Monday, March 31, 2014

Good thoughts from Nick Rowe on some old fashiony stuff

Here.

I've always had a tough time understanding a couple things. First, I've never understood the outrage at the money multiplier/endogenous money stuff. At best it's a semantic difference (this is largely true of "endogenous money" I think, where it boils down to whether the FOMC is "accommodating" banks or whether you want to think about its bond market activities as more pro-active - it's a sin of omission vs. sin of commission argument). On the money multiplier I think Nick makes the right point that the multiplier is the same no matter where the injections occur. Noting that central banks sometimes inject money (the pro-active view of the FOMC) certainly doesn't rule out the idea that "loans create deposits". Whether loans create deposits or deposits create loans depends on one thing: at which step in the Macro 101 exercise you start tuning in.

This segues nicely into the equally odd treatment of the Keynesian multiplier. This one I think is even more right-there-in-front-of-you than the money stuff. Whether you're reading it in the Keynesian original (where the chapter on the multiplier doesn't even HAVE a G and everything is talked about in terms of I!), or in modern textbooks (where neither I nor G are functions of income and enter the equations in the exact same ways). When I TAed for our big intro macro lecture and I did my review lectures I made them work through both and show that they got the same answer, so that they understood why the model works the way it does: the income/expenditure equation and the consumption function, not some magical powers of the government.

Finally, I've never understood the tendency to treat Old Keynesians like troglodytes and New Keynesians as sophisticates when it comes to the main components of the model. All of the important elements of the Old Keynesian model are in the New Keynesian model. That's why it's a called "Keynesian". What the New Keynesian model adds is some dotting of the i's and crossing of the t's: more realistic price formation, expectation formation, etc. Some things drop out, too. You're better served going to Nick's post for that.

1. "First, I've never understood the outrage at the money multiplier/endogenous money stuff."

Strange. Read some debates of 70s/80s when Friedman was making noises with this Monetarism and the UK government was experimenting trying to control the money stock.

It is more than just semantics.

1. I think the endogenous money issue is largely semantics.

The money multiplier issue is a little more, and I'm with you on the Friedman stuff but what's at issue there is a much, much stronger claim than just that there is a multiplier effect of monetary injections.

I think this is why these things are disputed - strong claims are attacked. They should be attacked, but it confuses the issue of whether the money multiplier itself is a useful concept.

2. I don't see how the endogenous money issue is semantics. Endogenous money is an old idea (as Blue Aurora duly points out) and all it really says is that the assets and liabilities of the banking system as a whole have to expand and contract simultaneously. How does this affect macro? For one, the liabilities of the banking system are the assets of the public.

It's pretty basic stuff. I've actually had professors tell me that for every dollar in reserves, the bank creates X dollars in assets, which is just a load of horseshit. The people who don't understand the accounting have been some of the ones who have been saying we'd have extremely high inflation and coming up with other crazy scenarios. Reserves don't really matter when a loan is made, but capital does. Banks, and the banking system as a whole, is capital constrained, not reserve constrained.

3. Suvy: "Endogenous money is an old idea (as Blue Aurora duly points out) and all it really says is that the assets and liabilities of the banking system as a whole have to expand and contract simultaneously."

Does "the assets and liabilities of the banking system as a whole" Include the assets and liabilities of the central bank? If so, that sounds exactly like what the money multiplier says.

Now suppose that the central bank either wants or does not want the assets and liabilities of the banking system as a whole to either expand or contract simultaneously. The central bank doesn't have to let base money expand and contract if it doesn't want to. And a central bank that wants to (say) target 2% inflation (which is what modern central banks do) will ensure it only expands and contracts when it wants it to, to keep inflation on target.

Bank capital is endogenous, by the way.

2. Daniel Kuehn - is it just me, or does "Endogenous Money" have an uncanny resemblance to the "Real Bills Doctrine"? Thomas Tooke, an economist who sided with the Banking School in the 19th Century, has been named as an advocate of the Real Bills Doctrine. Other prominent thinkers known to have been associated with the Real Bills Doctrine include John Law, John Fullarton, Charles Bosanquet, and Simon Clement, among others. It seems that even from a historical perspective, "Endogenous Money" isn't as novel or as original as the Post Keynesian economists like to think.

This makes me suspect that the process of money creation (whether it is endogenous or exogenous) matters little, as both forms of money need liquidity to be adopted for widespread usage.

1. Most top economists like Alan Blinder and all get simple stuff wrong and you say it is just semantics?

It is true ideas have existed historically, it is about how one puts these ideas together. Most people like Greg Mankiw are just quantity theorists.

2. Ramanan - I think you're stuffing words into my mouth. Where did I say that it was all just "semantics"? I said that the process of money creation "matters little, as both forms of money need liquidity to be adopted for widespread usage."

J.M. Keynes's theory of liquidity preference would still hold *regardless* of how the money is created - and I believe that's the real problem, as it's a force that has been present for a *very* long time.

3. "When I TAed for our big intro macro lecture and I did my review lectures I made them work through both and show that they got the same answer, so that they understood why the model works the way it does: the income/expenditure equation and the consumption function, not some magical powers of the government."

Yes, that's why I once said free marketers really ought not be objecting to the multiplier: isn't this how investment creates wealth?!

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