An Austrian Critique of MMT?

Economics Economics Questions
121

everyone seems to forget the ‘demand leakages’ which means income that goes unspent

Why do these demand “leakages” occur? That is the more important question.

it’s all based on the mistaken notion that with today’s non convertible dollar you need savings to have money for investmnet. again, that’s gold standard stuff, inapplicable with today’s institutional structure.

You don’t. However, Austrians analyse the impact of the fictitious economy on the real economy and compare with how savings occur under a 100% reserve system. The analysis isn’t pointless intellectual masturbation but to a) single out the causes of the business cycle and b) make the point that printing more paper will not increase real wealth.

unspent dollar income will not result in real savings- in fact in most cases the opposite is true. with low spending real investment suffers because to a large extent dollar sales drive real investment. why invest in real capital goods if you can’t sell the products?

Because the whole point is to develop a proposition that is marketable. If the goods aren’t selling and you cannot find a way to produce marketable, then there is indeed no point in the investment, which will materialise in losses. Low spending is a consequence of lack of demand.

this is in the book, tool

There is no need for insults.

122

under current institutional arrangements, the reserve % if close to meanless. Canada has had 0 reserve requirements for years, for example, and it hasn’t made any difference, as they correctly said it wouldn’t. nor would 100% reserves make any difference of consequence. It would matter under a gold standard, but not with today’s non convertible currency.

today most demand leakages are probably ‘caused’ by tax policy and other law, best I can tell.

‘printing paper’ does not cause wealth.

but not ‘printing paper’ when other govt policy has caused a demand for that paper can restrict growth. that is, fiscal adjustments can remove drag

sorry about the typo. should have read ‘this is in the book, too’ It’s spelled out in a lot more detail there.

Low total spending can be from a lack of spending power. for example, if the govt put a $1,000/mo tax on everyone and didn’t increase its spending, i’d bet total spending and gdp would go down. a lot. a monopolist can do a lot of damage

123

How can it not matter when it influences the total level of money in an economy? Of course, that depends on the appetite of banks to actually extend credit, but the fact that they can operate without reserves (for lack of fear of insolvency/bank runs etc.) is largely attributable to governmental institutions like the Fed.

124

"OK, since you brought up Bob Murphie’s article I am going to point out some errors in It, because I know guys like Warren Mosler, Bill Mitchell and Randall Wray are not even going to bother with It. Murphy doesn’t understand what is going on.

I see no reason why anyone would bother with them, so tu quoque I guess.

And what is that? There is no such thing in a wordl with central banks. This is some theoretical construct that doesn’t apply.

Which you have repeatedly failed to prove. Outline your theory of how real wealth is created."

What do I need to prove? That interest rate is set by fed? If there is some place where interest rate is not set by central bank, show It to me! Give me some data too on this “market interest rate”! After all this is not a theoretical construct right? You should be able to show me that. Where is the place in the world where there is a free market interest rate not manipulated by a central bank?

"They are always free to create loans at a given price level. They are not “more free” now after the fed has pumped reserves. Bank lending is not constrained by reserves. In fact the reserves are electonic numbers. Banks have a reserve account at the fed. Me and you cannot use those reserves to go shopping, banks are not lending those reserves to me and you, they stay at the fed. Banks need those reserves to settle payments with other banks and wit the government.

You’ve asserted this a number of times. Do you have any money supply figures showing that bank credit is out of tune with reserve requirements? Now let’s suppose it is. What does this prove? That the banks are even more unhinged than the Fed would like? Well, whoop-dee-doo?"

Even if I showed you the figures that would be just well-whoop-dee-doo. So why should I bother? I could find that but that’s not the point here at all. The reserves adjust to whatever level the reserve requirement is set. And if there isn’t one the reserves still adjust to whatever amount the banks need them to settle payments with other banks and the government. Not to create loans!

"Those reserves are a fiction to the real economy and the reserves cannot cause inflation.

The reserves the banks have on board with the Fed? Indeed. The credit the banks extend and pile on top of these reserves? Hell no."

Bank credit creating ability is not constrained by reserves. What part of It don’t you understand?

"He doesn’t understand that bank lending is not constrained by reserves but he is not the only one.

Actually, it is. Else banks would suffer bank runs and depositors would not put their money in the bank out of solvency concerns. Under the current banking system, they enjoy a degree of immunity from this mechanism due to government guarantees and the central bank’s ability to “print up” money. If your argument is that the banks need not abide by reserve requirements, first you need to prove this and secondly, you need to realise it does not alter Austrian theory one iota."

Bank solvency and bank liquidity are separate issues. You are mixing up reserves with capital.

"The fed funds rate was set by fed. Prime rate doesn’t set the fed funds rate. Prime rate comes down when fed funds rate goes down.

Got us there, Sherlock. I’m not sure what the significance of this point is. No one said the Fed controls it directly."

Seemed like Murphy didn’t understand that Watson.

"First you Austrians seem to be critisising the fed for central planning and setting the rates and now Bob Murphy seems to be assuming that fed is not setting the rates and the markets are. Do you see the error?

The Fed does not set the prime rate directly, that is true. Yet it does try to influence the market both by setting reserve requirements (if you say it doesn’t, prove it; even if it does not, it is the mechanism that allows banks to flood the system with credit) and OMO. Austrians criticise it for distorting market rates. Part of the Austrian theory is that eventually market rates will re-assert themselves. So what is the ‘error’ here?"

That’s a nice theory but under current rules the rates are staying where the fed wants them to stay. It is very hard to prove empirically that reserve requirements have nothing to do with the rates. They are not changed every day as you know. Just logic should do It, the fed has no choice but to provide the banking system with reserves if It wants to set the target interest rate. If it chooses not to provide the banking system with demanded reserves then it loses the control over the rates and fed is not doing that as we all know.

125

reads like you may be talking about capital rather than reserves?

capital is the ‘net worth’ of the banks- the difference between assets and liabilities- the private sector ‘skin in the game’

reserves are their cash balances in their account at the cb- part of bank assets

with fiat currency, like the dollar, banking is capital constrained but not reserve constrained.

126

“How can it not matter when it influences the total level of money in an economy? Of course, that depends on the appetite of banks to actually extend credit, but the fact that they can operate without reserves (for lack of fear of insolvency/bank runs etc.) is largely attributable to governmental institutions like the Fed.”

Again you are mixing up solvency with liquidity.

127

"2: Example: Reserve Requirement 100%

This means only $100 lend out so only $10 income and $5 costs to pay to the FED. Only 50% profit! Don’t you think that makes huge difference for the bank? A bank is therefore always interested to lend out as much as possible (constrained by the supply of creditworthy customers depending on the interest rate set by the FED). Sure it can whenever it wants increase the reserve to $1000 at the FED, so it also can lend out $1000. But still only 50% profitmargin!

A profitmargin of 95% gives you much more room for lending to even less creditworthy customers as a 50% profitmargin is doing. Isn’t it? So if the FED leaves the interest rate at 5% and inceases its reserve requirement from 10 to 100% then banks are forced to increase the reserves held at the FED, but banks with marginal profits would be bankrupted through the additional costs to pay to the FED and are forced to liquidate their marginal loans instead. Doesn’t sound like it would not affect the amount banks would lend…"

Bank loss is a bank loss no matter what the reserve requirement is. There are so many issues with the 100% reserve requirement. More than we want to discuss here :slight_smile:

128

right, and let me say it yet another way

loans create both deposits and reserves, as a matter of accounting (with non convertible currency like the dollar)

to explain,

if a bank loans you $100,000 to buy someone’s house,

the seller of the house gets the deposit and you got the loan.

the bank with the deposit has now a new reserve requirement (if there is one)

let’s assume a 10% reserve requirement- $10,000 to keep the math easy

in the first instance his reserve account is suddenly 10,000 lower than required due to the new deposit

call it an ‘overdraft’ for all practical purposes, which, functionally, is a loan from the fed.

so the loan created a deposit which created an ‘automatic’ overdraft at the fed.

if the bank does nothing and remains ‘overdrawn’ the fed actually and correctly books that overdraft as a loan.

normally the fed does open market operations, or something like that, to loan the bank the 10,000 at a rate below the overdraft rate.

why? because the rate charged to the bank gets passed through to borrowers, and the point of monetary policy is to control the rate of interest in the economy via the bank’s cost of funds.

So it’s all about price (the interest rate) and not quantity of funds.

also, this is a description of monetary operations, and not economic theory

129

What do I need to prove? That interest rate is set by fed?

That reserve requirements are immaterial. To make it simpler for you, what in this article is wrong?

Even if I showed you the figures that would be just well-whoop-dee-doo. So why should I bother? I could find that but that’s not the point here at all. The reserves adjust to whatever level the reserve requirement is set. And if there isn’t one the reserves still adjust to whatever amount the banks need them to settle payments with other banks and the government. Not to create loans!

What are you basing this on? In particular:

The reserve requirement (or cash reserve ratio) is a central bank regulation that sets the minimum reserves each commercial bank must hold (rather than lend out) of customer deposits and notes. It is normally in the form of cash stored physically in a bank vault (vault cash) or deposits made with a central bank.

Which part of this do you disagree with? I agree that absent reserve requirements, there is no limit to a bank’s ability to extend credit (other than the possibility of bank runs.) More appositely, what is your problem with the multiplier theory?

Bank credit creating ability is not constrained by reserves. What part of It don’t you understand?

The part that you’ve so far failed to justify by way of argument.

Bank solvency and bank liquidity are separate issues. You are mixing up reserves with capital.

A bank’s loans count as assets on its balance sheet. They’re not capital, but that isn’t currently what’s being discussed.

Seemed like Murphy didn’t understand that Watson.

Do oblige me by clarifying.

That’s a nice theory but under current rules the rates are staying where the fed wants them to stay. It is very hard to prove empirically that reserve requirements have nothing to do with the rates. They are not changed every day as you know.

Then prove so logically.

Just logic should do It, the fed has no choice but to provide the banking system with reserves if It wants to set the target interest rate. If it chooses not to provide the banking system with demanded reserves then it loses the control over the rates and fed is not doing that as we all know.

Indeed.

why? because the rate charged to the bank gets passed through to borrowers, and the point of monetary policy is to control the rate of interest in the economy via the bank’s cost of funds.

So it’s all about price (the interest rate) and not quantity of funds.

also, this is a description of monetary operations, and not economic theory

It factors in economic theory because it affects the size of the money supply (as credit extension is part of it) and therefore inflation in the economy, and the ABCT factors it in for its explanation of generic boom/bust cycles. In and of itself it is not a matter of economic theory, no.

130

in the past, the fed, as monopoly supplier of net reserves, would hit their fed funds target by just keeping the banking system slightly ‘net borrowed’ or short a few hundered million or so, and then setting the rate the banks would need to pay to borrow those funds from the Fed.

but today, the fed keeps excess reserves, and pays interest on reserves to hit its target ff rate

these are all operational matters the monopolist uses to set price

131

Ok I didn’t see this first:

1: CPI Price inflation: Will stay below 5%, below 10%, below 20%, might get even higher ?
2: Heavy deflation might set in?
3: US deficit will not get out of control and the creditworthyness remains and a major sell off of US bonds will not occur?
4: A break down of the fiat regime is unthinkable. Commodities won’t be used to back them again?
5: Will there be a QE3? Would you be in favor for it?
6: Why do central banks still own gold? Would they sell all of it if they knew MMT?
7: What do you think will happen to the Gold/Silver price? Will it go down to levels before 2008 or much higher?

these are just my personal opinions:

1 and 2. might get some deflation or inflation, both mild, depends on the government :slight_smile: if It cuts spending then might get some deflation and then It ends up spending even more.

  1. You have to define out of control. Right now Its out of control since they are not spending enough. They are focusing on bookkeeping entries and not on the real economy. Those bookkeeping entries can only have meaning if you look at the background too. It is just like stepping on the gas pedal of your car and applying brake. You have to look at the speed. If you are going uphill you might have to really step on It and It doesn’t matter that you haven’t applied the brakes for a while. Other times you might have to step on the brakes all the time. And sure accidents can happen, that doesn’t mean that you cannot drive at all.

  2. I guess break down of any regime is not unthinkable. In my opinion gold standard has a bigger chance of breaking down. Currency boards fail all the time, they are kind of similar to gold standard.

  3. I think not and I am not in favor of It.

6.I don’t know that. Old relic??? May be Warren knows better.

  1. It is very speculative and I don’t know, I used to trade gold myself with high leverage. Now I like to sleep at night. :slight_smile:
132

pretty much agreed on all

the fed doesn’t plan on doing qe3, but may if things soften. qe doesn’t actually do much of anything but they believe it does, so it becomes a case of ‘doing something rather than nothing’. I suspect the interest income qe removes from the private sector and turns over to the tsy as ‘profits’ does more harm than the lower rates do good. but just a guess.

yes, cb’s own gold because it’s politically easier to own it than to sell it. and it’s not a whole lot in the scheme of things

silver is on a tear/bubble- no telling how far it may go. gold may have run its course for a while. but I don’t have any conviction on either one.

133

It was not my intention to start a discussion about 100% reserve banking. I just wanted to keep the math easy :wink: It seems we are talking passed each other again. Yes I agree a bank is technically not constrained by the reserve requirement, but in real life losses/costs matter to a bank. All I am saying is that a bank will not make as many loans with a higher reserve requirement as with lower one, due to higher costs per $1 loaned. Borrowers are only able to pay certain amount of interest; this doesn’t change when reserve requirements are changed. So an increase of the reserve requirements will force banks to liquidate existing marginal loans, and stopping them from offering new ones in the future. And this affects the money supply accordingly. This still stands. And yes I agree, the ultimate constraint still is the rate of interest!

Thanks both for giving me your opinion about my questions.

134

I need to add, that you could offset the higher costs per 1$ loaned with decreasing the rate of interest set by the FED, but this was not the issue here.

135

"It was not my intention to start a discussion about 100% reserve banking. I just wanted to keep the math easy :wink: It seems we are talking passed each other again. Yes I agree a bank is technically not constrained by the reserve requirement, but in real life losses/costs matter to a bank. All I am saying is that a bank will not make as many loans with a higher reserve requirement as with lower one, due to higher costs per $1 loaned. Borrowers are only able to pay certain amount of interest; this doesn’t change when reserve requirements are changed. So an increase of the reserve requirements will force banks to liquidate existing marginal loans, and stopping them from offering new ones in the future. And this affects the money supply accordingly. This still stands. And yes I agree, the ultimate constraint still is the rate of interest!

Thanks both for giving me your opinion about my questions."

The way I undersood you was that you were thinking that if the reserve requirements were made lower, banks had a bigger slack somehow and the could lend more recklessly. (sorry if you didn’t mean that but this is the way I understood you.) This is not the case however. Bank still has to cover every loss out of its capital no matter what the reserve requirement is.

Let’s say a bank is issuing a loan to you and you use that loan(you transfer those numbers to my bank account) to buy my house. I have the freshly created deposit now that is a bank liability(what bank owes me). And you owe the bank exactly that amount that is an asset to the bank. If you don’t pay then the bank has to use Its own capital to pay me. This deposit was created and the reserve position of the whole banking system didn’t change because of that. (It could have changed for this individual bank if I had a bank account with another bank because corresponding change has to take place then in the reserves of this bank too). If the banking system is short of reserves then the banks are trying to borrow the reserves and fed is providing the demanded reserves at a certain price level.

If the reserve requirement goes up then this is certainly additional cost to the banks but I just don’t see why loans should start defaulting now. Banks are making money on the spread, they don’t pay me interest on my demand deposit yet they charge you interest on your house loan.

Sorry if I misunderstood you.

136

I was not talking about full reserve. With full reserve there are going to be another issues and there are so many modifications of the full reserve system, so this was about raising reserve requirements. Like I said we don’t want to get into that full reserve talk here.

137

"The reserve requirement (or cash reserve ratio) is a central bank regulation that sets the minimum reserves eachcommercial bank must hold (rather than lend out) of customer deposits and notes. It is normally in the form of cash stored physically in a bank vault (vault cash) or deposits made with a central bank.

Which part of this do you disagree with? I agree that absent reserve requirements, there is no limit to a bank’s ability to extend credit (other than the possibility of bank runs.) More appositely, what is your problem with the multiplier theory?"

“It’s normally in the form of cash stored physically in a bank vault or deposits made with a central bank”

The vault cash in the banks and the deposits made with central bank are all the same data in different forms and don’t exist in real economy. These numbers cannot by stuff from the real economy like your demand deposits do. That is why I call It fiction. Cash in economy can buy stuff. Demand deposits can buy stuff. If you want to say that banks are able to lend now, well I have said too many times that they are free to do that all the time. They don’t need the exess reserves for that.

“I agree that absent reserve requirements, there is no limit to a bank’s ability to extend credit(other than the possiblity of bank runs)”

They have capital requirements but let’s leave that aside.

case A: no reserve requirement and banks can extend credit as much as they like.They still need reserves to settle payments and they can get those reserves in unlimited quantity from the central bank at a certain price.

case B: there is 10% reserve requirement. Banks can get the reserves in unlimited quantity from the central bank at a certain price.

Are you saying now that in case B the banks’ ability to create loans is limited and in case A is not?

More appositely, what is your problem with the multiplier theory?

The money multiplier theory assumes that the Fed controls the money supply by setting the required reserve ratio and then providing the banking system with enough reserves to enable aggregate bank lending to a multiplie of that ratio. At first glance It even appears to be so(not now since fed has been pumping reserves). But the truth is exactly the opposite.

The money multiplier theory represents a misunderstanding about how the credit money supply grows. Banks can lend and do lend without adequate reserves on hand. They see a profitable customer and they lend ccause they can always get the required reserves. If i am not mistakek Its 2 week avarage or something like that in US. In other contries the rules are even more rrelaxed. In my country they had a reserve requirement and bank reserves could never get below 40% of that reserve requirement and the requirement was avarage of 2 months- something like that. It’s all about price and not quantity. That Wikipedia page is Wrong about China. it’s still about price in China and not quantity.

138

@Kristjan

No problem. Misunderstandings are a standard problem in such discussions.

Let’s get it through: Reserve requirements increase, and with it the costs a bank has. Now it will try to give these new costs to its customers and will tell them. We are sorry but we need to increase the interest charged for your loan. Unfortunately some borrowers will reply, we are sorry too but we cannot pay the new rates. The bank will apologize again and will inform them that they will call the loan and seize the collateral (e.g. the house). The bank will sell the collateral and can now with the cash reduce its overdraft at the FED and minimize its losses. A bank is not interested in paying with its capital for losses it can avoid completely. Along this the money supply would decrease accordingly.

139

(first, and not that it matters, I currently own a small bank)

yes, reserve requirements are a ‘bank tax’ as the old text books used to say

they raise the cost of funds for all banks, and hence are a tool for the Fed to hike rates for the economy

yes, if rates rise and borrowers become insolvent they lose their collateral. (that’s sort of part of how higher rates are supposed to cool demand)

yes, assets sales by banks increase their balances at the Fed by shifting balances from the bank of whoever bought the collateral in question. But if the buyer of the collateral has his accounts at that same bank its reserve balance doesn’t change. So the collateral sale does not alter total reserve balances of the banking system

140

@skylien

you have some odd ideas :slight_smile:

how about just taxing the banks? some % of their balance sheet?

they have to transfer that cost to their customers somehow and if some customers cannot afford the new higher fees they go belly up and money supply shrinks. You must be kidding skylien.