Tuesday, April 3, 2012

This is the first post of my first blog.  I'm starting this because for the last few years I've been overloading the inboxes of everyone on my email address list with impenetrable economic blather.  It's really just therapy for me.   Long ago, in an earlier lifetime, I completed a graduate program in economics, and then got a job doing something entirely unrelated to that field.  My relationship with economics was largely this: I was irritated by ignorant but pontification-prone politicians.  I started describing myself as a "recovering economist".  But a few years ago I looked around and got a little panicky about what was happening, and what the responses were from the political world.  That's when I started exporting my panic to my friends through email.  Most of them, I'm sure, didn't want to get panic in their inboxes several times a week, but I kept sending it out anyway.

It's time to make these posts voluntary: the stark panic has subsided a bit.  From now on I can just send links to this site rather than massive emails that only clog the internet.  But I'm new to blogging, and it's late, so I'll start by simply posting the latest email I sent out.  Here it is:


I'm going to send this to a bunch of you, but it's the beginning of a of personal exploration about a spat that has erupted on line between some of my favorite people. 

Here's the stimulus: some people I like a lot have been bickering.  Paul Krugman has apparently been dissing the Modern Monetary Theorists a bit---although it's not totally clear from his blog post what he said that dissed them.   And a Canadian economist named Nick Rowe is even more vocal on his blog. 

It's a spat I knew was coming.  I didn't think it would come this soon, or on this topic, but it had to come.  Krugman is an old school IS-LM-er, at least as a first cut at a policy generator during recessions, and I am totally with him on that.  He's also an eminence, an sage in the world of economics.  The MMT-ers are brash youngsters by comparison.  Well, some of them are not really young as individuals, but as a force in the economic world they are still youthful and full of swaggering confidence.  Somewhere in their main vision, if I understand it at all, there is a theme that simply points out some basic undeniable accounting facts: every transaction is simply a transfer of funds within a sector or from one sector to another, and a modern national bank with its own currency has no theoretical limit on its ability to create money: it is the limitless source of all money in its own currency.   And I'm completely with them on that, at least as an accounting or legal fact.

My only possible problem with this theme within MMT is that I don't trust accounting as an economic theory.  The world is full of accounting "truths", and they are very rarely really economic truths.  Government deficits may crowd out investment, if demand for investment resources are already stretched, but I=S does NOT require that economic outcome as an "accounting identity"---seriously, don't even get me started on that.  Say's law may may be absolutely true as an accounting vision, but it is not a binding economic equilibrium equation.  And so on.  So I'm always suspicious of economic theories that grow out of an accounting truth.  

But that's not the argument  that has emerged between Krugman, Rowe and the some denizens of the world of finance, possibly including the MMT folks, although it's not clear to me what the real argument is with the last group---must be buried in the comments to Krugman's posts.  No, this argument is about the limits on the growth of the money supply.  And here I'm not sure Krugman is right---since he is Krugman and I am not I'm not really sure he's wrong either, but I guess that I haven't fully grocked his view. 

So here's where I lose everyone on the email list who isn't already asleep. 

The standard economic view in a world of fractional reserve banking is that the Federal Reserve Bank can create money at it's merest whim, and that the money it creates is expanded by the banking system as a whole through the "Money Multiplier".  Any individual bank is limited to lending or purchasing by its own deposits or assets, that is, it can only lend what it has, but the banking system as a whole helps the Fed to create money.  It works like this: the Fed creates some amount of money, say $1000, by adding that amount to the Federal Reserve account of a member bank (not for free: it purchases some asset, usually a Treasury Note, that is owned by that bank).  When the Fed does this it can just create the money out of thin air.  The bank that receives the money can't do that, but it can  lend some of that money out---not all of it, but some of it.  A fraction must be reserved ("fractional reserve") in the Fed to preserve the soundness of the bank, and of the whole banking system.  The person who borrows that money puts it into his own bank account, possibly at another bank, but that new deposit is also new "money", since it is a deposit that did not exist before.  And the new bank can then lend out some of that new deposit (but must reserve a portion of its new deposits at the Fed).  And so on.  The net result is that the total money created by the Fed's initial action is far greater than the initial $1000: it is the Money Multiplier times the initial amount, and the pure theory in the textbooks would tell you that the Money Multiplier is 1/RR, where RR is the required reserve set by the Fed.

The problem comes in when RR approaches zero.  In that case, we have a problem.  As RR approaches zero, the multiplier approaches infinity.  And in many countries the reserve ratio is zero---and in the United States the reserve ratio is effectively above zero only for household deposits.  Check it out here.  That means that in theory we need a new theory for what is it that constrains the infinite explosion of the money supply.  Krugman offers one, but I don't completely buy it yet.  I think I have a different one, but it involves magical creatures, so I have to develop it a bit before I expose it to sunlight. 

Let me know if you have read this far and want to read a few economic fairy stories as I continue this puzzle.


  1. Looking forward to more musings. Nice blog title btw.

  2. Thanks. It will take a while to get used to the awesome blog powers. As soon as I figure out how to work any of them...The widgets! The widgets!