Download Money, Credit and Finance Endogenous Money

Money, Credit and Finance
Endogenous Money
Marc Lavoie
University of Ottawa
Outline
• 1. The main claims of the post-Keynesian views on
money, credit and finance
• 2. New developments in monetary policy implementation
• 3. Implications for public finance theory and for openeconomy monetary economics
• 4. The integration of PK monetary economics into PK
macroeconomics: the stock-flow coherent approach
(SFC)
Part I
The main claims
i
Ms
Ms
Ms
M
Horizontalists
(+ New Consensus)
Monetarists
IS/LM
Verticalists
Structuralists
(+ New Paradigm)
A simplified overview
of endogenous money
Endogenous money supply: A PK claim now
accepted by many schools
• Post-Keynesians
• Neo-Austrians
• New Keynesians
– (New consensus authors), Woodford, Taylor,
Roemer, Meyer
– (New Paradigm Keynesians, focus on credit) Stiglitz,
Greenwald, Bernanke
• Real business cycle theorists
– Barro, McCallum
• Goodhart
Main features in monetary economics
Features
PK school
Neoclassical
Money
Has counterpart
entries
Falls from an
helicopter
Money is tied to
Production
Exchange
The supply of money
is
Endogenous
Exogenous
Main concern with
Debts, credits
Assets, money
Causality
Reversed: credits
make deposits
Free reserves lead to
money creation
Credit rationing due to Lack of confidence
Asymetric information
Main features, interest rates
Features
PK School
Neoclassical
Interest rates
Are distribution
variables
Arise from market
laws
Liquidity preference
Determines the
differential relative to
base rate
Determines the
interest rate
Base rates
Are set by the central
bank
Are influenced by
market forces
The natural rate
Takes multiple values
or does not exist
Is unique, based on
thrift and productivity
Main features, macro implications
Features
PK School
Neoclassical
A restrictive monetary
policy
Has negative effects
in short and long run
Has negative effects
only in the short run
Schumpeter’s
distinction
Monetary analysis
Real analysis
(monetized production (money neutrality,
economy)
inessential veil)
Macro causality
Investment
determines saving
Saving determines
investment
Inflation
The growth in money
stock aggregates is
caused by the growth
in output and prices
Price inflation is
caused by an excess
supply of money
Two kinds of financial systems,
according to Hicks 1974
• The overdraft financial
system
• Firms are in debt towards
commercial banks
• Commercial banks are in
debt towards the central
bank
• The auto or asset-based
financial system
• Firms finance investment
with retained earnings
• Commercial banks have
large amounts of T-bills in
assets
Overdraft vs Asset-based systems
• Overdraft systems
• Asset-based systems
• 90% or more of the world
financial systems (including
the pre-euro Bundesbank)
• Ignored by textbooks
• No control on HPM, except
through credit control
• Clarifies how the monetary
system functions
• In a sense, all systems are of
the overdraft type: no central
bank controls directly the
supply of money
• Only in some anglo-saxon
countries
• Described by mainstream
textbooks
• Based on open-market
operations; is said to be
efficient in controlling the
money stock
• Puts a veil on the operating
procedures of monetary
systems
Simplified neoclassical view
Central bank balance sheet
Assets
Liabilities
Foreign reserves
Banknotes
Domestic T-bills
Reserves of commercial
banks
Simplified PK view
Central bank balance sheet
Assets
Liabilities
Foreign reserves
Banknotes
Domestic T-bills
Reserves of commercial
banks (deposit facilities)
(and repos)
Loans to domestic
Government deposits
banks (lending facilities)
(Central bank bills)
Credit rationing when there is a reduction in bank confidence
(Credit-worthy demand: demand with appropriate collateral:
Cf. De Soto, and Heinsohn and Steiger)
Interest rate
i2
i1
Creditworthy
demand
Notional
demand
A B
 
Loans
Part II
Historical perspective
And new developments
Cambridge proverbs
• The Cambridgian hare: « Economic ideas move in circles: stand in
one place long enough, and you will see discarded ideas come
round again. » (A.B. Cramp 1970)
• Most of modern monetary controversies can be brought back to the
1844 Currency school (Ricardo) and Banking school (Thomas
Tooke) debates.
• The Radcliffe commission view (1959), endorsed by Kaldor and
Kahn, which was considered dépassé in the 1970s and 1980s, is
now back into fashion.
– « There still do exist in England men whose minds were formed in 1939,
and who haven’t changed a thought since that time, and who … say
money doesn’t matter. They have embalmed their views in the Radcliffe
Committee, one of the most sterile operations of all time» Samuelson
1969
New operationg procedures and
horizontalism
• Central banks have new operating procedures, although
they are not that much different from what they used to
be. They bring central banks closer to the « overdraft
economy», and further away from the «asset-based
econonomy» as defined by Hicks.
• The procedures of some central banks are more
transparent (than they were and than those of other
central banks), so the horizontalist story is more obvious:
Canada, Australia, Sweden
• The procedures of other central banks are less
transparent; but when interpreted in light of
horizontalism, we can see that their operational logic is
identical to that of the more transparent central banks
(like the Fed).
The new operating procedures put in place in Canada
and other such countries are fully compatible with the
PK monetary theory
• Central banks set a target overnight rate, and a band
around it
• Commercial banks can borrow as much as they can at
the discount rate
• There are no compulsory reserves and no free reserves
(zero net settlement balances)
• The target rate is (nearly) achieved every day
• Central banks only pursue defensive operations, trying to
achieve zero net balances.
• When there are tensions, as during the recent subprime
financial crisis, they try their best to supply the extra
amount of balances demanded by direct clearers (mainly
banks)
The Bank of Canada channel
system
Overnight rate
Bank rate = TR+25pts
Target rate TR
Rate on positive
balances = TR-25pts
- (overdraft) 0 + (surplus)
Settlement
balances
Two different justifications for the
current interest rate procedures ?
• Post-Keynesians
• Based on a
microeconomic
justification
• Tied to the inner
functioning of the
clearing and settlement
system
• Linked to the day-byday, hour-per-hour,
operations of central
banks
• New Consensus
• Based on the 1970
Poole article
• A macroeconomic
justification
• If the IS curve is the
most unstable, use
monetary targeting
• If the LM curve is
unstable (money
demand is unstable),
use interest rate targets
The microeconomic justification for
interest rate targeting
• Central bank interventions are essentially « defensive ».
Their purpose is to compensate the flows of payments
between the central bank and the banking sector.
• These flows arise from: a) collected taxes and
government expenditures; b) interventions on foreign
exchange markets; c) purchases or sales of government
securities, or repurchase of securities arrriving at
maturity; d) provision of banknotes to private banks by
the central bank.
• Without these defensive interventions, bank reserves or
clearing balances would fluctuate enormously from day
to day, or even within an hour. The overnight rate would
fluctuate wildly.
Authors who support the
microeconomic explanation
• Several central bank economists
– Bindseil 2004 ECB, Clinton 1991 BofC,
Lombra 1974 and Whitesell 2003 Fed
• Some post-Keynesian authors
– Eichner 1985, Mosler 1997-98, Wray 1998
and neo-chartalists in general
• Institutionalists
– Fullwiler 2003 et 2006
The Fed never tried to constaint reserves !
• “The primary objective of the Desk’s open
market operations has never been to
‘increase/decrease reserves to provide for
expansion/contraction of the money supply’
but rather to maintain the integrity of the
payments system through provision of
sufficient quantities of Fed balances such
that the targeted funds rate is achieved”.
Fullwiler (2003)
This was understood a long time ago by
some PK economists
• “The Fed’s purchases or sales of government
securities are intended primarily to offset the
flows into or out of the domestic monetaryfinancial system” (Eichner, 1987, p. 849).
• “Fed actions with regards to quantities of
reserves are necessarily defensive. The only
discretion the Fed has is in interest rate
determination” Wray (1998, p. 115).
There is no relationship between open
market operations and bank reserves
• “No matter what additional variables were
included in the estimated equation, or how the
equation was specified (e.g., first differences,
growth rates, etc.), it proved impossible to obtain
an R2 greater than zero when regressing the
change in the commercial banking system’s
nonborrowed reserves against the change in the
Federal Reserve System’s holdings of
government securities ....”(Eichner, 1985, pp.
100, 111).
Part III
Implications for:
Public finance theory and
Open-economy monetary economics
Government deficits lead to lower
overnight interest rates !
• This is a consequence of the payment and clearing
system.
• When the government pays for its expenditure through
its account at the central bank, settlement balances
(reserves) are added to the clearing system.
• This tends to reduce the overnight rate (the fed funds
rate) (cf. Mosler 1994)
• Keeping the rate at its target level requires a defensive
intervention of the central bank
• Might as well let the overnight rate fall to zero, its
“natural” level, say some neo-chartalists !
Open economies: Are interest rates
exogenous?
• My position and that of Godley (The PK horizontalist
position ?) is that interest rates are exogenous both in
flexible and in fixed exchange rate regimes.
• Any increase in foreign reserves will be compensated
by a decrease in another asset of the central bank, or
will be compensated by an increase in some liability of
the central bank.
• This is the compensation thesis, or the thesis of
endogenous sterilization (Godley and Lavoie 2005-06),
first emphasized by Banque of France officials (1960s).
The compensation thesis
Central bank balance sheet
Assets
Liabilities
Foreign reserves
Banknotes
Domestic T-bills
Reserves of commercial
banks
Government deposits
Loans to domestic
banks
(Central bank bills)
Historical example of the compensation
thesis: The Bundesbank 1992-1993
31 August
1992
30 Sept.
1992
15 July
1993
Foreign
reserves
104
181
108
Domestic
credit
237
144
236
Total
assets
341
325
344
Part IV
The integration of PK monetary
economics into PK macroeconomics
and the stock-flow coherent
approach (SFC)
The stock-flow consistent approach
• The Holy Grail of PKE has always been the full integration of
monetary and real macroeconomic analysis, i.e., provide a true
“Monetary” analysis in the Schumpeter sense.
• Until recently, this seemed like a rather impossible task.
• Godley (1996, 1999) has now done it, under the name of SFC.
[Other authors, around Willi Semmler and Peter Flaschel, also
achieve something nearly similar]
• Portfolio and liquidity preference issues, along with banking and
financial stocks of assets and liabilities, are now tied with flows of
production, income, and expenditures. Deflated and monetary
variables can also be carefully distinguished.
• The method is presented in the Godley and Lavoie book (2007).
• In my view, the method is particularly appropriate to model the
interaction between (Minsky) financial crises and real crises, or to
deal with financialisation issues.
• At an aggregate level, it makes use of the fundamental identity,
underlined by Godley in the 1970s:
(S – I) = (G – T) + (X – IM + NFY)
1.1 Keynesian and modern (Barro
DGSE) macroeconomics
•
•
•
•
•
•
•
•
•
Y = C+I+G = W+P
There is no room or no role for banks
What about the central bank, where does it fit?
Individuals and firms are often netted out (representative
agent)
Where does personal saving go?
What are the liability counterparts of this saving?
What sector provides the counterparty to the
transaction?
How are government deficits financed?
What role play financial stocks?
1.2 National accounting and flow of
funds analysis 1940s-1950s
• Macroeconomics is based on the system of national
accounts of the UN 1953 (Richard Stone) (flow national
income and product accounts)
• This system left out flow-of-funds and balance sheets
• French and Dutch national accountants bitterly
complained then (Denizet: irony)
• “When total purchases of our national product increase,
where does the money come from to finance them?
When purchases of our national product decline, what
becomes of the money that is not spent?” (Copeland
1949)
• The 1968 new System of National Accounts (SNA)
remedies to all this (and again in SNA 1993). But to no
avail, despite the introduction of Social Accounting
Matrices (SAM).
2.1 No black holes
•
“The fact that money stocks and flows must satisfy
accounting identities in individual budgets and in an
economy as a whole provides a fundamental law of
macroeconomics analogous to the principle of
conservation of energy in physics”. (Godley and Cripps
1983)
• Everything must add up.
• The simplest way to make sure that nothing has been
forgotten is to construct matrices.
• This consistency requirement is particularly important
and useful in the case of portfolio choice with several
assets, where any change in the demand for an asset,
for a given amount of expected or end-of-period wealth,
must be reflected in an overall change in the value of the
remaining assets which is of equal size but opposite sign
(cf. Tobin)
The balance sheet of Model INSOUT (Basic banks)
Hhholds Firms
Inventories
Govt
Central
bank
Banks
+IN
HPM
+Hh
Checking
deposits

+IN
H
+Hb
0
+M1h
M1
0
Time
deposits
+M2h
M2
0
Bills
+Bh
B
+Bb
0
Bonds
+BLh.pbL
BL.pBL
+Bcb
0
L
Loans
+L
0
Balance
V
0
+GD
0
0
IN

0
0
0
0
0
0
2.2 The quadruple entry
principle
• This principle is attributed to Copeland (1949).
• Any change in the sources of funds of a sector must be
compensated by at least one change in the uses of funds
of the same sector.
• But any transaction must have a counterparty. Therefore
the above two changes must be accompanied by at least
two changes in the uses and sources of funds of another
sector.
• « Because moneyflows transactions involve two
transactors, the social accounting approach to moneyflows
rests not on a double-entry system but on a quadrupleentry system » (Copeland, 1949)
2.2A The quadruple entry principle
Sources of funds: + sign; Uses of funds: minus sign
2.2B The quadruple entry principle