Friday, 28 September 2018

Poor criticisms of The Narrow Bank by Cecchetti & Schoenholtz.

Given that the Fed is now offering interest on reserves, there is clearly scope for a bank, or perhaps specific types of accounts at existing banks, which simply accept deposits and place the money at the Fed, where such money will earn interest. Indeed, Jamie McAndrews, a former employee of the Fed has tried to set up the former: the name of his proposed new bank is “The Narrow Bank”.

Stephen Cecchetti and Kermit Schoenholtz, in an article entitled “Pitfalls of a Reserves-Only Narrow Bank” published by “Money and Banking” don’t like the idea and claim “we worry that they (narrow banks) would shrink the supply of credit to the private sector and aggravate financial instability during periods of banking stress.”

Well a narrow certainly would “shrink the supply of credit”. But one obvious reason for thinking that might not be a problem is that banks are subsidized, e.g. via the too big to fail subsidy, thus the amount of credit will at the moment be above the optimum or “GDP maximising” level.

Aggregate demand.

Next, one apparent problem with “shrinking the supply of credit” is the fall in aggregate demand that would result. But what’s to stop standard stimulatory measures being used to reinstate demand to its previous level? Absolutely nothing! 

The net result would be less loan-based economic activity plus less debt and more non-loan-based activity. Given the incessant complaints we hear about excessive debts, it’s far from clear what the big problem is there.

As for the idea that “standard stimulatory measures” can involve a deficit funded by government debt and hence that total debts might not decline, the answer to that is that deficits do not need to be funded via debt. As Keynes pointed out in the early 1930s, deficits can be funded via new base money. Indeed, that’s exactly what numerous countries have done over the last five years or so in the guise of QE. That is, governments have borrowed $X and spent that money, while the central bank has created $X of new money and bought back relevant bonds. That nets out to “the state creates $X and spends it (and/or cuts taxes)”.

Incidentally the UK’s Independent Commission on Banking made exactly the same mistake, that is, it assumed the existing amount of borrowing is optimum or sacrosanct and hence that we can’t possibly go for an economy which is less based on debt. (See the ICB’s sections 3.20 - 24)

Another bank subsidy.

Another bank subsidy or “artificial form of preference for banks” is as follows. Most governments (i.e. taxpayers) stand behind banks in that they provide deposit insurance for banks: that is, those who deposit money at banks with a view to banks then lending on their money so as to earn interest are protected against loss by taxpayers. In contrast, there are those who lend to corporations by buying corporate bonds, sometimes by buying into mutual funds (“unit trusts” in the UK) which specialise in corporate bonds. But those lenders enjoy no form of taxpayer backed guarantee against loss!

That is a blatant inconsistency, for which there is no conceivable justification. Moreover, taxpayer backed guarantees for those who lend via banks flouts a widely accepted principle, namely that it is not the job of taxpayers or governments to come to the rescue of private commercial ventures which go wrong.

The reason deposit insurance is needed is that banks make a wholly fraudulent promise to depositors, namely that depositors’ money is totally safe when such money has been loaned on. Clearly that money is not safe.

The latter fraud and inconsistencies could be disposed of if there were two basic types of bank account. First, totally safe accounts where relevant monies are simply deposited at the central bank, and second, accounts where relevant monies are loaned on, but (in line with the latter principle that it is not the job of taxpayers to stand behind commercial activity), those doing the lending are on their own: i.e. there is no taxpayer backed support for them if things go wrong.

The latter arrangement is basically what full reserve banking consists of. (I consider the latter fraud and inconsistencies in more detail in a “Medium” article entitled “The Basic Flaw in our Bank System is Simple”. 

Bank stress.

The second point made in the above quoted passage from Cecchetti & Schoenholtz’s article was that The Narrow Bank would “aggravate financial instability during periods of banking stress.”

So why exactly do banks have “periods of stress”? Well it all goes back to the above mentioned fraudulent promise that banks make to depositors. That is, banks specialise in “borrow short and lend long” . E.g. in that they borrow from depositors, while promising depositors their funds will be instantly available despite the fact that such funds have been loaned out and are quite clearly not available, banks are into fraud.

The standard excuse given for the latter trickery is that it creates liquidity / money. That is, what economists call “maturity transformation” creates liquidity / money. But there is absolutely no need to run the risk of bank runs and crashing the world economy just to create money because central banks can create any amount of money at zero cost and at zero risk whenever they want. Indeed, they’ve created astronomic and record amounts over the last five years in the form of QE.

I go into the latter point in more detail in the above mentioned “Medium” article.

Segregated balance accounts.

Segregated balance accounts (SBAs) is a name for the “specific types of accounts at existing banks” mentioned in the opening sentence above. That is, while it is clearly possible for accounts at a central bank to be available to anyone (an idea several central banks are actively considering), an alternative is for existing commercial banks to do most of the administrative work: i.e. they could make special “central bank” accounts available to customers, and remit sums deposited, net of withdrawals, to the central bank at the end of each working day.

Cecchetti & Schoenholtz say in relation to SBAs that “SBAs are unlikely to be attractive unless reserves are remunerated at a meaningful rate”.  Well the whole point is that the Fed ACTUALLY IS “remunerating in a meaningful way” at the moment! I.e. is paying interest on reserves.

Of course if a central bank pays NO INTEREST on reserves, then SBAs or accounts for all comers actually at the central bank will be less attractive because anyone can get a taxpayer backed account at a normal commercial bank which pays interest.

Thus the really central and crucial question here is whether taxpayers ought to be standing behind an activity which is quite clearly of a private and commercial nature. I say that that should not be happening. So if the latter taxpayer backed insurance for that commercial activity was withdrawn, there would then be a definite demand for accounts for everyone at the central bank, whether in SBA form or not.


P.S. "The Narrow Bank", far as I can see, actually aims just for relatively large depositors, not the typical household. But that doesn't make much difference to the above theoretical points.

Wednesday, 19 September 2018

Krugman’s not too clever criticism of MMT.

Krugman claimed in 2011 that if government ran a deficit of 6% of GDP when the economy was at capacity, then government might “lose access to the bond market”. Well the economy is either at, or pretty much at capacity right now, and there’s a 5% deficit. Any sign of losing access to the bond market? Nope.

I got that info thanks to Stephanie Kelton:

Moreover, MMTers do not advocate big deficits when the economy is at capacity. The latter policy is clearly daft. Thus if bond markets take a dim view of a government, like Trump’s, which is behaving in a daft manner, and charge that government extra interest, that says nothing about MMT.

And finally there is no such thing (as implied just above) as “losing access to the bond markets”. If a government behaves irresponsibly, lenders will charge more for lending to such a government. But as long as the interest rate is sufficiently attractive, they will nevertheless lend. Robert Mugabe, Argentina, Greece etc can always borrow – at a price.

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.

Tuesday, 11 September 2018

What are “normal” interest rates?

You can hardly have failed to have noticed the large amount of talk recently about returning to the sort of interest rates that prevailed prior to the 2007/8 crisis. Those rates are often described as “normal”.

In fact there are good reasons for thinking those rates were actually ABNORMAL and that the current very low rates are normal, or put another way, that the current low rates are the GDP maximising rates. Reasons for thinking that are as follows.

First, as David Hume pointed out nearly 300 years ago, politicians are always tempted to fund public spending via borrowing rather than via tax because voters notice tax increases and blame politicians for them, whereas voters tend not to blame politicians for the interest rate increases that stem from government borrowing. 

As Hume put it, “It is very tempting to a minister to employ such an expedient, as enables him to make a great figure during his administration, without overburdening the people with taxes, or exciting any immediate clamors against himself. The practice, therefore, of contracting debt, will almost infallibly be abused in every government. It would scarcely be more imprudent to give a prodigal son a credit in every banker’s shop in London, than to empower a statesman to draw bills, in this manner, upon posterity.” 

Simon Wren-Lewis (former Oxford economics prof) refers to that phenomenon as the “deficit bias”. Government borrowing which takes place for the latter reason obviously has the effect of artificially raising interest rates.

In contrast to the latter clearly unjustified reason for public borrowing, there are a host of ostensibly better reasons for such borrowing. Unfortunately even those reasons on closer inspection turn out to be feeble if not wholly invalid, for reasons I set out in section 2 of a recent paper.

This all lends support to the idea put by Milton Friedman in 1948, namely that government should borrow NOTHING. Warren Mosler (founder of Modern Monetary Theory) advocated the same “zero public borrowing” regime, as did Bill Mitchell (Australian economics prof.)

Re Friedman see his para starting “Under the proposal…” here.

Re Mosler, see his 2nd last para here. As to Bill Mitchell, see here.

As distinct to the above point that the current near zero interest rates are the norm or the GDP maximising rates, there is the related question as to whether governments and central banks ought to adjust interest rates so as to adjust demand. As I argue in the above mentioned recent paper, there is actually a good reason for thinking that interest rates should only rarely be adjusted, if at all.

The reason for thinking that is that in a perfectly functioning free market, the failure of interest rates to fall is not the cause of recessions lasting longer than we would like. The actual market failure that causes recessions to endure is the failure of wages and prices to fall, which in turn would increase the real value of the stock of money (base money in particular), which in turn would encourage spending. That’s known as the “Pigou effect”. The reason wages and prices do not fall significantly is of course Keynes’s “wages are sticky downwards” phenomenon: the fact that, particularly in heavily unionised sectors of the economy, it is very difficult to cut wages.

I deal with the Pigou effect in the 3rd section of the above mentioned paper.

Thursday, 6 September 2018