Friday, August 15, 2014

...because people don't spend money at night?

Yesterday I wrote:

That's a favor policymakers did for banks, not counting the sweeps. But it makes M1SL an unrealistic number.

I don't like to say anything so unequivocal without backing it up (unless I've already backed it up several times. (See? I can't even be unequivocal about that!)).

Sweeps. Jim said:

The way I understand it in 1994 the banks were allowed to change the way they figured the data that goes into computing M1. Banks were allowed to shift the money from accounts that were less active from checking to savings for reporting purposes. Doing this lowered their reserve requirements.

Lowering their reserve requirements is the "favor" that policymakers did for banks.

As for making M1SL "an unrealistic number" I turn to the link Jim provided: Sweep Programs.

Sweep programs create distortions between reported data on the monetary aggregates and accurate measures of the money stock.

I would love to quote that whole page, it is so good. But the whole thing is only three paragraphs, so taking one sentence is taking a lot.

They also provide this reference:
Cynamon, Barry Z., Donald H. Dutkowsky, and Barry E. Jones. "Redefining the Monetary Aggregates: A Clean Sweep." Eastern Economic Journal, 2006, vol. 32, issue 4, pages 661-673.

Barry Cynamon's name is one I recognize. The site is Sweep-Adjusted Monetary Aggregates for the United States, and I (for one) don't go there often enough.


jim said...

One could argue that the favor that Congress did for banks was back in the 30's when banks were limited on what they could pay in interest on savings and prohibited interest on demand deposits. The policy was designed to protect bank profits (i.e. the margin between interest received and interest paid)

This is what created a bright distinction between M1 and M2. The distinction between checking and saving was clear 50 years ago when you had to show up at a bank office with a passbook to move money from checking to saving or vice versa and the difference in interest you collected was large.

Today the boundaries between monetary aggregates are ill-defined because I can sit at home and move money from checking to saving at will and there is little or no difference in interest paid.
The bright distinction is pretty much gone.

And money market funds is another whole monetary aggregate that exists but is ill defined. Money market funds was the system of exchange and medium of account that failed catastrophically in 2008.

Government regulation of banks failed because it didn't keep up with the technology.

The Arthurian said...

Jim, isn't it amazing how slowly things progress? In the post, I am exploring thoughts you expressed a year and a half ago!

Prohibiting interest on demand deposits was a favor for me! It gives me a simple, interest-less medium of exchange. It provides a standard against which all interest-earning monies may be contrasted. It provides a starting point from which the development of financial innovation can be measured. It is a conceptual miracle that makes it easy to express my economic ideas. And yet, everyone who knows more than I do, thinks my work irrelevant because in practice, today, there is no bright distinction between M1 and M2.

That's my point, in a way. When the brightness was made obvious, back in the 1930s I think you said, the purpose was to help solve the problem we call the Great Depression. In the years since that time the brightness was lost because of financial innovation. Specifically, it was lost because of financial innovation that ultimately allowed the expansion of debt to an unsustainable level.

"Government regulation of banks failed because it didn't keep up with the technology."

I'm pretty sure regulators thought they were doing a good thing for the economy by encouraging financial innovation. Technology no doubt contributed to the advance of that innovation, but the innovation would have occurred anyway, as it always has.

jim said...

The purpose of excluding interest on demand deposits was to create financial stability by guaranteeing minimum levels of bank profits. In other words, by eliminating fierce competition among banks to attract in-flows of check money. But it did not really work. Banks innovated and found ways to circumvent that goal.

What makes you think regulators encouraged financial innovation?
Innovation was mostly about getting around existing regulation and Wall Street hired all the best rocket scientists to undertake that job. The policy makers and regulators were completely out-gunned. The shadow banking system grew to point where it was larger than traditional banking because it was mostly outside of regulatory purview.

"In a world of businessmen and financial intermediaries who
aggressively seek profit, innovators will always outpace regulators; the authorities cannot prevent changes in the structure of portfolios from occurring. What they can do is keep the asset-equity ratio of banks within bounds by setting equity-absorption ratios for various types of assets. If the authorities constrain banks and are aware of the activities of fringe banks and other financial institutions, they are in a better position to attenuate the disruptive expansionary tendencies of our economy."-Hyman Minsky, 1986

The Arthurian said...

"What makes you think regulators encouraged financial innovation?"

It's in the percentages.