Saturday, June 22, 2013

New Blog On Monetary Economics by Wynne Godley student

This blog is intended to allow me to record and share occasional ideas, principally in the realm of monetary economics.
My main inspiration comes from the work of Wynne Godley, my supervisor at Cambridge in the 1980s. I was privileged to spend many hours with him working on the development of prototype data-driven stock-flow models of the UK economy.  My own input was perhaps limited to inputting data, but in return I learned enormous amounts about theoretical and empirical modelling.  I had been interested in the long-run dynamics of models before, but Wynne's ideas were a revelation to me and have shaped the way I have thought about macroeconomic issues ever since.
For most of the time since then, I have worked in commercial fields, paying little attention to academic economics.  This has given me a much deeper understanding of the way things really work, but has meant that I have not been exposed to more recent developments in economic thinking.  Coming back to the subject now, I'm not sure that I've missed anything important.
Nick Edmonds
Reflections on Monetary Economics
(h/t Ramanan at The Case for Concerted Action)


Unknown said...

Unless I am misreading his blog, he says banks need deposits to loan money, is his statement even MMT compatible?

Tom Hickey said...

Banks need to fund their loans with either debt or equity. The higher the debt to equity ratio, the more leverage and the more profit potential. So banks fund through borrowing, and generally the least expensive form of borrowing for banks given their ALM strategy is taking deposits.

While it is not the case that banks lend out people's savings in taking deposits to fund loans, it is the the case that deposits are predominantly used to fund loans since they are least expensive funding source.

According to the loanable funds doctrine, banks intermediate saving and borrowing based on the stock of saving (deposits) available for lending. This is not the case in an endogenous system where loans create deposits and banks seek funding subsequent to making the loan. In addition, deposits are not the only funding source available.

Unknown said...

it is the the case that deposits are predominantly used to fund loans since they are least expensive funding source. Tom Hickey

Because it is a captive source of funds! The population has no risk-free alternative to the banking/credit union cartel for deposit storage and transactions.

The monetary sovereign should provide such an alternative as a NORMAL, NECESSARY part of its fiat money system and ABOLISH government deposit insurance!

Unknown said...

Just to make sure we are talking about the same thing, 'loans create deposits' describes what happens at the inception of deposit creation while 'deposits fund loans' is the description that applies to what is ongoing on balance sheets after that (the deposit moves between banks and can change form into term deposits or other funding forms such as stocks).

Unknown said...

The deposit does not move between banks, reserves move between one bank's account at the Fed and other banks' accounts at the Fed.

Reserves are the real money that banks use amongst themselves; deposits are the "credit" that the banks create to drive the population into debt.

If a risk-free Postal Savings Service was set up and government deposit insurance was (as it should be) abolished then the banks would experience (as they should) a huge reserve drain to the PSS.

But most MMT folks prefer the current fascist system it seems.

Unknown said...

"deposits are predominantly used to fund loans" Tom Hickey

But were did 'those' deposits come from? I assume ultimately all deposits came from loans?

Tom Hickey said...

Just to make sure we are talking about the same thing, 'loans create deposits' describes what happens at the inception of deposit creation while 'deposits fund loans' is the description that applies to what is ongoing on balance sheets after that (the deposit moves between banks and can change form into term deposits or other funding forms such as stocks)

Right. "Loans create deposits" is the basis of endogenous money creation through the banking system. "Deposits fund loans" is an ALM function after a loan has been extended.

When a loan is granted the bank's assets and liabilities accounts are both marked up, one with the loan and the other with the deposit created by the loan. Generally, deposits resulting from loans are spent down quickly since loans are sought for a purpose. This leaves the bank short of funding for the loan, so ALM secures funding iaw its strategy that ensures the widest possible spread consistent with the other relevant factors that are involved in maturity transformation {"borrowing short term and lending long term"), e.g., interest rate risk.

Tom Hickey said...

But were did 'those' deposits come from? I assume ultimately all deposits came from loans?

Loans create deposits but so do govt spending and transfers. But as a general example of what happens, when a bank takes in a deposit that deposit has either been created by the bank, in which case the accounting is internal, or by another bank. If by another bank then the deposit gets transferred from one bank to the other through clearing, first netting and then through the payments system.

The bank losing the deposit has its reserve account at the cb marked down and the bank gaining the deposit has its reserve account marked up. Both bank make corresponding entries on customer accounts, decreasing the liabilities of the bank losing the deposit and increasing the liabilities of the bank gaining the deposit.

Unknown said...

I assume ultimately all deposits came from loans?

No. Money from the monetary sovereign (fiat) is spent into existence and becomes both a deposit and reserve increase when it is deposited into a bank.

BTW, all money should be spent, not lent, into existence so that deflation is not built-in to money creation. Common stock is one private money form that can be spent into existence but why "share" when one, if "creditworthy", can legally steal instead?

Tom Hickey said...

The significant point from the POV of MMT is that loans extended create a stock on consolidated bank balance sheet and corresponding to the stock of loans is a stock of deposits. The deposits are a constituent of the money supply — M1 includes demand deposits, and M2 includes both demand and time deposits. Since loans show up on the LHS of the balance sheet and deposits on the RHs, these net to zero.

What this means is that event though deposits get transferred around the system, the balance of loans and deposits does not change. It remains zero. It also remains zero when a loan is paid down and the stock decreases, or when a new loan is made and the stock increases. Always net zero by the rules of double entry accounting. In other words, total net savers match total net borrowers. There can be no net saving in aggregate in this closed system of bank lending.

If a bank needs to obtain reserves from the Fed, it does so by borrowing. Again net zero. The banking system doesn't create any currency.

However, when govt spends and transfers, then deposits increase and reserves are credited to banks' reserve accounts. Since there is no bank loan corresponding to these deposits, nor do the banks borrow reserves from the Fed in this case, the net is positive. Although the flow may be negative for the period if govt taxes more than it injects, the stock is virtually always positive, since govts virtually never withdraw the total of what they have injected.

This stock whose net is greater than zero is the consolidated non-govt saving of net financial assets in aggregate.

Unknown said...

The banking system doesn't create any currency. Tom Hickey

You're forgetting "open market purchases" and when the central bank buys anything other than sovereign debt it is potentially creating currency since it may not be able to sterilize the "temporary" currency it uses to buy things with should the asset fall in value.

And btw, the instantaneous creation of new purchasing power say, for a 30 year mortgage, cannot be properly balanced by the destruction of that purchasing power over the next ~10 years. It is mere accounting sophistry to pretend otherwise. But hey, banking is historically rooted in embezzling so what's new?

Unknown said...

But if bank credit creation is a legitimate form of purchasing power creation then the banks should need no government privileges YET they do.

How many ways do the banks have to be wrong before some will quit defending them?

Ralph Musgrave said...


I don’t agree that private banks need government privileges. A bank could set up in a barter economy, and simply accept collateral and dish out Monopoly money to borrowers. As long as most people trusted the bank, that monetary system would work. No monetary base would be needed.

Unknown said...


1) Why would anyone want to borrow the bank's money?
2) Where will the aggregate interest come from? Unless the bank agrees to recycle 100% of it?
3) Even if 100% of the interest is recycled why should the banker get something for nothing?

Now the members of the barter community could instead set up a common stock store and sell the goods they want to sell in exchange for new shares at a price the common stock holders vote upon.

Anonymous said...

The interest payments associated with a bank loan do go on the bank's balance sheet under assets. They are "interest receivable", and are accrued before the interest is paid. If the interest payment is due in the current accounting period, the interest receivable is a current asset. If it is due at some point beyond the current period, it is a non-current asset.

Obviously, if a lender receives a promissory note for $100,000 principle and 50% interest, they are in possession of a larger asset than a lender that receives a promissory note for $100,000 in principle and 5% interest.

Anonymous said...

Bank deposits clearly can be transferred from bank to bank. If I pay someone who is a depositor at another bank, then when the banks settle my deposit account at my bank is going to be debited by the amount of the payment, and the payee's account at the payee's bank will be credited by that same amount. The banks settle between themselves on the books of the Fed (i.e. through their reserve accounts). So there is a decrease in deposit liabilities and decrease in reserve assets at my bank; with a corresponding increase in deposit liabilities and increase in reserve assets at the payee's bank.

Anonymous said...

In a growing economy, the growing volume of funds needed to pay both the interest and principle on a growing volume of loans comes from the ever-expanding volume of bank deposits created by new loans. The system as a whole is always rolling over its aggregate debt with new debt. But this cannot happen unless the central bank accommodates the continual growth in bank deposits by emitting ever larger quantities of its own liabilities - since the greater the volume of bank deposits, the greater the volume of interbank payments and the greater the demand for redemption of deposit balances into physical currency. Think of it as two overlapping circles. The banks in the aggregate keep making more loans and creating more loan-driven deposits to supply the universe of depositors with adequate funds to pay off the earlier rounds of loans, and at the same time the central bank keeps supplying more reserve balances and currency to the bank so that they can continue to meet their payment and redemption obligations.

The banks generally drive the process and the central bank accommodates it, although sometimes the central bank tries to push bank lending forward if it has the ability to lower the policy rates. That doesn't apply in our situation at the zero bound. Also there is no present need for ongoing accommodation since the commercial banks have tons of excess reserves already.

Matt Franko said...

"In a growing economy.."

Key distinction Dan


Unknown said...


Also where will the aggregate interest for the first loans come from? Before the interest can be recycled?

A common stock market is a better (ideal?) solution. People take the goods they wish to sell to the market and receive new common stock in exchange for them. The existing stock owners or a representative chosen by them sets the price. The goods are then put on sale for the same price or perhaps with a markup. The common stock received in sales is destroyed except for the profit which should be periodically distributed as stock splits.

There you have it. A democratic, ethical way to replace barter with money without built-in deflation. Also, price inflation is under the control of only those affected by it.

Matt Franko said...


Where do the taxes come in, in your hypo there?


Unknown said...

Taxes would be collected in inexpensive fiat only (to avoid enriching some private interest such as gold worshipers at public expense and to avoid some silly limit on the amount of fiat that can be produced such as the mining rate of gold.). The exchange rate with various private monies would be determined in the open market. The fiat would be spent into existence and taxed out of existence. The monetary sovereign would never borrow fiat since that is absurd and "welfare for the rich."

Unknown said...

And, of course, "deficits" by the monetary sovereign would be the NORM and it would NEVER run a budget surplus.

paul meli said...

"comes from the ever-expanding volume of bank deposits created by new loans" -Dan

Actually, expanding bank deposits comes from new loans plus public spending. What follows from that is this...

Incomes are partly a function of new loans and partly a function of public spending. so new loans alone don't create the income necessary to fund payments.

Thus new loans are dependent on public spending...without which credit can't expand...

...leading to the conclusion that growth is a direct function of public spending and only an indirect function of lending.

Anonymous said...

Paul, while I wouldn't at all recommend this approach, in principle deposits could continue to grow via lending and continue to provide the funds necessary to pay off all previous loans, even if the fiscal arm of government - the Treasury - ran a balanced budget. This could happen so long as the central bank continued to provide increasing funds to the private sector.

The central bank is part of the government, and the net financial assets of the private sector can grow even if the central bank is the only arm of the government that is providing them. The central bank could sell its own securities and then pay them off with interest (it effectively does this with interest on reserve balances).

But also, deposits could continue to grow and loans could be repaid on schedule, even if the net financial assets of the private sector didn't grow at all.

To see this, suppose that there were only a single bank - the central bank - and everyone's bank account was an account at some branch of the central bank. (There are no commercial banks and no reserve accounts.) And suppose there is no physical currency, but only bank deposits. Suppose total deposits (liabilities) at the central bank are $1 trillion, and that total notes receivable + interest receivable are $1.05 trillion, all due within the current fiscal year. That is, the private sector is a net debtor to the central bank to the tune of $0.05 trillion. Now suppose that during the current fiscal year the central bank lends an additional $0.05 trillion net to the private sector so that total deposits end up at $1.05, and total receivables are $1.1025 trillion. The private sector can pay off all its previous debts to the central bank, but is now a net debtor to the tune of $0.0525. Another way of looking at this is that the private sector money supply can grow even if its net financial assets decline.

The reason I wouldn't recommend that approach is that capitalist economies have a historically well-established pattern of driving themselves into a low-employment equilibrium that the private sector can't easily get out of by spending from some combination of retained earnings and credit. The most effective way for a government to support consumption, investment and employment, and counteract demand deficiencies, is for the government itself to participate actively as a consumer, investor and employer.

But the need for the government to do this doesn't fall out of the accounting alone.

paul meli said...

" in principle deposits could continue to grow via lending and continue to provide the funds necessary to pay off all previous loans, even if the fiscal arm of government - the Treasury - ran a balanced budget." - Dan

Dan, the problem with this argument is it ignores saving... which can't be's the sytemic friction that makes public spending a necessary condition.

To ignore saving is to leave the real world and enter a world where perpetual motion is possible...a frictionless system...and no such system is known to exist.

Said another way, it is possible for an economy to run on net public spending alone, but it's impossible for it to run (grow) on credit alone. Credit is a loan against future public spending.

A credit-only system is equivalent to pulling ones self up by the bootstraps.

Anonymous said...

Paul, why does the private sector need to net save in order to grow?

Tom Hickey said...

Paul, why does the private sector need to net save in order to grow?

IN the neoclassical model there is no saving. All product is sold since the producers' revenue from sales is sufficient to pay all costs, including labor, which provides the demand. According to Say's law, producers produce and consumers consume. There is no propensity to save, so the economy is only circular flow.

Theoretically, this works, but it doesn't actually due to saving and other friction that leads to demand leakage that introduces imperfection into circular flow. When there is demand leakage in a closed economy w/o govt, then there is economic contraction. Borrowing cannot offset the saving since the net is zero, and net borrowers will eventually run out of borrowing power due to limited means of repayment.

If there is govt then G-T can offset the demand leakage. If G-T does not offset demand leakage completely, then contraction will result owing to lack of effective demand, or private borrowing will rise, which unsustainable in the long run.

In an open economy, add net exports as offset, too. You know, sectoral balances.

Nick Edmonds said...

Saeid Binzagr

For the record, I think my views are broadly in line with what I understand of MMT, at least in relation to loans and deposits. I certainly believe in loans creating deposits, not merely in the accounting sense, but in the much deeper sense; the same sense in which Keynes saw that investment creating saving. My post on endogenous money and thin air money was intended to point out that the accounting sense is not the important one.

Jose Guilherme said...
This comment has been removed by the author.
paul meli said...

"The deposits previously created by deficit spending would be destroyed." - Jose

There are only two ways to destroy net financial assets held by the non-government…taxation and debt repayment…all other off-balance sheet transactions have no effect on the level of $NFA.

Interbank and Fed-bank transactions merely change the composition of those assets not the level.

What you are describing is a reduction in the value of real assets held by banks, denominated in dollars. This is an entirely different argument. A loss in those real assets undermines a banks equity position and has the same effect as reducing deposits, but it's not the same.

One has to keep net financial assets and real assets separate…they are two separate systems that interact but one of them is set in stone and the other one reacts to movements in the first.

paul meli said...

"Theoretically, this works…"

Tom, I have to strongly object to this characterization, even though your comment is otherwise spot-on.

In theory, i.e. the 2nd Law of Thermodynamics and by extension entropy, this never works and has never been observed to work. There is no theory that implies otherwise.

If in theory it worked then we are saying that in theory, perpetual motion is possible when in fact in theory it isn't.

This is an important distinction from my perspective…an accurate characterization would say…

"in a frictionless system this would work…but there are no frictionless systems in the known universe".

My turn to be pedantic. :-)

Tom Hickey said...

Right, that's why neoclassical economics is a description of a perpetual motion machine and no amount of jiggling with it will make it work as advertised.

I think that a lot of economists recognize that formal models are idealization and cannot be transport to actual events since they abstract from imperfections for methodological convenience. They are only meant as aids to thinking.

However, problems arise when some economists forget this and attempt to claim that the model is in fact "representational enough" and should be used in formulating policy.

Soon, the assumptions and methods become the memes and myths of Econ 101, and a secular religion is borne as students are exposed to these simplifications as if they were factually correct.

Then, many economists take advantage of these memes and myths to promore normative policy as it were widely acknowledge positive science on the level of physics.

Jose Guilherme said...

However, when govt spends and transfers, then deposits increase and reserves are credited to banks' reserve accounts

This is correct; however, where the deficit has been ultimately financed by non-depository institutions (say, when pension funds are buying all the T-bonds) there was a previous or concomitant or subsequent destruction of bank deposits. In that case, government deficit spending results in zero net creation of deposits.

Imagine an example with the commercial banks selling all the bonds in their portfolios to institutional investors. There would be a massive deposit drain from the banking system. The deposits previously created by deficit spending would be destroyed.

This would be an instance - a significant instance in the real world - of government deficits not leading to deposit creation in net terms.

Tom Hickey said...

The problem with neoclassical theory is indeed "thermodynamic." Neoclassical models use representative agents that function link, say, atoms in physics, where atoms are uniform and interchangeable. Of course, humans are not.

Moreover, failing to recognize that money functions in economics like energy in natural science, they ignore the behavior of money as "energy" and presume that the laws of thermodynamics don't apply to economics. The significance of the laws of thermodynamics is, of course, that there are no perpetual motion machines.

Although the circular flow model works theoretically abstracting from time and money, actual events occur in time and modern economies are monetary. As a result, economies are subject to imperfections that the assumptions-models do not take into account or minimize.

Rather than recognize these limitations, neoclassical economists account for imperfections and distortions as consequences of either govt intrusive policy or external shock. The story runs that if govt intrusion is precluded, then the only disruption of circular flow at optimal output and employment is external shock, and even then market will return to equilibrium at optimal output and employment when the shock subsides.

But neoclassical models also presume unlimited real resources including energy. While it may be ;possible for innovation and conservation to stay ahead of the game for some time, the assumption of unlimited resources is also false.

For example, even if there were no limitation on energy wrt to source, there is a limit wrt to the externality that energy use involves. All use of energy involves release of heat, if not effluent, as an externality of energy use. So economies are also subject to the laws of thermodynamics in this way.

paul meli said...

"So economies are also subject to the laws of thermodynamics in this way." - Tom

Exactly. One example is we can look at our petroleum reserves as a giant storage battery that took millions of years to charge up and we are discharging it over 2 or 3 hundred years.

We had better find an alternative battery charger, one that doesn't take millions of years but instead works in real time, or we will be screwed.

Unknown said...

Thorium reactors -> synthetic liquid fuels and other hydrocarbons.

The energy problem is solved, imo, except for the politics.

When liberals and progressives realize that it is the insane money system, usury for stolen purchasing power, that is the root cause of our problems then they CAN FOCUS on essentials and not be distracted by mere symptoms.

Instead, the MMT folks are hard at work trying to make the current crooked system work! It won't since MMT does not handle the unjust distribution problem.

Darren said...


If you add up all your comments on this thread, I think they can be turned into a blog post of their own. Highly recommended.

paul meli said...

"It won't since MMT does not handle the unjust distribution problem." - F.Beard

But of course thorium reactors will. Your logic sounds like this to me…

…Thorium reactors…



Unknown said...

Common stock as private money handles the distribution problem - automatically - by "sharing."

We don't have a resource problem, including energy, we have a moral problem with our money system.