Steve Keen: Is QE Quantitatively Irrelevant?

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Yves here. Some readers still equate quantitative easing with “printing money”, and Keen’s post explains what (little) QE actually does and does not accomplish.

By Steve Keen, author of Debunking Economics and the blog Debtwatch and developer of the Minsky software program. Cross posted from Business Spectator

America is a land of contention, and one of the most contentious topics here (I’m in Seattle as I write) is the impact of the Federal Reserve’s policy of “Quantitative Easing” – otherwise known as ‘QE’. The Federal Reserve has committed to spending $85 billion every month buying a wide range of bonds from banks, until such time as the US unemployment rate falls below 6.5 per cent.

The Fed has implemented this policy because it believes it is the best way to stimulate demand in a depressed economy. Its critics oppose it because they believe this massive amount of ‘money printing’ must inevitably lead to ruinous inflation.

I reckon they’re both wrong, and in a seriously wonky post I’ll try to explain why, using my modelling program Minsky.

Minsky develops a model of monetary flows using double-entry bookkeeping – which is the same way that banks run their businesses – so it’s a powerful way to cut through the confusion over what actually happens in QE. But double-entry bookkeeping can make your head spin because it involves lots of ALE – and unfortunately not the fun intoxicating kind, but the boring accounting trio of Assets, Liabilities and Equity.

The heart of accounting is the principle that the difference between the debts other people owe to you (your Assets) and the debts you owe to them (your Liabilities) is your net worth (your Equity). This is drummed into accounting students as the “Fundamental Equation of Accounting”: “Assets equal Liabilities plus Equity”.

Double-entry bookkeeping (DEB for short) enforces this equation in two ways. Firstly, it records any Asset as a positive amount, and Liabilities and Equity as negative amounts. Secondly, it ensures that any transaction between accounts sums to zero. So, for example, if a rich aunt died and left you $1 million in her will, your accountant would show that as your Assets changing by plus $1 million and your Equity changing by minus $1 million. It sounds counter-intuitive when you first learn it, but it works to make sure you don’t make mistakes when tracking financial transactions.

Minsky uses a similar approach: Assets are shown as positive sums, so assets are increased by adding to them – no big deal there. But Liabilities (and Equity) are shown as negative sums, so increasing a Liability involves subtracting from it (is your head spinning yet?). So a loan of $1,000 from a bank is recorded as plus $1,000 in its loan account – an increase in its Assets – and as minus $1,000 in your deposit account – an increase in its Liabilities to you. The sum across the row that records the transaction is zero.

Then Minsky assembles a model of financial flows from the economy’s point of view, in which everything is shown as a positive – just as the Federal Reserve does when it compiles its Flow of Funds record of the entire economy.

Boy, I’ve probably lost half my normal audience already – and probably to Ales of a different kind. But if the rest of you have survived that intro, let’s plug on and build a model of QE.

A model necessarily involves simplifications – otherwise you’d have a replica, not a model – and I’m using an extremely simple vision of a Central Bank. Firstly to acknowledge that it has an unlimited capacity to create money if it wants to, I’ve said that it has an Asset called a ‘Charter’ that lets it create as much money as it wants to. Then to balance its books following DEB, I’ve given it an Equity account that I label “Equity_FED” (for “Equity of the Federal Reserve”), and I’ve endowed this with an initial value that is the negative of the value of its Charter.

That leaves its liabilities to model, and as ‘the banker’s bank’ the Fed’s key liabilities are the deposits accounts of private banks – which economists call Reserves. Just to simplify the model, I set these as zero to begin with. So my model of the Fed in Minsky starts off looks like this:

Figure 1: The Fed’s balance sheet before QE


Next we have to model the private banks. I’m lumping them all together here (Minsky can handle modelling multiple private banks, but that’s not needed for this simple model), and giving them five accounts: two Assets, two Liabilities, and their Equity (Equity_B).

Their Assets are the Reserves they hold at the Fed, and the Loans they make to the public. Their Liabilities are the Deposits the public has with them, and another account I’m calling “Repo”.

Why Repo? Because when the Fed buys bonds off the banks, it normally does so in what is known as a “Repurchase Agreement” (or “Repo” for short): it buys a bond at one price and agrees to sell it back at another price at a future date. QE works the same way, but without a fixed date for selling the bond back. Figure 2 shows the private banks’ collective balance sheet before QE.

Figure 2: Private banks’ balance sheet before QE


Now enter QE. The Fed buys bonds off the private banks by transferring money from its essentially limitless Equity account. Following the rules of DEB, this is shown as a plus QE on its Equity and a minus QE on the Reserves of private banks: the liability the Fed owes to them has risen.


That’s seeing it from the Fed’s point of view. For the private banks, their Assets have risen by the amount QE. But they also have a liability: they have to buy the bonds back off the Fed whenever the Fed wants them to do so. For this reason, and to obey DEB, exactly the same amount has to turn up on Liabilities (and Equity – since the banks will make a profit out of this transaction by buying the bonds back for less than they sold them for – but for simplicity I’m ignoring this aspect for now). Figure 3 shows QE from the banks’ perspective: their assets have risen by QE (the Reserves liability of the Fed is an asset for the private banks), and they have a liability to the Fed of QE.

Figure 3: QE from the private banks’ point of view


QE is colloquially called ‘printing money’, and the fear that critics have about QE is that it’s going to dramatically increase the money supply and cause runaway inflation. But up to this stage in the model, QE has done nothing at all to the money supply.

That’s because, in a nutshell, the money supply that ticks over on Main Street and Wall Street is the sum of the liabilities of the banking sector to the rest of the economy, plus the money the banks have earned from their activities. In this simple model, this is the sum of Deposits plus Equity_B. So far, QE has done nothing at all to either. (In fact the banks could book the gain they expect to make from QE as part of their equity, but as noted I’m initially ignoring this detail in this simple model.) If QE is going to affect the money supply, then the banks have to lend from it to the public.

They can do so from the Repo account – so the next stage of the model shows them doing just that, with the flow Lend (see Figure 4). The banks have an incentive to do this, since the return they get on their Reserves from the Fed is a lot lower than they could get from the public (of course there are also good reasons not to lend, which I’ll get on to later).

Figure 4: The banks use QE to lend to the public


But this can’t be the end of it, because thus far the banks have lent money without recording the loan. So how do they do that? The loan to the public creates an asset for the banks (which must be shown as a positive), and this has to be matched by an increase in their liabilities as well (which must be shown as a negative). The next row shows this operation (see Figure 5).

Figure 5: Banks record the loans to the public


Notice what this does to the Repo account: the original lending from Repo is cancelled out by recording the loan! The net effect is just the same as if the banks had ignored QE and just lent to the public directly – creating assets on one side of their ledger (Loans) and liabilities on the other (Deposits). QE is actually quantitatively irrelevant to this operation.

Figure 6 completes the model by including repayment of loans by the public, and the (eventual) unwinding of QE by the Fed. It lets us work out the quantitative impact of QE on the money supply and the answer is – absolutely nothing. Nada. Zip. They money supply will expand if lending by private banks exceeds repayment of debt by the public, but quantitatively, QE is nowhere to be seen.

Figure 6: The full model including loan repayment and unwinding QE


QE could influence the money supply if it drove up lending by banks by increasing the margin between lending and deposit rates (which would make lending more attractive to banks), or by lower lending rates encouraging more borrowing by the public – and that in fact is what the Fed is hoping that QE will achieve (forlornly, in my opinion – which I’ll get to in a minute). But though it dramatically increases the Reserves of the private banks, it does nothing to directly increase the money supply.

So the ‘printing money’ moniker that critics give to QE is misguided: it actually creates no additional money at all (outside of the gain banks will make on the repo deal). For money to really be created, QE would have to go directly to the Deposits of the public in the private banks, and that’s not what QE does. ‘Printing Money’ is therefore a false model: it implies that Ben Bernanke is printing greenbacks and mailing them in little brown envelopes to everyone on Main Street, and that’s not even close to how QE operates.

But the critics of QE aren’t the only ones operating with a false model: so is the Fed. I’m sure that Bernanke knows that QE isn’t creating additional money, but he believes that it will reduce interest rates and thus encourage more lending by the private banks, which would stimulate demand. He sees no problem with more debt being taken on by the public, since he thinks that the level of private debt has no impact – good or bad – on the economy. From his “New Keynesian” point of view, a loan is simply a transfer from a saver to a borrower, and, as he put it in 2000: “Absent implausibly large differences in marginal spending propensities among the groups … pure redistributions should have no significant macro-economic effects…”

That’s where the neoclassical blindspot about banks gets in the way (‘New Keynesians’ like Bernanke and Paul Krugman are in fact a subset of the dominant sect in economics known as ‘neoclassical economics’). They imagine that lending by banks is just like lending between private individuals: if I borrow money from, say, John Carlson, then John’s spending power goes down and mine goes up – one largely cancels the other, and the net effect on macroeconomics will be just the difference between my propensity to spend and John’s, which will be a minor factor. They therefore argue that aggregate demand equals income alone, and the change in private debt can be ignored.

But lending from a bank isn’t like that: if a bank lends me money, then my spending power goes up without reducing anybody else’s. So bank lending is not simply a “pure redistribution”: it instead creates new money, and adds to demand when it is spent. From this perspective, aggregate demand is income plus the change in debt. (I get accused of double-counting here – I’ll explain why that’s not the case in another post.)

As I’ve explained at length before, this is why ‘the Great Moderation’ occurred – because Americans borrowed up big from 1993 till 2008, increasing private debt from $10 trillion to $40 trillion when GDP rose from $6 trillion to $14 trillion. It’s also why ‘the Great Recession’ occurred – because when Americans stopped borrowing and instead started to reduce their debt, demand (for both goods and services and assets like houses and shares) collapsed.

Figure 7: Aggregate demand collapsed when the growt of private debt stalled and turned negative


So contra Bernanke’s belief that the aggregate level of private debt doesn’t matter, it matters a great deal. That in turn means that Americans are very unlikely to spend more because of QE, because they’re already straining under a level of private debt that is unprecedented – even after several years of deleveraging, the level of private debt compared to GDP is higher than it ever was during the Great Depression.

Figure 8: America’s debt to GDP ratios since 1920


Lower interest rates therefore aren’t going to be a great enticement to Americans to borrow money from banks (or each other). They may do a bit more borrowing—especially if the Fed’s actions have spurred rallies in asset markets, which I consider below—but this is likely to run out of steam pretty quickly.

So QE isn’t going to cause The Great Inflation as some of its critics fear, but nor is it going to restore normal economic activity, as Bernanke appears to hope it will. However it’s not “mostly harmless” either: it could well be guilty of another charge critics throw at it, of artificially inflating asset markets in a way that could lead to market crashes when it is unwound. Considering this issue involves making my Minsky model of QE a bit more complicated—so if you’ve had enough of accounting ALEs for one day, skip the rest and go drink a real one. If you’ve got this far, you deserve one.


I ignored some extra issues in the above analysis that could enable some of QE to enter the money supply. These include other uses that banks might make of the excess reserves (such as buying shares from the public), and the Repo margin that banks will ultimately make when they buy the bonds back from the Fed when QE is unwound. There’s also a factor in QE that could reduce the money supply too – payment of interest on bonds in QE. This is because QE is not like standard Repos which last as little as a day or week, so presumably the banks have to pay interest to the Fed since the Fed owns the bonds for an indefinite period.

I’m tentative about these additions – I’m open to correction that I’ve wrongly characterised what banks do or how QE works here. That said, this final model shows two ways that QE could actually increase the money supply: by banks being net buyers of shares (and other assets) from the public before QE is unwound, and by the net margin that banks will make once the Repo side of QE comes to fruition (and which they have probably anticipated to some degree and booked as profits already). So QE could increase the money supply, if (a) the banks are net buyers of shares while QE lasts and (b) they make a margin on the repo trade within QE.

Figure 9: QE with share trading and Repo margin


Putting this all together, the net quantitative effect of QE on the money supply comes down to net buying by banks of shares (and other assets) from the public, and the difference between the Repo margin the banks make on QE and the interest they (presumably) have to pay to the Fed while QE lasts. There can also be a price effect – which is all that Bernanke really appears to be targeting – of lower interest rate costs spurring more borrowing by the public, so that net borrowing (the difference between ‘Lend’ and ‘Repay’ in my model) is larger than it would have been without QE.

All that results in this equation (generated by Minsky) for change in the money supply:


Of those factors, the largest is likely to be net buying of shares by banks while QE lasts. If this logic is in the ballpark of what banks are actually doing, then this puts flesh on economist Michael Hudson’s remark that “Bernanke’s helicopter is dropping money on Wall Street, not Main Street”, and on fears that QE is helping drive a stock market bubble. The reaction of the stock market to fears that Bernanke might start to unwind QE this year could therefore be well founded.


Here I have a confession to make: I am not, and never have been, an Accountant. I didn’t even study it at University: though obviously I studied Economics, I did so as part of an Arts/Law degree, and thus avoided the dry and dusty topic of DEB (double-entry bookkeeping). I’ve only belatedly come to appreciate its importance in understanding our monetary economy too – my earliest academic work on money ignored DEB – but I hope now I’ve atoned for my sins of omission.

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  1. Luis Enrique

    neoclassical [economists] ….imagine that lending by banks is just like lending between private individuals

    NO THEY DO NOT. Honestly, how do you get away with making such easily falsifiable statements, and why do so many people like Yves apparently go along with you?

    You may not like the “money multiplier” model of bank money creation, but you cannot deny that it’s in every introductory macroeconomics text book, and that the money multiplier model only makes sense because bank intermediated lending differs from lending between individuals.

    1. Yves Smith Post author

      Wow, is your ire misplaced.

      Banks have no role in neoclassical economics. Microeconomics is based on an assumption of a barter economy. Keen has discussed this ad nauseum in his book and other economists have pointed it out independently. In macroeconomics, banks sit outside the neoclassical paradigm and are nowhere to be found in DSGE models. Interest rates are an input that somehow materialize. Financial economists study how markets and investments operate, but their work does not connect to macro, or even to the banking system (see Larry Summers on “ketchup economics”).

      1. YankeeFrank

        Fascinating. So the level of indebtedness of the average punter is irrelevant to economic activity in Bernanke’s worldview. Amazing. Stupendous. Ludicrous. A five year old could do better understanding demand and debt.

      2. F. Beard

        I recall that Paul Krugman said something to the effect that questioning the money system was off-limits for economists.

        But the banks keep screwing up the economy and one of these days, if not now, it’ll be one time too many.

        1. Massinissa

          He did say that, you are correct. Just pointing that out.

          I have plenty of faults with Krugman, damn plenty, but you know, many mainstream economics priests- Er, I mean Economists, dont even bother to point something so obvious like that out (probably because they are paid/incentivized to not do so…)

          1. NotTimothyGeithner

            Economics is a self-selective field. One group was out for profit, and the other group studied economics because they wanted to understand the world* without being exposed to anything too ugly or complicated**. Yves Smith writes about economics because its an area of concern to her old career which if she is like most people was somewhat determined by the first person to hire her and the first thing she did well that people will pay.

            *I might be giving them too much credit. My guess is they just wanted to sound important.

            **Look at that great economic data from 1941-1945, or what labor saving devices did the American South produce in the early 19th century which required white people to not do any labor? If we cut defense spending, people will lose jobs!

      3. Chris Engel

        Yves writes:

        In macroeconomics, banks sit outside the neoclassical paradigm and are nowhere to be found in DSGE models.

        This incorrect. It wasn’t even correct 10 years ago, maybe 20 years ago it was.

        DSGE models can incorporate banking and the good ones do! (the really good ones stipulate a system with endogenous money as well — i.e., loans not deposit-constrained).

        1. jake chase

          Veblen’s Theory of Business Enterprise (1904) correctly explained the pivotal role of banks well before we even had a central bank. He distinguished what he called ‘the business system’ from the industrial system, which operates the real economy, in which material and human resources are combined to satisfy human needs (real and imagined).

          The business system essentially involves sabotage of the industrial system for the purpose of accumulating private profits. Its techniques are monopolization, combination, equity plays, and, particularly during the past 30 years, executive looting. Although banks have a theoretical role in the industrial system insofar as they merely disburse community savings for productive purposes, their more important function is to supply the speculative fuel energizing the business system, which demands an incessant recapitalization of real assets, producing booms and busts, and wealth accumulations, resulting in windfalls for the few and a treadmill for the many.

          Banks supported by a central bank now have an unlimited power to create loan credit and steroidal operation of the business system, regardless of any consequences to the industrial system and those dependent upon it. Bank executives keep the profits of these speculations, and the public absorbs any losses. Unsurprisingly, the banks maximize speculative lending and derivative bets. While the real economy contracts, speculative bubbles become bigger and more pervasive.

          Ultimately, there must be a crash, but it may be a long time before ultimately arrives.

          Nothing has really changed in 100 years except for technological advance, supporting propaganda and blanket insurance for banks and bankers.

        2. Yves Smith Post author


          Provide me with some examples not assertions. It was most certainly correct in 2009, numerous articles then pointing to the failure of DSGE models to incorporate the banking system.

          And they don’t incorporate it now in any meaningful manner either.

          DSGE models treat economies as having a propensity to equilibrium. As discussed widely, banking and financial assets do not have a propensity to equilibrium (see a good layperson recap via George Cooper’s The Origin of Financial Crises). Any system of collateralized lending has an INHERENT propensity to boom-bust cycles. So properly modeled, it CAN’T fit in DSGE framework.

          1. Chris Engel

            Provide me with some examples not assertions. It was most certainly correct in 2009, numerous articles then pointing to the failure of DSGE models to incorporate the banking system.

            And they don’t incorporate it now in any meaningful manner either.

            Here’s an example from a few years ago that quite explicitly models banking (but not endogenous loan/deposit creation):


            But the whole topic of incorporating credit intermediation/banking sectors into DSGE goes way back to Bernanke modeling credit intermediation in the 80’s with Mike Gertler (less than 20 years ago — 1989).

            He wrote another great paper also with Gertler in the 1999 (with Gilchrist) that successfully modeled the banking sector in a DSGE model (the aspect of downturns being aggravated by banking panics).

            But if you’re going to alter your statement from “banks are nowhere to be found in DSGE models” to “they don’t incorporate it now in any meaningful manner either” then I’m not sure how to interpret the incorrectness of your statement. There are people out there who don’t think DSGE models meaningfully incorporate anything and are inefficient at modeling any macro phenomena.

            The most explicit has been work AFTER Bernanke Gertler and Gilchrist’s model where people have included perfectly competitive banking sector, monopolistically competitive, loans funding deposits, loans creating deposits.

            I can’t imagine that anybody would think that Christiano, Eichenbaum, and Evans in 2005 did not “incorporate it” in a meaningful manner. Bernanke would probably disagree, so would the hundreds of other economists who have been incorporating credit and banking and developing the frictions and interactions with the macroeconomy….

          2. skippy

            @Chris Engel…. sorry can’t help myself defective marsupial thingy… but how did they model epidemic fraud wrt loan – credit creation and ensuing high-jinks.

            Skippy… its like modeling the solar system with out Jupiter… eh.

        3. Mark Pawelek

          Just because neoclassicts are wrong doen’t necessarily mean that Keynesians or Keen are right. In the UK, QE has done nothing apart from hike up shares, commodities and, now, even property. These don’t count in the consumer price index so it follows that QE can possibly be causing inflation. Static wages next to rising prices don’t count in conventional economists measures of inflation either.

          It seems an article of religious faith that QE is good for the economy. At a guess I’d the dogma in reinforced because QE followers worship at same temple as the magic money tree devotees.

          1. Yves Smith Post author

            Straw man. Saying that the conventional criticisms of QE are wrong is not tantamount to saying QE is good.

            Keen clearly stated that QE is not tantamount to money printing and did say later that it might indeed goose asset prices.

            So what exactly is your beef?

          2. Newtownian

            The goosing of asset prices is intriguing and helpful for me in Steve’s land down-under. It may make life difficult for normal workers but what it has done is provide the illusion of ‘wealth’ increasing especially via superannuation notional valuation which is where the savings of more ordinary people reside. As a result the crash of 2008 which caused much rumblings is being forgotten temporarily and the financial planners are sprooking one again, though for how long is hard to say.

    2. Ben Johannson

      Yes, and the multiplier is demonstrably false. Banks do not need reserves to make loans, they do not wait to receive a deposit to make loans, and the money supply does not expand with the quantity of reserves.

      The money multiplier is based on a 19th Century conception of banking.

      1. Moneta

        Even if you debate the order of execution it does not take away the fact that our system is still based on checks and balances.

        One of the reasons why we are in this dire situation is because we are increasingly bypassing the checks and balances that were put in place to protect it.

        1. Me

          This is the type of discussion that turns people off to economics in general, which is a shame. You have people like Keen who are concerned with theory but primarily with reality. What ACTUALLY causes financial crisis? How do you actually explain economic depressions and the pickle we are in now? What role does private debt have to play? What relationship does finance have to production? As usual, the neoclassical crowd resorts to theory and theory alone (since the real economy, economic history and the like have no place in their theories to begin with).

          “The money multiplier in textbooks is a rudimentary tool used to try and quickly explain how money gets created. It was very clear to me how individual banks created money, no hidden agenda from my teachers.”

          Your teachers didn’t write the books or create the theories. It is up to your teachers to decide whether or not the theories they teach you will help you understand the actual real economy and how it operates in reality. It is up to you then as a student and a person with your own mind to determine if your teachers are right and if the theories do help you to understand the way the economy actually works. They key is the assumptions. If your teachers teach you theories on perfect competition and perfect competition doesn’t exist, what do you do? If they teach you that people have perfect information, or they teach you neoclassical capital theory (which was completly destroyed by Sraffa decades ago, the neoclassical economists of the time like Samuelson admitted as much) and if we know that has nothing to do with the way firms and actually operate, what do you do? Or how about free trade? You can be taught comparative advantage but what did Ricardo say, what were his assumptions (like capital and production staying put and not going moving to other countries) and what has been the record of free trade in practice? Or how about externalities? How do neoclassical economsits deal with externalities and environmetnal/ecological issues? Do their pet ideas have a snowball’s chance in hell of working and, again, what assumptions are needed for their ideas to actually work?

          The history of economics is filled with theories that eventually get replaced. Classical economists used the labor theory of value and analyzed the economy in terms of class. That is no longer the case in most economic programs and with most any neoclassical economist. It seems that reality doesn’t seem to matter to neoclassical economists. Neither does the fact that their ideas have been taken apart piece by piece, neither does the failure of their ideas in practice. Neoclassical economics is much closer to religion than anything else. It isn’t to say there aren’t some useful ideas here and there but on the whole, it is less than worthless. It has persisted because it benefits powerful people, economists have spent their entire lives studying the nonsense and there is money behind the facade.

          1. nonclassical

            ..count me not at all “turned off” by this exchange…it is totally stimulating, to those of us not (non)classically economically educated…(though that is not to what “nonclassical” refers)…

            ..inherent exchanges afford learning opportunities, of a variety of discipline..

          2. Moneta

            In 2003, when the real estate bubble was starting to show the hockey stick effect, I had to make a convincing presentation to a committee. So I asked my spouse how I should present my facts. The answer was KISS, 3 points maximum.

            How on earth could one explain the situation and convince the audience by keeping the explanation to a 3 point slide… in 2003?

            That’s when I realized that we were doomed; that I could control my own debt level and help people pick themselves up when they would crash but that was it.

            Some people revel in complex matters but most avoid them like the plague.

          3. Me

            I think this article and this site is great and I enjoy the conversation. I was talking about the responses that the defenders of the neoclassical faith always articulate. It turns the conversation away from reality and back to their crappy, reality less, failed theories.

          4. Richard Kline

            So Me, agreed with all. Neoclassical economics is a theology. I only differ with you in the respect that Neoclassical economics was deliberately and explicitly invented _as a theology_, it’s inventors knew it was a con. I’m serious. NeoEcon was about spewing enough excelsior and blue ribbons around that popular interest in materialest economics, the place of labor in production, and the politics of socialism could be drowned out and driven out of the class room. NeoEcon is propaganda, in other words. That anyone has been fool enough to apply it’s nostrums in practice is a testament to the power of lazy belief, since any serious study of political economy showed neoclassical economists as right down there with carny barkers and thimblerig prestidigitators selling ‘self improvement tracts’ on the side.

    3. RueTheDay

      The money multiplier found in every Principles of Macro textbook (D=1/R) simply expresses a relationship between the MAXIMUM quantity of deposits and the required reserve ratio. It’s a static boundary condition, nothing more. While every textbook also includes a highly stylized example of how it works using a given reserve ratio and quantity of new reserves, this is just using a geometric series to solve and explain a simple algebra problem.

      There’s nothing in the money multiplier that explains what actually drives the process (e.g., the supply and demand for loans). There’s nothing that shows how the process actually evolves over time – the geometric series exposition is instantaneous, there’s no dD/dT dynamic. There’s nothing that links the creation of deposits to real economic activity.

      No one is ignoring the fact that introductory texts contain a money multiplier. They’re simply pointing out that 1) it’s just a simple boundary condition, not an actual model of how a banking system creates money and 2) it’s completely disconnected from the rest of the economic model, similar in many ways to the quantity theory of money.

      1. Moneta

        That’s because there is still no model that can tell us if the new money will go into housing or a new craze such as tulip bulbs or cabbage patch kids.

        And when we figure it out, life might not be worth living because that means we’ll have the crystal ball.

        1. James

          The textbook ‘money multiplier’ model is a lie invented by bank shills to conceal the fact that banks individually create money.

          1. Moneta

            The money multiplier in textbooks is a rudimentary tool used to try and quickly explain how money gets created.

            It was very clear to me how individual banks created money, no hidden agenda from my teachers.

          2. James

            no, the textbook ‘money multiplier’ model claims that the banking system *as a whole* creates money by lending out deposits and keeping a fraction in reserve. This is a lie.

            Banks do not individually create money in the textbook ‘money multiplier’ model. The model is con.

            In reality banks individually create money with keystrokes. They do not ‘lend out’ deposits or reserves.

            What banks actually do in reality would be considered to be fraud or counterfeiting by many people. Hence bank shills invented a lie to cover it up.

        2. digi_owl

          It will do both (never mind that housing turned into a “craze” thanks to banks and speculators).

          You get a craze any time some random asset grows faster in market “value” than the average interest on a loan.

          Take any asset that someone want to use for something, be it shelter, transportation, production or anything similar. Likely the person can’t afford the full asking price up front, so they take up a loan.

          Now if the interest on the loan is low enough, and the demand for that kind of asset is high enough, the person may well be able to sell the asset again down the road, pay off the loan and pocket a profit.

          Once enough people catch on that this is possible, the speculators move in and the craze starts rolling.

          the one “stopgap” on all this is the banks willingness to lend. Sadly they get blinded by the glare of the craze in motion. This because until the craze collapses, all the banks see are dropping default ratios.

          Meaning that less and less people are defaulting on their loans while the craze is ongoing. And so the banks could have made even more money had they been willing to loan out more, and to projects previously deemed too risky.

          What is happening in the background is that the banks are indirectly playing hot potato with a potato that is growing hotter on every pass.

          This because as the craze is building, the total debt is ratcheting up as the asset is being passed between speculators.

          And i think Keen’s work with Minsky has already modeled this, and demonstrating a death spiral once the “potato” goes boom and people start defaulting en mass.

      2. Adam1

        “The money multiplier found in every Principles of Macro textbook (D=1/R) simply expresses a relationship between the MAXIMUM quantity of deposits and the required reserve ratio. It’s a static boundary condition, nothing more.”

        This is the problem! It is NOT static!!! It is NOT a boundary!!! It does NOT even rudimentarily explain money creation. Virtually every central bank on the planet works via automatic overdraft. As the demand for reserves increases the system automatically adds them. As banks lend they create deposits and those deposits (as well as the increase in interbank clearing to support the lending transactions) causes and increase in demand for reserves. The central bank automatically responds via open market operations or discount window lending to meet those demands. If it does not it will lose control of its target interest rate and I’ve yet to ever see that happen to a central bank which issues a freely floating non-convertible fiat currency.

        1. Nathanael

          The money multiplier was a good explanation of how bank creation of money worked under the gold standard, with no reserve bank, during the Free Banking Era.

          That makes it something of historical interest.

          1. digi_owl

            Meaning it “works” when Mr. Central Banker can’t just walk into a vault, wave his magic printing press and present a new pile of bills. Or in other words, it “works” when there is a finite supply involved somewhere.

            But such finite supplies fuels hoarding and deflationary spirals. One can see historical examples of this when the access to British coinage was limited to the American colonies. Local trade in the colonies often devolved to straight up barter because of this.

        2. jake chase

          The money multiplier never envisioned a Federal Reserve $16 trillion bailout of the banks, in which zero interest loans with no maturity are made against fictional assets like mbs, cdo, etc.

          Today’s money multiplier is essentially infinite.

          PS, most of the lending is going into speculation.

    4. Luis Enrique

      Is that paragraph (starting: That’s where the neoclassicl blindspot …”) claiming that economists like Bernanke and Krugman think bank lending is just like lending between private individuals, or not?

      If it is making that claim, then it is false. If you think Bernanke doesn’t understand these ideas, you are a fool.

      If that paragraph is not making that claim, then my ire is misplaced but I think Keen needs to write more carefully because that para sure comes close to making that claim.

      Yes, mainstream pre-2007 DSGE models did not include banks, because model makers mistakenly thought banks were amongst the large number of things the model excludes on the basis that they are thought not to matter. That does not mean DSGE modellers thought bank lending was the same thing as private sector lending, they’ve taken intro macro, the know about bank money creation (even if you all think the money multiplier model gets it wrong, it’s still a model in which bank lending is very different from private sector lending, which is the point under discussion here).

      You can now find DSGE models with banks in, so statements like “banks … are nowhere to be found in DSGE models” need updating.

      1. Ben Johannson

        The problem with your interpretation is that Krugman has stated, “for every borrower there is a saver” repeatedly on his blog. He and most mainstream economists believe reserves literally become the deposit rather than being an entry on a balance sheet.

      2. Me

        Teaching anything about DSGE models is insane. I mentioned above how divorced from reality neoclassical economics is. I can’t think of a better example than DSGE models. I don’t even know if I can draw a parallel in another field. It like an astronomer who studies astrology because he wants to know how the universe works. Ugh.

      3. RueTheDay

        “You can now find DSGE models with banks in, so statements like “banks … are nowhere to be found in DSGE models” need updating.”

        What the banks in DSGE models do doesn’t even remotely resemble what banks in the real world do. The DSGE banks basically just collect deposits and then loan the deposits straight out, pure intermediation. The only reason they were added was to be able to introduce a friction (interest rate setting on deposits and loans via monopoly power) and then create a “shock” and see how the model responds in the face of the friction. This is pretty much the standard way that everything in NK DSGE models is modeled – a friction that slows down the price adjustment mechanism followed by some sort of “shock” (demand, technology, financial in this case, etc.) and then seeing what happens to key variables in successive time periods. It’s abject nonsense, that like most economic models developed over the past 130 years, starts by making dubious assumptions (typically involving equilibrium and market clearing) that are not only empirically false but also completely unnecessary and uncalled for (unless you’re setting out to prove your premise from the start). They should be tossed in favor of real simulation models.

        1. Yves Smith Post author

          Yes, they’ve basically added a doofus version of banking that allows them to do what they did before (shock the model for interest rate increases).

          As I wrote earlier:

          “DSGE models treat economies as having a propensity to equilibrium. As discussed widely, banking and financial assets do not have a propensity to equilibrium (see a good layperson recap via George Cooper’s The Origin of Financial Crises). Any system of collateralized lending has an INHERENT propensity to boom-bust cycles. So properly modeled, it CAN’T fit in DSGE framework.”

        2. KnotRP

          Debating the DSGE model, is like debating whether the Tooth Fairy’s coin which you found under your pillow is real, or not….of course the coin is real….but that doesn’t mean
          the Tooth Fairy ain’t a work of fiction.

  2. Schofield

    Michael Hudson’s remark that “Bernanke’s helicopter is dropping money on Wall Street, not Main Street” is apt but neglects the “feel good” factor as the 401K statements start to go radioactive. Of course, such false allures help one to forget one’s “balance sheet fundamentals” that your wage income has barely moved and neither has your debt repayment drain. Still dreaming is what it’s all about that you can one day turn asset bubbles to your advantage and maybe you can when you inherit your parent’s estate but what a way to run an economy! As the article below makes clear “bubble economies” always involve the game of “Musical Chairs” when you’ve stopped dancing around the chairs and the music stops there’s always someone left without a chair!

    1. Moneta

      Money WAS dropped onto main street, the problem is that it is hard to measure what-ifs.

      With no bailouts or QE, real estate might be even lower. I read that in many crisis, housing can go from 50% if income to less than 10%. Unemployment could be over 30% and GDP might have dropped like a rock and stayed there.

      1. David Lentini

        With no bailouts or QE, the banking system and economy would very likely have collapsed à la 1929-1932. The minimal TARP and the massive QE saved the status quo ante 2007. The implied promise was reform of the banks and an end to the shenanigans that led to the collapse. But we now see those were lies to keep the public from demanding real action or a true restructuring of the banks. So, QE has been nothing but life(style) support for the rich and pain for everyone else as we work to pay-off the debts.

        Of course, the hole is so big, and the austerity push (to avoid admitting the need for bailing our Main Street with real dollars) so suffocating of real economic activity, that we’ll not see the day when the crisis is over for everyone.

        As Warren Buffet predicted, we now have a sharecropper society.

        1. Yves Smith Post author

          QE had squat to do with the rescue of the financial system. Jim Hamilton found it lowered bond yields by a grand 17 bps. That is tantamount to nada.

          And it bought only GSE debt, so (contrary to some commentary of people who didn’t look at the how it works) it didn’t help toxic assets, which are credit sensitive, not interest rate sensitive.

          The only impact it might have had on the banking system was signaling that Fed was willing to throw anything and everything at the problem.

          1. washunate

            Can you clarify this sometime, perhaps as a separate post? I’m not seeing how this fits together. Where do the dollars come from, if not being created by the government?

            “QE had squat to do with the rescue of the financial system. Jim Hamilton found it lowered bond yields by a grand 17 bps. That is tantamount to nada.”

            So why is it being done? If private savers are interested in these financial assets at prices reasonably close to what the Fed has been paying, why is the government backstopping all of this to accomplish nada?

            “And it bought only GSE debt, so (contrary to some commentary of people who didn’t look at the how it works) it didn’t help toxic assets, which are credit sensitive, not interest rate sensitive.”

            Isn’t part of the bailout that the GSE’s got bailed out? Their debt was sold explicitly under the pretext that it was not backed by USFG.

            “Freddie Mac securities are not
            guaranteed by and are not obligations of the United States
            or any federal agency or instrumentality other than Freddie
            Mac.” — Freddie Mac, January 2008.

            [warning, opens PDF]


          2. john c. halasz

            I’m not quite getting this. Aside from which round of QE, wasn’t the point to flood the system with “liquidity”, so as to prop up financial “asset” prices, rather than letting them be written down? (If T-bonds and GSE bonds were targeted, it’s not just the direct effect on their rates that’s at issue, but the transfer of funds to “riskier” assets). That, plus the increase in wealth-effect consumption demand, seem to me to be the main points.

          3. Jackrabbit

            The finding that ‘QE had nothing to do with bailout out the banking system’ seems too convenient a finding. Like “TARP made money”. The first QE provided liquidity while the Fed jawboned Accountants to suspend Mark-to-Market.

            They STILL don’t MtM. And they probably WON’T until the Fed sparks a ‘housing recovery’ (thanks to…the latest QE).

    2. KnotRP

      If reflating any asset back into bubble territory is
      actually a cure for our economic woes, is it ok if
      the few(er) of us who are still gainfully employed
      also quit our jobs in favor of everybody relying on
      the Fed to inflate us all to riches and financial independence? Surely, we can all just live on the
      capital gains from (Fed induced) asset appreciation?

      Or are you saying that only works if it’s restricted
      to the beautiful people?

  3. Schofield

    “Interest rates are an input that somehow materialize.”

    Not only that Luis Enrique can’t be bothered to do a balance sheet analysis of the non-government sector including all global economies where he’d discover that accounting on aggregate the interest on private bank loans cannot come from this sector but must come from the government sector to drive economic growth. The same mechanism applies for reserves and savings.

  4. jake chase

    Steve Keen wrote a terrific book, but this post makes one enormous mistake: assuming that QE is ever going to be unwound. It will not be unwound because it cannot be unwound without collapsing the financialized economy. What QE amounts to is a gift to the TBTF banks and their executives. The whole thing is papered over with newspeek abbreviations: TALP, TAF, TRAF, BARF, etc. According to the GAO, $16 trillion was dispensed between 2008 and 2010 against assets that weren’t worth the electrons they had been printed on.

    I agree with Steve that he doesn’t really understand accounting. Believe me, if your aunt dies and leaves you $1 million, your equity goes up, not down, and you can take that million to the bank and earn $1.67 on it every month.

    1. tomk

      I didn’t follow that either. Is that a misstatement or do I really not get it? Why does an inheritance reduce your equity? OK, I see now, it’s a double negative, your equity is reduced by a negative amount, so in the final tally you still have your aunt’s million.

      1. HotFlash

        Think of the accounting equation this way: Assets – liabilities = equity (ie, what you own minus what you owe = what you are worth), that’s more intuitive. Basic math allows us to restate this as assets minus liabilities minus equity = 0, or A = L + E (ie, everything you have either belongs to somebody else or yourself, eg, your house = mortgage plus equity). If everything has been recorded correctly, your total A-L-E = 0, and bookkeepers regularly ‘balanced the books’, to check the accuracy. If it didn’t sum to zero, you had to hunt through to find out where you went wrong. For ease in summing accounts, assets are denominated ‘normal debits’ and liabilities are denominated ‘normal credits’ and denoted with red ink (olden days), a minus sign or in brackets in the accounting equation; equity may be a credit if you are ahead of the game, but can also be a debit if you are in the hole. Example: House $100,000 + mortgage ($150,000) + equity $50,000 = 0. This, BTW, shows ‘positive’ equity (no brackets)but this homeowner is clearly underwater.

        Most of you won’t have seen this b/c financial statements are stated in ‘normal’ terms, ie, liabilities and positive equity shown without brackets, b/c of the confusion it causes. But it was a great hoot for me in accounting 101, Chapter 1, to find that ‘red ink’ was exactly what you wanted on your bottom line!

        I have a long background in accounting and this must be the first time I have read NC and my head *didn’t* spin!

        1. Nathanael

          “Most of you won’t have seen this b/c financial statements are stated in ‘normal’ terms, ie, liabilities and positive equity shown without brackets, b/c of the confusion it causes. But it was a great hoot for me in accounting 101, Chapter 1, to find that ‘red ink’ was exactly what you wanted on your bottom line!”

          OK, I’m beginning to see what’s going on, and a lot of it is conventions to account for the loss of color printing.

          The 19th century account books I’ve seen (yes, I’m a bit of an antiquarian) have a very particular style. The asset books are written positive, in black ink, with any “subtrations from assets” being in red ink in parentheses.

          The liability/equity books are written in positive form, in *red* ink, but NOT in parentheses, with any “subtractions from assets” being in black ink in parentheses.

          This particularly complicated convention clearly got messed up at some time.

          1. Nathanael

            Please note that this convention meant that the parentheses were always the same for any given entry in both of its copies, while the ink color was always swapped for the two copies.

            It’s quite a useful set of rules. If you need to check for entries which didn’t get matched up properly, you’re looking for exactly the same string of characters in both books. And by having the dominant ink color be different in the two books, you make it really easy to tell which book you picked up.

      2. washunate

        FYI, the reason for the confusion is the application of double entry bookkeeping where it is not used (in DEB, equity is a liability, thus a positive liability is not good – that’s just the complimentary statement to the observation that the person to whom you owe the money is happy that you owe them. For them, your liability is their asset. In general, this is why money is referred to as debt – it’s just a promise one person makes to pay someone else).

        Personal finance is much simpler with single entry bookkeeping (like balancing your checkbook). If the equation is positive, that’s good.

        Assets – Liabilities = Net Worth.

        Just add $1 million to your cash (assets) and throw a party.

      3. aj

        Steve’s not confused, you are just not following his logic. Since he is trying to make the columns add across to 0, an Increase in Equity is recorded as a negative number. Thus, the $1 million inheritance is recorded as a positive number under assets and a negative number under equity, increasing the balance of both.

        1. F. Beard

          Ah, so! Now it makes sense more to me.

          But Equity = Assets – Liabilities requires that one sum Assets and sum Liabilities first. Equity then falls out as the difference.

        2. F. Beard

          Since he is trying to make the columns add across to 0, an Increase in Equity is recorded as a negative number. AJ

          Ah, so! Now it makes sense to me.

          But Equity = Assets – Liabilities requires that one sum Assets and sum Liabilities first. Equity then falls out as the difference.

          1. F. Beard

            Still, direct entries to Equity is possible too, something I haven’t considered that much.

    2. Jim Haygood

      ‘If a rich aunt died and left you $1 million in her will, your accountant would show that as your Assets changing by plus $1 million and your Equity changing by minus $1 million.’ — Steve Keen

      The appropriate application of double entry bookkeeping to this event is that your assets are credited with $1 million, while your aunt’s are debited by $1 million. This is the same bookkeeping that applies every time a check is deposited.

      Your equity rises by $1 million; your aunt’s declines by $1 million; deposits in the banking system as a whole are unchanged.

      Steve Keen probably is confusing his hypothetical with a loan. If you borrow $1 million from the bank, then your assets rise by $1 million with the loan proceeds, but so does your liability to repay it. In this case, your equity is unchanged, not negative as Keen states.

      Frankly I didn’t work through Keen’s further examples since he is so obviously out to lunch on double entry bookkeeping. The classic application of double entry bookkeeping to banking is Murray Rothbard’s The Mystery of Banking, which is posted here:

      1. F. Beard

        Rothbard’s book is where I learned about double-entry bookkeeping too. Rothbard’s diagnosis is correct, but his “solution” isn’t, being a primitive gold-bug (there is no other kind).

        Keen’s example is either a typo or he’s still learning. In either case, I would not count him out. Can YOU do differential equations? Or can many economists?

      2. HotFlash

        Um, no, Jim. Double entry means two entries *per accounting entity*. In this case, you would record a debit to Cash (or Bank) $1 million, credit Equity $1 million on your books. Your aunt’s trustee/executor would record it as debit Inheritances Payable $1 million and credit Cash (or Bank) $1 million on her books.

        Note: There isn’t actually any equity involved on the aunt’s books. Trust accounting is different since the goal is not to see if you made or lost money (equity), but to ensure that funds have been disbursed as authorized. Govt accounting is like this too, which confuses people who are used to profit-oriented business accounting.

          1. washunate

            I hear you on the accounting fun of people applying accrual basis to government books, but I still agree with the conclusion that Keen is out to lunch on this particular post.

            The only way to fund the bailouts without QE is to raise taxes on the wealthy. Those are the only two major sources of marginal dollars. So to say QE is irrelevant is to claim that the President and Congress are willing to meaningfully cut the bankster bailouts and national security state. I see no warrants for that claim in this post.

          2. F. Beard

            The only way to fund the bailouts without QE is to raise taxes on the wealthy. washunate

            No. Keen also recommends a universal bailout, including non-debtors, with new fiat. THAT would fix everyone from the bottom up in nominal terms and in real terms too if (as Keen also recommends) leverage restrictions were slapped on the banks to prevent another bubble.

          3. washunate

            Um, F. Beard, how does that fund the financial fraudsters and war criminals and all the rest?

            Plus, printing new fiat is exactly what QE is. The process of spending existing fiat is called taxation.

          4. Calgacus

            Washunate: Plus, printing new fiat is exactly what QE is. Printing new fiat, plus shredding (perhaps temporarily, more or less) what the Fed’s new fiat buys is what QE is. If QE is just buying Treasury bonds, it is just monkeying with interest rates. Unnecessary, not too meaningful prestidigitation with smoke and mirrors. Mainly just reverses the Treasury’s unnecessary magic show called a “bond auction.” The main, and very successful purpose of these shows is to confuse everyone, to make them disbelieve very simple, very obvious truths.

            As Yves says: “QE had squat to do with the rescue of the financial system. Jim Hamilton found it lowered bond yields by a grand 17 bps. That is tantamount to nada.” And QE has much less than squat nada to do with allowing Uncle Sam to spend on the national security state or anything else. Uncle Sam and his national security state don’t need rescuing. The rest of us need rescuing from IT!

            The process of spending existing fiat is called taxation. BZZZTTTT!! NO!!

            The government really, really, really does not get or spend “existing fiat” when it taxes. When the government taxes, the “existing fiat” is GONE. When the US government spends, it spends new fiat money into existence. The US government does not need anybody’s money. If you want to make life hard on yourself and imagine that the Fed isn’t part of the government, then the thing to understand is that the US Treasury stands behind the Fed, gives value to the Fed’s otherwise worthless money, NOT vice versa.

            A lot of people don’t grasp that the MMT thinkers, like all true philosophers, really mean what they say. Figures of speech are misunderstood as precise theoretical statements, and precise theoretical statements are misunderstood as figures of speech.

            The Fed cannot stop QE until the President and Congress implement a budget that replaces QE with taxation. This is just basic math.

            No, it is quite mistaken. QE (and bond auctions) are merely monetary operations. Taxing and spending are fiscal, and far more important and consequential. QE doesn’t and can’t “replace taxation”. Doesn’t mean much, and if it stopped tomorrow, wouldn’t mean much. Business as usual, government “borrowing”, printing bonds, Treasury auctions and no QE would have worked just fine. Especially fine in a depression, when the gubmint (hopefully) deficit spends like mad, because that is what a depression is. A bear party when everyone wants government debt = NFA = money.

          5. washunate

            I would just ask you to think through this logic to the end. You acknowledge that interest rates would go up if the Fed sold its existing $3 trillion worth of securities and stopped purchasing new ones.

            So, what happens as interest rates go up because the government (the Fed) isn’t buying the Treasury and Mortgage-backed securities? Over time, interest payments overwhelm the budget (or taxes are raised to offset the spending).

            This is why exponential growth simply doesn’t exist in sustainable systems – at some point, even 2% compounded growth becomes astronomical (or, as I prefer the joke, economical). This is why the government has to choose between ending QE and keeping corporate welfare. It can’t do both – the act of having a budget that provides massive corporate welfare necessitates printing the money to pay for it.

          6. washunate

            Maybe a quantitative approach would be more persuasive.

            In the 12 year period from September 2000 to September 2012, public debt outstanding increased from about $5.7 trillion to $16.1 trillion. Now, over short periods of time, I’m not a deficit fetishist. We are a wealthy nation and have the means to invest in productive outlays in the public commons of infrastructure and social insurance.


            But waste isn’t productive investment. We cannot continue on a path of 9% compound annual growth forever when that growth is being squandered rather than spent wisely. At some point, we either have to shift from wasteful corporate welfare to productive investment in the public commons, or, there will be some kind of reset of the system (external war, internal revolution, currency collapse, police state, whatever) as the basic mathematics of long-term compound interest overwhelm short-term accounting gimmicks and kick the can strategies.

            If the government unwinds QE and instead funds corporate welfare by selling securities to private actors, then even 3% or 4% interest rates will start taking up huge portions of the budget if outstanding debt is growing anywhere near 9% annually. And of course, there is a nonzero risk that rates would rise much higher, because the whole point of markets is allowing markets to price things – you can’t decree what the interest rate is without buying the securities directly (which then lets the market set the price for dollars – you can’t guarantee purchasing power or wage increases when increasing the money supply, particularly when most of the benefit accrues to criminal enterprises closest to the money spigot).

            If we had 9% compound growth and the average yield on outstanding debt reached 5%, by the end of the decade you’re talking about spending a trillion and a half dollars just on interest.

            And all of that doesn’t take into account what will happen to the already insolvent TBTF firms when their existing holdings decline in value due to the increase in interest rates. The GSE backing alone carries a risk level on the order of trillions of dollars – if that risk wasn’t material, they wouldn’t need government backing!

            The whole house of cards is premised upon funding corporate welfare through inflation – stagnating wages and rising prices. Mathematically speaking, the government simply cannot stop inflating the money supply unless it stops the corporate welfare necessitating it.

        1. H. Alexander Ivey

          Very good comment. Double entry accounting has a reason, not just to be confusing. It gives you a quick and accurate and understandable answer to basic money questions, like did the company or I or the government earn/lose money or is what I gave the same as what s/one else got?

          thanks for the posting

    3. Dan Kervick

      I also initially lost Steve at that point, but I think it’s just a matter of clarifying which convention is being used. There are two main conventions you can use for double-entry accounting, depending on which values are entered as positive numbers and which as positive.

      If you record assets, liabilities and equity as positive numbers, then you want to express the fundamental equation as E = A – L, which is equivalent to both A – L – E = 0 and A = L + E.

      If instead you record assets as positive numbers, and equity and liabilities as negative numbers, then you have the fundamental equation A + L + E = 0. And that is equivalent to A = -(L + E).

      Suppose we use the first convention, and therefore use the first form of the fundamental equation. If a person’s assets are $10 million and its liabilities are $9 million, then their equity is $1 million. Recording these all as positive numbers we get A = L + E. Equivalently: A – L – E = 0.

      However, if we decide to use the second convention and record liabilities and equity as negative numbers, then we have assets as $10 million liabilities as -$9 million and equity as -1 million. Then using the second form of the fundamental equation, we get A + L + E = 0 or A = -(L + E).

      Steve creates a little bit of confusion, because he first says that the fundamental equation is

      “Assets equal Liabilities plus Equity”

      but then adopts the convention of treating liability and equity as negative numbers. However, when he then applies the equation, he says:

      The sum across the row that records the transaction is zero.

      So I think everything is fine in application (although I haven’t worked through the rest of the piece). He is using the second convention in Minsky and he just misspoke when he gave his initial presentation of the fundamental equation.

      By the way, the idea that equity is a negative number on the second convention, like liabilities, can seem confusing since equity is supposed to be what you have left over when you discharge your liabilities from your assets, and is therefor something “positive” for you. The way I understand the rationale for that convention (and maybe some corporate finance guys can tell me whether I have it right), is that we need to think of the company and its owners as two separate things. If the company’s assets exceed its liabilities, then the difference is the owners’ residual claim on the assets of the company. In other words, it’s what the company “owes” its owners. Since it is an amount owed, we can think of that as a negative thing from the standpoint of the company, analogous to the company’s liabilities, but a positive thing from the standpoint of the owners. When we call that amount “capital”, we tend to think of it from the point of view of the company, and when we call that amount “equity” we are thinking of it from the standpoint of the owners.

      It doesn’t matter, as long as we use the appropriate equation given the appropriate convention. If, for example, we decided to record both equity and assets as a positive number, and liabilities as a negative number, then we would want to rewrite the fundamental equation in a third form as E = A + L or A + L – E = 0.

      1. SteveZ

        Yes, Dan. That explains it perfectly. I think the naysayers either really just didn’t or won’t (because of biases) think it through. It is really not that hard either. Steve admits that equity being a negative number is counterintuitive, but it became obvious to me early on that Minsky was set up to easily sum across the row. The sum should always be zero. If not, something was entered wrong.

        “It sounds counter-intuitive when you first learn it, but it works to make sure you don’t make mistakes when tracking financial transactions.”

        1. H. Alexander Ivey

          It sounds counter intuitive – really means that the reader(the one who thinks it is counter intuitive)’s POV is wrong. Kernick explanation shows the need not to confuse the company with the CEO with the stockholder with the bond holder with the …

        2. H. Alexander Ivey

          and for the writer to anticipate his reader’s wrong POV and (gently) correct it.

    4. Yves Smith Post author


      QE does not have to be “unwound.”

      The Fed bought mortgage backed securities.

      They amortize. People refi or pay them off when they sell the house. Average duration 5 years. It will go longer, but not enormously longer in a rising rate environment.

      The Fed just has to STOP QE. The unwind happens on its own.

      1. ian

        Why does it have to stop? I see here that the conventional criticism of QE is wrong, and I don’t see any harm identified here? OK, so why can’t it just go on forever?

  5. Schofield

    “Fascinating. So the level of indebtedness of the average punter is irrelevant to economic activity in Bernanke’s worldview. Amazing. Stupendous. Ludicrous. A five year old could do better understanding demand and debt.”

    Yeah. Seconded.

    1. Synopticist

      Amazing isn’t it?

      Back in the days when this sort of thing didn’t really seem particularly important, and we were content to leave it to the serious economist types, I never stopped to think about how delusional that assumption was.

      What’s really scary is that some people still seem to think like that.

      1. Massinissa

        Kind of reminds me how people have priests tell them whats in the bible instead of bothering to read the damn thing…

        Kind of dangerous to leave these kinds of things to people who will gain by completely obscuring accurate understandings of the issues.

        1. digi_owl

          Well back when the (catholic) church held serious power over Europe, the bible was hand-copied and in Latin. Making the act of sitting down and reading it, unless you were a monk or priest, highly unlikely. With the printing press came mass printed translations, and with it rapid erosion of church power in Europe.

      2. Thorstein

        My experience is that most bankers think like that. Especially when FDIC (or TARP or BARF) will bail them out if their borrowers’ indebtedness becomes beyond redemption.

  6. SteveB

    The aggregate level of private debt is certainly important, but so is the yearly personal interest payments on that debt. And those payments have dropped dramatically, from about 275 billion per year in in 2007 to about 175 billion per year in 2013. The reduction in interest rates, due to QE, has thus had a major impact on the economy.

    I think the major weakness in Keen’s modeling is that he emphasizes overall debt, and not the yearly payments on that debt. I think that more attention should be paid to the flow of funds than to the debt to GDP ratio. When a homeowner refinances, they probably spend a large fraction of those savings in various retail purchases. This should be a stimulant to the economy, and it has indeed led to inflation in some areas that are sensitive to extra available cash, such as travel, entertainment, luxuries, etc. And this stimulant will largely remain even when interest rates go back up, because many people have fixed rate mortgages.

    The story is more complicated, of course, since only a subset of the population has a home mortgage, and only a subset of those with mortgages have been able to refinance at a lower interest rate. And a significant fraction of the population is burdened by other types of debt that can not be refinanced at a lower interest rate.

        1. EconCCX

          Thanks, @SteveB. The data source is the BEA, which indeed shows “Personal interest payments” as “Non-mortgage interest paid by persons.”

          Moreover, it’s a measure of interest paid, not interest accrued. The drop is precipitous, and the trend predates the official recession, let alone QE. So it’s the story of consumers prioritizing, keeping the electricity on and trying gamely to save their houses. Not a depiction of the easing manageability of interest payments as a consumer benefit of QE. And not a mortgage story at all.

    1. EconCCX

      @SteveB >And those [yearly personal interest] payments have dropped dramatically, from about 275 billion per year in in 2007 to about 175 billion per year in 2013.

      I’d appreciate seeing your source for those numbers. Did foreclosure contribute a bit to that drop?

    2. Yves Smith Post author

      Stop attributing the drop in consumer rates to QE. As I indicated above, QE has had impacted Treasury yields, but less than most people think. You had huge deflationary pressures in the wake of the crisis, and in deflation, the place you want to be is in cash and high quality bonds. So the Fed is getting a lot of credit (or taking a lot of blame) for what would have happened to a considerable degree without its intervention.

      The one place it has had a serious impact is on mortgage rates, as a result of the Fed buying GSE debt. That would not affect other consumer borrowing rates since the duration is very different.

      The bigger deal is still ZIRP. Banks borrow short to fund consumer lending like credit cards. And have banks lowered THOSE rates? You still see rates on purchases on credit cards at 19is% and default rates at 24.99%, 29.99%, even 34.99%.

      In fact, you saw BETTER credit card deals the last time the Fed drove short rates below inflation, in the 2002-2004 period. I regularly got “Transfer your balance” (which you could do to a credit card that was CURRENT, so you could fund spending “and get XYZ rate FOR THE LIFE OF THE BALANCE.” Rates were under 10%, I think the lowest I saw was an astonishing 4%, and I saw lots at 5, 6, 7, 8%. Finally started creeping up to 10% before they stopped doing that.

      Now there is ALSO a school of thought that the Fed is manipulating the stock market….Citadel is usually cited as the party through which it is working. That still sounds a lot like conspiracy theory but a ton of sane, seasoned investors at very large firms believe it. If true, that would also mean the stock market prices aren’t so much due to QE as to more brute force measures.

      You see no life of the balance offers now, just teaser rates of 6 months to max 24 months.

      1. SteveB

        Most of the total debt in those plots of Keen are mortgage debt. So if we are going to analyze whether this total debt is too large compared to the GDP, then we also need to look at the interest payments on these mortgages. And as you note, the QE has reduced the mortgage interest rates. Thus the interest burden has been coming down much faster than the level of total debt. And I have seen it among my contacts. People have been repeatedly refinancing their mortgages, and using the extra money for daily living.

  7. Samuel Conner

    The Fed’s QE is an asset swap that takes assets onto the Fed’s balance sheet from the financial sector and exchanges that for additional Reserves in the Fed reserve accounts of Financial sector entities. If this money is to be used to purchase shares, it seems to me that it would only be from other financial sector entities that have Fed reserve accounts. After the Fed asset swaps with the financial sector, the financial sector asset swaps among itself.

    I suspect that the principal effect on asset prices seen by real economy actors is a yield effect. As bond yields are suppressed by QE, other riskier assets also rise in price as investors are willing to pay more for what little yield there is.

    1. EconCCX

      @Samuel Conner
      If this [QE] money is to be used to purchase shares, it seems to me that it would only be from other financial sector entities that have Fed reserve accounts.

      Of course the sellers will be anyone in the market that day. The sellers’ banks will gain reserves as a result of the share sale, and the sellers will gain infusions of deposit money, which will immediately set about seeking a return. There absolutely is a channel from QE to deposit accounts.

      1. wunsacon


        >> Its critics oppose it because they believe this massive amount of ‘money printing’ must inevitably lead to ruinous inflation.

        I’ve lost half my purchasing power. “Ruinous” enough for me.

  8. chris_gee

    It may well be that I don’t get this.
    If the treasury issues bonds and the banks buy them they hold bonds instead of cash. If then sell them to the fed, they get the cash back and are square.
    But where did the cash come from for the fed to buy them? It seems either reserves or printing.
    The missing part seems that the banks and the fed include cash as well as loans as assets.Swapping cash for bonds or loans is only a change insofar as they are not equivalent i.e some loans are bad and some adjustment is made for that possibility of loss as part of the interest.
    However cannot the fed print and the money go to the treasury albeit through the banks as intermediaries? This might square as long as the bonds are seen as money equivalents. If they crash they are not.

    1. Schofield

      You are quite right QE is a “Mooching for the Rich” program to reinflate bad asset calls. Nevertheless as a good Mooching Libertarian you must participate in making as much anti-government propaganda as you possible can to stop government devising anti-mooching laws particularly against the creation of “bubble dreck”!

    1. Chris Cairns

      Smart man Aaron. Valuing things at what they are worth in your balance sheet was where the finance world was heading until USA decided that perhaps it wasn’t really necessary.

      Everyone can see the US stock market is overvalued. Only the smart ones will profit, those in the club. The last ones last through the door, the cab drivers and elderly, those with the least clue about what is going on, will lose their money.

  9. Moneta

    If a bond should get a haircut or be written off but gets bought up by the Fed, I call that printing because the entire system should have shrunk and not stayed equal.

    If a bond is not impaired but gets bought up by the Fed so the new cash can be used to purchase other securities, I call that printing because it keeps the prices up higher than what they should be, once again keeping the total market value of the system higher than it would be without the intervention.

    1. Massinissa

      I agree. While its not ACTUALLY ‘money printing’, its an easy way to explain whats happening, even if its rather innacurate.

      Care should be taken while calling it that, but its an easy explanation with some basic uses. I mean lets face it, the average person will NOT understand complicated definitions of what QE does. Hell, im not sure I do!

    2. Jim Haygood

      Keen’s claim that Bernanke’s critics imagine him ‘printing greenbacks and mailing them in little brown envelopes to everyone on Main Street’ is a ridiculous straw man.

      It is the process of reserve creation via the Fed’s purchases of securities in open market operations to which critics object.

      Ever get the impression that we’re being talked down to? Fortunately it’s in print, so we don’t have to be subjected to the Crocodile Dundee strine which has become so bloody tiresome in the flipping Geico ads.

    3. washunate

      Yep, the unwillingness to acknowledge that the market price and the price paid by the Fed are two different prices is remarkable.

  10. cm

    Steve – I think you do great work. How could you miss the monetization of federal deficits? The govt borrows 40-50% of every dollar it spends. This goes directly into income. QE keeps this game going. QE also stacks the deck by distorting the plumbing of the modern collateral system, which further distorts rates.

    1. Adam1

      In a monetary system when the government issues a freely floating non-convertible fiat currency the central bank always monetizes debt. The fact that it is not transparent is sad. Prior to QE there were basically ZERO excess reserves in the system. Only reserves can be used to buy US Treasuries. If there were no excess reserves in the system where did the reserves come from (without the central bank losing control of its target interest rate) to buy the debt? The only place they can come from, the central bank. The issuance of debt instead of currency/reserves is a policy choice, but in the end the money comes from the central bank!

    2. washunate

      150 comments and no one has disputed your basic premise that the government is monetizing its budget deficits.

  11. Richard Kline

    QE is not designed to stimulate lending to the public and thus reflate the real economy. QE is designed to put deployable assets in the hands of the major banks by which they can replenish their nonexistant capital reserves through profit seeking _by any means they choose_. Speculation in jiggered (if not completely rigged) markets offers far more in profits faster without the risks of lending into a deflationary real economy where there is little demand for high margin loans. We don’t really need to parse or debate a question of why the money injected hasn’t stimulated the real economy, since QE was NEVER designed to stimulate the real economy.

    QE is simply Greenspan’s ‘re-fund the banks’ scheme on massive steroids and doubled down delusions. Selling the crap ASBs back on repo to their private holders for less than the Fed’s purchase price is a real gift of money to the banks as well, an implicit subsidy; it’s just not of the scale of full face value free money injections, so the eventual inflationary impact will be muted. Of course, this couldnt’ be easily sold to the public if _that_ was the narrative, so we get the ridiculous music about how this is to provide money ‘for the little guy to borrow.’ Not so. Calling Bernanke and his ilk ‘neo-Keynesians’ is a misreading of him and them: they don’t really CARE about demand, they’re all supply side guys, supplying capital to the financial oligarchs to stimulate _the banks’_ capital standing. Can we please stop repeating the propaganda about ‘enabling demand?’ Because that’s all the talk is, propaganda, not integral or even incidental to macrocapitalIST economic policy.

    Should this policy of Greens— ahh, Bernanke’s be the one pursued? Given that Alan the Spinmeister serially blue up asset bubbles by the same approach every single time it was used? Not really. But that’s not the point. The major financials took over the country’s government in a soft coup following intellectual capture of decades, and simply demand that they be made whole on the public dime. It doesn’t matter if it’s a good policy or a bad policy, the banks get what they demand.

    Will ‘massive inflation result?’ On the scale of the free money injection to this point, no. Massive speculation will certainly result, and has. Reflation of the real economy? Don’t make me laugh, that notion’s for willing fools.

    1. Synopticist

      “The major financials took over the country’s government in a soft coup following intellectual capture of decades…”

      Well put. I’ll use that.

    2. Elbridge Spaulding

      “QE is designed to put deployable assets in the hands of the major banks by which they can replenish their nonexistent capital reserves through profit seeking _by any means they choose…”

      I have never before seen a Richard Kline comment with which I disagreed, and I agree with everything ELSE in this comment. With respect…

      ‘deployable assets’?
      Account balances used internally WITHIN the CB – DI payments and settlement system seem hardly like ‘deployable’ anythings. How? By whom?
      While real ‘cash’ reserves are deployable media, they are FIRST cash and then become reserves and the CB is not creating any ‘cash’ in its ill-fated QE effort.

      ‘by which they can replenish their nonexistent capital reserves through profit seeking…’

      Banks can build their needed capital-reserves through profits generated from loan-making and investment, but the excess reserves ‘swapped’ by the Fed in QE are again not themselves ‘deployable’ in any sense, especially given the existence of any excess reserves to begin with.

      Adding excess reserves creates excess lending policy space, but the only real profits coming from the asset-swap will come from getting the toxic assets off the bank’s BS. This might provide the appearance of soundness in the banks, reducing their capital requirements.

      Hoping my comment is neither too narrow nor off base.

    3. Lee

      Thank you for cutting through the Gordian knot of a brain trying to wrap itself around just what this explication of double entry bookkeeping might have to do with the world I live in.

    4. Yves Smith Post author


      1. The Fed is not buying toxic assets. It is buying only GSE debt, and earlier, Treasuries. It did during the crisis have lending programs that took drecky collateral, but those were terminated years ago.

      2. The Fed does believe pumping up asset prices stimulates the real economy. It’s called wealth effect. Bernanke talked about it even BEFORE the crisis. That’s the argument for why the Fed is so attentive about stock prices and housing prices, which when I was a kid, was NEVER something the Fed was all that interested in (except if the banks were too lax in mortgage lending, that meant it was time to take the punchbowl away).

      The first central bank to try to goose asset prices (by running short term rates that were too low) to stimulate consumption was the Bank of Japan in the late 1980s. We know how that movie ended.

      1. Richard Kline

        So Yves, 1. I _have_ rather lost track of which thimble the dodgy securities are stashed under, yes. However, if QE is sucking the _best collateral_ out of the banking system, that’s even sadder still. Maybe that’s intended to act as a brake of aking on the shadow banking system, but obviously the impact has been limited in that regard if so.

        2. I do believe that QE is heavily targeted at supporting asset prices, and commented (similarly loosely I might add) in that regard a day or two ago. I didn’t mention that in these remarks to be sure.

        QE is a a policy to too complex implications to even sum it up simply. The conclusions I draw from the process are that QE has a) stimulated speculation, b) only questionably repaired major bank capital destroyed in the Implosion, c) correlated banking activity excessively with QE repo provison so thad d) QE cannot be turned off without severely disrupting asset valuations while also e) QE cannot be continued without enforcing a speculative blowout.

        The largest problem with QE and Fed policy in general is that the minds at the Fed are possessed of the delusion that they can impact a _specific financal system BEHAVIOR_ via a non-specific blunt instrument of an intervention. They cannot, have not, will not, and we’ll pay a stiff price in the end for the attempt.

    1. HotFlash

      It’s not negative equity, it’s just the convention that equity and liabilities are expressed as negative (ie, credits, in accounting lingo) in order to get the Accounting Equation to come to zero. And that is a convention to make checking manual bookkeeping easy. All this was done by hand, written in ink on paper and then added up, usu in their heads, by humans. Old time bookkeepers are amazing!

      1. Nathanael

        That convention does not exist.

        I’m beginning to wonder if Steve Keen has ever actually read a double-entry accounting book.

        Equity is entered as positive numbers. So are liabilities.

        The “left column”, assets, sums to a positive number.

        The “right column”, liabilities and equity, ALSO sums to a positive number. (So, if I owe a million bucks, it’s entered as a positive number.)

        The two numbers are supposed to be the same.

        Since Steve is describing a non-standard, non-traditional, and bizarre form of double-entry accounting as if it’s standard, it makes me wonder if he knows anything about double-entry accounting.

        1. F. Beard

          Don’t worry about Steve Keen. Someone who can do differential equations can pick up accounting very quickly. But vice versa? I doubt it, in most cases.

          1. F. Beard

            Well heck, amateurs would not be dragged into this problem if the pros were competent.

            But wait till enough engineers become unemployed … :)

        2. Lois

          I’ve been an accountant for 15 years, and you are wrong. Half right anyway. Some accounting systems represent all numbers positive. But many use negative numbers for liabilities, equity, and revenue, with all entries netting to zero, just as described in the article. Often we have to explain to people that negative numbers on the P&L and in equity are a good thing.

    2. washunate

      Ah, the question you are asking is, why would someone use double entry bookkeeping in their personal finances :)

      Equity is, technically, a liability. It is what the business owes to its owners after all the other liabilities have been paid. This naturally can be a little obtuse when discussing personal finance, where distinguishing between a business and its ownership is kind of silly.

      For personal finance, it makes much more sense to use single entry bookkeeping (like balancing a checkbook), where the equation is Assets – Liabilities = Net Worth.

      Here, you just increase cash assets by $1 million and throw a party. No ‘T account’ journal entries required.

      1. HotFlash

        The reason to use double entry in personal and household finance is that it makes clear whether you are getting ahead or just being sucked dry. Single-entry may get your bills paid on time but it doesn`t differentiate betw asset (wealth) accumulation and expenses (reduction in wealth).

        1. washunate

          Wow, you are an accountant. That is a lot of work! More power to you if that’s how you do your own finances.

          I would just argue that the most important part of personal finance is the psychological, the behavioral, getting people comfortable with the basics, taking the first step. Understanding an approximation is far more valuable than getting an answer precise to 8 decimal places. Net worth is a perfectly fine approximation of getting ahead or being sucked dry, particularly if you are also tracking a basic monthly budget and annual income statement (of course, not actually using that terminology in conversation, no need to scare people) and tying that in to your overall goal setting process.

          I can’t imagine discussing debits and credits and journal entries with anyone who didn’t look forward to their financial accounting classes in college. I mean, most people, even those who graduate from college, don’t even take a single personal finance course in their entire academic career, never mind dedicated formal instruction in accounting. Personal finance is right up there with public speaking that just freaks people out in large numbers.

      2. F. Beard

        Equity is, technically, a liability. washunate

        No. It indicates what remains of Assets – Liabilities.

        The Equity owners ARE the company. They own it.

        1. diptherio

          I don’t think that’s technically correct. The business entity is separate from any individual shareholder (equity owner), obviously. I don’t think that the shareholders severally could be considered the business, either. The way I understand it, the business per se is really just a form filed with the state; a business structure.

          And linguistically, it would seem that the relation of ownership requires a separation of essences. If the owners are the business, then they cannot also be its owners (paradoxically), since ownership necessarily implies the presence of two parties (i.e. the owner and the owned).

          1. F. Beard

            Good linguistic point!

            But consider the word “company.” Did it not once primarily mean a group of people with a common goal or purpose? And would not their combined net assets be their “common stock?”

            Let’s NEVER forget that the common stock owners own the company and could, in principle, fire the management.

  12. Chris Cairns

    Steve, love your work. I also have a BEc, but I did a major in accounting too, mate. When your Aunt leaves you a mil and you do the accounting, your assets go up by a mil and so does your equity. Dr Assets, Cr Equity.

    That criticism aside, blind Freddy can see what is going on with the Fed and, yes it is all money that trickles to the top. Duh! The American public was sold the biggest lie ever in 1913. At least the Aust Fed Reserve is a real Govt body and does a reasonable job on inflation, interest rates and employment. (Although wasn’t always that way when we had 18% interest rates on home loans twenty or so years ago.)

    Australia is a high wage and high cost of living country, yet it, and every other country, could do so much more if there were no people advising our politicians on why they need to double account for the money. Crediting pensioners bank accounts, for example, without borrowing money or using tax revenues is entirely feasible. Helicopter money, in moderation, is a realistic policy option, but who is going to listen?

    Certainly not the elite running the American way…

  13. Ferridder

    How can the bank “lend from the repo account”?
    The repo is a liability of the bank, not an asset that can be lent out, and banks do not lend out their assets anyway.
    A bank loan is usually recorded simply as

    Deposits -Loan (the borrower’s deposit)
    Assets +Loan (the borrower’s agreement to repay the loan)

    I also agree with the comments of philippe hales on the Business Spectator site:
    1) Many of the original bond holders are not banks; the increase in their account balances when selling bonds to the Fed shows up in M1.
    2) QE is an outright purchase, not a repo.

    If the bank owned the bond outright, the effect of the QE purchase on the bank balance sheet would instead be
    Assets -QE (the bond)
    Assets +QE (the new reserves).

    A repo would additionally be accounted for as
    Assets +QE (the future bond)
    Liabilities -QE (the future payment),
    adding up to the first transaction shown above.

  14. Elbridge Spaulding

    It’s great to get Steve’s MINSKY macro-econ model out in the open and take part, if we like.
    But to use the ‘model’ to prove that the central bank’s creations of reserve assets have nothing to do with the real economy and inflation is rather overkill.
    It’s simply by definitions and the Fed’s own publication on Modern Money Mechanics that certain truisms can be ascertained.
    As Steve said, the CB does not create any money.
    In an endogenous money system that is based upon the securitization of existing assets as a backing for credit issuance, the role of the CB is to create NOTHING except settlement-media for the banks to use in their DI – to – CB interactions.
    Reserves never enter the money supply and thus cannot contribute to either demand (making them impotent as opposed to High-Powered media), and without becoming aggregate demand “somethings” that are measured in consumer-general-price terms, can never contribute to inflation.
    Yes, the Bernank has stated clearly – reserves do not enter circulation and they just sit in the bank’s account at the Fed.
    End of that story.
    But the MINSKY working model might prove something else.

  15. washunate

    “The Fed has implemented this policy because it believes it is the best way to stimulate demand in a depressed economy.”

    To continue offering a different perspective: the Fed is buying bonds to artificially raise their prices. This is for the purpose of doing what the President and Congress have tasked the Fed to do: bail out the banksters specifically and provide funding for corporate welfare more generally.

    The Fed cannot stop QE until the President and Congress implement a budget that replaces QE with taxation. This is just basic math. The national security state and bankster bailouts require trillions of dollars, and there are only two ways to get significant dollars – tax the wealthy to obtain existing dollars, or print new dollars.

    1. The Rage

      The trouble is, the economy is not depressed. US growth demographics peaked in 2000 and have been weakened since by lack of innovation in the modes of production.

      The stupid leverage boom is still be worked out, growth continues on.

      1. washunate

        I would be curious to know what you mean by growth demographics peaking?

        If you’re pointing out that the problem isn’t that we need to increase debt, but rather, that our wealth needs to be distributed differently, then we agree.

        If you’re saying something else, I’m not following. I agree growth as presently measured is obsolute, but I’m hesitant to agree too strongly, because I’m not fundamentally pessimistic. We can grow; there is tremendous opportunity in our society. Just not within the financialized world of nominal GDP and understated price inflation in which policy makers are attempting to restrict thought.

        We don’t need to lend more money to increase house prices; we need to lower house prices so people can afford them (or raise wages, which is the same effect in real terms). We don’t need to lend more money to students, we need to lower the cost of education so that people can afford it. We don’t need to bail out failed companies; we need to shift workers from SUVs and CDOs and TSA and DEA to trains and wind turbines and farmers and civil engineers. Etc.

        All of that is growth in the sense of increasing productive output, but it’s primarily accomplished by reallocating resources, not exponential credit growth.

  16. JIMBOJ

    Describing QE as a repo is a remarkably embarrassing mistake and proves that Keen really has no clue what he’s talking about. The whole article can’t be taken seriously when the author makes such a basic mistake.

    1. washunate

      Interesting that in a great set of comments about the minutiae of accounting and economic theory no one has disputed this basic observation.

  17. Nathanael

    Steve: you made what looks like a fundamental accounting error.

    When your aunt leaves you $1 million in her will, your assets go up by $1 million *and so does your equity*.

    Steve, you claimed that your equity would go down. This confusion is probably caused by your writing equity in the negative.

    The way that the standard double-entry ledger looks is:
    (Left Side: Assets)


    (Right Side: Liabilities and Equity)


    Liabilities are expressed positive (if I owe a million bucks, that’s a positive number), and so is equity.

    The two totals are supposed to be the same. That’s the “double entry”

    1. HotFlash

      Yes, you do that if you have two columns. If you don`t, as in a prose article such as this, debits are normal and credits are brackets, preceded by a minus sign or printed in red. Steve is not confused.

      1. Nathanael

        Do you seriously do double entry accounting without two columns? It isn’t double entry accounting without two columns!

          1. F. Beard

            IF the entries are differentiated such that they could, if desired, be separated into two columns.

  18. Russell

    ” So, for example, if a rich aunt died and left you $1 million in her will, your accountant would show that as your Assets changing by plus $1 million and your Equity changing by minus $1 million.”

    This seems like a mistake. If I receive a gift, my assets go up by the after-tax value of the gift AND my equity goes up by the same amount. A = L + E. A increases, so there must by an increase in L or E and debt didn’t increase so it must be E for equity.

  19. john c. halasz

    I’m not understanding why if a bank sells or repos a T-bond to the Fed, the bank would be liable for the interest on the bond. The bond is simply sold at a price, but isn’t the interest paid by the U.S. Treasury?

  20. HotFlash

    People! This wrangling about double entry accounting totally baffles me. Surely anyone can see that if a = b + c, then a – b – c = 0. Rather than subtraction, we can also express this as adding negative numbers, thus a + -b + -c = 0.

    Steve is right on the money (heh) with his equations, although he may not be expressing it in whatever accounting terms you are used to. JChees, it`s like the blind man holding the elephants trunk and saying, this can`t be an elephant, in my experience an elephant is very like a tree-trunk.

    Can we talk about quantative easing, It seems to me that it won`t cause inflation in the general economy since money loaned out into the general economy goes out for a purpose and has an associated cost (interest) and isn`t just out `chasing goods`. OTOH money (or whatever, same diff) retained by the banks *can* cause inflation in the things that banks buy — stocks, executives, etc. Which I think is happening.

    It seems to me that money creation should recognize and follow actual wealth creation, ie, labour by humans minus resource or environmental inputs or something, I haven`t thought it all through. Debt-created money can only end in all the money going to the banks as interest. That, friends and neighbours, is the miracle of compound interest.

    We do, I think, need to inject money into the system, but QE sure ain`t the way to go.

    1. F. Beard

      Debt-created money can only end in all the money going to the banks as interest. HotFlash

      Money can be created as equity too but why “share” when a government-backed credit cartel allows the so-called “credit-worthy” to legally steal purchasing power or at best borrow it without true permission or just compensation?

    2. EmilianoZ

      QE causes inflation in stuff that banks buy (stocks, etc.) but also on stuff that banks speculate on and that we need for subsistence. For example, oil or food. QE provides the lever thanks to which they can (pardon my French) f*ck us over and over again.

    3. washunate

      I’d like to offer a simple explanation for the wrangling. Keen didn’t define what he means by QE.

      Therefore, we’re all sort of guessing what exactly we’re talking about here. Is the backstopping of the GSEs QE, or something else? Is ZIRP QE, or something else? Is buying treasury securities QE, or something else? Is ignoring fraud QE, or something else?

      I think Keen doesn’t define it because then he would have to start at the beginning. He writes, “So the ‘printing money’ moniker that critics give to QE is misguided: it actually creates no additional money at all”

      If he had to define QE, he would have to start at step 1 – where do the banks get the dollars to buy the GSE debt or treasury securities or whatever? Of course, AFTER that money creation event, ‘QE creates no additional money at all’ becomes essentially a true statement.

  21. Chris Engel

    AB says:

    Why would the $1M from the Aunt create $1M in negative equity? A-L=E, right?

    Nathanael says:

    The equation is actually
    A = L + E

    Actually, it’s -E + A = L

    No no it’s -L = E – A

    NOoooo i mean it’s -A = -L – E

  22. allcoppedout

    Been a Keen fan for years. Students have trouble working out that balance sheets balance. Accountants are smarter than the average bear (Managers and Magic by Graham Cleverley 1967). Big deal Steve.
    We don’t know what QE is – typical of mystification in economics and politics. My own guess is that it’s like money-laundering/tax dodging in some ways – a false flow of profits through the system. Everyone is at it whether it’s called QE or not.
    If everyone has a rich aunt dying conveniently next week and we all become $1 million richer we would all be considerably less rich than I’d be if only my aunt died. It’s all about proportion (discounting the morality of being richer for someone else’s death). Lawyers would benefit most.
    QE may also be delayed money printing along the lines of wandering into a swamp full of alligators looking for the plug-hole. The question is when you will get bitten.

    Intercourse the double-entry Mumbo-Jumbo. None of us can read balance sheets these days, other than in classroom situations where the numbers can be taken at face value. In practice we are faced with visiting 10 times rehypothicated assets lodged in a tax haven that delays access for years.

    What will QE look like after the next “margin call” on leverage collapse? To a scientist who thinks the ideas should be about fixing decaying infrastructure, going green on energy and creating conditions for peaceful human freedom, pouring money into banks and the trough of the rich instead of concrete into bridges looks like madness. Indeed, to someone lucky enough to do a bit of anthropology and unlucky enough to teach economics and business finance, the latter looks increasingly like a poison oracle or self-mutilation ritual. It’s all as explanatory as Sooty’s Magic Wand (Sooty is a yellow glove puppet).

    Maths would make sense if we could track money and do reliable stock-taking. This, of course, would allow interventions where they were needed instead of centralised fantasy action like QE and its Cantillon effect. I think the problem here is crude maths considering inflation figures and the rest of our economic numbers in sums they fit in. An alien ethnographer would have his class back home in belly-laughter on the antics of flooding banks with money ‘in order to build bridges’!

    1. F. Beard

      and we all become $1 million richer we would all be considerably less rich than I’d be if only my aunt died. allcoppedout

      In nominal terms, everyone would be better off (assuming debt prepayment penalties).

      In real terms, maybe not. But a bailout with new fiat could be combined with at least a temporary ban on new credit creation and metered to just replace existing credit as it is repaid for no net change in the total money supply.

  23. nikhil

    I have a question. You say that the amount that banks pay back to the Fed for QE is slightly less than what they were given. In figure 3 shouldn’t that be booked as an equity?

    Also later when they lend this money out the repayment asset they get will be sligthly higher than the liability they created correct? WHy is this not booked as an equity?

    I see how these might seem insignificant, but couldn’t they start adding up on a large scale? I’m not saying its inflationary, but couldn’t it actually stimulate demand?

  24. Hugh

    I hate it when simple things are explained in unnecessarily convoluted and misleading ways. Keen says that the fundamental law of accounting is Assets equals Liabilities plus Equity: A = L + E. This is the most inobvious form of this equation.

    It is much simpler to say that net equity is just the difference between our assets and our liabilities:

    A – L = E.

    If we take out a loan for $10,000 to buy a plot of land and at some point we have paid off $2500 of it, that’s our equity, and we still owe $7500.

    $10,000 – $7500 = $2500

    Keen makes it sound like some arcane principle that in double entry accounting liabilities and equity are negative. But it is really just another form of this equation:

    A – L – E = 0

    If you want the real fundamental equation of accounting in its proper form, that’s it.

    Keen does manage to convey that from your point of view your deposit at a bank is an asset for you, but from the bank’s it is a liability since it is money it owes you. And so in the same way, from your point of view, money the bank loans to you is a liability for you, but an asset for the bank since it expects to get the money back from you.

    Keen then says:

    I’m using an extremely simple vision of a Central Bank. Firstly to acknowledge that it has an unlimited capacity to create money if it wants to, I’ve said that it has an Asset called a ‘Charter’ that lets it create as much money as it wants to.

    But later Keen says, “The Fed buys bonds off the private banks by transferring money from its essentially limitless Equity account.” Well, the reason the Fed’s equity (remember equity is just the difference between assets and liabilities) is limitless is because its assets are limitless.

    It is at this point, the real problems set in. Keen says, “For the private banks, their Assets have risen by the amount QE. But they also have a liability: they have to buy the bonds back off the Fed whenever the Fed wants them to do so.

    My understanding is that the Fed purchases of securities through QE are outright. That’s certainly what it calls them. These are not repos. There is the assumption that at some point the Fed will start selling some of its holdings. But I do not think the banks have to buy these securities back from the Fed and certainly not at par.

    Nor do the banks have to keep the money their QE money in reserves at the Fed. I calculate that Fed QE purchases total something like $2.5 trillion while bank reserves held at the Fed have only increased $1.1 trillion.

    I think the concern is that whenever the Fed starts selling off its portfolio of MBS, it will do so at a loss. One question is who will bear the loss, the Fed or the GSEs, but either way it won’t be the banks. The sales could also depress the bond markets and siphon money out of the stock market bubble depressing it as well.

    But this should be expected. As others have noted, the QEs have kept both bond and stock markets overvalued. You can look at it that the QEs did not remove these losses but delayed them and probably reassigned who would be taking them.

    In any case, the Fed did print the money (create it out of thin air) to make its securities purchases under the QEs. This money will be extinguished when the Fed sells its portfolio but not before, and not to the extent that its portfolio incurs losses.

    It is also important to realize that when the Fed stops and even reverses the QEs, bubbles in stocks but also in bonds are likely to burst and this will result not only in the revealing of the losses the QEs covered up from the original housing bubble but also new losses from these bubbles.

    Finally and again as others have noted, the QEs have not stimulated the real economy because the money generated by them never reaches the real economy or ordinary people.

    1. Dan Kervick

      My understanding is that the Fed purchases of securities through QE are outright.

      Yes, that’s my understanding too. So if the Fed ever decides it needs to drain reserves (rather than, say, just preventing their rate of increase), it will need to offer to sell something to the banks that is worth more to the banks than the reserve balances they already hold.

      It might also be able to impose negative interest (a tax) on reserves, and drain them directly. But my current understanding is that there is some legal dispute as to whether the act of Congress that authorized interest on reserves permits a negative rate of interest.

    2. Thisson

      Losses are irrelevant to a central bank that prints its own currency. A central bank that prints its own currency doesn’t have any real capital at risk in a financial transaction. It obtains what it wants by tendering printed money or by crediting a reserve account as a bookkeeping entry.

      1. Elbridge Spaulding

        Please explain.

        The assets it receives in QE and the interest thereon are parts of the Fed’s statements, and, at present, in the end the Fed’s BS increases are ‘balanced’ via transfers to the Treasury.
        If their statement totals a loss – for whatever reason – it can readily reduce the transfer to Zero ($0) or could reduce the amount itself (offsetting interest and other gains) to less than zero, a negative. An operating Loss.

        Q. What happens to the government budgeting constraint when the internal transfer is a negative?
        A. A reduction in spending or an increase in taxation revenues.
        Either way the taxpayers would pay.

        Please explain your statement that :

        ‘(The Fed) obtains what it wants by tendering printed money or by crediting a reserve account as a bookkeeping entry.’

        If the Fed wanted to ‘prevent’ the loss from being transferred to the taxpayers, how could it manage its book entries?
        And, by ‘printed monies’. do you mean currency notes?

    3. CapVandal

      “I think the concern is that whenever the Fed starts selling off its portfolio of MBS, it will do so at a loss.”

      It never has to sell. The portfolio amortizes to zero after time.

      The fed business model: Create money. Buy bonds. Collect interest.

  25. Doug Terpstra

    Keen’s end-note “complexities” are marginal additions to the money supply in the same way that sudden death is a side-effect of certain pharmaceuticals (“…discontinue use and consult your doctor if you experience liver failure, heart failure, convulsions, or sudden death”). As Washington’s Blog documents, the unprecedented QE-fueled equity bubble has once again gushed into the stock market, housing, student loans, auto loans, luxury goods and more. This comes not only from banks buying shares, hedgehogs borrowing to buy REOs to rent, and corporations borrowing free money in boatloads to buy back their own stock (ratcheting up share prices and artificial profits), but also from central banks buying stocks directly. It gives new meaning to “Operation Twist”.

    So the wealth effect is working in an extremely perverse way, but this is also why QE can never ever end or even be “tapered”, until it is forced to by externalites. The entire casino will fold like house of cards either way.

    But Bernanke has his own escape plan and will retire soon, probably to a non-extraordinary rendition island somewhere. So fortunately, we will soon be out of his frying pan. And NC readers will be delighted to know that according to Jewish Business News, his successor a is likely to be a luminary financial genius named Larry Summers. No, this is not an Onion article.

    1. EconCCX

      @Doug Terpstra

      Ms. Yellen may not have the strength to handle the buffeting that is suspect to begin at a time when the almost four years of easy capital flow driven by the Fed begins to be eased off….

      While Messrs. Geithner, Kohn and Fischer undoubtedly have the backbone for the job, Obama may well feel that, as the trio are all well into their seventies, that a younger man may well be more fitting to take up the position.

      And that’s where Larry Summers is looking more and more attractive among people in the know to fill the role.

      Not only sexist but math-impaired is that JBN piece. Geithner is 51.

  26. F. Beard

    Of course, when it comes to government-backed banks, A = E + L is accounting sophistry anyway since, for example, the IMMEDIATE creation of new purchasing power for a 30 year mortgage CANNOT be justly balanced with the extinction of that purchasing power over the next ~10 years.

  27. F. Beard

    Where have all the counterfeiters gone?
    Long time passing …
    Where have all the counterfeiters gone?
    Long time ago …
    Where have all the counterfeiters gone?

    Gone to bankers, everyone.
    Oh, when will they ever learn?
    When will they ever learn?
    apologies to Pete Seeger

  28. Thisson

    Steve Keen’s model overlooks something significant: the loans issued by the bank out of the repo account can be defaulted upon. In such a case, the deposits have been issued but the loans are not fully collectible, which is the same effect as printing money.

    1. KnotRP

      I always presumed this was a major intent of this arrangement. Think of it like an on-demand debt
      bomb containment system:

      If (potential) bad debts are thought of as unexploded bombs,
      the Fed is the bomb disposal crew’s bomb containment system….the bomb crew “repos” the worst of the
      unexploded debt bombs from the Banks into the
      Fed (containment system), where if they blow up, the
      Fed quietly and automatically “monetizes” them (i.e.
      doesn’t ask the Bank to buy them back). Those that
      don’t blow up, but turn back into viable assets over
      time (due in part to the Fed providing liquidity everywhere and eliminating low risk assets), the Bank can eventually buy back that debt which appears unlikely to pose further

      It’s basically a bad underwriting get out of jail free
      card, paid for by the tax payers, only the payment only
      occurs on the debt that actually blows up.

      1. Thisson

        Sure, you can think of it that way, but in plain english, the banks can make poorly underwritten loans knowing that the Fed can always buy those loans at par with printed money (or, alternatively, by issuing credits to the banks’ reserve accounts in exchange for the faulty loans). This ultimately expands the total amount of money and credit in the system, perpetuating inflation.

  29. JGordon

    “outside of the gain banks will make on the repo deal”

    This is exactly right. QE functionally is an aide that allows the federal government to print and spend money at low interests rates. Absent QE, the government deficit would quickly spiral into a mathematical blackhole and the destruction of the US would quickly ensue (or government would stop spending and a consequent horrific deflation would destroy the economy.

    In other words 1) there is no practical difference between fiscal and monetary policy because at the moment they are both being perfectly coordinated to keep the system from collapsing outright. 2) So instead we are in a slow motion collapse, where assets and resources are slowly being drained from the periphery to support the core. Which will eventually lead to collapse anyway, but when it finally does happen now, thanks to QE and government deficits, instead of having something to fall back on the people will be drained of assets and the earth will be (much more) drained of resources. It’d be far better for everyone involved if we just let the collapse happen now. Because the elites are going to end up offing themselves anyway when they suddenly discover that the system they’re parasitizing is suddenly gone and they have their predictable mental breakdown–whether that’s tomorrow or ten years from now–but the rest of us who are actually interested in keeping going will have a much easier time of it if it happens tomorrow.

    1. washunate

      Right on. I find it increasingly hilarious when people claim that wasteful government spending doesn’t matter, because as a monetarily sovereign nation we can never default on our debt, and then get upset when it is pointed out that the process of doing so is called printing money.

  30. help me

    Is not double entry bookkeeping relevant to the income statement,
    which is then recatagorized into the balance sheet.

  31. Jackrabbit

    QE is very relevant.

    OK, it may not juice the money supply but it HAS transformed the credit risk of the banks into market risk. The Banks STILL don’t mark to market.

    The Fed is hellbent on sparking a new housing bubble but they miscalculated or just lied to us about how long that recovery would take (we are now in the midst of yet another faux ‘housing recovery’ that is trumpeted by the MSM). Now they are faced with an equities bubble so they have begun to talk about ‘tapering’ in an attempt to cool the market. ‘Tapering’ is unlikely until they have the housing recovery that they seek – and that is 6-12months away (absent some ‘hiccup’ in the market).

    The Fed’s actions have benefited the wealthy directly (as credit-worthy borrowers at low rates) and indirectly (no need to raise taxes – the Fed will heal the economy!) AND has dramatically increased moral hazard. That is why Columbia Professor Jeffrey Sachs is complaining about ‘pathological’ greed on Wall Street. The Fed’s ‘Great Experiment’ risks tearing a frayed social fabric and pushes the ultimate bill to into the future.

    In addition, I believe that the risks of any crash is compounded (now we are being warned of re-hypothecated securities). And Wall Street will use that risk to argue that the punch bowl should remain in place far longer than necessary (‘tapering’ is a gift that could last years).

    But the Fed is only part of the overall problem of a financialized economy, vote-with-your-money politics, and culture of me.


    Perhaps Keen should be brushing up on Political Economy rather than Accounting.

    1. Jackrabbit

      Quantitatively Irrelevant?

      Yes, in that the Fed wants to see a certain result.

      No, in that there are implications to QE that can be described quantitatively.

  32. allcoppedout

    QE looks very suspiciously like a continuation of an older make the very rich richer strategy. Figures in the US tally with the last 25 years in the UK that show liquid assets stripped away from most of us -
    We don’t know how QE will unwind, but we can reasonably fear this will happen in conditions that will make the vast majority poorer and leave rich vultures with the ‘cash’ to scoop up bargains in the fire-sale.

  33. Bob

    I didn’t get a chance to read all the comments, but I’d like to point out an error which could negate the whole DBE point. Say your aunt did leave you $1 million. If assets equal liabilities plus equity, and your assets increase by $ 1 million, SOMETHING on the other side of the equation must INCREASE by $ 1 million, otherwise their would be no equality. In this case the equity would increase by $ 1 million, not decrease! So maybe the author might want to rethink the entire QE argument again.

  34. brookside

    There are at least two problems with Dr. Keen’s explanation of the Fed’s QE program. First the Fed is not using repos to execute its bond purchases. Currently the Fed holds zero ($0) repos. All of the Treasury and GSE bonds on the Fed’s balance sheet are held outright. Second the M1 money supply (checking accounts and currency) has increased from about $1.7 trillion on 1/1/2010 to about $2.5 trillion on 5/20/2013 or about 50% over the period.

    A couple of the things to note. The Fed uses broker/dealers to make QE buys and does not really know if the sellers are banks, mutual funds, corporations, or individuals. Most of the purchases of GSE securities (about 1/2 of all the Fed’s QE buys) have taken place in the “to be announced” market and are in effect direct puchases from Fannie Mae, Freddie Mac and Ginnie Mae.

  35. CapVandal

    I seem to be missing the central point of this.

    It seems like Yves is saying that:

    1. At least 1/2 the complaints regarding QE are simply wrong. EG, buying toxic assets, etc. It is what it is and I agree 100% with Yves correction of frequently repeated myths.

    2. QE has had little impact on interest rates. Interesting. It probably has less than it commonly thought, but not trivial. But — if it hasn’t reduced interest rates, then how can it possibly be a problem?

    If it hasn’t done much of anything positive (improved the economy by lowering interest rates), then how much damage could it possibly do?

    More specifically, if it hasn’t had a big impact on interest rates, then there can’t be any asset bubble driven by the fed.

    The real disconnect — in my opinion — is anchoring regarding the ‘normal’ interest rate.

    There is no ‘normal’

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