Brad DeLong calls it my "self-imposed Sisyphean task". He's probably right. But it seems worth a try, as long as there's a small chance he's wrong. I have a Cunning Plan.
Like it or not (and there is much to like as well as dislike), New Keynesian macro has become the main accepted approach for teaching, research, and policy. It would be hard to persuade economists to ditch it. Rather than ditch it, I want to reinterpret the New Keynesian model as a model of a monetary exchange economy (and argue that it only makes sense as a model of a monetary exchange economy). Then I want to make small changes to the model so that the stock of money enters essentially (and argue that it only makes sense if the stock of money enters essentially). My Cunning Plan is a bait-and-switch.
Simplify massively, to clear the decks of anything that is not required for me to make my points. Large number of identical infinitely-lived self-employed agents who produce and consume haircuts (the only good). So wages and prices are the same thing, and output, consumption, and employment are the same thing. All agents set the same price (which may be sticky or flexible). The central banks sets a rate of interest (somehow, and this is a question that must and will be answered). To make it even simpler, we can assume the central bank indexes the nominal interest rate to the inflation rate, so it sets a real rate of interest. No shocks, nothing fundamental ever changes, and full employment equilibrium is 100 per period.
Suppose the central bank sets the rate of interest too high. Will this cause unemployment?
No. Any unemployed agent would simply cut his own hair.
Suppose we change the model so agents can't cut their own hair, to motivate trade. Can we get unemployment now?
No. Two unemployed agents would simply do a barter deal to cut each other's hair.
We need to change the model so that monetary exchange is essential — they can't trade without using money as a medium of exchange. So let's do that.
You can't cut the hair of anyone who cuts your hair. So we get a Wicksellian triangle. And agents can only meet pairwise, and have bad memories for names and faces and can only remember the central bank. Or whatever. So they have to use central bank money to buy haircuts. Every agent has a chequing account at the central bank. The central bank pays a rate of interest r on positive balances, and charges the same rate of interest r on negative balances. And the sum of the positive balances equals the sum of the negative balances, so the central bank has no other assets or liabilities and zero net worth and zero income.
Now we can get unemployment if the central bank sets the real interest rate too high. Each individual wants to accumulate a positive balance in his chequing account by spending less money than he earns, which is impossible in aggregate.
Reinterpreting the New Keynesian model as a model of a monetary exchange economy, where every agent has an interest-earning chequing account at the central bank, kills two birds with one stone (it explains how the central bank can set the rate of interest, and explains how this can cause deficient-demand unemployment). Yet it leaves the equations of the model unchanged. No sensible New Keynesian macroeconomist should object to this reinterpretation. It's a friendly amendment — and not even really an amendment.
That was the easy part — the bait part of my Cunning Plan to bait and switch. And I'm just recapitulating my old post on solving the riddle of the New Keynesian Cheshire Cat.
Now for the harder part — modifying the model to make the stock of money essential. That's the switch part.
There are two definitions of the stock of money that would be useful in a model like this:
- The Net money stock = the sum of positive balances minus negative balances.
- The Gross money stock = the (absolute) sum of positive balances plus negative balances.
In the model I have sketched above, Net money is zero by assumption. The central bank could make Net money positive by buying some asset, or negative by selling some asset (open market purchases or sales).
In the model I have sketched above, Gross money will be zero, because all agents are identical. Holding Net money constant, aggregate receipts of money must equal aggregate payments of money by accounting identity, but if agents are identical this also is true for each individual agent. Each agent's receipts and payments of money are perfectly synchronised, so his inventory of money will always be zero.
If we add individual-specific shocks to agents' receipts and/or expenditures of money, we can change the New Keynesian model so that agents' receipts and payments of money are not automatically perfectly synchronised, which means the Gross money stock is now strictly positive.
Assume that the central bank sets a spread between the interest rate it charges on negative balances and the interest rate it pays on positive balances. Assume it is costly for agents to synchronise their payments and receipts of money (for example by agents with a positive balance lending to agents with a negative balance). We now have a demand for gross money as a negative function of the spread set by the central bank.
We now have something that looks a bit more like a traditional macro model, because it does have a money demand function.
Hold that thought. Because I now want to take a detour, and talk about the New Keynesian IS equation.
There is a very big problem with the New Keynesian Macro model. It simply assumes, with zero justification for this additional (hidden) assumption, that agents in the model expect an automatic tendency towards full employment. As I explained in my old post, Old Keynesians would be screaming blue murder if they understood that New Keynesians were making this illicit assumption. Because it is precisely this question that Keynes wrote the General Theory to address.
To repeat the point I made in that old post, if the central bank always sets the real rate of interest equal to the natural rate of interest, that is a necessary but not a sufficient condition for output being at the natural ("full employment") level. There is a continuum of equilibria, with anything from 0% to 100% unemployment being an equilibrium. This result follows immediately from the Consumption-Euler equation. In the simple case of log preferences, where n is the rate of time preference proper, it is: C(t)/C(t+1) = (1+n)/(1+r(t)). The real interest rate only pins down the expected growth rate of consumption, not the level of consumption. And New Keynesians evade this problem by simply assuming that in the limit, as t approaches infinity, C(t) approaches the full employment level.
That's a problem with the New Keynesian model. A very big problem. How can we fix it?
This big problem with the New Keynesian model is the result of the New Keynesian Long Run IS curve being horizontal. It is horizontal at the natural rate of interest. So if the central bank sets the real rate of interest equal to that natural rate, the long run equilibrium level of output is indeterminate. As any second-year economics student knows, if you have a horizontal IS curve, you need an upward-sloping LM curve to determine the level of output.
Back to that thought you were holding, about how we can modify the New Keynesian macro model so there is a well-defined demand function for the gross stock of money. What else do we need to get something like a standard upward-sloping LM curve? You guessed it: we need a supply function for the gross stock of money. And if we want the LM curve to slope up, so that the level of output is determinate, that supply function cannot be perfectly elastic at any given rate of interest.
It is not sufficient for a central bank to set a rate of interest (or one rate of interest plus a spread) and let the stock of money be determined by demand at that rate of interest. Long run output (not to mention the price level) is indeterminate if it does that, even if it sets the correct rate of interest. It needs to control the nominal quantity of money too. The central bank needs to set some nominal anchor, not just to make the price level determinate, but to make the level of output determinate.
The only mechanism that can provide an automatic tendency towards full employment (if, and that's a big "if", the central bank does the right thing) is the hot potato mechanism. If we reinterpret and reform the New Keynesian model the way it needs to be reinterpreted and reformed, we end up with Keynso-monetarism.
I ought to talk about "haircuts" in the financial market sense, and how collateral constraints mean the central bank puts limits on individual agents' negative balances, and how this creates a link between the Gross and Net stocks of money, and how Open Market purchases increase both Net and Gross money. But this post is already too long, so I will stop there.
Update: In a comment on my previous Cheshire Cat post, Brad DeLong asks: "If it isn't an RBC model minimally-tweaked to deliver Old Keynesian conclusions, why is it what it is at all? What other telos could it possibly have?"
On Thursday I heard Michael Woodford give a talk at a Bank of Canada conference. He started his talk by saying he visited the Bank of Canada in the late 1990's, spent time talking with Chuck Freedman and Kevin Clinton about how the Bank of Canada conducted monetary policy, which had been very influential in his subsequent work. I understood him to be talking about his "Interest and Prices". Indeed, the only important difference is that it is commercial banks, and not regular people, who have chequing accounts at the Bank of Canada. Otherwise, the model fits pretty exactly. I think that is the telos. Blame Canada.
Worthwhile Canadian Initiative 
Oliver,
I interpret negative money is an abstraction from the idea of an overdraft.
The total amount of positive and negative money is the sum of the quantities (or absolute values) of each.
Without CB intervention, the quantity of positive money equals the quantity of negative money
CB OMO can create net positive (or net negative) money
In that context, I think all of the following are coherent measures:
gross positive money
gross negative money
gross money in total
net money
JKH: “I interpret negative money is an abstraction from the idea of an overdraft.”
Yes (and yes to all the rest of your comment). But as a thought-experiment I still like to think of negative red currency too (though it’s hopelessly impractical, because it would be very hard to stop people throwing it away, but that impracticality teaches us something important about why we only see green currency and how the anonymity of currency may matter).
The arguments here are based on the common illusion that neoclassical economics, real business cycle models, new keynesian theories happen because of “honest mistakes”: that Economists sort-of stumble into a paradigm without realizing it, get stuck into it, and it takes some cunning face saving interpretative bait-and-switch to get them out of that paradigm.
But the popularity (with sponsors) of paradigms of Economics depends on how much they are validated by the desired policy implications, and by their support of JB CLark’s “three fables”, and no reinterpretation that violates that is going to be popular (with sponsors), and if a reinterpretation continues to be validated by the desired policy implications and supports JB Clark’s “three fables” then it is largely futile.
So the choice really is whether Economics paradigms are to be validated by the popularity (with sponsors) of their policies recommendations, or not, and reinterpretations simply cannot fudge that choice (because sponsors are not stupid).
I’m still struggling with the basics of the model.
I can see that if you set r below the n then (with the assumptions in the post) this looks like it mean that consumption will fall through time (people want to move some future consumption back to the current period). But at any point in time if r is below n they will increase their consumption in that period expecting to do so by running down their savings or borrowing money and consuming less next period. But then at the end of the period they will have indeed consumed more but will end up with greater money balances than expected (because they also sold more). So they then don’t have to reduce consumption in the next period like they had expected to do. So r < n doesn’t actually lead to falling consumption.
Is there something wrong with my logic ?
I interpret negative money is an abstraction from the idea of an overdraft.
That’s how I interpreted it, too. Funnily enough, I arrive at a different conclusion wrt the stock of money.
…Now suppose the central bank allows overdrafts, and at the same time does an open market sale to reduce net money by $50 per person. But suppose the even/odd apples/bananas and $100 each trade stays the same. So each agent keeps alternating between +$50 and -$50.
The reduction by the CB is compensated by the overdrafts. Net money decreases, gross money does not. The average agent’s stock of money consists of $25 of CB money and $25 of overdraft, leaving each with $50. But, if I add the overdraft to the money received by the seller, I get a stock of $75 per head. At least, that’s what you seem to be saying above.
An example:
Banana seller has $100 of bananas for sale. Banana buyer has $50 of fiat money and an overdraft limit of $50.
Banana buyer buys bananas for $100.
Now, banana seller has $100 in his account, banana buyer has -$50 in his account. The total stock of money in the economy is NOT $150!
You can either count the overdraft (debt) or the money received by the seller (asset). You cannot count both.
Blissex: Bullshit. My sponsor is Carleton University (and University of Adelaide and government-owned Bank of Canada for sabbatical years). And I’ve been trying to get my head around New Keynesian macro since 1977 grad school. The comment section of this blog is reserved for people trying to understand economics, not to drag their political knuckles along the ground. Mark Thoma may not police his comment section, but I do. And we have a different culture here.
“I interpret negative money is an abstraction from the idea of an overdraft.”
An overdraft can be used to make purchases.
How can you buy something with negative money?
Doesn’t it defy the basic definition of money?
JKH,
Thanks for putting me right on exactly what the Mosler argument consists of. My reaction is that my argument for 0% is better than the Mosler one, and also better than the Nick Rowe argument. So I’m demanding a Nobel Prize…:-)
MF: Take an example where we just assume that everyone believes that next year’s Y is fixed at 100 (full employment). Now suppose that the CB sets r > n this year (but not next year). Each individual wants to have C < Income this year, and C > Income next year (accumulating money balances this year and running them down again in future years). But that can’t be an equilibrium if everyone does it. The only equilibrium (given our illicit assumption) is that Y and C fall below 100 this year (raising the marginal utility of C enough that each individual wants C=Income).
OK, so maybe you’re talking about a used overdraft as opposed to an unused overdraft facility (which is what I was thinking of).
But if you are talking about a used overdraft facility, then I can’t see how you can call it money.
A used overdraft facility can’t be used to buy anything.
“Gross money stock is now strictly positive.”
Isn’t gross money always positive? It’s defined as the absolute value.
Stop press. I contacted Warren Mosler earlier in the day to draw his attention to the discussion of his paper here. He’s just sent me an email saying I got his argument right. I’m now terminally confused and will book an appointment with my shrink or watch episode of Blackadder in order to regain my sanity.
Oliver: take a snapshot. Half the agents have a +$50 balance in their chequing account, and the other half have a -$50 balance in their chequing accounts. There are no other forms of money. Then those with +$50 write a cheque for $100 to those with -$50, which means they all swap places.
Nobody ever has $25 of anything.
“And I’ve been trying to get my head around New Keynesian macro since 1977 grad school.”
Nick,
You are an intelligent person trained in economics.
Doesn’t your statement say something about NK macro?
Maybe it’s time to throw the baby out with the bath water.
Henry: in the simplest example (considered here), there are no overdraft limits. Everyone is honest, and never plans to run up a bigger overdraft than they can possibly ever pay back.
Yes, that assumption is problematic, which is why I mention collateral constraints and the other type of “haircuts” right at the end of the post. But set it aside for now. You buy things by increasing your overdraft. You buy things by accepting (as opposed to giving) red (as opposed to green) money from the seller. “Give me your apples, and you can give me your negatively-valued red (garbage) money at the same time in exchange.”
Ralph: Blackadder is both cheaper and often more effective than shrinks! (My auto mechanic once told me a noise in my car was probably in my head. I said maybe, but his hourly rate was lower than my shrink’s)
Henry: except I’m still trying to get my head around every macro model I’ve ever learned! I still keep thinking new thoughts about the very simple Old Keynesian model I learned in high school in 1971/2. And my interpretation of it differs from e.g. Roger Farmer’s, and we are the same age and have much the same education.
“You buy things by accepting (as opposed to giving) red (as opposed to green) money from the seller..”
So you buy things by accepting someone else’s debt. Is that what you are saying?
Henry: don’t call it “debt”, because “debt” implies a promise to pay some specified thing to some specified person. If green paper/electronic money is a financial asset, who precisely owes you precisely what? If red paper/electronic money is a financial liability, to whom precisely do you owe precisely what? [edited to fix big typo spotted by Henry. NR]
“If red paper/electronic money is a financial liability, who precisely owes you precisely what?”
Don’t you mean “who do you owe precisely what”?
To look at red money as gross money, I think one way of framing it is that my “spendable money” is the balance of my account less my (negative) overdraft limit. In the no-default equilibrium, I don’t have a fixed limit but I have an implicit personal one set by own tolerance.
That tolerance isn’t easily measurable, but it has real money-like effects. If I wake up tomorrow and believe that I can support a larger overdraft, that’s symmetric to waking up tomorrow with an unexpectedly large positive balance: I’m tempted to increase present consumption, leading to a hot potato effect.
So you purchase a good by either handing over green money or accepting red money?
Henry: Yes. And yes. (I typod, and will edit my comment.)
“Yes. And yes.”
Thank God you said that – I was about to go out on to the main road and throw myself under a bus.
Finally, after reading your blog for 18 months (I think) I’ve understood something you’ve said. 🙂
I can kind of see why you then define Gross Money = green money + red money.
Doesn’t the introduction of red money unnecessarily complicate the issue?
Henry: after seeing JKH spot a typo in John Cochrane once, I came up with my Rule: If the reader can spot a typo, where the author accidentally says the exact opposite of what he meant to say, it shows the reader understands it, and the argument makes sense.
Yes red money complicates. But overdrafts are real, and it helps both clarify and generalise the NK model.
Ralph Musgrave,
I think your earlier comment is more along the lines of how the MMT zero rate system would actually work in effect. Set the policy rate at 0, and uses fiscal policy to “control” aggregate demand. Forget about issuing bonds. It is in the context of such operational framing that MMT asserts that anything other than this amounts to an “artificial” tinkering of interest rates (away from zero) and an unnecessary use of bonds. This is also consistent with a “euthanasia of the rentier” type of argument in general – that it’s not necessary to pay savers a positive rate of interest.
That’s a coherent line of thinking about the subject that is consistent with how MMT approaches it, but it’s not the rationale used in the paper to “prove” that the natural rate of interest is zero. That argument is about what happens when you stop issuing bonds in a system where the CB happens to pay 0 % on excess reserves. And as I say, that number 0 is the CB’s choice. It is most simply understood as a choice when you consider the stripped down model of a single central bank (without a commercial banking system) that has to make a decision on the rate of interest to pay on deposits. There is nothing about the number zero that is particularly natural in that context. The more complicated arrangement that involves commercial banks and commercial bank settlement balances essentially delegates that interest rate choice to the commercial banks, although they in turn must consider the economics resulting from the central bank’s control and choice over the quantity and pricing of bank settlement balances.
I’ll put your last comment down to my own apparent misunderstanging of the concept of a representative agent, which I took to mean average, also in terms of account balances. I.e. all agents have the same balance per definition at all times. Which is why money can seem to disappear in net and gross terms. But I don’t think that’s where our main disagreement lies. I still maintain that by your own definition, a world in which all money is the product of an overdraft, as opposed to an asset purchase / fiat operation, you end up counting twice the amount of money.
Maybe you can help me by answering this question:
If you give me apples and I take on an overdraft (you pay me with red money), does your account balance turn positive / green in return? If not, that can only be so if you start out with an overdraft, too. But where does the initial overdraft come from in such a world? Who made it for what reason? Is it original sin in financial disguise?
Stop me if I’m being a pain. But you write:
Henry: don’t call it “debt”, because “debt” implies a promise to pay some specified thing to some specified person.
I promise to pay money to my creditor on a certain schedule at a certain interest rate. That’s pretty specified, if you ask me. The question is, what do you have to do to get money without incurring further debt? And the answer would be: sell your labour.
Oliver: “If you give me apples and I take on an overdraft (you pay me with red money), does your account balance turn positive / green in return?”
Yes. (Or goes to $0, or stays red but smaller)
“But where does the initial overdraft come from in such a world?”
start with everyone at a $0 balance. Then you buy apples from me for $100. You now have -$100 and I have +$100 in our chequing accounts.
OK, good. We agree on that.
So it’s as I originally assumed. Your maths is flwasless and your Definition consistent. It jus doesn’t make any sense to me :-).
The alternative to your last example is that the cb swoops in and buy $100 worth of apples from you. You then have +$100 but there is no corresponding -$100 in the non Banks sector.
Now assume, after theses Acts there was no further cration of green money allowed (for whatever reason).
In both cases, the residual purchasing power is $100. That’s what the gross number should capture, imo.
The difference is that in your example, there is also a $100 obligation to repay the +$100 to the bank. After which purchasing power will go back to $0. That’s what the net number captures.
What the number 200 signifies, which would be your gross number, is still beyond me.
Pardon the typos. It’s early and I can’t turn of my German autocorrect at the office.
Oliver: I’ll try to show that I’m even less a crank than I might appear: I will defend Nick’s viewpoint.
Nick talks about the degree of non-synchronisation. When I tell NICK that the Gross money stock is $200, and that there are only two people with non-zero balances, he will immediately conclude that there are two people who are BOTH $100 out-of-sync. This makes the “aggregate degree of non-synchronisation” $200 (it doesn’t matter which way one is $100 out-of-sync). When I tell YOU that the Gross money stock is $100, and that there are only two people with non-zero balances, you will immediately conclude that there are two people who are both $100 out-of-sync. For you (or me) “gross money stock” is not the same thing as “aggregate degree of non-synchronisation”. For Nick it seems to be. Fine. We don’t need to think in the same way, but it helps to understand how the other thinks.
Why does this “aggregate degree of non-synchronisation” represent the “Gross money supply” for Nick? It’s because Nick lives in the world of “green and red bits of paper”, and each bit of paper is money to him. You and I might not see it, but the people at the central bank have shoeboxes for every account, and in those shoeboxes might or might not be green or red bits of paper, or, at times, both. This is how it works: Andy buys bananas from Betty for $100. The bank people (think of Gnomes of Zürich or Ottawa, or whatever), in secrecy, first create 100 green bits AND 100 red bits of paper — 200 bits in total — which they put, first, into Andy’s shoebox. Only then they move 100 green bits from Andy’s box to Betty’s box. If Betty’s box contained 50 Reds prior to the transaction, then her box will contain 50 Reds and 100 Greens after the transaction. The bank-gnomes don’t like this, so they will take away both 50 Reds and 50 Greens so that only 50 Greens remain. You might say that this doesn’t take place in reality, so why think like that, but Nick answers: “Who cares what happens in reality. All that matters is observational equivalence.”
Nick doesn’t want to abandon the world where money moves between accounts/holders. An overdraft — which I believe is “observationally equivalent” to a “traditional loan” (using a separate “loan account”) — makes it harder to see money moving between accounts. But Nick is a creative guy (and perhaps a bit desperate, too?), so he comes up with this “cunning plan”, insisting there are red and green bits of paper.
I can try to show Nick, in vain, that the bank-gnomes don’t really move these bits of paper BETWEEN the shoeboxes; that they, more (though not wholly) realistically, have massive piles of Reds and Greens outside of the shoeboxes, as an inventory, and the only thing they do is they take Reds or Greens from those piles and add only one type/color to a shoebox when needed. If, as a consequence of a new trade, Andy’s account balance should go from -$100 to +$100, then the bank-gnomes take 100 Reds from Andy’s box and put them back into the “inventory pile” of Reds. Then they take 100 Greens from the inventory pile and put those in Andy’s box. If Andy traded with Betty, then the gnomes do the necessary adjustments in Betty’s box, too, but they NEVER move any bits of paper between two shoeboxes.
Nick: How does this sound? My approach is observationally equivalent, isn’t it?
Nick: What is the rule when it comes to having to choose whether to move Greens or Reds? Take this example:
Andy’s box has 100 Greens and Betty’s box has 100 Reds. Betty sells bananas priced at 100 to Andy. The bank-gnomes have to choose which way money will move. 100 Reds to Andy or 100 Greens to Betty? And what if Betty has, say, only 50 Reds. (Andy still has 100 Greens.) Betty will think that she can pass her 50 Reds along her bananas to Andy, and will get 50 Greens in return from Andy, BUT Andy, not knowing what Betty’s box contains, will think that he is going to give 100 Greens to Betty. Even in your “reality”, the expectations of both parties will not be valid? In my world there is no such problem, because the gnomes will not move anything between the two shoeboxes.
@ Antti
Thanks, that actually makes sense to me. I’d personally prefer to talk of 100 vs. 0 unsynchronisation as opposed to 100 vs. 200. But the delta remains the same.
I said: “But Nick is a creative guy (and perhaps a bit desperate, too?), so he comes up with this “cunning plan”, insisting there are red and green bits of paper.”
You might notice that what Nick really does here is this: he converts, in his mind, an overdraft into a “traditional loan” (in which case the bank creates “red money” on the loan account and “green money” on the checking account, both accounts belonging to the debtor; because Nick cannot net these accounts against each other without “destroying” all of the money — or without breaking the rules of accounting — he comes up with a shoebox which can contain both types of “money”). By doing this, and insisting that his approach is observationally equivalent, he just confirms what I said above: that an overdraft and a “traditional loan” are observationally equivalent. Any difference between these is a difference IN PRACTICE, and it is due to the related credit contracts between the bank and the customer — not due to the choices made regarding how it should appear in the ledger.
Makes sense?
Sort of. I do see an equivalence between an overdraft and a loan. I don’t see that they ever end up in the same ‘shoebox’. The overdraft appears the instant I commission a payment to someone else. Similarly with a loan, although there may be intermediate steps and of course barring the silly case of lending to myself.
With ‘they’, I meant red and green money (pertaining to the same loan / overdraft operation), not overdrafts and loans.
Oliver: Of course you don’t see them ever ending up in the same ‘shoebox’. They don’t. But Nick imagines they do. Let’s say you apply for a $1000 overdraft limit/”loan”. The bank approves. In case of an overdraft (unused), this doesn’t affect the balance on your checking account (you just know that you can have it “overdrawn” when you want to buy something). But in case of a traditional loan, your checking account balance would go up $1000 and separate loan account balance would be minus $1000. As far as I know, in Nick’s overdraft world the gnomes put 1000 Reds and 1000 Greens in your shoebox-account, but they are not visible to you because in your e-bank view they are netted against each other so that your balance is zero. Or something like that.
Here’s (again) my attempt to show how an overdraft and a “traditional loan” are equivalent: https://drive.google.com/open?id=0B1iEL0TpgRtkZ2l3dmVibUZfV2M (See the color codes mapping the numbers. Note that this only applies when the initial balance on checking account is zero. If not, then the title “Unused overdraft” — yellow color code — should actually read “Unused overdraft + initial checking account balance” so that it would match the checking account balance — yellow color code — in “traditional loan” scenario.)
“TMF: Jeez! What the Hell do you think happens? The seller’s balance rises by $20, and the buyer’s balance falls by $20.”
I wanted an accounting answer to that question.
“And why are you asking JKH?”
because I am extremely confident in JKH’s accounting.
Can I talk to JKH uninterrupted?
Nick said: “start with everyone at a $0 balance. Then you buy apples from me for $100. You now have -$100 and I have +$100 in our chequing accounts.”
Oliver and Henry, I don’t think a -$100 balance is negative money. It means Andy owes the bank $100. He has issued a bond to the bank.
I don’t think there can be “liability swaps” like Nick has. I would need to ask JKH about that.
You can get ‘gross money is red plus green’ by looking at the monochromatic worlds and adding them together.
In the green-only world, obviously green money is money. I don’t think there’s an argument here.
In the red-only world, then the absolute value of red money is money. Here, if I hold $100 red notes and I am the sole holder of red notes, it means that other people can purchase my labour by offering to take some of those notes. Without further exchange (setting velocity to 1), only $100 of trade is enabled by the currency stock. Since PY=MV and $100 in product was exchanged, M must be $100.
So in the red+green worlds, the money stock is green money (holding it lets you buy things) plus red money (holding it lets you sell things).
There’s a tempting error in the ‘overdraft’ analogy, one I fell into above: you can only use an overdraft if someone is willing to create red and green money ex nihilo. In Nick’s red+green world, the total stock of red money is the aggregate overdraft limit and that’s it.
Majromax said: “In the green-only world, obviously green money is money. I don’t think there’s an argument here.”
Perhaps not an argument, but I think this “green-only world” is the source of all problems in this discussion. What is a green-only world? A world with
1. pure commodity money,
2. (Friedman’s) “fiat money” which should be included in the net wealth of the community, or
3. (with)-out overdrafts? (Let’s imagine that Scots didn’t come up with it in the 18th century, nor did anyone afterwards.)
I think I posed the following question already, but I don’t remember getting an answer, so here it is again: Would there be “red money” if there was no overdrafts BUT one could agree with a bank on a traditional loan WITHOUT any pre-set repayment schedule (fully possible even today)? Or is this kind of loan taken to be an overdraft in Nick’s model? And could Nick finally answer what is so special about an overdraft? Another question to Nick specifically: Do you see, in your mind, a checking account with a negative balance on the LHS of the bank balance sheet? I do, and it seems like the most natural thing in the world. (I’m sure Too Much Fed agrees? It’s a bond in his terminology.)
Is it only me, or does someone else see Nick’s world full of holes? Nick is quite a trouble-maker: He doesn’t only double-count the Gross money supply, but he has doubled all money-related issues as well; for instance, we/I are/am now arguing about why should only a checking account with a negative balance be included in “negative money”, whereas at least for a hundred years we’ve been arguing why certain credit/positive balances should be included in “money” and some others (like bonds and equity) not!
Majromax (also) said: “So in the red+green worlds, the money stock is green money (holding it lets you buy things) plus red money (holding it lets you sell things).”
I cannot sell things if I don’t have “red money”? (I know you didn’t mean it like that, but this is related to my earlier criticism.) If you hold “red money”, you MUST sell things (incl. labor). The funny thing is that you also MUST sell things if you have student/car/any debt. By selling things you get rid of both “red money” and (bank) debt. Where’s the difference?
@ Majro
In Nick’s red+green world, the total stock of red money is the aggregate overdraft limit and that’s it
That would make some amount of sense. But doesn’t Nick say somewhere above that there is no limit to overdrafts in this model? That would make gross money infinite, i.e. not much use as a measure.
In the business world, you often buy another concern by assuming the debts. Instead of giving one color of money, you accept the other kind. There doesn’t to be a lot of soul searching in that universe.
Am I right or is humble IO playing in big people bowling alley?
@ Jacques
Nick will have to answer for himself. But it sounds like the most plausible real world example of Nick’s red money I’ve heard of. I do suppose, the bank the debt is owed to has to give its consent to such a transaction?
@Antii:
Oliver, I wrote this here:
http://worthwhile.typepad.com/worthwhile_canadian_initi/2016/09/cheshire-cats-and-new-keynesian-central-banks.html
“Next, assume the entity #1 with the “overdraft” wants to sell something. Entity #2 does not have any demand deposits (or currency). The buyer does not qualify for a loan/”overdraft”.
Here is not what happens. The seller (entity #1) sends the overdraft liability and good to the buyer (entity #2). People can see that if the entity #2 defaults. The bank will hold entity #1 liable. Entity #1 says I sent the liability to entity #2. Bank says you need our permission (the asset holder’s permission) to do that. You did not. Entity #1 is liable. What really happens is that entity #2 sold a bond (debt) to entity #1 in exchange for the good and then defaulted on it. Entity #2’s default can cause entity #1 to default to the bank.
If the bank gives permission to entity #2, then there is a second “overdraft”/loan for demand deposits that pays for the good, and entity #1 uses the demand deposits to pay off its “overdraft”/loan. That was assumed to not happen.”
” It means Andy owes the bank $100. He has issued a bond to the bank.”
TMF,
Look at it from the green money point of view.
In your terms (i.e. you see red money as a bond), you would have to argue also that the CB had issued a bond to the holders of green money. Strictly speaking, when the CB issues green money it generates a liability in its balance sheet – but this liability is really only notional. If you take your green money to the CB and ask it to exchange this for some other asset do you think they will do so?
We normally don’t think of green money in this way. So why think of red money in this way necessarily?
(I hope I’ve got that right?)
“If you hold “red money”, you MUST sell things (incl. labor).”
Anti,
Why “MUST”? I think this is around the wrong way. If you want to sell something you must have red money or must find a buyer with green money.
What is so unique/special about green money? Why does a vendor accept green money? He accepts green money because he believes when he wants to buy something with that money a potential purchaser will be happy to accept green money in return.
Similarly, why does a purchaser of good accept red money? Because he believes when he sells a good or his labour the purchaser will accept his red money.
If green money wasn’t accepted as a medium of exchange, we would all be in trouble. Green money is notionally someone else’s liability (i.e. the CB’s) but we accept it. Red money is someone else’s liability, but we accept it also.