would agree and disagree with parts of that post. Something I am curious about is this:
    Government debt is actually more inflationary than using money creation for fiscal spending, because it's an asset that is almost as good as money, and it carries interest, making it more inflationary (and more profitable/desirable to hold) than plain money

    If a government borrows and spends 100 billion it will affect prices the same as if it spent the 100 billion without it being borrowed. But, money is extinguished when the borrowed 100 billion is paid back. The money simply printed doesn't have this deflationary effect as it is not paid back and extinguished making it more inflationary.


  • Closed Accounts Posts: 5,797 ✭✭✭KyussBishop


    SupaNova2 wrote: »
    Well I would agree and disagree with parts of that post. Something I am curious about is this:



    If a government borrows and spends 100 billion it will affect prices the same as if it spent the 100 billion without it being borrowed. But, money is extinguished when the borrowed 100 billion is paid back. The money simply printed doesn't have this deflationary effect as it is not paid back and extinguished making it more inflationary.
    The thing to think about though: Debt grows faster than Money in an economy (because of interest payments), meaning the Debt:Money ratio is constantly increasing and Debt will become many multiples of Money over time (10x, 40x, 100x etc.), unless something is done to reduce the ratio of Debt:Money.
    That is done, by borrowing more money - creating more money (and debt) on a 1:1 ratio - which pulls the overall ratio of Debt:Money back down.

    In the current monetary system, debts have to be rolled over, forever - debts (aggregate public and private debts) are not paid down, ever: Otherwise there would be no money in the economy at all :)

    So, interest has to be paid on debt-based money - it's this interest that is inflationary, because that is what perpetuates the requirement, that Debt be rolled over with more Debt.

    Here's a table in the context of US, which covers a lot of this (Platinum Coin Seigniorage = public money creation):
    8278730043_d023a21d83_b.jpg
    Originally from here: http://neweconomicperspectives.org/2012/12/platinum-coin-seigniorage-issuing-debt-keystroking-deficit-spending-and-inflation.html


  • Registered Users Posts: 515 ✭✭✭SupaNova2


    In the current monetary system, debts have to be rolled over, forever - debts (aggregate public and private debts) are not paid down, ever: Otherwise there would be no money in the economy at all.

    Agree with that.
    So, interest has to be paid on debt-based money - it's this interest that is inflationary, because that is what perpetuates the requirement, that Debt be rolled over with more Debt.

    Now I see what you are saying. That the current system has to inflate, that it is an inflationary system. And I think you are saying if we had a system that used debt free money creation the system wouldn't be required to inflate?

    I would disagree with that chart though. Although it could be just their wording.


  • Closed Accounts Posts: 5,797 ✭✭✭KyussBishop


    SupaNova2 wrote: »
    Agree with that.



    Now I see what you are saying. That the current system has to inflate, that it is an inflationary system. And I think you are saying if we had a system that used debt free money creation the system wouldn't be required to inflate?

    I would disagree with that chart though. Although it could be just their wording.
    I think it's still desirable to have some steady level of inflation anyway, for other reasons, but certainly - government money creation (debt-free money), certainly doesn't carry the inflationary pressure of interest-bearing government debt (debt-based money); you could have zero inflation (or target it at least), but I don't think it'd be desirable.

    So there would still be inflation, but it would no longer be a mandatory built-in condition of the economic/monetary system.

    Government would have more control over inflation with money creation vs public debt: There would be no interest payments causing added inflationary pressure, no incentive to use inflation deliberately for reducing the debt load as a percentage of GDP, and no escalating inflationary pressures on increased government spending (e.g. from skyrocketing interest rates on debt).

    Politicians and the population would also understand better (due to seeing that money would be directly created and removed from circulation by government), how inflation management really works and that taxes play a significant part in this - and so the political gain from excessively inflationary policies would be limited.


    That graph confused me a lot for a while when I first saw it - this is the first time I've brought it up in ages, and (given the context of what I've learned since), makes a lot more sense to me now.


  • Closed Accounts Posts: 5,797 ✭✭✭KyussBishop


    Well, this couldn't be more explicit - Martin Wolf:

    "Strip private banks of their power to create money"
    http://www.ft.com/intl/cms/s/0/7f000b18-ca44-11e3-bb92-00144feabdc0.html

    Some more relevant parts:
    ...the central bank would create new money as needed to promote non-inflationary growth. Decisions on money creation would, as now, be taken by a committee independent of government.

    Finally, the new money would be injected into the economy in four possible ways: to finance government spending, in place of taxes or borrowing; to make direct payments to citizens; to redeem outstanding debts, public or private; or to make new loans through banks or other intermediaries. All such mechanisms could (and should) be made as transparent as one might wish.

    The transition to a system in which money creation is separated from financial intermediation would be feasible, albeit complex. But it would bring huge advantages. It would be possible to increase the money supply without encouraging people to borrow to the hilt. It would end “too big to fail” in banking. It would also transfer seignorage – the benefits from creating money – to the public. In 2013, for example, sterling M1 (transactions money) was 80 per cent of gross domestic product. If the central bank decided this could grow at 5 per cent a year, the government could run a fiscal deficit of 4 per cent of GDP without borrowing or taxing. The right might decide to cut taxes, the left to raise spending. The choice would be political, as it should be.
    ...
    This will not happen now. But remember the possibility. When the next crisis comes – and it surely will – we need to be ready.

    As described above, part of this can mean, government use of money creation, for fiscal funding - that pretty much vindicates MMT, and from an economist as influential as Martin Wolf no less (again: leading editor of the Financial Times).

    This is a pretty big deal, in my view - hopefully should see support for this kick up a lot of steam now, since this is going to help it gain a lot more credibility.


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  • Closed Accounts Posts: 5,797 ✭✭✭KyussBishop


    Great article, which explains what the BoE's report means for Quantitative Easing (also touching on what it means for interest rates) - why (sustained) QE is not as helpful as it is made out to be, and may be a net-harm:
    ...
    In the BoE's latest quarterly bulletin, they conceded this point, recognizing that QE is indeed tantamount to pushing on a piece of string. The article tries to salvage some central banker dignity by claiming somewhat hopefully that the artificially lower interest rates caused by QE might have stimulated some loan demand.

    However the elasticity or price sensitivity of demand for credit has long been understood to vary at different points in the economic cycle or, as Minsky recognized, people and businesses are not inclined to borrow money during a downturn purely because it is made cheaper to do so. Consumers also need a feeling of job security and confidence in the economy before taking on additional borrowing commitments.

    It may even be that QE has actually had a negative effect on employment, recovery and economic activity.

    This is because the only notable effect QE is having is to raise asset prices. If the so-called wealth effect -- of higher stock indices and property markets combined with lower interest rates -- has failed to generate a sustained rebound in demand for private borrowing, then the higher asset values can start to depress economic activity. Just think of a property market where unclear job or income prospects make consumers nervous about borrowing but house prices keep going up. The higher prices may act as either a deterrent or a bar to market entry, such as when first time buyers are unable to afford to step onto the property ladder.

    Dr Andrea Terzi, Professor of Economics at Franklin University Switzerland, also suggests that many in the banking and finance industry, who often have trouble with the way academics teach and discuss monetary policy, will find the new view much closer to their operational experience. "The few economists who have long rejected the 'state-of-the-art' in their models, and refused to teach it in their classrooms, will feel vindicated," he adds.

    Foremost among those economists is Prof Steve Keen
    : a long-time proponent of the alternative view, endogenous money. Having co-presented with Prof. Keen, I've been taken with the way that his endogenous money beliefs stand up to 'the common sense test.' The proverbial 'man on the Clapham omnibus' knows that borrowing your way out of debt while your returns are dwindling makes no sense. Friedman and Bernanke couldn't see that.

    Ben Bernanke positioned himself as a student of history who had learned from the mistakes of the past. Dr. Terzi questions this, "This view that interest rates trigger an effective 'transmission mechanism' is one of the Great Faults in monetary management committed during the Great Recession."

    "The reality is that the level of interest rates affects the economy mildly and in an ambiguous way. To state that monetary policy is powerful is an unsubstantiated claim."


    For a central bank to recognize that its economic understanding is flawed is a major admission. However, unless it takes the opportunity to correct its policy in line with this new understanding then it will repeat the same old mistakes.

    The world's central banks are steering a course unwittingly directly towards a repeat of the 1930s but on a far greater scale. It's not yet clear that there is any commitment to change this course or indeed whether there is still time to do so. Either way, it will be very interesting to see what future economic historians make of Ben Bernanke's contribution to economic policy.
    http://www.cnbc.com/id/101649411

    Nice hat-tip to Steve Keen there as well.


  • Closed Accounts Posts: 4,981 ✭✭✭KomradeBishop


    The UK Parliament is going to have a 3 hour debate on money creation (for the first time in 170 years), on the 20th of November:
    http://www.positivemoney.org/2014/11/uk-parliament-debate-money-creation-first-time-170-years/

    This should be interesting - if there's any kind of a decent turnout.


  • Closed Accounts Posts: 4,981 ✭✭✭KomradeBishop


    Here is the full transcript of the UK Parliament debate on money creation - it is an interesting debate:
    http://www.parliament.uk/business/publications/hansard/commons/todays-commons-debates/read/unknown/314/

    I'm only part way through it, and while I'm impressed that Steve Baker initiated that debate, am less than impressed with some of his views about how the monetary system should be reformed (he seems to support virtually complete removal of government supervision/control over money creation - currently through the central bank - and replacement with unlimited privately-created alternative currencies; even backing the alternative currencies through allowing their use for taxation, which I view as very dangerous democratically) - still, it's a very interesting debate.


  • Closed Accounts Posts: 4,981 ✭✭✭KomradeBishop


    Finally finished reading the whole debate - even though there is quite a lot I disagree with, and even though I'd have a different point of view to many in the debate, it was overall an extremely good debate which discusses issues in detail that you pretty much never hear talked about, outside of the topic of money creation.

    It's a very long read unfortunately, but extremely good at parts.

    Interestingly, there is also mention of the Irish version of 'Postive Money' (PM are an influential monetary reform group within the UK, who can probably be partially credited with this debate) - the Irish version is 'Sensible Money':
    Mark Durkan (Foyle) (SDLP):
    People in organisations such as Positive Money in the UK or Sensible Money in Ireland are therefore saying, rightly, that politics—those of us charged with overseeing public policy as it affects the economy—need to have more of a basic look at how we treat the banking system and at the very nature of money creation.
    I think Sensible Money are now defunct though.


  • Closed Accounts Posts: 4,981 ✭✭✭KomradeBishop


    Calls for government spending, funded by money creation, are starting to become increasingly more mainstream now - slowly though - following in the footsteps of 'endogenous money' (i.e. the idea that banks create money when they make loans, and do not actually lend out deposits/savings):
    http://www.theguardian.com/commentisfree/2014/nov/26/eu-cash-bomb-recession-juncker-new-fund

    Martin Wolf in particular, the leading Financial Times editor, seems to be one of the leading voices pushing this into mainstream discussion. Given how quickly 'endogenous money' has achieved credibility, and how discussion of government spending from money creation is picking up steam in a similar way now, this could enormously and permanently transform public/media discussion of economic/political issues, extremely quickly.


    A few years ago, the idea that banks don't lend from deposits/savings, but create money when they make loans, was viewed as ridicule-worthy, yet is now pretty much undeniable; the same kneejerk reaction is made whenever the idea of government use of created money comes up, yet here are some of the same people who led the way in bringing 'endogenous money' to mainstream legitimization, doing the same with government use of created money.

    Once that achieves mainstream credibility, people are really going to be wondering "what in fúck have we been doing for the past 6-7 years?", as it makes world economic policy since the crisis, look insane.


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  • Registered Users Posts: 515 ✭✭✭SupaNova2


    Economists have observed that banks create money on loan origination for at least over a century. Isn't the misconception that is now emphasized more to do with the fact that banks are not limited in the amount of money they create by the amount of reserves they have on hand as explained in textbooks?

    I also don't see the focus on how money is created being ridiculed, more so the policy prescriptions of those focusing on money creation. Hasn't that been your own experience on these forums? I don't recall you being ridiculed for pointing out that banks create money when they make loans, but I do recall you being ridiculed for policy prescriptions.


  • Closed Accounts Posts: 4,981 ✭✭✭KomradeBishop


    What I said was "the idea that banks don't lend from deposits/savings, but create money when they make loans" - only a minority of economists have observed that, and mainstream economic theory has been based upon 'loanable funds' (the idea that banks lend from deposits/savings, with a money multiplier), for a very long time.

    On Boards overall, that idea has always generated a kneejerk backlash, until Martin Wolf and the Bank of England report, gave me enough ammo to legitimize it.

    The same with government use of created money: One of the few posters I have encountered who is capable of actually discussing that, without a kneejerk backlash claiming hyperinflation, is yourself (and others specifically here on Economics); now Martin Wolf and others, are in the process of legitimizing that idea now too.

    It is the very idea of government using created money, that has always generated the ridicule/backlash - trying to discuss any policy prescriptions based upon that, is usually dismissed/ridiculed with claims of hyperinflation, based on government use of created money; the idea generates such a strong reaction from so many people, that it seems they are simply incapable of thinking about or discussing the entire topic.


    The myth of "government use of created money = Weimar Republic", is equally as strong (if not far stronger), as the myth of "banks lend out money from deposits/savings" - topics which conflict with these myths, generate cognitive dissonance in a huge swathe of people, like no other topic I've ever encountered.

    Try it :) try to discuss with people, the mere hypothetical possibility of governments spending using created money, and see how strong the reaction is.


  • Registered Users Posts: 1,169 ✭✭✭dlouth15


    What I said was "the idea that banks don't lend from deposits/savings, but create money when they make loans" - only a minority of economists have observed that, and mainstream economic theory has been based upon 'loanable funds' (the idea that banks lend from deposits/savings, with a money multiplier), for a very long time.

    On Boards overall, that idea has always generated a kneejerk backlash, until Martin Wolf and the Bank of England report, gave me enough ammo to legitimize it.
    I have a problem with it. Yes, when a loan is made a deposit is created in the account of the person to whom the loan is made and no extra deposits are needed for it to do this. This can look like magic money creation.

    However at some point shortly aftwards this deposit is going to be used for something. It is not simply going to sit in the borrower's account. Then the bank is going to have to attract a deposit from somewhere else or borrow from the interbank market otherwise it will be digging into reserves.

    The problem I think is defining the point at which the loan is made as being the point at which this simultaneous loan and deposit action is carried out. This is merely an bookkeeping exercise. No money has left the bank at this stage.

    If, instead, we redefine the point at which a loan is made as being the time at which the recipient of the loan actually takes the money out, then the problem goes away.

    Now it is much closer to the ordinary punter's understanding of what goes on. A bank makes a loan (in the sense of the borrower actually removing the money) but before it does, it must ensure it has sufficient funds from deposits and other sources of funding.

    I have read the BOE report, and towards the end it goes into a lot of detail concerning the limits of what banks can do and why they still need sources of funding for their lending.


  • Closed Accounts Posts: 4,981 ✭✭✭KomradeBishop


    dlouth15 wrote: »
    I have a problem with it. Yes, when a loan is made a deposit is created in the account of the person to whom the loan is made.

    However at some point shortly aftwards this deposit is going to be used for something. It is not simply going to sit in the loanee's (is that a word?) account. Then the bank is going to have to attract a deposit from somewhere else or borrow from the interbank market otherwise it will be digging into reserves.

    The problem I think is defining the point at which the loan is made as being the point at which this simultaneous loan and deposit action is carried out. This is merely an bookkeeping exercise. No money has left the bank at this stage.

    If, instead, we redefine the point at which a loan is made as being the time at which the recipient of the loan actually takes the money out, then the problem goes away.

    Now it is much closer to the ordinary punter's understanding of what goes on. A bank makes a loan but before it does, it must ensure it has sufficient funds from deposits and other sources of funding.
    People don't generally 'take out' a significant portion of their money, they often spend it through bank transfers or credit cards etc., using electronic means of payment - often this means the payment goes right back into the same bank.

    Only around 3% of the money in the economy, is made up of physical currency - the money that has been 'taken out'.

    Banks do not check deposits first, before making a loan - they make the loan first, and then they shore up reserves on the interbank market, and (this is really important) if they fail to find money on the interbank market, they can pretty much always go to the central bank to shore up reserves (explained in detail here); the real limit is capital requirements, not reserve requirements.


    The idea that banks lend out deposits/savings, is not true in any way - not even superficially.


  • Registered Users Posts: 1,169 ✭✭✭dlouth15


    The idea that banks lend out deposits/savings, is not true in any way - not even superficially.
    I think it is only actually true in a superficial way that banks can create loans without deposits or other sources of funding.

    I'll deal with some of your points below:
    People don't generally 'take out' a significant portion of their money, they often spend it through bank transfers or credit cards etc., using electronic means of payment - often this means the payment goes right back into the same bank.

    Often you say. But in general for a one typical bank in a market of several banks, a majority of the time the money will actually leave the bank. At that precise moment if it doesn't have matching deposits, the bank is digging into its reserves.
    Only around 3% of the money in the economy, is made up of physical currency - the money that has been 'taken out'.

    The borrower doesn't need physical cash for this to be the case. The above illustration works just as well with transfers.

    In the case of the the borrower purchasing something from a seller who also has an account in the bank, yes, this is a transfer from one account to the other. The bank doesn't need to dig into reserves in this case because it has already attracted a deposit (in the seller's account from the sale of e.g. land to the original borrower).

    This is all fairly simple and straightforward because I've redefined the act of borrowing as the act of taking out money from the bank as a loan as opposed to the bank creating matching loans and deposits. And it works with electronic transfer. This action could better be described as the bank creating the facility for a loan rather than the loan itself.

    Explained in this way, there's no mysterious money creation involved yet nothing has been left out either.

    On the point of the central bank. Yes this usually acts as lender of last resort, but here's where the money creation actually does occur in the sense of "narrow" money being created.


  • Closed Accounts Posts: 4,981 ✭✭✭KomradeBishop


    dlouth15 wrote: »
    I think it is only actually true in a superficial way that banks can create loans without deposits or other sources of funding.
    It's an accounting fact - pretty much undeniable. The loans come first, the reserves come later - that's how banks work.
    dlouth15 wrote: »
    Often you say. But in general for a one typical bank in a market of several banks, a majority of the time the money will actually leave the bank. At that precise moment if it doesn't have matching deposits, the bank is digging into its reserves.

    The borrower doesn't need physical cash for this to be the case. The above illustration works just as well with transfers.

    In the case of the the borrower purchasing something from a seller who also has an account in the bank, yes, this is a transfer from one account to the other. The bank doesn't need to dig into reserves in this case because it has already attracted a deposit (in the seller's account from the sale of e.g. land to the original borrower).

    This is all fairly simple and straightforward because I've redefined the act of borrowing as the act of taking out money from the bank as a loan as opposed to the bank creating matching loans and deposits. And it works with electronic transfer. This action could better be described as the bank creating the facility for a loan rather than the loan itself.

    Explained in this way, there's no mysterious money creation involved yet nothing has been left out either.

    On the point of the central bank. Yes this usually acts as lender of last resort, but here's where the money creation actually does occur in the sense of "narrow" money being created.
    You're leaving out the interbank market and central bank. The reserve requirements don't impose any real restrictions - banks lend first, shore up reserves later.

    You're mixing up the causality here (mixing up what comes first) - this is how the theories differ:
    Endogenous Money|Loanable funds
    Banks create money through loans|Banks lend out through savings/deposits
    Money created as matching Asset and Liability|Money created through money multiplier
    Investment (loans) leads to Savings (deposits)|Savings (deposits) leads to Investment (loans)
    Banks lend first, fix up reserves later|Banks get reserves first, then give out loans
    Banks are not limited by reserve requirements|Banks are limited by reserve requirements

    In order for savings/deposits to have any restriction on bank lending, banks need to be restricted from lending by reserves (but when banks lend first, and fix up reserves later, this is impossible), and in addition to that, bank reserves need to depend upon savings/deposits (they don't - banks can always go to the central bank, who will not refuse to shore-up bank reserves).

    This doesn't mean there are no restrictions though (there are - capital requirements), but it does mean that reserve requirements are not a restriction.


    Additionally, need to be careful about semantics here: Money created by banks through loans, is just as 'real' and usable for exchange for the average person, as physical currency - focusing on bank reserves ('narrow money') is misleading, as to your average person, 'Money' includes money created by banks.


  • Registered Users Posts: 1,169 ✭✭✭dlouth15


    It's an accounting fact - pretty much undeniable. The loans come first, the reserves come later - that's how banks work.
    Do you mean here the granting of a loan or the moment the loan amount is removed from the bank? I certainly agree that when a bank grants a loan that at this precise moment in time there's no need to access reserves. But that is because the money is still in the bank.

    But we can't regard that as the totality of the lending process. For example a bank could lend me 100bn provided I sign a watertight legal agreement that I don't touch the money and that it stays as a deposit in the bank.

    From one point of view this is lending: a loan and deposit are simultaneously created. But it is not really lending in any practical sense I think you will agree.

    But it is only for lending in this sense that your statement holds true.
    You're leaving out the interbank market and central bank. The reserve requirements don't impose any real restrictions - banks lend first, shore up reserves later.

    No, I'm regarding deposits, the interbank market and the central bank all as funds for lending. I'm not distinguishing between them.

    When people say that banks only lend out deposits they are using a simplified model. What they really mean is that banks lend out funds that are invested with them (deposits, interbank loans, central bank funds).

    The point is they can't generate infinite amounts of loans on their own individually.
    You're mixing up the causality here (mixing up what comes first) - this is how the theories differ:
    Endogenous Money|Loanable funds
    Banks create money through loans|Banks lend out through savings/deposits
    Money created as matching Asset and Liability|Money created through money multiplier
    Investment (loans) leads to Savings (deposits)|Savings (deposits) leads to Investment (loans)
    Banks lend first, fix up reserves later|Banks get reserves first, then give out loans
    Banks are not limited by reserve requirements|Banks are limited by reserve
    requirements
    In order for savings/deposits to have any restriction on bank lending, banks need to be restricted from lending by reserves (but when banks lend first, and fix up reserves later, this is impossible), and in addition to that, bank reserves need to depend upon savings/deposits (they don't - banks can always go to the central bank, who will not refuse to shore-up bank reserves).

    This doesn't mean there are no restrictions though (there are - capital requirements), but it does mean that reserve requirements are not a restriction.

    Additionally, need to be careful about semantics here: Money created by banks through loans, is just as 'real' and usable for exchange for the average person, as physical currency - focusing on bank reserves ('narrow money') is misleading, as to your average person, 'Money' includes money created by banks.
    But I think if you look at your table, it comes down to what constitutes a loan in the first place. Is it what I would call the granting of the facility of a loan without the loan money being withdrawn? If so, then the endogenous money concept holds true.

    Is it, on the other hand, the process of the money actually being withdrawn? Then the loanable funds model holds true.

    But these are just two ways of looking at the same thing with emphasis given to different aspects of the process.

    I hope you will address this aspect of what I'm arguing - that of what constitutes a loan. And note I'm not pushing one idea over the other. I think both are equally valid, just different ways of describing the same thing.


  • Closed Accounts Posts: 4,981 ✭✭✭KomradeBishop


    dlouth15 wrote: »
    Do you mean here the granting of a loan or the moment the loan amount is removed from the bank? I certainly agree that when a bank grants a loan that at this precise moment in time there's no need to access reserves. But that is because the money is still in the bank.
    Unless someone takes out physical cash from an ATM, the money does not 'leave' the overall banking system; you're focusing on individual banks, when you need to look at the overall banking system (because interbank lending and the central banks ability to shore-up reserves, are critical here; you can't treat them as separate parts of the discussion).
    dlouth15 wrote: »
    No, I'm regarding deposits, the interbank market and the central bank all as funds for lending. I'm not distinguishing between them.

    When people say that banks only lend out deposits they are using a simplified model. What they really mean is that banks lend out funds that are invested with them (deposits, interbank loans, central bank funds).

    The point is they can't generate infinite amounts of loans on their own individually.
    You're getting the causality wrong again: The loan comes first, reserves are not sought before making the loan, they are sought after making the loan.

    Never said banks were able to generate infinite loans - just that reserve requirements aren't a limit. Capital requirements though, are a limit.
    But I think if you look at your table, it comes down to what constitutes a loan in the first place. Is it what I would call the granting of the facility of a loan without the loan money being withdrawn? If so, then the endogenous money concept holds true.

    Is it, on the other hand, the process of the money actually being withdrawn? Then the loanable funds model holds true.

    But these are just two ways of looking at the same thing with emphasis given to different aspects of the process.

    I hope you will address this aspect of what I'm arguing - that of what constitutes a loan. And note I'm not pushing one idea over the other. I think both are equally valid, just different ways of describing the same thing.
    Again, you're ignoring how banks shore-up their reserves after lending, they do not seek reserves before lending - and ignoring the interbank market and central bank ability to shore-up reserves. Your semantic argument of what defines a loan (i.e. when a loan 'really' happens), doesn't change anything.

    Endogenous money vs Loanable funds, are 100% mutually incompatible - it is one or the other, it's not an issue where it just depends upon how you look at it.


  • Registered Users Posts: 1,169 ✭✭✭dlouth15


    You're getting the causality wrong again: The loan comes first, reserves are not sought before making the loan, they are sought after making the loan.
    There is a point of view - the one you hold - that says that banks don't lend out funds but rather they create a matching asset and liability. From this point of view, yes, banks make the loan by creating the matching asset and liability and then seek to settle up on the markets.

    That is fine as far as it goes, but it is nevertheless just a point of view. And here's why.

    If you go back to the days when business transactions were conducted using cash, a bank making a loan to someone did involve the bank literally handing over physical cash to the borrower (who would then spend the amount).

    If we want to accurately update the idea of making a loan to today's world, we must regard it as a two-stage process. The first stage is that the matching asset and liability is created. The second stage is that the borrower then transfers the money to wherever it is required.

    You're view of lending places all the weight on the first part while ignoring the second part. This gives rise, superficially at least, to the banks magically creating money and a number of conspiracy theories have this as their subject. Of course this is not the case. But a long explanation is needed as to why this is not happening.

    It would also be wrong to concentrate only on the second stage of the process. The first stage does grant the right to the borrower to remove the money. It is an option held by the borrower and has a monetary value.

    However when the second stage is executed, this is when funds from the bank are involved. The bank must have funds to cover the transfer out of the loan amount.

    So if you regard a loan as a two stage process corresponding to what was a single stage process in the early days, then banks really do lend out funds.

    Note I'm using the word funds here, not deposits. You earlier pointed out that banks borrow on the interbank market and so don't rely wholly on deposits. This has never been the issue. This issue is whether banks require funds in order to lend and the answer is: yes they do. It doesn't matter where the funds come from - depositors, interbank, central bank or other.

    On the issue of a single bank vs. a banking system, as came up earlier. We can scale this up to multiple commercial banks easily enough. For example, in order for the Irish banking system to lend in to the Irish property market, it must have funds. These funds could be Irish depositors, foreign depositors, the interbank system, etc. They actively attracted these funds in order to lend into the bubble. When these funds dried up the Irish banking system got into trouble.

    A broader view of what constitutes lending leads to a simpler explanation of why banks need funds. They need funds because funds are what they lend out. The BOE document, taking the endogenous view, takes quite a few paragraphs to explain the limits of bank lending, where as in fact it is fairly simple.


  • Closed Accounts Posts: 4,981 ✭✭✭KomradeBishop


    The first part, you identify as the "creation of money" the bank creating matching Assets and Liabilities - the 'second part' is where you are stating there is a difference, where there is ambiguity, but I have already addressed that: The second part, is that no matter where the money is transferred within the economy, it (except for 3% of the money taken out as cash) ends up in another bank, and this is where the interbank market and central bank 'lender of last resort' comes into play.

    I don't lend weight to any one part, I consider both parts - the first part shows that reserve requirements do not play a part in limiting loans, and the second part also shows that :) banks that seek to shore up reserves on the interbank market, and which fail to shore up reserves on the interbank market, can always go to the central bank to shore-up reserves - the central bank will not refuse to shore up a banks reserves.


    This statement, is precisely where you go wrong:
    dlouth15 wrote:
    However when the second stage is executed, this is when funds from the bank are involved. The bank must have funds to cover the transfer out of the loan amount.
    Banks actually do not require the reserves before making the loan, they first make the loan, and then they seek the reserves afterwards- this is critical, it is the difference between banks being able to create money, and not create money.

    If a bank must seek reserves before making the loan, then the interbank market and central bank can fail/refuse to provide the bank with enough reserves, without any consequence.

    If a bank can seek reserves after making the loan, then the interbank market can fail/refuse to provide the bank with enough reserves, but the central bank will not refuse to provide enough reserves, as that would require that the bank recall loans - leading to serious economic disruption.


    Do you see how the causality is important there? That if reserves are sought before loans, that it leads to the system you describe, but if loans are put out first and the reserves sought later, it leads to the system I describe?

    That's one of the key differences. Loans are put out first, and then reserves are sought afterwards.


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  • Moderators, Category Moderators, Science, Health & Environment Moderators, Social & Fun Moderators, Society & Culture Moderators Posts: 36,787 CMod ✭✭✭✭ancapailldorcha


    Article in the Guardian yesterday basically stating that the premise for austerity in Britain was false. I know next to nothing about economics (if anyone has any book recommendations, that'd be great) so I was curious as to what people here might think. Here is the Bank of England paper cited in the article.

    We sat again for an hour and a half discussing maps and figures and always getting back to that most damnable creation of the perverted ingenuity of man - the County of Tyrone.

    H. H. Asquith



  • Moderators, Science, Health & Environment Moderators, Society & Culture Moderators Posts: 3,368 Mod ✭✭✭✭andrew


    ancapailldorcha's thread merged with this one, since they're pretty much the same topic.


  • Closed Accounts Posts: 4,981 ✭✭✭KomradeBishop


    Ya David Graeber is a good author on this topic :) His book 'Debt: The First 5000 Years' is quite good.

    My favourite quote on this topic, is from John Kenneth Galbraith:
    "The process by which banks create money is so simple that the mind is repelled."

    Highly recommend Galbraith's 'Age of Uncertainty' economics documentary - linked all of them here - one of the best documentaries I've seen.


    That quote captures well, peoples reaction to the idea that banks create money when extending loans - but now that that has entered the political mainstream (thanks to the Bank of England) and is now considered as indisputably true, the same sentiment applies to the idea of governments creating money in a similar way:
    If you put forward the idea, that central banks can create money (without any debt/interest owed), and give it to government for public spending (limited by an inflation rate of ~2% - the same as banks) - then peoples minds are completely repelled by this idea - people are just not capable of processing it, and quickly make up any excuse to dismiss the idea.

    I have not encountered any other political/economic topic (other than bank money creation), that triggers such a strong and emotional reaction in people - it's pretty fascinating :)
    If you take the time to calmy/dispassionately/unemotionally think it through though, and determine whether this is a real possibility (as well as - importantly - learning how inflation works, how it is not determined by psychology and how much people subjectively value money), then gradually, it will completely and irrevocably change your view of all of both politics/economics, and you won't be able to view worldwide political/economic topics in the same way ever again.

    I know that probably comes across as (rather extreme) hyperbole, but I honestly believe that's one of the few things you can learn - more than any other topic/subject - that will teach you more about how messed up the world is politically, and more about how to fix worldwide political/economic issues, than any other topic you can think of (I view it as that important a topic).
    Unfortunately, it's also one of the most difficult topics that there is, to express in words and properly convey to people.


  • Closed Accounts Posts: 5,191 ✭✭✭Eugene Norman


    Isn't the idea though that there is no net creation of money if one man's debt (the buyer) is another man's money (the seller) on deposit.

    Increases in net money supply must come from somewhere else.


  • Closed Accounts Posts: 4,981 ✭✭✭KomradeBishop


    You're precisely right, in that neoclassical/mainstream economics treats it as if "there is no net creation of money if one man's debt (the buyer) is another man's money (the seller) on deposit".
    Neoclassical is the dominant economic school (probably 90+% of economics courses teach neoclassical economics), and predominantly, it teaches this.

    However, if you think about it - treating one mans debt, as the other mans deposit (this part is true), as if there is no net creation of money (this part is false) - is inherently flawed (not just flawed in my view, but completely insane), because it means:
    1: Neoclassical economics completely ignores the role of Private Debt in the economy (and this is completely insane, because the entire post-2007/8 economic crisis, was actually caused by the levels of Private Debt becoming unsustainable - just look at figures of 'Private debt to GDP'; they reached historical highs, and now we are in debt deflation now as a result of this - it is actually Private Debt levels that are holding back economic recovery; something neoclassical economics ignores completely), and

    2: Obviously, Private Debt takes quite a lot of time to repay - so ignoring the role of Private Debt, as if there is no net creation of money, means completely ignoring the time difference between the debt being issued, and the money being repaid - how can this possibly make any sense? Where else in the economy, can you think of accountants advocating ignoring debts? It's totally irrational.

    3: Roughly 97% of the money in the entire economy, is made up of money sourced from loans. If this is true, and if loans carry interest, then where does the money for the interest come from? The total stock of 'Debt' in an economy (which incurs interest every year, on a regular basis), almost always exceeds the total stock of 'Money' - meaning it is literally impossible for all Debts to be paid off, as the money required for paying off debts, has to come from further debts.

    So, as you can see, how the monetary system functions, is the single most important thing in an entire economy - it also happens to be the single thing that economists understand the least.


  • Closed Accounts Posts: 4,981 ✭✭✭KomradeBishop


    A new Bank of England paper, elaborates on some of the consequences of what Endogenous Money (banks creating money when they make loans) means:
    http://www.bankofengland.co.uk/research/Documents/workingpapers/2015/wp529.pdf

    This paper describes how 'loanable funds' theory, has been a key part of macroeconomic models - even ones developed since 2008 - and how that theory is wrong, and thus leads to serious errors in these economic models:
    Since the Great Recession, banks have increasingly been incorporated into macroeconomic models. However, this literature confronts many unresolved issues. This paper shows that many of them are attributable to the use of the intermediation of loanable funds (ILF) model of banking. In the ILF model, bank loans represent the intermediation of real savings, or loanable funds, between non-bank savers and non-bank borrowers. But in the real world, the key function of banks is the provision of financing, or the creation of new monetary purchasing power through loans, for a single agent that is both borrower and depositor.

    One of the other big notable things here, is that people are often taught that Savings leads to Investment (because under 'loanable funds' theory, saving in a bank, leads to those savings/deposits being loaned out and invested) - this is false however, because under Endogenous Money, Investment actually leads to Savings (because a loan being taken out and put into an investment, creating new money in the process, leads to that newly created money ending up in the savings/deposits account, of those it has been invested in) - this upends the basis of a lot of economic thinking and economic models in yet another way (as they often assume S->I):
    Furthermore, if the loan is for physical investment purposes, this new lending and money is what triggers investment and therefore, by the national accounts identity of saving and investment (for closed economies), saving. Saving is therefore a consequence, not a cause, of such lending. Saving does not finance investment, financing does. To argue otherwise confuses the respective macroeconomic roles of resources (saving) and debt-based money (financing).

    The document also expands/clarifies, on the fact that the 'Money Multiplier' idea of banking is wrong, that banks face no reserve limits - that the quantity of bank reserves, is actually determined by the lending itself (of course, there are other limits, which the document goes into):
    This finally takes us to the venerable deposit multiplier (DM) model of banking, which suggests that the availability of central bank high-powered money imposes another limit to rapid changes in the size of bank balance sheets. The DM model however does not recognise that modern central banks target interest rates, and are committed to supplying as many reserves (and cash) as banks demand at that rate.
    The quantity of reserves is therefore a consequence, not a cause, of lending and money creation.


    Further into the document, there are statements such as this - that macroeconomic models of the economy, completely ignored the role of banks (and thus, the role of the monetary system - since banks are the main outlet of created money - and of the nature of money itself, since that is also central to banks) - this should make it clear to people, just how utterly backwards and insane economic teaching is, that something as important as banks, the monetary system, money creation, and money itself effectively, had been ignored by economists! (it is no wonder then, that we stumbled into the current crisis - economists were neglectful in a way that should have completely destroyed the professions credibility, for ignoring something so important, which - ignoring that - directly led to the economic crisis)
    In the wake of the 2007/8 financial crisis, the role of banks in the economy has attracted more attention than at any time since the 1930s, with policymakers clearly recognising the importance of a healthy banking system for the real economy. Macroeconomic theory was however initially not ready to provide much support in studying the interactions between banks and the real economy, as banks were not a part of most macroeconomic models. The reason is that for many decades the private banking system had not been seen as an important source of vulnerability, so that almost all interest in banks and in prudential banking regulation was of a microeconomic nature.
    ...
    The Great Recession changed this dramatically. Among policymakers, this culminated in the recent debates over the Basel III framework and other regulatory initiatives. Academic macroeconomics also started to pay attention to the role of banks and of prudential banking regulation. However, as emphasised by Adrian, Colla and Shin (2013), in this new literature there are many unresolved issues. We will show in this paper that many of these are due to the fact that this literature is almost without exception based on a version of the intermediation of loanable funds (ILF) model of banking.

    In a bit I cut out from the middle of the above, the document gives a shout out to the Post-Keynesian school of economic thought (Steve Keen, and MMT'ers - Modern Money Theorists - are some predominant Post-Keynesians), as the only economic school that did pay attention to this:
    This is in stark contrast to the preoccupation of the leading macroeconomists of the 1920s, 1930s and 1940s with the problems of banking, which after the 1950s continued only in a small part of the profession, with the work of some post-Keynesians.
    A lot of right-leaning posters on Boards like to mock Post-Keynesian views and try to shout them down (all of my own economic views are Post-Keynesian, and I'd identify as Post-Keynesian) - yet here is the Bank of England lending significant credibility to that school of thought, as being the only school of the 60 years prior to the crisis, to understand banks and money creation correctly.

    Another shout-out to PK's in the document:
    Charles Goodhart (2007), the UK’s preeminent monetary economist: “... as long as the Central Bank sets interest rates, as is the generality, the money stock is a dependent, endogenous variable. This is exactly what the heterodox, Post-Keynesians ... have been correctly claiming for decades, and I have been in their party on this.”

    So, this should be a good hint to budding economists and enthusiasts, to start analysing the Post-Keynesian school and learning its views, in great detail - I'd recommend Steve Keen as one of the best among them.


    Later in the document, it also expands well on the history of knowledge that banks create money - how it became accepted in the 1930's, yet thereafter the consensus view eventually reverted to 'loanable funds' again:
    However, this debate did not continue much beyond the 1960s, as the macroeconomic and monetary functions of banks disappeared almost entirely from mainstream macroeconomic theory. As a result, many important insights of the past have been forgotten, and need to be relearned today.

    Overall, the document does a thorough job of trying to address a lot of the common counterarguments and fallacies, surrounding the debate around bank money creation.


  • Closed Accounts Posts: 4,981 ✭✭✭KomradeBishop


    Really excellent paper, from the inventor of Quantitative Easing, Richard A. Werner, evaluating the three different theories of money creation, and empirical tests which support credit/endogenous theory:
    "A lost century in economics: Three theories of banking and the conclusive evidence"
    Link


    Towards the end of the paper, there is an important evaluation of the state of economic teaching and research, which points to the corruption/censorship of economic research/narrative - though it points out that this needs further study:
    Progress in economics and finance research would require researchers to build on the correct insights derived by economists at least since the 19th century (such as Macleod, 1856).
    The overview of the literature on how banks function, in this paper and in Werner(2014b), has revealed that economics and finance as research disciplines have on this topic failed to progress in the 20th century.

    The movement from the accurate credit creation theory to the misleading, inconsistent and incorrect fractional reserve theory to today's dominant, yet wholly implausible and blatantly wrong financial intermediation theory indicates that economists and finance researchers have not progressed, but instead regressed throughout the past century.
    ...
    The analysis of the fractional reserve and financial intermediation theories in this paper and in Werner (2014b) provides indications that attempts were made to obfuscate, as if authors were at times wilfully trying to confuse their audience and lead them away from the important insight that each individual bank creates new money when it extends credit.
    ...
    Many economists appear to have been aware of the fact that banks create money out of nothing, but chose to de-emphasise it, or even produce analysis that contradicts it.
    ...
    That such important insights as bank credit creation could be made to disappear from the agenda and even knowledge of the majority of economists over the course of a century delivers a devastating verdict on the state of economics and finance today.
    As a result, the public understanding of money has deteriorated as well. Today, the vast majority of the public is not aware that the money supply is created by banks, that banks do not lend money, and that each bank creates new money when it extends a loan.
    ...
    The question whether the sequential introduction of the incorrect fractional reserve and financial intermediation theories of banking [...] was intentional or not requires further research.
    Research should focus on the role of interested parties, especially that of internationally active banks, central banks and privately funded think tanks, in influencing academic discourse.


    It is worrying, for instance, that the topic of bank credit creation has been a virtual taboo for the thousands of researchers of the world's central banks during the past half century. As Cheng and Werner (2015) show, among the 3882 research papers produced and made available online by five major central banking research outlets (Federal Reserve Board Washington, Federal Reserve Bank of New York, Bank of Japan, European Central Bank, Bank of England) in the two decades to 2008, only 19 articles even included the words ‘credit creation’.

    Of these, only 3 seemed to use the term in the correct sense of bank creation of credit and money.

    ...
    A former central banker in a rare frank interview discusses this issue [...] and suggests that central banks have been engaging in ‘information management’, by purposely controlling and shaping the research they publish.

    Senior staff approve the research topics and check, modify and censor articles written by the central bank researchers before delivering them to the public.

    In this process, what is considered a ‘harmful truth’ gets weeded out, while what is considered useful for the central bank remains.
    ...
    ...investigative journalists have pointed out that the editorial boards of leading journals in economics and especially monetary economics are staffed by current or former employees of and consultants to central banks, particularly the US central bank. More research on the ‘information management’ policies of central banks, think tanks and even universities is called for.

    Even though this isn't conclusive and points to a need for further research, it's something that - in my opinion - every single economics and finance student should take singular interest in, as being the most important issue to focus on in both fields of research.

    If these fields of study are as corrupt as the above indicates, then students in this field have a responsibility to educate themselves about that and root it out (even if just for the sake of their own intelligence/knowledge) - because nobody else is better suited to.


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