Friday, February 22, 2013

Monetary policy is ineffective? Gee, I wonder why.

At Unlearning Economics, the current post links to an older one where, in comments, Unlearningecon writes:

If you think about your household income, you receive your income plus however much you borrow. So say your income is £10 and you borrow £5, your total income is £15. But to keep it constant you must continue to borrow £5 a year. To increase your income, you must borrow more than that each year. If you reduce the amount you borrow to £2, your income will fall ... even though you are still borrowing.

In the mainstream framework this cancels out at a macro level. However, in the endogenous framework, the banking system is effectively the economy’s ‘bank’ and so it scales up – money paid back goes out of circulation and into the banking system.

He links to a Keen post (we looked at it yesterday), then continues:

The point is that you can think of money paid back into the banking system as out of circulation. So if you imagine that, say, only the CB lent out money, you would see that paying it back to them would take it out of the economy.

It's an important point. Dunno if I missed it in the Keen post or if Unlearningecon is taking the thought in his own direction. But I like it.

The economy is transaction. Exchange. The economy is measurable in dollars of spending. If you take a dollar out of the spending stream and sit on it, that's very nice but it does nothing for the economy.

It doesn't matter who takes money out of the economy -- the Fed, or an individual saver. A dollar not being spent is not a participating dollar.

Oh, sure: you can lend your dollar into the economy so that it becomes a participating dollar. But with that dollar comes a cost to the economy.

If the economy needs a dollar, and the Fed just prints one, somebody will complain about inflation and loss-of-value and cost. A loss, perhaps; but this isn't really a cost. Not like Adam Smith's factor costs are costs. And not like the cost of interest.

Savers and lenders compete with the monetary authority by performing comparable economic acts, putting money in and taking money out of circulation. As savings accumulate, the competing power grows, weakening the monetary authority.


nanute said...

money paid back goes out of circulation and into the banking system. Does this imply that it never circulates again?

The Arthurian said...

Hi nanute. The money can re-enter circulation two ways that I know of: Either the guy who saved it withdraws it and spends it. Or somebody borrows it. (And lots of people would say that savings are never loaned out.)

If somebody does borrow the money, then everything is just as before (I mean, the money is back in circulation) EXCEPT that there is an additional interest cost that did not exist before. This gets to the problem that I focus on most often, debt-per-dollar. The higher the DPD ratio, the more interest there is to be paid. The lower the DPD, the less interest to be paid. Interest is a cost that competes with wages and profits... Finance is a sector that competes with the productive sector for income.

If the guy who saved it withdraws the money and spends it back into circulation, then everything is just as before and there is NO additional interest cost.

What are the chances that a dollar saved will be withdrawn and spent? If savings tends to increase, then I have to say: Not good. It depends largely on policy. But as you know, policy encourages saving.

I can't say never, but I do say that money saved tends not to be withdrawn.

jim said...

Art wrote:
"If somebody does borrow the money, then everything is just as before (I mean, the money is back in circulation)."

The fundamental problem with that analysis is how does one determine what is meant by "money in circulation".

If I take $10,000 out of savings account and buy something and the seller of that something puts the money in their savings account, the amount of money in savings remains the same and that is not counted as money in circulation. OTOH if I perpetually keep $10k in a cookie jar that is counted as money in circulation. The money in currency and savings has a constant flow in and out (that nets close to zero). The stock of currency and savings changes slowly compared to the flow.

And then there is also the problem of quantifying what people think is "saving". Before 2008 lots of people thought home equity was savings - not so much anymore.

I would say the current policy is to discourage savings since the real interest on savings is negative. The rise in money found in saving accounts can be attributed to the decline in money market accounts and QE. That is really just moving money from one saving vehicle to another. But that increase in savings is not evidence of policy intent. I think
savers are defying policy.

The Arthurian said...

"I would say the current policy is to discourage savings since the real interest on savings is negative."

Jim, you always look at policy now, since the crisis, when people are scurrying to patch things up and scurrying to understand what the problem is.

I always look at the way things were for 60 years before the crisis. I think I have the better perspective.

Specifically: Since they pushed rates to zero in 2008, okay, fine: it may be said that this particular policy discourages saving... or at least if fails to encourage saving, I'll give you that. But 401K plans still exist and still encourage saving. And all the other policies created by CONGRESS since the end of the second world war all work to increase the supply of credit and the demand for credit. Besides, the whole mindset of not only policymakers but almost everyone is that we need to expand credit use in order to expand the economy.

So I think it is not correct to say that on the whole, current policy discourages saving.

jim said...

I have no objection to postmortem analysis of the 60 years prior to the crises. But face it, you're chopping up something that's now dead and gone.

Does putting money into the stock market count as savings?
If I take $10K out of my savings account and buy stock then do I still have my savings and someone else has $10K to spend?

It does not look to me that putting money in 401k is equivalent to putting money in a saving account.