Tag: finance

At The International Economy: Low Interest Rates Were OK

(I am an occasional contributor to roundtables of economists in the magazine The International Economy. This month’s roundtable was on concerns that ultra-low interest rates after the 2007-2009 financial crisis contributed to rising inequality and asset bubbles, and asked contributors to grade post-2007 monetary policy on a scale of A to F.)

Overall, I give the negative interest rate experiment a grade of B. The costs of negative rates have been greatly exaggerated. But so have the benefits. The main lesson is that conventional monetary policy is surprisingly weak in a depressed economy, even when carried to extremes. The next time we need stimulus, greater weight should be put on fiscal policy.

The case against ultra-low rates on distribution grounds is not very strong, in my view. Yes, low rates do tend to raise asset values,  and it’s the rich who own most of the assets. But we should not make the mistake so many people do, and confuse a change in the present value of future income streams with a change in those streams themselves. Low rates, for example, imply a greater present value of the same future dividend payments, and thus higher stock prices. But that has no effect on income distribution — the owners of the stock are receiving the same payments as they were before.

The bigger criticism of ultra-low rates is that they didn’t have much effect one way or another. Did 20 years of zero nominal rates in Japan significantly boost demand and growth? It doesn’t seem like it.

At the same time, we should be careful of language like “distortion,” which suggests that there is some true, natural level of interest rates and investment. Whether high or low, interest rates are always set by policy. And this always involves tradeoffs between competing social goals.

Whether ultra-low rates contribute to bubbles is debatable. Many of the world’s great bubbles — from the 1920s in the US to the 1990s in Sweden — have occurred in environments of high interest rates. But let’s say for the sake of argument that cryptocurrency is socially useless, and that it would never have taken off if rates were higher. Is this a problem with negative rates? Or is it a problem with the financial system? The reason we have so many well-educated, well-compensated people working in finance is that they are supposed to direct credit to the best opportunities. If cheap money leads them to invest in projects that are worthless, or worse, rather than ones with moderate returns, they’re not doing their jobs.

If jet fuel were free, we would all probably fly more. But if planes kept crashing into the ocean, we’d blame the airlines, not the cheap fuel.

Speaking of airlines, it’s easy in retrospect to see the subsidized loans to them and other pandemic-hit industries as excessive. But we don’t know what the counterfactual is — it’s possible that without public support, they would have collapsed into bankruptcy, leading to a much slower recovery. Certainly we couldn’t be sure at the time. Under the extraordinary circumstances of the pandemic, there was no safe course, only a balance of risks. The high inflation of 2021-2022 was unfortunate; a prolonged depression would have been much worse. Perhaps next time — and climate change ensures that there will be a next time — we will strike a better balance. But it seems to me that under the circumstances, policymakers did pretty well.

*

That’s what I wrote for the symposium. Let me add a couple of things here.

First, this is not a new debate. Many of the same arguments were being made immediately after the global financial crisis, and even before it in the mid-2000s, in the context of the supposed global savings glut. At that time, the idea was that the volume of excess savings in Asia were too great to be absorbed by productive investment in the US and elsewhere, leading to downward pressure on interest rates and an excess of speculative investment, in housing especially.

It’s progress, I suppose, that the more recent period of low interest rates is attributed straightforwardly to central banks, as opposed to an imagined excess of “saving.” (For a critique of the savings-glut story, you can’t do better than Jörg Bibow’s excellent work.) But the more fundamental problem remains that the savings-glut/too-low-for-too-long stories never explain how they coexist with all the other economic stories in which more abundant financing is unambigously a good thing. As I wrote a dozen years ago1:

the savings glut hypothesis fails to answer two central, related questions: Why was there a lack of productive investments available to be financed, and why did the financial system fail to channel the inflow of savings in a sustainable way? From a Keynesian perspective, there is nothing strange about the idea of a world where savings rates are chronically too high, so that output is demand-constrained; but this is not the perspective from which the savings-glut hypothesisers are arguing. In other contexts, they take it for granted that an increase in the savings rate will result in greater investment and faster growth.

In particular, as I pointed out there, many of the same people arguing for these stories also think that it is very desirable to reduce government budget deficits. But if you ask any economist what is the economic benefit of moving the government balance toward surplus, their answer will be that it frees up saving for the private sector; that is, lower interest rates.2

Second. Returning to the International Economy roundtable, it’s striking how many of the contributors shared my basic analysis3 —  ultra-low rates didn’t achieve very much, but they were better than nothing given the failure of the budget authorities to undertake adequate stimulus. It’s interesting is that people with this same analysis — and who also reject the idea that the low rates of the 2010s are to blame for the inflation of the early 2020s — give such different responses on the grading component. I agree with everything that Jamie Galbraith writes, and especially appreciate his points that hardly any private borrowers ever faced zero (let alone negative) rates, and that higher rates do not seem to have done much to curb speculative excess. (Just look at “AI”.) I also agree with everything Heiner Flassbeck says (especially the underappreciated point that we’ve also had a decisive test of the benefits of wage flexibility, with negative results) and with almost everything Brigitte Granville says. Yet two of us give As and Bs, and two give Ds and Fs. It’s the difference between comparing monetary policy’s actual performance to what it reasonably could have accomplished, and to what it promised, perhaps.

Finally. It might seem strange to see me speaking so positively about macroeconomic policy over the past decade. Aren’t I supposed to be a radical of some sort?4 It was even a bit disconcerting to me to see I typed those words a few months ago (there’s a bit of turnaround time with these things), given that my main feelings about Western governments these days tend toward rage and disgust.

But the point here is important. It’s important to remember that the central macroeconomic problem in recent years has been insufficient demand.5 It’s important to remind people of the overwhelming evidence, and the quite broad consensus, that the economic problem over the past 15 years has not been a lack of real resources, but a lack of spending — of demand. (A world in which over-low interest rates could even be a concern, is not a world where the central economic problem is scarcity.) And I think that it’s true, and important, that the institutions — at least in the US and Western Europe — that were consistently trying to address this problem, were the central banks.

Even today, while we can certainly argue that central banks raised rates too aggressively, the main contractionary pressure is coming from elected governments. This is most obvious in Europe, but in the US, it seems to me, the withdrawal of pandemic unemployment benefits and the child tax credit have done more harm than anything the Fed has done. There’s an old idea that elected governments are structurally biased toward deficits and generous social benefits.6 But it’s clear this is no longer true, if it ever was.

Against this background, I think both the broader recognition of hysteresis and chronic demand shortfalls in the 2010s, and the aggressive response to the pandemic in this decade, are positive lessons that need to be preserved and defended and built upon. It’s very challenging to separate this positive record on domestic economic policy from the increasingly horrifying treatment of the rest of the world that we have seen from the same governments. (I make this argument in the context of industrial policy in a forthcoming piece in Dissent.) But I think it’s vitally important, both politically and analytically, that we continue to try to do so.

 

Taking Money Seriously

(Text of a talk I delivered at the Watson Institute for International and Public Affairs at Brown University on June 17, 2024.)

There is an odd dual quality to the world around us.

Consider a building. It has one, two or many stories; it’s made of wood, brick or steel; heated with oil or gas; with doors, windows and so on. If you could disassemble the building you could make a precise quantitative description of it — so many bricks, so much length of wire and pipe, so many tiles and panes of glass.

A building also has a second set of characteristics, that are not visible to the senses. Every building has an owner, who has more or less exclusive rights to the use of it. It has a price, reflected in some past or prospective sale and recorded on a balance sheet. It generates a stream of money payments. To the owner from tenants to whom the owner delegated som of their rights. From the owner to mortgage lenders and tax authorities, and to the people whose labor keeps them operating — or to the businesses that command that labor. Like the bricks in the building’s walls or the water flowing through its pipes, these can be expressed as numbers. But unlike those physical quantities, all of these can be expressed in the same way, as dollars or other units of currency.

What is the relationship between these two sets of characteristics? Do the prices and payments simply describe the or reflect the physical qualities? Or do they have their own independent existence? 

My starting point is that this is a problem — that the answer is not obvious.

The relationship between money-world and the concrete social and material world is long-standing, though not always explicit, question in the history of economic thought. A central strand in that history is the search for an answer that unifies these two worlds into one. 

From the beginnings of economics down to today’s textbooks, you can find variations on the argument that money quantities and money payments are just shorthand for the characteristics and use of concrete material objects. They are neutral — mere descriptions, which can’t change the underlying things. 

In 1752, we find David Hume writing that “Money is nothing but the representation of labour and commodities… Where coin is in greater plenty; as a greater quantity of it is required to represent the same quantity of goods; it can have no effect, either good or bad.”

And at the turn of the 21st century, we hear the same thing from FOMC member Lawrence Meyer: “Monetary policy cannot influence real variables–such as output and employment.” Money, he says, only affects “inflation in the long run. This immediately makes price stability … the direct, unequivocal, and singular long-term objective of monetary policy.”

We could add endless examples in between.

This view profoundly shapes most of our thinking about the economy.

We’ve all heard that money is neutral — that changes in the supply or availability of money only affect the price level while leaving relative prices and real activity unchanged. We’ve probably encountered the Coase Theorem, which says that the way goods are allocated to meet real human needs should be independent of who holds the associated property rights. We are used to talking about “real” output and “real “ interest rates without worrying too much about what they refer to.

There is, of course, also a long history of arguments on the other side — that money is autonomous, that money and credit are active forces shaping the concrete world of production and exchange, that there is no underlying value to which money-prices refer. But for the most part, these counter-perspectives occupy marginal or subterranean positions in economic theory, though they may have been influential in other domains.

The great exception is, of course, Keynes. Indeed, there is an argument that what was revolutionary about the Keynesian revolution was his break with orthodoxy on precisely this point. In the period leading up to the General Theory, he explained that the difference between the economic orthodoxy and the new theory he was seeking to develop was fundamentally the difference between the dominant vision of the economy in terms of what he called “real exchange,” and an alternative he vision he described as “monetary production.”

The orthodox theory (in our day as well as his) started from an economy in which commodities exchanged for other commodities, and then brought money in at a later stage, if at all, without changing the fundamental material tradeoffs on which exchange was based. His theory, by contrast, would describe an economy in which money is not neutral, and in which the organization of production cannot be understood in nonmonetary terms. Or in his words, it is the theory of “an economy in which money plays a part of its own and affects motives and decisions and is … so that the course of events cannot predicted, either in the long period or in the short, without a knowledge of the behavior of money.”

*

If you are fortunate enough to have been educated in the Keynesian tradition, then it’s easy enough to reject the idea that money is neutral. But figuring out how money world and concrete social reality do connect — that is not so straightforward. 

I’m currently in the final stages of writing a book with Arjun Jayadev, Money and Things, that is about exactly this question — the interface of money world with the social and material world outside of it. 

Starting from Keynes monetary-production vision, we explore question of how money matters in four settings.

First, the determination of the interest rate. There is, we argue, a basic incompatibility between a theory of the interest rate as price of saving or of time, and of the monetary interest rate we observe in the real world. And once we take seriously the idea of interest as the price of liquidity, we see why money cannot be neutral — why financial conditions invariably influence the composition as well as the level of expenditure. 

Second, price indexes and “real” quantities.  The ubiquitous  “real” quantities constructed by economists are, we suggest, at best phantom images of monetary quantities. Human productive activity is not in itself describable in terms of aggregate quantities. Obviously particular physical quantities, like the materials in this building, do exist. But there is no way to make a quantitative comparison between these heterogeneous things except on the basis of money prices — prices are not measuring any preexisting value. Prices within an exchange community are objective, from the point of view of those within the community. But there is no logically consistent procedure for comparing “real” output once you leave boundaries of a given exchange community, whether across time or between countries

The third area we look at the interface of money world and social reality is corporate finance and governance. We see the corporation as a central site of tension between the distinct social logics of money and production. Corporations are the central institutions of monetary production, but they are not themselves organized on market principles. In effect, the pursuit of profit pushes wealth owners to accept a temporary suspension of the logic of market – but this can only be carried so far.

The fourth area is debt and capital. These two central aggregates of money-world are generally understood to reflect “real,” nonmonetary facts about the world — a mass of means of production in the case of capital, cumulated spending relative to income in the case of debt. But the actual historical evolution of these aggregates cannot, we show, be understood in this way in either case. The evolution of capital as we observe it, in the form of wealth, is driven by changes in the value of existing claims on production, rather than the accumulation of new capital goods. These valuation changes in turn reflect, first, social factors influencing division of income between workers and owners and, second, financial factors influencing valuations of future income streams. Debt is indeed related to borrowing, in a way that capital is not related to accumulation. But changes in indebtedness over time owe as much to interest, income and price-level changes that affect burden of existing debt stock as they do to new borrowing. And in any case borrowing mainly finances asset ownership, as opposed to the dissaving that the real-excahnge vision imagines it as.

Even with the generous time allotted to me, I can’t discuss all four of those areas. So in this talk I will focus on the interest rate.

*

Some of what I am going to say here may seem familiar, or obvious. 

But I think it’s important to start here because it is so central to debates about money and macroeconomics. Axel Leijonhufvud long ago argued that the theory of the interest rate was at the heart of the confusion in modern macroeconomics. “The inconclusive quarrels … that drag on because the contending parties cannot agree what the issue is, largely stem from this source.” I think this is still largely true. 

Orthodoxy thinks of the interest rate as the price of savings, or loanable funds, or alternatively, as the tradeoff between consumption in the future and consumption in the present.

Interest in this sense is a fundamentally non-monetary concept. It is a price of two commodities, based on the same balance of scarcity and human needs that are the basis of other prices. The tradeoff between a shirt today and a shirt next year, expressed in the interest rate, is no different between the tradeoff between a cotton shirt and a linen one, or one with short versus long sleeves. The commodities just happen to be distinguished by time, rather than some other quality. 

Monetary loans, in this view, are just like a loan of a tangible object. I have a some sugar, let’s say. My neighbor knocks on the door, and asks to borrow it. If I lend it to them, I give up the use of it today. Tomorrow, the neighbor will return the same amount of sugar to me, plus something  extra – perhaps one of the cookies they baked with it. Whatever income you receive from ownership of an asset — whether we call it interest, profit or cookies — is a reward for deferring your use of the concrete services that the asset provides.

This way of thinking about interest is ubiquitous in economics. In the early 19th century Nassau Senior described interest as the reward for abstinence, which gives it a nice air of Protestant morality. In a current textbook, in this case Gregory Mankiw’s, you can find the same idea expressed in more neutral language: “Saving and investment can be interpreted in terms of supply and demand … of loanable funds — households lend their savings to investors or deposit their savings in a bank that then loans the funds out.”

It’s a little ambiguous exactly how we are supposed to imagine these funds, but clearly they are something that already exists before the bank comes into the picture. Just as with the sugar, if their owner is not currently using them, they can lend them to someone else, and get a reward for doing so.

If you’ve studied macroeconomics at the graduate level, you probably spent much of the semester thinking about variations on this story of tradeoffs between stuff today and stuff in the future, in the form of an Euler equation equating marginal costs and benefits across time. It’s not much of an exaggeration to say that mathematically elaborated versions of this story are the contemporary macro curriculum.

Money and finance don’t come into this story. As Mankiw says, investors can borrow from the public directly or indirectly via banks – the economic logic is the same either way. 

We might challenge this story from a couple of directions.

One criticism — first made by Piero Sraffa, in a famous debate with Friedrich Hayek about 100 years ago — is that in a non monetary world each commodity will have its own distinct rate of interest. Let’s say a pound of flour trades for 1.1 pounds (or kilograms) of flour a year from now. What will a pound or kilo of sugar today trade for? If, over the intervening year, the price of usage rises relative to the price of flour, then a given quantity of sugar today will trade for a smaller amount of sugar a year from now, than the same quantity of flour will. Unless the relative price of flour and sugar are fixed, their interest rates will be different. Flour today will trade at one rate for flour in the future, sugar at a different rate; the use of a car or a house, a kilowatt of electricity, and so on will each trade with the same thing in the future at their own rates, reflecting actual and expected conditions in the markets for each of these commodities. There’s no way to say that any one of these myriad own-rates is “the” rate of interest.

Careful discussions of the natural rate of interest will acknowledge that it is only defined under the assumption that relative prices never change.

Another problem is that the savings story assumes that the thing to be loaned — whether it is a specific commodity or generic funds — already exists. But in the monetary economy we live in, production is carried out for sale. Things that are not purchased, will not be produced. When you decide not to consume something, you don’t make that thing available for someone else. Rather, you reduce the output of it, and the income of the producers of it, by the same amount as you reduce your own consumption. 

Saving, remember, is the difference between income and consumption. For you as an individual, you can take my  income as given when deciding how much to consume. So consuming less means saving more. But at the level of the economy as a whole, income is not independent of consumption. A decision to consume less does not raise aggregate saving, it lowers aggregate income. This is the fallacy of consumption emphasized by Keynes: individual decisions about consumption and saving have no effect on aggregate saving.

So the question of how the interest rate is determined, is linked directly to the idea of demand constraints.

Alternatively, rather than criticizing the loanable-funds story, we can start from the other direction, from the monetary world we actually live in. Then we’ll see that credit transactions don’t involve the sort of tradeoff between present and future that orthodoxy focuses on. 

Let’s say you are buying a home.

On the day that you settle , you visit the bank to finalize your mortgage. The bank manager puts in two ledger entries: One is a credit to your account, and a liability to the bank, which we call the deposit. The other, equal and offsetting entry is a credit to the bank’s own account, and a liability for you. This is what we call the loan. The first is an IOU from the bank to you, payable at any time.  The second is an IOU from you to the bank,  with specified payments every month, typically, in the US, for the next 30 years. Like ordinary IOUs, these ledger entries are created simply by recording them — in earlier times it was called “fountain pen” money.

The deposit is then immediately transferred to the seller, in return for the title to the house. For the bank, this simply means changing the name on the deposit — in effect,  you communicate to the bank that their debt that was payable to you, is now payable to the seller. On your balance sheet, one asset has been swapped for another — the $250,000 deposit, in this case, for a house worth $250,000.  The seller makes the opposite swap, of the title to a house for an equal value IOU from the bank.

As we can see, there is no saving or dissaving here. Everyone has just swapped assets of equal value.

This mortgage is not a loan of preexisting funds or of anything else. No one had to first make a deposit at the bank in order to allow them to make this loan.  The deposit — the money — was created in the process of making the loan itself. Banking does not channel saving to borrowing as in the loanable-funds view, but allows a swap of promises.

One thing I always emphasize to my students: You should not talk about putting money in the bank. The bank’s record is the money.

On one level this is common knowledge. I am sure almost everyone in this room could explain how banks create money. But the larger implications are seldom thought through. 

What did this transaction consist of? A set of promises. The bank made a promise to the borrowers, and the borrowers made a promise to the bank. And then the bank’s promise was transferred to the sellers, who can transfer it to some third party in turn. 

The reason that the bank is needed here is because you cannot directly make a promise to the seller. 

You are willing to make a promise of future payments whose present value is worth more than the value the seller puts on their house. Accepting that deal will make both sides better off. But you can’t close that deal, because your promise of payments over the next 30 years is not credible. They don’t know if you are good for it. They don’t have the ability to enforce it. And even they trust you, maybe because you’re related or have some other relationship, other people do not. So the seller can’t turn your promise of payment into an immediate claim on other things they might want. 

Orthodox theory starts from assumption that everyone can freely contract over income and commodities at any date in the future. That familiar Euler equation is based on the idea that you can allocate your income from any future period to consumption in the present, or vice versa. That is the framework within which the interest rate looks like a tradeoff between present and future. But you can’t understand interest in a framework that abstracts away from precisely the function that money and credit play in real economies.

The fundamental role of a bank, as Hyman Minsky emphasized,  is not intermediation but acceptance. Banks function as third parties who broaden the range of transactions that can take place on the basis of promises. You are willing to commit to a flow of money payments to gain legal rights to the house. But that is not enough to acquire the house. The bank, on the other hand, precisely because its own promises are widely trusted, is in a position to accept a promise from you.

Interest is not paid because consumption today is more desirable than consumption in the future. Interest is paid because credible promises about the future are hard to make. 

*

The cost of the mortgage loan is not that anyone had to postpone their spending. The cost is that the balance sheets of both transactors have become less liquid.

We can think of liquidity in terms of flexibility — an asset or a balance sheet position is liquid insofar as it broadens your range of options. Less liquidity, means fewer options.

For you as a homebuyer, the result of the transaction is that you have committed yourself to a set of fixed money payments over the next 30 years, and acquired the legal rights associated with ownership of a home. These rights are presumably worth more to you than the rental housing you could acquire with a similar flow of money payments. But title to the house cannot easily be turned back into money and thereby to claims on other parts of the social product. Home ownership involves — for better or worse — a long-term commitment to live in a particular place.  The tradeoff the homebuyer makes by borrowing is not more consumption today in exchange for less consumption tomorrow. It is a higher level of consumption today and tomorrow, in exchange for reduced flexibility in their budget and where they will live. Both the commitment to make the mortgage payments and the non-fungibility of home ownership leave less leeway to adapt to unexpected future developments.

On the other side, the bank has added a deposit liability, which requires payment at any time, and a mortgage asset which in itself promises payment only on a fixed schedule in the future. This likewise reduces the bank’s freedom of maneuver. They are exposed not only to the risk that the borrower will not make payments, but also to the risk of capital loss if interest rates rise during the period they hold the mortgage, and to the risk that the mortgage will not be saleable in an emergency, or only at an unexpectedly low price. As real world examples like, recently, Silicon Valley Bank show, these latter risks may in practice be much more serious than the default risk. The cost to the bank making the loan is that its balance sheet becomes more fragile.

Or as Keynes put it in a 1937 article, “The interest rate … can be regarded as being determined by the interplay of the terms on which the public desires to become more or less liquid and those on which the banking system is ready to become more or less unliquid.”

Of course in the real world things are more complicated. The bank does not need to wait for the mortgage payments to be made at the scheduled time. It can transfer the mortgage to a third party,  trading off some of the income it expected for a more liquid position. The buyer might be some other financial institution looking for a position farther toward the income end of the liquidity-income tradeoff, perhaps with multiple layers of balance sheets in between. Or the buyer might be the professional liquidity-providers at the central bank. 

Incidentally, this is an answer to a question that people don’t ask often enough: How is it that the central bank is able to set the interest rate at all? The central bank plays no part in the market for loanable funds. But central banks are very much in the liquidity business. 

It is monetary policy, after all, not savings policy.  

One thing this points to is that there is no fundamental difference between routine monetary policy and the central bank’s role as a lender of last resort and a regulator. All of these activities are about managing the level of liquidity within the financial system. How easy is it to meet your obligations. Too hard, and the web of obligations breaks. Too easy, and the web of money obligations loses its ability to shape our activity, and no longer serves as an effective coordination device. 

As the price of money — the price for flexibility in making payments as opposed to fixed commitments — the interest rate is a central parameter of any monetary economy. The metaphor of “tight” or “loose” conditions for high or low interest rates captures an important truth about the connection between interest and the flexibility or rigidity of the financial system. High interest rates correspond to a situation in which promises of future payment are worth less in terms of command over resources today. When it’s harder to gain control over real resources with promises of future payment, the pattern of today’s payments is more tightly linked to yesterday’s income. Conversely, low interest rates mean that a promise of future payments goes a long way in securing resources today. That means that claims on real resources therefore depend less on incomes in the past, and more on beliefs about the future. And because interest rate changes always come in an environment of preexisting money commitments, interest also acts as a scaling variable, reweighting the claims of creditors against the income of debtors.

*

In addition to credit transactions, the other setting in which interest appears in the real world is in the  price of existing assets. 

A promise of money payments in the future becomes an object in its own right, distinct from those payments themselves. I started out by saying that all sorts of tangible objects have a shadowy double in money-world. But a flow of money payments can also acquire a phantom double.  A promise of future payment creates a new property right, with its owner and market price. 

When we focus on that fact, we see an important role for convention in the determination of interest. To some important extent, bond prices – and therefore interest rates – are what they are, because that is what market participants expect them to be. 

A corporate bond promises a set of future payments. It’s easy in a theoretical world of certainty, to talk as if the bond just is those future payments. But it is not. 

This is not just because it might default, which is easy to incorporate into the model. It’s not just because any real bond was issued in a certain jurisdiction, and conveys rights and obligations beyond payment of interest — though these other characteristics always exist and can sometimes be important. It’s because the bond can be traded, and has a price which can change independent of the stream of future payments. 

If interest rates fall, your bond’s price will rise — and that possibility itself is a factor in the price of the bond.

This helps explain a widely acknowledged anomaly in financial markets. The expectation hypothesis says that the interest rate on a longer bond should be the same as the average of shorter rates over the same period, or at least that they should be related by a stable term premium. This seems like a straightforward arbitrage, but it fails completely, even in its weaker form.

The answer to this puzzle is an important part of Keynes’ argument in The General Theory. Market participants are not just interested in the two payment streams. They are interested in the price of the long bond itself.

Remember, the price of an asset always moves inversely with its yield. When rates on a given type of credit instrument go up, the price of that instrument falls. Now let’s say it’s widely believed that a 10 year bond is unlikely to trade below 2 percent for very long. Then you would be foolish to buy it at a yield much below 2 percent, because you are going to face a capital loss when yields return to their normal level. And if most people believe this, then the yield never will fall below 2 percent, no matter what happens with short rates.

In a real world where the future is uncertain and monetary commitments have their own independent existence, there is an important sense in which interest rates, especially longer ones, are what they are because that’s what people expect them to be.

One important implication of this is that we cannot think of various market interest rates as simply “the” interest rate, plus a risk premium. Different interest rates can move independently for reasons that have nothing to do with credit risk. 

*

On the one hand, we have a body of theory built up on the idea of “the” interest rate as a tradeoff between present and future consumption. On the other, we have actual interest rates, set in the financial system in quite different ways.

People sometimes try to square the circle with the idea of a natural rate. Yes, they say, we know about liquidity and the term premium and the importance of different kinds of financial intermediaries and regulation and so on. But we still want to use the intertemporal model we were taught in graduate school. We reconcile this by treating the model as an analysis of what the interest rate ought to be. Yes, banks set interest rates in all kinds of ways, but there is only one interest rate consistent with stable prices and, more broadly, appropriate use of society’s resources. We call this the natural rate.

This idea was first formulated around the turn of the 20th century by Swedish economist Knut Wicksell. But the most influential modern statement comes from Milton Friedman. He introduces the natural rate of interest, along with its close cousin the natural rate of unemployment, in his 1968 Presidential Address to the American Economics Association, which has been described as the most influential paper in economics since World War II. The natural rates there correspond to the rates that would be “ground out by the Walrasian system of general equilibrium equations, provided there is imbedded in them the actual structural characteristics of the labor and commodity markets, including market imperfections, stochastic variability in demands and supplies, the cost of gathering information … and so on.” 

The appeal of the concept is clear: It provides a bridge between the nonmonetary world of intertemporal exchange of economic theory, and the monetary world of credit contracts in which we actually live. In so doing, it turns the intertemporal story from a descriptive one to a prescriptive one — from an account of how interest rates are determined, to a story about how central banks should conduct monetary policy.

Fed Chair Jerome Powell gave a nice example of how central bankers think of the natural rate in a speech a few years ago. He  introduces the natural interest rate R* with the statement that “In conventional models of the economy, major economic quantities … fluctuate around values that are considered ‘normal,’ or ‘natural,’ or ‘desired.’” R* reflects “views on the longer-run normal values for … the federal funds rate” which are based on “ fundamental structural features of the economy.” 

Notice the confusion here between the terms normal, natural and desired, three words with quite different meanings. R* is apparently supposed to be the long-term average interest rate, and the interest rate that we would see in a world governed only fundamentals and the interest rate that delvers the best policy outcomes.

This conflation is a ubiquitous and essential feature of discussions of natural rate. Like the controlled slipping between the two disks of a clutch in a car, it allows systems moving in quite different ways to be joined up without either side fracturing from the stress. The ambiguity between these distinct meanings is itself normal, natural and desired. 

The ECB gives perhaps an even nicer statement:  “At its most basic level, the interest rate is the ‘price of time’ — the remuneration for postponing spending into the future.” R* corresponds to this. It is a rate of interest determined by purely non monetary factors, which should be unaffected by developments in the financial system. Unfortunately, the actual interest rate may depart from this. In that case, the natural rate, says the ECB,  “while unobservable … provides a useful guidepost for monetary policy.”

I love the idea of an unobservable guidepost. It perfectly distills the contradiction embodied in the idea of R*. 

As a description of what the interest rate is, a loanable-funds model is merely wrong. But when it’s turned into a model of the natural rate, it isn’t even wrong. It has no content at all. There is no way to connect any of the terms in the model with any observable fact in the world. 

Go back to Friedman’s formulation, and you’ll see the problem: We don’t possess a model that embeds all the “actual structural characteristics” of the economy. For an economy whose structures evolve in historical time, it doesn’t make sense to even imagine such a thing. 

In practice, the short-run natural rate is defined as the one that results in inflation being at target — which is to say, whatever interest rate the central bank prefers.

The long-run natural rate is commonly defined as the real interest rate where “all markets are in equilibrium and there is therefore no pressure for any resources to be redistributed or growth rates for any variables to change.” In this hypothetical steady state, the interest rate depends only on the same structural features that are supposed to determine long-term growth — the rate of technical progress, population growth, and households’ willingness to defer consumption.

But there is no way to get from the short run to the long run. The real world is never in a situation where all markets are in equilibrium. Yes, we can sometimes identify long-run trends. But there is no reason to think that the only variables that matter for those trends are the ones we have chosen to focus on in a particular class of models. All those “actual structural characteristics” continue to exist in the long run.

The most we can say is this: As long as there is some reasonably consistent relationship between the policy interest rate set by the central bank and inflation, or whatever its target is, then there will be some level of the policy rate that gets you to the target. But there’s no way to identify that with “the interest rate” of a theoretical model. The current level of aggregate spending in the economy depends on all sorts of contingent, institutional factors, on sentiment, on choices made in the past, on the whole range of government policies. If you ask, what policy interest rate is most likely to move inflation toward 2 percent, all that stuff matters just as much as the supposed fundamentals.

The best you can do is set the policy rate by whatever rule of thumb or process you prefer, and then after the fact say that there must be some model where that would be the optimal choice. 

Michael Woodford is the author of Interest and Prices, one of the most influential efforts to incorporate monetary policy into a modern macroeconomic model. He pretty explicitly acknowledges that’s what he was doing — trying to backfill a theory to explain the choices that central banks were already making.

*

What are the implications of this?

First, with regard to monetary policy, let’s acknowledge that it involves political choices made to achieve a variety of often conflicting social goals. As Ben Braun and others have written about very insightfully. 

Second, recognizing that interest is the price of liquidity, set in financial markets, is important for how we think about sovereign debt.

There’s a widespread story about fiscal crises that goes something like this. First, a government’s fiscal balance (surplus or deficit) over time determines its debt-GDP ratio. If a country has a high debt to GDP, that’s the result of overspending relative to tax revenues. Second, the debt ratio determines to market confidence; private investors do not want to buy the debt of a country that has already issued too much. Third, the state of market confidence determines the interest rate the government faces, or whether it can borrow at all. Fourth, there is a clear line where high debt and high interest rates make debt unsustainable; austerity is the unavoidable requirement once that line is passed. And finally, when austerity restores debt sustainability, that will contribute to economic growth. 

Alberto Alesina was among the most vigorous promoters of this story, but it’s a very common one.

If you accept the premises, the conclusions follow logically. Even better, they offer the satisfying spectacle of public-sector hubris meeting its nemesis. But when we look at debt as a monetary phenomenon, we see that its dynamics don’t run along such well-oiled tracks.

First of all, as a historical matter, differences in growth, inflation and interest rates are at least as important as the fiscal position in determining the evolution of the debt ratio over time. Where debt is already high, moderately slower growth or higher interest rates can easily raise the debt ratio faster than even very large surpluses can reduce it – as many countries subject to austerity have discovered. Conversely, rapid economic growth and low interest rates can lead to very large reductions in the debt ratio without the government ever running surpluses, as in the US and UK after World War II. More recently, Ireland reduced its debt-GDP ratio by 20 points in just five years in the mid-1990s while continuing to run substantial deficits, thanks to very fast growth of the “Celtic tiger” period. 

At the second step, market demand for government debt clearly is not an “objective” assessment of the fiscal position, but reflects broader liquidity conditions and the self-confirming conventional expectations of speculative markets. The claim that interest rates reflect the soundness or otherwise of public budgets runs up against a glaring problem: The financial markets that recoil from a country’s bonds one day were usually buying them eagerly the day before. The same markets that sent interest rates on Spanish, Portuguese and Greek bonds soaring in 2010 were the ones snapping up their public and private debt at rock-bottom rates in the mid-2000s. And they’re the same markets that returned to buying those countries debt at historically low levels today, even as their debt ratios, in many cases, remained very high. 

People like Alesina got hopelessly tangled up on this point. They wanted to insist both that post-crisis interest rates reflected an objective assessment of the state of public finances, and that the low rates before the crisis were the result of a speculative bubble. But you can’t have it both ways.

This is not to say that financial markets are never a constraint on government budgets. For most of the world, which doesn’t enjoy the backstop of a Fed or ECB, they very much are. But we should never imagine that financial conditions are an objective reflection of a country’s fiscal position, or of the balance of savings and investment. 

The third big takeaway, maybe the biggest one, is that money is never neutral.

If the interest rate is a price, what it is a price of is not “saving” or the willingness to wait. It is not “remuneration for deferring spending,” as the ECB has it. Rather, it is of the capacity to make and accept promises. And where this capacity really matters, is where finance is used not just to rearrange claims on existing assets and resources, but to organize the creation of new ones. The technical advantages of long lived means of production and specialized organizations can only be realized if people are in a position to make long-term commitments. And in a world where production is organized mainly through money payments, that in turn depends on the degree of liquidity.

There are, at any moment, an endless number of ways some part of society’s resources could be reorganized so as to generate greater incomes, and hopefully use values. You could open a restaurant, or build a house, or get a degree, or write a computer program, or put on a play. The physical resources for these activities are not scarce; the present value of the income they can generate exceeds their costs at any reasonable discount rate. What is scarce is trust. You, starting on a project, must exercise a claim on society’s resources now; society must accept your promise of benefits later. The hierarchy of money  allows participants in various collective projects to substitute trust in a third party for trust in each other. But trust is still the scarce resource.

Within the economy, some activities are more trust-intensive, or liquidity-constrained,  than others.

Liquidity is more of a problem when there is a larger separation between outlays and rewards, and when rewards are more uncertain.

Liquidity is more of the problem when the scale of the outlay required is larger.

Liquidity and trust are more important when decisions are irreversible.

Trust is more important when something new is being done.

Trust is more scarce when we are talking about coordination between people without any prior relationship.

These are the problems that money and credit help solve. Abundant money does not just lead people to pay more for the same goods. It shifts their spending toward things that require bigger upfront payments and longer-term commitments, and that are riskier.

I was listening to an interview with an executive from wind-power company on the Odd Lots podcast the other day. “We like to say that our fuel is free,” he said. “But really, our fuel is the cost of capital.” The interest rate matters more for wind power than for gas or coal, because the costs must be paid almost entirely up front, as opposed to when the power is produced. 

When costs and returns are close together, credit is less important.

In settings where ongoing relationships exist, money is less important as a coordinating mechanism. Markets are for arms-length transactions between strangers.

Minsky’s version of the story emphasizes that we have to think about money in terms of two prices, current production and long-lived assets. Long-lived assets must be financed – acquiring one typically requires committing to a series of future payments . So their price is sensitive to the availability of money. An increase in the money supply — contra Hume, contra Meyer — does not raise all prices in unison. It disproportionately raises the price of long-lived assets, encouraging production of them. And it is long-lived assets that are the basis of modern industrial production.

The relative value of capital goods, and the choice between more and less capital-intensive production techniques, depends on the rate of interest. Capital goods – and the corporations and other long-lived entities that make use of them – are by their nature illiquid. The willingness of wealth owners to commit their wealth to these forms depends, therefore, on the availability of liquidity. We cannot analyze conditions of production in non-monetary terms first and then afterward add money and interest to the story.  Conditions of production themselves depend fundamentally on the network of money payments and commitments that structure them, and how flexible that network is.

*

Taking money seriously requires us to reconceptualize the real economy. 

The idea of the interest rate as the price of saving assumes, as I mentioned before, that output already exists to be either consumed or saved. Similarly, the idea of interest as an intertemporal price — the price of time, as the ECB has it — implies that future output is already determined, at least probabilistically. We can’t trade off current consumption against future consumption unless future consumption already exists for us to trade.

Wicksell, who did as much as anyone to create the natural-rate framework of today’s central banks, captured this aspect of it perfectly when he compared economic growth to wine barrels aging in the cellar. The wine is already there. The problem is just deciding when to open the barrels — you would like to have some wine now, but you know the wine will get better if you wait.

In policy contexts, this corresponds to the idea of a level of potential output (or full employment) that is given from the supply side. The productive capacity of the economy is already there; the most that money, or demand, can accomplish is managing aggregate spending so that production stays close to that capacity.

This is the perspective from which someone like Lawrence Meyer, or Paul Krugman for that matter, says that monetary policy can only affect prices in the long run. They assume that potential output is already given.

But one of the big lessons we have learned from the past 15 years of macroeconomic instability is that the economy’s productive potential is much more unstable, and much less certain, than economists used to think. We’ve seen that the labor force grows and shrinks in response to labor market conditions. We’ve seen that investment and productivity growth are highly sensitive to demand. If a lack of spending causes output to fall short of potential today, potential will be lower tomorrow. And if the economy runs hot for a while, potential output will rise.

We can see the same thing at the level of individual industries. One of the most striking, and encouraging developments of recent years has been the rapid fall in costs for renewable energy generation. It is clear that this fall in costs is the result, as much as the cause, of the rapid growth in spending on these technologies. And that in turn is largely due to successful policies to direct credit to those areas. 

A perspective that sees money as epiphenomenal to the “real economy” of production would have ruled out that possibility.

This sort of learning by doing is ubiquitous in the real world. Economists prefer to assume decreasing returns only because that’s an easy way to get a unique market equilibrium. 

This is one area where formal economics and everyday intuition diverge sharply. Ask someone whether they think that buying more or something, or making more of something, will cause the unit price to go up or down. If you reserve a block of hotel rooms, will the rooms be cheaper or more expensive than if you reserve just one? And then think about what this implies about the slope of the supply curve.

There’s a wonderful story by the great German-Mexican writer B. Traven called “Assembly Line.” The story gets its subversive humor from a confrontation between an American businessman, who takes it for granted that costs should decline with output, and a village artisan who insists on actually behaving like the textbook producer in a world of decreasing returns.

In modern economies, if not in the village, the businessman’s intuition is correct. Increasing returns are very much the normal case. This means that multiple equilibria and path dependence are the rule. And — bringing us back to money — that means that what can be produced, and at what cost, is a function of how spending has been directed in the past. 

Taking money seriously, as its own autonomous social domain, means recognizing that social and material reality is not like money. We cannot think of it in terms of a set of existing objects to be allocated, between uses or over time. Production is not a quantity of capital and a quantity of labor being combined in a production function. It is organized human activity, coordinated in a variety of ways, aimed at open-ended transformation of the world whose results are not knowable in advance.

On a negative side, this means we should be skeptical about any economic concept described as “natural” or “real”. These are very often an attempt to smuggle in a vision of a non monetary economy fundamentally different from our own, or to disguise a normative claim as a positive one, or both.

For example, we should be cautious about “real” interest rates. This term is ubiquitous, but it implicitly suggests that the underlying transaction is a swap of goods today for goods tomorrow, which just happens to take monetary form. But in fact it’s a swap of IOUs — one set of money payments for another. There’s no reason that the relative price of money versus commodities would come into it. 

And in fact, when we look historically, before the era of inflation-targeting central banks there was no particular relationship between inflation and interest rates.

We should also be skeptical of the idea of real GDP, or the price level. That’s another big theme of the book, but it’s beyond the scope of today’s talk.

On the positive side, this perspective is, I think, essential preparation to explore when and in what contexts finance matters for production. Obviously, in reality, most production coordinated in non-market ways, both within firms — which are planned economies internally — and through various forms of economy-wide planning. But there are also cases where the distribution of monetary claims through the financial system is very important. Understanding which specific activities are credit-constrained, and in what circumstances, seems like an important research area to me, especially in the context of climate change. 

*

Let me mention one more direction in which I think this perspective points us.

As I suggested, the idea of the interest rate as the price of time, and the larger real-exchange vision of which it is part, treats money flows and aggregates as stand-ins for an underlying nonmonetary real economy. People who take this view tend not be especially concerned with exactly how the monetary values are constructed. Which rate, out of the complex of interest rates, is “the” interest rate? Which f the various possible inflation rates, and over what period, do we subtract to get the “real” interest rate? What payments exactly are included in GDP, and what do we do if that changes, or if it’s different in different countries? 

If we think of the monetary values as just proxies for some underlying “real” value, the answers to these questions don’t really matter. 

I was reading a paper recently that used the intensity of nighttime illumination  across the Earth’s surface as an alternative measure of real output. It’s an interesting exercise. But obviously, if that’s the spirit you are approaching GDP in, you don’t worry about how the value of financial services is calculated, or on what basis we are imputing the services of owner-occupied housing.  The number produced by the BEA is just another proxy for the true value of real output, that you can approximate in all kinds of other ways.

On the other hand, if you think that the money values are what is actually real — if you don’t think they are proxies for any underlying material quantity — then you have to be very concerned with the way they are calculated. If the interest rate really does mean the payments on a loan contract, and not some hypothetical exchange rate between the past and the future, then you have to be clear about which loan contract you have in mind.

Along the same lines, most economists treat the object of inquiry as the underlying causal relationships in the economy, those “fundamental structural characteristics” that are supposed to be stable over time. Recall that the natural rate of interest is explicitly defined with respect to a long run equilibrium where all macroeconomic variables are constant, or growing at a constant rate. If that’s how you think of what you are doing, then specific historical developments are interesting at most as case studies, or as motivations for the real work, which consists of timeless formal models.

But if we take money seriously, then we don’t need to postulate this kind of underlying deep structure. If we don’t think of interest in terms of a tradeoff between the present and the future, then we don’t need to think of future income and output as being in any sense already determined. And if money matters for the activity of production, both as financing for investment and as demand, then there is no reason to think the actual evolution of the economy can be understood in terms of a long-run trend determined by fundamentals. 

The only sensible object of inquiry in this case is particular events that have happened, or might happen. 

Approaching our subject this way means working in terms of the variables we actually observe and measure. If we study GDP, it is GDP as the national accountants actually define it and measure it, not “output” in the abstract. These variables are generally monetary. 

It means focusing on explanations for specific historical developments, rather than modeling the behavior of “the economy” in the abstract.

It means elevating descriptive work over the kinds of causal questions that economists usually ask. Which means broadening our empirical toolkit away from econometrics. 

These methodological suggestions might seem far removed from alternative accounts of the interest rate. But as Arjun and I have worked on this book, we’ve become convinced that the two are closely related. Taking money seriously, and rejecting conventional ideas of the real economy, have far-reaching implications for how we do economics.  

Recognizing that money is its own domain allows us to see productive activity as an open-ended historical process, rather than a static problem of allocation. By focusing on money, we can get a clearer view of the non-monetary world — and, hopefully, be in a better position to change it. 

Keynes and Socialism

(Text of a talk I delivered at the Neubauer Institute in Chicago on April 5, 2024.)

My goal in this talk is to convince you that there is a Keynesian vision that is much more radical and far-reaching then our familiar idea of Keynesian economics.

I say “a” Keynesian vision. Keynes was an outstanding example of his rival Hayek’s dictum that no one can be a great economist who is only an economist. He was a great economist, and he was many other things as well. He was always engaged with the urgent problems of his day; his arguments were intended to address specific problems and persuade specific audiences, and they are not always easy to reconcile. So I can’t claim to speak for the authentic Keynes. But I think I speak for an authentic Keynes. In particular, the argument I want to make here is strongly influenced by the work of Jim Crotty, whose efforts to synthesize the visions of Keynes and of Marx were formative for me, as for many people who have passed through the economics department at the University of Massachusetts.

Where should we begin? Why not at the beginning of the Keynesian revolution? According to Luigi Passinetti, this has a very specific date: October 1932. That is when Keynes returned to King’s College in Cambridge for the Michaelmas term to deliver, not his old lectures on “The Pure Theory of Money,” but a new set of lectures on “The Monetary Theory of Production”. In an article of the same title written around the same time, he explained that the difference between the economic orthodoxy of the “the theory which I desiderate” was fundamentally the difference between a vision of the economy in terms of what he called “real exchange” and of monetary production. The lack of such a theory, he argued, was “the main reason why the problem of crises remains unsolved.”

The obvious distinction between these two visions is whether money can be regarded as neutral; and more particularly whether the interest rate can be thought of — as the textbook of economics of our times as well as his insist — as the price of goods today versus goods tomorrow, or whether we must think of it as, in some sense, the price of money.

But there is a deeper distinction between these two visions that I think Keynes also had in mind. On the ones side, we may think of economic life fundamentally in terms of objects — material things that can be owned and exchanged, which exist prior to their entry into economic life, and which have a value — reflecting the difficulty of acquiring them and their capacity to meet human needs. This value merely happens to be represented in terms of money. On the other side, we may think of economic life fundamentally in terms of collective human activity, an organized, open-ended process of transforming the world, a process in which the pursuit of money plays a central organizing role. 

Lionel Robbins, also writing in 1932, gave perhaps the most influential summary of the orthodox view when he wrote that economics is the study of the allocation of scarce means among alternative uses. For Keynes, by contrast, the central problem is not scarcity, but coordination. And what distinguishes the sphere of the economy from other areas of life is that coordination here happens largely through money payments and commitments.

From Robbins’ real-exchange perspective, the “means” available to us at any time are given, it is only a question of what is the best use for them. For Keynes, the starting point is coordinated human activity. In a world where coordination failures are ubiquitous, there is no reason to think — as there would be if the problem were scarcity — that satisfying some human need requires withdrawing resources from meeting some other equally urgent need. (In 1932, obviously, this question was of more than academic interest.) What kinds of productive activity are possible depends, in particular, on the terms on which money is available to finance it and the ease with which its results can be converted back into money. It is for this reason, as Keynes great American successor Hyman Minsky emphasized, that money can never be neutral.

If the monetary production view rejects the idea that what is scarce is material means, it also rejects the idea that economic life is organized around the meeting of human needs. The pursuit of money for its own sake is the organizing principle of private production. On this point, Keynes recognized his affinity with Karl Marx. Marx, he wrote, “pointed out that the nature of production in the actual world is not, as economists seem often to suppose, a case of C-M-C’, i. e., of exchanging commodity (or effort). That may be the standpoint of the private consumer. But it is not the attitude of business, which is the case of M-C-M’, i. e., of parting with money for commodity (or effort) in order to obtain more money.”

Ignoring or downplaying money, as economic theory has historically done, requires imagining the “real” world is money-like. Conversely, recognizing money as a distinct social institution requires a reconception of the social world outside of money. We must ask both how monetary claims and values evolve independently of the  real activity of production, and how money builds on, reinforces or undermines other forms of authority and coordination. And we must ask how the institutions of money and credit both enable and constrain our collective decision making. All these questions are unavoidably political.

For Keynes, modern capitalism is best understood through the tension between the distinct logics of money and of production.  For the orthodox economics both of Keynes’s day and our own, there is no such tension. The model is one of “real exchange” in which a given endowment of goods and a given set of preferences yielded a vector of relative prices. Money prices represent the value that goods already have, and money itself merely facilitates the process of exchange without altering it in any important way.

Keynes of course was not the first to insist on a deeper role for money. Along with Marx, there is a long counter tradition that approaches economic problems as an open ended process of transformation rather than the allocation of existing goods, and that recognizes the critical role of money in organizing this process. These include the “Army of brave heretics and cranks” Keynes acknowledges as his predecessors.

One of the pioneers in this army was John Law. Law is remembered today mainly for the failure of his fiat currency proposals (and their contribution to the fiscal troubles of French monarchy), an object lesson for over-ambitious monetary reformers. But this is unfair. Unlike most other early monetary reformer, Law had a clearly articulated theory behind his proposals. Schumpeter goes so far as to put him “in the front rank of monetary theorists of all times.” 

Law’s great insight was that money is not simply a commodity whose value comes from its non-monetary uses. Facilitating exchange is itself a very important function, which makes whatever is used for that purpose valuable even if it has no other use. 

“Money,” he wrote, “is not the Value for which goods are exchanged, but the Value by which goods are exchanged.” The fact that money’s value comes from its use in facilitating exchange, and not merely from the labor and other real resources embodied in it, means that a scarcity of money need not reflect any physical scarcity. In fact, the scarcity of money itself may be what limits the availability of labor: “’tis with little success Laws are made, for Employing the Poor or Idle in Countries where Money is scarce.”

Law here is imagining money as a way of organizing and mobilizing production.

If the capacity to pay for things — and make commitments to future payments — is valuable, then the community could be made better off by providing more of it. Law’s schemes to set up credit-money issuing banks – in Scotland before the more famous efforts in France – were explicitly presented as programs for economic development.

Underlying this project is a recognition that is central to the monetary production view; the organization of production through exchange is not a timeless fact of human existence, but something that requires specific institutional underpinning — which someone has to provide. Like Alexander Hamilton’s similar but more successful  interventions a half century later, Law envisioned the provision of abundant liquidity as part of a broader project of promoting commerce and industry.

This vision was taken up a bit later by Thornton and the anti-bullionists during the debates over suspension of gold convertibility during and after the Napoleonic Wars. A subsequent version was put forward by the mid-19th century Banking School and its outstanding figure, Thomas Tooke — who was incidentally the only contemporary bourgeois economist who Karl Marx seems to have admired — and by thinkers like Walter Bagehot, who built their theory on first hand experience of business and finance.

A number of lines divide these proto-Keynesian writers from the real-exchange orthodoxy.

To begin with, there is a basic difference in how they think of money – rather than a commodity or token that exists in a definite quantity, they see it as a form of record-keeping, whose material form is irrelevant. In other words credit, the recording of promises, is fundamental; currency as just one particular form of it.

Second, is the question of whether there is some simple or “natural” rule that governs the behavior of monetary or credit, or whether they require active management. In the early debates, these rules were supposed to be gold convertibility or the real bills doctrine; a similar intellectual function was performed by Milton Friedman’s proposed money-supply growth rule in the 20th century or the Taylor Rule that is supposed to govern monetary policy today. On the other side, for these thinkers, “money cannot manage itself,” in Bagehot’s famous phrase.

Third, there is the basic question of whether money is a passive reflection of an already existing real economy, or whether production itself depends on and is organized by money and credit. In other words, the conception of money is inseparable from how the non-monetary economy is imagined. In the real-exchange vision, there is a definite quantity of commodities already existing or potentially producible, which money at best helps to allocate. In the monetary production view, goods only come into existence as they are financed and paid for, and the productive capacity of the economy comes into being through an open-ended process of active development.

It’s worth quoting Bagehot’s Lombard Street for an example:

The ready availability of credit for English businesses, he writes, 

gives us an enormous advantage in competition with less advanced countries — less advanced, that is, in this particular respect of credit. In a new trade English capital is instantly at the disposal of persons capable of understanding the new opportunities… In countries where there is little money to lend, … enterprising traders are long kept back, because they cannot borrow the capital without which skill and knowledge are useless. … The Suez Canal is a curious case of this … That London and Liverpool should be centres of East India commerce is a geographic anomaly … The main use of the Canal has been by the English not because England has rich people … but because she possesses an unequalled fund of floating money.

The capacity for reorganization is what matters, in other words. The economic problem is not a scarcity of material wealth, but of institutions that can rapidly redirect it to new opportunities. For Bagehot as for Keynes, the binding constraint is coordination.

It is worth highlighting that there is something quietly radical in Bagehot’s argument here. The textbooks tell us that international trade is basically a problem of the optimal allocation of labor, land and other material resources, according to countries’ inherent capacities for production. But here it’s being claimed is not any preexisting comparative advantage in production, but rather the development of productive capacities via money; financial power allows a country to reorganize the international division of labor to its own advantage.

Thinkers like Bagehot, Thornton or Hamilton certainly had some success on policy level. For the development of central banking, in particular, these early expressions of of monetary production view played an important role.  But it was Keynes who developed these insights into a systematic theory of monetary production. 

Let’s talk first about the monetary side of this dyad.

The nature and management of money were central to Keynes’ interventions, as a list of his major works suggests – from Indian Currency Questions to the General Theory of Employment, Interest and Money. The title of the latter expresses not just a list of topics but a logical  sequence: employment is determined by the interest rate, which is determined by the availability of money.

One important element Keynes adds to the earlier tradition is the framing of the services provided by money as liquidity. This reflects the ability to make payments and satisfy obligations of all kinds, not just the exchange of goods focused on by Law and his successors. It also foregrounds the need for flexibility in the face of an unknown future.

The flip side of liquidity —  less emphasized in his own writings but very much by post Keynesians like Hyman Minsky — is money’s capacity to facilitate trust and promises. Money as a social technology provides offers flexibility and commitment.

The fact that bank deposit — an IOU — will be accepted by anyone is very desirable for wealth owner who wants to keep their options open. But also makes bank very useful to people who want to make lasting commitments to each other, but who don’t have a direct relationship that would allow them to trust each other. Banks’ fundamental role is “acceptance,” as Minsky put it – standing in as a trusted third party to make all kinds of promises possible. 

Drawing on his experience as a practitioner, Keynes also developed the idea of self-confirming expectations in financial markets. Someone buying an asset to sell in the near term is not interested in its “fundamental” value – the long-run flow of income it will generate – but in what other market participants will think is its value tomorrow. Where such short-term speculation dominates, asset prices take on an arbitrary, self-referential character. This idea is important for our purposes not just because it underpins Keynes’ critique of the “insane gambling casinos” of modern financial markets, but because it helps explain the autonomy of financial values. Prices set in asset markets — including, importantly, the interest rate — are not guide to any real tradeoffs or long term possibilities. 

Both liquidity and self-confirming conventions are tied to a distinctive epistemology , which emphasizes the fundamental unknowability of the future. In Keynes’ famous statement in chapter 12 of the General Theory,

By ‘uncertain’ knowledge … I do not mean merely to distinguish what is known for certain from what is only probable.  The sense in which I am using the term is that in which the prospect of a European war is uncertain, … About these matters there is no scientific basis on which to form any calculable probability whatever. We simply do not know!

Turning to the production side, taking the he monetary-production view means that neither the routine operation of capitalist economies nor the choices facing us in response to challenges like climate change should be seen in terms of scarcity and allocation.

The real-exchange paradigm sees production as non-monetary process of transforming inputs into outputs through a physical process we can represent as a production function. We know if we add this much labor and this much “capital” at one end, we’ll get this many consumption goods at the other end; the job of market price is to tell us if it is worth it.  Thinking instead in terms of monetary production does not just mean adding money as another input. It means reconceiving the production process. The fundamental problem is now coordination — capacity for organized cooperation. 

I’ve said that before. Let me now spell out a little more what I mean by it. 

To say that production is an open ended collective activity  of transforming the world, means that its possibilities are not knowable in advance. We don’t know how much labor and machinery and raw materials it will take to produce something new — or something old on an increased scale — until we actually do it. Nor do we know how much labor is potentially available until there’s demand for it.

We see this clearly in a phenomenon that has gotten increasing attention in macroeconomic discussions lately — what economists call hysteresis. In textbook theories, how much the economy is capable of producing — potential output — does not depend on how much we actually do produce There are only so many resources available, whether we are using them or not. But in reality, it’s clear that both the labor force and measured productivity growth are highly sensitive to current demand. Rather than a fixed number of people available to work, so that employing more in one area requires fewer working somewhere else, there is an immense, in practice effectively unlimited fringe of people who can be drawn into the labor force when demand for labor is strong. Technology, similarly, is not given from outside the economy, but develops in response to demand and wage growth and via investment. 

All this is of course true when we are asking questions like, how much of our energy needs could in principle be met by renewable sources in 20 years? In that case, it is abundantly clear that the steep fall in the cost of wind and solar power we’ve already seen is the result of increased demand for them. It’s not something that would have happened on its own. But increasing returns and learning by doing are ubiquitous in real economies. In large buildings, for instance, the cost of constructing later floors is typically lower than the cost of constructing earlier ones. 

In a world where hysteresis and increasing returns are important, it makes no sense to think in terms of a fixed amount of capacity, where producing more of one thing requires producing correspondingly less of something else. What is scarce, is the capacity to rapidly redirect resources from one use to a different one.

A second important dimension of the Keynesian perspective on production is that it is not simply a matter of combining material inputs, but happens within discrete social organisms. We have to take the firm seriously as ongoing community embodying  multiple social logics. Firms combine the structured cooperation needed for production; a nexus of payments and incomes; an internal hierarchy of command and obedience; and a polis or imagined community for those employed by or otherwise associated with it.

While firms do engage in market transactions and exist — in principle at least — in order to generate profits, this is not how they operate internally. Within the firm, the organization of production is consciously planned and hierarchical. Wealth owners, meanwhile,  do not normally own capital goods as such, but rather financial claims against these social organisms.

When we combine this understanding of production with Keynesian insights into money and finance , we are likely to conclude, as Keynes himself did, that an economy that depends on long-lived capital goods (and long-lived business enterprises, and scientific knowledge) cannot be effectively organized through the pursuit of private profit. 

First, because the profits from these kinds of activities depend on developments well off in the future that cannot cannot be known with any confidence. 

Second, because these choices are irreversible — capital goods specialized and embedded in particular production processes and enterprises. (Another aspect of this, not emphasized by Keynes, but one which wealth owners are very conscious of, is that wealth embodied in long-lived means of production can lose its character as wealth. It may effectively belong to the managers of the firm, or even the workers, rather than to its notional owners.) Finally, uncertainty about the future amplifies and exacerbates the problems of coordination. 

The reason that many potentially valuable  activities are not undertaken is not that they would require real resources that people would prefer to use otherwise. It is that people don’t feel they can risk the irreversible commitment those activities would entail. Many long-lived projects that would easily pay for themselves in both private and social terms are not carried out, because an insufficient capacity for trustworthy promises means that large-scale cooperation appears too risky to those in control of the required resources, who prefer to keep their their options open. 

Or as Keynes put it: “That the world after several millennia of steady individual saving, is so poor as it is in accumulated capital-assets, is to be explained neither by the improvident propensities of mankind, nor even by the destruction of war, but by the high liquidity- premiums formerly attaching to the ownership of land and now attaching to money.”

The problem, Keynes is saying, is that wealth owners prefer land and money to claims on concrete productive processes. Monetary production means production organized by money and in pursuit of money. But also identifies conflict between production and money.

We see this clearly in a development context, where — as Joe Studwell has recently emphasized — the essential first step is to break the power of landlords and close off the option of capital flight so that private wealth owners have no option but to hold their wealth as claims on society in the form of productive enterprises. 

The whole history of the corporation is filled with conflicts between the enterprise’s commitment to its own ongoing production process, and the desire of shareholders and other financial claimants to hold their wealth in more liquid, monetary form. The expansion or even continued existence of the corporation as an enterprise requires constantly fending off the demands of the rentiers to get “their” money back, now. The “complaining participants” of the Dutch East India Company in the 1620s, sound, in this respect, strikingly similar to shareholder activists of the 1980s. 

Where privately-owned capital has worked tolerably well — as Keynes thought it had in the period before WWI, at least in the UK — it was because private owners were not exclusively or even mainly focused on monetary profit.

“Enterprise,” he writes, “only pretends to itself to be mainly actuated by the statements in its own prospectus, however candid and sincere. Only a little more than an expedition to the South Pole, is it based on an exact calculation of benefits to come. Thus if the animal spirits are dimmed and the spontaneous optimism falters, leaving us to depend on nothing but a mathematical expectation, enterprise will fade and die.” 

(It’s a curious thing that this iconic Keynesian term is almost always used today to describe financial markets, even though it occurs in a discussion of real investment. This is perhaps symptomatic of the loss of the production term of the monetary production theory from most later interpretations of Keynes.)

The idea that investment in prewar capitalism had depended as much on historically specific social and cultural factors rather than simply opportunities for profit was one that Keynes often returned to. “If the steam locomotive were to be discovered today,” he wrote elsewhere, “I much doubt if unaided private enterprise would build railways in England.”

We can find examples of the same thing in the US. The Boston Associates who pioneered textile factories in New England seem to have been more preserving the dominant social position of their interlinked families as in maximizing monetary returns. Schumpeter suggested that the possibility of establishing such “industrial dynasties” was essential to the growth of capitalism. Historians like Jonathan Levy give us vivid portraits of early American industrialists Carnegie and Ford as outstanding examples of animal spirits — both sought to increase the scale and efficiency of production as a goal in itself, as opposed to profit maximization.

In Keynes’ view, this was the only basis on which sustained private investment could work. A systematic application of financial criteria to private enterprise resulted in level of investment that was dangerously unstable and almost always too low. On the other hand — as emphasized by Kalecki but recognized by Keynes as well — a dependence on wealth owners pursuit of investment for its own sake required a particular social and political climate — one that might be quite inimical to other important social goals, if it could be maintained at all.

The solution therefore was to separate investment decisions from the pursuit of private wealth.  The call for the “more or less comprehensive socialization of investment” at the end of The General Theory, is not the throwaway line that it appears as in that book, but reflects a program that Keynes had struggled with and developed since the 1920s. The Keynesian political program was not one of countercyclical fiscal policy, which he was always skeptical of.  Rather it envisioned a number of more or less autonomous quasi-public bodies – housing authorities, hospitals, universities and so on – providing for the production of their own specific social goods, in an institutional environment that allowed them to ignore considerations of profitability.

The idea that large scale investment must be taken out of private hands was at the heart of Keynes’ positive program.

At this point, some of you may be thinking that that I have said two contradictory things. First,  I said that a central insight of the Keynesian vision is that money and credit are essential tools for the organization of production. And then, I said that there is irreconcilable conflict between the logic of money and the needs of production. If you are thinking that, you are right. I am saying both of these things.

The way to reconcile this contradiction is to see these as two distinct moments in a single historical process. 

We can think of money as a social solvent. It breaks up earlier forms of coordination, erases any connection between people.As the Bank of International Settlements economist Claudio Borio puts it: “a well functioning monetary system …is a highly efficient means of ‘erasing’ any relationship between transacting parties.” A lawyers’ term for this feature of money is privity, which “cuts off adverse claims, and abolishes the .. history of the account. If my bank balance is $100 … there is nothing else to know about the balance.”

In his book Debt, David Graeber illustrates this same social-solvent quality of money with the striking story of naturalist Ernest Thompson Seton, who was sent a bill by his father for all the costs of raising him. He paid the bill — and never spoke to his father again. Or as Marx and Engels famously put it, the extension of markets and money into new domains of social life has “pitilessly torn asunder the motley feudal ties that bound man to his “natural superiors”, and has left remaining no other nexus between man and man than naked self-interest, than callous “cash payment”.

But what they neglected to add is that social ties don’t stay torn asunder forever. The older social relations that organized production may be replaced by the cash nexus, but that is not the last step, even under capitalism. In the Keynesian vision, at least, this is a temporary step toward the re-embedding of productive activity in new social relationships. I described money a moment ago as a social solvent. But one could also call it a social catalyst.  By breaking up the social ties that formerly organized productive activity, it allows them to be reorganized in new and more complex forms.

Money, in the Keynesian vision, is a tool that allows promises between strangers. But people who work together do not remain strangers. Early corporations were sometimes organized internally as markets, with “inside contractors” negotiating with each other. But reliance on the callous cash payment seldom lasted for long.  Large-scale production today depends on coordination through formal authority. Property rights become a kind of badge or regalia of the person who has coordination rights, rather than the organizing principle in its own right.

Money and credit are critical for re-allocating resources and activity, when big changes are needed. But big changes are inherently a transition from one state to another. Money is necessary to establish new production communities but not to maintain them once they exist. Money as a social solvent frees up the raw material — organized human activity —  from which larger structures, more extensive divisions of labor, are built. But once larger-scale coordination established, the continued presence of this social solvent eating away at it, becomes destructive.

This brings us to the political vision. Keynes, as Jim Crotty emphasizes, consistently described himself as a socialist. Unlike some of his American followers, he saw the transformation of productive activity via money and private investment as being a distinct historical process with a definite endpoint.

There is, I think, a deep affinity between the Keynes vision of the economy as a system of monetary production, and the idea that this system can be transcended. 

If money is merely a veil, as orthodox economics imagines, that implies that social reality must resemble money. It is composed of measurable quantities with well-defined ownership rights, which can be swapped and combined to yield discrete increments of human wellbeing. That’s just the way the world is.  But if we see money as a distinct institution, that frees us to imagine the rest of life in terms of concrete human activities, with their own logics and structures. It opens space for a vision of the good life as something quite different from an endless accumulation of commodities – a central strand of Keynes’ thinking since his early study of the philosopher G. E. Moore.

 In contemporary debates – over climate change in particular – a “Keynesian” position is often opposed to a degrowth one. But as Victoria Chick observes in a perceptive essay, there are important affinities between Keynes and anti-growth writers like E. F. Schumacher. He looked forward to a world in which accumulation and economic growth had come to an end, daily life was organized around “friendship and the contemplation of beautiful objects,” and the pursuit of wealth would be regarded as “one of those semi-criminal, semi-pathological propensities which one hands over with a shudder to the specialists in mental disease.”

This vision of productive activity as devoted to its own particular ends, and of the good life as something distinct from the rewards offered by the purchase and use of commodities, suggests a deeper  affinity with Marx and the socialist tradition. 

Keynes was quite critical of what he called “doctrinaire State Socialism.” But his objections, he insisted, had nothing to do with its aims, which he shared. Rather, he said, “I criticize it because it misses the significance of what is actually happening.” In his view, “The battle of Socialism against unlimited private profit is being won in detail hour by hour … We must take full advantage of the natural tendencies of the day.” 

From Keynes’ point of view, the tension between the logic of money and the needs of production was already being resolved in favor of the latter.  In his 1926 essay “The End of Laissez Faire,” he observed that “one of the most interesting and unnoticed developments of recent decades has been the tendency of big enterprise to socialize itself.” As shareholders’ role in the enterprise diminishes, “the general stability and reputation of the institution are more considered by the management than the maximum of pro

A shift from production for profit to production for use — to borrow Marx’s language — did not necessarily require a change in formal ownership. The question is not ownership as such, but the source of authority of those managing the production process, and the ends to which they are oriented. Market competition creates pressure to organize production so as to maximize monetary profits over some, often quite short, time horizon. But this pressure is not constant or absolute, and it is offset by other pressures. Keynes pointed to the example of the Bank of England, still in his day a private corporation owned by its shareholders, but in practice a fully public institution.

Marx himself had imagined something similar:

As he writes in Volume III of Capital, 

Stock companies in general — developed with the credit system — have an increasing tendency to separate … management as a function from the ownership of capital… the mere manager who has no title whatever to the capital, … performs all the real functions pertaining to the functioning capitalist as such, … and the capitalist disappears as superfluous from the production process. 

The separation of ownership from direction or oversight of production in the corporation is, Marx argues, an important step away from ownership as the organizing principle of production.  “The stock company,” he continues, “is a transition toward the conversion of all functions… which still remain linked with capitalist property, into mere functions of associated producers.” 

In short, he writes, the joint stock company represents as much as the worker-owned cooperative “the abolition of the capitalist mode of production within the capitalist mode of production itself.” 

It might seem strange to imagine the tendency toward self-socialization of the corporation when examples of its subordination to finance are all around us. Sears, Toys R Us, the ice-cream-and-diner chain Friendly’s – there’s a seemingly endless list of functioning businesses purchased by private equity funds and then hollowed out or liquidated while generating big payouts for capital owners. Surely this is as far as one could get from Keynes’ vision of an inexorable victory of corporate socialism over private profit? 

But I think this is a one-sided view. I think it’s a mistake — a big mistake — to identify the world around us as one straightforwardly organized by markets, the pursuit of profit and the logic of money.

As David Graeber emphasized, there is no such thing as a capitalist economy, or even a capitalist enterprise.  In any real human activity, we find distinct social logics, sometimes reinforcing each other, sometimes in contradiction. 

We should never imagine world around us — even in the most thoroughly “capitalist” moments — is simply the working out of a logic pdf property, prices and profit. Contradictory logics at work in every firm — even the most rapacious profit hungry enterprise depends for its operations on norms, rules, relationships of trust between the people who constitute it. The genuine material progress we have enjoyed under capitalism is not just due to the profit motive but perhaps even more so in spite of it. 

One benefit of this perspective is it helps us see broader possibilities for opposition to the rule of money. The fundamental political conflict under capitalism is not just between workers and owners, but between logic of production process and of private ownership and markets. Thorstein Veblen provocatively imagined this latter conflict taking the form of a “soviet of engineers” rebelling against “sabotage” by financial claimants. A Soviet of engineers may sound fanciful today, but conflicts between the interests of finance and the needs of productive enterprise — and those who identify with them — are ongoing. 

Teaching and nursing, for example, are the two largest occupations that require professional credentials.But teachers and nurses are also certainly workers, who organize as workers — teachers have one of the highest unionization rates of any occupation. In recent years, this organizing can be quite adversarial, even militant. We all recall waves of teacher strikes in recent years — not only in California but in states with deeply anti-union politics like West Virginia, Oklahoma, Arizona and Kentucky. The demands in these strikes have been  workers’ demands for better pay and working conditions. But they have also been professionals’ demands for autonomy and respect and the integrity of their particular production process. From what I can tell, these two kinds of demands are intertwined and reinforcing.

This struggle for the right to do one’s job properly is sometimes described as “militant professionalism.” Veblen may have talked about engineers rather than teachers, but this kind of politics is, I think, precisely what he had in mind. 

More broadly, we know that public sector unions are only effective when they present themselves as advocates for the public and for the users of the service they provide, and not only for their members as workers. Radical social service workers have fought for the rights of welfare recipients. Powerful health care workers unions, like SEIU 1199 in New York, are successful because they present themselves as advocates for the health care system as a whole. 

On the other side, I think most of us would agree that the decline or disappearance of local news outlets is a real loss for society. Of course, the replacement of newspapers with social media and search engines isn’t commodification in the straightforward sense. This is a question of one set of for-profit businesses being displaced by another. But on the other hand, newspapers are not only for-profit businesses. There is a distinct professional ethos of journalism, that developed alongside journalism as a business. Obviously the “professional conscience” (the phrase is Michelet’s) of journalists was compatible with the interests of media businesses. But it was not reducible to them. And often enough, it was in tension with them. 

I am very much in favor of new models of employee-owned, public and non-profit journalism. Certainly there is an important role for government ownership, and for models like Wikipedia. But I also think — and this is the distinct contribution of the Keynesian socialist — that we should not be thinking only in terms of payments and ownership. The development of a distinct professional norms for today’s information sector is independently valuable and necessary, regardless of who owns new media companies. It may be that creating space for those norms is the most important contribution that alternative ownership models can make 

For a final example of this political possibilities of the monetary-production view, we can look closer by, to higher education, where most of us in this room make our institutional home. We have all heard warnings about how universities are under attack, they’re being politicized or corporatized, they’re coming to be run more like businesses. Probably some of us have given such warnings. 

I don’t want to dismiss the real concerns behind them. But what’s striking to me is how much less often one hears about the positive values that are being threatened. Think about how often you hear people talk about how the university is under attack, is in decline, is being undermined. Now think about how often you hear people talk about the positive values of intellectual inquiry for its own sake that the university embodies. How often do you hear people talk about the positive value of academic freedom and self-government, either as specific values of the university or as models for the broader society? If your social media feed is like mine, you may have a hard time finding examples of that second category at all.

Obviously, one can’t defend something from attack without at some point making the positive case that there is something there worth defending. But the point is broader than that. The self-governing university dedicated to education and scholarship and as ends in themselves, is not, despite its patina of medieval ritual, a holdover from the distant past. It’s an institution that has grown up alongside modern capitalism. It’s an institution that, in the US especially, has greatly expanded within our own lifetimes. 

If we want to think seriously about the political economy of the university, we can’t just talk about how it is under attack. We must also be able to talk about how it has grown, how it has displaced social organization on the basis of profit. (We should note here the failure of the for-profit model in higher education.) We should of course acknowledge the ways in which higher education serves the needs of capital, how it contributes to the reproduction of labor power. But we also should acknowledge all the ways that is more than this.

When we talk about the value of higher education, we often talk about the products — scholarship, education. But we don’t often talk about the process, the degree to which academics, unlike most other workers, manage our own classrooms according to our own judgements about what should be taught and how to effectively teach it. We don’t talk about how, almost uniquely in modern workplaces, we the faculty employees make decisions about hiring and promotion collectively and more or less democratically. People from all over the world come to study in American universities. It’s remarkable — and remarkably little discussed — how this successful export industry is, in effect, run by worker co-ops.

 At this moment in particular, it is vitally important that we make the case for academic freedom as a positive principle. 

Let me spell out, since it may not be obvious, how this political vision connects to the monetary production vision of the economy that I was discussing earlier. 

The dominant paradigm in economics — which shapes all of our thinking, whether we have ever studied economics in the classroom — is what Keynes called, I distinction to his own approach, the real exchange vision. From the real-exchange perspective, money prices  and payments are a superficial express of pre-existing qualities of things — that they are owned by someone, that they take a certain amount of labor to produce and have a definite capacity to satisfy human needs. From this point of view, production is just a special case of exchange. 

It’s only once we see money as an institution in itself, a particular way of organizing human life, that we can see production as something distinct and separate from it. That’s what allows us to see the production process itself, and the relationships and norms that constitute it, as a site of social power and a market on a path toward a better world. The use values we socialists oppose to exchange value exist in the sphere of production as well as consumption. The political demands that teachers make as teachers are not legible unless we see the activity they’re engaged in in terms other than equivalents of money paid and received.

I want to end by sketching out a second political application of this vision, in the domain of climate policy. 

First, decarbonization will be experienced as an economic boom. Money payments, I’ve emphasized, are an essential tool for rearranging productive activity, and decarbonizing will require a great deal of our activity to be rearranged. There will be major changes in our patterns of production and consumption, which in turn will require substantial changes to our means of production and built environment. These changes are brought about by flows money. 

Concretely: creating new means of production, new tools and machinery and knowledge, requires spending money. Abandoning old ones does not. Replacing existing structures and tools and techniques faster than they would be in the normal course of capitalist development, implies an increase in aggregate money expenditure. Similarly, when a new or expanding business wants to bid workers away from other employment, they have to offer a higher wage than an established business needs to in order to retain its current workers. So a rapid reallocation of workers implies a faster rise in money wages.

So although decarbonization will substantively involve a mix of expansions of activity in some areas and reduction of activity in others, it will increase the aggregate volume of money flows. A boom in this sense is not just a period of faster measured growth, but a period in which demand is persistently high relative to the economy’s productive potential and tight labor markets strengthen the bargaining position of workers relative to employers – what is sometimes called a “high-pressure economy.” 

Second. There is no tradeoff between decarbonization and current living standards. Decarbonization is not mainly a matter of diverting productive activity away from other needs, but mobilizing new production, with positive spillovers toward production for other purposes.

Here again, there is a critical difference between the monetary-production and the real-exchange views of the economy. In the real-exchange paradigm, we possess a certain quantity of “means.” If we choose to use some of them to reduce our carbon emissions, there will be less available for everything else. But when we think in terms of social coordination organized in large part through money flows, there is no reason to think this. There is no reason to believe that everyone who is willing and able to work is actually working, or people’s labor is being used in anything like its best possible way for the satisfaction of real human needs. Nor are relative prices today a good guide to long-run social tradeoffs. 

Third.  If we face a political conflict involving climate and growth, this will come not because decarbonization requires accepting a lower level of growth, but because it will entail faster economic growth than existing institutions can handle. Today’s neoliberal macroeconomic model depends on limiting economic growth as a way of managing distributional conflicts. Rapid growth under decarbonization will be accompanied by disproportionate rise in wages and the power of workers. Most of us in this room will probably see that as a desirable outcome. But it will inevitably create sharp conflicts and resistance from wealth owners, which need to be planned for and managed. Complaints about current “labor shortages” should be a warning call on this front.

Fourth. There is no international coordination problem — the countries that move fastest on climate will reap direct benefits.

An influential view of the international dimension of climate policy is that “free riding … lies at the heart of the failure to deal with climate change.” (That is William Nordhaus, who won the Nobel for his work on the economics of climate change.) Individual countries, in this view, bear the full cost of decarbonization measures but only get a fraction of the global benefits, and countries that do not engage in decarbonization can free-ride on the efforts of those that do.

A glance at the news should be enough to show you how backward this view is. Do Europeans look at US support for the wind, solar and battery industries, or the US at China’s support for them, and say, “oh, what wonderfully public-spirited shouldering of the costs of the climate crisis”? Obviously not.  Rather, they are seen as strategic investments which other countries, in their own national interest, must seek to match.

Fifth. Price based measures cannot be the main tools for decarbonization.

There is a widely held view that the central tool for addressing climate should be an increase in the relative price of carbon-intensive commodities, through a carbon tax or equivalent. I was at a meeting a few years ago where a senior member of the Obama economics team was also present. “The only question I have about climate policy,” he said, “is whether a carbon tax is 80 percent of the solution, or 100 percent of the solution.” If you’ve received a proper economics education, this is a very reasonable viewpoint. You’ve been trained to see the economy as essentially an allocation problem where existing resources need to be directed to their highest-value use, and prices are the preferred tool for that.

From a Keynesian perspective the problem looks different. The challenge is coordination — bottlenecks and the need for simultaneous advances in multiple areas. Markets can, in the long run, be very powerful tools for this, but they can’t do it quickly. For rapid, large-scale reorganization of activity, they have to be combined with conscious planning — and that is the problem. The fundamental constraint on decarbonization should not be viewed as the potential output of the economy, but of planning capacity for large-scale non-market coordination. 

If there is a fundamental conflict between capitalism and sustainability, I suggest, it is not because the drive for endless accumulation in money terms implies or requires an endless increase in material throughputs. Nor is it the need for production to generate a profit. There’s no reason why a decarbonized production process cannot be profitable. It’s true that renewable energy, with its high proportion of fixed costs, is not viable in a fully competitive market — but that’s a characteristic it shares with many other existing industries. 

The fundamental problem, rather, is that capitalism treats the collective processes of social production as the private property of individuals. It is because the fiction of a market economy prevents us from developing the forms of non-market coordination that actually organize production, and that we will need on a much larger scale. Rapid decarbonization will require considerably more centralized coordination than is usual in today’s advanced economies. Treatment of our collective activity to transform the world as if it belonged exclusively to whoever holds the relevant property rights, is a fundamental obstacle to redirecting that activity in a rational way. 

 

At The International Economy: How Worried Should We Be about Asset Bubbles?

(I am an occasional contributor to roundtables of economists in the magazine The International Economy. This month’s topic was “What about the Risk of a Bursting Asset Bubble?”, with corporate debt and equity mentioned as possibilities. Contributors were asked to rank their level of concern from 1 to 10. My response is below.)

Any time you have an asset held primarily for capital gains, a story that allows people to extrapolate from recent price increases to future ones, and a reasonably elastic credit system, you have the ingredients for a bubble. The question is not whether there will be bubbles, but how damaging they will be, and what steps we should take if we think one is developing in a particular asset market.

Corporate debt is an unlikely asset for a bubble. Unlike with equity, real estate, or currency, there are clear limits to potential capital gains. High levels of stock buy- backs are problematic for a number of reasons, but they don’t particularly suggest a bubble. When a greater share of corporate value added is paid out to shareholders rather than retained and invested or paid to workers, that may be bad news for the economy in the long run. But it is good news for owners of corporate stock, and there’s nothing strange about it being priced accordingly.

Cryptocurrencies are a better candidate for a bubble. It’s safe to say they are mostly held in expectation of capital gains, since they pay no income and, despite the promises of their boosters, have limited utility for transactions. It wouldn’t be surprising if their value fell to a small fraction of what it is today.

But that brings us to the question of how damaging a bursting bubble will be. The housing bubble was exceptionally damaging because housing is the main asset owned by most middle-class families, housing purchases are mostly debt-financed, and mortgages are a major asset for the financial system. It’s hard to see how a collapse of bitcoin or its peers would have wider consequences for the economy.

The other question is what to do about a bubble if we have reason to believe one is forming. One common answer is to raise interest rates. The problem is that, historically, there’s no sign that low rates are more favorable to bubbles than high ones. The 1980s savings and loan crisis took place in an environment of—indeed was driven by—historically high interest rates. Similarly, Sweden’s great real estate bubble of the late 1980s took place when rates were high, not low.

And why not? While productive investment may be discouraged by high rates, expected capital gains at the height of a bubble are too high for them to have much effect. This was most famously illustrated in the late 1920s, when the Fed’s efforts to rein in stock prices by raising rates did a great deal to destabilize European banks by reversing U.S. capital outflows, but had little or no effect on Wall Street.

A better policy in the face of a developing bubble is to directly limit the use of credit to buy the appreciating asset. Tighter limits on mortgage lending would have done far more than higher rates to control the housing bubble of the 2000s.

In other cases, the best policy is to do nothing. As economists going back to John Maynard Keynes have observed, a chronic problem for our economy is an insufficient level of investment in long-lived capital goods and new technology. To the extent that inflated asset values encourage more risky investment—as in the late 1990s— they may be even be socially useful.

By all means, let’s take steps to insulate the core functions of the financial system from speculation in asset markets. But holding macroeconomic policy hostage to fears of asset bubbles is likely to do more harm than good.

Weighing the chance of a major bubble along with its likely consequences, I’d put my concern over asset bubbles at three out of ten. The biggest danger is not a bubble itself, but the possibility that a fear of bubbles will prompt a premature tightening of monetary policy.

Video: Finance and Decarbonization

Here is a roundtable hosted by the Jain Family Institute on finance and decarbonization.

What’s the best way to fund the massive investments the green transition will require? Saule Omarova and Bob Hockett make the case for a specialized National Investment Authority (NIA), which would issue various kinds of new liabilities as well as lend to both the public and private sector. Anusar Farooqui and Tim Sahay present their proposal for a green ratings agency, to encourage private investment in decarbonization. I speak for the Green New Deal approach, which favors direct public spending. Yakov Feygin and Daniela Gabor also take part. Yakov is another voice for the NIA, while Daniela criticizes a private finance-based approach to decarbonization, which effectively puts her with me on team Green New Deal. The panel is moderated by Adam Tooze.

My part starts at around 38:00, if you want to skip to that, but the whole thing is worth watching.

 

Finance, Money and Cow Clicking

Finance and its derivatives like financialization, are like many political economy categories: they’re a widely used term but lack an agreed-upon definition. One often encounters formulations like “financialization means the increasing role of financial motives, financial markets, financial actors and financial institutions.” That isn’t very helpful!

Let me offer a simple definition of finance, which I think corresponds to its sense both for Marx and in everyday business settings. Finance is the treatment of a payment itself  as a commodity, independent of the transaction or relationship that initially gave rise to it. 

The most straightforward and, I think, oldest, form of finance in this sense is the invoice. Very few commercial transactions are in cash; much more common is an invoice payable in 30 or 60 or 90 days. This is financing; the payment obligation now appears as a distinct asset, recorded on the books of the seller as accounts receivable, and on the books of the buyer as accounts payable.

The distinct accounting existence of the payment itself, apart from the sale it was one side of, is a fundamental feature, it seems to me, of both day-to-day accounting and capitalism in a larger sense. In any case, it develops naturally into a distinct existence of payments, apart from the underlying transaction, in a substantive economic sense. Accounts payable can be sold to a third party, or (perhaps more often) borrowed against, or otherwise treated just like any other asset.

So far we’re talking about dealer finance; the next step is a third party who manages payments. Rather than A receiving a commodity from C in return for a promise of payment in 30 or 60 or 90 days, A receives the commodity and makes that promise to B, who makes immediate payment to C. Until the point of settlement, A has a debt to B, which is recorded on a balance sheet and therefore is an asset (for B) and a liability (for A.) During thins time the payment has a concrete reality as an asset that not only has a notional existence on a balance sheet, but can be traded, has a market price, etc.

If the same intermediary stands between the two sides of enough transactions, another step happens. The liabilities of the third party, B, can become generally accepted as payment by others. As Minsky famously put it, the fundamental function of a bank is acceptance — accepting the promises of various payors to the various payees. Yes, the B stands for Bank.

Arriving at banks by this route has two advantages. First, it puts credit ahead of money. The initial situation is a disparate set of promises, which come to take the form of a uniform asset only insofar as some trusted counterparts comes to stand between the various parties. Second, it puts payments ahead of intermediation in thinking about banks 

But now we must pause for a moment, and signal a turn in the argument. What we’ve described so far implicitly leans on a reality outside money world. 

As money payments, A —> C and A —> B —> C are exactly equivalent. The outcomes, described in money, are the same. The only reason the second one exists, is because they are not in reality equivalent. They are not in reality only money payments. There is always the question of, why should you pay? Why do you expect a promise to be fulfilled? There are norms, there are expectations, there are authorities who stand outside of the system of money payments and therefore are capable of enforcing them. There is an organization of concrete human activity that money payments may alter or constrain or structure, but that always remain distinct from them. When I show up to clean your house, it’s on one level because you are paying me to do it; but it’s also because I as a human person have made a promise to you as another person.

This, it seems to me, is the rational core of chartalism. The world, we’re told, is not the totality of things, but of facts. The economic world similarly is not the totality of things, but of payments and balance sheets. The economic world however is not the world. Something has to exist outside of and prior to the network of money payments.

This could, ok, be the state, as we imagine it today. This is arguably the situation in a colonial setting. The problem is that chartalism thinks the state, specifically in the form of its tax authority, is uniquely able to play this role of validating money commitments. Whereas from my point of view there are many kind of social relationships that have an existence independent of the network of money payments and might potentially be able to validate them.

Within the perspective of law, everything is law; just as within the perspective of finance, everything is finance. If you start from the law, then how can money be anything but a creature of the state? But if we start instead from concrete historical reality, we find that tax authority is just one of various kinds of social relations that have underwritten the promises of finance. 

Stefano Ugolino’s Evolution of Central Banking describes a fascinating variety of routes by which generalized payments systems evolved in Western Europe. The overwhelming impression one takes away from the book is that there is no general rule for what kinds of social relationships give rise to a centralized system of payments. Any commitment that can be commuted to cash can, in principle, backstop a currency.

In the medieval Kingdom of Naples payments were ultimately based on the transfer of claims tokens at the network pawnbrokers operated by the Catholic Church. The Kingdom of Naples, writes Ugolino, “is the only country with a central bank that was founded by a saint.” 

A somewhat parallel example is found in Knibbe and Borghaerts’ “Capital market without banks.”  There they describe an early modern setting in the Low Countries where the central entity that monetizes private debt contracts is not the tax-collecting state, but the local pastor. 

The general point is made with characteristic eloquence by Perry Mehrling in “Modern Money:Credit of Fiat”:

For monetary theory, so it seems to me, the significant point about the modern state is not its coercive power but the fact that it is the one entity with which every one of us does ongoing business.We all buy from it a variety of services, and the price we pay for those services is our taxes. … It is the universality of our dealings with the government that gives government credit its currency. The point is that the public “pay community” …  is larger than most any private pay community, not that the state s more powerful than any other private entity.

There are different kinds of recipients of money payments and the social consequences they can call on if the payments aren’t made vary widely both in severity and in kind. The logic of the system in which payments are automatically made is the same in any case. But all the interesting parts of the system are the places where it doesn’t work like that. 

Let me end with a little parable that I wrote many years ago and stuck in a drawer, but which now seems somehow relevant in this new age of NFTs.

Once upon a time there was a game called cow clicker. In this game, you click on a cow. Then you can’t click it again for a certain period of time. That’s it. That is the game.

How much is a cow click? Asked in isolation, the question is meaningless. You can’t compare it to anything. It is just an action in a game that has no other significance or effect.  How much is a soccer goal, in terms of baseball runs?

On one level, you cannot answer the question. They exist in different games. You could add up the average score per game as a conversion factor … but then should you also take into account the number of games in a season… ? But you can’t even do that with cow clicker, there is no outcome in the game that corresponds to winning or losing. There is no point to it at all — the game was created as a joke, and that is the point of the joke.

Nonetheless, and to the surprise of the guy who created it, people did play cow clicker. They liked clicking cows. They wanted more cows. They wanted to know if there was any way to shorten the timeline before they could click their cow again. 

Now suppose it was possible to get extra cow clicks by getting other people to also click a cow. These people, who wanted to click their cows more, now could persuade their friends to click cows for them. Any relationship now is a potential source of cow clicks.

For example, if you exercise any kind of coercive power over someone — a subordinate, a student, a child — you might use it to compel them to click cows for you. Or if you have anything of value, you might offer it in return for clicking cows. Clicking cows is still inherently valueless. And your relationship with your friends, kids, spouse, are valuable but not quantifiable in themselves. But now they can be expressed in terms of cow clicks.

Imagine this went further. If enough cow-clicker obsessives are willing to make real-life sacrifices — or use real-life authority — to get other people to click cows, then a capacity to click cows (some token in the game) becomes worth having for its own sake. Since you can offer it to the obsessives in return for something they have that you want. Even people who think the game is pointless and stupid now have an interest in figuring out exactly how many cows they can click in a day, and if there is any way to click more.

As more and more of social life became organized around enticing or coercing people into clicking cows, more and more relationships would take on a quantitative character, and be expressible in as a certain number of cow-clicks. These quantities would be real — they would arise impersonally, unintentionally, based on the number of clicks people were making. For instance, if a husband or wife can be convinced to click 10 times a day, while a work friend can only be convinced to click once a day on average, then a spouse really is worth 10 co-workers. No one participating in the system set the value, it is an objective fact from the point of view of participants. And, in this case, it doe express a qualitative relationship that exists outside of the game — marriage involves a stronger social bond than the workplace. But the specific quantitative ratio did not exist until now, it does not point to anything outside the game.

In this world, the original  contentless motivation of the obsessives becomes less and less important. The answer to “why are you clicking cows” becomes less anything to do with the cows, and more because someone asked me to. Or someone will reward me if I do, or someone will punish me if I don’t. And — once cow-clicks are transferable — this motivation applies just as much to the askers, rewarders and publishers. The original reason for clicking was trivially feeble but now it can even disappear entirely. Once a click can reliably be traded for real social activity, that is sufficient reason for trading one’s own social existence for clicks.

EDIT: The idea of finance as intermediation as an object in itself comes, like everything interesting in economics, from Marx. Here’s one of my favorite passages from the Grundrisse:

Bourgeois wealth, is always expressed to the highest power as exchange value, where it is posited as mediator, as the mediation of the extremes of exchange value and use value themselves. This intermediary situation always appears as the economic relation in its completeness… 

Thus, in the religious sphere, Christ, the mediator between God and humanity – a mere instrument of circulation between the two – becomes their unity, God-man, and, as such, becomes more important than God; the saints more important than Christ; the popes more important than the saints.

Where it is posited as middle link, exchange value is always the total economic expression… Within capital itself, one form of it in turn takes up the position of use value against the other as exchange value. Thus e.g. does industrial capital appear as producer as against the merchant, who appears as circulation. … At the same time, mercantile capital is itself in turn the mediator between production (industrial capital) and circulation (the consuming public) or between exchange value and use value… Similarly within commerce itself: the wholesaler as mediator between manufacturer and retailer, or between manufacturer and agriculturalist…

Then the banker as against the industrialists and merchants; the joint-stock company as against simple production; the financier as mediator between the state and bourgeois society, on the highest level. Wealth as such presents itself more distinctly and broadly the further it is removed from direct production and is itself mediated between poles, each of which, considered for itself, is already posited as economic form. Money becomes an end rather than a means; and the higher form of mediation, as capital, everywhere posits the lower as itself, in turn, labour, as merely a source of surplus value. For example, the bill-broker, banker etc. as against the manufacturers and farmers, which are posited in relation to him in the role of labour (of use value); while he posits himself toward them as capital, extraction of surplus value; the wildest form of this, the financier.

You read this stuff and you think — how can you not? — that Marx was a smart guy,

Money and Cryptocurrencies


(This is an edited and expanded version of a talk I gave in Trento, Italy in June 2018, on a panel with Sheila Dow.)

The topic today is “Digital currencies: threat or opportunity?”

I’d like to offer a third alternative: New digital currencies like bitcoin are neither a threat or an opportunity. They do not raise any interesting economic questions and do not pose any significant policy problems. They do not represent any kind of technological advance on existing payment systems, which are of course already digital. They are just another asset bubble, based on the usual mix of fraud and fantasy. By historical standards, they are not a very large or threatening bubble. There is nothing important about them at all.

Why might you conclude that the new digital currencies don’t matter?

– Aggregate size – the total value of all bitcoin is on the order of $200 billion, other digital currencies are much smaller. On the scale of modern financial markets that’s not much more than a rounding error.

– No articulation with the rest of the financial system. No banks or other important institutions rely on cryptocurrencies to settle transactions, or have substantial holdings on their balance sheets. They’re not used as collateral for loans.

– Not used to structure real activity. No significant part of collective productive or reproductive activity is organized by making payments or taking positions in cryptocurrencies.

Besides that, these currencies don’t even do what they claim to do. In practice, digital currencies do depend on intermediaries. Payment is inconvenient and expensive — as much as $14 per transaction, and accepted by only 3 of top 500 online retailers. And markets in these currencies are not decentralized, but dominated by a few big players. All this is documented in Mike Beggs’ wonderful Jacobin article on cryptocurrencies, which I highly recommend.

Compare this to the mortgage market. Total residential mortgages in the US are over $13 trillion, not far short of GDP. The scale is similar in many other countries. Mortgages are a key asset for the financial system, even when not securitized. And of course they play a central role in organizing the provision of housing (and commercial space), an absolutely essential function to social reproduction.

And yet here we are talking about cryptocurrencies. Why?

Partly it’s just hard money crankery and libertarianism, which have a outsized voice in economics discussions. And partly it’s testimony to the success of their marketing machine. One might say that the only thing that stands behind that $200 billion value, is the existence of conversations like this one.

But it’s not just cranks and libertarians who care about cryptocurrencies. Central bank research departments are earnestly exploring the development of digital currencies. This disproportionate attention reflects, I think, some deeper problems with how we think of money and central banking. The divide over whether crypto-currencies represent anything new or important reflects a larger divide over how we conceive of the monetary system.

In the language of Schumpeter — whose discussion in his History of Economic Thought remains perhaps the best starting point for thinking about these things — it comes down to whether we “start from the coin.” If we start from the coin, if we think of money as a distinct tangible thing, a special kind of asset, then bitcoin may look important. We could call this the quantity view of money. But if we follow Schumpeter — and in different ways Hyman Minsky, Perry Mehrling and David Graeber — and start from balance sheets, then it won’t. Call this the ledger view of money.

In the quantity view, “money” is something special. The legal monopoly of governments on printing currency is very important, because that is money in a way that other assets aren’t. Credit created by banks is something different. Digital currencies are a threat or opportunity, as the case may be, because they seem to also go in this exclusive “outside money” box.

But from the Minsky-Mehrling-Graeber point of view, there’s nothing special about outside money. It’s just another set of tokens for recording changes in the social ledger. What matters isn’t the way that changes are recorded, but the accounts themselves. From this perspective, “money” isn’t an asset, a thing, it is simply the arbitrary units in which ledgers are kept and contracts denominated.

The starting point, from this point of view, is a network of money payments and commitments. Some of these commitments structure real activity (I show up for work because I expect to receive a wage). Others are free-standing. (I pay you interest because I owe you a debt.) In either case money is simply a unit of account. I have made a promise to you, you have a made a promise to someone else; these promises are in some cases commitments to specific concrete activities (to show up for work and do what you’re told), but in other cases they are quantitative, measured as a certain quantity of “money.”

What does money mean here? Simply whatever will be accepted as fulfilment of the promise, as specified in whatever legal or quasi-legal provisions govern it. It is entirely possible for the unit of account to have no concrete existence at all. And in any case the concrete assets that will be accepted are never identical; their equivalence is to some extent a fiction enshrined in the terms of the contract, and to some extent the result of active interventions by whatever authorities are responsible for the payments system.

In short, the fact that some particular asset that serves as money in this or that case is not very interesting. What matters is the balance sheets. Money is just a means of recording changes on balance sheets, of making transfers between ledgers. If we take the ledger view, then there’s no difference between physical currency and an instrument like a check. In either case the social ledger maintained by the banking system has a certain credit to you. You want to transfer a part of that to someone else, for whatever reason. So you give that person a piece of paper with the amount written on it, and they take it to their bank, which adjusts the social ledger accordingly. It makes no difference whether the piece of paper is a dollar or euro bill or a check or a money order, any more than it matters what its physical dimensions are or whether it is one sheet of paper or two.

And of course the majority of transactions are made, the majority of obligations, are settled without using pieces of paper at all. In fact the range of transactions you can carry out using the pieces of paper we call “money” is rather limited.

To put it another way: At the train station there are various machines, which will give you a piece of paper while debiting your bank account. Some of those pieces of paper can be used in exchange for a train ride, others for various other purposes. We call one a ticket machine and one an ATM. But conceptually we should think of them as the same kind of machine. Both debit your social ledger and then give you a claim on something concrete — a paper from the newsstand, say, or a train ride, as the case may be.

In the quantity view of money, there is some special asset called money which the rest of the payments system builds off. So the fact that something else could “be” money seems important. It matters that the government has a legal monopoly on printing currency, so it also matters that something like cryptocurrency seems to evade that monopoly. In the ledger view, on the other hand, that legal monopoly doesn’t matter at all. There are lots of systems for making transfers between bank accounts, including many purely electronic ones. And there are social ledgers maintained by institutions that we don’t officially recognize as banks. New digital currencies introduce a few more of each. So what?

In the quantity view, money and credit are two distinct things. We start with money, which might then be lent. This is how we learn it as children. In the ledger view, money is just anything that settles an obligation. And that is constantly done by promises or IOUs. The fact that “banks create money” in our modern economy isn’t some kind of innovation out of an original situation of cash-on-the-barrelhead exchange. Rather, it is a restriction of money-creation from the historical situation where third-party IOUs of all kinds circulated as payment.

Related to this are two different views of central banks. In the quantity view, the fundamental role of the central bank is in some sense setting or managing the money supply. In the ledger view, where money is just an arbitrary subset of payments media, which is constantly being created and destroyed in the course of making payments, “the money supply” is a nonsense term. What central banks are doing in this view is controlling the elasticity of the credit system. In other words, they are managing the willingness and ability of economic units to make promises to each other.

There are a variety of objectives in this; two important ones today are to control the pace of real activity via the elasticity of money commitments (e.g. to keep the wage share within certain bounds by controlling the level of aggregate employment) and to maintain the integrity of the payments system in a crisis where a wave of self-perpetuating defaults is possible.

In either case the thing which the central bank seeks to make more scarce or abundant is not the quantity of some asset labeled as “money”, but the capacity to make promises. To reduce the level of real activity, for example, the central bank needs to make it more difficult for economic units to make claims on real resources on the basis of promises of future payments. To avoid or resolve a crisis the central bank needs to increase the trustworthiness of units so they can settle outstanding obligations by making new promises; alternatively it can substitute its own commitments for those of units unable to fulfill their own.

Now obviously I think the ledger view is the correct one. But many intelligent people continue to work with a quantity view, some explicitly and some implicitly. Why? I think one reason is the historical fact that during the 20th century, the regulatory system was set up to create a superficial resemblance to the quantity theory. The basic tool of monetary policy was restrictions on the volume of credit creation by banks, plus limits on ability of other institutions to perform bank function. But for various reasons these restrictions were formalized as reserve requirements , and policy was described as changing quantity of reserves. This created the illusion we were living in world of outside money where things like seignorage are important.

Axel Leijonhufvud has given a brilliant description of how regulation created this pseudo quantity of money world in several essays, such as “So Far from Ricardo, So Close to Wicksell.”

Now this structure has been obsolete for several decades but our textbooks and our thinking have not caught up. We still have an idea of the money multiplier in our head, where bank deposits are somehow claims on money or backed by money. Whereas in reality they simply are money.

The fact that money as an analytic category is obsolete and irrelevant, doesn’t mean that central banks don’t face challenges in achieving their goals. They certainly do. But they have nothing to do with any particular settlement asset.

I would frame them the problems like this:

First, the central bank’s established instruments don’t reliably affect even the financial markets most directly linked to them. This weak articulation between the policy rates and other rates has existed for a while. If you look back to 2000-2001, in those two years the Federal Reserve reduced the overnight rate by 5 points. But corporate bond rates fell only one point, and not until two years later. Then in 2003-2006, when the Fed raised its rate by 4 points, the bond rates did not rise at all.

Second, neither real economic behavior nor financial markets respond reliably to interest rate changes. It’s a fiction of the last 25 years — though no longer than that — that this one instrument is sufficient. The smugness about the sufficiency of this tool is really amazing in retrospect. But it’s obvious today — or it should be — that even large changes in interest rates don’t reliably affect either the sclae of concrete activity or the prices of other assets.

Third, there is no single right amount of elasticity. A credit system elastic enough to allow the real economy to grow may be too elastic for stable asset prices. Enough elasticity to ensure that contracts are fulfilled, may be too much to avoid bidding up price of real goods/factors.

People who acknowledge these tensions tend to assume that one goal has to be prioritized over the others. People at the Bank for International Settlements are constantly telling us that financial stability may require accepting persistent semi-depression in real activity. Larry Summers made a splash a few years ago by claiming that an acceptable level of real activity might require accepting asset bubbles. From where I am sitting, there are just competing goals, which means this is a political question.

Fourth, the direction as well as volume of credit matters. In discussion like this, we often hear invocations of “stability” as if that were only goal of policy. But it’s not, or even the most important. The importance of crises, in my opinion, is greatly overrated. A few assets lose their values, a few financial institutions go bust, a few bankers may go to jail or leap out of windows — and this time we didn’t even get that. The real problems of inequality, alienation, ecology exist whether there is a financial crisis or not. The real problem with the financial system is not that it sometimes blows up but that, in good times and bad, it fails to direct our collective capabilities in the direction that would meet human needs. Which today is an urgent problem of survival, if we can’t finance transition away from carbon fast enough.

For none of these problems does some new digital currency offer any kind solution. The existing system of bank deposits is already fully digital. If you want set up a postal banking system — and there’s a lot to recommend it — or to recreate the old system of narrow commercial banking, great. But blockchain technology is entirely irrelevant.

The real solution, as I have argued elsewhere (and as many people have argued, back to Keynes at least) is for central banks to intervene at many more points in financial system. They have to set prices of many assets, not just one overnight interest rate, and they have to direct credit to specific classes of borrowers. They have to accept their role as central planner. It is the need for much more conscious planning of finance, and not crypto currencies, that, I think, is the great challenge and opportunity for central banks today.

“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. 7 

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.8

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.9 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.10 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.11  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.12 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.

 

Acquisitions as Corporate Money Hose

Among the small group of heterodox economics people interested in corporate finance, it is common knowledge that the stock market is a tool for moving money out of the corporate sector, not into it.  Textbooks may talk about stock markets as a tool for raising funds for investment, but this kind of financing is dwarfed by the payments each year from the corporations to shareholders.

The classic statement, as is often the case, is in Doug Henwood’s Wall Street:

Instead of promoting investment, the U.S. financial system seems to do quite the opposite… Take, for example, the stock market, which is probably the centerpiece of the whole enterprise. What does it do? Both civilians and professional apologists would probably answer by saying that it raises capital for investment. In fact it doesn’t. Between 1981 and 1997, U.S. nonfinancial corporations retired $813 billion more in stock than they issued, thanks to takeovers and buybacks. Of course, some individual firms did issue stock to raise money, but surprisingly little of that went to investment either. A Wall Street Journal article on 1996’s dizzying pace of stock issuance (McGeehan 1996) named overseas privatizations (some of which, like Deutsche Telekom, spilled into U.S. markets) “and the continuing restructuring of U.S. corporations” as the driving forces behind the torrent of new paper. In other words, even the new-issues market has more to do with the arrangement and rearrangement of ownership patterns than it does with raising fresh capital.

The pattern of negative net share issues has if anything only gotten stronger in the 20 years since then, with net equity issued by US corporations averaging around negative 2 percent of GDP. That’s the lower line in the figure below:

Source

 

Note that in the passage I quote, Doug correctly writes “takeovers and buybacks.” But a lot of other people writing in this area — definitely including me — have focused on just the buyback part. We’ve focused on a story in which corporate managers choose — are compelled or pressured or incentivized — to deliver more of the firm’s surplus funds to shareholders, rather than retaining them for real investment. And these payouts have increasingly taken the form of share repurchases rather than dividends.

In telling this story, we’ve often used the negative net issue of equity as a measure of buybacks. At the level of the individual corporation, this is perfectly reasonable: A firm’s net issue of stocks is simply its new issues less repurchases. So the net issue is a measure of the total funds raised from shareholders — or if it is negative, as it generally is, of the payments made to them.

It’s natural to extend this to the aggregate level, and assume that the net change in equities outstanding similarly reflects the balance between new issues and repurchases. William Lazonick, for instance, states as a simple matter of fact that “buybacks are largely responsible for negative net equity issues.” 13 But are they really?

If we are looking at a given corporation over time, the only way the shares outstanding can decline is via repurchases.14 But at the aggregate level, lots of other things can be responsible — bankruptcies, other changes in legal organization, acquisitions. Quantitatively the last of these is especially important.   Of course when acquisitions are paid in stock, the total volume of shares doesn’t change. But when they are paid in cash, it does. 15 In the aggregate, when publicly trade company A pays $1 billion to acquire publicly traded company B, that is just a payment from the corproate sector to the household sector of $1 billion, just as if the corporation were buying back its own stock. But if we want to situate the payment in any kind of behavioral or institutional or historical story, the two cases may be quite different.

Until recently, there was no way to tell how much of the aggregate share retirements were due to repurchases and how much were due to acquisitions or other causes.16 The financial accounts reported only a single number, net equity issues. (So even the figure above couldn’t be produced with aggregate data, only the lower line in it.) Under these circumstances the assumption that that buybacks were the main factor was reasonable, or at least as reasonable as any other.

Recently, though, the Fed has begun reporting more detailed equity-finance flows, which break out the net issue figure into gross issues, repurchases, and retirements by acquisition. And it turns out that while buybacks are substantial, acquisitions are actually a bigger factor in negative net stock issues. Over the past 20 years, gross equity issues have averaged 1.9 percent of GDP, repurchases have averaged 1.7 percent of GDP, and retirements via acquisitions just over 2 percent of GDP. So if we look only at corporations’ transactions in their own stock, it seems that that the stock market still is — barely — a net source of funds. For the corproate sector as a whole, of course, it is still the case that the stock market is, in Jeff Spross’ memorable phrase, a giant money hose to nowhere.

The figure below shows dividends, gross equity issues, repurchases and M&A retirements, all as a percent of GDP.

Source

What do we see here? First, the volume of shares retired through acquisitions is consistently, and often substantially, greater than the volume retired through repurchases. If you look just at the aggregate net equity issue you would think that share repurchases were now comparable to dividends as a means of distributing profits to shareholders; but it’s clear here that that’s not the case. Share repurchases plus acquisitions are about equal to dividends, but repurchases by themselves are half the size of dividends — that is, they account for only around a third of shareholder payouts.

One particular period the new data changes the picture is the tech boom period around 2000. Net equity issues were significantly negative in that period, on the order of 1 percent of GDP. But as we can now see, that was entirely due to an increased volume of acquisitions. Repurchases were flat and, by the standard of more recent periods, relatively low. So the apparent paradox that even during an investment boom businesses were paying out far more to shareholders than they were taking in, is not quite such a puzzle. If you were writing a macroeconomic history of the 1990s-2000s, this would be something to know.

It’s important data. I think it clarifies a lot and I hope people will make more use of it in the future.

We do have to be careful here. Some fraction of the M&A retirements are stock transactions, where the acquiring company issues new stock as a kind of currency to pay for the stock of the company it is acquiring.17 In these cases, it’s misleading to treat the stock issuance and the stock retirement as two separate transactions — as independent sources and uses of funds. It would be better to net those transactions out earlier before reporting the gross figures here. Unfortunately, the Fed doesn’t give a historical series of cash vs. stock acquisition spending. But in recent years, at least, it seems that no more than a quarter or so of acquisitions are paid in stock, so the figure above is at least qualitatively correct. Removing the stock acquisitions — where there is arguably no meaningful issue or retirement of stock, jsut a swap of one company’s for another’s — would move the M&A Retirements and Gross Equity Issues lines down somewhat. But the basic picture would remain the same.

It’s also the case that a large fraction of equity issues are the result of exercise of employee stock options. I suspect — tho again I haven’t seen definite data — that stock options accout for a large fraction, maybe a majority, of stock issues in recent decades. But this doesn’t change the picture as far as sectoral flows goes — it just means that what is being financed is labor costs rather than investment.

The bottom line here is, I don’t think we heterodox corporate finance people have thought enough about acquisitions. A major part of payments from corporations to shareholders are not distribution of profits in the usual sense, but payments by managers for control rights over a production process that some other shareholders have claims on. I don’t think our current models handle this well — we either think implicitly of a single unitary corporate sector, or we follow the mainstream in imagining production as a bouillabaisse in where you just throw in a certain amount of labor and a certain amount of capital, so it doesn’t matter who is in charge.

Of course we know that the exit, the liquidity moment, for many tech startups today is not an IPO — let alone reaching profitability under the management of early investors — but acquisition by an established company. But this familiar fact hasn’t really made it into macro analysis.

I think we need to take more seriously the role of Wall Street in rearranging ownership claims. Both because who is in charge of particular production processes is important. And because we can’t understand the money flows between corporations and households without it.

 

The King’s Two Bodies

This looks like a good book:

Private outposts in the state and public outposts in finance, central banks have historically moved back and forth between very different institutional forms: private, public and various combinations of the two. Far from constituting a rational-functionalist formation, they have performed widely diverse and often barely related functions—from the administration of state debt to the issuing of currency and the supervision of private banks—cobbled together more or less ad hoc according to political expediency… Central banks, Vogl argues, constitute a fourth power, overshadowing legislature, executive and judiciary, and integrating financial-market mechanisms into the practice of government.

Central banks’ claim to autonomous authority is based on their assumed, and asserted, technical competence. As they and their aficionados in the media and in economics departments are fond of telling us, central bankers know things about the economy that normal people, inevitably overwhelmed by such complexity, cannot even begin to fathom. … Central bankers themselves have always been aware … that what they sell to the public as a quasi-natural science is in fact nothing more than intuitive empathy, an ability acquired by long having moved in the right circles to sense how capital will feel, good or bad, about what a government is planning to do in relation to financial markets. (Economic theory is best understood as an ontological reification of capitalist sensitivities represented as natural laws of a construct called ‘the economy’.) At critical moments, such as when the Bank of England went off the gold standard in 1931 …, central banking relies on the trained intuition of great men and their capacity to make others believe that they know what they’re doing, even when they don’t. At a university event in London almost a decade after the 2008 crash, Alan Greenspan was remembered by an enthusiastic admirer as having had ‘a complete model of the American economy in his body’.