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 
Majromax said: “In the red+green world, a transaction requires either a buyer with green money or a seller with red money.”
OK. So you can sell without possessing red money. I didn’t catch that you meant red-only world. I’m afraid this whole discussion about red/green is turning into a waste of time, but I’ll continue anyway… I think the language used is confusing. “Requires a buyer with green money” doesn’t mean that the buyer should be in possession of green money as a consequence of a previous transaction; the buyer could as well overdraw his account, in which case Nick would conclude that
1. there was already Greens and Reds waiting in the buyer’s shoebox, reflecting his UNUSED overdraft, or
2. Greens, and Reds, were put into the buyer’s shoebox at the moment he requested entries related to the transaction to be made.
Which one? I go for #2. It is clear that the Gross money stock cannot have anything to do with the unused overdraft (the limit), because Nick takes the Gross stock to be equal with non-synchronisation, and the latter is only about USED overdrafts. So this is not about trading being limited by existing possessions of Reds and Greens, but by the bank’s willingness to make certain entries on certain accounts (or play with bits of paper and shoeboxes).
I’m getting tempted to conclude that Nick has just found a twisted, complicated way to talk about simple accounting. But there are still important insights here (which could have been explained in a much easier way, though). There is truth in Nick’s argument that “negative money” is no one’s asset, just like “positive money” is no one’s liability. But this should be expanded: a bank holding any agent’s liability (not just an overdraft, but “loans” and bonds too) makes that liability no one’s asset. Fed holds Treasuries and MBSs — no one’s asset, someone’s liability. I’m writing blog posts where I’ll go through all this and much more. Stay tuned 🙂
Henry: Ask Nick why one MUST sell if one has red money. I think he explained that bad things happen to you in after-life if you die while in possession of red money.
As I said earlier, it’s the green-only world (and red-only world) which create the problems in this discussion. This is because green+red world is a world of ACCOUNTING, whereas green-only and red-only are worlds where there only exists CREDITS or DEBITS, not both. Makes no sense. Well, perhaps to a monetarist, but not to an accountant 🙂
Antti: “By selling things you get rid of both “red money” and (bank) debt. Where’s the difference?”
One is a commonly accepted medium of exchange, and the other isn’t. Just like some positively-valued things (financial or real assets) are commonly accepted media of exchange, and others aren’t.
If you have a regular debt, you sell goods to acquire green money, then use the green money to pay off your debt. With red money you just sell goods to get rid of it; no intermediate step.
«My sponsor is Carleton University (and University of Adelaide and government-owned Bank of Canada for sabbatical years)»
Well, those are not sponsors, those are people who pay you an upper middle class salary for indulging in doing research. The really big money in Economics is made by those who are aligned sponsors who can pay millions or dozens of millions a year for “speaking fees” and “consultancy” or “strategic advice”, and a lot of Economists take notice of that. Plus big sponsors try to influence negatively the careers of those whose theories are not validated by the desired policy recommendations, perhaps not as obviously as the campaign against Tarshis in the 1940s/1950s, but still. C Ferguson has made a rather revealing movie about how sponsors influence Economics:
https://en.wikipedia.org/wiki/Inside_Job_(2010_film)
Spending time on reinterpreting New Keynesian models seems rather futile: if the reinterpretation results in the same policy recommendations it is futile one way, if it does not it may be more academically interesting but will not be popular. It is not by chance that many interesting insights in political economy research come from countries where political economists are content to work in obscurity for middle class wages.
As to this:
«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 am sorry to see that you shame yourself with malicious and gratuitous insinuations and personal attacks.
Graziani triangle – type in more than three letters in my citation manager
Graziani, Augusto (1989), Theory of the Monetary Circuit, ISBN 978-0-902169-39-5
Nick: I was slightly frustrated yesterday, but perhaps it was a sign that I’m very close to understanding exactly how you think. It seems I didn’t manage to offend you, so you must have recognized the friendly undertone in all I said.
I think this is getting very, very interesting. It seems you and I have encountered the same problem, and our solutions to it are exact opposites. (I’m partly guessing, but think about it and let me know if this resonates?) The problem has to do with green money being a medium of exchange (MOE). In red+green world, green money cannot be a MOE unless red money is too. This is why you go to great lengths to explain to yourself — and few others who might be able to follow your thought — how red money is a MOE. It seems to work OK, at least when seen from where you’re looking at it (being a monetarist of a sort, right?). But like I said, to me it seems you just double the trouble. If people have not been able to agree on the definition for “positive money”, they won’t be able to agree on the definition for “negative money” either.
My solution to the same problem is simple, yet even more radical (in some sense). I conclude that green money is not a MOE, and definitely not a “means of payment” — that its role has been misunderstood. I don’t need to come up with labored explanations about how red money acts as a MOE. Instead, I need to change the way we see green money. That’s easy! It took me a year or two to change the way I see it (it was intense; even many of my friends think/thought I’ve gone slightly mad, and I cannot know for sure if this is true or not). The pessimist in me says that trying to make people change the way they see green money is a “Sisyphean task” (I must be wrong, right?) while the optimist in me says that it is a “Copernican task” (there’s a small chance that I’m right).
What is good about my solution is that it doesn’t double the trouble. Instead, we get rid of the “money problem” in economics. (Big talk, I know. I’m expecting a call from Earth.) In a way it makes a lot of sense: we were never able to agree on a definition for money, because money as we knew it doesn’t really exist. Our “axioms” were invalid.
Going forward, observational equivalence is an important concept. That’s why I’d like you to confirm that the way I see the bank-gnomes working (see my earlier comment) with their bits of paper is observationally equivalent with the way you see them work? What matters is not how Greens and Reds are moved between shoeboxes, but the amount of Greens or Reds in a shoebox at each moment. It is irrelevant how the bits of paper got into the shoebox and whether they are the same bits that have previously been in another shoebox. For all we know, the bank-gnomes could have a rule which says that a certain piece of paper can only be used once / can only visit one shoebox during its existence. It is created just before it is put into a shoebox and it will be destroyed once it is taken out of a shoebox.
Especially Post-Keynesians (including “circuitiste” and quantum-economists) will find much to agree with in my theory. (They might even feel that I’m not saying anything new — perhaps because I focus on the same accounting as they do.) But so should you, Nick, because you and I live in the same world, even though we describe it differently.
Here’s one way of depicting both green and red money as media of exchange in a balance sheet context:
Consider a transaction involving some type of “durable” asset in exchange for some type of money. For this purpose only, by durable asset I mean any real asset that appears as a balance sheet asset – i.e. that it is not immediately “consumed” – or any type of financial asset other than money.
Now consider a household balance sheet. Green money is a household asset. Red money is a household liability.
Then the following types of durable asset transactions are possible, involving either green or red money as media of exchange:
a) The purchase of a durable asset in exchange for the sale of green money (an asset). In this case, the size of the balance sheet remains the same while the asset composition changes.
b) The purchase of a durable asset in exchange for the assumption of a red money liability. In this case, the size of the balance sheet expands to reflect the increase in both a durable asset and a red money liability.
c) The sale of a durable asset in exchange for the purchase of green money (an asset). In this case (similar to case a)), the size of the balance sheet remains the same while the asset composition changes.
d) The sale of a durable asset in exchange for the removal of a red money liability. In this case (obverse to case b)), the size of the balance sheet shrinks and both asset and liability disappear.
@ JKH
So the measure gross money signifies the size of the balance sheet?
But would you agree with Nick that you are describing red money, i.e. a commonly accepted medium of exchange? Sounds to me more like conventional debt that each individual has to negotiate with his own bank.
The illusion of it becoming an ordinary medium of exchange can only arise in the context of identical agents who bank with the same bank, all have the same overdraft limit and towards which the bank is completely indifferent.
It seems to me that when green money is extracted from Nick’s fantasy world and inserted into real world examples, it retains most of its characteristics. But if one does the same with red money, it falls flat on its face.
Antti: you are not offending me. You are trying (like me) to get your head around this stuff. Yes, it can be frustrating.
What you say resonates. I think I get where you are coming from (not 100%). Let me expand on where I’m coming from (what you say about this is right but incomplete). I want a definition of money that can include not just green and red paper, but gold and shells and cigarettes (at one end) and ink marks and electrons on books and computers (at the other end). And I want it to exclude all the other physical assets and bits of paper and ink marks and electrons that are not money. And that’s because I see medium of exchange as central in understanding recessions, whether the medium of exchange is cigarettes or electrons on silicon.
JKH has it right (I think).
Nick: I find myself in partial agreement with Antti (Nov. 10, 2016 05:09) when he writes “I conclude that green money is not a MOE, and definitely not a “means of payment” — that its role has been misunderstood.”
I posted a related article (updated this morning) at
http://mechanicalmoney.blogspot.com/2016/11/the-ngc-model-banking-and-creation-of.html
Extending from my post, we could conclude that green money (in the most basic concept) is simply evidence of a delayed barter exchange. It is NOT payment. It is evidence that something will be available from a specific responsible entity upon demand.
Your red money would be a notation that evidence-of-a-delayed-barter-exchange has been issued and then transferred to someone who has agreed to return it to the issuer.
Thanks for sustaining the discussion. Your green-red money analogy continues to create lots of interest.
JKH: I have noticed that whatever you happen to say usually makes a lot of sense. You can count me as a fan. But I think a balance sheet is, more or less by definition, a poor tool if one wants to highlight the medium-of-exchange role. Your example says nothing about flows between the balance sheet owner and other agents. So I think Oliver has a point when he talks about your “red money” being conventional debt.
You might agree?
If you stayed fully within the balance sheet context, you could actually only say that certain account balances go up or down. A liability disappears / is removed when a durable asset is sold. Makes sense. The liability is not transferred to someone else, it just disappears. Similarly, there are no sales or purchases of green money (this is language used by Clower; I find it misleading; interesting that you didn’t talk about sales or purchases of red money?) in the balance sheet context. Instead, a checking account balance is increased or decreased, without any knowledge about where that green money ended up, if it was even transferred somewhere (I argue not). If I sold green money, who bought it? Not the seller of the durable good, because he might have sold me red money with the durable good, or so he thinks (I didn’t buy red money, of course).
Nick: Good to hear that what I said made at least some sense to you. Very good.
First, it’s interesting that you mention understanding recessions. I came up with my theory when I was trying (hard) to understand how credit/debt really works at the macro level, because I thought THAT was central in understanding recessions. I guess we all want to understand what happened in 2008-2009, and will IT happen again (another discussion).
You say: “I want a definition of money”
Do you see yourself as trying to come up with a definition, or do you already have a definition and want it to be commonly accepted? It sounds you already have a definition, because you are able to say what it should include and exclude.
I see two problems with the definition you are after:
1. You want to call money three things/concepts that are different in kind: a nominal asset (green money; credit balance), a nominal liability (red money; debit balance) and goods. It is common to call two of these — green money and certain goods; both are assets — “money”, and I think even this has been a mistake. I don’t care which one people call money (the word doesn’t belong to my terminology), but they shouldn’t call both money.
2. You want to call money something that is NOT different in kind from something you don’t want to call money. You say that certain nominal assets (credit/positive balances) are money while others are not. This alone might not be a serious problem if you’re able to make a clear distinction between your two types of nominal assets. (Money is no one’s liability? Is a positive/negative balance on a checking account in a commercial bank “money”?)
When it comes to, for instance, cigarettes as “money”, they could be compared to a kilogram of salt (“s-kilo”) I talk about in my first blog post (if someone hasn’t read it, you find it by clicking my name). I understand how cigarettes can function as a unit-of-account and a numeraire (and how they could, just like “skilo” in my blog post, cease to function as a numeraire and become an abstract unit of account; the price of a cigarette could be 1.20 cigs). I also understand how people (say, POWs) can use them in trade. But like I said, if I’d call cigarettes “money”, then I couldn’t call green paper “money”.
I don’t know if this makes any sense. I’m a bit tired. I think we will have a lot more to discuss when I have published my next blog post (any day now…).
A distinction between liquidity and credit risk:
Red money can be used to pay for stuff, with the buyer assuming the red money liability of the seller. In that context, red money is liquid and a medium of exchange.
However, buyers cannot be allowed to accumulate red money liabilities without limit. There must be credit risk rules for red money. Those rules are imposed by the bank(s) that hold red money as an asset. Operating within such credit constraints, red money is nevertheless liquid as a medium of exchange.
Antti,
Using red money, the seller of an asset transfers both the asset and the red money liability to the buyer. The seller’s balance sheet shrinks on both accounts and conversely the buyer’s balance sheet expands.
Using green money, the seller of an asset transfers the asset to the buyer and takes back a green money asset from the buyer. Both balance sheets are unchanged in size.
“There must be credit risk rules for red money.”
I am wondering if this is necessarily so. There is no restriction on green money – no-one worries about whether the CB will honour its green money liability.
I presume the CB is the issuer of green money. How does it arise? The CB can’t purchase haircuts (presumably).
Who issues red money? How does it arise? Does the CB sell haircuts with red money?
Henry,
Nick’s starting point is a single central bank (no commercial banks) that issues both green money and red money.
Green money, like conventional money, is on the liability side of the CB balance sheet.
Red money is on the asset side. (Alternatively, it might be represented as a negative liability, but that just muddies things).
As is the case with conventional money, a household holding green money has no credit risk exposure, given the general nature of fiat central banking. (This is also true of money that households hold with commercial banks, up to the limits of deposit insurance).
In this case, a central bank holding red money has credit risk exposure to the household or business whose liability it is. Consider a household that otherwise runs up a negative net worth in financing consumption by assuming red money liabilities to excess. Without credit risk limits, at least some of that money becomes worthless as a CB asset. This will show up in a truly meaningful way if the CB runs monetary policy with positive interest rates charged on red money. Hence the need for credit risk limits. This holds a fortiori when commercial banks that hold red money as an asset are added to the system.
aside:
Red money is an interesting idea in the sense that you can think about debt and equity as a conceptual, instrumental evolution of red money. Capitalism would be a pretty tough functional challenge if red money were the only type of non-bank financial liability.
Antti: suppose I’m an anthropologist, visiting a new island. I observe 3 goods: apples, bananas, and mangoes. No bits of paper, records, or anything else. I observe: a market where apples are traded for mangoes; a market where bananas are traded for mangoes. I do not observe a market where apples are traded for bananas. I conclude that mangoes are used as money (in the medium of exchange function). Replace “mangoes” with green bits of paper — same conclusion.
JKH: agree with your above comments (except maybe the last one, which I maybe don’t follow).
“Consider a household that otherwise runs up a negative net worth in financing consumption by assuming red money liabilities to excess.”
But who is going to call them on their liability?
Presumably, just as the CB doesn’t expect to be called on it’s green money liability, it doesn’t expect to call on its red money asset?
OK the CB could end up with a worthless (red money) asset but the public could also end up worthless (green money) asset – it doesn’t stop them playing the game.
And I know this can lead to absurd situations.
Theoretically, ANYBODY could buy a $10M yacht from someone with the yacht and $10M in red money. Where would it end? (Anybody could become a Donald Trump and run for president. 🙂 )
Doesn’t it get back to how much red money is issued, presumably by the CB? And again, how is the red money put into circulation? Does the CB sell a yacht with each $10M tranche of red money? Where did the yacht come from?
And it could not be called money if the CB charges an interest rate on it, can it?
“This holds a fortiori when commercial banks that hold red money as an asset are added to the system.”
JKH,
How would a commercial bank come to hold red money? Would it because it accepts red money deposits on which it is paid interest by the depositor? Or could it acquire red money from the red money market for on lending?
Could it lend out red money and expect to pay the borrower interest?
How would this be different from banking based on green money?
Perhaps someone wishing to sell their $10M yacht could borrow $10M in red money from the bank?
Nick,
My last comment was premature and cryptic as a result.
Requires more thought on my part.
Henry,
Red money is Nick’s baby. I’m just interpreting the nature of his creation. I’m playing at Nick’s slot machine of truth, and so far I seem to be coming up OK in the interpretation process.
I think it’s an interesting and challenging abstraction. As an abstraction, the starting point for my own thinking is that red money is similar to an overdraft position or a line of credit. But what makes it different is that a red money balance is a medium of exchange balance.
There are two things to consider:
a) How is the medium of exchange created
b) How does it circulate
This first example shows how red money is created:
Suppose a yacht buyer starts out with balances of zero green money and zero red money. The yacht buyer pays $ 10 million to the seller. Because the buyer has zero green money, he pays for the yacht from his red money balance. That balance becomes $ 10 million as a result. The buyer now has a $ 10 million yacht asset and a $ 10 million red money liability. His bank has created $ 10 in red money.
The yacht seller now settles that payment with his bank. (This could all be done through Nick’s single central bank idea, or through a commercial banking system with both red and green money.) The yacht seller’s bank credits his account with $ 10 million in green money. This begins to look like the “loans create deposits” mantra of MMT. In this case, its “red money creates green money”. So this is the example of the creation of both media of exchange – red money and green money.
Now consider a second example. Suppose the yacht buyer again has a zero balance in both green and red money. Suppose the yacht seller has a red money balance of $ 10 million. Then, the buyer can pay for the yacht by assuming the seller’s liability of $ 10 million. He ends up in the same position, but in this case the transaction took place using existing rather than newly created red money. That’s what makes red money a medium of exchange. The trick I think is that there must be some credit risk mechanism that allows the buyer to assume such a liability.
If interest rates were eternally zero for all financial assets, then the issue of credit risk might be moot. But that’s not the case. And non-zero interest rates matter, because they affect income and income distribution.
I still earn positive interest on my Canadian dollar chequing account – even at this low general level of rates. I consider that to be a money account, particularly in the context of how Nick has set up his framework for red and green money – he hasn’t restricted it to non-interest bearing currency (on the contrary). And I pay interest on my line of credit. CB’s around the world now pay interest (positive or in some cases negative) on some portion of excess reserves. CB reserves are also a type of money.
“Red money is an interesting idea in the sense that you can think about debt and equity as a conceptual, instrumental evolution of red money. ”
I would think that the more interesting question is why has not red money, unlike green money, become a feature of the real world economy.
Equity probably arose in part because of people’s differential attitude to low risk/expected higher payoffs and a willingness to risk some portion of held wealth.
Henry said: “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?)”
Green money point of view where “red money” is a bond/overdraft is a loan.
When Andy gets a loan/overdraft, there is an asset swap (bond for green money). Now I am not sure what that money is (it is a liability of the CB).
Is it currency? I thought Nick said no because there is no “negative balance” of currency, which I would agree with.
Is it a central bank reserve or a demand deposit similar to what the commercial banks issue? Not sure.
Is the CB acting like a storage facility for currency (asset remains Andy’s, I think) or more like the commercial banks where there is an exchange (currency for demand deposits)? Not sure.
“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?”
You can buy back your bond from the CB at fixed, preset price (1 to 1). I assume that is at any time. Any other asset? Probably not.
“Suppose a yacht buyer……..”
To me this just seems to be no different than the standard money/credit system we are used to in the real world.
I think of money as something I can fold and put in my pocket. If I had a red money note I could do this. If had a thousand of these I could sell my old car and hand over a $1000 in red money. The purchaser would happily do this because he could go to work and sell one week of his labour for $1000 in red money. His employer would accept this because when he sells his goods the purchasers would happily accept his red money, etc..
That’s the system I thought Nick was talking about in his original green/red money blog.
As far as the current blog is concerned, bringing up green/red money seems to be an unwelcome diversion and distraction and not applicable. And of course Nick is not in this blog interested in getting people to think about money per se but how the NK model can be rethought – something I have not got any where near understanding, seemingly bogged down in this money business.
“Red money is Nick’s baby.”
JKH,
I beginning to think Nick has created a monster. 🙂
“Green money point of view where “red money” is a bond/overdraft is a loan.”
TMF,
And what is green money?
“I beginning to think Nick has created a monster.”
Would a bank robber be indifferent between green money and red money? I can’t see why he wouldn’t.
And of course new meaning has been given to the saying “Show me the colour of your money”. LOL!
My green money point of view.
If there is a CB and commercial banks, currency, central bank reserves (caveat, I think they are vault cash substitutes), and demand deposits of the commercial banks.
Nick has a CB only here, but the CB has “checking accounts” for private entities.
I believe he says no currency in this model.
Not sure if green money is central bank reserves, demand deposits of the commercial banks, or both for his model.
JKH said: “The buyer now has a $ 10 million yacht asset and a $ 10 million red money liability. His bank has created $ 10 in red money.
The yacht seller now settles that payment with his bank. (This could all be done through Nick’s single central bank idea, or through a commercial banking system with both red and green money.) The yacht seller’s bank credits his account with $ 10 million in green money. ”
So does the CB have green money, red money liability, and red money on its balance sheet?
@ JKH
I see I stand corrected but not completely disarmed.
I think this distinction of your’s is very important:
a) How is the medium of exchange created
b) How does it circulate
The monetarist world is typically a green money only world in which money creation is a unilateral act performed by a (central) bank. The economy is then a sequence of bilateral exchanges of goods for money and money for goods. It is this taxonomy that the abstraction of bits of green paper is good at capturing.
You say : This begins to look like the “loans create deposits” mantra of MMT. In this case, its “red money creates green money”.
Those were exactly my thoughts when Nick replied to me confirming that an act of red money creation automatically creates an equal amount of green money somewhere else. Add credit risk management to that and it becomes apparent that a red & green world of credit money cannot easily be divided into acts of money printing and subsequent acts of money circulation. It always takes three to tango. And it is at that point that I question the usefulness and intention behind the red / green abstraction.
Within a science, even if it’s a social science, abstraction seems only legitimate if it manages not to omit any essential details. You’re smarter than most when it comes to these things, so you can ‘read’ Nick’s language while filling in the blanks as you go along. I personally feel that for example the Graziani triangle that Andrew Lainton mentions above, does a much better job at ‘permissible abstraction’ and is by no means more complicated. I think Nick wants to expand his view of the monetary system to incorporate credit money but isn’t prepared to leave his ‘native taxonomy’ to do so.
I will put what I said earlier slightly differently:
Nick, or “Dr Frankenstein”, is not happy with the “accounting view” of money. Reducing the monetary system to nothing but an accounting system takes the magic of money away, because the system itself is the medium of exchange, while (green) money isn’t anymore. It’s the credits AND debits, building blocks of our ingenious record-keeping system (JKH: There are people who say that capitalism is the child of double-entry bookkeeping!), that are the medium of exchange.
Someone might conclude that there isn’t really money in this system, as nothing in reality (only in our minds) moves BETWEEN the accounts. But Nick cannot let go of money. So Nick MUST insist that the debit balances are also money, so that it could still be money which functions as a medium of exchange.
It is obvious that we can build a lot simpler view of the monetary system, and the economy, if we are ready to let go of money altogether. As I said, GREEN money is not a medium of exchange either (physical cash is, in a way, but that is not needed in the accounting realm). In my coming blog posts I will present you this alternative view, so stay tuned 🙂
Antti: I read your first post. It’s interesting and good. It reminds me of my old post Media of exchange and the Clearing House. It requires multilateral trust, as opposed to bilateral trust between each individual and the CB.
Nick: Thanks! Your post reminds me of Jevons’ chapters XIX-> in his “Money and The Mechanism of Exchange” (which is famous for the phrase “double coincidence of wants”): http://oll.libertyfund.org/titles/jevons-money-and-the-mechanism-of-exchange — For instance J.S. Mill, in his “Principles”, recommended those chapters as a good overview of the British banking system at the time.
It also reminds me of Wicksell’s “pure credit economy” (I have a feeling Wicksell got the idea from Jevons).
Multilateral trust is an important concept in my theory. But it doesn’t mean that everyone has to trust everyone else. It’s more like trust towards the whole system, or the key players who are expected to guarantee that the system works like it’s expected to work. Well, this sounds like a description of our monetary system — and it is. Nothing new, I guess.
When it comes to your island economy, the problem is the usual: Why do the intrinsically worthless bits of paper have value? They are clearly very different from mangoes as “money”.
Antti: I’m impressed how much you’ve read.
Each individual has an incentive to build up a big stock of red money, then vanish. Who has the incentive to stop him doing that? In my system, it’s the CB, because the CB is left holding the bag if he vanishes. The CB is like the cop, because each individual in a large population has only a very small incentive to monitor all the other individuals.
“When it comes to your island economy, the problem is the usual: Why do the intrinsically worthless bits of paper have value? They are clearly very different from mangoes as “money”.”
True. Short answer: by controlling some mixture of gross/net money stocks, and interest rates, to make sure it does have value (target inflation, price level, NGDP, whatever).
Nick: [Nov. 11, 2016 at 08:08]
In addition to green and red money, we have bananas. Andy wanted bananas. Betty was outside(?) the money system UNTIL she exchanged the bananas for green money.
Now think of “value”. How would Betty build the interrelation of bananas, money, and value? Would future bananas be a consideration?
Nick said: “Each individual has an incentive to build up a big stock of red money, then vanish. ”
Yes of course. However, I can’t see red money being created in the first place if it is created by the CB. How can the CB create red money? It needs to have goods/services/assets to sell with the money, otherwise, who would accept it?
“Would a bank robber be indifferent between green money and red money? I can’t see why he wouldn’t.”
I wrote this earlier on. I see now it was a stupid thing to say.
A masked man rushes into a bank, sticks red money into the till, then rushes out again to the getaway car!
Starting from scratch, a central bank that owned some assets originally could create red money by selling those assets. Or it could simply open for business, and let one customer sell something to another customer.
Nick: I haven’t read more than others (but thanks for the compliment!). Probably less, because I’ve done almost all my reading after 2013 (full-time, though). Perhaps it helps that I haven’t wasted my time on a PhD or Economics courses above 101 😉 And I definitely haven’t used my time on trying to learn the math required from an economist nowadays. Instead, I’ve focused on what my intuition said is the most relevant material for someone trying to understand the real world economy. Most of that material is pre-WW2. It could be that there hasn’t been big enough crises since the Great Depression, and we need big crises to advance the science? Now we have got one, and lo and behold: here we are, advancing the science by discussing “red money” 😉 Desperate times call for radical solutions!
You said: “Each individual has an incentive to build up a big stock of red money, then vanish. Who has the incentive to stop him doing that? In my system, it’s the CB, because the CB is left holding the bag if he vanishes. The CB is like the cop, because each individual in a large population has only a very small incentive to monitor all the other individuals.”
Yes. Although you could replace “red money” with (any) debt/liabilities and the statement would still be true (even in a community without money or banks). What exactly does it mean to you that the “CB is left holding the bag”? I agree on the CB being like the cop. But the cop doesn’t usually end up holding the bag if someone manages to commit a crime. Right?
“A masked man rushes into a bank, sticks red money into the till, then rushes out again to the getaway car!”
Very good 🙂 So good, that I have to try to build on it:
A masked man rushes into a bank, points his gun at the teller, gives him a big bag of red money (without a dye pack) and commands him to take the money, calmly, out of the bag and to put it into the till, then rushes out again to the getaway car! A moment later, the cops arrive at the bank. They ask the teller to give them the red money in a bag. Then they jump into their patrol car, throwing the bag on the (plastic) back seat. Now the chase begins! Finally, after an hour-long pursuit on the highway, the masked man crashes his car. He is barely conscious when the cops get to him. They hear the man say: “Don’t give me the money, you pigs…”. The cops push his face in the mud, cuff him, and with another pair of handcuffs they attach the money bag on the man’s left leg and take him to jail.
A masked man rushes into a bank, sticks red money into the till, then rushes out again to the getaway car!
Great stuff! Thanks for the good discussion! It has been very interesting!
While doing some research for my next blog post, I stumbled upon this line from Fed (I’m looking for something a bit silly they have said which I think is in this same document — yes, I’ve read a document like this before… crazy):
“An institution sending payment orders to a Reserve Bank is required to have sufficient funds, either in the form of account balances or overdraft capacity, or a payment order may be rejected.”
https://www.federalreserve.gov/paymentsystems/files/fedfunds_coreprinciples.pdf (p. 7)
Look carefully at the wording. FUNDS. What are ‘funds’? Obviously not just “green money”, but an overdraft CAPACITY as well (if we overlook the word ‘capacity’, then ‘funds’ would be Nick’s ‘money’…). This is getting close to a definition for ‘purchasing power’ (another problematic concept!). What do native speakers say: Is this proper use of the word ‘funds’?
Fed’s ‘Funds’ (pun intended) seem to match Keynes’ ‘Cash Facilities’ (“A Treatise on Money”, Bk 1, Ch 3, 8ii(i.) “Deposits and Overdrafts”):
“… it is the total of the cash-deposits and the unused overdraft facilities outstanding which together make up the total of Cash Facilities. Properly speaking, unused overdraft facilities – since they represent a liability of the bank – ought, in the same way as acceptances, to appear on both sides of the account. But at present this is not so, with the result that there exists in unused overdraft facilities a form of Bank-Money of growing importance, of which we have no statistical record whatever, whether as regards the absolute aggregate amount of it or as regards the fluctuations in this amount from time to time.
Thus the Cash Facilities, which are truly cash for the purposes of the Theory of the Value of Money, by no means correspond to the Bank Deposits which are published.”
I thought this is somewhat relevant to our discussion, so I wanted to share it.
It happens that the line I’m looking for in that Fed document also is about ‘funds’. And I think the definition of ‘funds’ in that sentence must be different from the definition above. I’ll get back to it later.
An alert reader might notice that Keynes would have liked to see Nick’s bank-gnomes put Reds and Greens in an overdraft customer’s shoebox already before he had even used the ovedraft facility/capacity:
“Properly speaking, unused overdraft facilities – since they represent a liability of the bank – ought, in the same way as acceptances, to appear on both sides of the account.”
How about that, Nick?!!
I apologize for the spam… But this is just so interesting stuff! Look at what Fed has to say about banks that exceed their (daylight) overdraft limit:
“Counseling — Institutions that incur daylight overdrafts in excess of their net debit caps are contacted by the Reserve Banks and counseled to keep future overdrafts within the appropriate limits. Institutions that frequently exceed their net debit caps may be required to apply for a higher cap, to increase their balances, to pledge collateral, or to have payments monitored in real time.”
COUNSELING. You exceeded your net debit cap… It’s bad, mmmmkay? You have to promise to try to not do it again, mmmkay? But if you do, then you should apply for a higher cap, mmmmmkay.
Nick: I suggest the central bank should adopt the role of a counselor, not a cop. Or then they could have a good cop / bad cop arrangement, where the good cop would be a counselor and the bad cop would be a… cop.
Have a nice weekend, all of you!
Nerds like me might also appreciate this from the Fed (regarding computation of required reserves): “Overdrafts in demand deposit or other transaction accounts are not to be treated as negative demand deposits or negative transaction accounts and shall not be netted since overdrafts are properly reflected on an institution’s books as assets.”
So the Fed (in full agreement with Too Much Fed…) says that overdrafts are NOT “negative money” (negative demand deposits), but should be recorded as assets (LHS of balance sheet; what TMF calls “bonds”). I don’t present this as any conclusive evidence against Nick, but as something to take into ACCOUNT (bad jokes continue…).
Nick: Are you familiar with the following papers?
Ostroy. 1973. “The Informational Efficiency of Monetary Exchange”
Ostroy & Starr. 1988/1990. “The Transactions Role of Money”
Kocherlakota. 1996. “Money Is Memory”
In my next post I will refer to this “tradition” (Kocherlakota builds on Ostroy 1973), so it would help if you and others have an idea on what these people are talking about. Just checking.
Here is finally my (over-advertised) second post: http://gifteconomics.blogspot.com/2016/11/a-new-monetary-system-from-scratch-part_14.html (or just click my name to get to the blog)
Any feedback appreciated! I’m slightly worried that there might be too much to handle in that post. I’m happy to elaborate, so don’t hesitate to ask if something is unclear.
(Sorry, guys. I got a bit carried away on Friday/Saturday. Looking at my comments, it might seem I was drunk — but I wasn’t.)
this looks like a great case study for monetarists:
http://www.thehindu.com/news/resources/the-political-economy-of-demonetising-high-value-notes/article9348002.ece