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 17 September 2018
J.T.Harvey claims private money creation means borrowers don’t need to wait for loans.
Harvey is professor of Economics at Texas Christian University. In this Forbes article entitled “Four Lessons (not) Learned from the Financial Crisis”, his first lesson is that we should bail out debtors not creditors (i.e. banks). So the US should have let half of US banks go under during the crisis? I think that would have been too disruptive.
Certainly it’s important to let one or two go under in a crisis “pour encourager les autres” as the French say: i.e. as a lesson to other banks thinking of taking excessive risks. But letting half the bank system collapse would have been going too far.
Next, he claims an advantage of letting private banks create and lend out money is that borrowers don’t “need to wait for people to save up their money before it can be borrowed…” Wrong.
If private banks were barred from creating money, clearly the initial effect would be to cut demand. But that’s easily countered by having government and central bank create and spend extra base money into the economy. Savers would allocate some of that extra money to saving in various forms: mutual funds, organisations which make small and large loans etc. Net result: there’d always a pot of money available to borrowers, just as under the existing system.
However, a saving grace of Harvey's article is that he debunks the idea that deficits are invariably a problem. That’s not to say they are NEVER a problem: running a large deficit when the economy is at or near capacity is plain irresponsible, which is what Trump is doing right now. But deficits in a recession are not a problem.
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"his first lesson is that we should bail out debtors not creditors (i.e. banks). So the US should have let half of US banks go under during the crisis?"
ReplyDeleteIf mortgage defaulters had been bailed out, MBS would not have been devalued by labile panicky traders to $0, and the banks would not have failed.
"running a large deficit when the economy is at or near capacity is plain irresponsible, which is what Trump is doing right now."
Are you making a prediction of inflation? When will we know if you're wrong or right?
Re MBSs, yes that's one possibility. Another is to bail out mortgage defaulters while telling irresponsible lenders to go hang: i.e. refusing to let them have the taxpayer money given to defaulters. I assume that's what Harvey was getting at, though he didn't explain too well.
DeleteRe irresponsible deficits, the result will not be excess inflation because the Fed will raise interest rates by enough to damp down demand. But it's stilly to run a large deficit when the result is that entirely artificial rise in interest rates, seems to me.
"refusing to let them have the taxpayer money given to defaulters."
ReplyDeleteIt wasn't taxpayer money though; it was largely new debt-free money created by the Fed.
In the sidebar, I noticed you wrote:
"Government backed deposit insurance for private banks means government makes the liabilities of money lenders (private banks) as good as the liabilities of the central bank."
I think you're on the right track. MBS were created as Net Financial Assets, because the MBS price does not have a corresponding liability: once the MBS is sold, it is off the seller's books and even if all mortgages in it default, the seller still has his money.
In effect MBS (and other derivatives created as Net Financial Assets) are creating future liabilities of the central bank.
In other words, say I make an MBS and sell it to you. Say you borrowed from the Fed to pay me. Then say all the mortgages defaulted and the MBS was worth $0 and you couldn't pay me back. My money is still good; the Fed will still give me cash for the deposit you borrowed to pay me with. Even if you default, the Fed will keep its balance sheet expanded and won't "repossess" my money.
Essentially that's how banks were bailed out: the Fed expanded its balance sheet so the defaulting borrowers didn't go bankrupt.
The larger point is that taxpayer money was not needed to rescue the world financial system in 2008 and after.