In the wake of some recent economic reports, most prominently the employment report, there’s some discussion of how the recovery is in doubt [1], possibly leading to a “W”, or double dip, [2]. Anxieties focus on 2010 or possibly 2011. I think, in retrospect, such worries cast the criticisms of the stimulus bill in a different light than just a few months ago.
First, to the current situation and outlook:
Figure 1: Log GDP, SAAR, in Ch.2005$ (blue), Deutsche Bank forecast of 9/30 (red), e-forecasting estimate of 10/2 (teal), and IMF World Economic Outlook forecast of 10/1 (green squares). NBER defined recession shaded gray, assumes trough at 2009Q2. Sources: BEA, GDP 3rd release of 2009Q2, Deutsche Bank Global Economic Perspectives, e-forecasting, IMF, World Economic Outlook, NBER, and author’s calculations.
Note that the newly released IMF WEO forecasts project continued growth into 2010. Of course, that’s just a forecast. In fact, preliminary real time estimates of 09Q3 GDP suggest a somewhat faster rebound in activity than the IMF anticipates.
But if indeed there is underlying weakness in 2010 or 2011, then it’s a good thing the stimulus package incorporated substantial spending for long-gestating infrastructure projects. Indeed, I made this exact point (on repeated occasions [3] [4] [5]) — that with the recession likely being of a prolonged nature, and the recovery relatively slow, the concerns about timing were misplaced. Nonethelss, I suspect that those many critics of the stimulus package will not be retracting their criticisms in 2010.
Just to remind readers, depicted below is the projected spend-out time profile as estimated by CBO back in February, and graphed in this February 16th post.
Figure 2: Estimated spending and tax revenue reductions, per fiscal year, embodied in HR 1 final version. Shaded areas pertain to spending occurring outside of the 19.5 month time frame. Source: CBO, H.R. 1, American Recovery and Reinvestment Act of 2009 (February 13, 2009).
Mark Zandi‘s June 2009 quarter-by-quarter spend-out estimates are here:
Figure from M. Zandi, “US Fiscal Stimulus Revisited,” Economy.com (June 22, 2009).
As it turns out, Zandi’s estimates for 2009Q2 were a bit low, but not too far off of the $99.8 billion cited by the CEA [6].
As the stimulus spending diminishes, the impact on 2010Q4 growth becomes negative, according to Zandi’s estimates. However, it’s important to recall that this is an impact on the first derivative. The level of output will still be above what it would be in the no-stimulus counterfactual — in other words the output gap would be smaller than otherwise.
The problem is that the US economy is in a “structural” recession because the US credit markets can not reach equilibrium even at low nominal interest rates.
In early 2000s, the supply of credit increased dramatically mostly due to the structural current account deficit and changes in the demographic structure of the US population (baby boomers began saving for retirement). At the same time the demand for credit fell as net corporate borrowing (adjusted for net equity issuance) declined from 3% of GDP to nearly zero after the end of the telecom and internet bubble of 1990s.
Low nominal rates led to an increase in real estate prices, causing a temporary debt-financed (home equity withdrawal) consumption boom as well as a construction boom. The government also helped the economy by cutting taxes and increasing military spending.
If you look at the Flow of Funds Accounts, you will see that in 2004-2006 the US economy reached full employment only when the total net borrowing by the real sector (including the government) exceeded 15% of GPD, compared to 8-9% of GDP in 1990s. Such a high level of borrowing could only be sustained as long as the value of collateral (residential and commercial real estate) was going up, and when the real estate market peaked, the borrowing level began to decline and the economy began to slow down eventually falling back into recession.
There are many ways to fix this structural problem through various changes to the trade, fiscal and monetary policies. My personal favorite is to balance the credit markets with higher inflation and lower real interest rates. But in any case, we have to accept that fundamentally this recession was not caused by the financial sector, though the financial crisis made it much worse than it would otherwise be.
Is it any surprise that the USG spending peaks in 4Q10–just at Congressional election time?
This spending would have (& have had) a much greater impact on a possible US recovery if it had been moved up one or two quarters…but then you lose the voter impact.
I really fear–if not quite expect–that 1Q10 will be such a disaster that this plan (& likely budget supplements) will be moved up abruptly anyway.
Prof. Chinn. Given the unemployment path, the remaining output gap, and everything else, how much more of a new fiscal stimulus would make you comfortable about a “full” recovery? (Just back of envelope)
To understand the effect of the stimulus a medical example will be helpful. Consider a patient with a curable but potentially fatal disease. There are two doctors. One doctor would like to treat the disease to bring the patient back to health. Another doctor would rather treat the symptoms.
In consultation more of the doctors attended medical schools that teach treating symptoms and so that treatment prevails. The patient is given methamphetamine and almost immediately the patient’s energy increases and many of the symptoms disappear. The doctors celebrate.
But some offer caution because many vital signs have either declined or stayed at an alarmingly negative level. The soon the patient’s condition return’s to its previous state, with even greater declines in some vital signs. The doctors quickly rush to his side with more methamphetamine, many rush into print articles in the NYTimes and peer-reviewed books explaining why the patient should actually be getting better and suggesting that the initial dosage was too small and timid and must be increased.
And so here we are. In the fourth quarter some of the meth will ware off of our patient. The unemployment vital sign is alarmingly high indicating that other symptoms could get worse. There is a good chance that we will see “stimulus” treatments such as nationalized health care and cap-and-trade in some form passing congress. This will be a severe blow to the patient. As we see the health of our loved one decline as the end of the year draws near there will be increased calls for more meth. Even now the schedule calls for an even greater injection of meth in 2010. While the injections may “stimulate” and hide some of the patient’s symptoms – recall the patient’s earlier 1929 illness that appeared to recover from 1934 to 1937 – the treatment will do nothing to help the patient and could even sap more of the patient’s strength.
As an aside, do not forget that, in its current form, GDP is more a measure of government injections of meth than an indicator of the health of the patient.
Terry: Point of clarification: Spending peaks in 2010Q1 and 2010Q2, not 2010Q4 as you asserted.
Some may have noticed that the graph of CBO spending shows almost half tax changes. Only one change will have a supply side affect with the other provisions being direct tax subsidies that will have no Laffer affect on the economy.
In 2009 there is an accelerated depreciation provision that will allow for the modernization of equipment. Because this follows on the heels of two similar Bush accelerated depreciation actions this will have less of an impact but will act to push the economy down the Laffer curve.
But offsetting this one provision are an array of tax credits that are temporary subsidies to targeted groups that will have virtually no Laffer effect and will actually create conditions where financing the credits will push the economy up the Laffer curve much more than the accelerated depreciation will push the economy down the curve.
$500 tax subsidy to low income
Tax credit for education
Tax credit for state and local tax exempt bonds
Tax credit for alternative energy development
Increase in the earned income tax credit.
In addition to these provisions there are scheduled increases in unemployment payments in both 2009 and 2010 that will increase the unemployment rolls along with an increase in the unemployment payments. There is also a provision that will remove some unemployment payments from the states taking the money from the general fund instead.
In summary unemployment will continue to rise, business will continue to be sluggish failures increasing, credit will continue to be limited, home prices will continue to be stagnant, and the dollar will continue its slow decline in value as confidence in the US wanes.
The Democrats in Congress are counting on the meth injection in 2010 to pull them out of the fire. Chances are great right now that with a worse economy there will be significant losses for Democrats in the 2010 elections. That will not significantly change the economic climate since the power structure will remain basically the same. There are few Republicans who would not sign on to the current economic initiatives. We are in for a very long economic decline.
Menzie – as usual provocative through low-key and valuable. Beyond the next 18 months have you looked at the OMB’s mid-session update? They’re looking for 2.5% real GDP growth and Unemployment not returning to 5% until 2019! 2.5% growth is, to my understanding and my own analysis, not quite breakeven on labor force growth. Add in balance sheet re-structuring to an extended jobless recovery and it’ll be along time before consumer spending comes back.
Gee, DickF, aren’t metaphors fun? You can use them to prove anything. I could repost your doctor story, but replace stimulus with tax cuts and it would be saying the same thing.
DickF, how could you possibly think that we are on the left hand side of the Laffer curve at 35%. Laffer effects only kick in at very high rates, for example in the Kennedy tax cuts when we were coming off 90%+ top maringal rates. At current levels Laffer deserves to be Laughed at.
Off Topic:(sorry I need to source the intelligent people hanging around here)
If china, india, saudi arabia etc are going to peg to the dollar….what is the net effect to trade if the dollar keeps going down?
at what exchange rate will local manufacturing and local hiring will start to make sense.
(I doubt it though, since most manpower is being outsourced to china and india…..who will not budge for a while, i dont think local manpower will be able to compete globally yet)
Germany/japan/france will suffer in exports….but they can buy more stuff with their currency? is that bad for them?
DickF:
The analogy is not a good one because it does not apply to the economic situation we are in. (G-T) = (S-I) NX. Which means if (S-I) down and also NX is negative we need the deficits. There is no way you are going to fix this with additional deficits.
Also remember that we live in the era of chartalism and fiat currency, the federal govt which is a monopoly issuer of currency does not suffer from budget constraints like households which are users of currency. Of course the concern of unlimited deficits is inflation but I dont think with nearly 10% employment or more around the country and tremendous amount of un-utilized capacity we are even close to it.
In fact private sector cannot create net “financial” assets on their own. Govt spending creates net financial assets, in other words currency does not come in to existence until govt spends and currency ceases to exist when govt taxes. Taxes dont really fund anything. The primary function is to create demand for the fiat currency and to decrease aggregate demand. I see techy is starting to think along the correct lines on how modern monetary economies work.
Thanks
Menzie said, “Spending peaks in 2010Q1 and 2010Q2, not 2010Q4 as you asserted.”
I was speaking specifically of USG spending–the green portion of the quarterly bar in your graphic–not the total “payout” as described. This excludes transfers to states and tax cuts–whose benefits to the electorate are at least secondary (from a political if an not economic perspective). In contrast, incumbent Congresspersons (most Democrats) can point directly to “new jobs” created by the stimulus in their district.
I’ll stick with my admittedly cyncial point.
Techy,
It sounds as if you are a little new to this kind of discussion so I would ask you to keep an open mind and dont let bad economics distort the truth.
If China, India, Saudi Arabia, etc peg to the dollar it will cause folks like Sen. Chuck Schumer to get on their soap boxes and accuse these countries of currency manipulation to gain a trade advantage because doing that prevents the US from manipulating the dollar to gain a trade advantage. You know, kind of like a robber complaining about his victim pulling a gun to stop him from robbing.
Concerning Germany, Japan, and France, as their currencies strengthen against the dollar they will become more attractive as a store of value and so more traders will transact in their currencies rather than in dollars. That will weaken the dollar even more as foreign held dollars begin to return to the US.
Consider, a currency is actually nothing but a medium of exchange; you cannot eat a currency, nor wear a currency, nor live inside a currency, you can only exchange a currency. That means that the attractiveness of a currency is its QUALITY in exchange. If Germany, Japan, and France are more attractive producers with a more attractive currency (stable so that if you hold the currency you do not experience a windfall loss) then their exchange rate with other currencies including the dollar will actually have little meaning.
Also consider that it takes about 90 yen to buy what you can buy with 1 dollar. Does that make the yen stronger or weaker than the dollar? In truth the quality of stronger or weaker in a currency is its CHANGE in exchange value not its absolute exchange value. But consider that if 180 yen buys 2 dollars and two dollars buys one loaf of bread while 150 yen buys a loaf of bread which currency is more attractive? Exchange rates cannot be divorced from the currency buying real goods.
Right now the US is the strongest economy and until recently the dollar was the most stable currency, but just for illustration to demonstrate my point, consider US trade with Zimbabwe and Japan. The dollar is strengthening against the Zimbabwean dollar but weakening against the Japanese dollar. How has this change in exchange rate affected trade between these countries?
Just food for thought as you reason through the issues.
Dirk van Dijk,
Point E on the Laffer curve changes with different economic environments. If we are in war point E could approach 100% because the use of capital would need to be totally committed to survival. But if we are in extreme economic distress point E could approach zero as we need to dedicate as much capital as possible to production. (Remember government is totally a consumer not a producer.)
Most who have studied this issue consider any taxation above 20-25% in a normal economy as being in the prohibitive range of the Laffer curve. Now understand this means all taxes, federal, state, and local. This is why you see producers leave places like New York City and California to live in Florida and Nevada or Arizona.
With our economy is its current weakened economic condition I would say that point E is closer to 10%. Right now our economy is tied into all kinds of knots and suffering under all kinds of foolish regulations. Unemployment insurance and minimum wage laws have pushed wages up squeezing business profits, while government spending is crowding out producers. Any increase in taxes in our current ecoomic climate increases the stress on the economy pushing it deeper into the prohibitive range of the Laffer curve.
Econrebel,
Your name should be Econ-Tory. Your reasoning is pure British Keynesian.
John,
When you consider metaphors you need to see if they apply. A tax cut is a permanent change in the economy. Monetary stimulus is just a shot in the arm. In this analogy tax cuts are not equal to monetary stimulus.
I remeber most arguments weren’t related to timing. The timing argument was usually tacked on to the end more dire claims; “Even if you ignore…, the timing of the stimulus spending make it ineffective.”
Since we slipped into monetary policy, not that far from what we are discussing, the fact that gold hit a new high today is very instructive. I know that many here do not know any more about the power of gold than what they have been told by the infomercials on late-night TV or by Bernanke (not much difference) so it might be helpful to discuss the dynamic.
Late yesterday reports surfaced that the oil producing countries were working a secret deal to no longer quote oil in dollars. Most people understand that if this were to happen dollars being held in reserve would flood out of central banks and return to the US. In all probablity the dollar would tank big time. Because of this there was a rush to quality, dollar traders bought gold.
The oil producers have denied the rumor but gold only stabilized at $1,040/oz, near the new high. There is still uncertainty out there.
Anyway, for those who do not understand the power of gold and still cosider it a “barbaric relic,” consider what just happened. This is not an isolated event. The dollar may no longer be tied to gold but gold is still tied to the real economy. If you do not understand the relationship between gold and the dollar you cannot understand monetary policy. If you want to know the condition of the dollar watch its value relative to gold.
DickF:
The reasoning is different from the neo-liberal thinking that has dominated the economics sphere for the last 35 years. My thinking is more along the lines of chartalism, where taxes don’t fund anything and it is how the real world works. Also in the real world, Loans create deposits and not the other way round. Economics is demand driven and Say’s law does not apply. And it is not Ok to have unemployment. Japan is a working model for the dynamics of Modern Monetary theory. Unfortunately the mainstream starts with the wrong premise and has such a prejudice to even look and learn.
I agree that economics is demand driven. I believe supply does not always create demand but demand will always, except for a few rare cases, create supply. You cannot invest or save your way out of a recession when capacity utilization is less than 70 percent. And there is nothing wrong with being “pure Keynesian”. Compare prices and business cycles from 1800 to WWII with prices and business cycles from WWII to 2009. The latter period brought a giant leap in prosperity to millions in the working class with a relatively stable economy for 60 years. Like it or not, Keynesian economics played a role in that fact.
Has anyone noticed ( are there any studies of periods) 18 month cycle in US stocks over the last 30 years? Of course, there can be many frequencies involved BUT the test with Lehman impulse should discover the deepest internal dissipation and resonance times in financial system, as, as long as system is not broken, the higher pulse amplitude will test it more properly, and the time of Lehman crisis in Stocks ( which started in Oct 2009) and should almost exactly follow the internal resonance period of the system.
So far, it looks like it is approx 18 months, Aug (peak) /over a year March ( dip) /next year Aug (peak) /over a year March (dip) etc cycle.
Normally , this cycle is not so visible as price oscillations are not deep, but it should be always in the bacground as it is inherent to the system called stock market, at least during last decades.
Econ…
Thanks for clearing up your thoughts on economics. It appears that you take all of the bad in Keynesianism and throw out any good (yes, I will admit that there can be good from Keynes’ thought if only by accident).
In the real world taxes are necessary to fund the state’s job of enforcing contracts. It is a cost of production just like a nightwatchman is a cost.
In the real world you cannot demand anything without having something to trade. The only way you can have pure demand, meaning demand without prior production, it to be gifted of the production of another.
In the real world people are unemployed all the time as they change jobs or improve their conditions. But that is different from unemployment created by government.
Japan has had many monetary systems none consistently so I am not sure which one you are referring to. You could help me here by describing the monetary system you are referring to.
You and I do agree that the mainstream starts with the wrong premise and is prejudiced to the point of failing to learn.
Peter Van Schaik,
Supply never creates demand. Keynes incorrectly paraphrased Say.
Supply satisfies demand. Demand comes from scarcity and is always with us. Confiscating from others through taxation or inflation does not create demand. Demand models simply redistribute supply and often create malinvestment giving the illusion of a supply glut. The demand model is an illusion.
Says law in Says own words:
“It is not the abundance of money but the abundance of other products in general that facilitates sales… Money performs no more than the role of a conduit in this double exchange. When the exchanges have been completed, it will be found that one has paid for products with products. Emphasis is mine.
DicKF
You said
” In the real world taxes are necessary to fund the state’s job of enforcing contracts. It is a cost of production just like a nightwatchman is a cost”
I don’t know if this means taxes are needed to generate demand for currency. But taxes don’t fund anything at all. When you pay taxes, you take currency out of circulation.
You said
“In the real world you cannot demand anything without having something to trade. The only way you can have pure demand, meaning demand without prior production, it to be gifted of the production of another.”
In the real world, firms use credit to create resources to trade. They only trade so much to satisfy the demand. In the real world loans create deposits and not the other way around.
When I mentioned Japan, I am referrring to the current monetary system we all live in. Where we have a fiat currency that is not convertible and have a flexible exchange rate and where the govt that is the monopoly issuer of the currency has no spending constraints (but for the real resources including labor).
In Japan, we are still looking for the elusive inflation due to the extreme level of deficit spending.
I would refer you to the works of Randall Wray, Wynne Godley, Marc Lavoie, Scott Fulwiller and others.
In the real world people are unemployed all the time because govts are so ideologically hijacked by the mainstream that they don’t realize that they have the means to prevent unemployment.
And the demand model is not an illusion. In the real world market clearing does not occur. Thanks
DickF:
Here is a post from Bill Mitchell. it is good starting point to understand how to build macro economic models that are stock flow consistent and why it is important to do so.
Stock-flow consistent macro models
Those who hoped that a bigger, faster stimulus could cure the economy might now be expected to recast their hopes on prolonging the stimulus. But it would be strange if classical liberal critics of the stimulus changed their critique, as economic malaise despite, and, as time goes on, even because of the stimulus is exactly what we expected.
Econorebel,
I’ve got another one for your repertoire:
“In the real world, pregnancy precedes sex, not the other way around.”
Say hello to the real world for me.
Cedric:
When you cannot give economic repertoire, use a random analogy or discredit arguments completely without any economic basis As for loans creating deposits, its not my ideology. Thats how the real banking system works. Please look up how reserve accounting and banking works and also in the real world firms produce on credit and they sense an opportunity looking at the demand. In fact the analogy you gave most applies to the neoclassical/neoliberal operating paradigm which influences the current policy decision. So the analogy you gave applies to you and other neoclassical/neoliberals. Thanks
Econ…. wrote:
In the real world, firms use credit to create resources to trade. They only trade so much to satisfy the demand. In the real world loans create deposits and not the other way around.
Econ…
You need to read Henry Hazlitt’s Economics in One Lesson. You must not limit economic analysis to only that portion of an economic transaction that supports your point.
How can a firm obtain credit without either having existing assets from prior production or pledging future production in return for the credit? You have to think your transactions through completely.
Next, what business intentionally produces more product than it intends to sell or use? Firms do not trade based on demand they produce based on expected demand. If they mistakenly produce too much for the real demand they will lower the price to increase the market for their product exactly as Say’s law suggests.
Loans do not create deposits. No bank is able to loan without having the deposits to loan. The bank may receive deposits from the FED in the form of fiat currency, but they still have to have the deposits to loan. Loans do not simply appear out of thin air. You can only come to your conclusion if you begin your analysis in the middle of the total economic transaction rather at the beginning, once again I refer to Hazlitt.
Give me a specific example of a loan being made without a prior deposit (but think through the entire transaction first).
I have printed out the article by Bill Mitchell and will give it a detailed read when I can find the time.
Just for the record Cedric’s comment is very amusing but not throught through. Without the prior production of sperm and egg there can be no pregnancy. In other words if you attempt to stimulate production out of thin air you end up getting nothing but screwed.
DickF
I didn’t think it thru that much, but thanks for fleshing it out for me.
But you did touch on my half baked point here:
“You must not limit economic analysis to only that portion of an economic transaction that supports your point.”
If you don’t know why she’s pregnant, don’t go inventing wild theories.
Econ…
I read the paper by Bill Mitchell. He has bought into the money illusion.
If an economic theory will not work with a barter economy it is not a complete theory. Early in the paper Mitchell defines what he considers “the modern monetary economy.” This sets the pace of the remainder of his analysis, but because of his fundamental assumption he is unable to deal with the non-money economy that is a significant part of any economy.
He states “the socereign government deficit (surplus) equals the non-bovernment surplus (deficit).” If he means deficit/surplus relative to the federal budget then this is a created identity that has little meaning. Consider a government with a budget of $10 million. If the legislature authorizes the spending of 10% over the budget there is a $1 million deficit. This must be paid for in additional taxes, through borrowing, or through printing additional money. None of these results in a surplus for the non-governmental sector, each actually resulting in a deficit in the non-governmental sector relative to what it had before the government spending.
Has the legislature created $1 million surplus of goods and services? I am sure that Mitchell assumes this, but it is not at all given. It is just as valid, actually more valid, to assume that the additional $1 million was simply absorbed in inflation. This is where the money illusion comes in.
What the government has done is created $1 million additional dollars to be used in exchange for no change in goods and services. What that means is that the value of each dollar is worth less in exchange.
I would suggest that you study more about third party exchange and the origin of money. Mitchell could also benefit from studying more about the theory of the origin of money.
I encourage you to look at your theory again and ask what comes before and what comes after and also ask if the assumptions made are the only results possible.
Dick F and Cedric:
I will read through the article DickF pointed out. but in the real world Loans do create deposits and the money multiplier is reversed. Consider you going to your local branch for a loan, the local loan officer does not have any knowledge about the entire day’s transactions or pending transactions or the reserve positions before making or approving your loan and making your loan. Your loan is made just on the basis on your credit worthiness. And the bank’s balance sheet expands on the basis of the loan that is just made. The loan becomes the asset and the corresponding deposit an asset. This changes the reserve positions of banks and then FED performs Open market operations to maintain reserves/interest rates.
Post Keynesian Economic analysis is the most complete in terms of keeping track of transactions between stocks and flows and does not look at a single transaction to suit their point. I don’t blame you guys for getting this wrong or not believing it since mainstream economics textbooks reinforce the money multiplier over and over again. Please look up this article on how modern money mechanics work by Scott Fulwiller.
There are extensive references/evidences for how loans create deposits and not otherwise and how reserve banking works. You will see how screwed up mainstream economic analysis is and how they have gone about “inventing wild theories” that do not apply to the modern world and wonder how they ended up messing up so much. In fact mainstream economists are the ones that have limited their economic analysis to a portion that supports their models and thats why the whole economy is so messed up. All I ask is to read these papers and blogs without prejudices and just follow the content. Thanks
DickF and Cedric:
Here is a nice presentation about Modern Money Mechanics
Thanks
DickF
The identity he mentions is a known one to every one in macroeconomics. It is an accounting identity and is not made up. Remember expenditure identity is Y = C + I + G + X – M.
The wage identity is Y = S + T.
Equating both and rearranging terms we get
(S – I) = (G – T) + (X – M)
Private sector surplus S is directly corresponding to Govt deficit (G-T).
In reality the private sector cannot create net FINANCIAL ASSETS.
In the private sector balance sheet for every asset there is a corresponding liability. New financial assets can come in to the system only by Govt spending which by the way need not be financed by any debt issuance since the Govt is a monopoly issuer of fiat currency and levies taxes only in that currency.
In your example the legislature creates $1 million in financial assets which creates real goods and services in the world. Bill Mitchell does not assume this. This is how the world of currency works. Currency comes in to existence when Govt spends and goes out of existence when Govt taxes. As for the origin of money, I encourage you to deeply understand the mechanics of modern money and how it helps produce real goods and service.
As I see you when you read Bill Mitchell’s post you got immediately carried away because of your prejudices built in due to Quantity theory of Money.
Inflation happens when spending exceeds demand when the economy operates at full capacity. With several percentage points in unemployment the economy is nowhere close to giving rise to inflation. I am strongly encouraging you study Japan closely on this subject
Finally on a closing note, I think the Post Keynesian way of looking at stocks and flows comprehensively is the best method to build a model of economy. In fact if you look at Marc Lavoie or Wynne Godley’s works you will see they deal with REAL economy including goods and services in a very comprehensive way.
Also my thinking on modern money has been shaped by several papers by Randall Wray. Here is a paper that will address the questions you ask The Origins of Money and the Development of the Modern Financial System
Econ…wrote:
Consider you going to your local branch for a loan, the local loan officer does not have any knowledge about the entire day’s transactions or pending transactions or the reserve positions before making or approving your loan and making your loan.
Have you ever applied for a loan?!! This is utter nonsense. If loan officers approached their business like this they would have to work for the government becuase they would be fired from a real loan office.
In recent years as loan rules were relaxed loans based on a person’s signature have come into vogue especially with credit cards, but I can remember when this only happened for the very best customers of a loan office. But you have to understand what a signature loan means. You are placing your reputation up as collateral for the loan. That is the asset. If you fail to pay the loan the loan company will take your reputation in the form of your credit rating. Nothing is free.
One of the biggest problems we have with loans today is the way bad debts are dealt with by the government. Business write off bad debts as a course of doing business so bad debts are socialized, paid for by you and me. Government does the same when it intervenes in loan agreements and forces a bank or mortgage company to give a loan to someone their experience determines is a bad risk. The whole reason for Fannie and Freddie to exist was to take on risk that banks would not so that bad credit risks, those who has already sold their reputations, could get loans.
We need to get back to a world where no company can make money selling an analysis of your credit rating. Not long ago, within my lifetime, if you had asked someone what their credit rating was they would have thought you were a nut. Today you get credit rating infomercials in prime-time. And we wonder when we have a credit crisis.
It is theories like these that have caused our problems. Loans create deposits so just borrow your butt off…..NOT!
Anon:
Loans creating deposits is not a theory. It is the operational reality of the banking system and it has been like this for a long time. Next time you go to a bank for a loan ask the loan officer if he has made sure that the bank has enough reserves to make the loan. I have already provided several resources above that show that loans indeed create deposits and money gets created endogenously in the system. Thanks
Econrebel,
It is not correct to say that money gets created in a fractional reserve banking system. It is correct to say that credit is created in a frbs.
Well DickF, I guess we are all wet about things. Our model of the real world does not adequately take into account the female organism, and the fact that the magic moment may not occur at exactly the same time between a male and a female, and is even less likely when viewed from a macro perspective.
I guess it’s back to the drawing board.
Rob:
It depends on how narrowly you define money. Essentially loans create deposit that in turn lead to an increase in reserves in the processes. Neither the govt nor the central bank has control over it. It is all endogenous and to make sure the economy functions smoothly reserves are made availabe. Actual paper money may not have changed in the US for a long time but deposits indeed have.
Thanks
“Note that the newly released IMF WEO forecasts project continued growth into 2010.”
Remind me. What did the IMF WEO forecast in January 2007? I believe it was continued growth into 2009.
Econ,
You whole theory is spontaneous generation, something from nothing.