Friday, May 27, 2011

Harvey's new assumptions links to John T. Harvey on Inflation. The Harvey link is a four-page article prefaced by an advertisement, with a confounded graphic that makes you wait while it scrolls text up and down the screen every time you turn the page.

Impatience aside, the article reviews the equation of exchange MV = Py. Harvey says nothing new until the last paragraph of page three where MMT stuff comes into play. Even then, it doesn't get interesting until Harvey states his "new assumptions with respect to M, V, P, and y". I want to look at some of his new assumptions about M.

A precise definition and identification of money is elusive in a modern, credit-money economy...

As Jude Wanniski said (Reader's Digest, Feb 1995, p.49): "You have to have lived in the 1950s and 1960s to have experienced a good economy." Sadly, many people have never known a "good" economy. Some of those people do studies and base their views on stats going as far back as the 1970s. Those studies consider only the bad economy. Those views are based on a bad economy.

It is no doubt true that "A precise definition and identification of money is elusive in a modern, credit-money economy." But, that definitions are 'elusive' is not the problem; it is a result. The problem is that we have become a modern, credit-money economy: Define money and regulate it, and financial innovation will come up with something new and unregulated -- and then money is undefined, again.

The problem is excessive debt. Additions to debt are created when the quantity of "modern, credit-money" is increased. Debt is already excessive, and has been since the 1970s. Creating more debt in an environment of already-excessive debt does more harm than good. Yet this is what happens in a modern, credit-money economy.

Because central banks almost always target interest rates (the price of holding cash) rather than the quantity of money, they tend to simply accommodate demands from banks. When private banks communicate that they need more reserves for loans and offer government debt to the Fed, the Fed buys it. It’s the private sector that is in the driver’s seat in this respect, not the central bank.

Because central banks almost always target interest rates, rather than the quantity of money, they tend to simply accommodate demands from banks.

And what happens if central banks stop targeting interest rates and start targeting the quantity of money again? What happens then? The central banks no longer provide reserves on demand. So the private banks cannot make loans first, and get the reserves to cover them, later. So then, banks need deposits before they can lend. So then it is no longer true that "loans create deposits".

Does the MMT argument fall apart in that moment?


Liminal Hack said...

Firstly, if you accept that the private sector in general would 'innovate' using computers, for example:

* risk models
* securitisation
* the way the chinese private sector have turned copper into base money

then targeting the quantity of base money is not going to help, is it?

Don't take this the wrong way but I think this kind of seeking for a 'systems control theory' is utterly doomed, in part because you are focusing on outdated levers.

Secondly, I thought you advocated more base money, not less?

Thirdly, you are advocating monetarism, which was tried prior to the current regime of inflation targeting and both failed dismally.

What I think makes more sense, is to stop trying to prevent a socio-economic-cultural complex, dynamic system from achieving its own equilibrium.

The Arthurian said...

It might help me understand if you dumb it down a notch or two and remember that probably all my thinking is "outdated." I do not accept the premise that unlimited expansion of credit-use is a sustainable policy. Excessive reliance on credit is as absurd as excessive reliance on labor or excessive reliance on capital. Balance is required.

2. I actually advocate more M1 money, which is close to base and even includes some debt I suppose. But let's say I advocate more base and less "thinning out" of money by the fractional reserve process that creates money-and-debt. I advocate more money relative to debt, and less debt relative to money. That never changes.

3. However, in the post -- in the latter part, specifically -- I am not advocating anything. I am just asking a question. What happens to the 'loans create deposits' notion if the Fed changes its approach?

I think the validity of the notion may depend on the approach the Fed takes. And if that is true, then the notion is very much less than a valid theory.

But I do not pretend to have a definitive answer to my question.

What you think makes more sense, reminds me of something Lester Thurow wrote in Head to Head (1992):
Left to itself, unfettered capitalism has a tendency to drift into either financial instability or monopoly.
...and, given enough time and leeway, into a dark age.

So, tell me about the chinese private sector turning copper into base money.

Jazzbumpa said...

Left to itself, unfettered capitalism has a tendency to drift into either financial instability or monopoly.

Didn't Karl Marx say something rather similar a few years earlier??

Capitalist production, therefore, develops technology, and the combining together of various processes into a social whole, only by sapping the original sources of all wealth-the soil and the labourer.

Not the same, but consistent.


The Arthurian said...

"...the soil and the labourer."

Land and labor... two of Adam Smith's three factors of production, capital being the third.

Marx defines Smith's factors differently, by excluding capital.

I define Smith's factors differently, by including money.


LiminalHack said...

Here's a link on that copper thing:

LH said...

"Left to itself, unfettered capitalism has a tendency to drift into either financial instability or monopoly."

Absolutely. I wasn't suggesting that any equilibrium would be one of unfettered capitalism which since it isn't stable as you observe, can't be an equilibrium.

I'd say we left unfettered capitalism behind in roughly the first decade of the 20th century. I'm not saying that in the way your traditional libertarian would mean it - simply observing that the institutions and money system we have is decidedly something else.

The key I think, is that capitalism is not first and foremost about debt, its much more to do with the relations between the factors of production.

Greg said...

If you are talking about a zero reserve system, they already have one in Canada and loans still create the deposits. So I dont think anything at all happens to the MMT argument in that scenario.

Reserves are NOT capital. Banks need capital to remain solvent not reserves. Loans will always be made by considering the income flow position of the borrower, not the reserve level of the lender.

If I can show that my income will support the payments on the loan I will be able to secure it.

The Arthurian said...

Hi Greg. Yeah Canada has had zero reserves since the '90s I think, and we have zero reserves on savings... But I read that when Volcker terminated the inflation of the 1970s he did it by targeting M1 money growth rather than interest rates. And it didn't work very well, except that it *did* change the pattern of inflation.

Later the Fed targeted M2 for a decade maybe, and then switched to interest rates. (And maybe I missed a step in there.)

Anyhow, if the Fed targets interest rates, then they will generate reserves to keep rates on-target, if they have to. So private banks are 'in the drivers seat'.

But if the Fed targets M1, then they have to be more judicious in the creation of reserves, and therefore, I think, loans don't create deposits.

Or no, maybe the loans still create deposits but only when the reserves permit it. (So the private banks are *not* "in the drivers seat".

But I only read that thing once about Volcker targeting M1, and this is all very hazy to me. (As is MMT.)

Greg said...

Bill discussed much of this the other day.