Download Eichner`s monetary economics Ahead of its time

Eichner’s monetary economics
Ahead of its time
Marc Lavoie
University of Ottawa
The received wisdom on Eichner’s
work on monetary economics
• “Most, or maybe all, of Eichner’s analysis
doesn’t really come to grips with the
nature of money and the financial system”.
(Sawyer in King, 1995)
• “… in the area of monetary theory and
macrodynamics [Eichner] barely scratched
the surface”. (Davidson 1992)
•
The thesis of this paper
• On the contrary, Eichner was very much
concerned with monetary economics and
the financial system.
• In addition he did put forward four key
concepts which are now at the forefront of
post-Keynesian monetary economics.
• Thus, Eichner, like Joan Robinson, has
been unfairly ignored in monetary
economics
The four key monetary theory
concepts highlighted by Eichner
• The starting point of monetary theory is the
demand for credit, not the demand for money;
• Central banks pursue essentially defensive
operations when intervening on the open
market;
• The liquidity pressure ratio of banks plays an
important role throughout the economy;
• An understanding of the economy can only be
acquired by going beyond the standard national
income and product accounts, that is by making
use of the flow of funds accounts.
The starting point:
credit
Credit availability
to avoid financial crises
• “Post-Keynesian short-period models emphasize the
importance of credit availability – as determined by the
central bank – in enabling business firms and other
spending units to bridge any gap between their desired
level of discretionary spending and the current rate of
cash inflow. Credit availability is important in determining
not only discretionary spending but also liquidity crises
and the number of bankruptcies.... Thus it is credit
availability – or the degree of ‘liquidity’ pressure
throughout the economy – that becomes the critical
monetary factor in a post-Keynesian short-period model,
not the stock of money”. (Eichner 1979, 40-1).
An integration of real and monetary
factors
• For instance, Eichner (1987, pp. 660-1)
relates household consumption to stocks
of financial assets and to the availability of
credit, interest rates on consumer loans
and the loan amortization duration.
Money, or rather credit, does matter!
• “The amount of funds available to finance
investment depends far more on the lending
policies of the banks, including the central bank,
than on the willingness of households to forego
consumption” (Eichner 1987, p. 138).
• “If additional investment is going to be
undertaken, it can only be financed ... through
bank loans” (Eichner 1987, p. 836-7).
Focus on credit, not money
• “It is the demand for credit rather than the demand for
money that is the necessary starting point for analyzing
the role played by monetary factors in determining the
level of real economic activity” (Eichner 1985, 99)
• “Eliminating the money stock from the model has the
further advantage that it avoids any need to distinguish
the ‘demand’ for money from its supply. It also renders
moot the question of how the money stock is to be
defined .... Indeed the only disadvantage is that it would
mean abandoning the LM-IS framework that has
dominated macroeconomics .... But then that might not
be such a disadvantage” (Eichner, 1985, 110)
A debt monetary economy
• “The amount of funds available to finance investment
depends far more on the lending policies of the banks,
including the central bank, than on the willingness of
households to forego consumption” (Eichner 1987, p.
138).
• “If additional investment is going to be undertaken, it can
only be financed ... through bank loans” (Eichner 1987,
p. 836-7).
• “The only way the amount of funds circulating as
checkable deposits can be increased is if some
nonfinancial sector is prepared to increase, not its net
savings but rather, its net debt” (Eichner 1987, 824)
Rejection of the standard textbook
money multiplier
• “Banks are not inclined to approve bank
loan applications just because they have
excess reserves. They will, in fact, be
willing to grant loans only to those who
can demonstrate that they are ‘creditworthy’, and once this demand for loans
has been satisfied, no additional credit is
likely to be extended” (Eichner 1987, p.
854).
The liquidity pressure ratio
Eichner, for good or for worse, believed in
the persuasion power of econometrics.
• Eichner constructed a post-Keynesian econometric
model of the American economy.
• One of the blocks of this model consisted of the
monetary-financial block, which gave rise to a series of
interesting and original empirical findings.
• As early as 1979, Eichner and his research assistants
found a new variable, the liquidity pressure ratio, that
seemed to perform well in the regressions of several
equations.
• Originally, this liquidity pressure ratio was described as
the difference between the growth rate of bank loans and
the growth rate of base money.
Main definition of the liquidity
pressure ratio
• The “lending capacity of the commercial banking
system”,
• “The ratio of bank loans to bank deposits”
(Eichner 1985, p. 99).
• More formally, the variable that explains the
cyclical evolution of investment expenditures or
of personal consumption on durables is the
discrepancy between the actual degree of
liquidity pressure and its secular or trend value
(Forman, Groves and Eichner, 1984).
A useful variable
• The empirical relevance of the degree of liquidity
pressure in explaining the future evolution of
discretionary expenditures, as well as the future level of
bank loans and some interest rates, including the federal
funds rate, is mainly attributed to credit rationing.
• Eichner (1985, p. 105) says that the amount of bank
deposits “measures the lending capacity of the
commercial banking system”, and thus that when the
degree of liquidity pressure decreases (relative to its
trend value), “the commercial banking system will
become less liquid and less capable of providing credit”
Similarity with Godley’s bank
liquidity ratio
• Godley’s bank liquidity ratio is defined as the bills to
deposits ratio, or the ratio of defensive assets to
liabilities (it is also some kind of secondary reserves
ratio, since bills can be sold to the central bank to obtain
reserves if these are lacking). The bank liquidity ratio is
thus the converse of the degree of liquidity pressure.
• According to Godley, when the federal funds rate and
hence the Treasury bills rate moves up, hence when the
central bank is pursuing a non-accommodating policy,
the bills to deposits ratio drops.
• Simulations clearly show that the bank liquidity ratio is
strongly reduced, and hence the degree of liquidity
pressure moves up with a reduction in government
expenditures.
The defensive role of the
central bank
This insight is obtained not
through high theory but through
his empirical work
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).
A defensive and accommodating
behaviour
• “The Fed purchases or sales of government
securities are intended primarily to offset the
flows in and out of the domestic monetaryfinancial system and thereby hold bank reserves
constant”.
• “The Fed’s primary objective, in conducting its
open market operations, is to ensure the liquidity
of the banking system. This means that its open
market operations necessarily consist, for the
most part, of two elements: (1) defensive
behavior, and (2) accommodating behavior”
(Eichner 1987, 847).
Eichner’s views are consistent with
current PK monetary economics
• His description of the operations of the
Fed is consistent with that of PKE Mosler
(1996-97), Wray (1998), Bell, Fullwiler
(2003, 2006).
• It is also consistent with the descriptions of
the operations of the Bank of Canada
(Lavoie 2005) or that of the ECB (Bindseil
2004).
Eichner has a horizontalist viewpoint
• “It is clear that the Fed is able to set the
short-term interest rate at whatever level it
wishes .... The Fed is fully able to
determine the [federal funds rate] – along
with the other short-term interest rate, the
Treasury bill rate .... (Eichner 1987, p. 857)
• This has been pointed out by Rochon
(1999) and Carvalho and Oliveira (1992).
Flow of funds analysis
Copeland and the quadruple entry principle
• And indeed in the recommended readings of Chapter 2,
Eichner (1987, p. 108) does refer to the research of
Copeland, the US creator of flow-of-funds analysis. It
confirms that Eichner was indeed attempting to put
together a synthesis of Cambridge Keynesian economics
and Institutionalist economics.
• Eichner (1987, pp. 810-838) devotes nearly 30 pages to
flow of funds analysis in the chapter on money and credit
of his main book, with more than a dozen tables
reproducing flow of funds consequences of various
decisions by economic agents.
• The very first of these tables (Eichner 1987, p. 811)
illustrates the quadruple accounting entry principle first
put forth by Morris Copeland.
Eichner at the vanguard of
stock-flow consistent analysis
• Eichner “almost alone among economists – recognized
that the flow-of-funds approach provides a much more
useful analytical tool for explaining economic processes
than the national income accounts”. Davidson (1992, p.
189)
• Eichner (1987, 863) was favourably impressed by the
work of Godley and Cripps (1983). He recommends the
book to his readers, besides making use of it by drawing
on some of its tables.
• Eichner was in the vanguard of the post-Keynesian
movement to bring back flow of funds analysis to the fore
(Godley (1999); Lance Taylor (2004); Dos Santos (2006);
Godley and Lavoie (2007
Conclusion
• Alfred Eichner’s contribution to post-Keynesian
or to heterodox economics extends way beyond
his contribution to pricing theory and the
behaviour of the megacorp; it also includes
monetary theory.
• The key monetary concepts highlighted by
Eichner in the 1980s are key features of modern
post-Keynesian monetary theory, while they
were not necessarily so at the time of Eichner’s
writings.
• Hence Eichner’s monetary theory was ahead of
its time.