While what he says about endogenous money is logical consistent (it could in theory work that way) I find it hard to reconcile what he says with the way things really work.
Is it not well documented that the money supply in the US is controlled by the Fed via policy tools such as targeting the overnight interest rate? Banks are free to lend as much as they want within the fed constraints but it is the fed that sets the upper-limit beyond which it would never be beneficial for banks to continue lending. Is Keen saying this story is a myth ?
He throws out things like "increased bank lending usually precedes the creation of new reserves by the fed" and "the money multiplier can empirically be shown to be false" as though they prove that endogenous money theory is true, when it seems relatively easy to fit these facts into a conventional view of how the banking system works.
"Paul Volcker attempted a monetarist experiment from 1979–1982, by trying to control the growth rate of M1, through targeting non-borrowed reserves.
....the lesson we learn is that Volcker’s quasi-monetarism was a miserable failure, with the Fed badly missing its M1 targets (Wray 2003: 92). The Fed simply could not control M1, but this should come as no surprise to advocates of the endogenous money theory."
That episode from the early 1980's did indeed show that an attempt to target the money supply directly failed miserably.
However this doesn't seem like a smoking gun in favor of Endogenous Money. Today's monetarists would simply say the Fed chose the wrong thing to target. After the failure of money-supply targeting the fed adopted quasi-inflation targeting that lasted for nearly 3-decades and seemed to give the fed tight control of AD (until it all blew up in 2008). I find it hard to reconcile this with a theory that says that the banking system can create credit money entirely independently of the central bank.
Correct, however this is ONLY true while the economy has an appetite for loans. In a deleveraging environment, no amount of lowering rates or creating excess reserves can induce borrowers into applying for loans.
"He throws out things like "increased bank lending usually precedes the creation of new reserves by the fed" and "the money multiplier can empirically be shown to be false" as though they prove that endogenous money theory is true, when it seems relatively easy to fit these facts into a conventional view of how the banking system works."
Well these things certainly don't prove in themselves that endogenous money theory is correct, but they do at least lend support to the claim that it is.
In what way could conventional theory account for the empirical observations that Keen mentions?
I'm not an expert on the banking system and quite open-minded on Endogenous money. The way I see it is this:
On increase in lending leading increases in reserve: In a system where the CB attempts to control the money supply via policy then sometimes it may see that banks are increasing lending and decide to accommodate this trend by increasing the amount of base money that is used for bank reserves. This would be the default case in fact - at a given overnight rate the fed will increase base money in response to demand. If it wished to halt the additional lending it would have to increase the overnight rate and make it less attractive for banks to lend.
On the multiplier: The CB controls the level of base money - it doesn't control what the banks do with it. In "normal" times there is likely to be some kind of correlation between bases and money supply - but this is not fixed for all time. It can vary between periods and the CB could always have the capacity to create, or find itself faced with, a situation where interest rates are too low to clear the market and reserves will stay unused.
I am assuming that I am missing something in my understanding here - I am sure that Keen is not really saying that these CB mechanism don't exists (when they clearly do), but rather that somehow they are factors. I don't see this explicitly stated anywhere though and I don't think the facts fit even this version of the theory.
The CB controls the rate on base money and everywhere else up the yield curve, and that is all it can control.
It cannot control the quantity, and must supply the quantity required by the private banks or the payment system collapses (and the policy rate shoots rapidly upwards).
Unless it is prepared to put a bank into administration for cash flow failure. And as we've seen they won't put a bank into administration for clear solvency problems!
The key to endogenous money for me is the failure of the loan/savings market to clear on its own automatically while maintaining full output.
Depressions are the neo-classical mechanism for clearing the saving/loan market.
I read a couple of papers on this topic yesterday.
It seems that endogenous money theorists accept the standard view of how new bank reserves are created - they just see the whole process as reversed, with the CB passively adapting to the money demands of the economy,
It isn't clear to me how the interest rates get set though - as it seems its still the CB that control this and uses it for its own policy ends.
Also I'm not sure how the "great moderation" fits into this theory. Interest rates were used by the CB during this period to more or less keep MV stable (or at least growing at a controlled rate) over time.
During the great moderation mercantilist policies of first Japan, then tigers then China took money from US consumers' cash balances to the US banking reserves via purchase of US Treasuries. Consumers could only gain purchasing power by borrowing. Since the banking system prefers to lend against collateral this created a boom in asset prices, rather than consumer prices (MV).
Jan said:I read this in Lars P Sylls blog http://larspsyll.wordpress.com/2012/06/19/new-directions-in-monetary-economics/ about New directions in monetary economics Intereting thougts.
"Marc Lavoie is a post-Keynesian professor of economics in the Department of Economics at the University of Ottawa, Canada. In an interview conducted by Philip Pilkington he talks about his latest work - Monetary Economics - written with the late Wynne Godle:
PP: I know it’s a rather general question, but what did you and Wynne feel were the most fundamental weaknesses of neoclassical/monetarist theory? In the book you put a lot of emphasis on dynamism and change, was this a major point of departure from the mainstream?
ML: Well, that is a rather grandiose question! Critics of neoclassical economics, and of Friedman’s monetarism, have written dozens of books and thousands of pages about this topic. To start with, I suppose that Wynne objected to basic demand-pull explanations of inflation, where the excess supply of money generates excess aggregate demand and hence inflation. Wynne thought that the money supply is endogenous, brought about by the requirements of the economy, mainly by the time taken by the production process, which involved unfinished goods and goods not yet sold, the production of which had to be financed by credit. Wynne also rejected the mainstream explanation of inflation because his work on pricing theory led him to believe that prices were based on normal unit costs, with no clear relationship between higher output and this normal unit cost, nor between higher output and the markup. So any relationship that could be found between prices and money was likely to be due to a reversed causality. Indeed, Wynne never believed in the concept of the natural rate of unemployment, the NAIRU, or the associated vertical Phillips curve; and the most sophisticated econometric analysis, meta-analysis, has proved him right.
Reversed causation also affected the link between investment and saving: for Keynesians, investment drives saving, whereas the neoclassical view is that saving allows investment. The importance of getting this causality right is clear nowadays: a true neoclassical author would argue that households need to save more so as to provide firms with the funds they need to invest; but if households reduce their consumption expenditures, with firms selling less, why would they want to invest more? Neoclassical macroeconomics is essentially supply-led; this to us is its fundamental weakness: capitalist economies, most of the time, are demand-led. They generally suffer from a lack of effective demand, not from a lack of capacity or a lack of labour resources. Thus we mostly focus on the variables that determine aggregate demand. I used to believe that only advanced economies had spare capacity; but then I read a 1983 book of Lance Taylor, showing the peculiar features of less-developed economies and how they should be modelled: he also assumed spare capacity!"
While what he says about endogenous money is logical consistent (it could in theory work that way) I find it hard to reconcile what he says with the way things really work.
ReplyDeleteIs it not well documented that the money supply in the US is controlled by the Fed via policy tools such as targeting the overnight interest rate? Banks are free to lend as much as they want within the fed constraints but it is the fed that sets the upper-limit beyond which it would never be beneficial for banks to continue lending. Is Keen saying this story is a myth ?
He throws out things like "increased bank lending usually precedes the creation of new reserves by the fed" and "the money multiplier can empirically be shown to be false" as though they prove that endogenous money theory is true, when it seems relatively easy to fit these facts into a conventional view of how the banking system works.
Am I missing something ?
"Is it not well documented that the money supply in the US is controlled by the Fed via policy tools such as targeting the overnight interest rate?"
DeleteNo, it not. It is, however, a well documented fact that the base interest rate in the US is controlled by the Fed via policy tools.
The last time the Fed tried to target actual money supply growth rates it was a disaster: the failed quasi-monetarist experiment of Paul Volcker.
See my post here:
http://socialdemocracy21stcentury.blogspot.com/2011/02/reaganomics-analysis.html
"Paul Volcker attempted a monetarist experiment from 1979–1982, by trying to control the growth rate of M1, through targeting non-borrowed reserves.
....the lesson we learn is that Volcker’s quasi-monetarism was a miserable failure, with the Fed badly missing its M1 targets (Wray 2003: 92). The Fed simply could not control M1, but this should come as no surprise to advocates of the endogenous money theory."
That episode from the early 1980's did indeed show that an attempt to target the money supply directly failed miserably.
DeleteHowever this doesn't seem like a smoking gun in favor of Endogenous Money. Today's monetarists would simply say the Fed chose the wrong thing to target. After the failure of money-supply targeting the fed adopted quasi-inflation targeting that lasted for nearly 3-decades and seemed to give the fed tight control of AD (until it all blew up in 2008). I find it hard to reconcile this with a theory that says that the banking system can create credit money entirely independently of the central bank.
The key point is that the central bank can only control the base rate.
DeleteIt cannot control the quantity of lending. Base rate is just one of the factors that go into the decision to lend.
The decision of a bank to lend during a euphoric boom is different to a depressive bust for any given level of interest rate.
At a given base rate banks can lend as much as they find profitable to do so and the CB will provide the reserves to support this.
DeleteIs that a correct understanding of what endogenous money theory says is happening ? If so, I don't think this differs from conventional theory.
Correct, however this is ONLY true while the economy has an appetite for loans. In a deleveraging environment, no amount of lowering rates or creating excess reserves can induce borrowers into applying for loans.
Delete"He throws out things like "increased bank lending usually precedes the creation of new reserves by the fed" and "the money multiplier can empirically be shown to be false" as though they prove that endogenous money theory is true, when it seems relatively easy to fit these facts into a conventional view of how the banking system works."
ReplyDeleteWell these things certainly don't prove in themselves that endogenous money theory is correct, but they do at least lend support to the claim that it is.
In what way could conventional theory account for the empirical observations that Keen mentions?
I'm not an expert on the banking system and quite open-minded on Endogenous money. The way I see it is this:
ReplyDeleteOn increase in lending leading increases in reserve: In a system where the CB attempts to control the money supply via policy then sometimes it may see that banks are increasing lending and decide to accommodate this trend by increasing the amount of base money that is used for bank reserves. This would be the default case in fact - at a given overnight rate the fed will increase base money in response to demand. If it wished to halt the additional lending it would have to increase the overnight rate and make it less attractive for banks to lend.
On the multiplier: The CB controls the level of base money - it doesn't control what the banks do with it. In "normal" times there is likely to be some kind of correlation between bases and money supply - but this is not fixed for all time. It can vary between periods and the CB could always have the capacity to create, or find itself faced with, a situation where interest rates are too low to clear the market and reserves will stay unused.
I am assuming that I am missing something in my understanding here - I am sure that Keen is not really saying that these CB mechanism don't exists (when they clearly do), but rather that somehow they are factors. I don't see this explicitly stated anywhere though and I don't think the facts fit even this version of the theory.
The CB controls the rate on base money and everywhere else up the yield curve, and that is all it can control.
DeleteIt cannot control the quantity, and must supply the quantity required by the private banks or the payment system collapses (and the policy rate shoots rapidly upwards).
Unless it is prepared to put a bank into administration for cash flow failure. And as we've seen they won't put a bank into administration for clear solvency problems!
The key to endogenous money for me is the failure of the loan/savings market to clear on its own automatically while maintaining full output.
Depressions are the neo-classical mechanism for clearing the saving/loan market.
I read a couple of papers on this topic yesterday.
DeleteIt seems that endogenous money theorists accept the standard view of how new bank reserves are created - they just see the whole process as reversed, with the CB passively adapting to the money demands of the economy,
It isn't clear to me how the interest rates get set though - as it seems its still the CB that control this and uses it for its own policy ends.
Also I'm not sure how the "great moderation" fits into this theory. Interest rates were used by the CB during this period to more or less keep MV stable (or at least growing at a controlled rate) over time.
Was that just chance ?
During the great moderation mercantilist policies of first Japan, then tigers then China took money from US consumers' cash balances to the US banking reserves via purchase of US Treasuries. Consumers could only gain purchasing power by borrowing. Since the banking system prefers to lend against collateral this created a boom in asset prices, rather than consumer prices (MV).
DeleteJan said:I read this in Lars P Sylls blog http://larspsyll.wordpress.com/2012/06/19/new-directions-in-monetary-economics/
ReplyDeleteabout New directions in monetary economics
Intereting thougts.
"Marc Lavoie is a post-Keynesian professor of economics in the Department of Economics at the University of Ottawa, Canada. In an interview conducted by Philip Pilkington he talks about his latest work - Monetary Economics - written with the late Wynne Godle:
PP: I know it’s a rather general question, but what did you and Wynne feel were the most fundamental weaknesses of neoclassical/monetarist theory? In the book you put a lot of emphasis on dynamism and change, was this a major point of departure from the mainstream?
ML: Well, that is a rather grandiose question! Critics of neoclassical economics, and of Friedman’s monetarism, have written dozens of books and thousands of pages about this topic. To start with, I suppose that Wynne objected to basic demand-pull explanations of inflation, where the excess supply of money generates excess aggregate demand and hence inflation. Wynne thought that the money supply is endogenous, brought about by the requirements of the economy, mainly by the time taken by the production process, which involved unfinished goods and goods not yet sold, the production of which had to be financed by credit. Wynne also rejected the mainstream explanation of inflation because his work on pricing theory led him to believe that prices were based on normal unit costs, with no clear relationship between higher output and this normal unit cost, nor between higher output and the markup. So any relationship that could be found between prices and money was likely to be due to a reversed causality. Indeed, Wynne never believed in the concept of the natural rate of unemployment, the NAIRU, or the associated vertical Phillips curve; and the most sophisticated econometric analysis, meta-analysis, has proved him right.
Reversed causation also affected the link between investment and saving: for Keynesians, investment drives saving, whereas the neoclassical view is that saving allows investment. The importance of getting this causality right is clear nowadays: a true neoclassical author would argue that households need to save more so as to provide firms with the funds they need to invest; but if households reduce their consumption expenditures, with firms selling less, why would they want to invest more? Neoclassical macroeconomics is essentially supply-led; this to us is its fundamental weakness: capitalist economies, most of the time, are demand-led. They generally suffer from a lack of effective demand, not from a lack of capacity or a lack of labour resources. Thus we mostly focus on the variables that determine aggregate demand. I used to believe that only advanced economies had spare capacity; but then I read a 1983 book of Lance Taylor, showing the peculiar features of less-developed economies and how they should be modelled: he also assumed spare capacity!"
It should also be pointed out that Lavoie is a former Olympic fencer.
Delete