“On money, debt, trust and central banking”

The central point of my Jacobin piece on the state of economics was meant to be: Whatever you think about mainstream macroeconomic theory, there is a lot of mainstream empirical and policy work that people on the left can learn from and engage with — much more than there was a decade ago. 1 

Some of the most interesting of that new work is from, and about, central banks. As an example, here is a remarkable speech by BIS economist Claudio Borio. I am not sure when I last saw such a high density of insight-per-word in a discussion of money and finance, let alone in a speech by a central banker. I could just say, Go read it. But instead I’m going to go through it section by section, explaining what I find interesting in it and how it connects up to a larger heterodox vision of money. 

From page one:

My focus will be the on the monetary system, defined technically as money plus the transfer mechanisms to execute payments. Logically, it makes little sense to talk about one without the other. But payments have too often been taken for granted in the academic literature, old and new. In the process, we have lost some valuable insights.

… two properties underpin a well functioning monetary system. One, rather technical, is the coincidence of the means of payment with the unit of account. The other, more intangible and fundamental, is trust. 

This starting point signals three central insights about money. First, the importance of payments. You shouldn’t fetishize any bit of terminology, but I’ve lately come to feel that the term “payments system” is a fairly reliable marker for something interesting to say about money. We all grow up with an idealized model of exchange, where the giving and receiving just happen, inseparably; but in reality it takes a quite sophisticated infrastructure to ensure that my debit coincides with your credit, and that everyone agrees this is so. Stefano Ugolini’s brilliant book on the prehistory of central banking emphasizes the central importance of finality – a binding determination that payment has taken place. (I suppose this was alsso the point of the essay that inaugurated Bitcoin.) In any case it’s a central aspect of “money” as a social institution that the mental image of one person handing a token to another entirely elides.

Second: the focus on money as unit of account and means of payment. The latter term mean money as the thing that discharges obligations, that cancels debts. It’s not evenb included in many standard lists of the functions of money, but for Marx, among others, it is fundamental. Borio consciously uses this term in preference to the more common medium of exchange, a token that facilitates trade of goods and services. He is clear that discharging debt and equivalent obligations is a more central role of money than exchanging commodities. Trade is a special case of debt, not vice versa. Here, as at other points through the essay, there’s a close parallel to David Graeber’s Debt. Borio doesn’t cite Graeber, but the speech is a clear example of my point in my debate with Mike Beggs years ago: Reading Graeber is good preparation for understanding some of the most interesting conversation in economics.

Third: trust. If you think of money as a social coordination mechanism, rather than a substance or quantity, you could argue that the scarce resource it’s helping to allocate is precisely trust.  More on this later.

Borio:

a key concept for understanding how the monetary system works is the “elasticity of credit”, ie the extent to which the system allows credit to expand. A high elasticity is essential for the system’s day-to-day operation, but too high an elasticity (“excess elasticity”) can cause serious economic damage in the longer run. 

This is an argument I’ve made before on this blog. Any payments system incorporate some degree of elasticity — some degree to which payments can run ahead of incomes. (As my old teacher David Kotz observes, the expansion of capital would be impossible otherwise.) But the degree of elasticity involves some unresolvable tensions. The logic of the market requires that every economic units expenditure eventually be brought into line with its income. But expansion, investment, innovation, requires eventually to be not just yet. (I talked a bit about this tension here.) Another critical point here is the impossibility of separating payments and credit – a separation that has been the goal of half the monetary reform proposals of the past 250 years.2

Along the way, I will touch on a number of sub-themes. .. whether it is appropriate to think of the price level as the inverse of the price of money, to make a sharp distinction between relative and absolute price changes, and to regard money (or monetary policy) as neutral in the long run.

So much here! The point about the non-equivalence of a rise in the price level and a fall in the value of money has been made eloquently by Merijn Knibbe.  I don’t think Borio’s version is better, but again, it comes with the imprimatur of Authority.

The fact that inflation inevitably involves relative as well as absolute price changes is made by Leijonhufvud (who Borio cites) and Minsky (who he surprisingly doesn’t); the non-neutrality of money is the subject (and the title) of what is in my opinion Minsky’s own best short distillation of his thought. 

Borio: 

Compared with the traditional focus on money as an object, the definition [in terms of means of payment] crucially extends the analysis to the payment mechanisms. In the literature, there has been a tendency to abstract from them and assume they operate smoothly in the background. I believe this is one reason why money is often said to be a convention, much like choosing which hand to shake hands with: why do people coordinate on a particular “object” as money? But money is much more than a convention; it is a social institution. It is far from self-sustaining. Society needs an institutional infrastructure to ensure that money is widely accepted, transactions take place, contracts are fulfilled and, above all, agents can count on that happening. 

Again, the payments mechanism is a complex, institutionally heavy social arrangement; there’s a lot that’s missed when we imagine economic transactions as I hand you this, you hand me that. Ignoring this social infrastructure invites the classical idea of money as an arbitrary numeraire, from which its long-run neutrality is one short step. 

The last clause introduces a deep new idea. In an important sense, trust is a kind of irrational expectation. Trust means that I am sure (or behave as if I am sure) that you will conform to the relevant rules. Trust means I believe (or behave as if I believe) this 100 percent. Anything less than 100 percent and trust quickly unravels to zero.  If there’s a small chance you might try to kill me, I should be prepared to kill you first; you might’ve had no bad intentions, but if I’m thinking of killing you, you should think about killing me first; and soon we’re all sprawled out on the warehouse floor. To exist in a world of strangers we need to believe, contrary to experience, that everyone around us will follow the rules.

a well functioning monetary system … will exploit the benefits of unifying the means of payment with the unit of account. The main benefit of a means of payment is that it allows any economy to function at all. In a decentralised exchange system, it underpins the quid-pro-quo process of exchange. And more specifically, it is a highly efficient means of “erasing” any residual relationship between transacting parties: they can thus get on with their business without concerns about monitoring and managing what would be a long chain of counterparties (and counterparties of counterparties).

Money as an instrument for erasing any relationship between the transacting parties: It could not be said better. And again, this is something someone who has read Graeber’s Debt understands very well, while someone who hasn’t might be a bit baffled by this passage. Graeber could also take you a step farther. Money might relieve you of the responsibility of monitoring your counterparties and their counterparties but somebody still has to. Graeber compellingly links the generalized use of money to strong centralized states. In a Graeberian perspective, money, along with slavery and bureaucracy, is one of the great social technologies for separating economic coordination from the broader network of mutual obligations.

The central banks’ elastic supply of the means of payment is essential to ensure that (i) transactions are settled in the interbank market and (ii) the interest rate is controlled. The interbank market is a critical component of our two-tier monetary system, where bank customer transactions are settled on the banks’ books and then banks, in turn, finally settle on the central bank’s books. To smooth out interbank settlement, the provision of central bank credit is key. The need for an elastic supply to settle transactions is most visible in the huge amounts of intraday credit central banks supply to support real- time gross settlement systems

“Two-tier monetary system” is a compressed version of Mehrling’s hierarchy of money. The second point, which Borio further develops further on, is that credit is integral to the payment system, since the two sides of a transaction never exactly coincide – there’s always one side that fulfills its part first and has to accept, however briefly, a promise in return. This is one reason that the dream of separating credit and payments is unrealizable.

The next point he makes is that a supply and demand framework is useless for thinking about monetary policy: 

The central bank … simply sets the desired interest rate by signalling where it would like it to be. And it can do so because it is a monopoly supplier of the means of payment: it can credibly commit to provide funds as needed to clear the market. … there is no such thing as a well behaved demand for bank reserves, which falls gradually as the interest rate increases, ie which is downward-sloping.

An interesting question is how much this is specific to the market for reserves and how much it applies to a range of asset markets. In fact, many markets share the two key features Borio points to here: adjustment via buffers rather than prices, and expected return that is a function of price.

On the first, there are a huge range of markets where there’s someone on one or both sides prepared to passively by or sell at a stated price. Many financial markets function only thanks to the existence of market makers – something Mehrling and his Barnard colleague Rajiv Sethi have written eloquently about. But more generally, most producers with pricing power — which is almost all of them — set a price and then passively meet demand at that price, allowing inventories and/or delivery times to absorb shifts in demand, within some range.

The second feature is specific to long-lived assets. Where there is an expected price different from the current price, holding the asset implies a capital gain or loss when the price adjusts. If expectations are sufficiently widespread and firmly anchored, they will be effectively self-confirming, as the expected valuation changes will lead the asset to be quickly bid back to its expected value. This dynamic in the bond market (and not the zero lower bound) is the authentic Keynesian liquidity trap.

To be clear, Borio isn’t raising here these broader questions about markets in general. But they are a natural extension of his arguments about reserves. 

Next come some points that shouldn’t be surprising to to readers of this blog, but which are nice, for me as an economics teacher, to see stated so plainly. 

The monetary base – such a common concept in the literature – plays no significant causal role in the determination of the money supply … or bank lending. It is not surprising that … large increases in bank reserves have no stable relationship with the stock of money … The money multiplier – the ratio of money to the monetary base – is not a useful concept. … Bank lending reflects banks’ management of the risk-return tradeoff they face… The ultimate anchor of the monetary system is not the monetary base but the interest rate the central bank sets.

We all know this is true, of course. The mystery is why so many textbooks still talk about the supply of high-powered money, the money multiplier, etc. As the man says, they just aren’t useful concepts.

Next comes the ubiquity of credit, which not only involves explicit loans but also any transaction where delivery and payment don’t coincide in time — which is almost all of them. Borio takes this already-interesting point in an interestingly Graeberian direction:  

A high elasticity in the supply of the means of payment does not just apply to bank reserves, it is also essential for bank money. … Credit creation is all around us: some we see, some we don’t. For instance, explicit credit extension is often needed to ensure that two legs of a transaction are executed at the same time so as to reduce counterparty risk… And implicit credit creation takes place when the two legs are not synchronised. ….

In fact, the role of credit in monetary systems is commonly underestimated. Conceptually, exchanging money for a good or service is not the only way of solving the problem of the double coincidence of wants and overcoming barter. An equally, if not more convenient, option is to defer payment (extend credit) and then settle when a mutually agreeable good or service is available. In primitive systems or ancient civilisations as well as during the middle ages, this was quite common. … It is easier to find such examples than cases of true barter.

The historical non-existence of barter is the subject of the first chapter of Debt . Here again, the central banker has more in common with the radical anthropologist than with orthodox textbooks, which usually make barter the starting point for discussions of money.

Borio goes on:

the distinction between money and debt is often overplayed. True, one difference is that money extinguishes obligations, as the ultimate settlement medium. But netting debt contracts is indeed a widespread form of settling transactions.

Yes it is: remember Braudel’s Flanders fairs? “The fairs were effectively a settling of accounts, in which debts met and cancelled each other out, melting like snow in the sun.”

At an even deeper level, money is debt in the form of an implicit contract between the individual and society. The individual provides something of value in return for a token she trusts to be able to use in the future to obtain something else of value. She has a credit vis-à-vis everyone and no one in particular (society owes a debt to her).

In the classroom, one of the ways I suggest students think about money is as a kind of social scorecard. You did something good — made something somebody wanted, let somebody else use something you own, went to work and did everything the boss told you? Good for you, you get a cookie. Or more precisely, you get a credit, in both senses, in the personal record kept for you at a bank. Now you want something for yourself? OK, but that is going to be subtracted from the running total of how much you’ve done for the rest for us.

People get very excited about China’s social credit system, a sort of generalization of the “permanent record” we use to intimidate schoolchildren. And ok, it does sound kind of dystopian. If your rating is too low, you aren’t allowed to fly on a plane. Think about that — a number assigned to every person, adjusted based on somebody’s judgement of your pro-social or anti-social behavior. If your number is too low, you can’t on a plane. If it’s really low, you can’t even get on a bus. Could you imagine a system like that in the US?

Except, of course, that we have exactly this system already. The number is called a bank account. The difference is simply that we have so naturalized the system that “how much money you have” seems like simply a fact about you, rather than a judgement imposed by society.

Back to Borio:

All this also suggests that the role of the state is critical. The state issues laws and is ultimately responsible for formalising society’s implicit contract. All well functioning currencies have ultimately been underpinned by a state … [and] it is surely not by chance that dominant international currencies have represented an extension of powerful states… 

Yes. Though I do have to note that it’s at this point that Borio’s fealty to policy orthodoxy — as opposed to academic orthodoxy — comes into view. He follows up the Graeberian point about the link between state authority and money with a very un-Graeberian warning about the state’s “temptation to abuse its power, undermining the monetary system and endangering both price and financial stability.”

Turning now to the policy role of the central bank, Borio  starts from by arguing that “the concepts of price and financial stability are joined at the hip. They are simply two ways of ensuring trust in the monetary system…. It is no coincidence that securing both price and financial stability have been two core central bank functions.” He then makes the essential point that what the central bank manages is at heart the elasticity of the credit system. 

The process underpinning financial instability hinges on how “elastic” the monetary system is over longer horizons… The challenge is to ensure that the system is not excessively elastic drawing on two monetary system anchors. One operates on prices – the interest rate and the central bank’s reaction function. … The other operates on quantities: bank regulatory requirements, such as those on capital or liquidity, and the supervisory apparatus that enforces them.

This is critical, not just for thinking about monetary policy, but as signpost toward the heart of the Keynesian vision. (Not the bastard — but useful  — postwar Keynesianism of IS-LM, but the real thing.) Capitalism is not a system of real exchange — it shouldn’t be imagined as a system in which people exchange pre-existing stuff for other stuff they like better. Rather, it is a system of monetary production — a system in which payments and claims of money, meaningless themselves, are the coordinating mechanism for human being’s collective, productive activity. 

This is the broadest sense of the statement that money has to be elastic, but not too elastic. If it is too elastic, money will lose its scarcity value, and hence its power to organize human activity. Money is only an effective coordinating mechanism when its possession allows someone to compel the obedience of others. But it has to be flexible enough to adapt to the concrete needs of production, and of the reproduction of society in general. (This is the big point people take form Polanyi.) “You can’t have the stuff until you give me the money” is the fundamental principle that has allowed capitalism to reorganize vast swathes of our collective existence, for better or worse. But applied literally, it stops too much stuff from getting where it needs to go to to be compatible with the requirements of capitalist production itself. There’s a reason why business transactions are almost always on the basis of trade credit, not cash on the barrelhead. As Borio puts it, “today’s economies are credit hungry.” 

The talk next turns to criticism of conventional macroeconomics that will sound familiar to Post Keynesians. The problem of getting the right elasticity in the payments system — neither too much nor too little — is “downplayed in the current vintage of macroeconomic models. One reason is that the models conflate saving and financing.“ In reality,

Saving is just a component of national income – as it were, just a hole in overall expenditures, without a concrete physical representation. Financing is a cash flow and is needed to fund expenditures. In the mainstream models, even when banks are present, they imply endowments or “saving”; they do not create bank deposits and hence purchasing power through the extension of loans or purchase of assets. There is no meaningful monetary system, so that any elasticity is seriously curtailed. Financial factors serve mainly to enhance the persistence of “shocks” rather than resulting in endogenous booms and busts.

This seems right to me. The point that there is no sense in which savings finance or precede or investment is a key one for Keynes, in the General Theory and even more clearly in his subsequent writing.3 I can’t help noting, also, that passages like this are a reminder that criticism of today’s consensus macro does not come only from the professionally marginalized.

The flipside of not seeing money as social coordinating mechanism, a social ledger kept by banks, is that you do  see it as a arbitrary token that exists in a particular quantity. This latter vision leads to an idea of inflation as a simple imbalance between the quantity of money and the quantity of stuff. Borio:

The process was described in very simple terms in the old days. An exogenous increase in the money supply would boost inflation. The view that “the price level is the inverse of the price of money” has probably given this purely monetary interpretation of inflation considerable intuitive appeal. Nowadays, the prevailing view is not fundamentally different, except that it is couched in terms of the impact of the interest rate the central bank sets.

This view of the inflation process has gone hand in hand with a stronger proposition: in the long run, money (monetary policy) is neutral, ie it affects only prices and no real variables. Again, in the classical tradition this was couched in terms of the money supply; today, it is in terms of interest rates. … Views about how long it takes for this process to play itself out in calendar time differ. But proponents argue that the length is short enough to be of practical policy relevance.

The idea that inflation can be thought of as a decline in the value of money is effectively criticized by Merijn Knibbe and others. It is a natural idea, almost definitionally true, if you vision starts from a world of exchange of goods and then adds money as facilitator or numeraire. But if you start, as Borio does, and as the heterodox money tradition from Graeber to Minsky to Keynes to Marx and back to Tooke and Thornton does, from the idea of money as entries in a social ledger, then it makes about as much sense as saying that a game was a blowout because the quantity of points was too high.  

once we recognise that money is fundamentally endogenous, analytical thought experiments that assume an exogenous change and trace its impact are not that helpful, if not meaningless. They obscure, rather than illuminate, the mechanisms at work. … [And] once we recognise that the price of money in terms of the unit of account is unity, it makes little sense to think of the price level as the inverse of the price of money. … any financial asset fixed in nominal terms has the same property. As a result, thinking of inflation as a purely monetary phenomenon is less compelling.

“Not that helpful”, “makes little sense,” “is less compelling”: Borio is nothing if not diplomatic. But the point gets across.

Once we recognise that the interest rate is the monetary anchor, it becomes harder to argue that monetary policy is neutral… the interest rate is bound to affect different sectors differently, resulting in different rates of capital accumulation and various forms of hysteresis. … it is arguably not that helpful to make a sharp distinction between what affects relative prices and the aggregate price level…., not least because prices move at different speeds and differ in their flexibility… at low inflation rates, the “pure” inflation component, pertaining to a generalised increase in prices, [is] smaller, so that the distinction between relative and general price changes becomes rather porous.

In part, this is a restatement of Minsky’s “two-price” formulation of Keynes. Given that money or liquidity is usefulat all, it is presumably more useful for some things more than for others; and in particular, it is most useful when you have to make long-lived commitments that expose you to vagaries of an unknown future; that is, for investment. Throttling down the supply of liquidity will not just reduce prices and spending across the board, it will reduce them particularly for long-lived capital goods.

The second point, that inflation loses its defintion as a distinct phenomenon at low levels, and fades into the general mix of price changes, is something I’ve thought myself for a while but have never seen someone spell out this way. (I’m sure people have.) It follows directly from the fact that changes in the prices of particualr goods don’t scale proportionately with inflation, so as inflation gets low, the shared component of price changes over time gets smaller and harder to identify. Because the shared component is smaller at low inflation, it is going to be more sensitive to the choice of basket and other measurement issues. 20 percent inflation clearly (it seems to me) represents a genuine phenomenon. But it’s not clear that 2 percent inflation really does – an impression reinforced by the proliferation of alternative measures.

The Minskyan two-price argument also means that credit conditions and monetary policy necessarily affect the directiona s well as the level of economic activity.

financial booms tend to misallocate resources, not least because too many resources go into sectors such as construction… It is hard to imagine that interest rates are simply innocent bystanders. At least for any policy relevant horizon, if not beyond, these observations suggest that monetary policy neutrality is questionable.

This was one of the main points in Mike Konczal’s and my monetary toolkit paper.

In the next section, which deserves a much fuller unpacking, Borio critiques the fashionable idea that central banks cannot control the real rate of interest. 

 Recent research going back to the 1870s has found a pretty robust link between monetary regimes and the real interest rate over long horizons. By contrast, the “usual suspects” seen as driving saving and investment – all real variables – do not appear to have played any consistent role. 

This conflation of the “real”  (inflation-adjusted) interest rate with a rate determined by “real” (nonmonetary) factors, and therefore beyond the central bank’s influence, is one of the key fissure-points in economic ideology.4 The vision of economics, espcially its normative claims, depend on an idea of ecnomic life as the mutually beneficial exchange of goods. There is an obvious mismatch between this vision and the language we use to talk about banks and market interest rates and central banks — it’s not that they contradict or in conflict as that they don’t make contact at all. The preferred solution, going from today’s New Keynesian consensus back through Friedman to Wicksell, is to argue that the “interest rate” set by the central bank must in some way be the same as the “interest rate” arrived at by agents exchanging goods today for goods later. Since the  terms of these trades depend only on the non-monetary fundamentals of preferences and technology, the same must in the long run be true of the interest rate set by the financial system and/or the central bank. The money interest rate cannot persistently diverge from the interest rate that would obtain in a nonmonetary exchange economy that in some sense corresponds to the actual one.

But you can’t square the circle this way. A fundamental Keynesian insight is that economic relations between the past and the future don’t take the form of trades of goods now for goods later, but of promises to make money payments at some future date or state of the world. Your ability to make money promises, and your willingness to accept them from others, depends not on any physical scarcity, but on your confidence in your counterparties doing what they promised, and in your ability to meet your own commitments if some expected payment doesn’t come through. In short, as Borio says, it depends on trust. In other words, the fundamental problem for which interest is a signal is not allocation but coordination. When interest rates are high, that reflects not a scarcity of goods in the present relative to the future, but a relative lack of trust within the financial system. Corporate bond rates did not spike in 2008 because decisionmakers suddenly wished to spend more in the present relative to the future, but because the promises embodied in the bonds were no longer trusted.

Here’s another way of looking at it: Money is valuable. The precursor of today’s “real interest rate” talk was the idea of money as neutral in the long run, in the sense that a change in the supply of money would eventually lead only to a proportionate change in the price level.5  This story somehow assumes on the one hand that money is useful, in the sense that it makes transactions possible that wouldn’t be otherwise. Or as Kocherlakota puts it: “At its heart, economic thinking about fiat money is paradoxical. On the one hand, such money is viewed as being inherently useless… But at the same time, these barren tokens… allow society to implement allocations that would not otherwise be achievable.” If money is both useful and neutral, evidently it must be equally useful for all transactions, and its usefulness must drop suddenly to zero once a fixed set of transactions have been made. Either there is money or there isn’t. But if additional money does not allow any desirable transaction to be carried out that right now cannot be, then shouldn’t the price of money already be zero? 

Similarly: The services provided by private banks, and by the central bank, are valuable. This is the central point of Borio’s talk. The central bank’s explicit guarantee of certain money commitments, and its open ended readiness to ensure that others are fulfilled in a crisis, makes a great many promises acceptable that otherwise wouldn’t be. And like the provider of anything of value, the central bank — and financial system more broadly — can affect its price by supplying more or less of it. It makes about as much sense to say that central banks can influence the interest rate only in the short run as to say that public utilities can only influence the price of electricity in the short run, or that transit systems can only influence the price of transportation in the short run. The activities of the central bank allow a greater degree of trust in the financial system, and therefore a lesser required payment to its professional promise-accepters.6 Or less trust and higher payments, as the case may be. This is true in the short run, in the medium run, in the long run. And because of the role money payments play in organizing productive activity, this also means a greater or lesser increase in our collective powers over nature and ability to satisfy our material wants.

 

  1. On twitter this point was unsurprisingly lost among the responses to my more dismissive comments about mainstream theory. I’ll defer that conversation to another time.
  2. For example.
  3. Keynes: “The point remains, however, that the transition from a lower to a higher scale of activity involves an increased demand for liquid resources which cannot be met without a rise in the rate of interest, unless the banks are ready to lend more cash… If there is no change in the liquidity position, the public can save ex-ante and ex-post and ex-anything-else until they are blue in the face, without alleviating the problem in the least… This means that, in general, the banks hold the key position in the transition from a lower to a higher scale of activity. If they refuse to relax, the growing congestion of the short-term loan market or of the new issue market, as the case may be, will inhibit the improvement, no matter how thrifty the public… The investment market can become congested through shortage of cash. It can never become congested through shortage of saving. This is the most fundamental of my conclusions within this field.”
  4. I use this term to distinguish economics as an organizing vision of social reality and not just the academic project.
  5. As Borio notes, even the superficial logic of this story no longer works in a world where central banks are understood to set the interest rate rather than the money supply.
  6. The idea that low interest rates are a barometer of civilization has been a popular one on parts of the Right, as Quinn Slobodian discusses in chapter 5 of his magnificent book Globalists. Am I straying close to that view here? In my defense, I strongly doubt Röpke and co would have agreed that the way to get low interest rates is to replace a big part of the private financial system with a public body.

20 thoughts on ““On money, debt, trust and central banking””

  1. v interesting. Some of these ideas – such as money allowing you to transact without needing to gather information on your counterpart, and the importance of trust, reminds me of (I think) Gary Gorton.

    I am on uncertain ground (meaning I am not sure I know what I’m on about) but the idea that inflation is not caused by an exogenous increase in money is rather flogging a bit of a dead horse imo. Still, I don’t think I really understand the money as a social ledger argument.

    The part about inflation and relative price changes reminds me of this sort of thing.
    https://www.princeton.edu/~mwatson/papers/pureinflation_November09_2007.pdf
    I am not sure how close that is to your thinking.

    1. the idea that inflation is not caused by an exogenous increase in money is rather flogging a bit of a dead horse imo

      This is an interesting question. On the one hand, my impression is that a lot of contemporary macroeconomic scholarship does not make much use of an exogenous money supply. On the other hand, it is definitely still a staple of undergraduate teaching. Just turning to a textbook that’s close to hand, the 8th edition of Blanchard and Krugman’s international Economics (which is less than 10 years old) frames its whole discussion of monetary policy in terms of the cetnral bank exogenously setting the money supply, and then says that “money supply growth at a constant rate eventually results in ongoing price level inflation at the same rate.” This is exactly the old story. Also, even people who wouldn’t use that language still implicitly rely on it. FOr example, the intuition that says flexible prices will eventually cancel out any effort by thte central bank to set the “wrong” interest rate, relies on the link from exogenous monsey-stock changes to inflation.

      And then of course even if this idea had completely died out in in contemporary work, people in policy settings are often still thinking in terms of what was current when they got their training decades ago.

      So I thik there’s a funny asynchrony here where people “officially” don’t believe this anymore but still often seem to believe it in practice.

    2. Thanks, that looks interesting. I’d been thinking that someone ought to do an exercise like that.

  2. this is something I’d like to understand better:

    “In the mainstream models, even when banks are present, they imply endowments or “saving”; they do not create bank deposits and hence purchasing power through the extension of loans or purchase of assets. There is no meaningful monetary system, so that any elasticity is seriously curtailed. Financial factors serve mainly to enhance the persistence of “shocks” rather than resulting in endogenous booms and busts.”

    So to take the most recent example I came across of a mainstream model with credit booms and busts:

    https://voxeu.org/article/credit-booms-and-information-depletion

    Does that have banks creating purchasing power through the extension of loans? And if it doesn’t, what would result from introducing that?

  3. “Now you want something for yourself? OK, but that is going to be subtracted from the running total of how much you’ve done for the rest for us.”

    The problem is that society’s valuations are arbitrary and fickle.

    Sidney Bechet has a much better theory of value than Borio. For Bechet, value exists independently of money. Please see http://thejazzclarinet.blogspot.com/2013/01/treat-it-gentle-autobiography-of-sidney.html

    “And maybe there’s another thing why so many of these musicianers ended up so bad. Maybe they didn’t know how to keep up with all this commercializing that was happening to ragtime. If it could have stayed where it started and not had to take account of the business it was becoming–all that making contracts and signing options and buying and selling rights–maybe without that it might have been different. If you start taking what’s pure in a man and you start putting it on a bill of sale, somehow you can’t help destroying it. In a way, all that business makes it so a man don’t have anything left to give.

    “I got a feeling inside me, a kind of memory that wants to sing itself…I can give you that. I can send it out to where it can be taken, maybe, if you want it. I can try to give it to you. But if all I’ve got is a contract, I’ve got nothing to give. How’m I going to give you a contract?”

    Borio destroys the natural idea of value by trying to measure it with a price. He is crass and shallow.

    1. Robert,

      I couldn’t agree more. That’s a lovely quote that I’m sure I’ll use in the future. But I don’t think Borio is the right target here. He is trying to describe the system as it exists. That’s an important part of the work of replacing it with a better one.

    2. “The problem is that society’s valuations are arbitrary and fickle.”

      In my understanding, that is precisely the point for the existence of such discrepancy between values and prices. And I can think of at least one guy who focused on that theme.

  4. Good post.

    Is there a formal model of the position you endorse?

    I think when using the word money it is essential to distinguish between the monetary base and aggregate. The mainstream position, when clearly stated, is that (1) the monetary aggregate is endogenous, (2) in the long run it has no effect on the general price level, (3) the general price level is entirely a function of the supply and demand for the monetary base.

    1. I don’t think formal models really operate on this level. First you have to figure out your preanalytic vision, as Schumpeter said, only then do you think about formalizing particular propositions within it.

      Your statement of the mainstream position seems right to me. On the other hand, there does seem to be a strand within the mainstream that would like to dispense with M entirely, e.g. Woodford.

  5. “Two-tier monetary system” is a compressed version of Mehrling’s hierarchy of money. The second point, which Borio further develops further on, is that credit is integral to the payment system, since the two sides of a transaction never exactly coincide – there’s always one side that fulfills its part first and has to accept, however briefly, a promise in return. This is one reason that the dream of separating credit and payments is unrealizable. [bold added]

    A two-tiered monetary system is a consequence of needlessly expensive fiat and is thus as obsolete and unjust (if privileged by government) as the Gold Standard itself.

    Inexpensive fiat allows the entire population to use fiat directly via debit/checking accounts at the Central Bank or Treasury itself and all other privileges for the banks (e.g. government-provided deposit insurance) abolished.

    Then instant clearing at point of transaction between individuals, businesses, State and local governments, etc. disallows any need for overdraft protection since accounts with insufficient funds would only prevent the specific account holder from paying his/her/its bills and not a bunch of innocent depositors as is now the case with “the banks” and their captive depositors.

    Your thinking is thus obsolete and your disparagement of separating credit and the payment system is unwarranted.

    Nor are high interest rates a necessary consequence of separating credit from the payment since equal fiat distributions to all citizens (i.e. a Citizen’s Dividend) should lower them as desired. How to finance? Overt Monetary Finance and/or negative interest rates on large and non-citizen accounts at the Central Bank or Treasury.

  6. “You can’t have the stuff until you give me the money” is the fundamental principle that has allowed capitalism to reorganize vast swathes of our collective existence, for better or worse. But applied literally, it stops too much stuff from getting where it needs to go to to be compatible with the requirements of capitalist production itself.

    That sounds a bit like:

    “At a certain stage of development, the material productive forces of society come into conflict with the existing relations of production or – this merely expresses the same thing in legal terms – with the property relations within the framework of which they have operated hitherto. From forms of development of the productive forces these relations turn into their fetters. Then begins an era of social revolution.”

  7. I disagree with Borio’s article for this reason:

    In a “quantity of money” type of theory, the price level P depends from the quantity of money M and the quantity of stuff S, basically:

    M/S -> P

    I use the sign “->” and not “=” because this is a matter of causality, not osimple equivalence.

    In a “endogenous money” theory, on the other hand, M is what adjusts, so we have:

    S*P -> M

    the problem of an endogenous money theory is that we need an exogenous P to make it work.

    So where does P come from? Borio seems to think that the interest rate is what determines inflation and thus P, but this makes the argument circular because the interest rate determines the level of credit, that is what Borio threats as the quantity of money, so the quantity of money determines itself.

    More generally, there is a flow of income that is made of a quantity of services and stuff created and consumed, for a price. nominal GDP represents this.

    There is also an amount of credit (not a flow), so that we can have a (total credit)/(nominal GDP) ratio, that is expressed in a quantity of time (because it’s a stock/flow ratio, so $/($/time)=time), so that we can say that the whole credit in the USA is, say equivalent to 5 years of GDP.

    This ratio in my opinion is very important: for example if the interest rate is fixed, an increase in this ratio means a larger share of GDP goes into interest; if the interest share of GDP is fixed then the interest rate has to fall.

    So I think that there is a problem with this idea of equating “credit” with “money”, and then implicitly equating “money” with the nominal GDP (although one is a stock and the other is a flow), because this tends to hide this particular credit/income ratio that I think is very important.

    I tend to think that inflation is mostly due to wage/price spirals, that depend on whether the economy is booming or busting, and that stuff like increase in public or private debt tend to create booms (because I’m an underconsumptionist), so that this causes indirectly inflation, and not directly the change in the inflation rate.

  8. With a bit of serendipity, today the blog eureferendum.com has a short discussion of the role of insurance in modern economies, that I think is germane to this argument about credit and elasticity:


    Latest of the drips of water on stone is a report on the response of credit insurers to the growing uncertainties of Brexit. The role of credit insurance in big business is absolutely pivotal for, unless the insurers approve, businesses are limited in the amount of credit they can allow their customers, as any bad debt will be irrecoverable.

    In the frame is the food industry. We are told that Atradius, one of the biggest credit insurers, is warning that a “no-deal” scenario “would pose a material threat” to Britain’s meat industry. It is also understood to have removed cover for a range of food businesses, including a bakery and a dairy company in recent weeks. Euler Hermes, another leading insurer, is apparently reducing cover and tightening terms to the food industry.

    I’m not sure whether The Sunday Times, the source of the report, has quite got the full flavour of the issue, as the debtor chain works from top to bottom. Most at risk are the primary producers, who can be heavily exposed if their buyers go insolvent and can’t pay their invoices.

    Then, the businesses in the middle – the wholesalers, the hauliers and logistics companies, and the processors, are all at risk if their major retail customers go belly-up and stop paying their bills. What could happen here is that the supermarkets, which are notoriously late payers, could simply cut off payments to their suppliers if their shelves are empty and they are unable to restock.

    The point that emerges is that credit insurance is a major lubricant of business and if the insurers start throwing wobblies, that is going to have an impact long before we actually see the effects of a “no deal” Brexit.

    http://eureferendum.com/blogview.aspx?blogno=87093

  9. The relation between the level of trust and the level of the interest rate remains unclear to me. What are your thoughts on that?

  10. I had a look at Borio’s , still off the mark in his understanding of money although getting there.
    He notes “we can think of money as an especially trustworthy type of debt” and then “One could think of good money as an asset whose nominal value is highly (ideally perfectly) insensitive” to information about the issuer.
    Yes trustworthiness of issuer is the central aspect, but money is not special relative to other debts and is not insensitive to crediworthiness of issuer. Its nominal value is highly sensitive to that crediworthiness. It is the way the debt is structured that makes it circulate at par.

  11. Mr. Mason,
    I find it generally easy to read the starts of your writings, but when it becomes complicated, I can no longer follow.

    Actually, I read your article about managerial and rentier firms and was wondering what this means to the world where ETF’s/passive investment has become so dominant? ETF’s seem difficult to be called aggressive/revolutionary shareholders.

    I got to that article from a link where somebody was describing Amazon as a kind of collectivized farm, which I also don’t quite understand. My question there is, what is the problem with Amazon? It seems to me that this and other “platforms” (like Uber for instance), commodify personal/commercial relationships into star-ratings which do not adequately capture the broad spectrum of human qualities which are required for happiness. Where do these costs go? Are there real costs to these types of changes? If you would compare the earlier system, where buying an item might rely on the expertise of a retail intermediary and their ability to predict your demand and stock something for you, to the platform system, where it is more or less decided (predicted/recommended) for you.

    Finally, you write here that nearly all producers have pricing power. Does that mean there is no race to the bottom? If there were a race to the bottom, at least that would be something I could understand: in the future everything will be exteremely cheap (either money or product). If producers have pricing power, then why aren’t they giving everyone a bag of money to buy everything on Amazon asnd “become happy”?

    1. I just read your interview on Jacobinmag, so at least the ETF thing is cleared up. You say that the revolutionary stockholder is now indeed no longer looking after their money, lost interest in competition and lost interest in pushing the board around. That’s quite interesting, maybe it happens at the lower echelons too: money isn’t cancelling debt: fake/worthless services (invoices) are cancelling credit. You say competition is stifled by this, but index funds commonly include the disruptors that commodify the competition. It’s probably more that investor’s needs are satisfied with the money they extract because those needs have become cheap to fulfil. The commodities are personalised (it’s not soviet) services.

      The remaining problems are:
      – that there are still too many producers that don’t give in and don’t nullify their prices. They probably get their money from the government. Or, McDonald’s cheese teases your synapses absolutely right, but for some reason people then just want what they can’t have: cheese from the toe nails of 100 year old French nuns.
      – Jeff Bezos has been given all of society’s money and he is the only one actually doing something: making everyone happy. Jeff may not retire. He can never spend it all in a meaningful way.
      – Amazon’s warehouse drones (and the rest of the scum under Jeff’s foot soles who voted for this anyway) are complaining. For whatever reason these commodities want to be cared for.
      – America may not go bankrupt. You can grab em by the p*y but you cannot go bankrupt. (I guess these 4 don’t make much sense anyway is what I’m saying.)

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