Rant mode on. It made my flesh creep just to type that title.
Some statements are right. Some statements are wrong. Some statements aren't even wrong. Some statements, like the one in my title, aren't even not even wrong; they are just gibberish.
There are three distinct concepts. 1. "Demand" is what the buyers want. 2. "Supply" is what the sellers want. 3. Then there's what actually happens. What actually happens — the actual quantity – usually depends on demand and/or supply, but it's not the same thing conceptually as either demand or supply. Let's try again.
"The actual stock of money is demand-determined".
That's a bit better. It's no longer gibberish. It gets promoted to the "not even wrong" category. Because "demand" is not a number, it's a curve, or a function. The quantity demanded (which is a number) depends on stuff. Let's try again.
"The actual stock of money is determined by the quantity demanded at the rate of interest set by the supplier."
That's a lot better. It gets promoted to the "wrong" category.
It's wrong, but other than that it's a perfectly coherent theory of the world. Draw a picture with the stock of money on the horizontal axis and the rate of interest on the vertical axis. Draw a downward-sloping demand curve. Draw a horizontal supply curve. The actual stock of money is determined by the point where the supply and demand curves intersect. The actual stock of money depends on both supply and demand, but the supply curve is perfectly elastic at a given rate of interest.
There are two things wrong with that theory:
1. The "demand for money" normally means the relationship between the desired average stock of money that people wish to hold and its determinants. And money, as medium of exchange, is very different from other goods. Even if the demand for money were perfectly interest-inelastic (it isn't, but this assumption is just for illustration), it would be possible for the central bank to increase the actual stock of money, and make it exceed the desired stock of money, simply by lowering the rate of interest. By lowering the rate of interest people would want to borrow more money from the central bank. They would borrow that money, not because they want to hold more money (by assumption they don't), but because they want to spend more money. Money's funny like that. When I sell my car for $2,000 that doesn't mean I have decided I would prefer to hold an extra $2,000 money than hold a car. It normally means I have decided I want to hold a different car, or a bicycle, or whatever. I hold that $2,000 in my inventory of money only temporarily until I pass it on to someone else in exchange for a new car. My stock of money is a buffer stock that makes life easier by avoiding the need for perfect synchronisation of ingoings and outgoings.
2. Except for usually very short periods of time, that aren't usually very interesting macroeconomically speaking, the money supply curve is not perfectly elastic at a fixed rate of interest. [Update: and the monetary system would eventually explode or implode if it were perfectly interest elastic for a long enough period of time.]
Take Canada for example. The Bank of Canada has a Fixed Announcement Date every 6 weeks, at which it looks at everything it thinks is relevant and sets a new target for the overnight rate of interest. And it really doesn't like to change that target between FADs unless something big happens. So drawing a perfectly interest-elastic money supply curve is a reasonable approximation to reality for 6 week periods. For any longer period of time, it's totally wrong.
What's right? Well, the Bank of Canada targets 2% CPI inflation. It does whatever it takes to bring inflation back to the 2% target at a "medium-term" horizon, which it defines as about 2 years. The Bank of Canada does not target the rate of interest (except for the 6 weeks between FADs). It targets 2% inflation, and lets the rate of interest (and any other variable) move to whatever it takes to keep inflation at 2%.
At the Bank of Canada's medium term horizon, the supply of money is perfectly interest-inelastic. It's perfectly income-inelastic. It's perfectly almost everything-inelastic, except for one thing. It is perfectly inflation-elastic.
The money supply curve is vertical on the old picture, once we get past 6 weeks. Redraw the picture, delete the rate of interest on the vertical axis, and replace it with the rate of inflation. Draw the money supply curve perfectly elastic at 2% inflation. [Update: just to be clear, the inflation-elasticity of money supply is minus infinity, so it's perfectly negatively elastic.] That's a bit better.
Rant mode off.
Worthwhile Canadian Initiative 
Nick, you aren’t going to get anywhere with this kind of posting.
Endogenous proponents: ‘your theory is wrong, look at this evidence’
You: ‘no it isn’t because repeats economic theory‘
I align myself with endogenous money for empirical reasons, and have some basic questions for exogenous money proponents regarding that evidence and their theories:
http://unlearningeconomics.wordpress.com/2012/03/30/a-few-questions-for-exogenous-money-proponents/
Keen’s most recent post is also helpful – among other things, he notes that two fed economists effectively concluded that the money multiplier model is worthless:
http://www.debtdeflation.com/blogs/2012/04/02/ptolemaic-economics-in-the-age-of-einstein/
wh10
Good points about Nick. In general, Krugman has started coming off as very weak not because of the standard ‘oh you’re a neo-classical who just happens to like government spending’ bit, but because he keeps doing such a bad job of parsing the literature that should really be on his fingertips. E.g. the Tobin/ Brainard link today, the conclusion of which was only mildly relevant to the debate. He failed to explore the Tobin paper that Ramanan links above (and David Glasner has linked in the past)which would have automatically given him pause to think. Or even the Adam Posen speech, that Ryan Avent does a much better job of interpreting.
I don’t know who/what are the windmills that Krugman is tilting against.
An only somewhat related point – I’ve realised over the weekend the absolute importance of fully reading the literature that one is linking to/ sees linked. It seems most questions that arise have already been ‘answered’ somewhere, and a lot of the actual literature is significantly more nuanced to generate new insight (sometimes counter to the purpose intended!). As an example, Leijonhufvud’s essay (linked by JW Mason, I think).
Or, in the link that you provided http://rwer.wordpress.com/2012/01/26/central-bankers-were-all-post-keynesians-now/ . Notice how Goodhart is being quoted in the blog post. This made me ponder – Goodhart is surely sympathetic to PK points of view (and goes even beyond – I esp. love his argument about default risk preceding and creating the transactions demand for money) but he is fundamentally in the British central banking tradition (ala Buiter) who have always been keener analysts of the banking/financial system and balance sheets, and have never seen that as an impediment to being basically monetarists. (Nick might not agree that this is an advantage 😉 )
And sure enough, here is Goodhart :
“It is the further second line of argument, that we can in practice virtually ignore developments in the monetary aggregates in the conduct of monetary policy, focussing instead solely on a key policy determined interest rate, that I do want to question.”
He is opposing Woodford, but the point holds.
He goes on to say :
“Certainly if the demand for money function fits perfectly, and if its
arguments are correctly set out in equation (4), then you learn nothing more from
looking at money, than you already knew from looking at inflation, output and
interest rates. ….
…
But much the same is true of output, or of inflation; they too are endogenous,
dependent variables. If their functional relationships held perfectly, then you would
learn nothing more from looking at output, or inflation, outcomes than one already
knew from a knowledge of its functional (structural) relationship. In reality, however,
a great deal of time and effort is spent analysing whether the deviation of
output/inflation from forecast is due to one kind of shock, or another, e.g. transient or
permanent, demand or supply shock. Why do we not care as much to shocks, to
deviations of the money stock, from its expected value?..
.. ”
There is more, much more there. It is a really fantastic piece.
Though, I am not trying to spark a debate here. Just extolling the suddenly dawned (upon me) virtues of engaging with the full rather than the summary. This I think is a must for every macro autodidact.
W Peden,
“Curious. If I understand you correctly, you’re assuming that people never deal with excess money balances by consuming more?”
Yes. Because the decision to consume more is a decision based on income. It can be erratic of course but it is income-based rather than “money-based”. What is left is allocated in deposits and other assets. But my decision to allocate all my wealth in deposits (in extremis) cannot be said to cause me to consume more. It is income dependent and also wealth dependent – but wealth can be in various forms.
“If firms find it considerably easier to sell equity, why wouldn’t they just sell bonds instead?”
Yes they could do that as well.
“In contrast, it’s very hard to get a theory of endogenous money that eliminates exogenous CB action entirely from the money creation process altogether. Nicholas Kaldor really gave it a good try and could never get it to work either empirically or theoretically. I’m not really familiar with Tobin’s attempts.”
Yes difficult.
I am not saying that the decision of the economy is not interest-elastic. But it is also income-elastic.
So imagine a situation in which the central bank keeps raising rates from maybe 1%-6%. The government in the meantime is relaxing fiscal policy. These decisions are not coordinated in this hypothetical example. So what happens is a bit uncertain and depends on these things and many things. It may happen that the private expenditure when interest rates were at 3% would be lower than when interest rate was at 4.5% because of the higher fiscal relaxation near 4.5% which may led to a boom.
I think the common criticism of “endogenous money people” is that since they stress less on interest rate changes, it is common to assume that these people think it “doesn’t matter” and notions such as that.
W Peden
What follows is wildly speculative.
I think the British monetarist comfort (and even fascination) with credit/finance is because of
1) Walter Bagehot’s legacy.
2) The UK has for a long time been a medium sized, open, finance-heavy economy. The whole inflation vs. output obsession is a very domestic/inward style of macro thinking that had less relevance there (here, now that I’m in London) than say, banks and international finance.
Nick: “2. Setting aside 1, 99% of orthodox macroeconomists would say “yes”. I would say “no”. See my paragraph in the post beginning: “1. The “demand for money” normally means the relationship….””
Still having difficulties parsing. I noticed that your para beginning 1 uses the word money whereas my comment used reserves. I’m ignoring M1 and such. Perhaps we are speaking by each other due to differences in terminology.
Very much agreed, Ritwik.
Koning, I think it’s because of the way Nick is thinking of the word ‘demand.’ See the first part of my comment at 9:53AM.
Ramaman,
“Because the decision to consume more is a decision based on income… It is income dependent and also wealth dependent – but wealth can be in various forms.”
The first sentence here nearly made by eyes fall out of their sockets. As for wealth and consumption: yes, we consume at any one point in time based on considerations of our wealth and our (expected future) income. However, notice what this implies: if expenditure decisions aren’t based on income (and the slightest bit of introspection reveals that they are not) then we can consider people’s consumption decisions as their making trade-offs between their desire to hold particular kinds of wealth over time and their desire to consume.
So, if I have excess money balances (joy!) say because of a big bonus, then I can eliminate that excess in a number of ways: I can invest it in equity or bonds, but I can also use that money to buy something, including a non-financial form of appreciating e.g. I can use it as a down-payment on a mortgage at a time of rising property prices. And we’re into pretty simple Irving Fisher style hot potato territory, all by relaxing the unrealistic assumption that people consume on the basis of income.
“Yes they could do that as well.”
And a major purchaser of these corporate bonds would be commercial banks, increasing the volume of deposits as the banks create new deposits to finance their purchases.
“I think the common criticism of “endogenous money people” is that since they stress less on interest rate changes, it is common to assume that these people think it “doesn’t matter” and notions such as that.”
Gee whiz! Post-Keynesianism and (non-base money orientated) monetarism sound closer and closer as this thread goes on! 😉
Ritwik,
I like those Charles Goodhart quotes. I suppose he proves my point about the closeness of some Post-Keynesian ideas and ideas in British monetarism, since he swings from neo-Chartalist analyses of the origins of money to praising monetarists with a lot of comfort.
I agree with both of your points on the British monetarists’ interest in finance. I’d also add that almost all of the notable British monetarists are either employed or have been employed in the financial world (which as I’m sure you’ve noticed is very geographically concentrated in the UK) or as active players in monetary policy, while monetarism had a lot of problems getting traction in the very detatched and Keynesian world of British academia.
The result was that while there were some American-style monetarists (most notably Alan Watson, Margaret Thatcher’s longtime advisor) who tended to be dismissive of analyses framed in terms of broad money, credit creation and asset prices, monetarists tended to be of a different sort in the UK. Tim Congdon, Gordon P. Pepper, David B. Smith, David Cobham et al were in quite a different tradition.
Where Friedman falls is probably an essay in itself. I’d actually say he was more British than American at the fundamentals of his approach, since (1) he was primarily interested in broad money and therefore implicitly in credit; (2) his interest in base money was as a possible determinant of the money supply in a hypothetical new monetary policy system with 100% reserve banking and I don’t think anyone would doubt that that would make the monetary base important; (3) his criticism of PSBR targets was simply pointing out that the PSBR-money supply link is not tight; and (4) while he greatly disliked the Medium-Term Financial Strategy, Tim Congdon argues that his criticism was largely based on a misunderstanding of the dynamics of British reserve requirements.
It would also be interesting to try and place David Laidler (is there a Canadian school of monetarism?!) and placing Charles Goodhart into anything like a convenient filebox in economic classification is probably impossible.
And a major purchaser of these corporate bonds would be commercial banks, increasing the volume of deposits as the banks create new deposits to finance their purchases.
I disagee on two points:
1. My understanding is that institutional investors, such as mutual funds, pension plans, etc, are major purchasers of corporate bonds, not commercial banks. I’d appreciate seeing data that would either confirm or refute my understanding.
2. When a commercial bank buys a corporate bond, deposits will increase because the bond purchase transaction is indistinguishable from an ordinary commercial loan grant. The new deposit, however, is not a source of funds for the bond purchasing bank unless vacuously, i.e. the deposit is created at the same bank and, therefore, there is no need to settle. In order to settle interbank obligations, the purchasing bank would need to procure reserves in the usual way.
JP: “I noticed that your para beginning 1 uses the word money whereas my comment used reserves.”
In this context, I would say the same thing about reserves.
Unlearning: I skimmed your evidence. It doesn’t surprise me, and doesn’t change my mind. Your endogenous/exogenous money is a false dichotomy. Nobody believes in “exogenous money” in the way you have defined it.
“Surely in the money multiplier model banks would require reserves before expanding lending?” Nope.
“Surely, if banks can create deposits with loans (which they simply can in the real world), by definition a loan adds new purchasing power and increases nominal demand?”
Nope. Not “by definition”.
A couple of hours ago I started to Read Steve Keen’s Berlin paper. Then my ADD kicked in badly. It would take me 2 days of solid grinding to fisk that paper thoroughly.
E.G. “The Walras-Schumpeter-Minsky proposition that aggregate demand is income plus the change in debt….” Can anyone make any sense of his equation 1.1 that immediately follows?
I am really not surprised that Paul Krugman is accused of having failed to respond to Steve Keen’s paper.
So many of the commenters on this and the last post simply don’t understand the theory they are attacking.
Sergei:
Canada is different. We don’t have a Gross Real-Time Settlement System, we have a Deferred Net Settlement System. Financial transactions, by which I mean Large Value Transfer System transactions, are cleared daily at 11PM. They don’t clear instantly. The bilateral credit/debit position of each bank has to be secured by a pledged pool of money-market instruments to ensure clearance. This is what is called “Tranche II” of LVTS and it handles 90% of all LVTS transactions because it’s cheaper.
Bank of Canada accounts are used for 10% of transaction.
vjk,
2. By “finance their purchase” I meant no more than that the process of lending to the borrower is done through creating a deposit. As you say, this is the same as giving a loan.
1. This is the first info I could dredge up in a few seconds on google and shouldn’t be taken too seriously-
In China and Japan at least, commercial banks and OFIs are both major purchasers.
Being able to sell more equity also helps businesses participate in the wider business borrowing market and I don’t think that it’s controversial that commercial banks play a big part in that.
Equity is one way at the individual level of eliminating excess money balances, but doing so affects asset prices. Equilibrium is reached only at the point when prices and balances have adjusted to eliminate excess at all levels; the process of moving towards such an equilbrium can be a very inflationary ride, especially since inflationary expectations themselves create a demand for speculative assets that will keep ahead of inflation.
Determinant: I gotta say, I’m impressed. How come you can always find out (or remember) stuff like that? “Google”, I suppose. Just makes me realise: I’m too old; yeah, someone should give you a job.
clear as mud.
wheres the link between money and inflation at full employment? we know empirically there is a link (see the weimar republic). mmt seems peculiarly designed to explain life in a liquidity trap, nothing else.
banks have to be constrained by the base else any level is of inflation is consistent with a given monetary base.
W Peden,
Not sure why your eyes fell out of the socket.
Make a model. If your consumption function is dependent on the money balances you have, then it is Monetarist. If it depends on income and wealth, it is not.
Just because I prefer to put my wealth mainly in deposits (such as time deposits) as opposed to an imagined almost identical behavioral twin with the same income and wealth who allocates his wealth into other classes such as government debt doesn’t mean I will consume more.
Nick:
Thanks. Hopefully I’ll get to Ottawa this year (new fiscal year for hiring) and I’ll tell you my wacky job hunting stories. I tried for a few Aboriginal Affairs positions, my killer pitch was a Treaty history of my house and cottage, which runs from 1800 to today and involves my mother. I live in the Williams Treaty lands, signed in 1923 which covers Ontario from the Humber to the Trent. It was the most screwed up treaty in Canadian history.
My secret weapon this time: http://www.bankofcanada.ca/publications-research/books-and-monographs/planning-an-evolution/
Skip to the chapter on LVTS. When they start saying “The Bank of Canada decided to make this the channel for implementing monetary policy” you know you need to pay attention.
This IS the plumbing, how yon beautiful interest rate target actually hits the road.
Ramaman,
“Not sure why your eyes fell out of the socket.”
Because-
“Because the decision to consume more is a decision based on income.”
– is one of those sentences that I can’t even imagine believing, at least not about the planet Earth.
“If your consumption function is dependent on the money balances you have, then it is Monetarist. If it depends on income and wealth, it is not.”
What about a consumption function based on permanent income?
It would also be interesting to try and place David Laidler (is there a Canadian school of monetarism?!)
I think they meet in a pub in Montreal every few months. All three of them.
Don’t worry, the five Post Keynesians have a beach party every summer….
It would also be interesting to try and place David Laidler (is there a Canadian school of monetarism?!)
I think they meet in a pub in Montreal every few months. All three of them.
Don’t worry, the five Post Keynesians have a beach party every summer….
Determinant: “This IS the plumbing, how yon beautiful interest rate target actually hits the road.”
Yep. I’ve read on it in the past, but can never get my head around all the issues. In my simplified understanding: all the banks bring their daily credits and debits to each other to the LVTS. A computer hunts for and cancels all the circles of offsetting debits and credits. What remains is the net debits and credits. Banks then borrow and lend to each other on the overnight market, and what remains is debits and credits on the banks’ accounts at the Bank of Canada. Roughly right? hopelessly wrong?
I’m curious Nick, how should we make sense of statements like this, and the way that the Reserve bank of Australia (RBA) conducts itself:
“The Reserve Bank has no prescribed target for the level of settlement balances [reserves], supplying whatever amount is needed to keep the cash rate near the target” (RBA, 2003, p. 4).
The day-to-day operations of the RBA: Each day the RBA will consult with its government and non-government clients as to the timing and size of their payments and receipts. The RBA classifies payments into two categories, low-value payments, which are settled the next business day, and high value payments, which are settled on a ‘real-time gross settlement’ (RTGS) basis. The impact of the latter on system liquidity is almost immediate, and therefore the RBA stands ready to provide intra-day liquidity, (Baker & Jacobs, 2010, p. 41) in the form of an intra-day repo (RBA, 1998, p. 58). These day-to-day activities have allowed the RBA to identify and accommodate the swings in demand for ES balances, whilst forecasting and offsetting swings in the supply of ES balances, and thus maintain the cash rate at the RBA’s target rate (Baker & Jacobs, 2010, p. 42).
It seems to be a perfectly consistent with accommodationist nature of central banks as suggested by Post Keynesian theory of endogenous money (Horizontalism). The reason according to Post Keynesians is that banks create loans without reference to their reserve position, what matters is the price of obtaining the necessary reserves to ensure a positive end-of-day balance (of course, the actual operations differ country-to-country depending on the institutional arrangements). Reserves are used as means of interbank settlement and to meet reserve requirements (if applicable). As reserves are a liability on the central banks balance sheet, only a change in the central banks balance sheet can change the total level of reserves in the banking system. THe banking system can only shift reserves around, it cannot create or destroy reserves, so a banking system that has excess reserves will see the overnight rate fall to near zero, a banking system that is deficient in reserves, and assuming that banks are interest rate inelastic, will push up the overnight rate, but be unable to find sufficient reserves to offset the deficiency. As Kaldor argued years ago, the central bank has no choice but to provide the necessary amount of reserves demanded by the banking system, otherwise it risks a payment crisis, with a flow on impact to the rest of the economy.
I’m curious to know where this theory goes wrong in its explanation.
Baker, A. & Jacobs, D. 2010. Domestic Market Operations and Liquidity forecasting. Reserve Bank of Australia. Bulletin Quarter 2010
Reserve Bank of Australia. 1998. Reserve Bank Domestic Operations under RTGS. Reserve Bank of Australia Bulletin.
Reserve Bank of Australia. 2003. The Reserve bank’s open market operations. Reserve Bank of Australia Bulletin.
Ramanan and W. Peden: Let me suggest you change your argument slightly. Instead of arguing over whether an excess supply of money will lead to increased consumption expenditure, just drop the word “consumption”. What matters I think is whether it leads to increased expenditure, whether consumption or not. It could well be investment.
W. Peden: “It would also be interesting to try and place David Laidler (is there a Canadian school of monetarism?!)”
David is from the UK originally, as you might know. He has lots of students (including me) scattered around the country who he has influenced. I wouldn’t really say we make up a Canadian monetarist school. We are all too idiosyncratic. Plus, David never seemed the type to try to create disciples, as such. But a lot of money/macro names you might recognise passed through U Western Ontario. E.g. Roger Farmer, David Andolfatto, Angie Redish.
I’m not sure if there is a monetarist school anywhere any more. MM comes the closest.
Thanks for the amusing conversation. Someone will have already mentioned the following three banal usage notes: 1) “jive” is way too cool a word to adumbrate with the near homonym “jibe,” the better word to use here, 2) “it’s” and “its”; 3) PK–most people here mean, I presume, post-Keynesianism, but at least one uses it for Paul Krugman. I also think of player-killer from MUDs. How about “PKey”?
@Nick
That’s pretty right, except that at the end of each day, the net balance position is given to each bank, which is then expected to finance its position in the overnight market, and if it can’t then it may go to the Bank of Canada. Most of the time if things are OK they won’t have to go to the Bank of Canada at all.
The key is that the Bank of Canada has an interest rate target and the overnight market is expected to provide better terms than the BoC rate. If the overnight market interest rate is higher than the BoC rate, for example, banks can and will borrow from the BoC instead and force the market down.
This is Lombard banking or Chuck Norris in action.
If the market overnight interest rate is lower than the overnight BoC deposit rate, there is an instant and very strong arbitrage opportunity borrow from the market and deposit at the BoC. This is Chuck Norris’ roundhouse kick.
Most of the time, the interest rate is an equilibrium rate and the overnight market doesn’t need BoC intervention to provide/take away funds. But during a crisis all bets are off.
The interest rate of course, though it plays a very important role in the plumbing, it set through the policy considerations we all know so well.
Nick Rowe,
Good point, not least because it means we can avoid wading into the murky depths of consumption theory. At any rate, personal expenditure does not depend on personal income except over the entire course of human existence, even though in any given period of time and over a closed group it is the case that gross expenditure = gross income.
On David Laidler: IIRC, he was (and is?) very, very close to Friedman theoretically?
Perhaps “school” is the wrong term. “Pattern of ideas” is a vague and woolly way of saying what I want to say: a tendency for a group to be interested in the same variables, the same relationships and have similar beliefs about the important causal pathways.
Nick said:
“A couple of hours ago I started to Read Steve Keen’s Berlin paper. Then my ADD kicked in badly. It would take me 2 days of solid grinding to fisk that paper thoroughly.
E.G. “The Walras-Schumpeter-Minsky proposition that aggregate demand is income plus the change in debt….” Can anyone make any sense of his equation 1.1 that immediately follows?
I am really not surprised that Paul Krugman is accused of having failed to respond to Steve Keen’s paper. ”
Steve is on the edge of the Post Keynesian school, his model is not widely accepted (particularly some of his core assumptions when bank loans are repaid), and neither is his argument that : AD = Y + change in debt. For instance, Marc Lavoie has recently criticised on a blog.
BTW, this is Post Keynesian theory, I’m not sure why it is being labelled as MMT. MMT simply accepts the Post Keynesian theory of endogenous money.
“So many of the commenters on this and the last post simply don’t understand the theory they are attacking.”
To be fair, shouldn’t the real test be whether the actual Post Keynesian economists are attacking the correct theory, rather than the commenters? Krugman makes the point that the commenters don’t understand what he is saying, but again, shouldn’t he consult the Post Keynesian literature on this, rather than, with a wave of his hand dismiss it, and shouldn’t he be engaging with the actual Post Keynesian economists?
Here come the heavy hitters: First up Steven Keen
http://www.creditwritedowns.com/2012/04/banks-matter-krugmans-barter-mysticism.html
mdm: with slight changes on details, you could read exactly the same thing from the Bank of Canada. My response:
1. A visiting anthropologist might listen to the natives’ theories of their own behaviour but isn’t obliged to make his own theories identical to their theories.
2. An orthodox response would be to say that that theory is perfectly correct in the very short run (6 weeks in the case of the Bank of Canada) but is incorrect/misleading over any longer time horizon, which is what we are interested in, because that target rate of interest is not exogenous but responds endogenously to the actions of the commercial banks and the rest of the economy.
3. My response would not be orthodox. See my point 1. in the post, about the distinction between the demand to accept money and the demand to hold money.
It is a far worse mistake to assume the rate of interest is “exogenous” than to assume that the stock of money is exogenous.
Nick you should do a separate post on the following, because I think you are completely wrong, as Sergei asserted:
“BTW, on the Nathan Tankus and others’ point: that the central bank must have a perfectly elastic supply of reserves to prevent a monetary crisis. If that were true, the Bank of Canada would never be able to adjust the target over time in response to the economy, including reining in the banks, to keep inflation on target. In fact, precisely the opposite is true. If the Bank of Canada had a perfectly elastic supply curve at a given rate of interest the monetary system would eventually either implode or explode.”
I think you’re still thinking that the way the CB changes the rate is by changing the amount of reserves. No- they just change it- they announce it.
“To be fair, shouldn’t the real test be whether the actual Post Keynesian economists are attacking the correct theory, rather than the commenters?”
I agree! It’d be great if Nick responded to a Post-Keynesian paper on endogenous money, like Basil Moore’s work. And also agree some of Keen’s stuff is potentially problematic, such as what Nick identifies.
wh10: “I think you’re still thinking that the way the CB changes the rate is by changing the amount of reserves. No- they just change it- they announce it.”
You’ve just given me the excuse to link to my old Chuck Norris post, where I say exactly the same thing!
Me: “Every 6 weeks, the Bank of Canada announces its overnight rate target for the next 6 weeks. And the actual overnight rate instantly moves to where the Bank of Canada wants it to be. It’s pure Chuck Norris. The Bank doesn’t actually do anything. It just lets the market know where it wants the market to move, and the market moves there. The market moves because of the Bank of Canada’s threat. If the overnight rate is above the Bank’s target, the Bank will add however much settlement balances as are needed for as long as is needed until the overnight rate falls to the target. And if the overnight rate is below the Bank’s target, the Bank will subtract however much settlement balances as are needed for as long as is needed until the overnight rate rises to the target. And because this threat is credible, the Bank doesn’t need to carry it out.”
And thanks for your kind words earlier. I’m not sure i always deserve them.
I might take issue with your last two sentences, but putting that aside, then why do you say “Bank of Canada would never be able to adjust the target over time in response to the economy…”?
“BTW, on the Nathan Tankus and others’ point: that the central bank must have a perfectly elastic supply of reserves to prevent a monetary crisis. If that were true, the Bank of Canada would never be able to adjust the target over time in response to the economy, including reining in the banks, to keep inflation on target. In fact, precisely the opposite is true. If the Bank of Canada had a perfectly elastic supply curve at a given rate of interest the monetary system would eventually either implode or explode.”
seems like I made the best impression among the “mystics” 😉
On to your argument. why would the monetary system explode? do you mean the banking system would inflate multiple bubbles? why that’s so unrealistic…. oh wait. More seriously, banks are still constrained by their access to capital and the expected profitability of their loans (as long as when they are insolvent they get cut off from the interbank market and the bank/discount rate and/or get foreclosed on by the deposit insurance entity in that country. This is an extra reason why TBTF is so alarming to Post Keynesians). This will certainly lead to periodic financial crisis (I mean this is Minsky’s whole argument. That’s why it’s so amazing to see Krugman claiming he’s working in the Minskyan tradition) as long as their are no “thwarting institutions” (Minsky’s phrase) actively preventing financial instability.
Somehow however, I don’t think this what you’re talking about. No one denies that central banks can raise their targeted interest rate. In addition, no one is arguing that a central bank can’t have a reaction function where it changes interest rates in response to economic variables (like inflation). However, changing one’s targeted interest rate in response to inflation is not the same as targeting inflation in the central bank sense. They are always targeting a chosen interest rate. Saying that changing one’s target interest rate in response to inflation is targeting inflation is like arguing that changing one’s interest rate based on how many times Lloyd Blankfein smiles in public in a given month is targeting Lloyd Blankfein’s smiles. That policy may influence inflation, just like that policy might influence Lloyd BlankFein’s public smiles, but it’s not targeting it. Making central bank provided reserves more costly in response to inflation, is still providing reserves on demand.
Nick,
Thanks for the reply.
“1. A visiting anthropologist might listen to the natives’ theories of their own behaviour but isn’t obliged to make his own theories identical to their theories.”
Of course not, he should observe their behaviour, and trying to limit theory-ladeness (i.e. priors) and interpret what is going on.
“2. An orthodox response would be to say that that theory is perfectly correct in the very short run (6 weeks in the case of the Bank of Canada) but is incorrect/misleading over any longer time horizon, which is what we are interested in, because that target rate of interest is not exogenous but responds endogenously to the actions of the commercial banks and the rest of the economy.”
Fair enough. My question is: if the target interest rate is at the discretion of the central bank, so that any potential structural relationship between it and economic variables will only arise if the central bank has a consistent behavioural function? What if the theory which which informs what the target rate should be changes? What about the supply curve for reserves in the long-run?
Post Keynesians argue that the causal relationship between reserves and bank credit, goes change in bank credit – > change in reserves. That is implicit in my comment above. Does the causality between these two series change in the long-run?
The Walras-Schumpeter-Minsky proposition that aggregate demand is income plus the change in debt….” Can anyone make any sense of his equation 1.1 that immediately follows?
While I am generally on the side of the MMTers here, that paper is a real mess. Equation 1.1 is nonsense as written — the four variables have three different dimensions. You can try to guess at what he might have meant, or should have meant, but that’s all. I have a new post on it, if anyone is interested.
(actually in the spirit of mdm above, I should say I’m on the Post Keynesian side.)
Tschaff: Steve keen is responding to Paul Krugman. I just skimmed steve’s post, and found this:
“Firstly, there are similar underlying principles to the DSGE models that now dominate Neoclassical macroeconomics, and as with Ptolemaic Astronomy, these underlying principles clearly fail to describe the real world. They are:
1. All markets are barter systems which are in equilibrium at all times in the absence of exogenous shocks—even during recessions—and after a shock they will rapidly return to equilibrium via instantaneous adjustments to relative prices;
2. The preferences of consumers and the technology employed by firms are the “deep parameters” of the economy, which are unaltered by any policies set by economic policy makers; and
3. Perfect competition is universal, ensuring that the equilibrium described in (1) is socially optimal.”
3 is totally wrong. Everybody knows that New Keynesian DSGE models assume imperfect competition. Imperfect/monopolistic competition is absolutely central to NK DSGE models, and has been for over 20 years. It is one of the big advances of NK macro. Jeez, Paul K totally understands this, and made his own name from introducing imperfect competition into international trade theory, and will go ape if he ever reads steve keen on this.
1. is totally false too. Whether NK models are really barter or not is debatable (I say they make no sense as barter models, even though money is inessential), but they certainly have sticky prices, and the rest of his point 1 is total crap.
Only his point 2 is (mostly) true.
What Steve Keen is saying is unadulterated BS. Sorry, but it has to be said. I do try to be nice, but Jeeeeez!
Yikes! What a comment-storm!
On a slightly different note: Nick, if I were to say to you, “The supply of XXX is demand-determined,” can you think of any value of XXX where the statement would not make your skin crawl? I tried, but could not. When someone tells me that supply is demand-determined, I cannot help but think that the words “supply” and “demand” are being misused. Perhaps you or your readers can think of exceptions…..
Steve keen again: “Neoclassical economists like Krugman who believe that capitalism can be modelled without either money or banks are Barter Mystics…”
Umm. ever read the Babysitter coop model that PK is always going on about? It’s a monetary exchange model, where a shortage of money causes a recession.
Simon: welcome to the storm!
“When someone tells me that supply is demand-determined, I cannot help but think that the words “supply” and “demand” are being misused.”
Absolutely.
I’m afraid Nick R. at 9:30 and 9:42 is absolutely correct. The Keen paper is bad.
JW- Keen isn’t MMT. And yes, as has been noted here already, his paper is unique to his views with some potentially problematic elements.
Simon van Norden,
“Perhaps you or your readers can think of exceptions…..”
How about things in natural abundance e.g. air? Of course, here the phrase “supply of air” must mean “the amount we breathe”, rather than the amount exchanged.
If we are talking about supply and demand in exchange, I can think of no exceptions. I go into a shop; I buy a stick of gum. Was it either my going into the shop and buying the gum make the shopkeeper give me the gum or did the shopkeeper having a shop with gum for sale make it possible for me to buy the gum? If the former is true, then gum is demand-determined. If the latter is true, then gum is supply-determined. However, the answer to the disjunctive question is “yes” and the dichotomy is an entirely false one.
I suspect that the reason people get into thinking this way (and thinking that they’re putting forward a serious causal theory of how the world works) is the point that Nick Rowe has made so often in the past: “the quantity demanded” and “desired demand” aren’t the same thing. However, if one confuses the two, it might seem that “desired demand” (which is not necessarily or even usually identical to “quantity demanded”) causes the quantity supplied, since (when the two kinds of demand are conflated) the two are always equal.
It is meaningful to say that the desired demand for credit = the quantity supplied of credit, which is what Kaldor said IIRC. However, that’s another case where the slightest introspection reveals the mistake: if you were a banker, would you be willing to lend to a cash-strapped business at ANY price? Even the most profligate banker isn’t that stupid!
J. W. Mason,
“Y(t) + dD/dt = GDP(t) + (PQT)”
That made my day.
JW makes a much more determined and careful attempt to understand Steve Keen’s Berlin paper than I did. He fails too. JW is well worth reading.
Nick- Ramanan also has a post on this issue, corroborating the Post-Keynesian view of banking but also critiquing Keen’s paper, with the help of Lavoie. http://www.concertedaction.com/2012/03/31/is-paul-krugman-a-verticalist/
As I said, I hope you respond to my question about why you said what you said / Nathan Tankus’s most recent post. I feel like this is the point at which the conversation usually stops, but it is a quite critical juncture.
W Peden,
“is one of those sentences that I can’t even imagine believing, at least not about the planet Earth.”
Okay so consumption is inversely related to income or what?
Maybe as Nick suggested I should use expenditure.
But let’s just talk of consumption only because you find what I say amusing. Ever heard of the “consumption function” ?
You give an example of bonus. But bonus is also a part of income!
One may loosely say “I got a lot of money this year in my bonus” but formally such statements are not used. It is better to say my income was high this year due to the high bonus.
So if I unexpectedly receive a higher bonus, naturally I will consume more. But from your viewpoint it is got to do with the fact that there’s higher money balance in my account which is making me take that decision. But I may already be having high money balances in my account because my portfolio allocation decision is such as to keep my previously accumulated wealth in the form of bank deposits.
wh10: can we imagine circumstances in which the Bank of Canada wants to tighten monetary policy to prevent inflation rising above target, but knows that if it did so a major commercial bank would be illiquid and fail? Maybe.
Does this happen all the time? Obviously not. If it did, the Bank of Canada would never be able to keep inflation on target.
More generally, one of the reasons people keep buffer stocks of money, and banks keep buffer stocks of central bank money, is so we don’t go illiquid when some sort of surprise happens. But cue Minsky/Leijonhufvud corridoor at this point.
Nick, sorry, slightly confused on the implications of your thought experiment. Why does that refute that CBs always have a perfectly elastic supply at a given rate of interest?