If we used cows as media of exchange (if we bought and sold everything else in exchange for cows), would you say that dairy farming is a special industry that is macroeconomically important?
I would. Because if we used cows as media of exchange, then what happened on dairy farms would affect the supply of media of exchange, and I think the supply of media of exchange is macroeconomically important in explaining short-run recessions.
And if you wouldn't say that, why would you say that banks are special and macroeconomically important in the real world?
Banks can create the medium of exchange "at the stroke of a pen", and lend it out for a monthly fee. But a talented artist can create valuable drawings at the stroke of a pen, and lend those drawings out for a monthly fee to those who want to hang them on their walls. If the medium of exchange is not special, or macroeconomically important, then banks are no more special or macroeconomically important than that talented artist.
Ask yourself these two questions:
1. Is the medium of exchange a special good, that is unlike all other goods, in a way that is macroeconomically important?
2. Are commercial banks special firms, that are unlike other firms, and unlike other financial intermediaries, in a way that is macroeconomically important?
I think those two questions are very closely related. It would be hard to answer "no" to the first and "yes" to the second. That's because:
Banks are financial intermediaries whose liabilities are used as media of exchange. If the medium of exchange is not a special good, and not a macroeconomically important good, then banks cannot be special or macroeconomically important either. Banks would be no more special or macroeconomically important than mutual funds.
My own view:
In long run equilibrium, banks are no different from other financial intermediaries. They borrow and lend. They make life easier for ultimate borrowers and ultimate lenders to get together, just like shopkeepers. And the main task of monetary policy is to keep the economy in that long run equilibrium by preventing monetary instability by preventing banks lending either more or less money for some people to invest or consume than other people want to save.
But in the short run disequilibrium, the quantity of medium of exchange matters a lot:
1. Every market in a monetary exchange economy is a market for the medium of exchange. This means that the medium of exchange is special because there are two ways an individual can get more medium of exchange: he can buy more medium of exchange (by selling more of other goods); or he can sell less medium of exchange (by buying less of other goods).
2. An excess demand for the medium of exchange prevents people making
the mutually advantageous exchanges that would be possible if barter
were easy so we did not need monetary exchange. That's what we call a
"recession". If I could sell my goods, I would want to buy your goods; and if you could sell your goods, you would want to buy my goods; but neither of us will part with our money because we don't know whether that money will return to us, and it's too difficult to organise a swap.
3. Unlike other goods, people will accept more medium of exchange even if they do not plan to hold more medium of exchange and even if they think nobody else plans to hold more medium of exchange. We accept money in exchange for other goods only because we know that others in turn will accept it from us. The quantity of medium of exchange is supply-determined in a way that is not true of other goods. The talented artist can create drawings at the stroke of a pen, but cannot rent them out unless he can find someone who wants to hang that drawing on his wall. An excess supply of drawings immediately refluxes to the artist. The talented artist cannot create an excess supply of his product; banks (in aggregate) can. I borrow the drawings because I want to hold the drawings; I borrow the money because I want to buy something else.
So I think that commercial banks are macroeconomically important because, and only because, they influence the supply of media of exchange. Otherwise, if that were not important, they would be just like any other financial intermediary.
But tell me: is the medium of exchange a special good, and a macroeconomically important good, and a good whose supply matters, in your macroeconomic view of the world? If not, what's the big deal about banks?
And if we did use cows as money, would you forget about financial intermediaries, and start writing about dairy farms instead? Or if we used the drawings of talented artists as money, would you forget about financial intermediaries and start writing about artists instead?
For Steve Roth.
Worthwhile Canadian Initiative 
Nick–from a regulatory standpoint doesn’t this tend to reinforce the view that banks are like the utilities and should be regulated in a similar fashion ? A second question: Has anyone tried to apply principal-agent theory to central banking? As per your post, I think it’s correct to say that banks are the means through which monetary policy is conducted.
Vladimir:
On the regulation question: hmmm, dunno. I think it does mean that the theory of the regulation of banks should be different from other industries. And central banks already “regulate” the banking system just by being the central bank. Commercial banks promise to make their money redeemable on demand into central bank money at a fixed exchange rate, and not vice versa, which is what gives the central bank its leverage over commercial banks.
Nothing immediately comes to mind on applying principal-agent theory to central banking, but that probably just means my mind is failing again. You can think of inflation targeting (or NGDP targeting) as the government, as principal, telling its agent the central bank what to target, and holding its agent accountable for hitting that target.
Commercial banks are one of the channels through which monetary policy can be conducted. (Some of us old guys still use central bank currency!)
Nick,
“And the main task of monetary policy is to keep the economy in that long run equilibrium by preventing monetary instability by preventing banks lending either more or less money for some people to invest or consume than other people want to save.”
Except for that to happen, you would need to identify the saver before you identify the investor / consumer. With banking, the reverse happens – a bank finds a willing borrower, makes a loan, and then tries to find a buyer for the loan (saver).
This post–it’s like you read my mind.
Frank: “Except for that to happen, you would need to identify the saver before you identify the investor / consumer.”
You would need to measure both desired saving and desired investment across the population in real time. Which can’t be done, of course, which is why macroeconomists instead recommend policies like inflation targeting or NGDP targeting instead.
And BTW, any individual commercial bank that created media of exchange and lent it out before figuring out what would happen when that loan gets spent and the cheque gets deposited at another bank would be a foolish bank. Likewise, an individual commercial bank that accepted a deposit before figuring out if it had potential customers for loans wouldn’t be very wise. My bank both advertises for new borrowers and advertises for new depositors. Simultaneity. Commercial banks care about the spread, which means both their lending and borrowing rates and opportunities. (Central banks aren’t like that.)
OK – I have read this post, and clicked over to read the Steve Roth post too, but I am overlooking some critical subtext. Everything you say here seems completely uncontroversial. I remain convinced that the MOE is special and that banks are, in some sense, special as a consequence.
I also disagree with Steve Roth: I don’t think that a detailed understanding of the mechanics of banking is required for the study of macroeconomics (though I personally find those details quite interesting.) But I don’t understand why Steve Roth should change his mind because of this post. How does it bear upon his claim? Why wouldn’t he just say that in a world in which cows are money, the incentives of dairy farmers are “orthogonal” to those of cow borrowers? Whatever that means.
But wait … maybe cows really are money. They certainly seem to be special:
“We examine the returns from owning cows and buffaloes in rural India. We estimate that when valuing labor at market wages, households earn large, negative average returns from holding cows and buffaloes, at negative 64% and negative 39% respectively.”
Lee: thanks! Yep, because you already believe the MOE is special and important.
Phil: The subtext: some bloggers criticise Market Monetarists (and people like Paul Krugman who aren’t MMs) for “ignoring” banks, or for not understanding that banks are “special” and macroeconomically important. In this post, I am turning that accusation around: are those who make that accusation ignoring the supply of the MOE, or failing to understand why the MOE is “special” and macroeconomically important?
I kept that subtext implicit in this post, because I am more interested in trying to present my own views clearly (hard enough to do) than in getting into arguments about who said what or didn’t say something else.
(There’s a side-argument going on as well, because not all MMs think alike on this question. Scott Sumner for example emphasises the MOA aspect of money, and it is central bank money that is the MOA. I put more emphasis on MOE, and both central and commercial bank moneys are MOE. I ignored that side-argument in this post.)
I don’t find Steve Roth’s story of why banks are special very convincing (though I’m not sure I understand what he is trying to say). And even if it were convincing, and I understood it, it doesn’t go to the root of the question of what it is that gives banks those properties he says they have. My story goes to the root of it, so he might find my story to be the underlying explanation of his story. (Of course, a still deeper explanation would explain why people use money instead of barter, etc., and why they use bank money instead of cows. But we have to start somewhere, or any blog post would be very long.)
“Everything you say here seems completely uncontroversial.”
It seems that way to me too. But I think I am contradicting the Tobin view of banks. The idea that the banking system in aggregate can create an excess supply of money is highly controversial nowadays. And the role of the supply and demand for MOE in understanding recessions is controversial. My guess is that some will find it controversial.
Curse of spellcheck: I assume you mean the dairy industry, not the diary industry.
(If we uses diaries as the medium of exchange, this would be good for the diary industry and terrible for privacy, unless we left them blank or were untruthful.)
Nick,
“And BTW, any individual commercial bank that created media of exchange and lent it out before figuring out what would happen when that loan gets spent and the cheque gets deposited at another bank would be a foolish bank.”
“Likewise, an individual commercial bank that accepted a deposit before figuring out if it had potential customers for loans wouldn’t be very wise.”
Banking system = no fools allowed? Wasn’t that what quantitative easing was all about – federal reserve forces banks to accept deposits without figuring out if those banks had potential customers for loans?
Here are the results of the U. S. federal reserve’s quantitative easing attempts:
Click to access z1.pdf
Page 73 – Private Depository Institutions
Assets – $15.24 Trillion
Liabilities – $15.52 Trillion
“Commercial banks care about the spread, which means both their lending and borrowing rates and opportunities.”
The spread is relevant for cash flow analysis of a bank. The spread does not factor in balance sheet analysis of a bank where deposits are treated as liabilities of that bank. Obviously things like deposit insurance mitigate the potential for bank runs when the solvency of a bank is in question.
Nick, I take you may have read Krugman and Cullen on this?:
http://pragcap.com/banks-are-special-the-ins-outs-of-money
(Krugman link at the top)
Phil @12.42: Nah, maybe cows are just Veblenesque status-goods, like having fancy artwork on your walls!
W Peden: Curses! Fixed. Thanks.
“The idea that the banking system in aggregate can create an excess supply of money is highly controversial nowadays.”
Is that supposed to be true of the commercial banking system AND the central bank, or just the commercial banks?
Tom: No I hadn’t, but I have now. My own opposition to the Tobinesque view has been influenced more by monetarists like David Laidler and Leland Yeager (and I disagree with other MM’s like David Glasner who sides with Tobin against Yeager, and sometimes I agree with Paul Krugman and sometimes I disagree). It would take too long to go fisking through these posts and explain precisely where I agree and disagree with everyone, which depends so much on how you interpret them. I think it’s more productive if I just try to explain my own views clearly.
W Peden: Some (e.g. the Neo-Wicksellian orthodoxy) say neither central nor commercial banks can create an excess supply of money. Others say central banks can and commercial banks can’t. I say that no individual commercial bank can create an excess supply of its money, but that both the central bank and the commercial banks (in aggregate) can. This, to my mind, is the old textbook story, as defended by Yeager against Tobin. The central bank can create a hot potato of central bank money among commercial banks, which in turn creates a hot potato of commercial bank money among the public. At one point Tobin seemed to argue for the Law of Reflux even for central banks, then he relaxed that and said the Law of Reflux applied to commercial bank money only.
Nick, nice article. This really gets me thinking. On first read, I’m inclined to agree with you that the MOE aspect of money is the important part here… and thus this DOES make banks special.
I look at it this way: banks in aggregate buy EVERYTHING they obtain from the non-bank private sector by creating MOE and crediting bank deposits with this MOE: time/work from employees (salaries), shareholder dividends, assets (2ndary market T-bonds, etc), electric bill, interest to depositors, and loan agreements from borrowers (i.e. they loan money to borrowers). Likewise, all payments made to banks (interest, points, fines, fees, service charges) by the non-bank private sector are accomplished by allowing banks to erase (destroy) this liability the banks previously created (i.e. they debit bank deposits). Well, I lied of course, because these things can be accomplished with paper reserve notes and coins too… but I doubt that figures in prominently: if it’s not costing us to keep our deposits at banks, then why hold any more cash than is convenient? It’s entirely up to us.
Fed deposits are used by the aggregated banks only in transactions w/ other Fed deposit holders (e.g. Tsy) or the Fed itself. The Fed itself behaves exactly as the aggregated banks do, only at the next layer out: buying all by crediting Fed deposits and selling all by erasing them: only the Fed doesn’t have to worry about solvency as much (but then again, neither do the aggregated banks… except in very unusual circumstances… like when the whole industry is in trouble)
Cows are indeed money among the Maasai in Africa.
It seems to me that there are a number of issues involved with the role of banks. It may be better to deal with each separately. They are
The extent of net credit in the economy and its effects.
The role of banks in creating money, both on their own and in concert non-bank financial companies.
The model of the traditional bank used by most economists. Open at 10, close at three and profit from the spread between interest paid and interest received. No funny stuff. Glass-Steagall rules.
How much it matters the the bank of Krugman bears very little resemblance to an integrated financial institution like Bank of America. Morgan Stanley has retail banking as a vestigial organ -an appendix to the giant colon of their wealth management division. There’s no way the First Bank of Krugmanland could lose $3 billion in a few weeks speculating in derivatives.
The financial sector has doubled in size since 2000. The purpose of a money center bank is to make money for its executives and stockholders (arguably in that order). Such a bank benefits from enormous information asymmetries (like manipulating the Libor rate) and views financial complications as opportunities to exact rents.
Morgan Stanley is currently defendant in 42 major law suits all with claims in excess of $100 million. It has also been notified of intent by customers to audit real estate securitization deals with a total value of (last I looked) $58 billion. Among other things, the GSEs want to be made whole for losses from loans not being of the quality required by the loan agreements.
It would seem to me that ignorable intermediation requires an alignment of interest between clients and the bank. Otherwise the invisible hand becomes the thumb on the scale.
If you want to see how far out of alignment interests can get and what the results of this are, take a look at Spain.
Nick,
That’s very helpful.
“I say that no individual commercial bank can create an excess supply of its money, but that both the central bank and the commercial banks (in aggregate) can.”
If there were no commercial banks (but still OMOs with primary dealers) then presumably you could ALSO possibly have an excess supply of money, i.e. the central bank could exchange more cash for securities than the non-bank public wanted to hold. Of course, there may be some uninteresting institutional issues with this (I don’t know how non-bank primary dealers sell and buy from central banks and I know of no reason to care) but in principle, once the central bank is involved in an economy, there can be an excess of central bank money, even without commercial banks. So the central bank is special.
I think I’m (a) starting to understand what a lot of your posts over the past few years were saying and (b) starting to see why free banking of the sort that George Selgin and Lawrence White propose has such stabilising properties.
Tom: I think I agree with that.
When the Bank of Montreal buys a computer, it creates money. When it sells that same computer again it destroys money. But the BMO buys and sells far more IOUs than it buys and sells computers. And the same is true if I replace “Bank of Montreal” in that sentence with “Bank of Canada”. A successful counterfeiter who printed money to finance his computer habit is as special and macroeconomically important as a bank.
Commercial banks, both individually and in aggregate, do have to worry about solvency. That’s because they promise to redeem their liabilities in central bank money at a fixed exchange rate, and if their assets go bad they won’t be able to do that. A central bank that promises to redeem its money for gold or foreign currency at a fixed exchange rate might also have to worry about solvency. A central bank that targeted CPI inflation (which means indirectly promising to redeem its money at a sliding exchange rate against the CPI basket of goods) might also worry about being able to keep that promise, if its assets went bad and there were a decline in demand for its money. But central banks, unlike commercial banks, earn monopoly profits, and the present value of those monopoly profits is a far more important asset than any asset that appears on their books.
W Peden: “If there were no commercial banks (but still OMOs with primary dealers) then presumably you could ALSO possibly have an excess supply of money, i.e. the central bank could exchange more cash for securities than the non-bank public wanted to hold.”
Yes. It certainly could create an excess supply for money (or an excess demand). Just because the market for securities clears doesn’t mean there isn’t an excess supply or excess demand for money. The “money market” is not the same as “the securities market”. The “money market” is every single market in the whole economy (except barter markets).
There have been lots of times and places where people did use cows for money. We have an empirical opportunity here. Did cow shortages actually cause recessions? Did cow surpluses cause booms?
I have not come across and historical reports that would support this view. What I do find, in abundance, is reports of coin shortages causing recessions, and of coin influxes causing booms. (But not a word about cows!)
The problems with coins seem to center around Gresham’s law. New coins are minted that weigh 16 oz. Wear and clipping reduces the weight to 15 oz. This reduces real money balances and causes a recession. The mint tries to issue new (16 oz.) coins, but they are hoarded. So the mint devalues and issues new coins that weigh 15 oz. These circulate and the recession ends. But the coins wear down to 14 oz. The process repeats and new coins are devalued to 14 oz. Seven hundred years go by and the coin that originally weighed 16 oz weighs just 1 oz., and we have a 700 year history of periodic coin shortages.
And I forgot to say: Clower has been a big influence on my thinking too.
Mike: Dunno. Were prices in terms of cows sticky? Because you need that too. But why should the physical form of the medium of exchange matter? (Except for the obvious practical reasons). If a shortage of gold coins causes a diminution in trade, and the failure of people to make mutually advantageous exchanges, why shouldn’t a shortage of cows?
“… because not all MMs think alike on this question”
Yes, I was just going to comment on that. Cue another big intra-market monetarist battle. Scott Sumner and David Glasner vs Bill Woolsey and Nick Rowe — a big repeat of last year’s big MOE vs MOA debate.
JP: Yep! Internecine warfare is much more fun! What’s sort of funny is that disagreements on this question cut right across some other party lines. And I’m not sure that all people have internally consistent views. For example, do some post-keynesians argue both that the supply of money is unimportant because the quantity of money is demand-determined, and that banks are really special and important because they create money? (Maybe I’m just imagining that, or misinterpreting them.)
Nick: point taken about solvency. I agree… both the CB and the banks in aggregate (but especially separately) have to worry about solvency. It’s perhaps less of a concern for the CB though? And the banks in aggregate can go down or get close to it, as we’ve seen…. but again, for the aggregate institution it’s less likely than for any one bank.
And yes, I agree that far more MOE is used to buy IOUs (loans) than computers.
… well I guess I did say “…only the Fed doesn’t have to worry about solvency as much” originally, so I wasn’t ignoring solvency altogether (the “as much” part) the 1st time… but yes, what I said gave the impression of “not at all.” Solvency is definitely an issue for all.
Nick:
The best historical episode for the study of money is the American colonial period. The subject of sticky prices never came up. Their biggest problems were (1) coin shortages and (2) people offering to pay with underweight coins, low quality tobacco, etc.
I’m not sure why a shortage of cows wouldn’t cause a recession. All I know is that they never mentioned it.
“Banks are financial intermediaries whose liabilities are used as media of exchange.”
I’m going to skip the financial intermediaries part for now. So you are saying demand deposits are MOE? Are they also medium of account (MOA)?
“In long run equilibrium, banks are no different from other financial intermediaries. They borrow and lend. They make life easier for ultimate borrowers and ultimate lenders to get together, just like shopkeepers.”
That sounds like loanable funds?
So for you a 20% capital requirement and a 50% capital requirement would not make any difference?
Mike: In a sense, Gresham’s law is an example of price stickiness. If bad money traded at a proper discount to good money, then bad money would not drive out good. If exchange rates are fixed, an excess supply or demand for money will look like a shortage or surplus of foreign exchange.
TMF: “So you are saying demand deposits are MOE? Are they also medium of account (MOA)?”
I would say that central bank money is the MOA. The definition of a MOA is that prices for other goods are expressed in terms of that MOA. Commercial banks promise to redeem their money on demand for central bank money at a fixed exchange rate, which means they are quoting the price of their money in terms of central bank money, which means the central bank money and not commercial bank money is the MOA. Both are MOE.
“That sounds like loanable funds?”
Yep. Loanable funds in the long run equilibrium, a mixture of loanable funds and liquidity preference in short run disequilibrium. Or, to say it another way, it’s the job of the central bank to try to make the loanable funds theory true at all times.
An increase in the legislated capital requirement would: increase the equilibrium spread between banks’ lending and borrowing rates; reduce the total quantity of commercial bank money; reduce the risk of the central bank having to act as LOLR or bail out insolvent banks. I think. But it wouldn’t make a qualitative difference to what I say here.
Thanks, Nick!
I think I’ve got the “money is special, n-1 markets” thing you keep prattlling on about (grin) about 85% internalized. I really need to get it fully compiled into my brain because the client-side interpreter/emulator I’m using over here is both slow and buggy. (And it’s not like I can think about it all day every day…) Working on it, a couple of readings of this got me closer.
Could use some help on this:
“there are two ways an individual can get more medium of exchange: he can buy more medium of exchange (by selling more of other goods); or he can sell less medium of exchange (by buying less of other goods).”
3. He can borrow (or more accurately retain?) more medium of exchange. Use his credit card instead of his debit card. If it’s a business, tap that line of credit. (I’m wildly curious why, if demand for money is so high [and the cost of borrowing is so low] people aren’t credit spending like crazy.)
This back to the reflux discussion. Now you can say he’s “selling” future spending/consumption/borrowing to “buy” current spending/consumption/borrowing (buying current borrowing by selling future borrowing??), but I just don’t think that’s a coherent or usefully explicatory analogue to (not) buying/consuming real, newly produced goods today.
But back to the whole post, and my interpreter problem: I’m kind of flummoxed about how this replies to my post, which was all about incentives, reaction functions, and intertemporal optimization of consumption preferences — none of which is mentioned here. There is a lot of implicit stuff embedded herein about those subjects, but much assembly (and deduction) required.
A somewhat weak analogy: I’m trying to understand relativity theory by thinking about a person in an enclosed capsule, who can’t tell the difference between that capsule’s acceleration and the capsule being held in place in a gravitational field–a warp in the space-time continuum. You say, “Think about two people’s subjective lifespans, one at light speed and the other at rest…”
“I would say that central bank money is the MOA. The definition of a MOA is that prices for other goods are expressed in terms of that MOA.”
I’m going to disagree there. When I go to buy something at a store, it seems to me the price is quoted in terms of currency and/or demand deposits. I can buy something for all demand deposits. Let’s even say the store and I share the same bank. I write a check for an item. There is a swap of my demand deposit(s) into the store’s checking account, while I get the item. No central bank “money” (currency, central bank reserves) involved. I’m assuming 1 to 1 convertibility of demand deposits and currency.
Also, I believe Canada has a 0% reserve requirement. Let’s say people don’t want currency any more. They turn it in for demand deposits at commercial banks. The commercial banks swap the currency for central bank reserves. The commercial banks decide they don’t want the central bank reserves. The commercial banks swap them for treasuries. Now central bank money (currency, central bank reserves) equals zero (0). Now there is an all demand deposit economy. It seems to me the MOA (and MOE) in that economy are demand deposits.
“An increase in the legislated capital requirement would: increase the equilibrium spread between banks’ lending and borrowing rates; reduce the total quantity of commercial bank money; reduce the risk of the central bank having to act as LOLR or bail out insolvent banks. I think. But it wouldn’t make a qualitative difference to what I say here.”
If demand deposits (commercial bank money) plus currency is the MOA and MOE, then I believe the capital requirement would make a difference.
I don’t know if I can find it, but have you seen where Miles Kimball says banks allow borrowers to increase their purchasing power more than the purchasing power of savers decrease?
Too much Fed,
“I don’t know if I can find it, but have you seen where Miles Kimball says banks allow borrowers to increase their purchasing power more than the purchasing power of savers decrease?”
Part of the reason is that long term borrowing by private individuals is amortization borrowing. As the borrower pays back the loan, interest is only applied to the outstanding loan balance. Contrast that with debt issued by the government (coupon or accrual bonds) – interest is paid on the principle of the bond until the bond reaches maturity at which time principle is returned in full. Tax policy also comes into play – many forms of private interest payments (mortgage, student loan, corporate) are tax deductible.
This is why you see that individuals (even at today’s low rates) are net interest recipients. It also explains that absence a change in credit demand, liquidity preference, or productivity nominal interest rates and inflation are positively correlated.
Steve: I know the feeling. It took me hours to write this pitifully short post. And I’m doing almost nothing else at the moment.
“3. He can borrow (or more accurately retain?) more medium of exchange. Use his credit card instead of his debit card. If it’s a business, tap that line of credit.”
“Borrowing” is just another word for “selling an IOU”. It counts as an example of “selling more other (non-money) stuff”.
“But back to the whole post, and my interpreter problem: I’m kind of flummoxed about how this replies to my post, which was all about incentives, reaction functions, and intertemporal optimization of consumption preferences — none of which is mentioned here.”
You are right. My post here doesn’t directly address your story of why banks are special. What I am saying here is that creating MOE is the only underlying reason why banks are special, so if what you say is right, it must be a consequence of creating MOE. And if what you say doesn’t follow as a consequence from creating MOE, what you say must be wrong.
“You guys” accuse “us guys” of not understanding banks. I’m flipping the accusation back: if you guys don’t understand money, you can’t understand banks!
TMF: Assuming commercial bank dollars are accepted at par is begging the question. If the BMO became insolvent, and my deposits at the BMO were only worth 50 cents on the dollar, the store would double the prices it charged me in BMO dollars, if it accepted them at all. Some Canadian stores will accept USD, but prices are quoted in Canadian dollars.
Hey,here is a selfish comment.
This was the best post on banking. http://www.freebanking.org/2013/07/11/misunderstanding-financial-history/
Here, https://archive.org/stream/banksbankingbank00macluoft/banksbankingbank00macluoft_djvu.txt
is B.E. Walker’s essay on free banking in canada. The Introduction.
The B.E. Walker is a must-read imo.
Lee Smolin’s Time Regained, oddly is helping my mind deal with the number markets, moe, relational metaphysics. Whitehead, which is what I was pursuing in undergrad.
The cryptocoins, are commodity coins + distributed ledger. Waiting for banks to develop on top of them, then the cryptocoin Bank-notes will be moe. I was at a music festival in the summer, and I was able to transfer my primecoin over to bitcoin, then to cash at a booth.
Armen Alchian’s University Economics, is the best text.
Also sticky prices don’t make sense. The mal-allocative kind. I think market participants are right and the explanation is wrong. Still think my edgeworthian explanation of infrequently traded items having stable prices works.
Good post btw.
Wrong forum, I need to get my own blog. Stop spamming people.
“For example, do some post-keynesians argue both that the supply of money is unimportant because the quantity of money is demand-determined, and that banks are really special and important because they create money?”
Yes, there are a few examples of this. See Cullen, for instance, although I could be wrong. Maybe other commenters can chime in on this? Is there an equivalent PK rift?
Nick:
Nick’s post said: “TMF: Assuming commercial bank dollars are accepted at par is begging the question. If the BMO became insolvent, and my deposits at the BMO were only worth 50 cents on the dollar, the store would double the prices it charged me in BMO dollars, if it accepted them at all. Some Canadian stores will accept USD, but prices are quoted in Canadian dollars.”
Let’s assume it is a one time event. I also like to talk about relative pricing. If it is a one time event, $1 of BMO demand deposits will still buy $1 of goods/services and $1 of Bank of Canada currency will still buy $1 of goods/services. The difference is the person holding $1 of Bank of Canada currency still has $1, while the person holding $1 of BMO demand deposits now has only $.50 (fifty “cents”) of BMO demand deposits. Currency is not directly “defaultable”, while demand deposits are directly “defaultable”.
For example, assume all currency and demand deposits are circulating. $800 billion of currency and $6.2 trillion of demand deposits get converted to $7.0 trillion in demand deposits with a velocity of 2. Next, a bank/banks become insolvent, and depositors get affected. Now there is only $6 trillion in demand deposits with a velocity of 2. Everyone panics even though it is only a one time event and turns in their demand deposits for currency. Now there is $6.0 trillion in currency, still a shortage of MOA/MOE. If commercial banks (or even hedge funds) are the ones that produce new demand deposits (MOA and MOE) and don’t use leverage/use margin, how is the amount of MOA/MOE going to expand?
JP Koning, Cullen supposes (and so do I) that Nick is actually mostly agreeing with Cullen here:
http://pragcap.com/banks-are-special-the-ins-outs-of-money/comment-page-1#comment-152817
http://pragcap.com/banks-are-special-the-ins-outs-of-money/comment-page-1#comment-152835
As you can see, I was 67% sure of it. :^)
BTW, Nick, didn’t this make your “flesh creep” to type out? “…supply of money is unimportant because the quantity of money is demand-determined”
I can’t speak for Cullen, but what about this view: MOE is special, banks (uniquely in the private sector) create MOE, and thus they’re special. In fact the MOE that banks create is so special that in some ways it’s MORE important than the MOE that the Fed creates (I’m pretty sure that’s where Nick get’s off this bus). In other words CB created MOE is one of two things:
1. physical cash
2. Fed deposits
2. is mostly for facilitating bank MOE (which is more special)
1. is mostly for convenience of the public, and the public freely swaps their bank MOE for cash whenever it’s most convenient for them to do so… and as long as they don’t have to pay the banks to hold deposits, there’s no special reason to exchange more bank MOE for more cash, even if there’s mountains of CB MOE piling up at the banks.
So I’m going to unceremoniously dump 1. here. Unless we have to pay for the convenience of holding bank deposits (which I think would cross some sort of psychological threshold for people), it’s a function of convenience.
As for 2., I like the facilitating argument, however, I freely admit the following:
non-bank private sector’s (the “public’s”) stock of money = L + B + F
= stock of bank deposits + cash in circulation with public
to a 0th order approximation, with the following definitions:
L = banks loans
B = Bank held Tsy debt (a small fraction in the US… on the order of $200M)
F = Fed held Tsy debt
independent of “C” where C = stock of cash in circulation.
So, sure, F is substantial and contributes directly to the public’s money stock, and for that reason it’s important. MOE, after all, is “special” … we do agree about that. I have more here:
http://brown-blog-5.blogspot.com/2013/08/banking-example-11-all-possible-balance.html
Sure I’m just an amateur at this stuff, and I’m POSITIVE I didn’t come up with that, but I like it nonetheless. Hopefully one of you will take a look and tell me where I’ve gone wrong so I can learn something. ;^)
I introduce mortgage debt and intra-gov debt holdings (e.g. SS) in the next two examples (11.1 and 11.2) but it doesn’t substantially change the approximation made here in #11 (as long as we realize that T = total of Fed, banks, and public held Tsy debt in #11, and excludes intra-gov … and I think maybe foreign too… but not sure yet about that).
If you do go, check out my fancy interactive charts/spreadsheet! MS actually made something for free better than Google there!
So the special thing about CB MOE piling up in banks as excess reserves is not the reserves themselves but the corresponding F contribution to the public’s MOE.
That’s what differentiates ER from the following: Say that the Fed calls up the BEP and tells them that for psychological reasons (read “expectations”) they’re going to need $10T more in paper reserve notes printed up, which they’re going to pay the cost of production for (say $1000) and then announce to the world that they’re going to stockpile in case there’s a rash of cash advances. This is a way to get the psychological effects of expectations, but for a lot less BS growth from the Fed’s point of view ($1k instead of $3T). The thing that would be missing here is F, which is still $0: so no growth of bank created MOE. Now Sumner says that at “zero rates” the HPE is “very weak” and it’s mostly an expectations game (I’ll show you the quotes if you don’t believe me), so if that’s true, then why not just have the BEP print up a bunch of notes ready to go?
I’m kind of being silly here, but it’s a serious question: in terms of expectations (expectations of future NGDP growth, or inflation or HPE) ONLY what’s the difference?
Mix of posts:
‘”In long run equilibrium, banks are no different from other financial intermediaries. They borrow and lend. They make life easier for ultimate borrowers and ultimate lenders to get together, just like shopkeepers.”
That sounds like loanable funds?
So for you a 20% capital requirement and a 50% capital requirement would not make any difference?”‘
‘”That sounds like loanable funds?”
Yep. Loanable funds in the long run equilibrium, a mixture of loanable funds and liquidity preference in short run disequilibrium. Or, to say it another way, it’s the job of the central bank to try to make the loanable funds theory true at all times.
An increase in the legislated capital requirement would: increase the equilibrium spread between banks’ lending and borrowing rates; reduce the total quantity of commercial bank money; reduce the risk of the central bank having to act as LOLR or bail out insolvent banks. I think. But it wouldn’t make a qualitative difference to what I say here.”‘
I hope to come back to this.
Tom Brown said: “In other words CB created MOE is one of two things:
1. physical cash
2. Fed deposits”
I don’t consider Fed deposits (the demand deposits of the central bank) to be MOE in the real economy. I also don’t believe they are MOA in the real economy.
TMF, well consider them MOE in the “fake” economy then: i.e. banks use those exclusively when buying and selling to other Fed deposit holders (foreign CBs, the Tsy, etc) or the Fed itself. They are also used in this manner of course when banks act as intermediaries between other Fed deposit holders or the Fed and the non-bank private economy (your “real” economy).
Nick, question about this part of your post:
“The talented artist can create drawings at the stroke of a pen, but cannot rent them out unless he can find someone who wants to hang that drawing on his wall. An excess supply of drawings immediately refluxes to the artist. The talented artist cannot create an excess supply of his product; banks (in aggregate) can. I borrow the drawings because I want to hold the drawings; I borrow the money because I want to buy something else.”
Is there a typo in there… or two, because I don’t follow. Let me re-phrase and please tell me where I go wrong:
1. Talented Artist (TA) creates goods, but can’t rent them out unless demand exits.
2. If TA creates excess supply of goods it “refluxes” to him.
3. The TA CANNOT create excess supply. Huh? Number 2. just described what happens when he DOES create an excess supply! How do we now conclude that CANNOT be done?
4. Banks, however, CAN create an excess supply of their product (MOE). What?? Again, this is a surprise.
5. …some other stuff that I’ll skip
Typo(s) or no? Should the “cannot” be a “can” and the “can” be a “cannot?”
Nick, another question. You write:
“1. … This means that the medium of exchange is special because there are two ways an individual can get more medium of exchange: he can buy more medium of exchange (by selling more of other goods); or he can sell less medium of exchange (by buying less of other goods).
2. An excess demand for the medium of exchange prevents people making the mutually advantageous exchanges that would be possible if barter were easy so we did not need monetary exchange. That’s what we call a “recession”. …”
So why then, if a recession is an “excess demand for MOE” isn’t the reaction from “people” just as likely to be “buy more medium of exchange (by selling more of other goods) [e.g. sell IOUs to banks, i.e. take out loans]” as it is to be “sell less medium of exchange (by buying less of other goods)”
You propose two responses to an “excess demand for MOE” in 1., but focus on just one of them in 2. Why? Why does a recession (which you say is equivalent to “excess demand for MOE”) lead to less buying and not more borrowing, if both buying and borrowing are the two ways people can respond to “excess demand for MOE?” Shouldn’t you at least mention why you choose to focus on “less buying” rather than “more borrowing?” Is there something that’s preventing the “more borrowing” route?
If we did use just cows as money (or gold coins), commercial banks would immediately start counterfeiting cows or gold coins. That is, if the going rate of interest charged by those depositing cows/coins in banks for extended periods, so that others could borrow was 5%, then commercial banks would soon discover they could simply credit cows/coins to borrowers accounts without actually needing to breed cows or dig up gold, and charge 4%.
Counterfeiting should be illegal. That is, the only form of money should be monetary base (either cows, coins or a fiat base).
Moooo.
Nick
“The idea that the banking system in aggregate can create an excess supply of money is highly controversial nowadays”
Change “banking system” to “financial intermediaries”. Change “an excess supply of money” to “a lower price of risk”.
And then, it would be perfect. 🙂
As in, the idea used to be controversial (perhaps no longer is), and that’s what’s really going on.
Nick Rowe,
“Some Canadian stores will accept USD, but prices are quoted in Canadian dollars.”
That’s a very elegant way of explaining the MOA/MOE distinction. In Northern Ireland, most shops will price in pounds but take euros. I suppose, when they give prices in both, then both the pound and the euro are the MOA.