Commentaries (some of them cheeky or provocative) on economic topics by Ralph Musgrave. This site is dedicated to Abba Lerner. I disagree with several claims made by Lerner, and made by his intellectual descendants, that is advocates of Modern Monetary Theory (MMT). But I regard MMT on balance as being a breath of fresh air for economics.
Monday, 16 May 2011
Three economics Profs go off the rails.
This post by David Beckworth (economics prof at Texas State University) is odd.
Beckworth’s basic argument is thus. We are allegedly in a balance sheet recession. But the latter idea is debatable because it begs the question as to why the creditors of those indebted households are not spending the money they get from such households. As he puts it “why aren't the creditors who are receiving the increased payments spending the money?” Thus, according to Beckworth, we have an “excess demand for money” problem, not a balance sheet problem.
Even stranger, is that Beckworth’s argument is supported in the comments after his post by two other economics profs: Scott Sumner, of Bentley University, and Bill Woolsey, economics prof at The Citadel, South Carolina.
Now for the flaws in the above argument.
A significant portion of the above mentioned creditors are banks. And the reason those banks don’t “spend the money” is that the fact of repayment extinguishes the money! That is, commercial bank money is borrowed into existence. And when the money is repaid, the money vanishes!
The only other major category of creditors are firms which supply households or other firms with goods on credit. The reason those creditors do not “spend the money” is, first, that the fact of coming into possession of such money does not expand such creditors’ net assets. That is, if someone repays me $X, then $X worth of “debtor” on my balance sheet is replaced with $X of cash. I am no better off. There is little inducement for me to go on a spending spree.
Second, firms are not in the business of spending money just because they have some in the bank. The ultimate source of all demand, households do that, but not firms.
Indeed, for a firm or employer, plenty of customers owing money to the firm indicates a decent level of sales in recent months, which represents profits, as long as the customers are credit worthy. That is, for firms, far from a large pile of cash being a reason to spend, it is arguably a sign of poor sales, and thus a reason NOT to spend on expansion.
Or have I missed something?
Afterthought (17th May): There is something I missed, namely reserves. As Neil in his comment below implies, banks are sitting on record reserves which they could lend. And this could be seen as “excess demand for money”. On the other hand it could equally well be claimed to be evidence of banks’ balance sheet problem, namely that their so called assets are toxic to a significant degree. Thus on the face of it, these excess reserves do not support either the “excess demand” theory or the “balance sheet” theory.
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To say that we have an excess demand of money when the banks are sat on zillions of unspent QE money tells you where the problem is.
ReplyDeleteThe economists mentioned have lost the plot completely.
I guess it depends on sectors in which this demand for money is supposed to exist? Banks have a high demand for money because they are still holding a bunch of crappy, toxic assents and would prefer to hold money. I guess they are very happy to swap crappy assets for cash, and then hold the cash. No doubt they would swap the cash for low-risk promises of high interest payments, but few want to make those promises right now.
ReplyDeleteI personally would have a a very high demand for money, if I could afford to pay for it. But the price of the money is a promise to repay it at a certain rate of interest. I can't afford to part with any promises these days, even if the interest rate built into the promise is relatively low, because I don't expect my income to increase any time soon and don't even know whether I will continue to have a job throughout this year.
Businesses who sell goods to millions of people like me know that their customers are not spending, and so they also have low demand for money. The price of the money is too high, even though the rates are very low.
Dan, Re toxic assets, I agree: that helps explain why banks are holding on to reserves or “monetary base”.
ReplyDeleteThe rest of your comment is essentially saying that the amount of money an economy requires varies with GDP. Agreed. But simply saying that does not tease out the distinction between cause and effect. To do this it is necessary to distinguish between central bank created money and commercial bank created money (or “vertical” and “horizontal” money as MMTers tend to say). Failure to make this distinction is one of the flaws in Beckworth’s analysis, I think.
Commercial bank money comes into existence AS A RESULT of the private sector’s desire to do business. In contrast, central bank money CAUSES things to happen. For example, a Bernanke helicopter drop would be dropping central bank money. And that would increase private sector paper assets, which would definitely cause an increase in demand, and possibly inflation.