I suggested that economists need to wake up and see the world as it really is yesterday.
Steve Keen sent me a link to a paper he described as ‘crap' in response. As some will know, I think ‘crap' is a technical term meaning ‘completely rubbish approximations' so I took a look.
The paper is by Salomon Faure and Hans Gersbach and is entitled 'Loanable Funds vs Money Creation in Banking: A Benchmark Result'. In essence it looks at whether economics need look at money creation the way it actually happens, as modern monetary theorists describe it, or whether economists can continue to pretend that banks are intermediaries who take in saver deposits and lend them out again, as may have been true when the world was ultimately linked to the gold standard before 1971.
The authors spend 52 pages working through their task. And as Steve says, it is crap.
How do I know? You only need to read a little bit of the paper (which was last revised in November 2017) to know that because, as they say:
Almost all models of banking - be they micro- or macro-oriented - are based on the so-called "loanable-funds approach to banking": Banks are financed through deposits, equity, and other financial contracts, and then they lend to firms or buy assets. In our current monetary architecture, however, the opposite process is at work. Banks start lending to fi rms and simultaneously create deposits. Firms use deposits to buy investment goods, and deposits flow to households who decide about their portfolio of bank deposits, bank equity, and other assets they want to hold. Subsequently, households buy consumption goods, and deposits are transferred back to firms that, in turn, repay their loans. We call this approach the "money-creation approach to banking."
So far, so good then: they recognise that almost all economics has got banking wrong and they realise the way the world really is. But then they ask this:
In which circumstances do the money-creation and loanable-funds approaches yield the same outcomes? In our paper, we establish a simple benchmark result. In the absence of uncertainty and thus of any bank default, both processes yield the same allocation. Hence, in such cases, using the loanable-funds model as a shortcut does not imply any loss of generality.
So, having recognised that economics has got banking wrong these two authors then expend considerable effort in trying to prove that they can ignore what they know to be right and can instead persist in using a model that they know to be wrong. What is more, they claim to have shown that this is possible, because what else can the word ‘establish' mean? All they asked their fellow economists believe is that there is a world in which there is no uncertainty and that banks cannot, as a result, ever default. Or to put it another way, they say ‘let's just assume that 2008 did not happen and carry on as we did before'.
There are those who would like to suggest that Howard Reed was wrong to say that economics needs reconstruction. You do, however, only need to see a paper like this, which is designed solely to maintain the economic status quo based upon an absurd set of assumptions to support the claimed existence of a market that cannot, and does not, exist in reality, to see why that reconstruction is essential. We can no longer live with this sort of crap. Or to put it another way, we can no longer live with this sort of completely rubbish approximation to the truth.
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The most elegant, simple and useful short definition of money, and the purpose of banking I have read, was written by Alfred Mitchell-Innes, ‘What is money?’ (The Banking Law Journal, May 1913).
Perhaps it should be sent to Faure and Gersbach; but better, read by the widest public:
“Money, then, is credit and nothing but credit. A’s money is B’s debt to him, and when B pays his debt, A’s money disappears. This is the whole theory of money.
Debts and credits are perpetually trying to get into touch with one another, so that they may be written off against each other, and it is the business of the banker to bring them together. This is done in two ways: either by discounting bills, or by making loans. The first is the more old fashioned method and in Europe the bulk of the banking business consists in discounts while in the United States the more usual procedure is by way of loans.”
What particularly struck me was the emphasis by Mitchell-Innes on ‘debits and credits’; it reminded me of Ch.3, Randall Wray, ‘Modern Money Theory’. It begins with accountancy; which non-MMT economists simply do not seem to understand.
Now a blog
Thanks
‘in the absence of uncertainty’
It’s actually a pretty horrible idea when you think about it
Reading your two blog posts this morning and those of the last few days and trying to make sense of the current state of things re: Economics and money I offer up the following :
1. The economic mainstream is rattled by all these discussions about money because in their fantasy world money is kept in a box and now it appears to be getting out of its box to the potential detriment of their entire theoretical base .
2. The correction of ‘ spend and tax ‘ by government as opposed to ‘ tax and spend ‘ is not a semantic distinction. If accepted across society as a whole it makes plain the fact that government ( or if you prefer the state ) is at the heart of all money creation and not ‘ the markets ‘ . For pretty much all ( I would say all ) Western governments given the fact that they have effectively handed over power to the markets to acknowledge reality is as good as saying it was all a confidence trick, this Ponzi scheme ( making everything about money, but not actually money, but debt ) and we allowed it to happen. So this is becoming and can only play out as a power struggle because that is what it is. Whether you choose to call that capital versus labour is up to you. Personally I don’t like these reductions because I find them distracting.
3. What is going on here is cultural and all power is exerted culturally . It does not exist in a vacuum hence the oft repeated aphorism ‘ power abhors a vacuum ‘ and cultures do NOT reform themselves, they collapse and new ones arise in the wake of the collapse and unless and until those of us who seek change are prepared to embrace that and the suffering that always attends it then nothing will change. Nibbling around the edges of the present construct won’t do.
As Henry Ford said ‘ If people knew how simple it was ( money creation ) there would be a revolution before morning.
Agreed
More distraction strewn in the path of the oncoming MMT juggernaught.
But the journals will only publish stuff that supports the current paradigm. Need to read The Structure of Scientific Revolutions by Thomas Kuhn ( I think it was him). The paradigm seldom gets replaced until it’s supporters die off.
We can but try….and not by killing them off
“We can but try….and not by killing them off”
Not even just a teensy weensy little push….?
No!
After posting my comment I checked the author’s name and ended up reading the Wikipaedia entry. Interesting that one of the examples cited was neoliberalism being replaced by neo Keynesianism. Need to move a bit further I think.
The paper actually contains the correct findings, although they’ve apparently misplaced the conclusions in the introduction.
In the paper, within the introduction on page 5 they reference two papers by Jakab and Kumhof (2015) and Faure and Gersbach (2016) which show different results between loanablefunds and money-creation models.
They then write:
“In the present paper, we develop a model to study constellations when the loanable funds and money creation approaches to banking might deliver similar results. For this purpose, we use a two-sector macroeconomic model, but we abstract from any type of uncertainty. Our main result is that in the two papers mentioned in the previous paragraph, all the newly detected phenomena linked to money creation are connected to the presence of risks and bank default. In the absence of idiosyncratic and aggregate risks, the loanable-funds and the money-creation approaches are equivalent, since the allocations are identical.”
“Our main result is that in the two papers mentioned in the previous paragraph, all the newly detected phenomena linked to money creation are connected to the presence of risks and bank default.”
This was their main finding which they appeared to forget to put in their conclusions!!
Their actual conclusions are meaningless in any real world application, since they “abstract from any type of uncertainty and thus no bank default”.
I agree: hence my reason for splitting the piece I quoted as I did
They know the truth
They know it matters
But mis-stating it is not chance: it is what they think they must do to stay in mainstream macro, so they have deliberately created an excuse to ignore what they know is right
In that sense the paper provides the starkest of evidence of the corruption (in a literal sense) at the core of modern macro
“They know the truth
They know it matters
But mis-stating it is not chance: ”
Had to check there that I hadn’t mistakenly drifted back to the Growth Commission report thread.
Did you get as far as looking at absurdity of their the mathematical model? Just nonsense.
I did
But decided I had evidence enough
Replace cet par with inter alia?
Richard Werner went through all of this argument in 2014 in his paper “Can banks individually create money out of nothing? – The theories and the empirical evidence.” with proof they can create money from nothing:-
https://ac.els-cdn.com/S1057521914001070/1-s2.0-S1057521914001070-main.pdf?_tid=fc75c23c-d83e-42f3-9d05-fe4552d6936d&acdnat=1528131924_e2c6d888db6e68ad00617c7b01f02c4e
I am familiar with it
Sort of off topic but Bill Mitchell goes Scottish Growth Commission:-
http://bilbo.economicoutlook.net/blog/?p=39501#more-39501
Mitchell is providing his response to the Growth Commission Report in two parts (Part 2 scheduled tomorrow). Part I is devastating critical dissection of the Report, effectively as a standard presentation of Neoliberal orthodoxy. Part 2 should provide an interesting detailed analysis of the Scottish currency option.
What I find more difficult to comprehend (or accept) is Mitchell’s apparent determined support for Brexit, for reasons that as much political as economic; and reasons rooted in history, and the lessons of history. I have no doubt that Britain can force Scotland out of the EU now, if Brexit actually happens: therefore my objections here may be academic. In any case the first critical reviews of the Growth Commission Report are scarcely favourable from either an economic of political perspective.
What’s the calibre of the SNP politicians when they let a banker Andrew Wilson for goodness sake take prime responsibility for producing the Growth Commission report? After the Great Recession surely anyone with any sense would be very iffy about handing out the lead role to a banker as Bill Mitchell rightly flags up!
@ Schofield.
Thanks for the link.
I expressed this statement badly: “for reasons that are as much political as economic; and reasons rooted in history, and the lessons of history”. For the avoidance of doubt this does not refer to Mitchell’s reasons for supporting Brexit, but but to mine, for not supporting them.
Not just economists, but those in central banks and politicians, SNP, Labour let alone Tories …
http://www.alhambrapartners.com/2018/06/04/another-confesses-the-impossible-we-might-not-have-known-what-were-doing/
Link from Roger Hunt says:
http://www.alhambrapartners.com/2018/06/04/another-confesses-the-impossible-we-might-not-have-known-what-were-doing/
Excellent.
Puts me in mind of the Mervyn King apologia. “Forgive us; we know what we do”
They don’t even rationalise after the fact. They just try to blame somebody else.
[…] liked this comment from John S Warren on the blog […]
Hi Richard,
I wrote a blog post just this Sunday defending Loanable Funds. Might be worth the read? Feedback is welcome.
https://macro-insights.blogspot.com/2018/06/mmt-loanable-funds-and-interest-rate
Best,
Alfred Mayaki
I confess I found your understand8ng of MMT to be deeply confused, and your style rather confusing
The result was a blog that made little sense to me, and which I think (I cannot be certain because of your style) was profoundly incorrect as to the arguments it made.
Sorry….
I do admit, my written style does seem to either enlighten or confuse, depending on how well it is received. I focus very much on the assumption of interncontextual references.
But nevertheless, I aim to please. Which part of the post in particular did you have a concern with? Or rather which part did you feel warranted more of an explanation?
Best,
Alfred Mayaki
I regret I do not have the time to explain
Summarise it like this: I was suffici9ently confused that I was not sure what you were arguing from which side of the argument
That’s not a good place to be
Alfred, put very simply there are no ‘ loanable funds ‘ . It’s a fiction that zombie economists continue to peddle . MMT describes the world as it actually is.
Nice explanation from http://publicmatters.org.uk/economy/ using, Dr Steven Hail’s position paper for the National Health Action Party.
Also an excellent paper by Deborah Harrington and Jessica Ormerod on NPM & privatisation on the same blog, which they have set up.
I agree: very good