What Paul Krugman Should Have Learned from James Tobin but Didn’t

Paul Krugman last week wrote yet another response on the issue of “how banks work”. This time he has decided to cite the two papers that he relies on to “think about the role of banks in the economy”. The first is a thirty year old paper on bank runs that, although interesting, isn’t relevant to the topic at hand. The second is a fifty year old paper written by James Tobin and William C. Brainard that is directly related to the relationship of the “monetary base” (briefly put, physical currency and coins plus settlement balances in checking accounts held with the central bank) to the overall level of loans. However, the authors make pains to point out in the beginning of the paper that

This paper is addressed to these questions, but it treats them theoretically and at a high level of abstraction

This is important to emphasize. Krugman’s thinking on the relationship between settlement balances (also called bank “reserves”), deposits and loans is primarily determined by one fifty year old theoretical, very abstract paper written by theoreticians. In other words, the people who actually implement monetary policy or are in the business of banking have had little to no influence on Krugman’s thinking about banking. A priori indeed.

There is more here to unpack however. James Tobin is actually quite a famous economist (known best for the idea of a “Tobin tax”, a tax on spot currency transactions) who didn’t die after co-writing this paper. In fact, he won a Nobel prize in 1981 and didn’t die until 2002. Nor did he think that he had sufficiently dealt with the role of banks and monetary policy because he continued to develop his ideas in these areas for decades afterwards. Thus Tobin himself wouldn’t agree that “Tobin and Brainard got it all straight half a century ago”. One truly seminal paper Tobin wrote on the topic is “The commercial banking firm: a simple model”. In this 1982 paper (nearly 20 years after the paper that Krugman cited), Tobin lays out a series of views that stand in stark contrast to views expressed by Paul Krugman.

In a post calling the belief that banks “create money” “Banking Mysticism” , Krugman states that:

First of all, any individual bank does, in fact, have to lend out the money it receives in deposits. Bank loan officers can’t just issue checks out of thin air; like employees of any financial intermediary, they must buy assets with funds they have on hand

Compare this statement with the statement of James Tobin, who Paul Krugman claims to have learned how banking works from:

When a bank makes a loan to one of its customers it simply credits the amount to the borrower’s account. In the first instance, therefore, the bank’s deposits are increased dollar for dollar with its loans. As the borrower spends the proceeds by check, some of the recipients will leave the money on deposit with the lending bank, while others will deposit their receipts in other banks or convert them into currency. As these recipients spend their balances and in succeeding generations of transactions, the lending bank will lose more and more of the deposit created by its initial loan

Thus, the one paper Krugman relies on “to think about the role of banks in the economy” was written by someone Krugman would derisively call a “banking mystic”. Such are the ironies that emerge from ignorance. There is more to learn from this interesting paper. First let us go back to Krugman’s argument.

In the “Banks and the Monetary Base” post, Krugman poses a thought experiment:

Now, think about what happens when the Fed makes an open-market purchase of securities from banks. This unbalances the banks’ portfolio — they’re holding fewer securities and more reserve — and they will proceed to try to rebalance, buying more securities, and in the process will induce the public to hold both more currency and more deposits. That’s all that I mean when I say that the banks lend out the newly created reserves; you may consider this shorthand way of describing the process misleading, but I at least am not confused about the nature of the adjustment.

Krugman’s argument here is confusing. In the thought experiment, his hypothetical bank tries to lower the amount of settlement balances it has by buying a security. This can only work in the aggregate if some other bank desires to hold more settlement balances or will use settlement balances to reduce its indebtedness to the treasury/central bank. Otherwise the banking system as a whole has more settlement balances than it desires. In no sense do “banks lend out the newly created reserves”. Saying that a completely incorrect description is a “shorthand” isn’t logically coherent. Further this process (if the banking system as a whole has more settlement balances than it desires) will lead to the inter-bank loan rate (the fed funds rate) to fall to the Interest On Reserves (ior) rate unless the central bank intervenes to preserve its interest rate target.

In the “Banking Mysticism” post and elsewhere Krugman argues that “currency is in limited supply — with the limit set by Fed decisions”. This is obviously not true -as confirmed by a simple glance at the New York Federal Reserve website.

Depository institutions buy currency from Federal Reserve Banks when they need it to meet customer demand, and they deposit cash at the Fed when they have more than they need to meet customer demand

Even if one desired to be charitable and say by “currency” Krugman meant settlement balances held with the central bank, this is still incorrect. The central bank provides all the settlement balances needed to get banks to lend to each other at the targeted inter-bank loan rate. One can see evidence of this every couple of weeks when an actual central bank practitioner gives a speech (you can subscribe to the speeches here). Take for example this speech given by an Australian central banker on the same day as Krugman’s blog post went live:

As with our regular open market operations, it will not be the Bank’s aim to simply supply overnight funds to those individual institutions that are short, or absorb overnight funds from those that are long cash. That is what the interbank cash market is for. As I mentioned a minute ago, the Reserve Bank’s operations are designed to put the appropriate amount of settlement funds in the system as a whole so that, in managing their individual ES accounts, ADIs [deposit-taking institutions] will transact with each other at the cash rate target

This means that whenever deposit-taking institutions want more settlement balances, the central bank will provide them on demand (either through lending or through open market operations). Thus, in no sense is “currency is in limited supply — with the limit set by Fed decisions”. The loss of settlement balances through out-flowing payments has no impact on lending unless the additional cost of borrowing more settlement balances makes lending unprofitable (quite unlikely). Note that the cost of settlement balances can vary wildly (as they did under Volcker) but they must ultimately be supplied at some price if payments are going to clear between banks. If you want to argue otherwise you have to argue that the central bank is willing to let the interbank loan market collapse and checks to stop clearing if some arbitrary amount of settlement balances is seen as “too many”.

Interestingly, the argument that it is the expected cost of acquiring additional settlement balances that matters is in James Tobin (1982). From the abstract:

In case withdrawals exceed its defensive position in liquid assets, the bank incurs extra costs in meeting reserve requirements, penalties in borrowing or losses in disposing of illiquid assets.

Thus it is not the quantity of settlement balances that impacts the loan decision of an individual bank, but the expected spread between the cost of liabilities and the return on assets. Being a good neoclassical, Tobin believes that the “profit maximizing bank” will equate expected marginal cost and expected marginal revenue. I think that is nonsense but at least we’re having the right conversation- one about the costs of liabilities and the return on assets rather then the quantity of settlement balances and deposits. Anyway, who are you going to believe? The Central bankers and the sole expert Krugman relies on to understand banking, or Paul Krugman?

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42 comments

  1. Hugh

    I think we have known for a long time now that Krugman doesn’t understand banking, money, or debt. He also used to be an ardent free trader so I am not sure how much he understands about trade either.

    1. Ken Ward

      Krugman may not know much about banking etc but he does know that his surname has the same initial letter as Keynes and Kalecki. He seemed thrilled a few days ago that John Quiggin had linked him to those two, even if Krugman felt obliged to call them ‘illustrious’.

    2. craazyman

      not one of them understands any of this because they’ve been brainwashed their whole lives by technical instruction in the levers of monetary bureaucracies.

      They have never studied cultures that organize themselves in ways that don’t use money and what that might imply for how humans self-organize and what role money plays in that process.

      And so they know only the forms they’ve been taught and not the broader forms of nature from which those they’ve been taught arise.

      It’s as if they know the statue but can’t comprehend the marble from which it is carved. Michaelangelo would never have stood for that for 10 seconds.

    3. Nathanael

      I do not know why Krugman is so weak on the topic of money. It seems to be a genuine blind spot for him.

      Maybe they didn’t teach about money when he went to econ grad school. :-P

  2. psychohistorian

    So why are we not having the discussion about whether the historical plutocracy is best making capital allocations in the long run or should sovereign entities be “trusted” with capital allocations and the “profits” from providing banking as a public utility?

    It is evident the plutocracy has erred (kind word) in many areas of social policy and governance, but the question becomes if the secular public can build a “better” (equitable, just, future prudent, etc.) society.

    I think we can and should get started on it immediately.

  3. kjboro

    Apparently, Krugman will not let go of his own ignorance (and arrogance) on this point. He. Simply. Won’t. Let. Go.

    And that (sad) fact diminishes Krugman’s effectiveness as well as, frankly, ethics. Krugman rails against ‘truthiness’:

    http://www.nytimes.com/2013/08/16/opinion/krugman-moment-of-truthiness.html

    He castigates (mostly) right wing efforts at intentionally making Americans ignorant, then concludes with a lament and a self-flattering promise:

    “Put it all together, and it’s a discouraging picture. We have an ill-informed or misinformed electorate, politicians who gleefully add to the misinformation and watchdogs who are afraid to bark. And to the extent that there are widely respected, not-too-partisan players, they seem to be fostering, not fixing, the public’s false impressions.

    So what should we be doing? Keep pounding away at the truth, I guess, and hope it breaks through. But it’s hard not to wonder how this system is supposed to work.”

    Truth-teller, heal thyself!

  4. mike smitka

    I think you’ve got two different issues here – portfolio rebalancing (Tobin & Brainard) and whether that rebalancing is costless (Tobin 1982).

    Note that (as a grad student in Tobin’s macro class in 1981, so familiar with both papers) Krugman seems to capture Tobin’s approach well, albeit I find Krugman’s prose sloppy — he fails in trying to make the ideas more accessible.

  5. craazyman

    faaaak does the baby come from the mama or the papa?

    I never seen a baby come out either one but I hear they usually come out of the mama.

    I also heard the papa has to do something to make the baby come out.

    It gets confusing.

  6. Benoit Essiambre

    I don’t always agree with Krugman but I think Nathan is playing semantic games here. Krugman understands how this works. He’s just using many “shorthands”, such is the nature of economic vulgarisation.

    For example:
    >Thus, in no sense is “currency is in limited supply — with the limit set by Fed decisions”.

    Its not limited in actual quantity but it is indirectly limited by the fed interest rate target.

    1. diptherio

      No. Currency is in no way limited in supply. The Fed does not target or even care much about the quantity of money, only the interest rate. The last time the Fed tried to target and control quantity was a disaster (Volcker, starting about ’79). Krugman isn’t using short-hand, he’s just wrong.

      By repeating the fallacy of limited currency, Krugman plays into the “we’re broke” meme, so beloved by deficit hawks. But then again, Krugman himself believes that “in the long run” budget deficits are harmful and pushes what is essentially “austerity lite,” so maybe that’s on purpose.

  7. middle seaman

    One of the most prominent voices on the liberal side is Krugman and his constant and lengthy hammering at the reactionary, illegitimate and destructive policies we live with.

    Is Krugman perfect? Surely, he isn’t. But then every Monday and Thursday some liberal decides to attack Krugman. Typically, claiming that he is totally wrong, an ignoramus and even worse.

    Although such attacks follow a well-worn tradition, I find it pointless.

    1. dcb

      the problem is as follows
      1) he is perhaps the most widely read economist in the world, and the populace does little research on their own. They don’t realize the extent of different views. Becase of the nature of his writing he paints everyone who disagrees with him as “evil”,
      2) He is an academic, at a major university. Part of being a real academic is to acknowlege and address issues of concern and make balanced presentations. then make you case.
      3) he pretends data that contradict him doesn’t exist, never addresses it, or explains why it’s wrong.
      4) his ego prevents him from admitting to not knowing what he doesn’t know. A fatal error
      5) To this day I have yet seen him acknowledge the fudge factors in inflation caluclations or that the methodology of the calculation has changed.
      6) the man won’t admit the Qe helps those with assets in the markets the most which is the 1%. That’s just wrong. not to admit or acknowledge the distributional aspects of qe and loose monetary policy while making you like you are all about helping the poor and down trodden really says a great deal about who he is inside.

      this is a wonderful op ed in bloomberg
      Economists Need to Admit When They’re Wrong
      http://www.bloomberg.com/news/2013-08-21/economists-need-to-admit-when-they-re-wrong.html
      7) krugman seems to have zero idea of his congative defects intellectual blind spots as discussed in the link
      8) if you really dig, and research most of the things “economists” say are based on assumptions that have never even been confirmed, are outright clearly wrong, etc
      9) my personal view most monetary policy decisions are done for the benefit of the financail services sector. then they have developed theories and models to justify it. Krugmans policies support an oever leveraged financial sector if you know markets always go up in the long run via printing the best bet is to lever up with funds given to you from the fed at less than the rate of inflation. it means the system is rigged to produce profits for you. the leveraging creates instability in the long run. In essence we are always bailing out the over leveraged instead of fixing the problem, and we are told that it’s for the “economy”. the wealthy have much of their wealth as debt, collateral for other securites, property, etc. Our monetray policy is designed to bail out speculators and the wealthy. they are hurt by deflation (margin calls) and their wealth gets destroyed. While 80% of americans own 7% of stocks. the vast majority of us would be better off getting a return on our savings, and lower prices at the pump. the problem is excess credit creation. Krugman ignores that entire side of the balance sheet

      1. dcb

        I want to add one thing. Bernanke is credited with being the greatest scholar of the great depression and he was completely blind to the liability side of the balance sheet and credit creation as a cause. Krugman fits into the same catgory of beleifs and ways of thinking as bernanke. If that isn’t enough to realize neither should be trusted with anything, I don’t know what else to say

  8. David Lentini

    Frankly, I find the arguments against Krugman’s and the conventional wisdom far more convincing. So, why won’t Krugman and the CW admit this? Well, once you make the admission, then banking is no longer “boring” (to quote Krugman) and the whole basis of macroeconomics is a lot messier. So, let’s just keep looking under this street light a little while longer.

  9. F. Beard

    However banking works, it should not require government privileges to work much at all UNLESS it is crooked – which it is.

    Banking is gambling – betting that one can borrow short and lend long and not get caught. So why does the government subsidize gambling?

  10. ColinM

    On the question of banks “creating money”, I think that the neglected role of bank capital may help to reconcile the two sides.

    When a bank is formed, it has capital but no loans. It lends out some of its capital to a borrower and the loan comes back as a deposit. So both sides are right in a way. Loans do create deposits, but loans are made using money which the bank already has on hand (at least in principle).

    For this to work for the monetary system as a whole, there must be an initial source of capital. That probably comes from sources such as the monetary gold held by the Federal Reserve and the earlier United States Notes.

    1. F. Beard

      It lends out some of its capital to a borrower and the loan comes back as a deposit. ColinM

      Wrong since a bank can lend out many times its Equity.

    2. Gary G

      Banks, as I understand, DO NOT loan out their capital as a matter of operations. Capital is there as a base of solvency contraposed against Risk (of loss). So long as Banks tell Regulators (Fed, BIC) that the the Loans they made, the Assets they hold, are Risk-Free … because of unbacked Credit Default Swap insurance they bought, or because they lied about collateral value exceeding the loan value, or because real estate prices “never fall” … and regulators and the market ALLOWS them to lie … then they can lend and acquire risk almost without limits.

      The act of issuing a loan by matching a Signed Debt Obligation with an equal Bank Deposit, both existing as a spread on an “expanded” balance sheet, this really has (almost) NO RELATION to Capital Base, nor to Reserves. Some, perhaps, indirectly, but not much.

      Right?

  11. James

    “his hypothetical bank tries to lower the amount of settlement balances it has by buying a security. This can only work in the aggregate if some other bank desires to hold more settlement balances or will use settlement balances to reduce its indebtedness to the treasury/central bank.”

    If the banks have excess reserves as the result of Fed open market purchases, and the banks then make more loans to the public, the level of excess reserves in the banking system GOES DOWN.

    This is because the extra reserves stop being “excess” and instead become “required”, as the direct result of the extra loans to the public.

    Some of those loans also result in the public withdrawing more cash, so reserves also go down in that sense.

    “In no sense do “banks lend out the newly created reserves”.”

    Banks lend reserves in the sense that each new deposit is a claim on base money (reserves) – i.e. a promise made by the bank to pay base money to the depositor, or on their behalf, on demand. A bank deposit is simply a bank debt, a promise to pay base money on demand.

    A bank deposit can thus also be thought of as a loan by a depositor to the bank. This is clearly the case when a depositor deposits physical cash at a bank. But it is still the case when a bank creates a new deposit “out of thin air”, when it makes a loan. Each time a bank creates a deposit, the depositor is essentially lending base money (either physical currency or its electronic equivalent, reserve balances) to the bank. No base money has to actually change hands for this to be the case.

    So banks don’t normally “lend out” reserves, because the reserves generally stay inside the banking system (unless they are withdrawn as cash) as so don’t go “out”. However banks still “lend reserves” in the sense that each deposit is simply a promise to pay reserves (base money) on demand.

    “Further this process (if the banking system as a whole has more settlement balances than it desires) will lead to the inter-bank loan rate (the fed funds rate) to fall to the Interest On Reserves rate”

    Not necessarily!

    If the banks make more loans, the amount of excess reserves goes down, as explained above. This causes the Fed Funds rate to rise, all else being equal. So if the Fed adds excess reserves through OMPs, and then the banks increase the amount of their loans to the public by a sufficient amount, the Fed Funds rate can potentially stay the same, or even RISE (assuming the Fed allows it to rise by not intervening).

    1. F. Beard

      However banks still “lend reserves” in the sense that each deposit is simply a promise to pay reserves (base money) on demand. James

      That liability is mostly virtual for the banking system as a whole since where can reserves go EXCEPT for the banking system? Who deals in physical cash much?

      Thought experiment:

      1) Set up a risk-free fiat storage and transaction service that is available to all citizens i.e. a Postal Savings Service.
      2) Announce in advance and shortly thereafter revoke government deposit insurance and abolish the Fed.

      What will happen? ans: A massive system-wide bank run which will reveal the banks weren’t lending reserves but were committing fraud by “lending” what they did not have and could not possibly obtain ethically either.

      The banking system is a government-backed counterfeiting cartel. How can this NOT be a root of all sorts of evil?

    2. mdm

      @James:

      “If the banks have excess reserves as the result of Fed open market purchases, and the banks then make more loans to the public, the level of excess reserves in the banking system GOES DOWN.”

      This is incorrect, and would only be applicable in an institutional setting with contemporaneous reserve accounting. The actual institutional arrangement uses ‘lagged reserve accounting’. The actual set up is a little complicated but it basically works as follows: a bank is required to hold a certain amount of reserves equal to an average of a subset of liabilities (e.g. certain types of deposits) from the previous ‘maintenance period’. In no way does a bank issuing a loan now affect the level of ‘excess reserves’. It may in the next maintenance period but not the current one.

      Keep in mind that in banking systems without reserve requirements, ALL reserves are by definition ‘excess reserves’, so again your example is of a limited case, applying to a highly stylized American case.

      “If the banks make more loans, the amount of excess reserves goes down, as explained above. This causes the Fed Funds rate to rise, all else being equal. So if the Fed adds excess reserves through OMPs, and then the banks increase the amount of their loans to the public by a sufficient amount, the Fed Funds rate can potentially stay the same, or even RISE (assuming the Fed allows it to rise by not intervening).”

      As I mentioned in my response here, this is only applicable in with contemporaneous reserve accounting.

      Your post misses the important point that, as Nathan argued above, the supplying of reserves is an accommodating behavior by the central bank to ensure that the there are sufficient reserves in the banking system. If we were to assume the causal process in your post (increase in reserves -> increase in loans), then we’re left with the awkward scenario of explaining banking systems that operate by either removing all reserves from the system (the Canadian case) or even where the amount of reserves is deliberately left deficient in order to encourage active participation between the central bank and the banking system, i.e. it encourages the banks to be actively communicating with the central bank, so that the central bank can better forecast the desired quantity of reserves demanded by the banking system (as is the case in the Australian example).

      Continuing on with your example, and the assumed causal process: if the OMO leave the banking system with more reserves than it desires to hold, the interbank rate would fall to zero or the lower bound set by the liquidity absorbing standing facility. On the other hand, if the banking system is deficient in reserves, i.e. the amount of reserves in the banking system is less than the amount demanded, then the interbank rate rise to infinite, with no possible market clearing price. So again, it’s not a great description of actual monetary policy implementation. Of course, in practice both instances are avoided because central banks have adopted standing facilities, as important instruments to minimize interbank interest rate volatility.

      . . .

      There’s a part in the middle of your post which is more semantic than anything else. If you want to call it ‘lending reserves’ fine, but it’s unnecessarily obscure.

      1. James

        “Keep in mind that in banking systems without reserve requirements, ALL reserves are by definition ‘excess reserves’.”

        If there is no official reserve requirement then all reserves are excess to official reserve requirements. This doesn’t mean that banks necessarily hold zero reserves though. In the UK for example, there is no official reserve requirement but banks there still maintain an average 3.1% reserve ratio to deposits. I believe the situation in Canada is similar. Also bear in mind that reserves include both central bank deposits (reserve balances) and vault cash. Do you know of any banks that hold no vault cash? If they hold cash in their vaults then by definition they hold reserves.

        The ‘maintenance period’ is not really relevant to the point. If in period 1 banks have excess reserves, they can if they want to (and if the central bank allows them to), reduce the level of excess reserves by making more loans. If they manage to make enough loans then in period 2 they will no longer have excess reserves, unless the central bank decides to add more excess reserves to the system to hit a lower target interest rate. If the central bank has decided to push the funds rate down, and so continuously adds reserves to hit that target rate, then the banks could keep trying to reduce their excess reserves through loans, whilst the central bank keeps frustrating that attempt by adding yet more reserves.

        “the supplying of reserves is an accommodating behavior by the central bank”

        The central bank usually targets a particular interest rate, so it usually supplies (through OMOs in the US) whatever quantity of reserves are needed to hit that target rate. But the central bank doesn’t only accommodate pre-existing demand. If it wants to push the funds rate down, and so encourage more lending, it can oversupply the banking system with reserves through OMPs. This normally results in a lower funds rate, which in normal circumstances is associated with more lending (because borrowing is cheaper). However if banks make enough loans the rate might actually end up staying the same or might even rise, meaning that the central bank would have to add even more reserves if it wanted to achieve the lower target rate.

        “If we were to assume the causal process in your post (increase in reserves -> increase in loans).”

        There isn’t always a causal relationship. The central bank can try to increase lending by increasing the supply of reserves and/or lowering the funds rate, but if banks don’t want to lend sufficiently and/or the public doesn’t want to borrow then the rate could go all the way to zero without having much effect on lending. It depends on the circumstances. Clearly a recession in the aftermath of a credit/financial crisis is not the ‘usual’ situation.

        “then the interbank rate rise to infinite, with no possible market clearing price.”

        It could rise very high if the central bank allowed it to. But at some point you would get cascading defaults and bankruptcies and the rate would eventually come down.

        “If you want to call it ‘lending reserves’ fine, but it’s unnecessarily obscure.”

        reserves, or rather base money, is what banks are promising to give to their borrowers. That’s what a bank deposit means. The fact that borrowers and other depositors choose to leave the money they are owed in the bank doesn’t change that fact. If borrowers immediately withdrew their loans as cash, then banks would literally be lending “out” reserves. But what normally happens is the bank lends base money to a borrower and the borrower immediately lends it back to the bank, by choosing to leave the money on deposit at the bank.

        1. F. Beard

          The fact that borrowers and other depositors choose to leave the money they are owed in the bank doesn’t change that fact. James

          It’s no real choice!

  12. digi_owl

    Shit like this seems like a repeating pattern in mainstream economics. Someone writes a paper that provide a semblance of backbone to vague theories that border on “might makes right”, but in later years categorically disown that paper as a unrealistic theory wank. But still said paper gets held up as the height of economic theory decades later. If anything it puts meat on the argument that economics is the religion of kletocracy, with Ayn Rand as their patron saint…

  13. Animal Nitrate

    Probably the best summation of Economics and Economists I’ve read anywhere, ever :

    “not one of them understands any of this because they’ve been brainwashed their whole lives by technical instruction in the levers of monetary bureaucracies.

    They have never studied cultures that organize themselves in ways that don’t use money and what that might imply for how humans self-organize and what role money plays in that process.

    And so they know only the forms they’ve been taught and not the broader forms of nature from which those they’ve been taught arise.

    It’s as if they know the statue but can’t comprehend the marble from which it is carved. Michaelangelo would never have stood for that for 10 seconds.”

    What has failed this past few years is the notion of Economics itself.

    The fact that there are so many blogs and commentators pitching in about the price of gold or oil or shares still amazes me.

    None of these economists seem to have the remotest idea that Economics, at its most basic, is the study of people and their interactions.
    Cullen Roche in a recent post on inflation suggested that while peoples real world experiences didnt tally with his theory/data (he said there was ‘no inflation’) that the peoples experience must be wrong.
    It certainly couldnt be errors in his data.
    Or the idea that his data was incomplete.
    Or that his theories, models and data were wholly f**king useless.
    But this is what you are up against.
    You are not allowed to believe the evidence of your own eyes. You must accept the evidence (and collection and analysis of same) presented to you as fact.
    To do otherwise makes you nuts; regardless of what your eyes and ears tell you.
    These people are out to subvert your very mind with their bluster and bullsh!t.
    Look away. Turn the other cheek.

    1. Nathanael

      There is no “inflation”, because it’s not inflation until your wages go up. Did you get a raise recently? If not, no inflation.

      What there is is nasty price-gouging in consumer products. The price-gouging creates profits, which go into CEO pockets.

      That’s not inflation.

      1. Roland

        Nathanael, I think you’re trying to “define the problem away” here.

        Of course you can get widespread price inflation without wage increases.

        There are good recent examples to be had. e.g. The price of higher education has soared in recent years, even as incomes have tanked. How? Easy: the consumers substituted large amounts of debt for the income they lacked.

        A rapid expansion of available credit can serve as fuel for inflationary fires.

        History is also full of examples of large numbers of people simply getting “eaten up” by secular price increases that exceeded their incomes. Entire classes can get effectively liquidated in such fashion.

        1. Gary G

          That can happen when Supply of something — energy, housing, etc. — is restricted or otherwise in short supply RELATIVE TO DEMAND. And yes, a rapid rise in bank credit shoved into Asset markets — not business growth — can and will inflate said Asset prices, AS INTENDED, until aggregate consumer debt swamps the ability to pay, overall.

          Futhermore, Steve Keen (Minsky) explained how at the tail end of a long growth period, higher and higher risks are taken by lenders as a “Ponzi” phase evolves where the only factor that makes loans “solvent” is the ability to re-fi, where neither principle NOR all the interest is payable by normal market rents. (I think I stated that right, but refer to Keen on Minsky and Ponzi finance.) In other words, the “Flip This House” syndrome.

          This still does not mean that banks are lending OUT of their Capital, nor out of their Reserves, nor that the Central Bank can restrict the growth of credit money by reducing Reserves, because banks look for reserves for clearing payments TWO WEEKS IN ARREARS of current credit creation operations. First they issue loans, THEN, two or four weeks in arrears, they determine whether the net of loan proceeds has gone to that bank or to others, then borrow sufficient reserves or lend reserves to other banks, or lastly, turn to the central bank to get the reserves they need.

          If the CB were to refuse, checks and payments would stop clearing, the financial system would seize.

          WE can’t regulate the supply of credit simply by empty non-workable threats to implode the entire financial system and freeze the entire economy, a few weeks or months after lending decisions. That makes no sense. If anything, it would seem to make more sense to (a) notice cases of obvious wholesale asset inflation (b) force banks to honestly report the real value of their Assets not some presumed value based on no risk and (c) force banks to honestly report both their Capital/Asset base AND their risks, and not just fudge the numbers (d) prevent taking on greater risks, issuing ridiculous loans, and creating inflationary (fraudulent) Assets which are harmful to the economy in the longer run, even if that spells a decline in super profits in the short term (before the scheme collapses).

  14. larry

    I agree with Mike Smitka. Krugman fails to make the ideas more accessible and is sloppy. I would like to add that K’s treatment of data is also often sloppy, even to the extent of leaving out the axes on data graphs, which is completely unacceptable.

    Nathan Tankus is working with Steve Keen. And a while ago, Keen and Krugman had a public argument with Keen contending that Krugman’s understanding of macroeconomic issues left something to be desired, more or less. I believe that the general consensus was that Keen “won” the interchange. Certainly, Krugman never seemed to adequately respond to Keen’s criticisms.

    I have often wondered how deep or broad Krugman’s knowledge of economic history actually is. As a comparison, one can peruse Antoin Murphy’s Genesis of Macroeconomics, a brilliant exposition.

  15. Dan Kervick

    The bottom line is that when Krugman says this:

    Similarly, if we ask, “Is the volume of bank lending determined by the amount the public chooses to deposit in banks, or is the amount deposited in banks determined by the amount banks choose to lend?”, the answer is once again “Yes”; financial prices adjust to make those choices consistent.

    he’s just wrong.

    The public’s portfolio balancing choice concerning how much of its present monetary assets it decides to hold in the form of physical currency and how much it decides to hold as balances in bank deposit accounts in no way determines the amount of bank lending. Banks in the aggregate can issue new liabilities in the form of deposit balances in exchange for borrower promissory notes, and then acquire any additional payment assets it needs (reserves) to meet the obligations that the new liabilities incur.

    Acquiring those assets usually has a cost, and so the bank’s concern is the difference between the amount it can earn from the loans and the cost of acquiring the additional funds. But banks don’t have to acquire the funds first, and to expand their lending they certainly doesn’t have to rely on the public making additional cash deposits at banks.

    1. MaroonBulldog

      “But banks don’t have to acquire the funds first, and to expand their lending they certainly don’t have to rely on the public making additional cash deposits at banks.” As any reflective persons might readily understand, who ever wrote a check against a home equity line of credit, or successfully asked a bank to extend a credit card limit and then made a large purchase the same day, or negotiated a bank’s car loan at the dealership that simultaneously sold them thenew car. Here is something I wonder about when economists make statements like Krugman’s: “Do such persons never reflect upon the practical necessities of their own transactions in the real world? Or is it that they have never done any transactions with banks?”

    2. Nathanael

      Indeed, in actual practice banks pay no attention in the short or even medium term to how much deposits they have.

      They lend out money profligately (printing money) and then go to the Federal Reserve at the end of the day to “balance their books”. They can operate with NO deposits at ALL, and they will happily do so, until the regulators come after them. If they look at their books at the end of the quarter and worried about the regulators, they start advertising for deposits. Eventually.

      1. Gary G

        They lend out money profligately (printing money) and then go to the Federal Reserve at the end of the day to “balance their books”.
        ——
        yes, but first they turn to other banks in the Interbank market for loans, from banks with excess reserves to banks with insufficient reserves. That’s what the Fed sets the “base” interest rate on, overnight Interbank loans.

        Only if ALL the banks collectively fall short of Reserves, and a short bank has nowhere to turn, THEN they go to the Fed’s discount window, which is more expensive than Interbank.

        At least that’s how it works in the USA, as far as I understand it.

  16. Jim

    “his hypothetical bank tries to lower the amount of settlement balances it has by buying a security. This can only work in the aggregate if some other bank desires to hold more settlement balances or will use settlement balances to reduce its indebtedness to the treasury/central bank.”

    The banking system as a whole CAN get rid of excess reserves by making more loans to the public.

    When banks increase the amount of loans made to the public, the quantity of excess reserves in the banking system GOES DOWN. This is because the reserves stop being “excess” and instead become “required”.

    So the banking system can get rid of “excess” reserves by making new loans, even if the total quantity reserves in the banking system doesn’t actually change.

    “Further this process (if the banking system as a whole has more settlement balances than it desires) will lead to the inter-bank loan rate (the fed funds rate) to fall to the Interest On Reserves (ior) rate unless the central bank intervenes to preserve its interest rate target.”

    Not necessarily!!

    When banks increase the amount of loans they make to the public, banks’ demand for reserves increases, so the quantity of excess reserves goes down and the Fed Funds rate RISES, all else being equal – unless the Fed stops it from rising by intervening and supplying more reserves to keep the FF rate where it is.

    So when the Fed adds excess reserves through OMPs, the Fed Funds rate could potentially stay the same or even rise, if banks make a sufficient amount of new loans to the public.

    1. Gary G

      But Loans create Deposits which create Reserves. It would seem to me that a boom in Lending creates the surplus Reserves which the CB usually purchases (by selling Govt Securities back to the Banks), thereby reducing “cash” balances in Reserves and propping the Interest Rate (for Interbank loans) up.

      That’s why Mosler explained that operationally the “natural rate of interest” is ZERO, the rate that Interbank lending would fall to if not for the CB intervening to prop up rates above ZERO.

    1. MaroonBulldog

      The man should be awarded an honorary degree from Mayven University, whose motto is “Opinion Above Knowledge” or something like that.

    1. Gary G

      like most “Truth” documentaries about the economy, this appears to be more conspiracy theory BS

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