Saturday, April 28, 2012

To Be Able To Do a Drain You First Have to Do an Add

This older baby knows that to be able to help with the other baby's bath, she must first fill the cup with water before she is able to pour any water out of the cup and on to her little brother's head.

I surmise that no one ever "taught" her how to do this.  She perhaps saw her mother do this act of first filling the cup and then pouring it out and picked  up this concept in about 5 seconds at age 2 1/2.

For this concept (ie Add : Drain) you cannot "dumb it down".  You cannot make this concept "easier to understand".  This little baby in the photo above is empirical evidence that normal humans are able to understand this concept in a foundational way.

In "Soft Currency Economics", Warren Mosler writes:
The imperative behind federal borrowing is to drain excess reserves from the banking system, to support the overnight interest rate. It is not to fund untaxed spending. Untaxed government spending (deficit spending) as a matter of course creates an equal amount of excess reserves in the banking system. Government borrowing is a reserve drain, which functions to support the fed funds rate mandated by the Federal Reserve Board of Governors.
I believe that I have read that Warren has sometimes quipped: "To be able to do a reserve drain you first have to have done a reserve add", this should be simple enough.  This is a concept that 3 year old babies can and often do exhibit knowledge of, yet, many morons in economic policymaking positions, some with advanced degrees, cannot understand this concept.

To these economic imbeciles, when the US Treasury issues securities, the US government is "borrowing from grandchildren" or "borrowing from China" or my favorite: "borrowing from the future"; and there is the potential that the US "can become the next Greece"; completely blind to the fact that to be able to settle all transactions for US Treasury securities, the US government first has to provide the USD balances required for this said settlement and is in no way restrained from doing so.

This is the mental equivalent of the little baby in the above picture, trying to pour from an empty cup onto her little brother's head, not realizing that the cup had to be filled first.  But she is not stupid.  Perhaps this little baby can teach these morons who have current charge of economic policy some basic concepts of logical procedure in between her nappy-time.  Maybe she would agree to put a seminar together for them; or chair a conference in Europe.  We could get her a teenie-tiny podium.

A concept that is easily understood by babies at bath-time cannot be made simpler to understand.  Indeed, it may be a bit of a fools errand to think that we can do so.


Clonal said...

The questions that have to be asked are -

What is the US Government borrowing?

Ans. Dollars

Where did these dollars come from?
Who issued these dollars?

This is where the answers get interesting!

Bank loans? But the loans have to be paid back with interest!

The only answer that makes any sense is that the US Government spent these $ into existence

Ralph Musgrave said...

Since banks are not reserve constrained, I don’t see the importance of holding the over-night rate to any particular level.

I.e. I suspect the connection between the overnight rate and interest rates in general is weak. And this idea is supported by the fact that official central bank rates are currently at record lows, but commercial banks are reluctant to lend. (At least in the UK they are.)

I suggest central banks still cling to the outmoded idea that banks are reserve constrained, so they think they can control credit availability by controlling the over-night rate. Or have I missed something?

Matt Franko said...

Ralph looks like you've identified two misperceptions that exist out there.

1. That banks 'lend out the reserves'; and

2. That there is a strong/direct linkage between lower policy interest rates and bank lending hence economic stimulus.

Recent history of course belies these two theories...

...maybe this little baby will grow up and someday and get us all out of this mess!


Tom Hickey said...

The cb can control price but not quantity under the present system. Setting the overnight rate above zero increases the cost of credit extension for banks, which the pass through to customers via the spread. So the cb can advantage savers and disadvantage borrowers by raising rates and vice versa by lowering them.

The presumption is that this affects relative demand wrt saving and investment. This is the basis for monetary policy other an creating expectations. The transmission for price shifts in interest rate works chiefly through the housing market though, which implies a lag.

The thinking is that expectations management is virtually instantaneous, and markets generally respond immediately to announcements of rate changes and even hints of it.

Letsgetitdone said...

"The thinking is that expectations management is virtually instantaneous, and markets generally respond immediately to announcements of rate changes and even hints of it."

But of course, this thinking is mistaken and foolish. What makes economists think they are qualified to do psychology?

Tom Hickey said...

"But of course, this thinking is mistaken and foolish. What makes economists think they are qualified to do psychology?"

They argue that they have produced statistical reasoning that shows causality. But that is is entry through the door of correlation and fails the test of explaining transmission empirically. As you say, Joe, it's psychology.