Transcript Money, Credit and Finance

Money, Credit and
Central Banks in
PKE
Marc Lavoie
Outline of the chapter on PKE money
• 1. The main claims of the post-Keynesian views on
money, credit and finance
• 2. PK monetary theory in historical perspective
• 3. The horizontalist and structuralist
controversies
• 4. New developments in monetary policy
implementation
• 5. Monetary policy implementation in the aftermath of
the subprime financial crisis
• 6. Implications for public finance theory and for openeconomy monetary economics
• 7. The integration of PK monetary economics into PK
macroeconomics
Part I
Preliminaries
Post-Keynesian monetary subschools
PostKeynesian
Monetary
Economics
Structuralists
Chartalists
UMKC school
Horizontalists
Circuit theory
Accommodationists
Paris and
Naples
Emissions
theory
Dijon
Free
University of
Berlin School
Endogenous money supply: A PK claim
now accepted by many schools
• Post-Keynesians
• Neo-Austrians
• New Keynesians
– (New consensus authors), Woodford, Taylor,
Roemer, Meyer
– (New Paradigm Keynesians, focus on credit)
Stiglitz, Greenwald, Bernanke
• Real business cycle theorists
– Barro, McCallum
• Goodhart
Cambridge proverbs
• The Cambridgian hare: « Economic ideas move in
circles: stand in one place long enough, and you will
see discarded ideas come round again. » (A.B.
Cramp 1970)
• Most of modern monetary controversies can be
brought back to the 1844 Currency school (Ricardo)
and Banking school (Thomas Tooke) debates.
• The Radcliffe commission view (1959), endorsed by
Kaldor and Kahn, which was considered dépassé in
the 1970s and 1980s, is now back into fashion.
Part III
The Structuralist vs
Horizontalist PK controversies
“A storm in a tea cup” (Moore 2001) ?
• The first exponents of money endogeneity were mainly
“horizontalists”: Robinson, Kahn, Le Bourva, Kaldor, Moore, and
the French “circuitists”.
• The main “structuralist” critics were Le Héron, Dow, Wray,
Howells, Pollin, and Palley, many of which got their inspiration
from Minsky.
• As Fontana (2003) puts it, “structuralists took over where the
accommodationists had stopped”.They brought some
clarifications and provided new details. For instance, they
insisted that spreads between interest rates could quickly vary,
due to assessed default risks or changes in liquidity confidence.
Sometimes, however, they constructed a “horizontal strawman”
in an attempt to highlight the originality of their contributions.
• To a large extent, the controversy has petered out, for reasons
that will soon be given (although Rochon has rekinkled some
excitement by editing a forthcoming book on the topic!).
The horizontalist claims
• 1. The supply curve of money (or high powered
money) can best be represented as a flat curve, at a
given interest rate. The short-term interest rate can
be viewed as exogenous, under the control of the
central bank, within a reasonable range.
• 2. There can never be an excess supply of money.
• 3. The supply curve of credit can best be represented
as flat curves, at a given interest rate (or rather at a
set of interest rates).
• 4. Central banks cannot exert quantity constraints on
the reserves of banks.
The structuralist points (in italics points
that I believe were off the mark)
• 1a. What about the reaction function of the central bank? [Chick
1977, Rousseas 1986, Palley 1991, Musella and Panico 1995]
• 1b. Long-term and other market-determined rates “cause” the
overnight rate [Pollin 1991]
• 2. If loans create deposits, how do we know that households wish to
hold these deposits? [Howells 1995]
• 3a. What about credit rationing (shape of credit supply curve)?
[Dow2 1989]
• 3b. What about borrower’s risk? [Minsky 1975, Dow and Earl 1982]
• 3c. and lender’s risk (liquidity preference of banks)? [Dow2, Wray
1989, Chick and Dow, Bibow 2009]
• 4a. What about financial innovation, with changes in the velocity of
money and liability management, which are the main sources of
money endogeneity [Pollin 1991, Palley 1994]
• 4b. Surely the central bank does not always “accommodate” and
hence exerts quantity constraints on bank reserves [Pollin 1991]
The horizontalist answers I
• 1. On the horizontal supply of HPM:
– New operating procedures, based on a target
overnight rate, show clearly that central banks
control the overnight rate and can set it at will,
notwithstanding what “markets” think;
– Of course, if, in general, higher economic activity
is accompanied by higher inflation rates, then,
through the central bank reaction function, higher
interest rates are likely to accompany higher
economic activity, and thus the supply of money or
HPM will appear to be upward-sloping through
time.
Horizontalist answers II
• 2. On the impossibility of excess money:
– The main argument is the “reflux principle”.
– The stock-flow consistent models of Godley have
shown that, despite the presence of an apparently
independent money demand function and the
presence of a supply of money function based on
the supply of loans, flow-of-funds accounting is
such that deposits must equate loans despite no
such condition being inserted into the model.
– In more sophisticated models, changes in liquidity
preference by households will induce changes in
relative interest rates; but this was never denied
by Horizontalists.
Horizontalist answers III
• 3. On the horizontal supply of credit:
– It has been shown by Wolfson (1996) that there is no
incompatibility between credit rationing and horizontalism. It was
never denied that banks could modify their lending norms.
– It is now clearly established that higher economic activity does
not necessarily entail higher debt ratio for firms (contradicting the
essence of Minsky’s financial fragility hypothesis). This is now
recognized by Wray, a student of Minsky.
– But of course, as firms move from one risk class to another, they
will trigger higher interest rates.
– Recent events have clearly shown that interest rate spreads rise
in times of crisis, or when the economy is brought down, not
when the economy is quickly expanding.
Horizontalist answers IV
• 4. On quantity restraints on bank reserves:
– There is no incompatibility between horizontalism and bank
innovations or liability management.
– New central bank operating procedures clearly show what
was hidden before: central banks passively try to provide the
reserves being demanded by the banking system.
– The «unconventional» operating procedures introduced
during the subprime financial crisis have shown that central
banks could impose excess reserves while keeping the
overnight rate at its target level.
Conclusion
• The original horizontalist depiction, that of Kaldor and
Moore, is still the most appropriate.
• But Structuralists have helped to fill in many details.
• As Wray (2006) concludes:
• «There cannot be any automatic and necessary
impact of spending on interest rates because loans
and deposits can and normally do increase as
spending rises. The overnight rate will change only if
and when the central bank decides to allow it to do
so. Short-term loan and deposit retail rates can be
taken as a somewhat variable mark-up and markdown from the overnight rate.»
Part IV
New developments in monetary
policy implementation by
central banks
New operating procedures and
horizontalism
• Central banks have new operating procedures, although they are
not that much different from what they used to be. They bring central
banks closer to the « overdraft economy», and further away from the
«asset-based econonomy» as defined by Hicks.
• The procedures of some central banks are more transparent (than
they were and than those of other central banks), so the horizontalist
story is more obvious: Canada, Australia, Sweden
• The procedures of other central banks are less transparent; but
when interpreted in light of horizontalism, we can see that their
operational logic is identical to that of the more transparent central
banks (like the Fed, until 2008, or Brazil, see Carvalho de Rezende
IJPE 2009).
The new operating procedures put in place in
Canada and other such countries are fully
compatible with the PK monetary theory
• Central banks set a target overnight rate, and a band
around it
• Commercial banks can borrow as much as they can
at the discount rate
• There are no compulsory reserves and no free
reserves (zero net settlement balances)
• The target rate is (nearly) achieved every day
• Central banks only pursue defensive operations,
trying to achieve zero net balances.
• When there are tensions, as during the recent
subprime financial crisis, they try their best to supply
the extra amount of balances demanded by direct
clearers (mainly banks)
Two different justifications for the
current interest rate procedures ?
• Post-Keynesians
• New Consensus
• Based on a
microeconomic
justification
• Tied to the inner
functioning of the
clearing and settlement
system
• Linked to the day-byday, hour-per-hour,
operations of central
banks
• Based on the 1970
Poole article
• A macroeconomic
justification
• If the IS curve is the
most unstable, use
monetary targeting
• If the LM curve is
unstable (money
demand is unstable),
use interest rate targets
The microeconomic justification for
interest rate targeting
• Central bank interventions are essentially « defensive ».
Their purpose is to compensate the flows of payments
between the central bank and the banking sector.
• These flows arise from: a) collected taxes and
government expenditures; b) interventions on foreign
exchange markets; c) purchases or sales of government
securities, or repurchase of securities arrriving at
maturity; d) provision of banknotes to private banks by
the central bank.
• Without these defensive interventions, bank reserves or
clearing balances would fluctuate enormously from day
to day, or even within an hour. The overnight rate would
fluctuate wildly.
Authors who support the
microeconomic explanation
• Several central bank economists
– Bindseil 2004 ECB, Clinton 1991 BofC, Lombra 1974 and
Whitesell 2003 Fed
• Some post-Keynesian authors
– Eichner 1985, Mosler 1997-98, Wray 1998 and neo-chartalists
in general
• Institutionalists
– Fullwiler 2003 et 2006
This was understood a long time
ago by some PK economists
• “The Fed’s purchases or sales of government
securities are intended primarily to offset the
flows into or out of the domestic monetaryfinancial system” (Eichner, 1987, p. 849).
• “Fed actions with regards to quantities of
reserves are necessarily defensive. The only
discretion the Fed has is in interest rate
determination” Wray (1998, p. 115).
There is no relationship between open
market operations and bank reserves
• “No matter what additional variables were
included in the estimated equation, or how the
equation was specified (e.g., first differences,
growth rates, etc.), it proved impossible to obtain
an R2 greater than zero when regressing the
change in the commercial banking system’s
nonborrowed reserves against the change in the
Federal Reserve System’s holdings of
government securities ....”(Eichner, 1985, pp.
100, 111).
Principles of central banking (Fullwiler 2009)
• 1: The daily operations of central banks are mostly about the
payments system, not reserve requirements.
• 2: The operating target of central banks is necessarily an
interest rate target. The money multiplier framework is
inapplicable and untenable in practice
• 3: The central bank accommodates banks’ demand for reserve
balances while offsetting changes to its balance sheet
inconsistent with such accommodation.
• 4: Reserve requirements have to do with interest rate targeting,
not money supply targeting.
• 5: Potential deviations in the overnight rate rate from the target
rate are set by the central bank collateralized lending rate and
the rate of interest on reserves.
• 6: Implementing a new target interest rate does not require any
open-market operation (the so-called liquidity effect).
• 7: The central bank operations, overall, are about “price,” not
“quantity”.
Conclusion: The Cambridgian hare!
• « Today’s views and practice on monetary policy
implementation and in particular on the choice of the operational
target have returned to what economists considered adequate
100 years ago, namely to target short-term interest rates »
Ulrich Bindseil 2004, ECB, formerly from the Bundesbank