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In general Too Much Fed, no it's not. If the lender is a non-bank, then the repayment of a debt lets the lender spend because both debt and loan are on the liability side of the banking system's ledger; but if the lender is a bank, then the repayment of the loan takes money out of circulation (I prefer that expression to "destroys money") because the debt is on the asset side of the ledger. That's the essential difference between Loanable Funds & Endogenous Money, which I'm trying to illustrate in a pair of very simple models that I'll post on my blog shortly--and link to Nick's discussion here.
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Yes, I agree it's messy Nick--there are a lot of points I would reject from a complex systems point of view alone. But the wisdom on equilibrium is very valuable. I argue--I'm arguing in my next book anyway--that economists have tended to mistake equilibria for identities, and therefore to insist on equilibrium outcomes when in fact identities (such as supply == demand in every market) apply in or out of equilibrium. Anyway, I'm very glad that you've read that paper. Please recommend it to some friends! Cheers, Steve
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Yes Philippe, that does seem to be what Nick is saying--that this applies in the very short run (though with a caveat as to whether the economy is ever in the long run). My take of course is that "in the long run we are still in the short run"--that the economy is always in disequilibrium and we therefore have to model it that way. Nick picked up on that in his rephrasing of my effective demand argument of course, and I was very pleased by that--a lot of commentators inadvertently shoehorn my views into an equilibrium framework for which they were explicitly not designed, and that makes it harder to argue my case. Incidentally Nick, there's one key Hicks paper on IS-LM and equilibrium that I've gone blue in the face trying to get certain authors to read (hint: one of them has the initials PK). But now that we're having a delightfully civil exchange here, can I ask whether you've seen it?: Hicks, J. (1981). "IS-LM: An Explanation." Journal of Post Keynesian Economics 3(2): 139-154. If not, I highly recommend reading it on this topic--of whether IS-LM can be used to model the economy at times like 2007/08 when it clearly was not in equilibrium. Here's Hicks's observation on this in relation to his perceived previous disequilibrium year of 1975: "We know that in 1975 the system was not in equilibrium. There were plans which failed to be carried through as intended; there were surprises. We have to suppose that, for the purpose of the analysis on which we are engaged, these things do not matter. It is sufficient to treat the economy, as it actually was in the year in question, as if it were in equilibrium. Or, what is perhaps equivalent, it is permissible to regard the departures from equilibrium, which we admit to have existed, as being random. There are plenty of instances in applied economics, not only in the application of IS-LM analysis, where we are accustomed to permitting ourselves this way out. But it is dangerous. Though there may well have been some periods of history, some "years," for which it is quite acceptable, it is just at the turning points, at the most interesting "years," where it is hardest to accept it."
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Sometimes it's a good thing to wait before replying; I like the turn the comments have taken recently, since they appear to have turned back (a) to Nick's original contribution in this post of providing an expression in which rising debt adds to demand which (b) is consistent with accounting, since it must be and (c) at the same time we are attempting to derive economic principles and should not confuse "accounting identities with causalities". [As an aside, I argue that Krugman does do that to argue that since assets = liabilities, the level of and change in private debt doesn't matter (outside a liquidity trap), but equally he is also at times quite aware of the mistake of confusing accounting identities with causalities, as he pointed out very well in his Cambridge lecture on the 75th anniversary of the General theory.] On JKH's continuous time points, the propositions you put there underlie how the monetary "Godley Table" component of the Minsky system dynamics program is designed (and I hereby admit that I learnt a lot about the importance of double-entry bookkeeping in designing the program that I didn't appreciate before I started). Those two extremely simple example files I've linked to above differ only in where loans originate--on the liability side in the "LFvEM" model and on the asset side in the "EMvLF" model--and the continuous time dynamic equations can be derived directly from the program. Both models are 100% accounting consistent--they have to be, otherwise the program flags an imbalance--and in one changing debt levels don't have any macroeconomic impact, while in the other they do. I think they're the simplest possible statement of the difference between Loanable Funds and Endogenous Money that one can make in an explicitly monetary model. I should be able to spend some time analyzing those equations as part of the course I'm giving down here in Quito, and I'll post a link to them when I've done so.
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Too Much Fed, yes they do--in the last 3 decades the main purpose of additional debt has been to finance asset purchases rather than production or consumption (though the dynamic between rising debt and rising demand applies in their absence as well, as Schumpeter argued), and a monetary macroeconomics has to integrate finance rather than treating it as a separate field. D_R, The models illustrate the causal role of additional debt in financing an expansion of monetary activity--but you're right that I should provide more explanation. I will have to leave that for a while though--I'm off for a bit of tourism here in Ecuador in the next couple of days, but I'll try to return to this thread early next week. Thanks again Nick for starting it.
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Quick clarification: it's the change in the level of "gross domestic private non-financial sector credit market debt outstanding", not the level itself of course.
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Hi DR, I'm not about to claim that my definitions are precisely accurate when applied to the aggregate data, but they have to be pretty accurate to generate the correlations you can see there. There could be instances where the reduction in debt doesn't reduce demand--though in your example (over to you JHK) I presume there could be a transfer from bank equity to bank capital to make up for the loss that would therefore reduce money in circulation and hence demand (to some degree). I also start from measuring changes in debt rather than changes in money since (a) from the loans create deposits perspective, the change in privately generated money is 1:1 with the change in debt and (b) money is notoriously hard to measure whereas debt is easily measured in the Flow of Funds. So the debt component of AD as I measure it is precisely "gross domestic private non-financial sector credit market debt outstanding". As noted, some fine tuning could be necessary, but the correlations I get with economic data--especially since they go against conventional expectations--imply that I'm roughly right rather than precisely wrong.
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Yes that's a pretty good statement of it Nick, and it's comparable to the arguments put here (that someone on Twitter just reminded me of): http://www.positivemoney.org/2013/03/economists-prove-that-the-earth-is-flat/ From my dynamic systems perspective, the phenomenon we're now both describing--and its difference with the conventional view--is the growth factor in what mathematicians call a "dissipative system". The conventional position, derived as it has been from a static model of macroeconomics, has unwittingly instead described what mathematicians call a "conservative system"--and in this case what is being conserved is the amount of money, and also (except for variations in velocity) the amount of demand. The creation of money by banks means of course that the amount of money in existence is not conserved but expands during booms (and can contract during slumps), as does the amount of demand (though not necessarily by precisely as much, for reasons including the one you gave initially about desired holdings of cash).
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PPS I think you've nailed the major issues in a very helpful way here Nick--which has been an extremely refreshing experience for me. Pardon the pun, but I now feel indebted to you--in the best sense of the word!
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PPS Yes Nick, I think you've nailed the major issue very accurately. This has been an extremely refreshing experience for me, and--pardon the pun, but--I feel indebted to you for your contribution here!
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On the empirical data issue, I have uploaded the following files FYI. The data goes back beyond Federal Reserve & BEA/BLS data, using historical data and interpolations from historical Census records: http://www.debtdeflation.com/blogs/wp-content/uploads/2013/09/DebtChangeAndUnemployment.xlsx http://www.debtdeflation.com/blogs/wp-content/uploads/2013/09/MortgageAccelerationAndHousePriceChange.xlsx http://www.debtdeflation.com/blogs/wp-content/uploads/2013/09/DebtChangeAndUnemployment.PNG http://www.debtdeflation.com/blogs/wp-content/uploads/2013/09/MortgageAccelerationAndHousePriceChange.PNG I'm the first to concede that I'm not a statistician/econometrician (or accountant!)--nonlinear dynamic analysis is my forte--so I'd be pleased to have others with more expertise analyze this data.
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Re JKH and Ramanan, I don't want to get bogged down in discussions of where an accountant might allocate that purchase: what we agree upon is that if it is allocated to the asset side, then it increases the money supply and demand, as Nick first said, and if to the liabilities/equity side, then it doesn't. It's more valuable to focus on is the point Nick concludes with that "What's special about banks is not what they buy with the money they create, but that they create money", and his original conclusion that my "effective demand is income plus the change in debt", at least when translated into his "Aggregate planned nominal expenditure equals aggregate expected nominal income plus amount of new money created by the banking system minus increase in the stock of money demanded", doesn't violate " any national income accounting identity", and therefore potentially indicates a disequilibrium source of additional demand to that identified in the conventional formula (and the reflux view). This is ultimately an empirical question: if it's insignificant then so will be the correlations between change in debt and economic activity; if it's significant then they'll be strong and provide explanations for what remain puzzles in the conventional view. This is in part Nick Edmonds hypothesis: "I suspect where we differ is whether the increase in spending is permanent or temporary. I think it's temporary". If the effect I've identified is temporary--and if that matters--then the change in debt will not be a significant factor in macroeconomics. I suggest that it's temporary and that that doesn't matter, because--to twist Keynes a bit--in the long run we are always in the short run, so that disequilibrium is a permanent state of the economy even if each instance is temporary. But I could be wrong on that: ultimately, it's the data that matters, not suppositions. So now that we're agreed that there is an effect, let's turn to the empirical data to see whether it's significant. I suggest looking at the correlation between the change in bank debt of the non-bank public and the unemployment rate from (say) 1990 till today. My hypothesis extends to asset markets too, and to the rate of change of demand as well as its level--in which case I hypothesize a relationship between the acceleration of mortgage debt (for example) and the rate of change of house prices (using annual data in both instances since the monthly data in both cases is so volatile). When I have time I'll post a link to data and graphs on this--though of course anyone here can have a crack at it themselves. I'm off to a 7am-9am course now here in Ecuador.
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Nick, on this point: "If I sell my computer to my bank, the money supply expands. If I then buy that computer back from my bank, the money supply contracts. Similarly: If I sell my IOU to the bank (if i take out a loan), the money supply expands. If I then buy that IOU back from the bank (if I repay the loan), the money supply contracts." N0, in the first case the bank is making a purchase of a commodity from you that it has to source from the liabilities and equity side of its ledger--not the asset side. To do otherwise is to commit seignorage--to use its capability to produce the IOUs we all use for transactions for its own use. So when a bank buys goods from non-banks, it uses the funds it has legitimately earned from its business of lending, not by using its capacity to create money. So there is no change in the money supply in either case. Now that we're discussing this topic, I heartily recommend the paper by Graziani that clearly set out the "Monetary Circuit" approach that led me to develop my monetary modeling. The maths in his papers is useless, but the philosophy and "first principles" discussion of what money is, and the nature of monetary exchanges, is really useful. To outline the key passages on this issue, they are that money is: (1) An essentially valueless token (2) Accepted as full payment for goods (3) Which doesn’t confer seignorage rights on the issuer “The only way to satisfy those three conditions is to have payments made by means of promises of a third agent, the typical third agent being nowadays a bank. When an agent makes a payment by means of a cheque, he satisfies his partner by the promise of the bank to pay the amount due. Once the payment is made, no debt and credit relationships are left between the two agents. But one of them is now a creditor of the bank, while the second is a debtor of the same bank.” (Graziani 1989, p. 3) I do of course agree that the very special role of banks is that they create money. Including that properly in macroeconomics alters the field dramatically in my view. Your second case is one of course where they do create money (and repaying the loan destroys it). This is one reason that I have come to appreciate the importance of using double-entry bookkeeping to explain the actions of banks: your first example involves transactions only on the liabilities & equity side of their ledger which transfers existing money but does not create or destroy it; the second involves an increase in assets and liabilities when the loan is made that increases money (and demand) while the repayment reduces assets and liabilities (and demand). Addendum: my definition of money as the liabilities of the banking sector to the non-bank public omitted cash in the possession of the public--of course that is also part of the money supply.
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Two quick comments. Nick, I'm delighted that you've provided a way for us to communicate on this issue, and I agree that Endogenous Money has been given a lot of different meanings, so the two words themselves don't convey a lot. On the reflux issue, I start from a definition of money as the sum of the liabilities of the banking sector to the non-bank public. An expansion of those liabilities (via the issuance of new loans) expands money, while a contraction (via loan repayment) reduces it, both with obvious effects on the level of economic activity. I think that's more the issue than whether or not there can or cannot be an excess supply. On this front, I've recently used the Minsky software (downloadable from https://sourceforge.net/projects/minsky/) that I've developed thanks to an INET grant to juxtapose the Endogenous Money/Reflux-Loanable Funds perspectives with a simple model which, with four keystrokes, can be converted from a model of one concept to a model of the other. If you're interested, I'd like to set out this model and discuss it with you (whether on or offline) and see whether it clarifies the issues being debated. Too Much Fed, I know that Bernanke went on to develop an interpretation of debt-deflation from his perspective, but this was focusing upon asymmetric information and the financial accelerator rather than the disequilibrium and quantity issues that were at the heart of Fisher's analysis.
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Yes that's still an issue Frank: the fact that additional money creation adds to demand doesn't make variations in spending propensities (either between agents or over time) irrelevant, though I think the empirical evidence would show that the former is at least an order of magnitude more important than the latter. Conventional theory has focused only on the latter, which is why Bernanke dismissed Fisher's "Debt Deflation Theory of Great Depressions": "Fisher's idea was less influential in academic circles, though, because of the counterargument that debt-deflation represented no more than a redistribution from one group (debtors) to another (creditors). Absent implausibly large differences in marginal spending propensities among the groups, it was suggested, pure redistributions should have no significant macro-economic effects…" (Bernanke 2000, p. 24) However there's no doubt that Fisher was in fact talking about the former effect: "the payment of a business debt owing to a commercial bank involves consequences different from those involved in the payment of a debt owing from one individual to another. A man-to-man debt may be paid without affecting the volume of outstanding currency; for whatever currency is paid by one, whether it be legal tender or deposit currency transferred by check, is received by the other, and is still outstanding. But when a debt to a commercial bank is paid by check out of deposit balance, that amount of deposit currency simply disappears." (Fisher, Booms and Depressions)
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Re your statement quoted below Too Much Fed, that is a classic example of "Loanable Funds"--"Patient agent lends to impatient agent". In this case there is no new money creation and the borrower's additional spending power is cancelled out by the lender's lower spending power. But a bank lending is the creation of an asset on one side of its ledger and a liability on the other--not a transfer of money and hence spending power but a creation of money and hence spending power. This is the essential difference between Loanable Funds and Endogenous Money. Loanable Fund shows loans as a minus for one agent (fall in money held by lender) and a plus for another (rise in money held by borrower), which cancel out: in mathematical language, this is a conservative system. Endogenous Money shows loans as a plus for one agent (increase in loan assets held by bank) and a plus for another (increase in money held by borrower). The same accounting balance applies, but in math-speak this is a dissipative system with a creation of money and hence spending power. ------------- Quoting Too Much Fed: Nick's post said: "Luis Enrique: (quoting Steve Keen) """In a credit-based economy, aggregate demand is therefore the sum of income plus the change in debt"" What that misses is that some debt has nothing to do with the creation of money, and doesn't have any obvious effect on either the supply or demand for money, or on AD. Like if I borrow $100 from TMF." I save $100. I lend $100 to Nick Rowe (Nick Rowe borrows $100 from me). I believe Steve Keen would call me saving $100 negative debt. Nick Rowe borrowing $100 from me would be called positive debt. Minus $100 plus positive $100 equals zero.
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Having done a more considered re-read, I very happily stand by my first reaction to your post: you've done a very good job of providing a Rosetta Stone between standard Neoclassical macroeconomics, and the perspective on endogenous money macroeconomics that I put forward (along with Richard Werner, Michael Hudson, Dirk Bezemer, Matheus Grasselli and a few others--and I hasten to add that it is still a minority position even within Post Keynesian economics). This is a first Nick, and I have to sincerely thank you for it. It is truly appreciated. Cheers, Steve Keen
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ProfSteveKeen is now following Nick Rowe
Sep 3, 2013
A very quick response Nick. Given that we use different languages to express our economics, I think you've provided a pretty good characterization of my argument. I'm very pleased about that, given that there has been so much non-communication involved in this overall issue until now. I'll leave any discussion of differences of opinion to later. I also note the caveats about bringing math in here, but Matheus Grasselli has recently done a comprehensive analysis of the stock-flow mathematics in one of my models to show that the statement that "effective demand of the non-bank public is income plus change in debt" is accounting-consistent with "income = expenditure" when the banking sector and the non-bank sector are lumped together. Matheus's blog is here: http://fieldsfinance.blogspot.com/2013/08/accounting-identities-for-keen-model.html and the PDF is here: http://ms.mcmaster.ca/~grasselli/keen2011_table.pdf The issue of whether rising debt adds to demand then comes down to whether loans turn up on the asset or the liability side of the banking system ledger. If we treat banks as mere intermediaries as in the Loanable Funds model, then all lending occurs on the liability side of the ledger, and changes in the level of debt have no impact on aggregate demand--as Krugman has repeatedly argued. If however loans turn up on the asset side of the banking ledger, then the change in debt does add to demand via the money creation mechanism you note. I think the empirical issue here is obvious--bank loans do occur on the asset side of the banking system's ledger--so that rising private debt does add to effective demand (to revive an old term, as Nathan Tankus first recommended). So integrating banking into macroeconomics significantly alters it from a macroeconomics in which banks (and normally also debt and money) are omitted.
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Dear Nick, Thanks for your post. You have actually engaged more with my analysis than any other Neoclassical economist to date, so I will happily write a response. However I'm too busy with other issues to respond in detail for about a month. In the meantime, can I suggest another reading for you: Chapter 4 of Alan Blinder's "Asking About Prices": http://www.amazon.com/Asking-about-Prices-Understanding-Stickiness/dp/0871541211 Cheers, Steve Keen
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ProfSteveKeen is now following The Typepad Team
Dec 2, 2012