Monetary Realism

Understanding The Modern Monetary System…

Krugman and Tobin on Banking

Paul Krugman cites a 1963 paper by James Tobin in the process of clarifying his own view of how banks should be considered as part of the broader financial system:

“All the points I’ve been trying to make about the non-specialness of banks are there. In particular, the discussion on pp. 412-413 of why the mechanics of lending don’t matter — yes, commercial banks, unlike other financial intermediaries, can make a loan simply by crediting the borrower with new deposits, but there’s no guarantee that the funds stay there — refutes, in one fell swoop, a lot of the nonsense one hears about how said mechanics of bank lending change everything about the role banks play in the economy. Banks are just another kind of financial intermediary, and the size of the banking sector — and hence the quantity of outside money — is determined by the same kinds of considerations that determine the size of, say, the mutual fund industry.”

The object of the professor’s displeasure appears to be a presumed blogosphere meme that allegedly uses the mechanics of bank lending as the rationale for characterizing a unique role for banking within the financial industry and the economy. And while it is possible that some of those he has previously characterized as banking “mystics” are conflating lending mechanics with some fundamental role for banking, others may be making separate but connected points about these two dimensions of banking quite legitimately. So we should unpack these things and then examine the effectiveness with which Professor Krugman’s channeling of Tobin (Krugman/Tobin for short) refutes the importance of either of these dimensions, whether considered separately or jointly.

First, consider the aspect of bank lending mechanics. This no doubt refers to the general statement that “loans create deposits”. So why do people make this simple point? In most cases, it is made in conjunction with a rejection of the old money multiplier idea that the central bank must supply reserves before a commercial bank can make loans. That said, there is indeed an ambiguity in that association, because the money multiplier even as an incorrectly described process itself features “loans create deposits” or at least can be interpreted that way. Accordingly, the full statement in this context should really translate to “loans create deposits without the necessity of prior reserves”. That is the point being made. And why is that point important? Because understanding how banks work is better than misrepresenting how they work, as has been done in economics textbooks over the last several generations by referring to this particular issue using the false money multiplier model. Indeed, such a view is presented in the Robert Hall paper assessed by Mathew Kline, as referenced in the Krugman post. Moreover, understanding this point is essential in even beginning to interpret the effect of the Federal Reserve’s quantitative easing process in a way that is logically correct. This point has been covered enough elsewhere for purposes here.

The Tobin paper itself refutes (in at least one part) the false causality of the textbook money multiplier, which is good to see for a paper written in 1963. So Krugman can’t be refuting anything so far, using Tobin.

Second, consider the claim that banking is unique. I can think of perhaps one blogosphere case where this issue has been tightly bound with “loans create deposits”, and that case is largely a matter of presentation style. But consider the aspect of banking uniqueness more generally. There is definitely a role for banking that is unique in finance and economics. A good description of it permeates the book Monetary Economics by Wynne Godley and Marc Lavoie. This has to do with the critical role of revolving bank loans used in the financing of business inventories. Indeed, this aspect is expressed in a formal way through the interpretation and adaptation of circuit theory within a post Keynesian context. This aspect is essential to understanding the critical role of banks in economic expansion. It is true in advanced G&L models, and it is true in the real world. In general, workers must be paid before they can buy the output of the economy. The rudiments of circuit theory help explain how that happens through bank lending and deposit creation. Economic expansion requires banks. Krugman/Tobin doesn’t touch on this essential process. If it did, it would negate its own conclusion.

Now, consider how Krugman/Tobin attempts to refute the importance of these aspects of banking – whether conflated or separate.

The main point made by Krugman in his post and in the Tobin paper to which he refers is a strangely benign one. The general point made in the Tobin paper is that banking expands in the same way that other financial intermediaries do – according to economic opportunities. But who is denying this in claiming the importance of either aspect of banking above? It is surely an obvious point to those who have unpacked the two ideas that Krugman considers jointly. Somehow, the grand conclusion of Krugman/Tobin seems to be that banks must price their loans and deposits in such a way that banking can be an economically viable enterprise, in the same way that other institutions price their assets and liabilities toward the same objective. Again, who would think otherwise, in that general sense?

Krugman/Tobin seems to imply that those who observe “loans create deposits” are sufficiently short sighted to think that this point having been made is also the end of the process. In other words, that these loans and deposits once they’ve been created should remain on bank balance sheets forever. Who would think such a thing? It is interesting that the perception of the intellectual damage done by “loans create deposits” itself doesn’t consider the possibility that the reverse mechanics are equally obvious to those who make the initial point – i.e. that deposits are regularly used to pay down the loans that originally created them, and that in this specific context it is also true that deposits may be used to “destroy” loans. It is interesting if not amusing that those who don’t directly acknowledge what goes on in bookkeeping terms when a prospective borrower goes into a bank branch and successfully negotiates a bank loan then proceed to double up by looking away from what goes on when the same person returns to repay his loan. The idea that deposits are used to pay down loans is not only common place in real world banking, but it is also fundamental to formal circuit theory and its application within post Keynesian economics. What Tobin would not have been in a position to be aware of 50 years ago is that is that the focus of modern post Keynesianism makes this dynamic crystal clear in a rigorous accounting sense – an accounting presentation that covers a galaxy of institutional possibilities with flow of funds analyses that extend Tobin’s succinct summary of same in much more detail. However, in the hubbub of considering this overall financial flow of funds, we are led to believe by Krugman/Tobin that those who understand that loans create deposits don’t understand that deposits can destroy loans in the process of loan repayment.

In fact, Tobin’s description of this essential process is somewhat roundabout, not really identifying the necessary micro accounting that records such flows as they traverse the banking system. Tobin summarizes the macro flow of funds between different financial intermediaries in adept fashion, but without referring to the bookkeeping that must occur within the banking system when a deposit “leaves” a given bank or “leaves” the banking system in its entirety. For example, a deposit cannot “leave” the banking system without some corresponding reduction in a loan or other asset, or some corresponding increase in a non-deposit liability or equity capital – those types of entries being made within the same banking system that the deposit previously occupied. Indeed, this is an example of a required “quadruple entry” accounting constraint under such conditions. We leave the associated task of detailing the corresponding pairs of double entry accounting as an option for commenters, where perhaps it may be seized upon with enthusiastic fervor. This is not hugely difficult, and it is a good complement to that other necessary requirement for economic coherence – accurate central bank accounting.

Tobin makes the point that the banking system expands in such a way that deposits account for only 15 per cent of household wealth. Something happens relative to a counterfactual in which all new saving flows into deposits created by loans. This reflects a straightforward feature of banking system expansion. Individual loans get repaid (or default) but the system still expands. It’s analogous to the job market. The monthly flow of actual gross job creation and gross job destruction is far greater than the flow of net job creation. And similarly for international capital account flows – the gross flows exceed the net flow that matches up with the current account balance. Again, accounting plays an essential role, and such accounting is the stock/flow in trade for the broader post Keynesian object audience (implied knowingly or unknowingly) of Krugman’s criticism.

So we are led to believe that understanding the expansion process described by Tobin/Krugman dominates the relevance of the observation that loans create deposits – because in effect those who make the point that loans create deposits are assumed not to understand that deposits can and do destroy loans in the process of loan repayment. One might be forgiven for assuming that this is intended to characterize certain provocateurs of “loans create deposits” as being members of a particular savant club.

As a side issue, it is unclear what the importance today is of the point being made by these Tobin papers (mostly Tobin Brainard) with regard to their microscopic examination of the “monetary control” effect of required bank reserves or deposit ceilings in 1963. Required bank reserves are a tax in effect, working essentially through price rather than quantity, as the central bank supplies the quantity of required reserves to the banking system after the deposits that generate the requirement are created. On the more relevant pricing front, required reserves increase the overall expense associated with the economics of making a bank loan. Other expenses include such items as employee compensation, the interest rate paid on deposit funding, income tax, and the cost of equity capital. All of these things need to be taken into account in determining break even pricing for a bank loan, so that all expenses including the cost of equity capital are adequately covered. These are things that determine whether a loan that is being considered is actually made by a bank – not the quantity of immediately available bank reserves (in either required or excess form).

Required bank reserves are a form of “monetary control” (Tobin’s language) that have a tightening effect on monetary conditions, in the sense that they push up the interest rate at which loans can be done on economically viable terms, compared to the counterfactual. And the fact that currency may move back and forth between public holdings and bank reserve holdings as a function of interest rate levels is an intriguing analytical curiosity, and one that complicates the calculus of determining the effect of monetary controls, but one of little importance to today’s monetary system and the implementation of central bank policy. Importantly, risk weighted capital measures along with capital adequacy regulations are the modern banking system’s natural successor to these old reserve requirements. In conjunction with that, some countries at the top of their monetary game (e.g. Canada) have recognized the essential role of bank reserves as settlement balances, and when considering that along with technological advances in payments systems, have decided to eliminate required reserves. Excess reserves and their correct interpretation (pre-2008 and QE) are the only real reserve game in town.

In other words, this all seems obvious in the context of what is being analyzed more broadly by many of those at whom the professor is taking full or partial aim (it’s hard to tell who is whom in the cavalcade of assumed culprits). But dusting off Tobin from 50 years ago (admittedly two excellent papers in reference here) just isn’t absolutely necessary in this context, given an accurate understanding of how the modern banking system operates. And the mere fact that Tobin categorizes banks as one type of financial intermediary obviously suggests that there is a common element in that particular scheme – which is what Tobin describes. Great. We can all agree on that commonality and the way in which it captures the mode of setting economic objectives and the corresponding pricing behavior of financial intermediaries in a general way. But this commonality in no way logically negates the elements of uniqueness in banking or their importance.

All this being said, there are some interesting additional points to be made about Tobin-Brainard, although a detailed review of this paper must be deferred to a future post.

First, it is critical to recognize that the model simplification employed in Tobin-Brainard assumes that all government liabilities pay a zero rate of interest – currency, bank reserves, and debt. While this is no doubt done to make orthogonal points about commercial banking with more clarity, it raises enormous questions about the entire framework for “monetary control” being used in that paper. And it has significant implications for the measured effectiveness of monetary controls in that context. Said another way, the absence of a positive interest rate possibility for the fed funds target rate in such a model invites serious questions about why the primary interest rate in the economy is not considered more realistically in its standard role as a mechanism of monetary tightening and easing – in contrast to the core role that the authors employ in the case of currency used with great leverage in a zero interest rate model. That said, I see no reason why the analysis of reserve and interest rate ceiling effects wouldn’t hold in a more complex and realistic model regime of non-zero government interest rates. But with that change the story surely advances in complexity and emphasis, just as the methodical model development in Godley-Lavoie illustrates a step-wise evolution from a starting point of a simple model that bears some resemblance in construction to that of Tobin-Brainard. This consideration should be combined with the more comprehensive importance of bank capital management in determining the fuller scale of “monetary control” in today’s banking system.

Second, we should note something briefly about the contrast between the Tobin and Godley-Lavoie frameworks for banking analysis. (This is very much a personal opinion.) Tobin-Brainard employs a general equilibrium model of portfolio balancing. I think Godley-Lavoie is compatible with this approach, although Godley-Lavoie seems to dispute this to some degree. At least that is my rough interpretation of it. I think Tobin-Brainard is compatible as a model with the modern approach of banks in their strategic balance sheet management, using risk management, pricing and other comprehensive portfolio strategies. I also think that Godley-Lavoie is an enormously sophisticated and accurate view of the logic of actual bank operations as modelled. That operational view is consistent with depicting outcomes of strategic balance sheet management. I see these two different views therefore being compatible rather than conflicting.

Returning briefly and finally to the Tobin paper on money creation, it is obviously a very good one and an important one historically. But it doesn’t refute the intellectual usefulness of points made by those today who correctly observe that central banks provide required reserves after the fact, or that bank finance is essential to economic expansion. The observation that banks are like other financial institutions is obviously implicit in their categorization as one type of financial intermediary. But that this idea should somehow disprove the relevance of the observation that they are unique according to the intended context and meaning of the phrase “loans create deposits” is very strange. Banks are different in the ways described, and these are important differences for the reasons described.


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195 Responses

  1. Tom Brown says

    … or how about an online game with real money stakes (to get people to play). Anybody use that kind of thing for doing “experimental macro economics?”

  2. Tom Brown says

    Ramanan, JKH, and Nick: Thanks so much for your comments and insights! It’s nice to get some hint from you that “it’s more complicated than they’re making it out to be.”
    And let me tell you something else… you guys are in luck because I had a LONG rambling, philosophical response written out exploring my thoughts on “head of a pin,” varying degrees of hotness in a whole sack of potatoes, where I thought each party had oversimplified or where they were talking past each other (in Glasner’s debates)… including links to examples, bad jokes and everything… and then I clicked on JKH’s Godley-Lavoie link above and whoosh! it was gone! The short version is that I think I understand Nick Rowe a lot better now, but at the same time have a better feel as to his oversimplifications. The same can be said of the other parties to some degree or another. Although I enjoy the “head of a pin” rationalism these MM/NK debates entail, and their fun stories… in the end it doesn’t substitute well for a more rigorous approach. I think the time has come to bite the bullet and look at Godley-Lavoie. But I have NO formal education in economics… is it a book someone like me can just pick up and start reading? … or is there a prerequisite or two or three or four I should start with?

    I’ll leave you all with one last question regarding Nick Rowe’s stance (there are SO many articles to choose from):

    The most interesting part of this post seems to be the part he wrote in strike through and didn’t finish (containing this bit):

    “Does this mean the stock of money is demand-determined? Absolutely not, because the demand for bank loans is a flow demand for loans, and the demand for money is a stock demand for the medium of exchange, and those ain’t the same thing…”

    What do you suppose he was getting at there? What does he mean a “flow demand?”

    • Nick Edmonds says


      Flow demand and stock demand should really amount to the same thing.

      The stocks everyone starts any period with are given, whether that’s loans or money. The flow (net flow that is) determines the stock you finish the period with. You can view the demand as being the demand for a flow or demand for a stock, but one implies the other, so it doesn’t make any difference.

      If anything, I think the relevant distinction in the crossed out bit of Nick’s post is between gross flow and net flow, i.e. just because someone is prepared to receive a gross amount of $1,000 for goods, say, doesn’t mean they want their money balances to increase by that amount.

      Having had a quick look at what you’re doing on your blog, I’d say you’d find Godley / Lavoie invaluable.

      • Ramanan says

        I’d say one can make a distinction between flow demands and stock demands. This is neater for things which are pure flows and have no stock counterparts – such as consumption. So one can think of consumption demand which is a flow demand.

        Such distinction is made for example by Kaldor for defining aggregate demand where aggregate demand is flow demand or “outside demand” in this case while “inside demand” or demand for inventories is a stock demand.

        But for things such as money which is both a stock and a flow (i.e., change in money held) that distinction isn’t that important.

        • Nick Edmonds says

          Yes, I think some demands are easier to understand in terms of their stock implications than their flow implications. So the demand for money (or inventories) is best understood by thinking of the stock that people wish to hold. My point was really only the perhaps rather the obvious one that if you have a stock demand that implies a flow demand.

        • JKH says

          what do you think NR means by it?

        • Ramanan says

          Seen in the light of this discussion, it seems that Nick Rowe is in constant denial of the fact that his monetarist hot potato story is a fantasy.

        • JKH says

          That all makes sense. Stocks are the same as or different from flows in the sense that they are cumulative flows. Flows are the same as or different from stocks in the sense that they are differential stocks. Sort of trivial calculus type stuff where sameness or difference depends on what you want to emphasize. Still, its probably more common to talk about the demand for money as a stock demand (i.e. outstanding quantity as per monetarism) than it is to talk about the demand for loans as a stock demand. Yet the logic is probably the same in terms of the calculus of stocks and flows. Maybe we should attribute it to monetarist bias in flow of funds interpretation.

        • Ramanan says

          Should have said although it makes sense to talk of flow demands versus stock demands, it’s just that Nick Rowe seems to be using that in a strange way.

        • Nick Edmonds says

          As I said, I think he was thinking about gross flows vs. net flows and I based that on the bit (in his crossed out text) where he says:

          “….just because someone wants to accept money in exchange for an IOU doesn’t mean he wants to hold a bigger stock of money…”

          I interpret this as saying that just because someone accepts a positive flow of money on one transaction doesn’t mean that they want an overall net positive flow of money in the relevant period. Which is a gross vs net issue.

          But maybe he meant something different.

    • JKH says

      I don’t know what he means.

      One thought – once money is created by loans, it becomes a homogenous thing used for transactions. People want a certain amount of it in their asset portfolios but no more. So any excess stock becomes a hot potato (according to the hot potatoists). The demand for the amount of money is the demand for a stock amount within a portfolio. Get rid of the rest.

      The demand for loans is a flow demand in the sense that each new loan creates a flow of new money for a specific purpose. It’s more difficult to say there is a stock demand for loans because the outstanding aggregate portfolio of loans is very heterogenous. And people don’t “use” the stock of loans the way they use the stock of money. The stock of money is subject to a turnover velocity as its being actively used in the economy. The stock of loans is just a record of the origination of loans and money. It’s a record of flow demand whereas money is a “live” stock demand.

      But I don’t think this is a hugely important thing to emphasize.

      On G&L, I think it’s an excellent investment. It’s not a particularly easy read, IMO. There’s an enormous amount of matrix notation throughout the book – which turns out in effect to be expressions that summarize balance sheets and income statements. It’s a lot of macro accounting without debit and credit language, so it can be tedious. But the accompanying text is very rich in insight as to the logic of how the monetary system works. I think anybody that uses it has to spend a long time with it and read it gradually.

      • JKH says

        On G&L, you’ll see an enormous difference between it and the type of discussion at NR’s. The latter can be very interesting sometimes, but it never seems to end, IMO. It seems like participants are always inventing new models on the run, forever. The overall tone of G&L is very conclusive in terms of some of the logic that the authors know must hold in the relationship between behavior and feasible accounting (i.e. real world) outcomes. They obviously don’t know everything, but its refreshing to get through each chapter and see some decisiveness about the explanation rather than unending brain scratching.

        • Tom Brown says

          Also, just to be clear JKH, is it your view that HPE and Law of Reflux are both partially true wrt common types of money (broad & base)? It’s not fully one way or the other due to a host of factors? Would that be fair?

        • JKH says

          Yeah, I think that’s right. You have to be very specific about the institutional setting and circumstances. Its more a matter of using those words in the description of particular cases than trying to define what those words mean in categorical terms. The latter is just too difficult. Maybe it’s like case study in law.

        • Tom Brown says

          Do mainstream macro people read it? (not that it will influence my decision to buy it). I googled “Godley themoneyillusion” for example, and one of Sumner’s readers was encouraging him to read it. He didn’t poo poo it… just said it was too complicated… and that he prefers simple models. I guess I was glad his response wasn’t “I would never read that muddled garbage!” I was also looking for evidence of Mark Sadowski referring to it… but didn’t find any. (He sure doesn’t think highly of the RBC people though! Shoot!). I was just curious if a self respecting MMist, traditional monetarist, or NKer would read it.

        • JKH says

          Interesting question – I don’t know. Probably not. You have to be quite invested in the idea that institutional arrangements matter to even pick up the book , and that seems to be a violation of most of mainstream economics (see my quote from Coase above). And it is a fairly significant time investment to try and make it through the entire book. There are a lot of matrices, and many different models. The models are like different slices of the economy under different assumptions, but they’re all coherent with respect to how they fit together as a whole.

      • Tom Brown says

        OK… I’m OK with linear algebra and matrix notation if that’s what you mean by “matrix notation.” Thanks for the feedback.

        • JKH says

          You should get the book.

    • Tom Brown says

      Is the HPE something that could be tested in a kind of economics laboratory? Seems like a possibility to me. (i.e. get a bunch of students in a room, and run some kind of a “laboratory” test on them… some kind of miniature economy).

      • JKH says

        Best tested at a barbecue to see if anybody starts refluxing potatoes over the fence and into the neighbours back yard.

        • Tom Brown says


  3. JKH says

    This is the truth:

    “Economics as currently presented in textbooks and taught in the classroom does not have much to do with business management, and still less with entrepreneurship. The degree to which economics is isolated from the ordinary business of life is extraordinary and unfortunate.

    That was not the case in the past. When modern economics was born, Adam Smith envisioned it as a study of the “nature and causes of the wealth of nations.” His seminal work, The Wealth of Nations, was widely read by businessmen, even though Smith disparaged them quite bluntly for their greed, shortsightedness, and other defects. The book also stirred up and guided debates among politicians on trade and other economic policies. The academic community in those days was small, and economists had to appeal to a broad audience. Even at the turn of the 20th century, Alfred Marshall managed to keep economics as “both a study of wealth and a branch of the study of man.” Economics remained relevant to industrialists.

    In the 20th century, economics consolidated as a profession; economists could afford to write exclusively for one another. At the same time, the field experienced a paradigm shift, gradually identifying itself as a theoretical approach of economization and giving up the real-world economy as its subject matter. Today, production is marginalized in economics, and the paradigmatic question is a rather static one of resource allocation. The tools used by economists to analyze business firms are too abstract and speculative to offer any guidance to entrepreneurs and managers in their constant struggle to bring novel products to consumers at low cost.

    This separation of economics from the working economy has severely damaged both the business community and the academic discipline. Since economics offers little in the way of practical insight, managers and entrepreneurs depend on their own business acumen, personal judgment, and rules of thumb in making decisions. In times of crisis, when business leaders lose their self-confidence, they often look to political power to fill the void. Government is increasingly seen as the ultimate solution to tough economic problems, from innovation to employment.

    Economics thus becomes a convenient instrument the state uses to manage the economy, rather than a tool the public turns to for enlightenment about how the economy operates. But because it is no longer firmly grounded in systematic empirical investigation of the working of the economy, it is hardly up to the task. During most of human history, households and tribes largely lived on their own subsistence economy; their connections to one another and the outside world were tenuous and intermittent. This changed completely with the rise of the commercial society. Today, a modern market economy with its ever-finer division of labor depends on a constantly expanding network of trade. It requires an intricate web of social institutions to coordinate the working of markets and firms across various boundaries. At a time when the modern economy is becoming increasingly institutions-intensive, the reduction of economics to price theory is troubling enough. It is suicidal for the field to slide into a hard science of choice, ignoring the influences of society, history, culture, and politics on the working of the economy.

    It is time to reengage the severely impoverished field of economics with the economy. Market economies springing up in China, India, Africa, and elsewhere herald a new era of entrepreneurship, and with it unprecedented opportunities for economists to study how the market economy gains its resilience in societies with cultural, institutional, and organizational diversities. But knowledge will come only if economics can be reoriented to the study of man as he is and the economic system as it actually exists.”

    Ronald Coase

    • Tom Hickey says

      Exactly. Business people — entrepreneurs and managers — read Peter F. Drucker rather than Milton Friedman. And they also read John Kenneth Galbraith, who the economics profession didn’t consider a real economist because he eschewed models in favor of narrative. While theoretical economics was mostly dropped from the curriculum of business schools, accounting, finance, and decision theory were emphasized as especially useful tools.

  4. Tom Brown says

    Ramanan, thanks for your response! I don’t follow you completely though. First of all, where did the “fiscal dominance” quote come from? I didn’t see it in DOB’s post or here. Also I don’t follow this:

    “So the idea is that their theory itself is right but it’s just that the above qualification could not have been met because of the supposed “fiscal dominance”. ”

    You write:

    “The central bank doesn’t control money but via changes in interest rate can control the money supply and hence set the price level. ”

    I think he’s actually claiming he can control the stock of money in circulation, the price level, AND target inflation and/or NGDP (or something else?) all at the same time: he’s got more that one knob he’s giving the CB to twiddle, so I guess if that’s really the case (and they’re independent) then you supposedly could have more than one control outputs.

    This is what Sumner had to say:
    “DOB, Yes, that looks like a standard Woodfordian model to me. I have no objections at first glance. You simply do monetary policy by adjusting the demand for MOA to control its value, not the supply.
    I work with supply of MOA models because currency doesn’t pay interest.”

    I think that ties into what you’re saying about it being the same old thing, repackaged a bit perhaps.

    “natural rate of interest” … that’s a Wicksell idea (yes, I used Wikipedia!). He writes about it there and in his “banking” post as if this is something actually used in the finance/banking industry. I have no idea (I’m an amateur)… but is that true?

    BTW, what are your views on “The Law of Reflux” as applied to MOE? (Rowe disagrees w/ Glasner & Mike Sproul on this):

    DOB claims banks are NOT special, and he (like Sproul) is a Law of Reflux believer wrt MOE. I’m wondering if that’s what separates them (Rowe is willing to grant banks ARE special, but only because they can create excess supply of MOE and MOE is special… and I think he thinks MOE is special because he thinks the Law of Reflux doesn’t apply to it (paraphrasing): “N goods including MOE, then there’s N-1 money markets, etc.”

    Any of that overlap your views, or are they all out to lunch?

    • Ramanan says

      About Reflux – denying is in the best interest of those who believe in the Monetarist hot potato process.

      Of course while the reflux mechanism works constantly in the background – without anyone noticing, it alone is not sufficient to dismiss the hot potato process. Hence those who believe in the hot potato dismiss it so simply. They could perhaps say that the reflux is true and still maintain their stand but instead simply dismiss it – as if it has no truth.

      Equally importantly in addition to the reflux mechanism there is asset allocation/reallocation process which changes prices of financial assets and the quantity of money and together with the reflux mechanism can be used to say that the hot potato process has no truth. It is a slightly complicated argument – I think I will write a post on this sometime.

      • Tom Brown says

        Thanks Ramanan… doing my best to digest. Interesting comment about what works in macro and blaming gov. I’m reading this right now:
        It seems there’s three opinions there:

        Nick Rowe/Bill Woolsey: bank & base money can be hot potatoes (anti-Tobin/anti-equilibrium/pro-disequilibrium)

        David Glasner: base can be hot potato, bank cannot (pro-Tobin/anti-Yeager/pro-equilibrium)

        Mike Sproul: no hot potatoes (Law of Reflux always works for base & bank/pro-“backing theory”)

        • Nick Edmonds says

          The problem I have with the hot potato analogy is that gets used as what the philosopher Daniel Dennett calls an “intuition pump”.

          The analogy is usually used within a simple imaginary economy with a very limited financial sector, often just goods and money. In that context, it is easy to be convinced by the idea of people only accepting money so they can pass on it on for real goods – no-one wanting money for money’s sake.

          The idea is not nonsense – I’d even go so far as to say it is a useful conceptual tool. But I think great care has to be taken in extending it to the real world. In real economies, there is a whole spectrum of financial assets, some more money like than others. Importantly this is not a fixed spectrum of assets – it morphs in response to the monetary environment, with new types of assets created or modified in response for need. When we conceptualize the hot potato story, we imagine that both the amount of money in circulation and the amount people wish to hold are given. In the real world, there is too much going on for that to hold.

          So there is some truth behind the hot potato story. But to understand it in a realistic context, it needs a more complete framework. As Ramanan says, Godley / Lavoie provides good examples of exactly that.

        • JKH says

          interesting discussion there

          but at the end of the day, it seems in considerable part like monetarist angels dancing on the head of a pin

          notice how many of the exchanges end up being disagreements as to the meaning or definition of terms – i.e. circular discussions

          instead of following through on various scenarios in specificity

          ALL of which can and should be depicted in accounting terms

          there are also a few errors, like this one by Glassner in comments:

          “Bill, Sorry, but I don’t seem to be getting your point. The Fed is paying interest on reserves, so banks are more than happy to hold whatever amount of reserves the Fed chooses to create. The reserves are not a “hot potato” because banks are happy to hold any reserves the Fed creates. I am not saying that this results in an equilibrium, just that there is no hot potato effect.”

          overlooks the fact that the Fed must pay interest on excess reserves to set a lower bound for fed funds – and funds would go to zero without that – which means the interest rate argument is moot in terms of its role in anti-hot potato

          (the current difference between 25 bp and 0 is not relevant; its done for operational reasons in consideration of NBFI interest margins)

          But not to be too cynical about technique, because its quite an interesting discussion in terms of content

        • Ramanan says

          Thanks Tom. Will read.

          I think I am reaching a conclusion that people believe in the quantity theory of money because they do not know the alternative to this hot potato well (even though they don’t know what hot potato itself is well).

          Also is the Basil Moore view which has no Tobinesque mechanisms at all and in which bank deposit holders non-volitionally lend the deposits to banks. A bit artificial.

          Funnily Steve Keen who talks a lot of endogenous money also doesn’t know the mechanisms and there is still excess money. It’s just that he knows it isn’t right to assign causality from money to prices.

          The best way to look at all this is via the models of Godley/Lavoie and one can see these things precisely. Tobin had attempted this but his analysis was not complete plus he had the neoclassical theory of prices and profits.

    • Ramanan says

      “The central bank doesn’t control money but via changes in interest rate can control the money supply and hence set the price level. ”

      Oh that was not my claim but phrasing the claim of others.

    • Ramanan says


      Actually it was more a self “a-ha” for me – as I was trying to find out earlier this week how this fiscal dominance of the central bank story came into existence!

      I wanted to say that such ideas

      ”There is nothing that fiscal policy, commercial banks, or the private sector can possibly do that cannot be offset by the right interest rate policy.”

      from the blog post have existed for long. And the blog post is just some minor changes from the old ideas.

      One of the things about Macro is that they make some claim and if the claim doesn’t work, they blame the government instead of changing the claim. So the idea that monetary policy can do anything has existed for long. The claim just got stronger. And the idea of fiscal dominance is a kind of (strange) explanation of why the claim continues to hold.

  5. Tom Brown says

    O/T: Michael Woodford fan (DOB) designs a fiat currency:
    Sumner has no objections. Thoughts?

    • Ramanan says

      Monetarism plus Barbaric Relic!

      • Tom Brown says

        “barbaric relic” Lol… are you referring to Sumner’s phrase about the gold standard recently?

        It’s kind of unique monetarism though… monetarism w/o any money. Or maybe that’s old hat to NKers?

        So what would be your top three comebacks to that? Or where’s the 1st place he goes off the rails?… other than wholesale rejection reality that is.

        • Ramanan says

          oh just kidding about the barbaric relic – basically meant to say that it’s the same old ideas which have existed since then.

          So you know why ideas of “fiscal dominance of the government over their central bank” exist?

          ” There is nothing that fiscal policy, commercial banks, or the private sector can possibly do that cannot be offset by the right interest rate policy.”

          So the idea is that their theory itself is right but it’s just that the above qualification could not have been met because of the supposed “fiscal dominance”.

          The idea is the same but with a different emphasis. The central bank doesn’t control money but via changes in interest rate can control the money supply and hence set the price level.

          Most of the ideas such as NKE, DSGE etc are finally just some minor changes here and there to already existing ideas.

          And note how the post begins with the “natural rate of interest”.

  6. Cullen Roche says

    There seems to be a few different lines of thought on the purchasing power issue and “specialness” of banks. For instance, does the issuance of t-bonds by the govt add to aggregate demand? Well, if you take the MR view then deficits add NFA and redistribute existing money (Peter buys a bond and the govt sends his deposits through to Paul, a recipient of spending). Peter has a bond and the same net worth AND Paul has deposits he didn’t previously have. Does that add to aggregate demand? I’d say yes. What about when a corporation issues common stock? It’s actually a similar transaction. The co issues shares to Peter who sends his deposits on through to the co who then spends them into Paul’s account. Did that increase aggregate demand? I’d say yes. We didn’t need banks involved in any of this.

    BUT, I’d argue that there’s a difference between banks and these forms of non-bank securities issuance. You can just about ALWAYS go to the bank and obtain new funds to spend. You can’t always go to the govt and corporate America for new securities or even to the secondary market to sell existing securities. So there’s an element of on demand aggregate demand issuance that banks have power over. That is, I could go to the bank right now and get a loan to buy a car that would add to aggregate demand. But if the govt isn’t spending or corporate America isn’t spending then there’s no new issuance involved and spending by them is just redistribution of existing money (without the financial asset creation).

    I don’t think adding NBFI’s into this simplistic view changes the story much. New asset issuance can potentially increase aggregate demand whether it’s a NBFI, bank or non-bank corporation. But I’d argue that banks hold a certain specialness because it’s the on demand readiness to provide liquidity that makes them special. This isn’t true for all economic agents and I’d argue that banks play an overwhelmingly special role in this process.

    • Cullen Roche says

      This also feeds into the whole “balance sheet recession” concept that I really latched onto in the last 5 years. If you understood why banks were so crucial to providing liquidity for this on demand contribution to AD then you understood why a broken banking system would contribute to a weak economy. And if you understood that then you understood why it was so important for someone else to pick up the slack. The US Govt did that for 4 years and corporate America has done it increasingly in the last 18 months.

      You didn’t need IS/LM models, QTM, Tobin or anything to understand this. In fact, those views seem to give people a more muddled view of all this stuff….

  7. Ramanan says

    My comment here:

    Also looking at Keen commenting on Nick Rowe’s blog, it looks as if he is saying non-bank lending doesn’t affect aggregate demand and things such as that.

    • Ramanan says

      And I think the confusion there lies in generalizing statements.

      So if there is some relationship between many variables, it may or may not survive when you generalize the model.

      To exaggerate a little, what is being done there is like taking lecture notes on projectile motion and concluding that any particle thrown anywhere in the world will have a horizontal acceleration of zero.

      • JKH says

        In the category of things that I don’t understand, that’s one of the most impressive analogies I’ve ever heard.


    • JKH says

      And to the degree that non-bank lending does affect aggregate demand, it reinforces the way in which Krugman/Tobin is correct – this is a way in which banks are not special. Not being special in one way doesn’t require not being special in all ways.

    • Nick Edmonds says

      Yes. I’m pretty sure he doesn’t think non-bank lending counts, and it seems this is because he thinks it has to create “endogenous money” in order to affect demand.

  8. GLG34 says

    Ramanan or JKH,

    Thanks for a great discussion. Are you saying endogenous money doesn’t mean banks can add to aggregate demand? I thought the difference between a bank and a non bank is that a bank loan increases purchasing power and a nonbank loan doesn’t because they’re just redistributing their purchasing power to someone else. Can you elaborate or clarify this point?

    • Nick Edmonds says
      • JKH says


        Some good points there.

        – The “loans create deposits” thing is usually invoked in the context of banking, but the intended meaning should be clarified in the context of the potential for NBFI liabilities to be classified as “deposits”. That said, it’s usually a banking context.

        – “The point is that it is quite wrong to say that NBFI lending doesn’t add to the medium of exchange and therefore cannot be expansionary.”

        I’d be more circumspect about the using the active “add to” language; it’s more an indirect reaction function.

        – Relative to that reaction function, I think it’s more general than the case of NBFI lending. Anything that results in the expansion of the household balance sheet can lead to a similar result – to the degree that households hold an exercisable put option on certain non-demand-deposit liabilities of banks (exchangeable for demand deposits) and to the degree that the stock of exercisable options (i.e. the stock of corresponding non-demand-deposit liabilities) hasn’t yet been exhausted. The expansion of NBFI savings deposits may trigger the exercise of that option. But that’s only one source. For example, the expansion of equity claims issued by non-bank, non-NBFIs held directly or indirectly by households (i.e. all such claims) could have the same result to some degree. This is all part of a broader portfolio choice function. Without elaborating further here, I think the specific example of NBFI lending can be framed in this much larger context.

        • jt26 says

          Hi JKH, just to clarify my interpretation of what you are saying:
          (a) JKH September 4, 2013 at 6:45 am: I think you are saying that for NBFI checkable deposits, there may be expansion of bank MOE via the banks acting as the liquidity provider for the NBFIs?
          (b) JKH September 4, 2013 at 5:50 am: I think you are saying that, NBFI lending could increase bank MOE, via the NBFI lending creating more lending in the banking sector (e.g. subprime mortgage lending via shadow banks increases net worth if house prices go up which allows for more borrowing capacity from the formal banking sector)?

        • JKH says

          5:50 a.m. As an example, suppose the economy expands in such a way that a corporation makes a real investment that it finances with debt, that an insurance company buys the debt security and issues a claim on a future pension, and that a household acquires that pension claim, with a corresponding increase in net worth. That’s a stylized example of household saving flowing through to real investment with a bunch of financial intermediation in between. Suppose all of that has been achieved using the existing money supply – however defined, it doesn’t really matter. Consider all of that being incremental at the margin with everything else being the same. Suppose the household at the start had a portfolio mix of assets that include some demand deposits and some term deposits, both with a bank. Given the long duration nature of the pension claim, the household has now increased the average duration of its asset portfolio and reduced its proportionate liquidity (demand deposits) compared to the start. If it wants to restore its asset mix proportions, it will want to increase its liquidity relative to its overall asset expansion. It can do this by maturing term deposits and leaving that in the form of demand deposits.

          6:45 a.m. I think what I’ve written there is not particularly clear – to myself or anybody else. The safe thing is to assume that NBFIs cannot offer checkable deposits. I was just thinking out loud about whether that had always been the case or whether it is absolutely impossible now. So consider it academic.

        • Nick Edmonds says


          I’d be inclined to agree with all of that.

          I’ve written in other posts about the same point applied to direct funding from households to firms, i.e. where no intermediary is involved. I used NBFIs here only because that seemed to be the focus of recent discussion.

    • JKH says

      As an extreme simplification, I’d say that bank loans and endogenous money creation are essential to the process of production of both consumer goods and capital goods.

      However, real fixed capital investment held by production firms tends to be financed more by long term debt and equity. And that debt and equity tends to be held by non-banks.

      So bank loans are critical to the flow production basis, but debt equity finance is critical to the long term financing of real investment stock. So the macro balance sheet profile of the economy shows a lot of debt/equity finance that corresponds to accumulated investment and wealth, and bank lending that corresponds to inventories and production in process.

      But there’s more to bank lending than that. For example, the Canadian banking system holds about half of the residential mortgages in Canada and there’s something supporting that on the other side of the balance sheet. What the “loans create deposits” snapshot fails to see though is that banks practice active liability management that in most cases ends up transforming the original demand deposits created by lending into something else. And this is the case in Canada with bank mortgage lending. There’s a large chunk of fixed term deposit funding behind those Canadian mortgages, funding that came about in effect by conversion from demand deposits back when the mortgage was booked and the deposit created… along the lines of this interpretation:

      To complicate things further, a good part of mortgage lending is for purposes of financing existing housing rather than new housing, so that’s disconnected from the new housing component of GDP in the direct sense, although there are spill over effects to aggregate demand.

      • GLG34 says

        Hi Nick and JKH,

        Thanks for the helpful replies. I am still a little confused on this point. It seems to me that loans from banks are quite different from loans by NBFIs. A NBFI can issue a CD, for instance, but doesn’t the NBFI do that so they can obtain the deposits from the CD buyer? This adds a new financial asset to the private sector (the CD), but that doesn’t necessarily add new money. And the CD owner can’t spend the CD at a store so they want to spend and actually add to economic growth then they must sell the CD. Thus, don’t NBFIs defer spending by issuing financial assets whereas banks can issue a zero duration deposit by issuing a loan? This adds to immediate demand and economic growth whereas the issuance of a CD defers someone’s spending.

        Am I wrong?

        • JKH says

          These are very good questions.

          I’m not sure that in this entire blogosphere discussion we have a good picture of a generic structure for an NBFI balance sheet or its operation – or more accurately a good picture of the range of heterogeneous balance sheet structures across different NBFIs. That may be one of the weaknesses of the entire discussion.

          It’s been a long time since I looked closely at a generic NBFI balance sheet structure. But I seem to recall that some NBFIs at one time (e.g. trust companies in Canada before they were bought by the banks) could issue checkable deposits. That would require that the NBFI have a clearing account with a bank for that purpose – and that checks written on the NBFI be cleared ultimately through the NBFI’s banker – sort of a two-tier financial institution payer structure in that sense. Cheques written on an NBFI deposit account couldn’t clear directly with the central bank, but could clear indirectly by clearing first with the banks that issued and accepted them. I don’t know if that’s right, or if there’s anything like that now. But if it was right, then presumably NBFI loans could create checkable deposits as NBFI liabilities. That said, this sort of thing wouldn’t seem to be intuitively obvious from Tobin’s 1963 paper, for example.

          So assume that’s not the case – that NBFIs can’t create checkable demand deposits from their own loans (checks that clear not through the central bank immediately but first through their banker).

          (Can anybody confirm this absolutely categorically? I wonder.)

          And apart from that, the NBFI balance sheet structure of those old trust companies would have been far different than say an insurance company.

          More broadly, one of the main issues is the more general liquidity structure of both bank liabilities and NBFI liabilities.

          We know there is ample liquidity back and forth between demand and time deposits on bank balance sheets – depending on the maturity structure and call features (if any) on time deposits. Canadian banks issue both callable and non-callable term deposits for example. And one of their important funding instruments is non-callable GICs (guaranteed investment certificates). These non-callable term deposits and GICs are “locked in” – they can’t be converted into a demand deposit until maturity (with certain compassionate reason exceptions). Similar things might be found as NBFI liabilities.

          In both cases, and quite apart from the question of NBFI checkable deposits, there are liabilities that can be exchanged quite immediately (even if they are only time deposit maturities) for either a demand deposit in the case of banks or something close to a demand deposit in the case of NBFI deposits – even if is a check written on an NBFI that then clear through its bank. After all, how does one get one’s money out of an NBFI?

          I think it’s that apparent liquidity profile of liabilities across the full spectrum of bank and NBFI balance sheets that needs to be looked at – separate from the clearing arrangements that are special to banks. What proportion of NBFI liabilities exist as something that either looks like demand deposits or can be converted into something (e.g. a check) that can be transferred immediately to another financial institution where it can be immediately accessed as a demand deposit?

        • Nick Edmonds says

          I’m not sure I quite follow you. You start off talking about loans from banks or by NBFIs. These are assets of banks or NBFIs. You then talk about CDs and deposits which are liabilities of banks or NBFIs. I’ll assume you are talking about the liability side.

          My main familiarity is with the UK. In the UK, a CD can only be issued by a bank, because it is a certificate of deposit and to take deposits in the UK, you have to have a banking licence. A CD is transferable, but you couldn’t spend it in a shop, so you would have to sell it or cash it in if you wished to spend.

          Whether it is money depends on what you count as money. CDs are included in the broad money definition, just as deposits are, but you might reasonably say it’s not money because you can’t spend it. Part of the reason why it’s useful to include it in a monetary measure is because that measure will then bear a close relationship to lending. Narrower measures of money, like checking account balances, have a much weaker relationship with lending because the balance between checking accounts and deposit accounts can change so easily. That was the main point of my post. The relationship between bank loans and the checking account balances of the non-financial sector is a weak one.

  9. Ramanan says
      • Nick Edmonds says

        Very interesting.

        Is that supposed to endorse Steve Keen’s definition of aggregate demand? It appears to refute it (i.e. it appears to be a simple manipulation of some accounting identities).

        • Ramanan says

          And the way it has been written such as:

          “bank demand = bank income + change in debt of banks to firms and households”

          is slightly misleading. As an identity of his model, it is okay but still ….

        • Nick Edmonds says

          And “change in debt” now means change in net debt, i.e. change in liabilities less change in financial assets. A rather crucial difference.

        • Ramanan says

          yeah especially because he and Keen tends to add purchase of financial assets in the definition of aggregate demand.

        • Ramanan says

          Asked him if that means aggregate demand is no longer GDP plus change in debt. Visible after approval.

    • JKH says

      good stuff

      in other words – and in your words – he’s completely missed the key point of the 1963 paper

      (i.e. bank disintermediation offset by NBFI intermediation)

      and grossly misrepresented it as a result

      • Ramanan says

        Yeah completely missed out.

        And makes more errors regarding money stock not changing – independent of Tobin’s papers.

      • Ramanan says
        • Fed Up says

          What are shares?

          Is the capital requirement for Non-bank Financial Institutions 100%?

        • Fed Up says

          So can NBFI’s increase purchasing power overall?

        • Tom Hickey says

          Auto manufacturers realized that vehicles were the new mortgage and they were giving a lot of profit to the banks by not self-financing, so they set up financing subsidiaries like GMAC. Now it is customary in the US to buy a vehicle from one of the major dealers and finance it at a lower interest rate than banks offer, as well as on more attractive terms and perhaps with less stringent credit standards.

          Does this add to AG? Seems so.

          If their analysis was correct this policy made it more affordable and simpler to purchase a vehicle for many people, thereby increasing sales while also reaping the interest on loans, which would otherwise have gone to banks. Win-win for the automakers and customers — until some of the finance arms of the automakers got into trouble.

        • Ramanan says

          Purchasing power has a specific meaning but people tend to use it in a strange way so I am going to avoid the usage.

          Yes direct lending by an NBFI can affect aggregate demand just like bank lending can.

        • Fed Up says

          ““shares” are like deposits.”

          Can shares be used to buy goods/services?

        • Ramanan says

          No they cannot. But sometimes they do offer check facilities.

        • Ramanan says

          “shares” are like deposits.

          capital requirement isn’t too important in the discussion.

        • JKH says

          changed it above for you as well

  10. Ramanan says


    Check this by Keen:

    “The difference between the Old and New Tobin is as stark as that between the Old and New Testament. Not only is there an emphasis on the uniqueness of banks in that 1982 paper, Tobin also makes copious use of T-accounts and double-entry bookkeeping to explain why banks do matter. So just as the Testament message moved from “An eye for an eye” to “Turn the other cheek”, Tobin moved from “banks don’t matter and the belief that banks create money is a shibboleth”, to “banks are crucial to macroeconomics and they can and do create money”.

    And whereas Tobin the Younger imagined that newly created bank money could be taken out of the system in a form other than bank deposits or cash, Tobin the Elder realizes that those are the only two options at the systemic level. Individuals might get out of bank deposits into (say) gold, but to do so they transfer money from their deposits in one bank into the deposits of the gold dealer in another bank. The only way for money not to be held in a bank is for it to be converted into some other kind of asset that is not a bank liability first. The only candidate here is cash—notes and coins—which you can insist on when you make a withdrawal (you might insist on gold instead, but a bank is under no obligation to deliver it in response to your withdrawal).”

    • Nick Edmonds says

      As far as I can tell, Steve Keen sees the world like this:

      “Banks and non-banks are different. An increase in bank lending increases the money supply. Money is therefore endogenous. The excess supply of money makes people spend more, but however much they spend it won’t get rid of the money. Non-banks lending doesn’t create money, so it doesn’t have this effect. Money is therefore special.”

      whereas Nick Rowe sees the world like this:

      “Banks and non-banks are different. An increase in bank lending increases the money supply. The excess supply of money makes people spend more, but however much they spend it won’t get rid of the money. Money is therefore exogenous. Non-banks lending doesn’t create money, so it doesn’t have this effect. Money is therefore special.”

      Spot the difference.

      • Fed Up says

        Nick Edmonds, explain this one to me…

        “It’s even more horribly wrong when we think about another accounting identity that holds in aggregate: for every $1 borrowed there’s $1 lent. To keep it very simple, imagine an economy where everyone is identical. If I wanted to borrow then so would everyone else want to borrow, which means nobody would want to lend to me, so I wouldn’t be able to borrow from anyone else. And to keep it even simpler, imagine that people pay for everything with central bank cash, and that the velocity of circulation is almost infinite and so the amount of cash in circulation is vanishingly small. (Yep, like Woodford’s New Keynesian model). If the central bank lowers the rate of interest, people borrow a tiny amount of extra cash from the central bank (they all want to borrow from each other but nobody wants to lend), and spend that cash, and their incomes increase as others spend, which increases their spending even more, and incomes and spending keep on rising until it reaches a level where nobody wants to borrow from other people or from the central bank (or the central bank decides it has increased enough and raises interest rates again).

        This is a world in which a cut in interest rates makes people want to borrow, and monetary policy works by making people want to borrow, but there is never any actual borrowing (except for a tiny amount of borrowing cash from the central bank).

        Monetary policy does not work by increasing actual borrowing. That is not the causal channel of the monetary policy transmission mechanism. Monetary policy works by increasing spending, not borrowing. And one person’s spending is another person’s income, so people in aggregate do not need to borrow more in order to spend more. Their increased spending finances itself.

        Yep. Macro is hard. You can’t just sit back and think “how would I react if my rate of interest fell?”. You have to think about how my reactions would affect others, and how their reactions to my reactions would affect me, and so on.”

        • Nick Edmonds says

          First of all, I should say that I would tend to agree with Nick in not liking the idea he is attacking in that post, although for rather different reasons.

          The thing that I would pick up on in the section you quoted is his assumption of identical agents. You can’t really examine the effect of debt on an economy with identical agents. Fundamentally you need some people who are inclined to borrow and some who are inclined to lend. If everyone is the same, then obviously everyone has to be spending their income at all times, with nobody saving or borrowing, because not everyone can save at once or borrow at once. If you make the assumption that everyone is the same, you’re obviously going to come to the conclusion he comes to. As soon as you assume hetrogeneous agents, his argument does not hold.

        • Greg says

          “not everyone can save at once or borrow at once.”

          Are you sure about that? Cuz I think everyone with an income could go to the bank and get a loan up to their income. The reason is of course that everyone is borrowing from a third party, the bank. I agree that everyone cant save at once but borrowing isnt the inverse of saving.

          That being said, there are certainly people who dont need to borrow or that borrowing would be silly (why borrow when you can use your accumulated cash to purchase) but the point remains, as I understand things, that anyone with an income can go and borrow up to that income, or a certain percentage of.

        • Nick Edmonds says

          If you take everyone to mean all agents, then yes (unless we allow some agents to both save and borrow – but that’s going beyond what was implied in the original example).

        • JKH says

          preceding my snark, that was the first thing I noticed as well

          its an elegant model in appearance, but there is still borrowing at the level of infinitesmals – for the purpose (in effect) of boosting aggregate demand – which seems conventional

          so I’m not sure what the point is supposed to be

        • JKH says

          macro accounting translation:

          – NIPA expands through spending – tick YEP

          – borrowing is a flow of funds transaction, not a NIPA transaction – tick YEP

          – but people sometimes borrow to spend – tick YEP

          YEP, YEP, YEP!

          macro is hard!

        • Tom Brown says

          NIPA, NBFI,… shoot! I’m in danger of learning something today.

      • Tom Brown says

        Edmond, I think Nick has recently and explicitly said something different though:

        “Tom: thanks, but that’s not quite right. Under inflation targeting the quantity of money is endogenous in both the short run and the long run. It’s the nominal rate of interest that is exogenous in the very short run (6 weeks or less, for the Bank of Canada anyway), but endogenous in the long run.”

        That was in response to a note to myself I made on some links to his articles (that I have on a public page… I was surprised to find him reading it!). Unfortunately Blogger won’t allow me to pick out links to particular comments… I guess because it’s a “page” rather than a “post” … but I’ll give you the link anyway along with my original note to myself that Nick was responding to. First the link to my “Links” page:

        And now I’ll repeat my original note-to-self on that page:

        “Nick Rowe’s comments on “The supply of money is demand determined.” … Not even not even wrong, and all that. Also some bits about “perfectly inelastic wrt” and perfectly elastic, etc. Basically one of two talking about money being endogenous in the short term (between six week meetings of the BoC or Fed) but not in the longer term (like two years out) where inflation targeting makes it exogenous. (see Nick Rowe’s 2012.08.22 comment below)

        • Nick Edmonds says

          Yes, I’m not sure that I’m representing either position fairly. I was thinking of this article

          but I’m not sure he actually says that makes money exogenous.

          Although what you’re saying suggests that maybe there’s even less difference between the two than I implied!

        • Tom Brown says

          Nick Edmonds,
          I haven’t read that helicopter one yet, but I know that Sumner took Krugman’s side (!) against Rowe and Beckworth on that.

          I have always referred back to Rowe’s “Banking Mysticism” post and the following “The Supply of Money is Demand Determined” post (that’s the one in which he says the title made his “flesh creep” to type out since in his view that statement is NOT EVEN not even wrong! Lol! (Now in the past, literally minutes after I refer to either one, Rowe shows up to set me straight… so he should be along here shortly). 😉

          If you look at my note-to-self there, that was my interpretation based on those previous posts of his… so I was surprised he took issue with it. (you can see me begging for more from him on my Links page.. but no response)… but the more I thought about it the more I see what he’s saying… and how that’s not necessarily inconsistent with his prior statements about elasticity and inelasticity in those prior posts of his. So w/ inflation targeting, the supply (or stock? … I get confused on this) of money becomes “perfectly” elastic wrt the inflation rate long term, but “perfectly” inelastic wrt the FFR. In the short term, money is “perfectly” elastic wrt the FFR however. (BTW, it’s “supply” … I just checked). Inelasticity does not equal exogenous… which I already knew, but I guess I was imagining the wrong relationship between them. What Nick leaves unsaid there (in the quote in my post above) is that the inflation rate is “exogenous” long term. So at least I think I understand him now (in this one small respect). (Still not sure about the qualifier “perfectly” though… I tried to actually sketch out the plots he describes with words, but they didn’t make much sense).

          Also, I’m still not sure why he agrees with Sumner (again, further down on my Links page) or in what “sense” Glasner meant “endogenous.”

        • Nick Edmonds says

          I’m fairly sure I’m not doing justice to Nick here. I have to say that, whilst I probably disagree with him on quite a bit, I find his posts very thought-provoking and they often test me on the way I see things myself. And he certainly understands the subtleties of exogeneity and endogeneity.

        • Tom Brown says

          Shoot! Excuse me, I should have addressed the above to “Nick Edmonds” not “Edmond”… sorry!

      • Ramanan says

        Good one!

    • JKH says

      looks like selective cherry/trash picking/creation and reverse guilt by association

      a widow’s cruse of something

      there’s no significant difference there

      may have to do another post to defend the brilliance and correctness of the 1963 paper

      do you have a link to that 1982 paper?

  11. Ramanan says


    Milton Friedman on Loans Create Deposits:


    • Ramanan says

      Best part was:

      “the most fascinating thing about economics … the most interesting thing …. is that it is the most trivial subject in the world … and yet so many people misunderstand it”

      • wh10 says

        Ugh that’s so terribly frustrating. Putting the Tobin debate aside, I do think that’s how Krugman is reflexively thinking about the banking system. Can’t we just get him to slow down his thinking and realize the obvious? Then we can talk about implications for the macroeconomy.

    • JKH says

      Interesting comment afterwards about economics as a study in fallacies of composition.

      (That’s occurred to me also – like the famous Kalecki quote about the confusion of stocks and flows.)

      Too bad MF mangles it in the case of how the monetary system works.

      LOL. Uncle Milton didn’t understand the monetary system.

      Guess he didn’t read 1963 Tobin.

    • Nick Edmonds says


  12. JKH says


    # 1

    Coins may be assets on Fed books in the same way that banknotes or coins may be assets on commercial bank books.

    These are essentially inventory operations.

    Commercial banks are obligated to redeem banknotes and coins for deposits (if the customer has a deposit account) and the Fed is obligated to redeem banknotes and coins for reserves.

    There is a liability in that sense in both cases.

    The liability appears in ultimate form explicitly on the balance sheet (the Fed) in the case of banknotes.

    It is not explicit (apparently) on Treasury’s balance sheet in the case of coins.

    But the economic nature of the liability is the same, IMO, as I described.

    In short – the inventory of notes and coins isn’t an issue for this liability aspect. Something else may be, but not that.

    # 2

    Regarding equity treatment, that is the opinion of the authors of the referenced Chicago Plan paper.

    I did a critique of that paper where I reject that interpretation:

    (The authors make some reference to an “official” document of some sort which refers to this equity treatment, which I haven’t seen, but I wouldn’t change my view because of that. Coins in circulation can be redeemed for bank deposits, which require reserve credit, which will have an effect on the deficit one way or another, as I described above. But this is a minor point in material terms obviously.)

    • Tom Brown says

      Thanks for the link, BTW! … re: Chicago plan: I wasn’t taking that guy too seriously… but phil had JUST dug that out for me w/ the quote he found, so I thought I’d point that out. I didn’t even open the thing myself… it appeared tl have an IMF URL so I took it w/ a grain of salt.

    • Tom Brown says

      “Coins may be assets on Fed books in the same way that banknotes or coins may be assets on commercial bank books.” … Sure! … I mean they’re an asset while AT the Fed. When the Fed sends them out the door to the banks and beyond they are no longer an asset of the Fed! In that sense they are similar to the way they are an asset for the banks, or the “shadow banks” (if shadow banks lent coins), or you or I: they are a liability outside of all of us… except perhaps in the contingent way you describe for Tsy, right?

      • JKH says


        Just think of your own actions in a standard weekend shopping trip. Where you spend your big bills but come back with a $ billion in coins that you’ve collected as change. You go to your bank where you have your deposit account, and exchange the $ billion in coins for credit to your account. The bank gets reserve credit for that. And other things equal, the Fed will either have to pay interest on yet another billion in excess reserves, or sell interest earning treasuries to offset your huge deposit of coin. That’s a deficit effect due to the interest differential relative to non-interesting bearing coins. So there’s a contingent liability in the sense of both the bank and the Fed responding to the largesse of coin accumulated from your typical weekend shopping trip.

        And both the Fed and the banks need inventory of same to satisfy the regular outflow to merchants who need the coin to respond to the contingency of you setting all this in motion on a regular basis.

        Of course, this is an unrealistic example, because you probably use credit cards for about the same amount, Tom.


        Have a good weekend!

        • Tom Brown says

          Last question!… I didn’t think the Fed paid IOR on vault cash? Am I correct or not?

          OK, you have a good weekend too!

        • JKH says

          No, they pay it on the reserve balances they issue to the banks when they redeem either coins or notes.

          (Maybe I didn’t make that clear. They issue reserves in the form of settlement balances – i.e. bank deposits at the Fed – in exchange for coins and notes redeemed. Coins can be held as inventory or sent back to Treasury or the Mint in exchange for debiting the TGA account (i.e. reducing a Fed liability). And notes are simply subtracted from the Fed’s balance sheet (i.e. reducing a Fed liability).

          (Didn’t mean to disinvite commenting over the weekend BTW. I’ll be around on and off.)

        • Tom Brown says

          OK, JKH, perhaps I’ll take you up on that. O/T: What are MBS exactly? Does the Fed accept the same kind for collateral that it buys (i.e. that originating from GSEs?). And what of this GSE originated MBS… how is it “made?” Let’s say a GSE acquires a mortgage for $100k from a bank using borrowed Fed funds (FF) to purchase it, and now their BS looks like this:

          A: 100 mortgage
          L: 100 borrowed FF

          Now they make an MBS from this and sell it to the Fed. How does that look? Do they keep the mortgage on their books and sell the Fed another debt instrument, or does the mortgage get included directly in the MBS?


        • JKH says


          MBS is a complex product and business.

          It really requires an expert to get into the detailed wiring for it.

          I’ve looked into it from time to time, but I’m not that expert.

          I’d just summarize it by saying they’re basically securitized packages of mortgages designed to appeal to investors looking for liquid assets of a certain credit quality.

          GSEs are heavily involved, but its a tangled web also requiring expertise to untangle.

          On your specific balance sheet question, the mortgages are embedded in the balance sheet representation of the MBS. However, the record keeping involves quite a network of interested parties. I gather this was quite a problem in the financial crisis when some mortgagors didn’t know where to go to negotiate with the ultimate lender, especially in cases where MBS got snarled up in fancy CDO packaging.

        • Tom Brown says

          JKH, thanks. To a very rough 0th order approximation, if the Fed were to buy an MBS, could you say the Fed was holding mortgage debt? Or is it just too complex to simplify like that?

        • Nick Edmonds says

          There are so many variations of MBS that it’s difficult to say anything without there being exceptions.

          However, as a starting point you could say it is like buying an interest in the actual mortgages. Buying an MBS means the investor can get a different risk profile, by buying a senior or junior piece, or as a result of swaps or credit enhancement. However, potentially of greater importance is the different form of the investment. In contrast with a mortgage portfolio, an MBS is a tradable, liquid (supposedly), rated (usually) security. Aside from any question of whether this presents a better investment, this has significant regulatory benefits. For a start, there are many investors who cannot hold mortgages, but can hold rated paper. For others, notably banks, transforming mortgage portfolios into securities can facilitate much better capital treatment.

          It’s an important point, because these factors expand the demand for mortgage assets and this played an important part in driving the growth of debt pre-crisis.

        • Ramanan says


          Yeah maybe it has stopped buying agency debt now and buys only MBS (?)

        • Oilfield Trash says

          @ Tom

          There’s a huge difference between a GSE-issued security and a private-issue one.

          ”GSE MBS as a general rule are not, actually, guaranteeing that any investor is going to end up making any actual real money off the deal. The guarantee is that you will get interest payments as long as there is still principal invested to earn interest (that is, while there is still an underlying balance of mortgage loans), you will get it on time, and you will not lose your principal.

          I think the FED stays with this type of MBS purchase due mainly to fact they can not lose any outstanding principal invested in the security.

          The link below will give you a very good understanding of GSE MBS. Anything with unbernerds in the title was written for this forum.

        • JKH says


          I was looking earlier for confirmation of agency debt in the current program, but didn’t see it. I assumed this was the case, but is it?

        • Tom Brown says

          Ramanan, thanks for the feedback. True, in my simple example in the comments here I assumed the GSEs borrowed Fed funds to purchase mortgages from banks. However, in my example 11.2 I don’t even assume this new “non-Tsy gov” entity has ANY liabilities (something I should probably change!) … but again my 1st thought there was to try in some way to account for the VAST amount of Tsy debt entities such as Social Security purchase. The MBS was a bit of an afterthought.

          “Also, If this interests you, GSEs create special purpose vehicles which holds the mortgages as assets and MBSs as liabilities. ”

          Yes, that does interest me! (that’s what I was afraid of!) Unfortunately it makes my nice tidy simple world of Ex 11.2 more complex… but perhaps I can justify keeping it simple and exploring this issue in another post. If not, then I might need to think of something else or just include it (I can put some liabilities on my “non-Tsy gov” entity’s BS, for example… and somebody else can be the creditor… such as the Fed).

          Regarding the info on how MBS collect interest and mature … that’s very interesting too. Perhaps if/when I go behond a 0th order approximation and try to account for time that will be something I need to explore.


        • Ramanan says


          Also note the Fed buys not only the MBSs but also the debt of the agencies. (the debt they issue to run their businesses).

        • Tom Brown says

          Ah, great point… about the agency debt. But that debt is traded on the open market, right? I suppose what actually happens is they own each other’s debt and Tsy’s. I’m sure it’s WAY more complicated than I’m trying to boil it down to… the question is… can I pull out the important details?

        • Ramanan says


          I think you are entering a complicated territory but interesting stuff.

          I think you are assuming GSEs purchase mortgages from banks directly by paying with their account at the Federal Reserve – which may or may not be the case.

          Also, If this interests you, GSEs create special purpose vehicles which holds the mortgages as assets and MBSs as liabilities.

          Now after the MBSs are created, there are specific ways the Fed trades them which is more complicated than Treasury Securities) – check dollar rolls here:

          Also if you want to look at how the balance sheets evolve in time, you have to take into account the fact that the MBSs amortize unlike Treasury securities which pay coupons regularly and the principal only at maturity.

        • Tom Brown says

          Nick and JKH, thanks… I did think of going to wiki first… but was hoping for a one-liner, ha! I started reading the wiki article… it does seem pretty good.

          I’m specifically interested in GSE created MBS: like Fannie, Freddie or Ginnie Mae might create (actually I’m not terribly sure what the differences are between these three and if they all create MBS or not).

          The reason for my interest is that the Fed purchases GSE created MBS (and also allows it to serve as collateral… but actually regarding collateral, I don’t know that they don’t also accept non-GSE created MBS).

          Why do I care? I’m trying to add Fed purchases of GSE MBS to this SUPER simple set of balance sheets:

          My first real attempt to do this with GSEs is here:

          I’m lumping GSEs and Social Security etc all together as “non-Tsy gov.” … and I realize I’m not treating that all quite correct because the SS trust fund really DOES belong to the non-bank private sector (what I call the “public”) … but since the public doesn’t directly control the fund… I’m not treating it as their asset. Maybe my project here has gotten WAY out of hand and I’m in WAY over my head… my original desire was to account for the fact that intra-gov and foreign holdings of Tsy debt are substantial, which my Ex 11 doesn’t touch on.

          So the way I dealt w/ GSE issued MBS (in Ex 11.2) was to say that it was really a part (Lg) of the liability the public has sold (L). The Fed can also own a part of this (Lf) and that presumably came through the GSEs.

        • JKH says

          This isn’t bad, Tom:

          Don’t know if its perfectly correct, but gives you an idea of the variety and complexity of possible cash flow structures – see under “Types”.

        • JKH says

          I guess so, colloquially.

          But I think they’re really holding securities with claims to a collection of underlying mortgage cash flows rather than the mortgages individually.

          MBS is a derivative security in the generic sense of that word. The actual mortgages are the “underlying” assets from which the structure of the MBS as a security is derived.

          I.e. there’s a difference between a financial institution holding individual mortgages – which is true mortgage debt – and an MBS, which is a debt security unto itself.

        • Tom Brown says

          Thanks JKH, yes… I reread and realized that you were NOT implying that the Fed pays IOR on vault cash. Got it!

  13. Fed Up says

    I’m going to do a Nick Rowe impression here.

    The accounting people say loans create deposits and there is a capital multiplier. However, there is an accounting identity that says $ borrowed = $ lent. Doesn’t loans create deposits violate $ borrowed = $ lent?

    • Tom Brown says

      Fed Up: shoot… another one caught in the “awaiting moderation” bin… but It’ll be out soon I think!

    • Tom Brown says

      ” there is an accounting identity that says $ borrowed = $ lent”

      Well, OK… all that means is that the loan has two parties it relates together: the lender and the borrower: to the former it’s an asset and to the latter it’s a liability. That’s NOT however the money itself! The money itself is the other entity: the obligation of the debtor to the creditor. In the case of bank deposits (demand or otherwise) the bank (debtor) sees this obligation as a liability and the depositor (creditor) sees it as an asset. In essence, when a loan is taken out creating a deposit, the bank and the borrower/depositor exchange IOUs. There are two distinct IOUs (the loan and the deposit) and each has two views associated with it. That’s why even the simplest depiction of this on balance sheets needs four entries (two for the creditor and two for the depositor/borrower):

      (see the 1st three balance sheets on the above)

      There’s no accounting identity that says that the two underlying entries these four views look at, have to stay “in balance.” For example:

      • Tom Brown says

        “That’s why even the simplest depiction of this on balance sheets needs four entries (two for the creditor and two for the depositor/borrower):”

        Should read:

        “That’s why even the simplest depiction of this on balance sheets needs four entries (two for the loan and two for the deposit): and there’ll be at least one creditor and one debtor, thus the simplest arrangement is the bank is both creditor and debtor and the borrower/depositor is both debtor and creditor.”

  14. Fed Up says

    Here is a question.

    Can demand deposits held in a checking account, savings account, or a CD be lent against or lent out directly?

    • Fed Up says

      Well as per usual, I probably didn’t say that right the first time. Let’s try it this way and start here. From my August 25, 2013 at 3:09 pm comment:

      Assets new bank = $100,000 in treasuries plus $2,000,000 in loans
      Liabilities new bank = $2,000,000 in demand deposits
      Equity new bank = $100,000 of bank stock

      Now someone tranfers $1,500,000 in demand deposits to the new bank. Plus, I will only do the CHANGE in the balance sheet.

      Assets new bank = $1,500,000 in central bank reserves
      Liabilities new bank = $1,500,000 in demand deposits
      Equity new bank = $0 of bank stock

      Next put $500,000 in a CD and $500,000 in a savings account.

      Assets new bank = $1,500,000 in central bank reserves
      Liabilities new bank = $500,000 in demand deposits plus $500,000 in a savings account plus $500,000 in a CD
      Equity new bank = $0 of bank stock

      1) The bank can’t do any kind of leverage for a loan, correct?

      2) The bank can’t take $500,000 from either the demand deposits, savings account, or the CD and give to a borrower for a loan, correct?

    • JKH says

      I imagine such things might be possible in some very exotic Wall Street structure, at least in the way a contract is written up with rights of claim, etc.

      But in general, I would say no. A demand deposit isn’t a negotiable security like a bond. Bonds are loaned so that the bond borrower can sell or deliver or re-lend them to somebody else (in general, I think).

      The CD may be a slightly different case, if the CD is negotiable. That may depend on the way in which that term is used in a particular banking system.

      It’s a good example of potential misuse of language though. Banks don’t “borrow deposits” the way somebody borrows a bond. That would be a case of double counting of meaning, I think. They accept or take deposits. Deposits are the result of borrowing in that sense, not the substance of what is being borrowed.

      Just my opinion though, because its about the use of language, which is always debatable.

    • Tom Brown says

      Fed Up, at the risk of sounding like a moron (having skipped your discussion until now) I’ll say the question doesn’t make sense. Here’s why:

      Demand deposits are mutually exclusive from savings accounts (saving deposits), and CDs. They are different kinds of deposits essentially.

      It does make sense for a “checking account” because that is a kind of demand deposit.

      Demand deposits aren’t really lent out… they already are liabilities… they represent something that already has been lent out in a sense: a demand deposit is a legal obligation identifying the depositor as a creditor of the bank. The same goes for savings deposits and CDs.

      Say you had $10 in a DD and moved it to a savings deposit (SD). The bank’s reserve requirement has dropped by $1. But the bank still has a $10 liability on it’s balance sheet. There may be some time restrictions on exactly when you can move the $10 back OUT of the savings deposit, but that’s about the only difference.

      Now hopefully JKH or somebody else will chime in and tell you the real story… but that’s how I understand it!

      • JKH says

        replied before seeing yours, Tom

        but similar

  15. Tom Brown says

    Shoot! The party moved over here and nobody told me? Nice that you guys are picking this over. Looks like Fed Up already brought up the two recent Nick Rowe pieces on this. Fed Up, did you get your accounting squared away? Did you figure out that everything I told you was BS? (that’s BS, not balance sheet) 😉

    JKH, did you happen to catch the exchange between Cullen, Rowe, Steve Roth, Geoff, and myself regarding trying to translate Nick’s “Excess demand for MOE is the definition of a recession” and the rest of us trying to square that with the BSR concept? Also, I wish he’d address you on the Two Tobin’s thing. I had another take I’d like him to consider as well.

    • JKH says

      Tom, as I said to Cullen, NR is a high church monetarist.

      My monetary motto:

      If you can’t explain it with accounting, you can’t explain it.


      • Tom Brown says

        JKH, where did you tell Cullen that? And what do you mean by “high church?” … and you actually tell monetarists that! … or that’s what you tell others (the bit about accounting) when dealing with a monetarist?

        • JKH says

          when – out of school and out of sight, Tom – but sharing here

          I picked up the term “high church monetarist” when it was used in a private email to me by a very well known investment industry economist who shall remain anonymous. I’d never heard it before, but I love the expression. He didn’t define it, but I immediately thought of it in association with the idea of formalism and the (intellectual) worship of a particular idea without much flexibility around that focus. It’s a fun term, IMO, not meant to be disrespectful. Think of it as the comeback to the monetarist view of accounting. And I’m sure they don’t mean to be disrespectful there.


          The bit about accounting I just made up. But it is now my motto.

          I don’t tell monetarists anything, because those with blogs stopped responding to me (for the most part) years ago. I have no street cred with those who claim that understanding banks doesn’t matter.

          (Sumner actually mistook me for an economist within the first two months of his blog opening up. Go figure.)

        • Tom Brown says

          Ah!… OK, I’ve heard the term “high church” before and it did leave me with the impression of something stuffy, calcified, and overly formal (and perhaps dogmatic).

          And now I see how you’d use the phrase “if you can’t explain it with accounting you can’t explain it.” … Yes! … that’s beautiful. I love it! So is this how it would be used:

          MMist: Don’t tell me about banks or show me your silly balance sheets!… You see, a shock to NGDP combined with sticky wages and Ricardian equivalence in a Wicksillian frame work… blah blah blah expectations blah blah blah hot potato blah blah Chuck Norris blah blah QTM blah blah never reason from a blah blah keep blah out of macro blah blah base money blah buy the whole word blah blah blah …

          JKH: [putting his hand up!] Whao!… hold on there! if you can’t explain it with accounting… you can’t explain it.

          I sooooooooo want to steel that from you! What if I changed the name of my blog to “If you can’t explain it with accounting you can’t explain it” and I put a note in small letters right under that “-JKH” with a link to monetary realism? 😀

        • JKH says

          I have to gloat on this one, because I like it a lot too, and you’re my first test case.

          Sounds good as a blog banner – attribute away, because I may want to steal it back some day – and maybe Mike, Carlos, or Cullen will like it too.


          Seriously (if that’s possible) it does refer to the specific logic of necessity versus sufficiency – i.e. as I’ve said before, coherent accounting is a necessary condition for coherent economics – but its obviously not necessarily sufficient in explaining why things happen – that said, its an awfully important part of the entire Godley and Lavoie book.

          And it gets richer – the typical Market Monetarist reaction to accounting references is to hold up a High Church cross and fend it off on the basis that it’s not sufficient (and probably completely useless in their view). So they use erroneous logic to try and put down something whose logic completely escapes them. And their case shrivels up like the Wicked Witch in a pool of water (or something).

          That was all just said in good fun, you know.


          Another way to think of it in more pragmatic terms is that accounting can be viewed as a very useful ground zero for resolving language disputes in economics – and on blogs in particular – as in, “if you can’t explain it with accounting, you can’t explain it”. A great deal of disagreement or difference of views seems to consist of different ways of using language.

        • Tom Brown says

          OK, done! check it out:

          In the end I didn’t change the name, but I added your quote to the title bar (with link!)

        • JKH says

          ha! – looking good, Tom

          (and I appreciate the links)

        • Tom Brown says

          JKH, off topic: (I tried to post last night, but it got caught in spam I guess), is the description of coins as a “contingent liability” of Tsy your own nomenclature? I can’t find that phrase anywhere, nor can I find any evidence of coins being an official liability of Tsy anywhere. I asked JP Koning about this, and he couldn’t see that they were either, though he’s a Canadian (I think!) and perhaps not up on the details here in the US. I posted a link to my brief discussion w/ JP last time so I’ll skip that now in case that’s why I got spammed. But if you look on his sidebar on the right, he’s got an article there called “Money as a Liability” … just a handful of comments … that’s where the discussion is.

        • Tom Brown says

          Fed Up, I have a very complete response for you, with lots of links to Fed docs, etc. Unfortunately (probably due to the links) it’s “Awaiting Moderation” but I’m sure someone will release it soon!

          You’re welcome! :)

        • Tom Brown says

          Fed Up,

          Actually coins are not explicit liabilities of the government. Here’s at least one source saying they are “equity” of the US government:

          But even if it’s considered “equity” it shows up on the right hand side (Cr side) of the balance sheet …. or it would, if that’s true and there is such a thing on Tsy’s balance sheet!

          But that guys with the IMF, not the US gov. Coins are clearly an asset of the Fed (which makes sense because they buy them from the US Mint (part of Tsy) at face value and the Mint/Tsy makes money off that (seingniorage) at least for everything except pennies and nickles, which are money losers! The Fed buys reserve notes at production cost from the BEP (which is also a branch of Tsy). So reserve notes are not really money and not recorded on anyone’s balance sheet (that I can find!) until they depart the Fed for the banking system and beyond. Reserve notes (in circulation, including bank vault cash) are explicitly recorded as liabilities of the Fed as you’d expect:

          … as are Fed deposits (at the banks, Tsy, etc). It’s all in there.

          That leaves the extremely unimportant US notes (another valid form of paper money in the US which hasn’t been released or even created since 1971). This paper money, unlike reserve notes, is a direct liability of the Tsy, but recorded as a special kind which does not contribute to the debt ceiling compliance calculation. The way the Tsy phrases this is “Not Subject to the Statutory Debt Limit.” Search for “United States Notes” in this document:

          Here’s more information of this obscure form of paper money:

          Other than US notes, I try to explain it all here (briefly):

          So in a sense the concepts of “inside” and “outside” money are a relative thing. It appears to me that coins are more “outside” than reserve notes, and US notes fall between those two. Fed deposits and reserve notes are on the same level on the in/out spectrum. Bank deposits are more inside. It could be that things like “Ithaca Hours” are more inside than that! Certainly handwritten IOUs are! You might consider gold to be on the most outside layer as well. Here’s how the Fed defines these terms (“inside” and “outside”):

          The first couple of paragraphs covers it. How’s that for a treasure trove of information!

        • Fed Up says

          I’d say coins and currency are liabilities of the treasury and central bank reserves are liabilities of the central bank. However, doesn’t the treasury just gift the coins and currency to the central bank?

        • JKH says

          good grief!


        • Tom Brown says

          JKH, thanks… if you just Google “contingent liability” and “coins” you come up with nothing but JKH related stuff. Here’s an example:

          I’ll mull your response over when I get a chance. Thanks again!

        • JKH says


          I don’t recall using that phrase contingent liability specifically in the case of coins, but if I did (and I’m not saying I didn’t) it was almost certainly one of my own making.

          Here’s the way I would think about it, which is not inconsistent with that usage:

          If a bank depositor brings coins into a branch and asks for a deposit credit, the bank has to get reserve credit from the Fed in order to balance its books (assuming the bank doesn’t want the coins and hands them over to the Fed or Treasury or the Mint or somebody).

          If the Fed gives reserve credit to that bank, it has to get payment from somewhere in order to balance its books. That means the Fed debits the Treasury TGA account.

          (Presumably the coins are delivered back to the Mint or reused (in which case the question is moot) or something. I don’t know. Bernanke could flush them down the toilet. I don’t think that matters. What matters is that the Fed balance its books.)

          The balancing of the books in the case of both the commercial bank and the Fed is essentially the same whether its coins or banknotes that are redeemed at the bank branch. That assumes that neither the bank nor the Fed has any further use for the coins and the Fed simply extinguishes that amount of banknotes issued from its balance sheet.

          So in either case, the compensating adjustment on the Fed’s books is an increase in the reserve liability to the bank, and a decrease in the TGA liability to Treasury.

          Banknotes appear on the liability side of the Fed balance sheet, but it is unclear whether coins appear somewhere in US government bookkeeping as a liability of Treasury. They may well not appear anywhere.

          But since the redemption impact is the same for the Fed in either case, and since bank notes are a nominal liability on the Fed balance sheet, I’d say that coins should be treated as at least a contingent liability. And note that the liability in either case is “paid off” in either case as a reserve credit to the commercial bank.

          This question of the meaning of liability is not entirely academic, because there is an economic effect. In the pre-2008 case, the contraction of either banknotes or coins would require the Fed to sell Treasuries in order to offset the reserve increase. That reduces the running seigniorage profit. In the QE environment, the Fed is now paying interest on reserves where it wasn’t paying interest on banknotes and neither was the government paying interest on coins.

          All that said, this is pretty much constructed by me as to how I think the consolidated bookkeeping and the economics must work. I stand to be corrected by anybody who may have evidence this is this incorrect on the basics.

          Also, we had some pretty involved discussions with Philip Diehl on the issues around coin seigniorage and the treatment of numismatic and circulating coins back in the platinum discussions. (Some of my discussions with him were off-line.) It’s pretty complicated stuff when you get into seigniorage accounting treatments across those different categories of coins.

  16. Dan Kervick says

    This mostly expresses my feeling about the Tobin paper, JKH. As you say, “Who would say such a thing?” Tobin seems to be arguing against a straw man opponent who thinks the loans-create-deposits picture entails that banks can loan without regard to the market demand for loans!

    • Cullen Roche says

      You know, if you’re going to pose as a banking expert by day then you really shouldn’t write things as terribly erroneous as “[banks] make money by charging interest on lending, in more or less the same way any of us could make money by charging interest in lending. Banks just do it on a much larger scale. ”

      “More or less”. Is that a Moslerism like “shredding” or “per se”? Just being loose with language to fudge a hugely important point so you can make your point sound more palatable? Come on Dan. If you’re going to write a daily banking post at NEP then get the basics right and don’t compare banks to households. That’s as egregious as comparing households to governments and you know how silly that is.

      • Tom Brown says

        “You know, if you’re going to pose as a banking expert by day…”

        Yeah! That’s my job! (except that “pretend” might be more appropriate than “pose” in my case… and “job” is stretching it bit) 😀

    • JKH says

      For clarity, the quote in context is:

      “Krugman/Tobin seems to imply that those who observe “loans create deposits” are sufficiently short sighted to think that this point having been made is also the end of the process. In other words, that these loans and deposits once they’ve been created should remain on bank balance sheets forever. Who would think such a thing?”

      So the “who” in reference is not Krugman/Tobin, but the prime purveyors of “loans create deposits”.

      And for further clarity, I defined Krugman/Tobin not as Tobin, but as Krugman’s channelling of Tobin.

      In other words, its really Krugman in effect, not Tobin.

      I slapped this post together over a weekend to try and saying something about that channelling context. I may do another post on Tobin, unfiltered by Krugman.

      As far as the quote is concerned, I think Krugman can be forgiven for his reflexive reaction against the prime purveyors over the past 18 months or so. They don’t make their case particularly well. I think Tobin in fact makes it much better. But I think Krugman has overlooked some of the elements of Tobin that would actually be helpful in making this case. So when he “seems to imply”, it is in some sense an understandable reaction to a presentation that in itself invites the implication.

      Beyond that, I’m increasingly impressed by Tobin, rereading what he has to say. I might have touched up my post here if I’d written it with that benefit, but I think most of it stands.

      • JKH says

        Here’s what I said elsewhere about the topography of the overall debate:


        Still some confusion in the general debate, IMO.

        Krugman argued that banks are not special in the same way Tobin did.

        Neither Krugman nor Tobin argue that financial intermediaries are not special relative to a counterfactual economy. Quite the contrary.

        Godley uses Tobin to build the case for how banks work.

        I don’t think that conflicts with what Tobin says about banks not being special.

        A point of logic:

        X = A + B
        Y = B + C

        X is special relative to Y in respect of A (e.g. banks creating money from lending)
        Y is special relative to X in respect of C (e.g. issuing insurance policies)
        But neither X nor Y is special relative to B (active asset liability management and pricing)

        It is quite possible for the same entity to be both special and not special

        It’s a matter of the classification paradigm


        I think “patient zero” for this sort of thing was Krugman’s interaction with Keen 18 months ago. And I think then then and now PK has committed some pretty basic errors.

        The first is that he definitely maintained back then that “loans create deposits” out of “thin air” was a ridiculous idea, whereas Tobin is clear about this right away. (Interestingly, Tobin makes this clear as the first thing in the essay that Krugman says he had “forgotten about”.) And PK seems to be avoiding that still. I think he’s actually getting trapped in some kind of fallacy of composition of his own making – he’s identifying the risk that a single bank faces in losing a deposit as something that disproves “loans create deposits”. It becomes interesting that Tobin’s argument against the widows cruse starts with that point, which he then expands to the case where the banking system in total also loses the deposit. So Krugman seems to be conflating all of that in his own rejection of “loans create deposits”, even though Tobin understands how “loans create deposits” exists while the widow’s cruse fails.

        The second is that he still seems to be hanging onto the money multiplier idea. I just don’t think he’s in synch at all with the idea that the central bank supplies required reserves after the fact.

        The third is connected somehow to the fact that Tobin-Brainard assumes a sort of Warren Mosler zero interest rate environment as a simplification. It assumes further that governments essentially deficit spend zero interest currency into the system. And it assumes that is the primary instrument of “monetary control”. In other words, it completely bypasses dealing with the issue of a central bank that sets an exogenous positive interest rate on government liabilities. It is a pure monetarist central bank, adjusting the quantity of currency in setting monetary policy. In fact this may be OK for analyzing the issues of monetary control in the form of reserves and commercial bank interest ceilings that Tobin sought to demonstrate. But I think Krugman is drawing all sorts of strange conclusions about being indifferent to whether the public holds currency or the central bank holds it (as reserves) from this very specific modeling case of a zero interest rate, and that is cluttering his general argument.

        Finally, I think his central bank accounting is not very good. This became clear in his debate with Steve Waldman earlier this year. That debate had to do with understanding the relationship between excess reserves and related central bank scenarios for lifting interest rates off the zero bound.

  17. Fed Up says

    JKH, what do you think are the MOA and MOE for the USA in the real economy?

    I’d say MOA = MOE = currency plus demand deposits.

    I don’t consider central bank reserves to be MOA or MOE.

    • JKH says

      I’m not into the MOA/MOE discussion.

      There’s too much in the way of spurious classification.

      It’s all context specific.


      reserve balances held with the central bank are the primary MOE for commercial banks (they also hold banknotes and coins in dealing with customers)

      deposit balances held with commercial banks (or cheques written on deposit balances) are one MOE for depositors, but so are coins and banknotes

      “the dollar” is the primary MOA for the US economy, whether its a dollar as represented through a 10 dollar bill, or a $ 1000 treasury bond, or a $ 10,000 commercial bank deposit

      I just don’t think you can get too categorical about what is in effect an arbitrary definition in search of an idea.

  18. Fed Up says

    Mix of posts:

    ‘”In long run equilibrium, banks are no different from other financial intermediaries. They borrow and lend. They make life easier for ultimate borrowers and ultimate lenders to get together, just like shopkeepers.”

    That sounds like loanable funds?

    So for you a 20% capital requirement and a 50% capital requirement would not make any difference?”‘

    ‘”That sounds like loanable funds?”

    Yep. Loanable funds in the long run equilibrium, a mixture of loanable funds and liquidity preference in short run disequilibrium. Or, to say it another way, it’s the job of the central bank to try to make the loanable funds theory true at all times.

    An increase in the legislated capital requirement would: increase the equilibrium spread between banks’ lending and borrowing rates; reduce the total quantity of commercial bank money; reduce the risk of the central bank having to act as LOLR or bail out insolvent banks. I think. But it wouldn’t make a qualitative difference to what I say here.”‘

    What is a good reply for that? I don’t think it is loanable funds in the long run.

    • JKH says

      “Loanable funds” is a poor descriptive term for what goes on. What goes on is a combination of “loans create deposits” at origination, followed by portfolio rebalancing according to asset preferences and price reactions across all financial intermediaries. I think he’s correct on capital.

  19. Fed Up says


    Assets new bank = $50,000 in central bank reserves
    Liabilities new bank = $0
    Equity new bank = $50,000 in bank stock

    Let’s say the new bank then bought $20,000 in doughnuts (an expense, not a real investment) from a company that has a checking account at the new bank. What does the accounting look like then?

    JKH: “What does the accounting look like then

    deposits up $ 20,000
    equity down $ 20,000”

    Is that a two step process?

    Buy the doughnuts:

    Assets new bank = $50,000 in central bank reserves plus $20,000 doughnuts
    Liabilities new bank = $20,000 in DD
    Equity new bank = $50,000 in bank stock

    Eat the doughnuts (write down the assets to zero):

    Assets new bank = $50,000 in central bank reserves plus $0 doughnuts
    Liabilities new bank = $20,000 in DD
    Equity new bank = $30,000 in bank stock

    Expenses can’t use leverage/margin, right (meaning the new bank can’t buy more than $50,000 in doughnuts)?

    Can the new bank use leverage/margin to build the new branch (real investment)? Can it build a $100,000 building on $50,000 in equity?


    Submitted on 2013/08/28 at 1:51 pm
    Is this possible?

    $0 in currency, $0 in central bank reserves, 0% reserve requirement, one gov’t, one central bank, and one commercial bank?


    Submitted on 2013/08/28 at 2:38 pm
    “Banks are intermediaries.”

    When I see this I think, a bank matches a saver with a borrower. That is what I picked up from Rowe, Krugman, and others. It seems to me a modified version of my example above shows that.

    Let’s say I save $100,000 in demand deposits. A new bank wants to add to its existing capital. They sell me $100,000 in bank bonds (bank capital) and then buy treasuries. The reserve requirement is 0%, and the total capital requirement is 10%. I believe that means the capital requirement is 5% for mortgages and is 10% for ordinary loans. This example will be all mortgages and focusing only on the new capital.

    Assets new bank = $100,000 in treasuries
    Liabilities new bank = $0
    Equity new bank = $100,000 of bank bonds

    The bank now makes 20 mortgages for $100,000 each. The 20 people use the demand deposits to buy 20 homes for $100,000 each from 1 home builder.

    Assets new bank = $100,000 in treasuries plus $2,000,000 in loans
    Liabilities new bank = $2,000,000 in demand deposits (DD)
    Equity new bank = $100,000 of bank bonds

    $100,000 / ($2,000,000 * .5) = .10

    The home builder sets up a checking account at the new bank. So 20 checking accounts at the new bank were marked up and then marked down by $100,000 each, while the home builder’s checking account was marked up by the $2,000,000. Now the DD’s can be spent in the real economy.

    Overall, I saved $100,000 in MOA/MOE, and the borrowers “dissaved” $2,000,000 in MOA/MOE for a difference of $1,900,000 in MOA/MOE. That difference is why banks and bank-like entities matter.

    I saved $100,000 in DD’s (or could be currency). The new bank borrowed $100,000 (bank capital), and I lent $100,000. The 20 people borrowed $2,000,000 in DD’s, and the new bank lent $2,000,000. Can the people who receive the $2,000,000 in DD’s be considered to have lent to the new bank and the new bank considered to have borrowed from the $2,000,000? If so and however, the people who have the $2,000,000 can stop saving at any time?


    Submitted on 2013/08/28 at 3:06 pm
    When the capital requirement is 100%, is that loanable funds?

    • Fed Up says

      “You say “they” but I understood this to be the builder at first.”

      I didn’t write that correctly. The builder spends, then someone else spends, and so on until some kind of “saving” occurs (assume same bank).

      Is an expense an asset that immediately gets written down to zero in terms of the medium of account (MOA)?

      • JKH says

        An expense generally goes directly to the income statement without passing through the balance sheet.

        One exception is depreciation, which is the amortized expensing of fixed asset degradation over time.

        The original fixed asset when booked on the balance sheet can be considered as a current “capitalized cost” that will be expensed in the future as the asset is used in the production process.

    • JKH says

      Your doughnut accounting is pristine, but probably not acceptable under generally accepted accounting principles. Doughnuts are a poor investment due to shelf life.

      It is two step accounting though in the sense that the expense would be reflected on the income statement before the income statement is consolidated and netted to equity. I.e. periodic accounting reflects all revenues as well (e.g. loan interest) and would normally result in a net addition to equity and retained earnings.

      Leveraging is a balance sheet technique. Financial leveraging of expenses is not possible.

      Good question on real asset (building) leverage. Not sure. Depends on the regulatory capital requirement. It may be 100 per cent. Don’t know.

      “Is this possible?”

      Yes – as a “thought experiment”, and its a very useful thought experiment to straighten out the role of reserves.

      “When I see this I think, a bank matches a saver with a borrower.”

      No. It means there is a process for the symmetric management of asset and liability risk in banking – especially in the area of liquidity risk and interest rate risk. This is an active intermediation process from an analytical and operational perspective.

      “Can the people who receive the $2,000,000 in DD’s be considered to have lent to the new bank and the new bank considered to have borrowed from the $2,000,000?”

      You’ve packed a lot in there. First, you’ve assumed a builder, which means new houses. That means $ 2 million of real investment for the economy. The macro household balance sheet shows a $ 2 million real asset and $ 2 million of debt, for a net savings (stock) addition of zero. The accumulated net saving and net savings addition to the economy shows up in the $ 2 million of demand deposits that you indicated (at first) went to the builder. His balance sheet shows up as $ 2 million in deposit assets and $ 2 million in net worth / equity / accumulated saving / savings.

      Tobin uses the lending and borrowing language in the comparative counterfactual where there are no banks and somebody lends $ 2 million directly to the builder. The factual case typically uses the language of depositor and deposit taker on that side of the bank balance sheet.

      “If so and however, the people who have the $2,000,000 can stop saving at any time?”

      This is an insightful question. The answer is yes. You say “they” but I understood this to be the builder at first. In any event, this deposit can be spent on consumption goods without the spender earning any further income. I.e. the spender spends down his equity position of $ 2 million. The interesting thing is that the factors of production of the $ 2 million in consumer goods will be forced to save, other things equal, because what they produced is no longer available for purchase by them, other things equal being emphasized here. And that means that the macro equity savings position corresponding to the original $ 2 million housing investment has now been relocated to those factors of production.

      “When the capital requirement is 100%, is that loanable funds?”

      I’d forget about loanable funds. It an incoherent concept that just isn’t needed for any analysis than I can think of.

  20. JKH says

    Tobin’s paper is fine.

    Banks are intermediaries.

    So are insurance companies.

    Banks are special.

    So are insurance companies.

    It’s only logical that different elements in a classified group have things in common and things that are unique.

    The primary role of banks is not necessarily payment settlement. You might think that way if you thought loans creates deposits describes banking. But banks have assets and liabilities with a non-trivial duration and risk mix. There is an intermediation effect. Banks manage that effect through centralized functions such as asset-liability management, risk management, and capital management. And if people don’t know how those functions work, they should check their bearings before being too aggressive about calling mainstream economists ignorant about banking. There’s some truth to that, but there’s also a question of degree. And in that context, Tobin’s paper is fine.

    Yes, return on capital is a priority.

    But you can’t get there without providing a service to borrowers and depositors, obviously.

    Everything gets priced.

    Return on capital is a constraint on asset-liability pricing, but in a sensible way market competition is a constraint on return on capital expectations. You can’t make 20 per cent ROE on a business where the market is at 15 per cent ROE. Otherwise, you end up with no banking business if you think that way about everything.

    “…the essential function of financial intermediaries, including commercial banks, is to satisfy simultaneously the portfolio preferences of two types of individuals or firms. On one side are borrowers, who wish to expand their holdings of real assets… On the other side are lenders who wish to hold part or all of their net worth in assets of stable money value with negligible risk of default.”

    Nothing wrong with that.

    Tobin is basically describing asset-liability management, which is an internal function performed by banks in fact.

    Nothing there implies loanable funds.

    Tobin fully understands loans create deposits and that the money multiplier is wrong. It’s right there in the paper.

    The reason Tobin appears to refer to bank depositors as lenders is because they are lenders in the counterfactual without banks. They become depositors instead with banks. This is what he means and it is a non-issue.

    Total confusion on the internet about this idea of intermediary. Like it’s some virus to be avoided.

    Incredibly silly.

    Its just more of moving definitions and vocabulary around from one corner of the room to another.

    Ramanan is right that Tobin is not responsible for Krugman’s confusion. Nothing wrong with Tobin (or very little). Krugman is responsible for his own confusion.

  21. Fed Up says

    Cashin: Excess bank reserves are a worrying 1930s parallel

    “The problem for many hedge funds, Cashin said, is that a number of them bet that inflation would hit the markets after continued easing from the Federal Reserve, but the expected move hasn’t materialized. “They’ve looked and said, ‘Gee the Fed is printing money like crazy, that’s got to be inflationary,’ and ordinarily it has been.”

    (Related: Art Cashin: ‘There’s no sign of inflation anywhere’)

    However, Cashin said, much of the Fed’s new money hasn’t found its way to the economy, as financial institutions—the major recipients of easy money—are too nervous to put the capital to work. This nervousness is reflected in nearly $2 trillion of excess free capital reserves, he explained.”

    The second paragraph about capital is not correct?

    • SqueekyWheel says

      “The second paragraph about capital is not correct?” As you suggest, it’s not.
      (I’m not confident I can compute capital ratios realistically, but tracking the equity position in total will serve)

      Assume Bank A at t=0
      Assets: $1 trillion US Treasuries, $100 billion CB reserves
      Liabilities: $1 trillion deposits
      Equity: $0.1 trillion

      Central Banker Beowulf prints 1 trillion in reserves and buys the treasuries.
      Bank A at t=1
      Assets: $1.1 trillion CB reserves, 0 treasuries
      Liabilities: $1 trillion deposits
      Equity: $0.1 trillion

      Not that total capital is unchanged. It’s form has changed (treasuries into reserves), which might impact capital ratios if the risk levels are different, but in this example, that’s not relevant. (ok, treasuries might be risky if the TeaParty gains enough seats)

      What about that new $1T in excess reserves? Isn’t that going to be lent? Well at t=0 the loan manager was looking at protecting the 0.1T equity, and at t=1 he’s still looking at 0.1T equity.

      QE through treasuries doesn’t change the capital position. There is no x trillion excess *capital* from QE.

      • JKH says


        picky point:

        “It’s form has changed”

        The form is really the equity itself, not the asset

        (e.g. certain debt instruments can qualify as tier 2 capital etc.)

        Also, the capital would be almost entirely excess capital in this example, because treasuries would have zero risk weight for credit purposes but a small amount of interest rate risk would attract a capital requirement in the market risk area of capital allocation

        (That’s a bit confusing for the example, because the excess capital is pre-existing at the first stage when the bank held the treasuries – the bank was already in a position to sell treasuries and lend instead – the point is that QE doesn’t change that opening capital situation where capital is already in excess and the bank presumably can’t find a use for it in lending – except that QE would free up that bit of capital that had been supporting interest rate risk on the bonds before the bank sold them, because there is no interest rate risk on reserves for capital allocation purposes – but this small nuance has nothing to do with how Cashin characterizes the situation)


        “Central Banker Beowulf”

        Yes, I understand this is the latest chatter

        i.e. that “Marriner Beowulf” is on the short list to replace Ben


        • SqueekyWheel says

          Thanks, that’s precisely what I was trying to say.

          I appointed Beowulf because I was hoping to use platinum-easing, but decided that would obscure the point.

    • JKH says

      Right – not correct.

      The Fed’s “new money” (i.e. excess reserves) can never find its way to the economy.

      That money is only used for settlement of payments between banks.

      And reserves are different and separate from capital.

  22. JKH says


    Another clear post:

    I just wanted to reiterate a basic point or two that I probably didn’t make that clear in my post:

    I think “loans create deposits” is a mostly a blogosphere tic that is the reflex response to the persistent appearance of false money multiplier thinking. As I noted, LCD is not an entirely coherent tic, because it also applies to the multiplier process itself. The better tick is LCD without prior reserves.

    Tobin’s point is entirely different. His point is that LCD is irrelevant to the degree that banks manage their asset/liability profiles according to sound portfolio management principles. I reduce that to saying that they manage their risk and the capital – which really amounts to the same thing. And in that sense of there being a consistent portfolio management approach, it doesn’t matter where the deposits come from.

    Put another way, to my way of thinking, capital allocation becomes the constraint on the widow’s cruse.

    A pleasant corollary of all this is that the Chicago Plan and similar wacko ideas for 100 per cent reserves are completely invalidated by the Tobin approach. I wonder if Tobin is on record regarding that issue. I wonder if he is consistent as per my thought.

    Finally, as I said in the post, I believe the Tobin approach is entirely compatible with the GL approach, even though GL seems to reject that (and they are in the best position to reject it). I think the two approaches are orthogonal but complementary – in the sense of strategic management (Tobin) and operational management (GL).

    • Ramanan says

      Thanks again JKH.

      Good point on t=2.

      Yes the loans create deposits is a natural response to the money multiplier thinking but commentators who simply say loans create deposits #enufsaid should say more.

      I won’t say GL completely reject Tobin’s approach but only many parts of it – finally their framework depends on Tobin’s asset allocation theory. Godley at one place used the phrase “Tobin’s monumental contribution to the subject”.

      • Nick Edmonds says


        As you know, it’s a favourite topic of mine that the actions of non-bank financials can have as much impact as that of banks. Nevertheless, the relative positions of their liabilities in the hierarchy of money means there is an important asymmetry here. Your illustration suggests an interesting thought experiment. Assume that there is only one bank and one non-bank financial, so that each is a monopoly in its immediate industry but so that they compete imperfectly.

        Now consider what happens if the bank decides to cut its deposit rate, or it the non-bank decides to cut its rate. In each case, the public might try to switch investments from one to the other. However, whilst this might lead to a reduction in money placed with the non-bank in the latter case, it may not (directly) lead to a reduction in bank deposits in the former. An attempt by the public to switch out of deposits can only work if they take it out as cash. Deposits might be reduced by, for example, loans being repaid as you describe, but that is not obviously a direct effect of a reduction in deposit rates.

        This does not of course invalidate any of the comments made above. The problem is when people understand this asymmetry but read too much into it.

        • Ramanan says

          Hi Nick,

          Agree completely.

          My aim to simply to create the scenario given by Tobin (in words) with some numbers in which banks’ loans and deposits reduce.

    • JKH says

      Note that in your example, “Cruse Control” for banking actually depended on the following operational step that you specified:

      “At t = 2, someone extinguishes his/her/its loan to the banking system by 10 unit.”

      Which is indicative of why I went on about loans being repaid in my post.

      However, in your example, NBFI expansion actually did not depend on that cruse control kicking in – not directly – and not from an operational perspective.

      The NBFI could have made a loan to somebody without that step.

      I.e. Cruse Control is not the same thing as NBFI expansion.

      CC requires an asset reduction or a liability/equity substitution – that is all.

      But Cruse Control and NBFI expansion are linked and correlated through Tobinesque pricing competition and adjustment and capital allocation disciplines.

  23. Ramanan says


    Sorry didn’t realize the comment was a response to someone.

    But something of this sort – in continuation of previous comments:

    Ignore other complications which can always be added. So let us say initially the banking system has (with deposits held by households and firms)

    Assets: Loans = 100
    Liabilities: Deposits = 100

    Now suppose a non-bank FI appears on the scene with liabilities called shares.

    And attracts 10 of deposits:

    Assets: Deposits = 10
    Liabilities: Shares = 10

    (Banks the same – deposits just transferred to the NBFI)

    Now someone extinguishes a loan from the bank

    Assets: Loans = 90
    Liabilities: Deposits = 90

    and then borrows from the NBFI. So the assets of the NBFI were previously deposits and after the transfer in exchange for loans, loans are now assets.

    So NBFI
    Assets: Loans= 10
    Liabilities: Shares = 10

    So 10 units of deposits have left the system.

    So Tobin’s point is that to prevent this from happening indefinitely, banks will have to put up interest rates and induce the public to keep deposits with them (and induce by other means as well). As in his asset allocation theory, asset demand depends on the natural portfolio preference times the interest rate, so inducing the public will tend to prevent this from happening or at least minimise this.

    • JKH says

      right, agree with that

      btw, this is an EXCELLENT post which I also totally agree with

      tried to make roughly the same point myself

      which I think simply put is

      “loans create deposits” co-exists with financial intermediation


      origination is supplemented by active management post origination

      some people who obsess over “loans create deposits” miss the point that its only an origination phenomenon

      which is one thing that causes me to sympathize with Krugman’s point to a degree

      • zanon says

        i don’t think anyone disagree with how, post origination is supplemented by active management. i think people just don’t see why this is important. OK, so running bank well you have to try and match term structure and liquidity. fine. so bank do that, so what?

        • JKH says

          Let me expand on that (not difficult to do).

          I think there’s a complicated multi-lateral discussion going on here. I think MMTers and likeminded are contemptuous of what they perceive to be Krugman’s lack of comprehension of “loans create deposits” and some of the accounting realities of banking. At the same time, Krugman embraces Tobin as the standard bearer for how banks are just another intermediary. At the same time, Tobin understood “loans create deposits” and the bogusness of the money multiplier 30 years before Mosler wrote about it – that’s absolutely clear from his essay. At the same time, those who embrace “loans create deposits” are delusional if they think that’s all there is to banking, or if they think it somehow negates Tobin’s essay, or if they think banks aren’t financial intermediaries in the sense that Tobin described (all of those being false claims, in my view). At the same time, some believe that Godley and Lavoie reject the Tobin thesis, which is also a false claim (in my view, but I stand to be corrected by the one person who might confirm that one way or the other). I think Godley and Lavoie in saying “we’re doing something different” were focusing on the aspect of the role of banks in facilitating firm production and that that really wasn’t inconsistent with what Tobin had to say at all. Tobin just didn’t focus on that piece, although once again he absolutely does reference it in his essay.

          So it’s complicated.

          Maybe there’s lot of “so what”s to go around – as in, why does anybody care about any of that?

        • zanon says

          I will be mores clear.

          how a bank manage portfolio is of interest to bank operator, but does not matter to man on street or to person trying to understand policy.

          krugman discussion is important because we do have bad policy and it is all his fault. krugman does not understand specific thing which lead to bad policy:
          1. he think “loanable fund” and bank act as ebay matching depositor which is also lender, and borrower. This is what he mean by “intermediary”. Eat it.
          2. he think that ability of bank to lend out multiple of deposit is manage by “reserve requirement”, and reserve act as cap on ability to lend.

          nobody think “loans create deposit” is all there is to banking. the “delusional” is think that the addendum “…and then they actively manage portfolio” is going to be what get lightbulb to go off in bearded one’s head which is entire point of discussion, and frankly PK.

          I can imagine Krugman, beard sweaty for Cullen’s exertions, saying “loans create deposit made no sense, but now that I’ve been told that, in addition, there is active portfolio management post origination, it all make sense and I can throw away all that loanable funds malarky and see if my Communism pushes me to MMT or I should just become PK”.

          Such pedantry make me sypathize with Krugy to a degree as well. So at least we agree on something, paul krugman is right in some resepect.

        • JKH says

          I can see elements of right and wrong in most of the factions here.

          (And this is not to presume that I’m necessarily right in entirety.)

          Unfortunately, the combination of right and wrong ends up as a distortion – even in the piece that is right, which becomes an unbalanced point of emphasis.

          So the pieces need to be put together more coherently than what is currently the case.

        • Ramanan says


          Great points again.

          Funny how having issues with the word “intermediary” has become the central point of the debate and most people around completely missing important insights of Tobin.

          Think Godley and Lavoie were a bit harsh on Tobin. But their attitude is still okay considering that Godley mentions the “monumental contributions of Tobin to the subject” and also said “my debt to Tobin is enormous”.

          But almost none of others’ attitudes has been anything like that. The fog around the word has given people sufficient ammunition to crucify Tobin instead of listening to some/many nice things he says.

          But same was true about Keynes – his vulnerabilities gave a great chance for others to try to prove him wrong.

          And Tobin’s error were something different which none of these commenters have anything to say on – it has to do with the neoclassical theory of profits etc but on monetary matters he was good.

          Things would have been much better if others had attitude like yours.

          For others it has sort of become a matter of insecurity and it is as if trying to banish Tobin has become a matter of survival. Instead they could have said look even Tobin who was a neoclassical was good and they have misunderstood a great leader himself. Of course even apart from G&L, other heterodox economists are not like that. Stephanie Kelton posted some comments on Twitter saying how she enjoyed friendship with Tobin who had ideas on taxes earlier.

        • JKH says

          Thanks, Ramanan.

          Haven’t even had a chance to focus more recently on where Tobin may have slipped a bit.

          I’m still rereading (a few times) the two essays, and discovering just how much he said that was right – and in an extremely compact and dense literary form in both cases. You have to look at every word – very closely.

        • JKH says

          I need a little context and relativity to answer that question.

          In this entire internet discussion (Tobin/Krugman et al), what doesn’t warrant that same question “so what”?

      • Ramanan says

        Thanks JKH :-)

  24. ef17 says

    It seems to me that Tobin’s argument might be wrong, but I haven’t thought it through and I don’t think I understand his argument. So I wouldn’t feel confident about saying it’s wrong. I wanted to ask for help understanding.

    He says (on p.413 of Commercial Banks as Creators of “Money”):
    ” . . . Borrowers do not incur debt in order to hold idle deposits . . . . The borrower pays out the money, and there is of course no guarantee that any of it stays in the lending bank. Whether or not it stays in the banking system as a whole is another question . . . [The answer] depends on whether somewhere in the chain of transactions initiated by the borrower’s outlays are found depositors who wish to hold new deposits equal in amount to the new loan.”

    But what if the borrower is, say, a homebuilder paying employees to build a house, and those employees buy services, and so on? I.e. these new deposits could just circulate around the banking system- no one needs to _save_ them. It seems to me he’s made a hidden assumption that deposits are either saved or not; but he’s forgetting about the notion of time. Maybe the more relevant question is: how long will the deposits stay in the banking system? (After all, eventually they’d be paid back if there is no default.) It seems like you need to attach a time period to make the question “well-defined”. Maybe this is an issue of confusing stocks and flows?

    I don’t understand his (a) and (b) about how the banking system can expand its assets (but I’m working on it), so maybe that’s where I’m missing something? (Incidentally, I also wonder if the two uses of the word “savings” are causing him problems, but I may be predisposed to that b/c of reading your blog, ha ha. Same with the stocks and flows, I suppose!)

    Thanks for any help (and for many useful things I’ve learned here in the past),


    • JKH says

      Time would definitely be a key variable in a perfect model.

      Godley and Lavoie are pretty sophisticated along those lines.

      As you note, Tobin says:

      “Whether or not it stays in the banking system as a whole is another question . . . [The answer] depends on whether somewhere in the chain of transactions initiated by the borrower’s outlays are found depositors who wish to hold new deposits equal in amount to the new loan.”

      This is a hugely important statement in the paper – but mostly because of what it omits, which is something I alluded to in my post.

      Let’s use your example for the purpose here (as opposed to the time element you identify)

      So the borrower is a homebuilder paying employees to build a house, and those employees buy services, and so on.

      Suppose one of those employees has a mortgage with another bank. And he uses his income to pay down that mortgage. That transaction will “destroy” those deposit balances and an equal amount of the mortgage. That shrinks the balance sheet of the bank and the banking system.

      That qualifies an example where Tobin would say the deposit “leaves” the banking system.

      And it has “left”, in the sense that its exited stage left by way of total disappearance.

      In order for a deposit to “leave” the banking system a la Tobin, there has to be some sort of balance sheet adjustment within the banking system, as in the example.

      We rule out the case of other deposit taking institutions that are non-banks, because those are limited in number, its not the same kind of deposit, and its not indicative of the general case that Tobin should be talking about.

      This is what I meant when I said there needs to be more accounting clarification of the type of flow of funds effect Tobin is talking about when he says deposits “leave” the banking system. And a bank depositor can only choose to have his deposit not “stay” in the banking system by taking action to make it disappear in effect. And this has to be explained in accounting terms.

      Another common example where a deposit “leaves” the banking system is when a stock market investor uses a deposit to pay for a new bank equity issue. The banking system changes by replacing a deposit with an equivalent amount of common equity on the balance sheet. The deposit “leaves” because it disappears.

      Tobin is obviously supremely insightful, but language and accounting clarification are really required to figure out in entirety what he is talking about.

      • Fed Up says

        “Another common example where a deposit “leaves” the banking system is when a stock market investor uses a deposit to pay for a new bank equity issue. The banking system changes by replacing a deposit with an equivalent amount of common equity on the balance sheet. The deposit “leaves” because it disappears.”

        Does that have to happen?

        Using my example above, I decide to save $50,000 in demand deposits at another bank. I then move the $50,000 to the new bank in a checking account.

        Assets new bank = $100,000 in treasuries plus $2,000,000 in loans plus $50,000 in central bank reserves
        Liabilities new bank = $1,500,000 in a savings account plus $500,000 in a 7 year CD plus $50,000 in demand deposits [asset in my checking account]
        Equity new bank = $100,000 of bank stock

        The new bank decides to issue $50,000 more in stock to build a new branch. Now asset swap (move) the $50,000 in demand deposits for $50,000 in stock.

        Assets new bank = $100,000 in treasuries plus $2,000,000 in loans plus $50,000 in central bank reserves plus $50,000 in demand deposits [new bank’s checking account]
        Liabilities new bank = $1,500,000 in a savings account plus $500,000 in a 7 year CD plus $50,000 in demand deposits
        Equity new bank = $100,000 of bank stock plus $50,000 in bank stock

        Now don’t cancel out the two(2) $50,000. Next, have the home builder build a new branch for the new bank for $50,000. Asset swap (move) the demand deposit for the building.

        Assets new bank = $100,000 in treasuries plus $2,000,000 in loans plus $50,000 in central bank reserves plus the building
        Liabilities new bank = $1,500,000 in a savings account plus $500,000 in a 7 year CD plus $50,000 in demand deposits
        Equity new bank = $100,000 of bank stock plus $50,000 in bank stock

        Lastly, have the home builder move the $50,000 in demand deposits to another bank.

        Assets new bank = $100,000 in treasuries plus $2,000,000 in loans plus the building
        Liabilities new bank = $1,500,000 in a savings account plus $500,000 in a 7 year CD
        Equity new bank = $100,000 of bank stock plus $50,000 in bank stock

        The demand deposit moved (not created and not destroyed) in all the cases. Thoughts?

        • JKH says

          That’s all fine from a single bank perspective.

          I specified the banking system in the quote.

          So you have to subtract the $ 50,000 in both bank reserves and deposit from the bank that you transferred the original money from. System bank reserves remain the same but system deposits netting all out have been reduced or “destroyed” by $ 50,000 to make way for the new $ 50,000 in system bank equity.

          Your # 1 earlier was correct (Fed Up August 25, 2013 at 3:09 pm)

          Your # 2 was too densely constructed for me to understand.

        • Fed Up says

          I’ll try to redo #2 without #1.

          The new bank decides to build a new branch. It is going to fund it with a new stock issuance.

          While ignoring #1,

          I decide to save $50,000 in demand deposits at another bank. I then move the $50,000 to the new bank in a checking account.

          Mark down my checking account at the old bank, mark down the old bank’s liabilities, mark down the old bank’s reserve account at the fed. Mark up my checking account at the new bank, mark up the new bank’s liabilities, mark up the new bank’s reserve account at the fed.

          Assets new bank = $50,000 in central bank reserves
          Liabilities new bank = $50,000 in demand deposits [asset in my checking account]
          Equity new bank = $0 of bank stock

          The new bank decides to issue $50,000 in stock to build a new branch. Now asset swap (move) the $50,000 in demand deposits for $50,000 in stock.

          Assets new bank = $50,000 in central bank reserves plus $50,000 in demand deposits [new bank’s checking account]
          Liabilities new bank = $50,000 in demand deposits
          Equity new bank = $50,000 in bank stock

          Now don’t cancel out the two(2) $50,000 in demand deposits. Next, have the home builder build a new branch for the new bank for $50,000. Asset swap (move) the demand deposit for the building.

          Assets new bank = $50,000 in central bank reserves plus the building
          Liabilities new bank = $50,000 in demand deposits [asset in the home builder’s checking account]
          Equity new bank = $50,000 in bank stock

          Lastly, have the home builder move the $50,000 in demand deposits to another bank.

          Mark down home builder’s checking account at the new bank, mark down the new bank’s liabilities, mark down the new bank’s reserve account at the fed. Mark up home builder’s checking account at the old bank, mark up the old bank’s liabilities, mark up the old bank’s reserve account at the fed.

          Assets new bank = the building
          Liabilities new bank = $0
          Equity new bank = $50,000 in bank stock

          The demand deposit moved (not created and not destroyed) in all the cases. Thoughts?

        • Fed Up says

          1) I don’t get why the demand deposit is destroyed then recreated instead of moved.

          2) If a non-bank, non-financial firm issued new stock, would the demand deposit be destroyed?

          3) Can the new bank have a checking account for itself?

          4) “Should be:

          Assets $ 50,000 reserves
          Liabilities $ 50,000 equity
          Demand deposit is converted to equity (i.e. demand deposit disappears/ is destroyed)”

          Do you mean:

          Assets new bank = $50,000 in central bank reserves
          Liabilities new bank = $0
          Equity new bank = $50,000 in bank stock

          Let’s say the new bank then bought $20,000 in doughnuts (an expense, not a real investment) from a company that has a checking account at the new bank. What does the accounting look like then?

        • JKH says

          Do you mean:

          Assets new bank = $50,000 in central bank reserves
          Liabilities new bank = $0
          Equity new bank = $50,000 in bank stock

          yes – sorry

          Let’s say the new bank then bought $20,000 in doughnuts (an expense, not a real investment) from a company that has a checking account at the new bank. What does the accounting look like then

          deposits up $ 20,000
          equity down $ 20,000


          banks generally have reserve accounts rather than checking accounts with other banks

          although they do have so-called correspondent banking relationships when dealing in foreign currencies

          there may be other exceptions I’m not aware of


          an NBFI that issued new stock would have a bank account (asset) that would be credited with funds

          some of its own liability holders might liquidate to do that (e.g. the unit holders of a publically listed mutual fund selling their units to buy stock newly issued by the mutual fund)

        • JKH says

          OK, except:

          Assets new bank = $50,000 in central bank reserves plus $50,000 in demand deposits
          [New bank’s checking account]
          Liabilities new bank = $50,000 in demand deposits
          Equity new bank = $50,000 in bank stock

          Should be:

          Assets $ 50,000 reserves
          Liabilities $ 50,000 equity
          Demand deposit is converted to equity (i.e. demand deposit disappears/ is destroyed)

          And in the next step, the bank adds the branch as a real investment and credits the builder with a new demand deposit.

          (The branch is treated as an investment on the balance sheet, not an expense, so the equity account isn’t affected – which you have correctly represented)

          Net/net, the banking system has expanded by the amount of the real investment and the equity.

          And the following did happen in the first phase:

          “Another common example where a deposit “leaves” the banking system is when a stock market investor uses a deposit to pay for a new bank equity issue. The banking system changes by replacing a deposit with an equivalent amount of common equity on the balance sheet. The deposit “leaves” because it disappears.”

          Then you added the investment plus a new deposit.

          That’s a separate assumption and a further step.

          So the deposit destruction did happen, but then something further happened (arbitrary relative to the equity issue) to create a replacement deposit.

      • Ramanan says

        Page 7 in the lower half also says this:

        “Bank deposits decline with bank assets”.


        “In effect, the non-bank intermediaries favoured by the shift in public preferences simply swap the deposits transferred to them for a corresponding quantity of bank assets”.

        • JKH says

          Not all bank assets are liquid, which is the case in my example.

        • ef17 says


          Thank you for taking the time to explain and give these helpful examples. I suspect that most who read the blog will have understood that this is what you were referring to, so thank you for taking the extra time. Good point re an employee paying off the mortgage, thank you.

          That’s nice that Godley and Lavoie include the time aspect- I should probably look into their work. I guess it’s an empirical issue how much the time aspect affects Tobin’s points. I need to read his paper more to understand this- I still feel intuitively (though I know I’m still missing a lot) that he’s not framing things precisely enough to be able to call something “superficial and irrelevant” (p. 412).


          Thank you also. I’ll have to think more on this too. I wonder also if he is also just thinking of people holding cash? Is that possible? Maybe b/c it was a different time?

          Have to think about all this more.

      • Ramanan says

        I think what Tobin is thinking of is something like non-bank financial lenders attracting funds and this leading to a rise in their lending and taking away the market from banks. Banks’ balance sheet shrink because loans shrink and so will deposits.

  25. Fed Up says

    Let’s say I save $100,000 in demand deposits. Someone else wants to start a new bank. They sell me $100,000 in bank stock (bank capital) and then buy treasuries. The reserve requirement is 10%, and the total capital requirement is 10%. I believe that means the capital requirement is 5% for mortgages and is 10% for ordinary loans. This example will be all mortgages.

    Assets new bank = $100,000 in treasuries
    Liabilities new bank = $0
    Equity new bank = $100,000 of bank stock

    The bank now makes 20 mortgages for $100,000 each. The 20 people use the demand deposits to buy 20 homes for $100,000 each from 1 home builder.

    Assets new bank = $100,000 in treasuries plus $2,000,000 in loans
    Liabilities new bank = $2,000,000 in demand deposits
    Equity new bank = $100,000 of bank stock

    $100,000 / ($2,000,000 * .5) = .10

    The home builder sets up a checking account at the new bank. So 20 checking accounts at the new bank were marked up and then marked down by $100,000 each, while the home builder’s checking account was marked up by the $2,000,000.

    The home builder allocates as follows:

    $1,500,000 in a savings account and $500,000 in a 7 year CD. The reserve requirement for savings accounts and CD’s is zero so that takes care of a positive reserve requirement.

    1) Is that correct?

    2) Overall, I saved $100,000 in MOA/MOE, and the borrowers “dissaved” $2,000,000 in MOA/MOE for a difference of $1,900,000 in MOA/MOE. That difference is why banks and bank-like entities matter.

  26. Fed Up says

    I don’t see anything about the capital requirement/capital multiplier.

    I believe that affects the amount of medium of account (MOA) / medium of exchange (MOE) where MOA = MOE = currency plus demand deposits.

    • JKH says

      “Other expenses include such items as employee compensation, the interest rate paid on deposit funding, income tax, and the cost of equity capital. All of these things need to be taken into account in determining break even pricing for a bank loan, so that all expenses including the cost of equity capital are adequately covered… importantly, risk weighted capital measures along with capital adequacy regulations are the modern banking system’s natural successor to these old reserve requirements. “

      • Fed Up says

        I only looked at pages 412 and 413. Did I miss it, or is it on a different page?

        • JKH says

          quote above is from my post – thought that was your reference – sorry

        • Fed Up says

          Actually, that is my bad. I should have said Tobin’s paper, pages 412 and 413.

  27. Ramanan says


    “Tobin summarizes the macro flow of funds between different financial intermediaries in adept fashion, but without referring to the bookkeeping that must occur within the banking system when a deposit “leaves” a given bank or “leaves” the banking system in its entirety. For example, a deposit cannot “leave” the banking system without some corresponding reduction in a loan or other asset, or some corresponding increase in a non-deposit liability or equity capital – those types of entries being made within the same banking system that the deposit previously occupied. ”

    While from an accounting viewpoint it is trivially true in one sense, just extrapolating it in the Widow’s cruse sense doesn’t make sense. Because if it is true, banks could easily pay zero interest on all deposits.

    Forgetting complications due to capital flight outside the country – which Tobin also notices – there are two things. A single bank cannot do so (pay zero interest) because of competition and neither can the banking system as a whole because non-bank lenders can attract deposit holders and still manage to lend borrowers on attractive terms so that the banking business can get hurt. Perhaps people will purchase government bonds on a large scale forcing the bank to borrow from the central bank.

    Even in international contexts, there is a pressure on the banking system if the nation as a whole is highly indebted.

    Even at a regional level in a single currency area this can be seen – such as in the case of the Euro zone. Banks in countries with a heavy outflow need to pay interest to keep the deposits.

    This comes at a cost which is what Tobin recognizes.

    Hence Tobin: “… induce the public …”

    Perhaps there is an overemphasis on the Widow’s Cruse running dry but there is sufficient truth to it.

    • JKH says


      I think I agree with all that, roughly.

      Not sure of your full meaning – are you emphasizing the point, or do you think I’ve written something that contradicts that?

      • Ramanan says

        I won’t say contradicting but Tobin is attempting to say that the fact that “loans create deposits” compared to non-banks who do not simply credit share accounts isn’t by itself the end of the story.

        One can possibly imagine a situation in which there is a rapid sustained rise in demand and output requiring a lot of lending activity and non-banks financial lenders taking away a lot of market share of loans by issuing more liabilities and so on and being successful even though they do not simply credit liability accounts. And the point that deposits do not “leave” for the banking system as a whole is not that important. Banks still have to prevent this rise in competition from happening.

        It is difficult to not be personal about the two personalities – Tobin and Krugman. So we have come to the point where loans creates deposits is no longer that important and won’t impress Tobin. But this is Econ 1103 unlike others who are stuck at Econ 101 (like Krugman!). Krugman is pretending to be Tobin and saying “that don’t impress me much”. I am trying to say something which I think is not expressed rightly.

        Nonetheless Tobin has his own errors. Tobin’s error is more about not recognizing that credit is demand-led and he uses some neoclassical model of marginal curves to explain away why lending doesn’t explode.

        • Ramanan says

          So in a sense saying that ideally there should be two criticisms – one aimed at Tobin and one aimed at Krugman.

          Like tackling two people making maths errors – one making a non-trivial error at somewhat advanced level for whom the fact that the real line extends to the left of zero into the negative isn’t important and for another who makes an error in which this fact is important. But maybe that is how you ended saying it doesn’t refute the intellectual usefulness of the points such as loans create deposits and the story following that.

        • JKH says

          also, see that I defined purpose as follows:

          “examine the effectiveness with which Professor Krugman’s channeling of Tobin (Krugman/Tobin for short) refutes the importance of either of these dimensions, whether considered separately or jointly.”

          i.e. defined Krugman/Tobin that way specifically

          which covers most of the post

          separately, I tried to identify comments specific to Tobin where applicable

          but you’re right; its messy tackling two at once

          But I do find the highlighted “puzzle” as to why the banking system doesn’t swallow everything up to be a bit obvious to resolve, which seems to be one thing that both Tobin and Krugman are keen to demonstrate – and that “puzzle” is essentially Krugman’s come back to why “loans creates deposits” is misleading – which I also find pretty naïve as a comeback

          The whole thing is complicated in that way

          And it’s actually just one point, and apart from that motivation, both Tobin papers are very deep in the way they describe things and well worth spending some time on; maybe to your point more generally, Tobin’s description of the monetary system is easily far superior to anything Krugman can manage at a technical level, and Krugman is cherry picking an aspect or two from it in an attempt to make his point