Consider three positions:
1. The stock of money is determined by the demand for money, and not by the supply of money.
2. The stock of money is determined both by the demand for money and by the supply of money.
3. The stock of money is determined by the supply of money, and not by the demand for money.
In my last post, I showed that the first (demand only) position was wrong. The central bank's supply function matters too.
Most reasonable economists, who understand the distinction between supply (function or curve) and quantity supplied, who understand that the interest rate target is endogenous with respect to the stock of money, if inflation is to be kept on target, will say that the second position (both demand and supply) is the sensible position to take (unless the central bank has a perfectly inelastic supply function).
But I now want to argue for a more extreme position. I now want to advance deep into enemy territory.
Suppose, just suppose, that the central bank does target an exogenously fixed rate of interest, and ignore the Wicksellian indeterminacy this creates, and ignore the fact that this is incompatible with targeting inflation or anything vaguely sensible. That interest rate target is the central bank's money supply function, and a change in that interest rate target money supply function will cause a change in the stock of money.
Will it be true that the actual stock of money will always be equal to and determined by the quantity of money demanded at that target rate of interest?
Any sensible economist, who accepts the sensible middle-ground of position 2 (both demand and supply) would answer "yes". I will answer "no".
It is hard for me to explain this clearly, so please let me simplify as much as possible.
Let us consolidate the commercial banks and central bank into one big central bank that prints money and lends that money directly to people at a rate of interest it sets. The money itself (think of it as currency) always pays 0% interest, but the bank charges r% on loans of currency.
Ignore risk on loans. Anyone who wants a loan from the central bank can get one, at the rate of interest r, and they never default.
Take the standard assumption that the demand for money (the average stock of money people wish to hold) is a positive function of P and Y, and a negative function of r (the opportunity cost of holding money that pays 0% interest). Md=L(P,Y,r).
In this economy, the (change in) the stock of money is determined by the supply (function) of money (i.e. the rate of interest set by the central bank), and by the demand for loans. It is not determined by the demand for money. P and Y will (eventually) adjust until the quantity of money demanded equals the quantity of money created by the supply (function) for money and the demand for loans. The supply (function) of money, and the demand for loans, together determine the quantity of money created, and that quantity created (eventually) determines the quantity of money demanded.
It should be obvious really. When people borrow money, they (usually) borrow it to spend it; they do not (usually) borrow it to leave it in their pockets. Because money is the medium of exchange.
Take a simple example, just to illustrate my point. Suppose, just suppose, that the demand for money were perfectly interest inelastic. Desired velocity is fixed. So the money demand function is Md=L(P,Y)=PY. (Yes, I know that this assumption is empirically false, but just suppose.) Given this money demand function, the rate of interest set by the central bank has no direct effect on the quantity of money demanded. If the stock of money was determined by the quantity of money demanded, the central bank would be powerless to do anything that would cause the stock of money to increase. Cutting the rate of interest would not work. But we know it will work, provided the quantity of loans demanded depends on the rate of interest. By cutting the rate of interest, the central bank increases the quantity of loans from the central bank, which creates more money. Eventually P and/or Y will increase and the quantity of money demanded will increase in proportion to the quantity created.
The supply of money determines the quantity demanded, and not vice versa. Even with a perfectly interest-elastic supply function, at an exogenously fixed rate of interest. Money is weird like that. The medium of exchange is not like other assets.
I have made this point before, in many different ways. This seemed like a good time to make it again. Maybe it's clearer this time.
Worthwhile Canadian Initiative 
“The supply (function) of money, and the demand for loans, together determine the quantity of money created, and that quantity created (eventually) determines the quantity of money demanded.”
I agree with this, but feel that the demand for loans is itself partially a function of P and Y. At any given interest rate there will be a certain demand for loans. This will initially determine the qty of money. But if that qty of money causes changes in P and Y then this may in turn cause the qty of loans at that rate of interest to change, which will in turn change the qty of money supplied and so on until a new equilibrium is met (or perhaps until the money supply becomes extremely large or small?).
“Let us consolidate the commercial banks and central bank” … As all right minded people do on occasion 😀
Sadowski likes to give me a little bit of grief for that kind of thing, but overall I can’t complain: he’s generally game to answer my questions even though he grumbled about it a bit.
Nick,
“In this economy, the (change in) the stock of money is determined by the supply (function) of money (i.e. the rate of interest set by the central bank), and by the demand for loans.”
In this economy, the change in the stock of money is determined by the supply (function) of money (interest rate charged by central bank for new loans), the demand for new loans, the amount of loans outstanding, and the interest rate on the existing loans outstanding. Remember in this economy no one ever defaults and there is one bank (the central bank). In this economy, all loans are repaid over time back to the central bank and so loan repayment reduces the stock of money flowing through the economy.
Also, under this situation it should be apparent that unless the interest rate on existing loans is a floating rate, the economy could suffer from an insufficient supply of money to service existing loans. Meaning, existing debtors are paying back money to the central bank at a faster rate than new loans are being created by the central bank. There is a potential for a “race to the exits”.
“In this economy, the (change in) the stock of money is determined by the supply (function) of money (i.e. the rate of interest set by the central bank), and by the demand for loans.”
Who determines the demand for loans?
If the bank is offloading loans as quickly as they make them , the money supply of interest is global. Interest rates will still have some effect , but the local CB generally loses traction.
“Spillover” is the hot topic these days , mainly for EMs , but advanced economies are not immune. EU hot money spilled over in the U.S. in the 2000s.
“The supply (function) of money, and the demand for loans, together determine the quantity of money created, and that quantity created (eventually) determines the quantity of money demanded.”
Looks much like Godley and Lavoie to me, although they get there through a different exposition.
Nick,
You constructed a mini flow of funds model here, in which the change in the stock of money is coherently linked to the loan side from an accounting perspective. That seems very different for you (to me) and that’s why it seems very post Keynesian in orientation. G&L basically assume away the concept of the stock demand for money as something that falls out of their models as determined by everything else. And that’s why money has a supply determined quality (from a stock perspective).
Nick, I don’t know if this belongs here or in the last post, but regarding Mark’s complaints about the money multiplier bit in the BoE paper (he left a long comment in your last post), it seems he likes to point out this form of the money multiplier:
“Every Econ 102 textbook I’ve ever seen teaches the money multiplier is a function of three variables. The currency ratio is always portrayed as the depositors’ choice, the reserve ratio (above required, if any) is always the lenders’ choice, and the total amount of currency and reserves (the monetary base) is the central bank’s choice (even if supplied through the discount window), and all are dependent on the conduct of monetary policy by the central bank.” – Mark S.
So he means this:
1. c = currency ratio (borrowers’ choice)
2. r = reserve ratio (lenders’ choice)
3. MB = total of currency + reserves (central bank’s choice)
M = MB(1+c)/(r+c)
Let’s analyze a simplified example. Say required reserves are 0% of deposits. And say cash is outlawed. Now our formula reduces to:
M = MB/r = (excess reserves)/((excess reserves)/deposits) = deposits.
So the CB chooses excess reserves and the lenders’ choose the ratio (excess reserves)/deposits. The borrower’s choice has been eliminated. But who chooses deposits?
Another way to say that is that lenders (who buy loans from borrowers) chose r so as to maximize their profits [Mark liked this sentence]. But isn’t the set of available r for them to chose determined by both the CB and the borrowers (the loan sellers) who control the supply curve for loans? [Mark’s response to this sentence below]:
“Well, it’s kind of a simultaneous system with multiple markets each with a set of supply and demand curves and multiple agents each maximizing their utility. But in a very real sense the CB is running the whole show even if they can’t force the other agents to act in a certain way.” – Mark S.
Link here for context:
http://www.themoneyillusion.com/?p=26355#comment-323668
I *think I like the 1st part of that about the “simultaneous system,” but I’m not sure what it means? Any ideas? However the bit starting here “But in a very real sense the CB is running the whole show…” I told him I considered that to be an assertion… that at this point I’d have to take on faith because I don’t see the full logic of it.
This business very much ties into your post here I think, and my question above? I think the answer to my question above is that the borrowers control demand for loans (i.e. the supply of loans to sell to the CB), and thus the do help determine the available choices for “r” which Mark says is the lenders’ choice. What do you think?
TMF: “I agree with this, but feel that the demand for loans is itself partially a function of P and Y.”
That would make sense to me. If we measure loans in nominal terms, the demand for loans should be proportional to P. It will very probably also depend on Y, though how exactly it would depend on Y would depend on what the loans are being used for, etc.
Tom: “Who determines the demand for loans?” My “model” isn’t specified fully enough to say, other than “the people who want to borrow”.
JKH: “Looks much like Godley and Lavoie to me, although they get there through a different exposition.”
My immediate reaction was surprise. Then I did not find it surprising. Sort of ironic, but not surprising. Sometimes you end up in the same place via different routes.
But if I had assumed that the central bank buys apples, rather than IOU’s, at a fixed price of apples, then I would have said that the (net) supply of apples, plus the supply (function) of money, determined the stock of money.
“But if I had assumed that the central bank buys apples, rather than IOU’s, at a fixed price of apples, then I would have said that the (net) supply of apples, plus the supply (function) of money, determined the stock of money.”
That’s equally compatible with G&L (in my view).
The important thing I think is that it’s a closed flow of funds model, and the stock demand for money is something that falls out as determined by everything else (my second comment above).
Apples are as good as gold.
JKH & Nick… am I reading you right? You’re both agreeing that Nick and Godley & Lavoie are on the same page here? Does that tie into my question about the money multiplier above (March 16, 2014 at 06:17 PM)? My head is reeling here… …Nick does this represent any change in your position? It doesn’t sound like it from your last comment… so in some sense you’ve agreed about this all along?
steady, Tom – Nick is arguing from a starting point of considerable qualification:
“But I now want to argue for a more extreme position. I now want to advance deep into enemy territory. Suppose, just suppose, that the central bank does target an exogenously fixed rate of interest, and ignore the Wicksellian indeterminacy this creates, and ignore the fact that this is incompatible with targeting inflation or anything vaguely sensible.”
Hi all
Sorry if this is a bit off topic, but it seems that in these discussions some key aspects of Post Keynesian thought are not being put forward so here are a couple.
Basil Moore (referenced in the BoE paper) was always quite clear that the CB rate, although he described it as ‘exogenous’, was never held static but was adjusted to meet the CB’s policy objectives. Underpinning this, however, was the rejection of the Wicksellian idea of the natural rate of interest: the capital debates had shown that, in a heterogeneous-capital-good economy, it has no theoretical basis and is only valid in the one commodity (corn) economy with its production function parables.
So, ironically, ‘exogenous’ rates are perfectly consistent with a CB following a Taylor Rule (as one policy rule for instance). The endogenous vs exogenous labels were merely to provide verbal distinction from the various forms of Monetarism prevalent at the time. It may well be time for them to be abandoned since Woodford’s models feature (what could easily be called) ‘endogenous’ money but, being neo-Wicksellian, are totally at odds with the Post Keynesian view.
Another interesting point to note is Kaldor’s belief that there can be no excess of credit money – it simply does not come into existence! This was also supported under quite a lot of attack from fellow Post Keynesians (and Charles Goodhart) by Moore.
See the recent edition of the Review of Keynesian Economics for a mini-symposium on Basil Moore’s book.
Nick,
On one of those linked posts, you said:
“The supply of money is determined by and equal to the demand for loans from the banking system at the announced rate of interest. The supply of money is not equal to the demand for money at the announced rate of interest.”
So is the difference here that you’re ignoring that “Wicksellian indeterminacy” for purposes of illustration? i.e. you’re assuming temporarily that’s not a problem?
JKH, duly noted, thanks!
JKH: “Apples are as good as gold.”
Yep. But it is a bit trickier to apply it to a gold standard world, because sometimes the gold itself (and not just currency convertible into gold) can be used as a medium of exchange.
Tom: I confess I have not read Godley and Lavoie, so I cannot say. But I am familiar with some of Marc’s work, and some of his students’ work, so I have a general sense of it. It is not implausible.
This is no change in my position (well, not in the last few years anyway). I have several posts arguing sort of the same thing, in various ways. I stole the example of the perfectly interest-inelastic money demand function from my PhD supervisor, monetarist David Laidler (who is not to be held responsible for my misrepresenting that idea). Bill Woolsey (I think) will agree and find nothing new here (except maybe exposition). David Glasner (I think, but am less sure) will be less inclined to agree. Scott Sumner could go either way, and would ask why it matters. Steve Keen (I think) would agree, but would say it shows that money is endogenous, and would talk about the stock of debt created rather than the stock of money created. New Keynesians (I think) will disagree. Many Old Keynesians will disagree. Mike Sproul will strongly disagree. This stuff cuts across party lines.
It’s a funny old world.
Nick,
In that same referenced post, you said:
“Perhaps we should abolish “the demand for money”. It only confuses people.”
Good idea.
E.g. it’s not easy keeping thoughts straight about the stock demand for money when the flow of funds (e.g. bank loans creating money) can be a factor in satisfying an “excess demand for money”.
O/T: JP Koning looks again at MOA and suggests credit card companies might have a competing one right now (especially there in Canada):
http://jpkoning.blogspot.com/2014/03/credit-cards-as-media-of-account.html
(BTW, I made his footnote)
Fed Up or Too Much Fed, or whatever he goes by would be interested in that I think. 😀
JKH @7.11. True. Godley and Lavoie would be (roughly) happy with those assumptions, I am not. I make them for illustration.
JKH @7:22. I don’t think there’s any substantive difference between what I am saying now and what I said then. Except I have cleaned up my language, and have just rapped my own knuckles for having said something so terribly sloppily.
“E.g. it’s not easy keeping thoughts straight about the stock demand for money when the flow of funds (e.g. bank loans creating money) can be a factor in satisfying an “excess demand for money”.”
Yep, that’s why I did that old post where banks bought houses. Because it’s harder to confuse houses with money.
HJC: I disagree on Cambridge Capital Controversies showing the natural rate of interest makes no sense (though it does have other problems, in a monetary economy with sticky prices). But let’s leave that aside here.
But yes, there are definite differences, as well as similarities, between Neo Wicksellians and Post Keynesians.
The “exogenous/endogenous” distinction has become terribly unhelpful, because some people seem to use those words in very strange ways. Yep.
Thanks Nick, I think the main point I was trying to make (without having to actually discuss them) is that there were theoretical reasons for rejecting the problem of Wicksellian indeterminacy, see Colin Rogers’ work for instance. And these were important parts of the monetary theory. So if there are any similarities between Neo-Wicksellians and Post Keynesians they are only very superficial. [Obviously, another related point is that it seems to me that a lot of this is not fully appreciated by many that put forward the ‘endogenous’ money theory, and this causes confusion.]
Nick, you write:
“The supply of money determines the quantity demanded, and not vice versa.”
But does it solely determine the quantity demanded, or does it work in conjunction with the “demand for loans” which you said earlier (in your response to my question) was determined by “the people who want to borrow.”
Nick, you write:
“Cutting the rate of interest would not work. But we know it will work, provided the quantity of loans demanded depends on the rate of interest.”
So the quantity of loans demanded depends on the rate of interest… but the demand curve which determines a quantity of loans demanded for each interest rate in turn depends on what? It still seems to me like you’re that it depends on the “the people who want to borrow,” i.e. the people putting loans up for sale to the central bank, at least in part. Is that true?
Hi Tom, I think that what Nick means is that, first, the demand for loans determines the amount of money created – i.e. the supply of money. But although this supply is accepted by its recipients (because it’s money), in all probability it will not match the desired money stock, or demand for money. So, second, P and/or Y will need to adjust to restore equilibrium on the demand side. Hence, by adjusting P and Y, “the supply of money determines the quantity demanded.” All subject to stated qualifications. (That’s what I think he means anyway.)
This question of the excess supply of credit money, that I referred to above, has been debated at length in the Post Keynesian journals.
JKH: “G&L basically assume away the concept of the stock demand for money as something that falls out of their models as determined by everything else.”
That’s where I would disagree. If people are holding more money than they wish to hold, they will spend more, to try to get rid of the excess. Collectively, they will fail to get rid of money, but their increased spending will increase P and/or Y. So we can’t ignore the stock demand for money.
Tom: from my post: “The supply (function) of money, and the demand for loans, together determine the quantity of money created, and that quantity created (eventually) determines the quantity of money demanded.”
In conjunction.
Nick, thanks I agree “In conjunction.” So to answer my last question above:
Posted by: Tom Brown | March 16, 2014 at 10:41 PM
i.e. “Is that true?”
The answer is “True,” correct?
Sadowski & I were discussing it and I was trying to clarify:
http://www.themoneyillusion.com/?p=26355&cpage=3#comment-323881
The G&L models are based on buffer stocks which absorb the difference between each sector’s expected and actual outcomes. Money is the buffer for consumers. (Inventory for firms etc.) At each time period the consumer adjusts their expectations, consumption and portfolio allocation plans until there is a steady state. At this point the ex ante supply and demand for money will be equated.
Yes you are right in your hypothetical example with the assumptions you make. But in the example you made you simply assume away the problem with the current system:
“Ignore risk on loans. Anyone who wants a loan from the central bank can get one, at the rate of interest r, and they never default.”
“By cutting the rate of interest, the central bank increases the quantity of loans from the central bank, which creates more money. Eventually P and/or Y will increase and the quantity of money demanded will increase in proportion to the quantity created.”
What happens if debt to gdp keeps increasing? Loan supply gets reduced because lenders are facing less quality borrowers. Borrowers want to borrow less also. Less loans equals less money.
The CB can keep bringing rates down further and further negative to compensate lenders. Debt to gdp keeps increasing and rates keep going further negative. At some point the monetary system collapses.
You need to take into account debt to gdp if we look at the current system.
In the long run bank lending based monetary policy fails because the banks misallocate funds during lending process so that debt grows faster than gdp.
Tom: in conjunction. True. (And stop using the words “supply of loans” when you mean “quantity of loans supplied”! The first is a function which describes what the supplier wishes to do, for various interest rates; the second is a number.) Mark S is right that PP and others like him will not like this post.
HJC: interesting. One old related post of mine. A second.
Your 10:45 comment was pretty accurate!
This works out in the information theory model:
Nick Rowe’s model of the money stock
There’s an interesting twist. Answering the question “Will it be true that the actual stock of money will always be equal to and determined by the quantity of money demanded at that target rate of interest?” …
I will answer no, but add that the actual money stock will always be less than or equal to the quantity of money demanded. This is because you can only lose information that is sent in the original message (the demand).
Like I always say, “Print more money.”
Especially now.
Jason, that is awesome! I don’t know if you’ve got it right or wrong (I’m a rank amateur: and I just gave it a quick once over), but just that concept of what you’ve done is awesome… to take a paragraph from Nick’s post and turn it into something more visual like that.
Now I’ll read it and see if my non-economist mind can make any sense of it.
But I don’t know how many times I’ve wished someone would do something like that…. hopefully you’ve got it all right!
Hey, while you’re at it, what do you think you could do with this Nick Rowe comment: I’m still scratching my head over the “rectangular parabola” … and pretty much all of it actually.
http://worthwhile.typepad.com/worthwhile_canadian_initi/2014/03/one-general-theory-of-money-creation-to-rule-them-all.html?cid=6a00d83451688169e201a73d91d608970d#comment-6a00d83451688169e201a73d91d608970d
He’s talking about a hypothetical I present here:
http://www.themoneyillusion.com/?p=26355&cpage=3#comment-323301
and I added “reserve requirements = 0%” too.
Nick’s response was supply and demand for MOA both go to zero, and then he elaborated with the above. I’m still trying to figure out if that means that the new steady state price level will thus not change (i.e. not go to zero) or not.
Man I wish I could visualize what Nick was talking about there with the rectangular parabola… I was going to take a crack and drawing it myself and see if I could get him to take a look.
Thanks Nick. A brief comment on each link:
I think that Keen’s model is a strange twist on Moore’s observation that for aggregate demand to increase there must be ‘deficit spending’. Credit money (as well as previously-saved money balances) can be the source of this spending. But, since credit money is ‘endogenous’, it does not cause the spending increase (or anything else!). Keen seems to have missed the second point and his ideas are really some form of monetarism.
Personally, I like Perry Mehrling’s idea that monetary policy affects asset prices in the first instance – any effect on borrowing, spending, investment etc come (perhaps much) later. This also seems to me to form a better basis for a ‘one general theory of money.’ (Add in a suspicion of the validity of the Wicksellian concepts as well.)
Tom: it’s rectangular hyperbola: Y.X = some constant.
HJC: “Keen seems to have missed the second point and his ideas are really some form of monetarism.”
Maybe that’s why it sorta resonated with me!
Nick, thanks!! Whew! … I’m pretty sure Mark was just messing with me at the end there… the smiley face says he was. I’m happy to take your word about Philip… and Mark’s, the thing is I don’t know anything about Philip. People must assume I’m a fan of Philip.
And regarding this: “And stop using the words “supply of loans” when you mean “quantity of loans supplied”! The first is a function which describes what the supplier wishes to do, for various interest rates; the second is a number.”
I absolutely agree!… I thought I was being careful, but I guess not (I’ll have to re-read and see where I misused it). I know “supply” is a function, but every point on that function (the locus of points) is determined by… What? “the people who want to borrow” … and some other stuff? Am I still missing something here. Shoot! 😦
Nick: Yes, but you’re not a soi-disant Post Keynesian! I was hoping to get your opinion on Perry Mehrling’s work, perhaps a post in the future? (You did a great job of discussing John Cochrane’s papers after I mentioned it, thanks.)
Nick & HJC,
Mark A. Sadowski already proved that Steve Keen was not only a monetarist, but an OLD school monetarist here:
http://www.themoneyillusion.com/?p=26140#comment-318544
😀
“Tom: it’s rectangular hyperbola: Y.X = some constant.”
Ah!.. I thought I was OK with my quadratic surfaces, but I must have missed the day they named that… I thought it was something you made up! … or an econ thing. Ha!
http://en.wikipedia.org/wiki/File:Rectangular_hyperbola.svg
Tom: Oh dear, if it weren’t so sad, it would be funny. Thanks for the link.
Tom: Sorry, the comment above is about Sadowski’s observations on Keen and not your re-discovery of the rectangular hyperbola.
HJC… Ha!… no problem. You wouldn’t have been the 1st to give me a hard time today (not that you did at all).
BTW, I go into some detail trying to figure out what Keen was talking about. I do it with Sadowski, but I have no idea where that thread is now. But I have the gist of it here:
http://pragcap.com/forums/topic/steve-keen-an-old-school-monetarist/page/2/#post-61368
Starting with “Oilfield, thanks. There’s a few issues there.”
“Oilfield Trash” was generally defending Keen, in particular from the charge of being a monetarist (which I never took seriously anyway), but I still couldn’t figure out what Keen was trying to do in those few formulas. Any idea?
Cheers, Tom. Thanks. FWIW, I don’t know if I am right either. I saw the later comment and you seem to be in the right place on the rectangular hyperbola … the solution Nick was talking about is the highest point (1/P = infinity) on the demand curve (rectangular hyperbola) that occurs as you approach zero one the x-axis (quantity supplied).
Jason, thanks so much for taking a look. It’s starting to make a little more sense now, but I’m not there yet. So the x-axis has quantity (supplied and demanded) on it. True?
Now I know “price” is normally on the y-axis, but in this case, I’m not sure what that means exactly. Nick writes:
“The vertical axis has (say) 1/CPI.”
I know what the CPI is… but what is actually on the y-axis here? If we’re at the tick mark labeled “10” on the y-axis what does that mean? $10? 1/($10)? 1/($0.1)? I’ll guess 1/($0.1). And I guess Nick means it’s normalized by CPI instead. So 1/(0.1*CPI) then? or CPI/($0.1)?
OK, some background: Scott thought supply went to zero (only), and Nick thought demand went to zero (originally), but then later Nick said both supply & demand go to zero as my epsilon goes to zero. So if both go to zero, then Scott’s solution (P goes to 0) is not correct. So what is the solution then? Is the demand curve a rectangular parabola now still? And if it is, then what does “making it go to zero” look like? Does it mean the rectangular parabola more closely hugs the x & y axes? (i.e. y = K/x, as K goes to 0)? Does it mean K stays the same, but it just shifts right or left or up or down? I’m going with K goes to 0.
I think I have the supply curve figured out: it’s a vertical line, e.g. x = Qs. To make it go to zero means to move it left towards Qs = 0.
And regardless of how the curves look, does it mean the price level stays fixed as supply and demand (i.e. “epsilon” in my example) go to zero?
Thanks!
Hi Tom
I’ve had a quick look at the long quote posted by Oilfield Trash. My impression is that Keen is confusing the separate concepts of income/expenditure and cash-flow/payments. Expenditure equals income at the aggregate level but the parallel system of financing this is quite separate since payments can be delayed by credit and all sorts of financing arrangements. His argument that debt injections create a discontinuity in expenditure/income suffers from not keeping the profit and loss accounting separate from the cash-flow accounting.
I’m not sure, but he also seems to confuse ‘Loanable Funds’ with a denial that banks create money. In his model banks don’t seem to have pay interest on the deposits they create either.
HJC, thanks for checking that out. I’m not familiar with the income/expenditure or cash-flow/payments you describe. Oilfield brought that up? I’ll take another look.
My problems with Keen’s paper had to do with why he talks about an instantaneous AD(t) = V(t)M(t), then integrates it (incorrectly) over a period of time. And then at one one point multiplies by a time interval, etc. I couldn’t figure out if he was trying to calculate a cumulative AD or an average AD, or even if those concepts make sense. Also he seems to be saying AD = Y instead of YP. Why? I’ll re-read and see if I can find the part about the points you were making… plus I didn’t read all of Oilfield’s refs yet.
Tom: I’d need to look again and focus on the instantaneous aspects. But I think the problems are more fundamental than whether the maths is correctly done or not.
“the interest rate target is endogenous with respect to the stock of money, if inflation is to be kept on target”
The interest rate is not endogeous, it is exogenously set by the central bank according to their theories.
If you had terminator robots patrolling the streets programmed to shoot people whenever CPI inflation rose, would that make the shooting of people by terminator robots “endogenously determined”? Nope.
Philippe: central banks adjust the money base to hit their interest rate target, and adjust the interest rate target to hit their inflation target. Everything they do is “according to their theories”, and depends on what is happening in the economy.
Is the weather endogenous? In an economist’s model, the weather is (usually) exogenous. In a meteorologist’s model, the weather is endogenous.
“If you had terminator robots patrolling the streets programmed to shoot people whenever CPI inflation rose, would that make the shooting of people by terminator robots “endogenously determined”?”
Yep.
Steve Keen and hot potatoes:
Start in equilibrium. Then the bank cuts the interest rate. The representative agent plans to borrow $100 more and spend $100 more than his income. But he does not know that he is the representative agent. (Why should he, unless he knows everything about everyone?). So when he spends an extra $100 he is surprised to find his income is also $100 higher. He was “fooled” into borrowing that extra $100. He could have spent an extra $100 without borrowing anything. He was “fooled” into holding $100 more money than he planned to hold. He revises his expectations and his plans. But he does not know if that extra $100 income was a permanent increase, just a temporary blip, or was just some of his customers buying stuff a few days earlier than normal.
Modelling this formally, with proper math, would be hard. You would need aggregate and individual shocks, with the agents unable to distinguish the two. You would need temporary and permanent shocks, with the agents unable to distinguish the two. You would need the central bank to sometimes make a mistake in cutting the rate of interest, because the central bank has imperfect information too.
Standard Keynesian and New Keynesian models ignore all this. They just assume the representative agent knows he is the representative agent, and so knows his own plans and knows his own income.
I’m not surprised Steve Keen is struggling with the math.
Probably the simplest way to set up the math is like this: Discrete time model. Within each period, this is the order of play:
Agent borrows from the bank. Agent spends money. Agent learns his income. In other words, there is a short delay between the time everyone spends and the time everyone learns how much everyone else has spent on his goods. They don’t add up the sales receipts until the end of the period. I reckon that’s sorta what Steve Keen is trying to do.
Nick, re: Keen & math: Yes, … and some people are just now realizing what a rectangular parabola is (can you believe it?). BTW, that post you did on Keen was identified by a commenter on Glasner’s latest, pointing out that you, “of all people,” get why Keen needs to resort to Lebesgue integration. Which led me to this very funny post:
http://fieldsfinance.blogspot.ca/2012/10/of-course-its-model-duh-final-post-on.html