Friday, January 3, 2014

JW Mason's Debt and Demand (1): Particle Economics

JW Mason writes:

The relationship between leverage -- especially household debt -- and aggregate demand was explored in a number of papers around the time of the last US credit crisis, in the late 1980s...

For most of these writers, the important point was that the effect of debt on demand is two-faced: new borrowing can finance additional expenditure on real goods and services, but on the other hand debt service payments (in the presence of credit constraints) subtract from the funds available for current expenditure.

Yup, exactly. There is a story that I can't document, about some real or imaginary theoretical particles in physics, where these particles emerge from nothingness in pairs, and cease to exist again only when a pair re-combines.

I don't know if I have that story right. But a story very much like that is the right story for the economy. (Maybe it's the "endogenous money" story; that's something else I don't know. I just know what I see.)

Borrowing a dollar creates a dollar of new money and a dollar of new debt. Not all kinds of borrowing create new money. That's okay. We're looking at the kind of borrowing that *does* create new money.

New borrowing creates new money and new debt. The new money and new debt are like the two new particles that emerge from nothingness in physics. Except money and debt don't emerge from nothingness. They emerge from available credit. (The act of putting credit to use is what creates the two new economic particles.)

Mason writes, "new borrowing can finance additional expenditure on real goods and services". For me, to say "borrowing can finance" something just doesn't pin it down clearly. It is the new money created by the new borrowing that allows the additional expenditure on real goods and services. Isn't that simple?

But new money is not the only economic particle created by new borrowing. New debt is also created. And new debt is unstable, particularly when it is gathered into a large enough mass. Like plutonium, I'm thinking.

Maybe it's just the morals of borrowers, wanting to repay... or the greed of lenders wanting repayment. It doesn't matter. That's the part of economics that doesn't matter. The fact is, debt is unstable and wants to return to the nothingness from whence it came.

But unless there is some sort of massive explosion, some sort of crisis, debt doesn't disappear on its own. Typically, a particle of debt re-combines with a particle of money and both go out of existence together, quietly. For example, when you make the monthly mortgage payment.

In the normal economy, the particles that emerge from the nothingness that we call available credit -- the new money and new debt -- cease to exist when a pair combines. When a pair combines, it means you are taking a dollar of your income and using it, not to buy something you might want, but to pay for something you already bought. You take that dollar, combine it with a dollar of debt, and the two cease to exist.

But you didn't get anything for that dollar today. You didn't buy anything with it. You didn't add to aggregate demand today. You didn't stimulate the economy. You didn't use it for "additional expenditure on real goods and services".

I mean, you paid down your debt with that dollar instead of spending it. And it's not like the dollar still exists. So you didn't get coffee, and the guy at the coffee shop didn't get your dollar. And then the coffee shop guy doesn't buy new socks, so JC Penny doesn't get that dollar. And then JC doesn't buy floor wax for the guy with the mop, so the floor wax supplier doesn't get that dollar, either. And then...

Nobody gets that dollar anymore, because that particle no longer exists. Or, as JW Mason puts it: "debt service payments (in the presence of credit constraints) subtract from the funds available for current expenditure."



Greg said...

Happy New Year Art

"Not all kinds of borrowing create new money. That's okay. We're looking at the kind of borrowing that *does* create new money."

The only kind of borrowing which doesn't create new money is me borrowing yours or someone else's saved money. Any borrowing via a financial institution does create new money as I understand it. Which of course is the overwhelming majority of borrowing. Im not sure the other borrowing (intratemporal borrowing ....maybe?) can even be measured and tracked. If the borrowing gets measured it is creating new money.

Re stated, A five dollar bill changing pockets might be borrowing in some sense, but it cannot be tracked or accurately measured, and it cannot affect demand that much. Only when a person seeks new credit, via a credit card or mortgage or car loan is new money created..... and of course this gets measured in credit market activity AND affects final demand.

The Arthurian said...

Yeah okay, we had this discussion before.

What I had in mind was, you know, borrowing from my mother-in-law or maybe from Mitt Romney's dad, without going through a bank.

But come to think of it, I think I do remember Krugman saying that shadow bank lending does not create money. I could have that wrong though.

Look, this way it's simple: If I withdraw a dollar from my savings account and I spend it, I MOVED money out of savings and into circulation. I did not create money.

Similarly, if we withdraw a dollar from my savings and YOU spend it, again we moved money and did not create it.

I don't claim to know a lot about this particular detail. What I know is, I put that stuff into the post, that stuff you quoted, because some people would want to interrupt my train of thought and say NOT ALL borrowing creates new money. And I didn't want what I thought was a really good post to be interrupted by something so insignificant and off-topic.

The whole range of possibilities from "almost no borrowing creates new money" to "absolutely all borrowing creates new money", people whose position is anywhere in that range can use the concepts presented in the post. Only those who say "absolutely no borrowing creates new money" cannot hope to find the post useful.

Happy New Year to you, Greg.