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 
Antii
You’re right – maybe my point on banks is not that relevant to your analysis. I picked that up from your rhetorical question – “What kind of entries does a bank make in its ledger in different situations?”
I think if you convert loans and overdrafts in the real world to red money in Nick’s world, you’ve got things pretty well covered in your analysis and you can make accounting for both the real world and Nick’s model mutually consistent.
P.S.
I personally wouldn’t get too carried away with the triple/quadruple/etc. stuff.
Double entry reflects the adjustments on a single balance sheet. Quadruple entry reflects the adjustments on the balance sheets of two counterparties to a single transaction. That kind of counterparty interaction is generally necessary for a transaction (or even a non-transactional revaluation) to take place as an economic event captured by accounting. From there, the sky’s the limit in term of multiplicity and higher order, depending on how much is going on and what range of transactions is to be captured “simultaneously”. This includes the case where banks are involved.
I also think it is possible to subdivide particular basic transactions into further artificial or hypothetical “elementary” transactions that can no longer be subdivided. I happen to think of accounting in this way. For example, in the case of the bicycle sold for cash, you can focus in on the marginal effect of just the transfer of bank deposits from one bank to another. With nothing else considered, that hypothetical would include double entry adjustments to deposits and equity for both counterparty banks. Then add in the fact that bank reserves are transferred as well, and that first hypothetical equity effect gets reversed out for both banks. You can do the same for those kinds of effects on the balance sheets of the buyer and the seller, looking at the demand deposit transfer alone with the corresponding hypothetical equity adjustment. Then do the bicycle transfer and the hypothetical equity adjustment gets reversed out for both non-bank counterparties. I find decomposing accounting in this way to its constituent hypothetical elementary sub-transactions makes the interaction between assets, liabilities, and equity much clearer from a logical construct perspective.
Above I meant:
“wouldn’t get too carried away with the sextuple/octuple/etc. stuff.”
JKH: It seems you and I agree on overdrafts and loans. I’ll anyway write a post about it, where I articulate my view more explicitly, in hope that it would help to bring all discussion participants closer to a common understanding on that issue as well. Sounds OK?
“wouldn’t get too carried away with the sextuple/octuple/etc. stuff.”
Again, I fully agree. These are just multiples of the basic element, which is double-entry (not single-entry). “Sextuple-entry” was more like a quip from my side. The point was that neither “sextuple-entry” nor “quadruply-entry” is more than double-entry bookkeeping which is being multiplied or “mirrored”.
“that hypothetical would include double entry adjustments to deposits and equity for both counterparty banks”
This is interesting. I think your point is more valid in case of non-banks than it is in case of banks. Why would it be equity, not customer deposits (checking accounts) that is affected on the RHS?
JKH: I would say that my having a loan is different from my having red money, in the same way that my having a bond is different from my having green money. If I get rid of the bond I own, I accumulate green money (or decumulate red money). If I get rid of the loan I owe, I accumulate red money (or decumulate green money).
Non-money assets (and liabilties) are promises to be paid (or to pay) green money (or to accept (or have accepted from me) red money).
Antii
“Why would it be equity, not customer deposits (checking accounts) that is affected on the RHS?”
It’s both. I’m just subdividing into elementary components. It’s artificial. It answers the question – what would be the effect of a transfer of deposits from one bank to another without considering the accompanying transfer of reserves. So a transfer of deposits alone from bank A to bank B would involve:
Bank A
debit deposits (reduction)
credit equity (increase)
Bank B
credit deposits (increase)
debit equity (decrease)
This is a hypothetical – other things equal. It’s a benefit to Bank A – it loses a liability which means its equity increases. Of course, this doesn’t normally happen in practice without the corresponding reserve transfer (which reverses that hypothetical equity effect) – but it is how the transfer of deposits alone would be reflected. It’s what I referred to as an elementary decomposition. And it’s not entirely nonsensical in a practical sense. Sometimes banks sell parts of their branch systems along with the deposits – and they have to pay out some amount of equity in order to get the buying bank to take on the deposit liabilities.
Nick
” JKH: I would say that my having a loan is different from my having red money, in the same way that my having a bond is different from my having green money. If I get rid of the bond I own, I accumulate green money (or decumulate red money). If I get rid of the loan I owe, I accumulate red money (or decumulate green money).
Non-money assets (and liabilties) are promises to be paid (or to pay) green money (or to accept (or have accepted from me) red money). ”
Understood.
Just to be clear, “your loan” in that context is your loan liability.
And to be additionally clear, that loan is a loan of green money.
You can repay it with green money or repay it by incurring (“accumulating” in your language) red money.
So my observation would be that you have introduced an asymmetry into your red/green world by allowing loans of green money.
Such an asymmetry doesn’t exist if you exclude that type of loan.
Or perhaps you wish to include loans of red money as well?
I’d be interested if you really want to go down that path.
My assumption without looking back at your posts was that it is purer to exclude either type of loan from the red/green money world.
BTW, Negative TARGET2 balances at the ECB are red money. Anyone know the spread between positive and negative TARGET2 balances? It’s clearly not large enough to cover the risk-spread between (say) Italian and German bonds. Unlike Bank of Canada settlement balances, where the 50bp spread is enough for commercial banks with positive balances to lend to commercial banks with negative balances, so red money is very rare (except intraday??).
I think that example also illustrates the difference between red money and loans.
JKH: I want to go down that path, and make it symmetrical. I was trying to make it symmetrical in my above comment, especially in that bit with all the parentheses.
If I have accepted a loan from Andy (a liability on my books) I have an obligation to either: give green money to Andy; or accept red money from Andy, to pay off that loan.
If I have made a loan to Andy (an asset on my books) I have a right to either: be given green money by Andy; or to give red money to Andy, to pay off that loan.
I think it’s symmetric.
Nick
It’s been a while since I looked at TARGET2, so I may be a bit rusty.
But TARGET2 is a clearing system for the reserve liability positions of the national central banks. The constituent national central banks that develop surplus TARGET2 positions do not actively “lend” TARGET2 money. Their positions are the passive result of inter-central-bank clearing and are taken on without any material attempt to actively manage them in a direct way. This is quite different from the case of commercial banks dealing in their reserve markets. So the interest rate formula and mechanism for the transfer pricing of TARGET2 surpluses and deficits is not really an issue in that context. (I believe there is a small spread, as you infer). In fact, national central bank specific risk is mostly shared through a capital allocation/risk sharing formula, where all central banks share in the financial result of the aggregate EZ national central bank balance sheet (the Eurosystem balance sheet). The system is designed not to reflect the credit quality differences on central bank balance sheets to which you refer. Hans Werner Sinn has written a lot about the potential breakup risk because of this. It’s complicated to be sure.
That said, I think that TARGET2 liability positions are like overdraft or red money positions in their own way.
But to be clear again, TARGET2 money is not the same as the reserve money of the national central banks – quite apart from your distinction between loans and red money. Your red money concept at TARGET2 level would not be the same kind of red money that might reflect the same concept at the level of commercial banks dealing with their respective central bank.
Nick,
I meant the path of red money loans.
It’s asymmetric in the sense that in the world of green and red money, there are only loans of green money.
(Notwithstanding that those green money loans can be paid off with either green or red money adjustments.)
Perhaps that asymmetry is quite OK.
So you created red money but so far you allow only loans of green money. That’s the asymmetry to which I referred.
Unless you are allowing loans of red money.
So I would be interested if you are doing that – and if so how you would explain that.
Without that, it is also interesting that loans of green money can be paid off with red money adjustment, but that there are no loans of red money.
Unless you specify that somehow.
Over to you.
JKH: thanks for the target2 stuff. Will think about it.
Assume a pure red money world (no green money, to keep it simple). You can’t sell anything unless you have enough red money to cover it. I want to sell you my car for $1,000, but my bank balance is at $0. So I borrow $1,000 of red money from Andy, who has a large stock of red money. Andy’s overdraft falls by $1000, mine rises by $1000, and Andy gives me a signed note promising to accept $1,050 in red money from me next year. I sell you my car, my overdraft falls back to $0, and yours rises by $1,000. The bit of paper signed by Andy is a loan (my asset, Andy’s liability) but not red money. It can’t be used as a medium of exchange, because I know and trust Andy, and recognise his signature, but other people don’t.
Tyger, tyger, burning bright
In the forests of the night
What immortal hand or eye
Could frame thy fearful symmetry?
back a little later
JKH: TARGET2. Suppose BMO became a bit risky. More than 50bp risky. And suppose BMO had a negative settlement balance at the BoC at the end of the day, while BNS had a positive balance. If BMO were safe, BNS would lend to BMO on the overnight market, because there would be a 50bp gain from trade they could split between them. But if BMO is risky, the overnight market dries up, because BNS won’t lend at any rate BMO would accept. So BMO’s negative balance might keep on growing day after day. Their positions would be the passive result of interbank clearing, just like TARGET2.
@ Nick
A red money only world is a strange place. I can’t help thinking of the origins story that MMTers sometimes come up with where the first act of a colonial government consists of imposing a tax liability on its subjects. In Nick’s colony, the subjects would have an initial overdraft imposed on them. On top of that, they would then be forbidden to move their accounts beyond 0 at any time. But anyway.
In your terminology, is money (red or green) that which banks create while loans (red or green) are promises of payments between non bank agents? A red loan would then be a promise to be paid, which you say cannot be? If you do establish red money as a medium of exchange, I don’t see why that would be a problem (that’s the symmetry that JKH is talking about, I think. More of a contradiction in terms, if you ask me). I do think it would be a problem, practically speaking. But that’s precisely why I wouldn’t, and nor would most others, consider red money a medium of exchange.
Nick 9:05
That’s excellent.
Is that the first time in writing on this topic that you’ve been specific about loans of red money – or did I miss that before?
P.S.
Although not quite sure about the language here:
“So I borrow $1,000 of red money from Andy … and Andy gives me a signed note promising to accept $1,050 in red money from me next year … the bit of paper signed by Andy is a loan (my asset, Andy’s liability) but not red money.”
A small point of semantics, not important – you say that you borrow but your stock of borrowing is the loan asset. Is that how you intend it?
Nick,
I think your TARGET2 /BMO analogy is partly true.
In your example, where the BMO becomes helpless as a result of market forces, it does resemble a case somewhat like the Greek central bank having problems preventing the migration of money to other Eurozone areas.
However, I think TARGET2 operates with systemic passivity. As I understand it, there is no overt attempt for each national central bank to square its TARGET2 balance in the best of times. So for example, if the Bundesbank were to have a surplus balance in “normal times”, I don’t think it would be in the market buying assets from counterparties that operated in the geographic area of other NCBs just in order to encourage an outflow of its reserve liabilities to other central banks in the Eurozone. I don’t think it would be driven by the economics of TARGET2 balance compensation to do that. I think it comes down to the fact that the NCBs are government creatures and that the compensation or cost for risk taken by individual NCBs is shared by formula across the entire spectrum of Eurozone NCBs.
JKH: Thanks!
I can’t remember if I have talked about loans of red money before. If I did, probably less clearly.
But yes, I’m still not 100% clear (either mentally or in words).
“A small point of semantics, not important – you say that you borrow but your stock of borrowing is the loan asset. Is that how you intend it?”
I think so. Because I’m borrowing a thing that has negative value. Like borrowing garbage. A minus times a minus is a plus.
Nick: Interesting that you mention TARGET2. When I first introduced my “gift economics” idea, in Finnish, a very knowledgeable Finn — who’s an avid reader of yours, and might be reading this as well — brought almost instantly up TARGET2. So there’s yet another thing that connects my view with yours.
I’ll come back to both you and JKH tomorrow! No time for deep thoughts now. You’re having an interesting conversation again!
This quote from the Central European Bank webpage “Payment transactions in TARGET2 are settled one by one on a continuous basis, in central bank money with immediate finality.” contains the definitive words “central bank money”.
I think that understanding what “central bank money” actually is would help this discussion.
I think you’re right Nick.
From a non-bank perspective:
If you’re borrowing an asset (i.e. green money), then the borrowing is a liability.
If you’re borrowing a liability (i.e. red money), then the borrowing is an asset.
Non-banks can lend and borrow either green or red money without creating new money or destroying old money.
From the bank perspective:
If you’re lending a non-bank asset (i.e. green money), then the lending is a bank asset and the green money it creates is a bank liability.
If you’re lending a non-bank liability (i.e. red money), then the lending is a bank liability and the red money it creates is a bank asset.
Banks can lend either green or red money by creating it and they can borrow either green or red money by destroying it.
Commercial bank reserve settlement balances held with a central bank are a higher order of money than money held by non-banks with a commercial bank. So in the money relationship, the commercial banks are to the CB as non-banks are to the commercial banks. That means the commercial banks would have green money reserve assets and red money reserve liabilities. And the CB would have green money reserve liabilities and red money reserve assets.
And in the case of the Eurozone, the NCBs would have green money TARGET2 assets and red money TARGET2 liabilities. And the ECB would have green money TARGET2 liabilities and red money TARGET2 assets.
As I said above, just as non-bank holdings of commercial bank green or red money are not the same type of money as commercial bank green or red reserve settlement balances held with the central bank, green or red reserve settlement balances held by Eurozone commercial banks with the NCBs are not the same type of money as green or red TARGET2 balances held by Eurozone NCBs with the ECB.
That’s quick revisit – not sure, but I think it may cover the set of symmetries for green and red money and loans of green and red money in the cases of non-banks, a singular (central) bank, a central bank with a set of commercial banks, and a super-central bank with a set of central banks.
This is my post on TARGET2 from a few years ago:
http://monetaryrealism.com/target2-window-on-eurozone-risk/
As I mentioned way above, I think Nick has created a monster with his red money concept.
Other than the mental gymnastics involved, I can’t see the point of it.
Unlike green money, red money is not a feature of any monetary system. For instance, I can’t walk into a coffee shop and purchase a cup of coffee by accepting red money with the cup of coffee from the vendor. The day this happens will be the day I begin to worry about red money.
Green money has evolved naturally in our monetary systems, why hasn’t red money?
And of course, as Nick has mentioned several times, if red money did exist, the aim in life of every individual would be to depart this world leaving behind a mountain of red money (after having consumed or given away all his assets). We could all die billionaires, except we won’t mention the fact that we’re talking about red money. And potential legatees will not be welcoming of that bequest from a red money rich uncle.
JKH: I think we are on the same page.
I’m re-reading your good long post on TARGET2. Along with your sources. God those guys make it complicated. That’s why red/green helps, to simplify! But I still don’t understand what stops gross money in TARGET2 growing without limit (net money is fixed at zero, it seems).
Henry: my father used red money for most of his life. He nearly always ran an overdraft in his chequing account. As long as the balance came close to zero after he sold the wheat every year, the bank manager seemed relaxed about it.
Nick,
I don’t think there is a limit – other than the size of the outstanding money supply at a particular point in time in a weak country that is susceptible to outflows to stronger countries.
For example, here is a possible highly theoretical worst case for Greece relative to Germany:
Suppose at a particular point in time all deposits in the Greek commercial banking system flee instantaneously to Germany via some combination of a current account deficit and net private capital outflows. Call that money supply M.
So the German commercial banking system gains deposits of M and gets credit from the central bank Bundesbank for bank reserves of M. The central bank Bundesbank now has new reserve liabilities of M. It “clears” that new incoming liability position with the ECB by obtaining credit in the form of a TARGET2 positive asset balance of M with the ECB.
On the other side, the Greek commercial banks lose deposits of M and reserves of M, driving their reserve position hopeless negative. They back into their LLR facility with the Greek central bank in order to bring their reserve position back to square. And the LLR funding they obtain now serves to fund their assets instead of the previous deposit funding. Finally, the Greek central bank, having lost M in reserve liabilities, backs into the ECB for what is in effect replacement funding (i.e. a red money overdraft) of M. The use of the term “funding” may sound a bit artificial at this point, since this all happens through accounting entries for the clearing process. But that’s not much different than the plain vanilla process accounting process that occurs with any central bank clearing system.
I think that unlike commercial banks dealing with CBs, the required Greek NCB red money position is technically not even an LLR loan – it is more of an automatic overdraft (and without limit) – so I think you are particularly correct to draw the analogy to your red money idea.
I think there is no technical limit to these sorts of imbalances. The Eurosystem was designed this way. And it is in fact technically sustainable – unless there is an exit event. That’s when resolution of the risk gets more complicated. And that’s the risk that Sinn was warning about concerning the German position. And he faced big push back from many other economists who focused on the “don’t worry be happy” mode of indefinite sustainability without thinking about possible exit complications.
P.S.
One further interesting technical point. Sinn used to point out that when the German central bank was flooded with incoming money that it had to credit in the form of reserves for the commercial banks, it was then faced with the dilemma of how to manage those excess reserves in the context of domestic commercial banking system requirements. That led him to sound the alarm that the Bundesbank would have to sell assets domestically to drain those reserves – and that in the worst case it might run out of assets to sell. It’s an interesting concern, except that the Bundesbank could have started to use liability management to drain those reserves if so desired – or pay interest on them – or whatever. I never followed up on that because I think the German Target2 position gradually peaked out, and I haven’t followed it much since.
JKH: Useful comment for me.
“I don’t think there is a limit – other than the size of the outstanding money supply at a particular point in time in a weak country that is susceptible to outflows to stronger countries.”
I’m not even sure there’s that limit. For example, commercial banks in the weak country could allow their customers to have bigger overdrafts.
” I never followed up on that because I think the German Target2 position gradually peaked out, and I haven’t followed it much since.”
It’s growing again, looking like it will set a new record. It’s now Italy and Spain with the growing negative balances. Click on SDW Report Sheet.
As far as I can tell, from a quick search, Eurozone National Banks neither earn nor pay interest on their positive or negative balances, so the spread is 0%. (But foreigners do). And the ECB itself now has a negative TARGET2 balance (due to its doing QE).
“my father used red money for most of his life.”
A bank overdraft is not quite red money, is it – there is no interest (positive or negative) with red money – there is no identified/nominated creditor as such – the issuer of red money has no obligation to the holder of red money – and I presume your father never attempted to sell his overdraft with his wheat.
All of the above presumes I understand what you mean by red money – perhaps I still don’t understand it?
Henry: there can be interest with green money (though interest on green paper money is administratively difficult to pay or collect). Same with red money.
With green money: we normally treat it as a liability of the bank that issues it, though with fiat money the exact nature of that liability is debatable.
With red money: we normally treat it as an asset of the bank that issues it, though with fiat money the exact nature of that asset is debatable.
My father always sold his overdraft with his wheat. The buyer of the wheat now had a larger overdraft, because the bank transferred the red money from my father’s account to the buyer’s account.
“A bank is not a storage facility for currency. And I’m talking about a bank.”
I still want to see how a storage facility for currency works.
Nick,
I think you are stretching this red money too far, and creating a good deal of confusion to boot. I can’t see the point of introducing the concept of red money. It’s fun mental gymnastics but really you are just playing with definitions with no practical value at all. The way you are using money you may as well say an asset is an asset, a liability is a liability. Colour is a red (green, blue, pink, yellow etc,) herring.
“If I have accepted a loan from Andy (a liability on my books) I have an obligation to either: give green money to Andy; or accept red money from Andy, to pay off that loan.”
What happens if you (Nick) defaults?
“With green money: we normally treat it as a liability of the bank that issues it, though with fiat money the exact nature of that liability is debatable.
With red money: we normally treat it as an asset of the bank that issues it, though with fiat money the exact nature of that asset is debatable.”
Green money is usually an asset of some entity.
What entity has red money as a liability?
Thanks for the intresting discussion.
“It’s growing again”
The ECB (https://www.ecb.europa.eu/pub/pdf/ecbu/eb201607.en.pdf):
Asset purchases from counterparties located in a different country from the
purchasing central bank can directly affect TARGET balances. Counterparties
whose NCBs are connected to TARGET use their accounts at those NCBs,
while counterparties located elsewhere can use an account at a correspondent bank with
access to TARGET. Banks based outside the euro area tend to make payments in
TARGET via branches or correspondent banks in countries with claims in TARGET,
such as Germany or the Netherlands. It follows that when an NCB purchases
securities from a non-domestic counterparty, whether it is located in another euro
area country or outside the euro area, the purchase is likely to give rise to cross
– border flows of central bank money.
Hah, I can see the red / green money analogy coming alive in context of unlimited, both way TARGET2 balances!
As a matter of interest, is there anything comparable in the context of a ‘normal’ bank / central bank arrrangement anywhere? Say between the different branches of the FED in the US?
TMF:
What entity has red money as a liability?
The holder.
Nick,
“I’m not even sure there’s that limit. For example, commercial banks in the weak country could allow their customers to have bigger overdrafts.”
Agreed.
I was constraining against that (to pin things down just for illustration purposes) by assuming instantaneous outflow at a fixed point in time
“other than the size of the outstanding money supply at a particular point in time … flee instantaneously”
But I agree there is no technical limit (other than the usual prudential constraints such as capital adequacy) against banks creating more money in the bathtub even as it is draining.
Nick,
A further thought on your idea of borrowing red money.
For illustration purposes – back to the case of a single (central) bank with no commercial banks.
Suppose we are constrained to a red money only system.
There is no stock of green money.
Suppose customer X has a 0 money balance to start.
He wants to sell something for $ 1,000 so he requires a red money balance to sell it.
So customer X borrows $ 1,000 in red money.
The customer then has a red money liability with an asset representing the borrowing.
That’s where we left off in defining red money borrowing.
Here’s the anti-symmetric way (a good thing actually) of looking at that.
The customer starts with a 0 balance.
He requires a red money balance.
So he lends $1,000 of green money to his bank.
That creates $ 1,000 of red money for the customer, because he is lending from a starting green money balance of 0.
So his asset is a loan of green money.
His liability is a stock of red money.
In that way, I would say that borrowing red money is equivalent to lending green money. The immediate balance sheet entries are the same – a $ 1,000 red money liability for customer X, and an asset which you can refer to either as a borrowing of red money or a loan of green money.
This equivalence of interpretation can hold under the assumption of a system with a specified green money stock of zero – i.e. green money stock is simply not allowed.
That’s because the green money loan in the example represents a realized flow of green money – but is not a stock of green money, rather a loan of green money.
So no problem with that interpretation in a red money stock only system.
I think this connects back to a basic point I made earlier.
Which is that in a dual system, red money (a bank asset) creates green money (a bank liability).
For example, when customer X creates a red money balance of $ 1,000 by spending from a starting money balance of 0, this in turn creates $ 1,000 as a green money inflow for the seller.
In an unconstrained dual money system, and assuming for illustration that the seller starts out with a 0 balance of either green or red money, this flow of green money will show up on the balance sheet of the seller as a green money asset and on the balance sheet of the bank as a green money liability. The green money expenditure and inflow has created a green money stock.
In a red money stock only system, that green money flow will show up first as a reduction in any red money stock outstanding held by the seller. But if that pushes the red money stock of the seller back to the point that it threatens to create net green money stock, the seller will then either have to buy something that spends that residual green money flow or lend the residual green money flow to the bank. For example, suppose the seller starts out with a red money balance of $ 500. Then his $1,000 green money inflow would create a $ 500 green money balance if the system were not constrained to red money stock. To prevent this from happening in the assumed red money system, the seller lends that $ 500 of green money to the bank. The full result is that he has reduced his red money liability balance from $ 500 to 0 and he now has an asset of $ 500 which can be interpreted as either a green money loan or red money borrowing. Nevertheless, his actual money balance at that point is $ 0 for both red and green money.
I think another interesting interpretation of that last example is that in order to prevent a stock of green money being created in the system, the bank has done what amounts to a “reverse repo” that supplies an asset of some sort to drain what would otherwise be the creation of outlawed green money stock. The bank is obligated to do this under the rule of no green money stocks.
Henry,
“I can’t see the point of introducing the concept of red money. It’s fun mental gymnastics but really you are just playing with definitions with no practical value at all.”
In a generic sense, I feel your pain.
I think it’s a matter of personal preference. In my own case, I find it quite challenging to try and map Nick’s logic on this one to a conventional interpretation of the actual monetary system as it works. I don’t know why this is so in this particular case, because in general I consider myself to be no slouch when it comes to understanding the mechanics of the real world monetary system. But for some reason, I find this one to be a useful challenge in that it causes me to think harder about how the actual system works.
You may find it to be of no use whatsoever. That’s understandable. I’ve been there, depending on the modelling situation. But that’s not to say that some people may find this one quite useful as the result of personal interpretation.
Nick,
One can imagine a world specified as:
Only green money
Only red money
Dual green and red money
But it is also possible to specify the world more flexibly in terms of the restriction on the type of stock, restriction on the type of flow, or both.
I think you are specifying a world of red money only as including a restriction on both stocks and flows. Only red money stocks and only red money flows.
In my earlier comment, I implied a red money world that specified a restriction to red money stock, but allowed for either type of flow.
This is logically possible.
For example, consider a given amount $ 500 of household red money stock.
The sale of $ 1,000 of stuff can be achieved with either a red money outflow or a green money inflow in this world. Both reduce the red money stock.
But once the red money stock has been reduced to $ 0, the residual $ 500 green money inflow or red money outflow can only be achieved by lending the same $ 500 residual in green money or borrowing it in red money.
Asymmetry in stock specification; symmetry in flow specification
on that very last point –
a green money loan is not the same thing as green money, so it could still be permissible in concept under such a red money stock system
Hold the press!
I got inspired by JKH’s and Nick’s discussion, started writing a comment, but it became a (long) blog post. I’ve been writing it for four hours now (including thinking), but don’t yet see an end to it. I hope it will offer you a whole meal for thought.
Oliver, should the holder be considered a borrower?
“Which is that in a dual system, red money (a bank asset) creates green money (a bank liability).
For example, when customer X creates a red money balance of $ 1,000 by spending from a starting money balance of 0, this in turn creates $ 1,000 as a green money inflow for the seller.”
It appears to me that customer X has a liability of $1,000 and that customer seller has an asset of $1,000.
I believe the result is the same with an overdraft as a loan, where loans create deposits. The “red money” is actually the loan/bond part.
“In a generic sense, I feel your pain.”
JKH,
It’s bemusment rather than pain.
For me, the interesting question is why no red money system has arisen naturally in preference to or in conjunction with a green money system.
Although, I think Nick would argue there are elements of red money in our green money system. But I don’t think calling an overdraft, or the like, red money of any practical or even theoretical use. It’s a both a liability and an asset depending on who’s balance sheet is under consideration, and that’s all that needs understanding.
I also understand the mental gymnastics required to process the notion of red money can lead to new modes of understanding the money system we have. So it has pedagogical value.
My blog post became a series of blog posts. Perhaps we should write a book together: “Monetary Economics in a Red Money World”?
Here’s the first post: <a href=http://gifteconomics.blogspot.com/2016/11/in-land-of-color-blind-neither-borrower.html”>In the Land of the Color Blind, Neither a Borrower Nor a Lender Be: Part 1. It doesn’t live up to the coherence standards I’ve tried to set to my blog posts (and those are not high). But that shouldn’t keep you from finding some interesting points in it, I hope!
Btw, here’s Nick’s dad, threatening his bank with a withdrawal.
“It’s bemusment rather than pain”
Could have fooled me.
In fact you did.
But I’m so pleased you recognize the pedagogical value.
I learned a lesson: Never publish a post in a hurry.
I just wrote an update:
“As you might have already realized, if X in JKH’s example is severely credit-constrained (totally unworthy of credit in the eyes of the DFRW) he can neither buy first nor take out a loan of red money (from a non-bank). The latter would involve a debit balance on his checking account, and the DFRW wouldn’t approve of it. From this it follows that collateral must play a decisive role in a red-only world. Logically, one must be able to sell first even if one’s promises are valued at zero.”
In red-only world, IF one is credit-constrained and needs to borrow red money to effect a sale, one has to post the goods one wants to sell, or other goods, as a collateral to the the central authority/bank (because the loan involves incurring a liability, even if the borrower ends up holding an asset, too). Right?
That red world is pretty imaginary, Antii, so I think it’s up to you as to what credit constraints you want to build into it.
Red money is like an overdraft, and regular overdraft facilities in the real world don’t necessarily require collateral. It would depend on credit quality assessment and the size of the exposure.
And as I said before, I would view borrowing red money as equivalent to lending green money. From a starting balance of zero, both interpretations create a resulting red money balance. Both interpretations result in a liability called red money and an asset that can be viewed as either borrowing red or lending green. And lending green could still be permissible in a world that outlawed net green stocks of money.
But I’m so pleased you recognize the pedagogical value.
You were right about that and I was too quick to dismiss it, just like Henry. There is pedagogical value in science fiction. And I mean that in the best possible way.
JKH: I mean that collateral is required from un-creditworthy agents, even though they only want to SELL. That’s a problem with the restriction that says you need to have red money to be able to sell goods. It’s not a (theoretical) problem if the goods to be sold are accepted as collateral at market value, or “face value” (no haircuts).
This makes “red borrowing” different from “green lending”. In green lending, the asset is a “general credit” (in centralized ledger) and the liability is in a private ledger, while in red borrowing the liability is a “general liability/debit” and the asset is in a private ledger. In other words, in green lending the lender can judge the borrower’s creditworthiness, while in red borrowing a central authority has to judge the borrower’s creditworthiness, while the borrower is the judge of the lender’s creditworthiness. Read that one carefully 🙂 Makes sense?