Monetary Realism

Understanding The Modern Monetary System…

S&P notices reality, agrees with MR

Interesting news from yesterday: S&P has finally understood pushing reserves into the system does not cause inflation or more lending.

The title of this paper is straight forward enough everyone can understand:

Repeat After Me: Banks Cannot And Do Not “Lend Out” Reserves

Why is this important? Lots of people think hyperinflation is right around the corner. These people are wrong.

Not wrong in the sense of a “valid counter argument” wrong, but rather, they are wrong in the “not understanding the logic flow of the operating system” wrong. They are wrong like the guys in business suits telling the programmers the program will crash the computer because “the program is too fast, so slow it down” wrong. They don’t understand the basics of how computers work, so the problems identified and solutions proposed seem hilarious to people who really understand the nuts and bolts of programming.

Unfortunately, the real world consequences of these misunderstandings are gigantic. We are all at least 5% poorer than we should be because of these huge errors.

Cullen has pounded the table on the exact topic of reserves for several years, so it’s nice to have some mainstream recognition of the basic facts of how our monetary system works. It’s remarkable, but this paper reads as though Cullen Roche and JKH were the ghost writers.

Looking at the table of contents, its a point by point agreement with what Monetary Realism and many other bloggers in a loose confederation of truth tellers (like Edward Harrison, Steve Waldman, Ramanan Iver, Steve Roth, and Frances Coppola) have been writing about since the first round of QE started.

Additionally, he name checks MMT, Godley, Lavioe, and Wray in footnote 4.

Really, looking at this more closely, it seems like he might be reading Monetary Realism.

Look at the table of Contents:

Table Of Contents
The Money Multiplier View Of Credit Creation
What Determines The Level Of Central Bank Reserves
How Banks Create Loans
Where Deposits Come From
Interest-Rate-Targeting Central Banks Supply Whatever Reserves Are
How Things Change Under QE
Why Understanding The Balance-Sheet Mechanics Of QE Is Important
The Bottom Line
Related Research

And then look at this post by JKH: Loans Create Deposits in Context. Additionally footnote 10 reads like it was written by JKH himself:

“Another way to conceptualize QE is as a debt management operation of the consolidated government (the government plus the central bank). When a central bank does QE by buying long-term government debt or government-guaranteed assets, the consolidated government retires long-term debt or guarantees on long-term debt and issues central bank debt (reserves) instead. This shortens the duration and debt servicing costs of the consolidated government’s outstanding debt, particularly when the central bank does not pay interest on excess reserves. This debt management operation effect is the flip side of the portfolio rebalance effect visited on the private sector’s aggregate portfolio”

Also, for some reason, the chief economist of S&P felt compelled to dispel the money multiplier myth, because so many people think there is a money multiplier. He does us a favor by collecting a large number of quotes from influential economists who apparently believe in the money multiplier view of credit creation. Noah Smith, read footnote 2 and weep with us. This view is everywhere.

(Update:  I’ve had time to read Paul’s note more carefully. This note will become the primer on understanding banking reserves and how they impact credit creation. Paul’s note on the Platinum Coin is also excellent. His understanding of the system is very deep. )



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161 Responses

  1. Greg says

    Not butting in at all, everyone was invited to respond!

    “Is the gov/fed-complex a monopoly issuer of the currency?
    Does government spending redistribute deposits or create new ones?
    Do taxes destroy money ?
    Do delta’s in gov spending equal delta’s in NFA ?
    Interpretaion on S=I + (S-I) ?”

    I was listing the places where there isnt much if any disagreement, trying to focus on where we are in fact alike. I think the bones of contention you bring up have been discussed and to some extent will remain because its more a matter of how one wishes to make a point. I have no problem personally with telling certain people “Think of govt spending as simply redistributing existing bank deposits”
    while going down the hall and telling another guy. “Think of govt spending as creating new money, that ends up in some non govt persons checking account, thats why when “they” are in deficit “we” are in surplus, in dollar balances”

    I think its not unlike when I have helped some people with their golf swing. With some guys who have an over active right side (RH golfers) I might say “At the top of your backswing try to wait a little bit and start down by pulling with your left side” I might even have them make a left arm only swing or two.

    With others you look and see they need to drive their right side much harder.

    There is more than one approach to getting right ideas across.

    Ultimately I dont think the goal of MR or MMT should be to get everyone to recite some operational reality per se it should be to get people to understand that
    1) banking is not like putting money in a piggy bank and then loaning some of that money to someone else. It is a complex business of risk analysis that hopes to make a profit off productive activities which it helps to facilitate by providing credit. We arent limited to lending only what we have previously saved.
    2) deficits are not evil. We arent missing something. They arent something unpaid that will eventually need to be repaid. Ditto with public debts
    3) inflations relationship to some quantity of measurement M1 or M2 or whatever is tenuous and production is a huge factor in keeping prices under control
    4) unemployment, at a time like now, is mostly a demand side problem not a structural problem
    5) expanding private credit WILL boost activity and is needed but it needs to occur along with expanding incomes and more people seeking credit. Not just people reshuffling the housing stock around.
    6) public spending WILL boost activity too and is needed but it should occur along with targeting to projects which can increase our real stock of future wealth

    Any more?

  2. A H says

    God, that Paul Davidson quote is ridiculous. Minsky uses ISLM? has he read any of Minsky’s work?

    Davidson actually reminds me a lot of some MMT guys with his insistence that his is the one true and good interpretation of Keynes, and everyone else can be damned.

    Marc Lavoie’s “big tent” PKE seems to me to be the best way to think of the term.

  3. bubbleRefuge says

    Anything else?

    Sorry to butt in. Seems there are interesting points to flesh out between MR/MMT:
    Is the gov/fed-complex a monopoly issuer of the currency?
    Does government spending redistribute deposits or create new ones?
    Do taxes destroy money ?
    Do delta’s in gov spending equal delta’s in NFA ?
    Interpretaion on S=I + (S-I) ?

  4. Greg says

    I know this thread has gone further down the MMT vs MR road than ever intended by Cullen or any one else but I do feel an urge to add one comment summing MY feelings on this. (BTW its great to see Winterspeak here commenting….. he introduced me to this stuff -sniff sniff *wipes tear from eye*)

    So mostly where we have arrived is that;

    MR and some MMT guys dont really like the concept of defining full employment as 0% involuntary unemployment,

    We all accept FF at least when comparing it to “sound finance” (hope this doesnt sound like “Mosler is better than Krugman I guess” : ) )

    Jamie Galbraith is fricken awesome

    Banks rule the roost and monetarists picture a porcelain piggy when they hear bank not a third party payment settle/risk manager with a huge stake in the outcome of a transaction (and a cost added)

    Taxes are a significant part of modern monetary systems, without which true sovereignty is questioned.

    Anything else?

    Lets go kick some monetarist ass!

  5. beowulf says

    Hadn’t heard that story about his Friedman speech, that’s kind of funny.
    Galbraith’s statement to the Bowles-Simpson Commission is hilarious, just an amazing explanation of public finance mixed with some Real Talk (“A Commission serving public purpose cannot accept funds or other help from a private party with a strong interest in the outcome of that Commission’s work. Your having done so is a disgrace.”).
    A guy with balls like that will need a doctor’s note to get past metal detectors.

  6. Cullen Roche says

    Yeah, I think that’s the right view. Galbraith is his own brand. He doesn’t need to round up a pack of dogs to go hunting with. He just goes outside and hunts down monetarists when he’s hungry. His Friedman speech is still my favorite econ speech ever. To walk into a Milton Friedman event and tell everyone that you come not to praise Milton, but to bury him is about as awesome as it gets.

  7. winterspeak says

    well beowulf, you might just be an MMTer yet.

    I don’t know of any MMT purity test either, but I know what the word “theory” means. Just as you can buy Ricardo on Comparative Advantage but reject free trade, you can buy MMT and reject JG. JG is policy recommendation, not a theory. Period.

    CULLEN: Yes if you want to get to zero involuntary unemployment a JG will get you there, but you can decide that’s a good idea without buying into FF, or understanding bank operations, or any of the other stuff, and do that anyway. Isn’t that sort of what the national job banks were in the depression?

    Personally, I think that the concept of “public purpose” and “public good” is broader than just targeting that one measure, you need to consider many other factors as well, and I think that’s inline with functional finance. Remember, the “functional” in “functional finance” is to stand in contrast to the “sound” in “sound finance”. “Sound finance” makes sense for households, but not for sovereigns. If someone’s saying “don’t shoot yourself in the foot” it doesn’t mean that they are saying “shoot yourself in the head”.

  8. Tom Hickey says

    Not sure that is actually the case with Galbraith. When asked what economic school of thought he belongs to, he has said “Galbraithian.” He is probably “Post Keyensian” like Hyman Minksy was “Post Keynesian.”

    Galbraithian economics is considered Institutionalist. MMT integrates PKE and Institutionalism, and at one MMT economist has said that he identifies more with the later than the former.

    As I’ve said before, PKE is not something homogenous, and there is no purity test that I am aware of.

  9. Tom Hickey says

    Yes, directed at Winterspeak. It is possible that he is not aware of this in rejecting the JG.

  10. beowulf says

    I see JG as being a policy recommendation (and I see the logic, but reject based on concern over second order effects) and therefore outside of MMT since it is not an element of “theory”

    Winterspeak, that is EXACTLY the point Cullen was making when he was told most emphatically that he was wrong. If what you were saying were true then we’d all be MMTers. But the sticking point is the Job Guarantee, that’s the red line that determines if you’re on the bus or you’re not on the bus. You seem to think you are, but you’re not.

    Riddle me this, don’t you find it curious that Jamie Galbraith (who is smart as hell, probably sharper than Krugman) doesn’t identify himself as an MMTer even though the first 9 paragraphs of the Washington Post’s MMT profile are actually about Galbraith?

    The answer to this riddle can be solved by this equation:
    (MMT – JG) + Medicare = MMT

    Ha, I’m such an idiot. JG is a pun, it can mean either Job Guarantee OR Jamie Galbraith…. I just noticed that and I wrote it!

  11. Cullen Roche says

    I presume that comment is not for me and is instead for your colleague here who thinks he’s MMT, but still hasn’t figured out that he’s not. :-)