"Otherwise what I was mostly trying to suggest was that the banks anticipate the fact that the central bank won't let them double the supply of money and factor this into their loan and deposit pricing. The idea is that the current amount of deposits is not so much based on the curren[t] supply of base but the supply expected in the future." (That was from commenter HJC, with my emphasis added and one assumed typo fixed).
Now that is what I call a real and important critique of the money multiplier, as exposited in the textbooks. Because the textbooks are implicitly assuming a permanent increase in the money base, but none of them AFAIK make that assumption really explicit and talk about the difference between the current monetary base and the expected future monetary base. And it is a critique that has important real world implications, like for the US right now. And it is us Market Monetarists who should be making that critique.
Compare two different cases:
1. The Bank of Canada announces it will permanently double the monetary base relative to what it would otherwise have done. It recognises that doing so will permanently (approximately) double the price level relative to the price level path that it would otherwise have chosen under 2% inflation targeting, and it wants this permanent doubling of the price level to happen.
2. The Bank of Canada announces that a computer glitch will cause the monetary base to double, but only for one month. Because the techies are absolutely certain that they can fix it, but are currently all on holiday. The Bank of Canada assures everyone that normal programming of 2% inflation targeting will resume shortly, and that it will take steps to ensure that this computer glitch will have zero permanent consequences for the price level, if necessary by tightening monetary policy in future to restore the previously planned path for the price level.
In the first case I would expect an (approximate) doubling of currency in public hands and doubling of deposits. The money supply would double, as would the price level and all nominal variables like NGDP. Nominal interest rates would rise temporarily, then revert to normal.
In the second case I would expect approximately nothing to happen. The banks would roll their eyes and sit on (approximately) all the extra base as reserves for one month. (Since Canadian banks normally hold very small amounts of reserves, because none are legally required, and the base is currency+reserves, the stock of reserves would much more than double.) The overnight rate would fall 0.25% to equal the deposit rate (the rate of interest the Bank of Canada pays on reserves), and one month interest rates on liquid assets would fall a little too, but approximately nothing would happen to loans and deposits and the stock of currency in public hands.
I think that the current US case is much closer to case 2 than to case 1. Yes, the US banks have been sitting on the extra reserves for much longer than one month, but it is the conditionality that matters more than the duration. As someone (sorry I forget who) once said: the Fed has put out a large punchbowl of free booze, but no individual bank wants to drink much unless the other banks drink too, and the Fed says it will take away the punchbowl as soon as they start drinking. The full punchbowl just sits there. The Fed would need to announce that it wanted the price level (or NGDP) path to be permanently higher to give them permission to start drinking. And if it did that, a much smaller punchbowl would work much better than the current uselessly large one.
Other critiques of the money multiplier totally miss the point. Like "loans create deposits!" or "base is endogenous!" or "banks don't lend reserves!" or "other things affect the money supply too!". This critique matters because the textbook exposition is designed to show (among other things) how the central bank's control over its own balance sheet (which is all it really controls) allows it to control the money supply, in the same sense that I control my car. (Yes, the position of the steering wheel is endogenous, given the bends in the road I have chosen to take.) The current state of the balance sheet matters less than the expected future balance sheet, and the expectations about the conditions under which the central bank will change that balance sheet.
Worthwhile Canadian Initiative 
Great Nick! Nice post… too bad you didn’t get my horse analogy in there rather than the car one… but other than that I like it. Lol 😀
BTW, this gets to a question I had for Mark Sadowski yesterday: I bungled the question a bit by bringing up Canada vs US, but the basic idea was “as an empiricist, how can he factor in intention?”
http://www.themoneyillusion.com/?p=26518&cpage=1#comment-327750
In Canada and elsewhere there are no rules as to what reserves commercial banks have to hold, thus I suggest that in that scenario what reserves banks currently have or think they will have in a year or two is utterly irrelevant.
It’s often claimed that commercial banks need a minimum stock of reserves to enable them to settle up between themselves, but even that is not true. That is, if there was no central bank at all, commercial banks could use other assets to settle up: shares, property, bonds, etc.
I admit I still don’t understand how changing the base is supposed to cause anything when required reserves is 0%. So neglecting that ignorance…
1) What if capital rules are more binding than reserve rules?
For example, CB says that government bonds + reserves must be >=X% of liabilities L. Assume that required reserves is 0, and bank B has a minuscule amount of reserves, plus enough government bonds to just barely cover the capital rule. CB engages in QE and buys all the bonds, swapping them for reserves. CB says this move is permanent. Now bank B still meets the capital rule, but only barely. Bank B is unable to make further loans. There is no change in money in circulation and no change in velocity. Why would any seller raise his prices?
2) What if there are no (additional) credible borrowers?
CB doubles the monetary base. All commercial banks look at the two entities in this world: It has already loaned Nick the maximum amount Nick is capable of repaying and SqueekyWheel is a dead-beat who never repays loans. No new loans are created. Why would SqueekyWheel raise the price of wheels?
3) What if velocity drops?
One of our seven consumers in the consumption-sale chain moves his spending from Monday to Sunday. Now all other consumers in the consumer chain need to hold much more money. The CB expands the monetary base to accommodate the desire for more money. However velocity has decreased proportionately. Hence, price level remains unchanged.
What timeframe would you expect prices to double? Instantaneously, 1 year, 50 years? If the Bank of Canada said we are going to double monetary base on December 31st of this year, do all suppliers/retailers instantly increase their prices today in anticipation? Interest rates would probably fall immediately, but it would take a considerable amount of time for this change to trickle through the economy as a whole and influence demand enough to double consumer prices. Does the time horizon of that price change matter, I think so but can’t say for certain how much?
Counterintuitively, depending on the state of household savings, isn’t it also possible that a drop in interest rates means that savings needs to now rise in order to meet a future liability, or that interest income falls and the combined effect of both of these reduces demand, offsetting at least part of the extra demand that would come from lower rates, thus causing the impact on prices to be less than a 100% increase.
Squeeky Wheel,
See:
It doesn’t explain exactly how a central bank hits a nominal GDP target, but at least it recognizes the potential trade offs between the supply of money and the velocity of money –
“If the NGDP target is 100% credible the correlation between growth in M and growth in V to be exactly negative 1.”
“1. The Bank of Canada announces it will permanently double the monetary base relative to what it would otherwise have done. It recognises that doing so will permanently (approximately) double the price level relative to the price level path that it would otherwise have chosen under 2% inflation targeting, and it wants this permanent doubling of the price level to happen. . . .
“In the first case I would expect an (approximate) doubling of currency in public hands and doubling of deposits. The money supply would double, as would the price level and all nominal variables like NGDP. Nominal interest rates would rise temporarily, then revert to normal.”
In the first case I would expect a crisis of confidence in the central bank.
Squeeky:
0. Desired reserves, not required reserves are what matter. Required reserves matter only insofar as they affect desired reserves. Plus, desired currency matters too. Create either excess reserves over desired, or excess currency over desired, and individual banks and individual people will try to get rid of it, and will create deposits.
1. Capital is endogenous. Banks can and will raise more capital if it is profitable to do so. (And to the extent that banks have real capital, as opposed to nominal, it will rise automatically).
2. First, solve for the equilibrium, where P and NGDP are doubled, so nominal money demand is doubled, and nominal loan demand doubles. Then think about the process of getting there. Starting in equilibrium, one more loan of $1 is all we need to get the ball rolling towards the new equilibrium. Or one bank buying something for $1.
3. It won’t. Velocity is a real variable. If it were going to drop it would have dropped anyway. If anything, velocity will temporarily rise due to the temporarily higher expected inflation.
Ralph: banks use central bank money for the same reason we use bank money and central bank money ourselves. We don’t settle our accounts with the supermarket in land and houses.
Tom: yep. Car don’t have expectations, which means the car analogy doesn’t work as well as horses. But a better analogy still would be a herd of cows, who all want to stick together. We used to send one guy out in front, holding a sack, so the cows would all follow, knowing where we wanted them to go. Or get the “boss cow” to go where we wanted her to go, and let the others follow. It was always much easier to get them into the milking parlour than somewhere new and unfamiliar.
Dismal: Good question. Sometimes, like in the case of a currency reform where old dollars are replaced with new dollars, and everyone understands and can solve for the new equilibrium, it happens instantly. Dunno. I don’t understand the Phillips Curve very well.
“Counterintuitively, depending on the state of household savings, isn’t it also possible that a drop in interest rates means that savings needs to now rise in order to meet a future liability, or that interest income falls and the combined effect of both of these reduces demand, offsetting at least part of the extra demand that would come from lower rates, thus causing the impact on prices to be less than a 100% increase.”
No. Fallacy of composition. For every lender there is a borrower. But the increase in the price level will change the distribution of wealth, which might have real consequences, which is why I kept sticking in “approximately”.
If everyone woke up on Monday morning and felt really optimistic about the future and started buying up stuff, and then on Tuesday businesses went to their banks and started asking for loans to meet all this new demand then those excess reserves would start getting eaten up really quickly even if the CB did and said nothing. On Wednesday the CB would have to start tightening and telling people that any impression they may have given that the increase in the base was permanent was based on a misunderstanding.
If everyone woke up on Monday morning and felt the same as the previous Monday but the CB announced that the increase in the base was permanent (or at least would be kept at whatever level was needed to hit an NGDP target) then its possible (but far from certain) that on Tuesday people would wake up feeling optimistic and start spending just like in the spontaneous optimism case.
In other words: Its largely expectations about the future that drive both demand for loans and willingness of banks to issue loans. If expectations are low then the banking system may well have excess reserves. While expectations that the CB will reduce the base as soon as banks start to lend against it would definitely dampen people’s overall economic expectation (and expectations that the base will be permanently increased increase them), its not clear to me that it this rather than spontaneous pessimism unrelated to CB policy that is the root cause of the current recession.
Squeeky Wheel,
1) This is admittedly a very unrealistic example, but I put it together based on John Carney’s write up at CNBC, and it demonstrates how a bank can create it’s own capital by charging fees to new lenders:
http://tinyurl.com/kjwfzz2
So, I’m not necessarily arguing against your point, just that it’s theoretically possible for a bank to simultaneously expand capital and loans. Also, I’m using a definition of Capital there as in (Tier 1 + Tier 2)/(sum of risk weighted assets). Does that correspond to your definition? I guess so, because both reserves and bonds have a zero risk weighting. BUT, I looked briefly at your Seeking Alpha profile, and I’m probably not telling you anything you didn’t already know (me being a complete amateur)… but if you do happen to glance at my link, I have another wherein I try to explore the difference between capital and equity. John Carney actually did look at my first link there and blessed it, so I at least feel I’ve adequately captured what he was trying to convey, but nobody has ever reviewed what I wrote on this one:
http://tinyurl.com/m9geu3u
Nick,
“3. It won’t. Velocity is a real variable. If it were going to drop it would have dropped anyway. If anything, velocity will temporarily rise due to the temporarily higher expected inflation.”
A rather bold prediction considering the evidence.
Nick, you write in response to Squeeky Wheel:
“3. It won’t. Velocity is a real variable. If it were going to drop it would have dropped anyway. If anything, velocity will temporarily rise due to the temporarily higher expected inflation.”
I agree that velocity (V) is a real variable and should return to the same steady state value from which it started, all else equal, however your assertion that if anything it will temporarily drop seems to be at odds with your example in this post:
http://worthwhile.typepad.com/worthwhile_canadian_initi/2014/03/the-sense-in-which-the-stock-of-money-is-supply-determined.html
“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.”
Recall in that example Md = PY. You described a scenario in which the quantity of money supplied (call it Ms) immediately rose when the quantity of loans rose, and then Md eventually moved through a combination of P and/or Y increasing (I’ll take that to mean that neither P nor Y decrease) until Md = Ms.
Well, Ms = M = PY/V, right? So if M moves immediately to Ms > Ms0, and only “eventually” P and/or Y catch up by increasing, that implies that P*Y doesn’t immediately increase, which implies that immediately V increases by a factor Ms/Ms0… and only eventually does it decrease to it’s starting value, which it reaches when Md = Ms.
“however your assertion that if anything it will temporarily drop ”
should read
“however your assertion that if anything it will temporarily rise”
Nick, Excellent post. MMs have always claimed that it’s not the current monetary base, but rather the expected future path of the base that matters. One of the things it matters for is the money multiplier.
Frank, There is a lot of empirical evidence that permanent increases in the money supply growth rate raise velocity (Cagan, etc.)
Nick, I don’t agree that commercial banks need base money for same reason as you and me need commercial bank money to do our shopping. If there was no central bank, commercial banks would let inter-bank debts lie for longer than they do in the real world: i.e. they wouldn’t settle up every inter-bank debt immediately using shares, property, etc. Moreover, any seriously in debt bank ought to see what’s going on and lend less, and thus in effect pay off its debts to other banks. Thus while exchanging property, shares, etc, is inherently expensive, it wouldn’t happen all that often.
In contrast, strikes me the real flaw in my above comment has to do with the fact that the state demands that taxes be paid using the state’s money, so the private sector (banks and non-bank entities) has to have a stock of the stuff.
Nick, I can’t believe how screwed up my question above is… replace this sentence too:
“which implies that immediately V increases by a factor Ms/Ms0… and only eventually does it decrease to it’s starting value, which it reaches when Md = Ms. ”
with
“which implies that immediately V decreases by a factor Ms0/Ms… and only eventually does it increase to it’s starting value, which it reaches when Md = Ms. “
I think you’re being overly dismissive of “temporary” effects. In the 2008 financial crisis, people were liquidating assets because everyone else was liquidating assets, not because they thought the Fed’s long range policy had changed. A “temporary” decrease in short term interest rates might have helped a lot.
So let me try to be more succinct and clear. In your example Nick, we have starting off in equlibrium:
Md0 = Ms0 = P0Y0 = P0Y0/V0, where we then must have V0 = 1
After Ms increases to Ms1 we have immediately:
Ms1 = P0Y0/V1, where V1 = V0Ms0/Ms1 < V0 since Ms1 > Ms0, but because P and Y did not increase immediately, we still have:
Md = P0Y0 (at time = t0 + epsilon)
Eventually P goes to P1 > P0 and/or Y goes to Y1 > Y0 such that we are in equilibrium again at:
Md1 = Ms1 = P1Y1, and V1 = V0 = 1 again.
TMF: fair point. But then we get into “sins of ommission vs sins of commission” by the central bank, and “relative to what would have happened otherwise”. Certainly, for a given time path of the base, lots of other things can change the money supply too.
Scott: thanks! Yep, this is really just apply to the money multiplier the same point we generally make about base and NGDP.
Max: Fair point. But that is more about the importance of how the bank responds to a temporary liquidity shock than about the effects of an exogenous shock to the central bank’s behaviour.
Tom: if it takes time for the increase in the base to affect both NGDP and the money supply, V could go either up or down temporarily, depending on which one increases first. The algebra alone won’t tell us that.
“The algebra alone won’t tell us that.”
I agree, I was just trying to relate it to your previous example where P and/or Y seemed to be strictly increasing, not decreasing.
But I guess your broader point is that P and/or Y may be increasing and/or decreasing, but they eventually end up in a place in which their product is higher than their previous product so that Md = Ms, and V is back to where it started, which says nothing about it’s trajectory to get there.
Scott,
“Frank, There is a lot of empirical evidence that permanent increases in the money supply growth rate raise velocity.”
How do you know that any increase in the money supply growth rate is permanent – because a central banker tells you it is? Central bankers get appointed and eventually replaced by politicians. Politicians get appointed and eventually replaced by the voting public. And so the permanence of any money supply is ultimately one decided by the voting public.
Also, how do you establish singular causality – supply of money caused an increase in the velocity instead of say:
1. Increase in legally obligated payments (taxes, interest payments, etc.)
2. Increase in supply / variety of goods
3. Increase in population
There may be some correlation to the money supply growth rate and the velocity of money, but I don’t think there is enough to establish causality.
Tom Brown,
Over at Money Illusion you said the following:
“Re: “money multiplier” … why not just call it the “broad to base ratio?” That’s save a lot of heartache wouldn’t it? Plus it’d save one syllable if you say “ratio” like many of us do.”
This question caused me to go on a somewhat fruitless quest to try and figure out when the phrase “money multiplier” was first used. Along the way I found the following on the history of the simple model of multiple deposit creation:
Click to access er730201.pdf
James Pennington seems to be the first one to explicitly explain the process of multiple deposit creation in writing in 1826. Alfred Marshall appears to have been the first one to give it mathematical expression sometime after 1877. But the current version found in most elementary and intermediate textbooks was originated by Chester Arthur Phillips in 1921.
The article also mentions that the formula relating the monetary base to broad money supply, involving the currency ratio and reserve ratio, was first derived by James Meade in 1934. The formula was explained again by Friedman and Schwartz in 1963, and Phillip Cagan in 1964, and this appears to be when it first became popular, particularly for historical analysis.
However, scanning these writings I can find absolutely no incidence of the phrase “money multiplier”, not by C.A. Phillips, or Friedman, or anybody.
In fact the earliest closest approximation I can find of the phrase is by Karl Brunner in 1961, who used the phrase “monetary multiplier”. This was as part of his model of the money supply creation process, which I’m sure most endogenous money enthusiasts would be absolutely appalled by.
Incidentally I think it was also in 1961 when Karl Brunner coined the phrase “base money”. So it is with some irony that over time “monetary multiplier” seems to have changed to “money multiplier”, and that “base money” has changed to “monetary base”.
In any case, I’m somewhat stumped and cannot believe the phrase itself is of so recent an origin. Perhaps this is a question for David Glasner.
I asked a simple question “why not call it the broad to base ratio instead of the money multiplier” at Scott’s, and Mark really dug in!… so if you’re interested in the history of the phrase “money multiplier” here’s Mark:
http://www.themoneyillusion.com/?p=26518&cpage=1#comment-327879
Shoot, next time I’ll read before posting. 😦
Mark: neat! My guess is that “multiplier” came into use because the Keynesian “multiplier” became commonplace. Just a guess.
Nick: Oh no, it looks like I’ve become a market monetarist when I wasn’t looking! (Yes, thanks for fixing the typo. I feel very honoured to have triggered an entire post!)
I am uncomfortable with the base money change arriving as manna as per Patinkin. He was always careful to maintain the previous distribution of money when it was magically doubled. But this only really is applicable to the abstract unit of account. Central banks do repo to change the base, this is not neutral in its distribution, exiting debts are nominal etc, nor permanent. That’s why I mentioned Metzler’s model, he incorporated open-market operations and found that there is no unique full-employment real interest rate. It’s not a monetary theory model either – price changes come via output changes, not directly from money changes.
HJC, I notice you mentioned “unit of account.” Do you happen to have a copy of Jurg Niehans book “The Theory of Money?” It’s been a pet project of mine to try and figure out whether or not what I call “the definition” should be attached to the UoA or the MoA or should properly stand on its own as a separate concept. See footnote (1) here to JP Koning’s post:
http://jpkoning.blogspot.com/2014/03/credit-cards-as-media-of-account.html
“Oh no, it looks like I’ve become a market monetarist when I wasn’t looking!” … relax… grab yourself a purple robe and a cup of Kool-Aide and stay awhile…. Haha!… I’m actually fighting the urge to “join up” myself, and so far my doubts are strong enough to keep me out of the compound.
Tom: Yes I do have a copy. It’s at work though, I’ll dig it out on Monday. My reference here was more to Patinkin though.
Awesome! JP thinks the “Tom Brown Multiple” as he dubbed it, should be attached to the MoA, and Sadowski thinks the UoA. Some of us are still confused (Marcus Nunes maybe?… but me certainly). Supposedly that book established a baseline, but neither JP nor Mark have a copy. Yes, I realize this is a bit of an off-topic request. But if my question makes sense, maybe the answer lies within. 😀
Nick you write
“Starting in equilibrium, one more loan of $1 is all we need to get the ball rolling towards the new equilibrium. Or one bank buying something for $1.”
Do you think the “people of the concrete steppes” could be partially mollified if you proposed a definite channel through which the CB actually get’s that going? Like telling them you definitely have on your list of things to do to throw a lit match on the pile of oily rags (even though you know in your heart it will burst into flames through spontaneously combustion anyway).
“1. Capital is endogenous. Banks can and will raise more capital if it is profitable to do so. (And to the extent that banks have real capital, as opposed to nominal, it will rise automatically).”
Banks need to improve their capital to assets at risk ratio. They can do this by changing either the numerator or the denominator. If investors lack confidence in banks and price capital too high, it’s more profitable to shed assets.
The situation is aggravated by balance sheet incentives to avoid recognizing nonperforming assets. This is tolerating insolvency to avoid illiquidity (zombie loans), something which governments often connive in (Japan and Spain for example), even though it makes the situation worse in the long run.
Also the change to Basel III capital rules has produced a large need for capital at a time when bank stock prices are very low and raising capital is unattractive.
Of course the Euro currency union and the special limitations of the ECB may make Europe a special case, though the example of Japan argues otherwise.
Regarding the use of the term “multiplier”, this is from the first text I mentioned yesterday (Stager 1979):
“Although there is an important similarity between the national income multiplier and the expansion of bank deposits, particularly in the formulae for calculating the final results, these two processes should not be confused in any way. They deal with quite different features of the economy. The term “multiplier” is reserved for the particular process of an expansion or contraction in national income resulting from an initial change in spending. This term cannot be used for the expansion and contraction of the money supply. In fact, there is no similar generally accepted term in the latter case; one simply refers to the deposit adjustment process.”
JKH… does that constitute the “next page” that Sadowski was referring to?
Frank, Of course one can never be certain about anything in macro. But when theory predicts X and evidence suggests X then you have about as much certainty as possible.
It’s true that the market never knows for sure if a given increase is permanent, but they do the best they can in forecasting.
If the general public had reserve accounts with the fed increases in base would always be permanent right?
continued from previous comment…
Increases in base would always be permanent if the public could directly hold reserves like commercial banks and reserves were capable of being used for transactions just like bank deposits. Reserves are transfered directly to the public on a non debt basis without purchasing assets like MBS or treasuries. Reserve expansion is classified as equity on CB balance sheet instead of being a liability. Reserve creation rate determined by ngdp or inflation targeting.
dannyb2b,
“If the general public had reserve accounts with the fed increases in base would always be permanent right?”
Why do you say that? Suppose the Fed purchased $1 of assets, an then the next day it sold those assets. The base would go up $1 and then back down again.
Tom Brown
sorry, check out my second comment for clarification
The way that I see the transmission of monetary policy is the follow: the central bank increases the quantity of monetary base supplied. This leads to a disequilibrium: banks, households, and firms are initially holding more monetary base than they collectively demand at the initial money market interest rate. Banks will attempt to reduce their excess holdings of monetary base by lending out their excess holdings of monetary base in the interbank market, purchasing money market instruments, etc. Households and firms will attempt to rid themselves of their excess holdings of monetary base by depositing them in interest-bearing short-term bank deposits, purchasing money market instruments, etc. Banks, households, and firms cannot collectively succeed; instead, money market interest rates will fall until the quantity of monetary base demanded has increased sufficiently to eliminate the initial disequilibrium. The lower money market interest rates will mean that the interest rate that banks must pay on their liabilities is lower. Thus, profit maximization implies that banks will supply more banks loans, lowering the interest rate on bank loans. This will cause the quantity of bank loans demanded to rise. A new equilibrium obtains with a higher quantity of bank loans, and thus, a higher quantity of bank liabilities, including bank deposits, which households are willing to collectively hold because of the lower interest rate. Aggregate demand rises because of the lower interest rate, which is financed through bank loans and other forms credit. This eventually causes the price level to rise. As the price level rises, the demand for the monetary base rises, and thus, by the reverse of the process explained above, interest rates rise back to their initial level. I have assumed throughout that the increase in monetary base is permanent, but the growth rate of monetary base has not changes so that expected inflation is pinned down (and so, I can fudge the distinction between real and nominal interest rates).
In all the above, the monetary base is of central importance, but broad money is not. Where am I wrong? Why does broad money matter? Why is the connection between the monetary base and broad money important?
dannyb2b,
“Increases in base would always be permanent if the public could directly hold reserves like commercial banks and reserves were capable of being used for transactions just like bank deposits. Reserves are transfered directly to the public on a non debt basis without purchasing assets like MBS or treasuries. Reserve expansion is classified as equity on CB balance sheet instead of being a liability. Reserve creation rate determined by ngdp or inflation targeting.”
Are these hypothetical “direct” reserves like coins are now (in an accounting sense)? Coins at not a liability on any balance sheet and take on their face value as soon as they are minted. Unlike paper reserve notes, the Fed purchases coins from Treasury at their face value, and while at the Fed they are an asset to the Fed. When the Fed sells $1 in coins to a bank, the Fed loses $1 of assets but also loses $1 of liabilities (either a paper note or an electronic Fed deposit was traded to the Fed for the coins — and electronic Fed deposits and paper reserve notes both serve as Fed IOUs, losing their value when returned to the Fed).
So just for laughs say people can get coins directly from the Fed. What do they have to do to get them if they aren’t selling the Fed assets? Is the Fed lending them the coins? Trading a coin asset for a loan asset?
With the real system we have, the CB can prevent the base from shrinking by simply not selling assets and also replacing ones that mature.
I’m not sure what problem you’re trying to solve with your new Fed deposits (which I’m likening to coins, only because the accounting you describe sounds similar).
Undergrad, by not caring about broad money you sound a little like Scott Sumner (to me). You might find this post of Scott’s interesting if you haven’t seen it:
http://www.themoneyillusion.com/?p=26400
In the second plot, he shows how an increase in the stock of money initially leads to a lower interest rate (moving from point A to point B) but then later prices rise (movement from point B to point C).
These direct reserves would be electronic like the reserve accounts of depository institutions. Im saying if reserves as they exist now are modified so they can be held by anybody and also used as a means of payment like commercial bank deposits in order to increase the functionality of base.
Coins and notes are a liability from the viewpoint of the issuer and so are reserves. This is why asset purchases are performed when expanding base otherwise issuers balance sheet would be negative. Thats why I said that if reserves are issued directly to public without asset purchase or lending then they should be recognized on fed balance sheet as equity. This is more accurate anyway as the public are the feds constituent (assuming the fed is a public entity, if it isnt public then it should be). Financial assets issued to owners are recognized as equity on balance sheet like stocks of General Electric.
“Coins and notes are a liability from the viewpoint of the issuer and so are reserves.”
Actually coins are never a liability to any entity. They are only an asset to the entity which owns them.
“if reserves are issued directly to public without asset purchase or lending then they should be recognized on fed balance sheet as equity.”
But why would they be Fed equity if someone other than the Fed owns them. Perhaps you can draw out the balance sheets and demonstrate what your are talking about.
The Fed is a hybrid entity. The member banks own its “stock” which I believe pays dividends, but it’s a very strange type of stock. Obviously the government has a role in the operation of the Fed as well.
I’m still not sure what problem is being solved. Are you trying to solve the problem of the Fed not being able to directly control the stock of money? It can do that: it has absolute control over the stock of base money, but not absolute control over the stock of broad money.
Why would the Fed issue me these reserves? They just send them to me for free? How does one obtain these new reserves?
Here’s an alternative idea… the government as a whole could issue either currency or deposits to pay for things creating money in the process: normal things that governments pay for like salaries, hiring contractors, building bridges, etc. Then when people pay taxes back to the government the money is destroyed. That’s the MMT concept as I understand it. At least I understand in that scheme why money comes into existence and why it’s destroyed again. But I’m not getting that with your scheme. The balance sheets would help! 😀
Tom Brown oops coin is an asset. Reserves are a liability though it doesnt change my example.
“But why would they be Fed equity if someone other than the Fed owns them. Perhaps you can draw out the balance sheets and demonstrate what your are talking about.”
I am saying the fed should be a public entity as it creates the national currency. Not quasi public.
Financial assets can be recognized as a liability or equity. Base is a financial asset from point of view of holder. It is more accurate to record these as equity than liability if issued to the Feds constituent (assuming fed is a public entity).
“I’m still not sure what problem is being solved. Are you trying to solve the problem of the Fed not being able to directly control the stock of money? It can do that: it has absolute control over the stock of base money, but not absolute control over the stock of broad money.”
The problems being solved relate to monetary policy effectiveness and efficiency.
If the money supply can be expanded on a non debt basis by the fed the demand for money can be met without needing an increase in debt or needing less debt. Higher debt to GDP is correlated to greater financial instability and longer lasting recessions. Deposits are generally expanded through lending which pushes debt upwards.
Higher functionality of base will increase the velocity of the money supply.
Money transferred to peoples account without asset purchases are permanent increases in base as opposed to through asset purchases they might not be.
The ZLB isn’t a problem either if base is sent straight into peoples accounts.
Money transfers to the general public have a higher MPC than proceeds from asset sales (QE or OMO’s) by large corporates.
“Why would the Fed issue me these reserves? They just send them to me for free? How does one obtain these new reserves?”
The amount of new reserves created will be relative to ngdplt. Yes they would be free.
“Here’s an alternative idea… the government as a whole could issue either currency or deposits to pay for things creating money in the process: normal things that governments pay for like salaries, hiring contractors, building bridges, etc. Then when people pay taxes back to the government the money is destroyed. That’s the MMT concept as I understand it. At least I understand in that scheme why money comes into existence and why it’s destroyed again. But I’m not getting that with your scheme. The balance sheets would help! :D”
The government and the fed need to be separate. Conflicts of interest and excessive burden on the government of managing monetary policy. There needs to be an independent focus on monetary policy and its importance and independence shouldn’t be underplayed. Just like the judiciary should be separate to the government. The gov can just tax to fund any project it needs anyway.
“If the money supply can be expanded on a non debt basis by the fed the demand for money can be met without needing an increase in debt or needing less debt. Higher debt to GDP is correlated to greater financial instability and longer lasting recessions. Deposits are generally expanded through lending which pushes debt upwards.”
What if the CB just purchased assets other than Treasury debt when there was an excess demand for money, and then sold them again when there was an excess supply? The CB could still keep at approximately zero equity, although it doesn’t matter too much, because it won’t go bankrupt. What if the assets it buys lose value and it sells them all but needs to further reduce the money supply? Well then it could sell some kind of time deposits maybe. Shoot I don’t know…
I don’t think I have what it takes to give you the feedback you’re looking for. Maybe Nick or someone else can help you! Good luck.
“What if the CB just purchased assets other than Treasury debt when there was an excess demand for money, and then sold them again when there was an excess supply? The CB could still keep at approximately zero equity, although it doesn’t matter too much, because it won’t go bankrupt. What if the assets it buys lose value and it sells them all but needs to further reduce the money supply? Well then it could sell some kind of time deposits maybe. Shoot I don’t know…”
Still not getting around the limitation that to increase broad money supply increased lending has to occur to expand deposits. If central bank money is equal to deposits in terms of functionality then less demand for deposits and hence lending to expand money. A greater proportion of broad money will be Base. Also from people’s viewpoint reserves will be a superior electronic money because deposits a the fed will be safer than at commercial banks.
“Still not getting around the limitation that to increase broad money supply increased lending has to occur to expand deposits. If central bank money is equal to deposits in terms of functionality then less demand for deposits and hence lending to expand money. A greater proportion of broad money will be Base. Also from people’s viewpoint reserves will be a superior electronic money because deposits a the fed will be safer than at commercial banks.”
Say for example the Fed bought land, gold and corporate stock directly from citizens. I don’t see how borrowing has to happen to expand deposits in that case (Fed deposits for citizens). The Fed could lend directly to citizens too I guess (which of course would create debt).
I don’t see how you sell the concept of the Fed crediting everyone’s deposits for free. IMO that’s going to be a tough sell politically… tougher than MMT probably… or even straight out socialism.
At a deeper level, I’m not aware of the problems with the debt based system you claim, nor do I have any way to check your claims… I’m afraid I’d be very skeptical no matter what. I’d be fascinated though to sit back and see you have a conversation with Nick or somebody else that’s more qualified than I am!