El Pais reports that the Spanish government has sold Catalunya Banc for €1.1 billion to BBVA. The newspaper writes:

Esta operación supone que los contribuyentes pierden definitivamente 11.839 millones de euros, una cantidad que se acerca a los recortes en sanidad y educación hasta 2013, que suman 13.800 millones.

La entidad, que llegó a ser la cuarta mayor caja de España, tenía unas ayudas directas del Estado de 12.050 millones y otros 572 millones inyectados posteriormente por el FROB para la venta de la cartera de hipotecas tóxicas. En total ha puesto 12.622 millones y recibirá 783 millones con la venta porque solo tiene el 66% de Catalunya Banc. La operación incrementará el déficit público porque el FROB valoró en sus libros a Catalunya Banc en 1.858 millones y percibirá 783.

So, the tax payers lose definitively €11.8 billion, which is about the full amount of cuts in health and education until 2013, which stand at €13.8 billion. The bank, which was the fourth biggest of Spain, had direct aid from the government of €12.05 billion and another €572 million from the sale of the toxic mortgages from the ‘Fund for Orderly Bank Restructuring’ (FROB). The public deficit will go up as a result of this operation because FROB valued Catalunya Banc at €1.848 billion and will receive €783 million.

This is what happens when you bail-out a bank that is not illiquid, but insolvent. I think that there needs to be a discussion why you use €11.5 billion for bank restructuring, which then become a definite loss, and not for propping up health care, education or other government services which have been cut harshly over the last years. The Spanish governments (Zapatero, Rajoy) had a political choice to increase taxes or cut government spending, to bail-out their insolvent banks or to let them fail in an orderly way (yes, there are rules for that), they had the possibility to press for a European solution because Spanish banks owed German banks hundreds of billions of euros on the interbank market, they could have pressed for a less harsh interpretation of the deficit rules, etc. Whatever they did, the results have basically been zero. Yes, they kept Spain in the euro zone, but that is the status quo and it is unclear whether it was a good idea to stay in, given that the institutions (fiscal rules, banking regulation) are what they are.

Reality is constructed through politics, and politics can be quite one-sided. That, it seems to me, is the lesson to be learned from Spain, where creditors are saved once and again at huge fiscal costs while youth unemployment stands at 54%. Spain’s GDP today is still below that of 2007.

Posted by: Dirk | July 17, 2014

A fresh look at Positive Money

The World Economics Association has featured an article on Positive Money in its latest newsletter. Let me discuss some aspects of this text because I think that there are still many open questions regarding both the analysis and the policy recommendations. The article starts its analytical part like this:

Now, which are the malfunctions of the present monetary system?

1. Money is created as debt.Today, money comes into existence by debt creation when commercial banks borrow from central banks and when governments, producers or consumers borrow from commercial banks. Thus, the money supply of the economy can only be maintained if the private or public economic actors get into debt. Economic growth requires a proportionate increase in the money supply in order to avoid deflation that would paralyze business, but an increase in the quantity of money involves a simultaneous increase in debt. This way, economic actors run into danger of excessive indebtedness and bankruptcy. It is not necessary to say that overindebtedness causes serious problems to societies and individuals in the face of the ongoing debt crisis.

As I find myself in disagreement with almost all sentences, let me tackle them one by one. (I am doing this because I think that the analysis is flawed, not because I don’t like the conclusions.) The first sentence of the answer is correct, but imprecise. What is meant by money? Money-reserves created by the central bank? Money-deposits created by banks? Money-deposit certificates created by money market funds? As we start here with “money” being highlighted – although not defined – and loan demand and interest rates neglected we’re roughly in the Monetarist camp.

The next sentence could have cleared things up – but it doesn’t because the readers are not experts in monetary theory and don’t know that “when commercial banks borrow from central banks” it is central bank money (reserves) that is created while “when governments, producers or consumers borrow from commercial banks” it is bank money (deposits). And, it is wrong to put government in one list with the private sector. The government, while often able to do so to some extent, actually does not “borrow” from commercial banks. It is selling government bonds. Selling government bonds is different from getting a loan because in most monetary system the government is not in danger of a failed auction. Selling government bonds in countries with a sovereign currency always succeeds. Exceptions are few, and only the euro zone with its no-bail-out clause chose a difference path (which Draghi corrected in the meantime). So, while a loan is not always granted, a government bond is always placed in the market, and if banks don’t buy it the central bank will (if not in the primary than in the secondary market). I find it quite wrong to place government, which is issuing riskless assets in almost all sovereign money systems, in one category with private sector loans, which are prone to default. Especially since government bonds are promises to pay central bank money (reserves) while private sector bank loans only promise to pay deposits. Next sentence:

Thus, the money supply of the economy can only be maintained if the private or public economic actors get into debt.

With no clear definition of a money supply it is impossible to evaluate whether this is true or not. The next question is whether that “or” is an “and/or” or an “exclusive or” (in a closed economy private sector wealth equals public sector debt). As general as was written, the sentence is wrong. If the private sector keeps its share of loans steady, then no increase in public debt is necessary to maintain the money supply (if that includes deposits). Also, a country with a current account surplus can have a rise in deposits and hence the money supply while both the private sector and the public sector run a surplus, meaning that the private sector saves more than it invests and the government’s tax income is higher than its spending. Next sentence:

Economic growth requires a proportionate increase in the money supply in order to avoid deflation that would paralyze business, but an increase in the quantity of money involves a simultaneous increase in debt.

That’s nice, here we can check the available data to see whether it is true that “economic growth requires a proportionate increase in the money supply”. Here is the data for the US via FRED2:


Well, the consumer price index change from year to year is inflation (fat black line), and it is positive almost all of the time. However, some monetary aggregates (M1, M3, MB) had negative growth rates from time to time. Also, inflation in the late 1970s does not correlate with movement in the monetary aggregate (M1). A rise in the monetary base (cash plus reserves) in the last recession also did not coincide with the inflation rate. Comparing all those colored line with the inflation rate, I can hardly make out which one is proportionately increasing in relation to the inflation rate. Can you? (If you can, you’d be a monetarist.)

Now for the second part of that sentence (“an increase in the quantity of money involves a simultaneous increase in debt”) I can not see how that can be true. Money is debt, sure, but not all debt is money. Government can create huge debts, which would allow the private sector to use the additional deposits (from incomes paid by the public sector) to pay down its own debt. This would shrink the private sector debt and therefore money and increase the amounts of government bonds, which are not counted as “money”. So, an increase in (public) debt can decrease the quantity of money. Probably this is part of the Japanese story of the last 20+ years.

“This way, economic actors run into danger of excessive indebtedness and bankruptcy.” Well, except that a government with a sovereign currency cannot go bankrupt. The case of Japan shows that government spending can prop up an economy is the private sector decides to pay down debt. Technically there is not a problem with the monetary system, quite the opposite. One just has to use it right. Also, “excessive indebtedness” is very vague. What is the yardstick? Sure, we can outlaw any loans, but then you can only start production if are very, very rich. Only the super-rich do not have to worry about “excessive indebtedness”.

It is not necessary to say that overindebtedness causes serious problems to societies and individuals in the face of the ongoing debt crisis.

Hmmm. This is very one-sided. After 1945, many Western societies had good growth rates. Many firms borrowed from banks to start and expand businesses, households borrowed to buy houses, etc. Now there are some countries that suffer, but they are mostly inside the euro zone (Spain, Ireland, Greece, Cyprus, etc.), which is a special case due to the lack of exchange rate adjustment. The UK was a case of self-imposed austerity, which was not necessary under the monetary system. Iceland defaulted on its bank debt and seems to be doing more than OK.

Going through the rest of the text I encounter many expressions which I think are just plain wrong: “interest has to be paid on all the money in circulation” (I pay no interest on my cash, do you? And banks can acquire cash from the central bank by selling government bonds to it), “Interest is a subsidy to the banks because the account money they create is handled as legal tender” (no, it is not), “In a sovereign money system the unnecessarily complicated two-level banking system would be replaced by a single-level system, in which money is no longer backed by reserves” (money is not “backed” by reserves today), and last but not least, “the existing bad framework that governments attempt to straighten out with evermore complex regulation consisting of the fractional reserve system, …” (we don’t have a fractional reserve system because banks cannot lend out reserves).

While I believe that many Vollgeld (100% money) supporters have good intentions, I’m afraid that their analysis once and again builds on a neoclassical world view which should have been discarded decades ago. Building on flawed foundations, the new financial house will be unable to wheather the storm – like the euro, which has also been build on neoclassical foundations (crowding-out, monetarism). Nevertheless, there are still many issues that are of shared concern: the role of private banks and financial markets in the crisis, the lack of concern for the real economy (jobs) and ecology, and political economy and macroeconomic problems resulting from a very unequal income and wealth distribution.

To sum it up: I am not convinced that the economic malaise in some European countries has been caused by inherent flaws in our monetary system and I am not convinced that these flaws cannot be remedied in the existing framework (through higher capital requirements, for instance). Yes, bank loans financing real estate have caused the boom (and the bust), but without those loans we would have had lots of unemployment and very likely negative growth rates. Of course, fiscal spending could have been used to fill the gap in demand, but the politicians (and economists) did not want to touch that policy except for that brief time during 2009. I cannot see how we need a new monetary system in order to clean up the mess in Europe. There is much to be done, but from the macroeconomic perspective freeing us from the fiscal constraints should be enough to return Europe to growth and prosperity shared by all Europeans.

Posted by: Dirk | July 17, 2014

Wicksell (1898) on financial crises

Knut Wicksell in his 1898 [1936] Interest and Prices discusses financial booms and busts over some pages in chapter 7 (87-101). He discusses three possible mechanisms which can lead to a rise in prices of capital goods. These are always discussed as changes in relative prices given some level of loan demand. The section name is a hint: B. Simplest Hypothesis. Variations of the Rate of Interest when the Market Situation Remains otherwise Unaltered. On page 92 he writes:

If railway companies could issue debentures at 3 per cent, instead of 4 per cent., they would be able, ceteris paribus, to pay almost 33.1/3 per cent, more for all their requirements: 4 per cent, on 100 million marks comes to the same thing as 3 per cent on 133.1/3 million marks.

A fall in the interest rate thus has an effect on some goods prices, those that are used as inputs in the production of railways and railway equipment. Prices of inputs, land rents and wages go up, but so does the price of whatever the entrepreneur produces. So, the entrepreneur will pay more and more for his inputs since the rising prices given some interest rate increase his profits. As long as the interest rate remains at its level, prices move up cumulatively. This is classic Wicksell, only price effects at work and no changes in demand or supply. This whole episode reminds me a bit of Tobin’s q. However, Wicksell does not assume that changes in relative prices cause any quantity adjustments, as Tobin said. Wicksell continues to discuss house prices and expectations (p. 96):

An abnormally large amount of investment will now probably be devoted to durable goods. There may result a relative over- production of such things as houses and a relative under-production of other commodities. [...]

We may go further. The upward movement of prices will in some measure “create its own draught”. When prices have been rising steadily for some time, entrepreneurs will begin to reckon on the basis not merely of the prices already attained, but of a further rise in prices. The effect on supply and demand is clearly the same as that of a corresponding easing of credit.

The second paragraph clearly is about expectations. Wicksell notes that the effect of expectations of rising house prices have the same effect on the market as ‘a corresponding easing of credit’. This is especially interesting in the European context, where real estate bubbles had developed in some countries (Spain, Ireland) but not in others. Finally, on page 97/98, Wicksell takes on speculation:

The matter takes on an entirely different aspect in the case where the market is under the influence of speculation proper. Goods are now bought, not merely to be passed on to other producers and to be distributed to consumers by the normal methods, but to be hastily disposed of to other speculators. The time element, which normally plays a decisive part, now ceases to be of any great significance; and it becomes impossible to make even the roughest kind of estimate of the probable rise in prices. Insecure sentiment governs the market; as prices continue to soar and profits are easily earned, the movement may rapidly reach fever-point. There is almost no limit to the rise in prices in spite of the fact that credit becomes more and more expensive. But when prices ultimately come to rest, and the prospect of further profits disappears, the credit position is so strained and the rate of interest is so high as immediately to bring about a contrary movement, which proceeding in analogous fashion may rapidly drag down prices even below their normal level.

The idea that prices are overshooting in the boom and undershooting in the bust phase of the business cycle is widely understood today, of course. Nevertheless, Wicksell’s 1898 monograph might still be a good starting point for those interested in interest and prices and other things macroeconomic, like endogenous money.

Posted by: Dirk | July 15, 2014

Diagrams & Dollars: Modern Money Educational Video

I like this video, but I am afraid that those who did not yet think through modern money will need to watch this in slow motion. Working with metaphors is a good idea, but then this can only be a teaser. As that, it works quite well. It reminds me of the good old Phillips machine.

Posted by: Dirk | July 15, 2014

(Book review) Freedom from National Debt

Frank Newman was a CEO and chairman of commercial banks in both the US and China, and he also was Deputy Secretary of the U.S. Treasury Department. Perhaps it surprises that the cover of his book features the following inscription:

Why U.S. Treasury Securities

  • never have to be paid off in total by taxpayers
  • cannot present the problems of eurozone nations
  • are safer than money
  • represent savings for millions of investors

and why America does not need to fear “national debt”

His book Freedom from National Debt makes all these claims and more, backing them up with an insider’s perspective on the working of federal balance sheets. The book focusses on U.S. treasuries and popular misconceptions of the public. With a slim 77 pages it is a quick read, suitable for everyone interested in a confirmation of the view that Post-Keynesians and MMTers hold of the fiscal side of the economy. The only point I find myself in strong disagreement with is chapter 7: why foreign ownership of treasuries is not a problem. Well, from the financial point of view there is nothing wrong with foreign ownership of U.S. treasuries, but from the real point of view this translates into more and more exports of goods and services. While this would create employment, it is a drain of production that otherwise could be consumed at home. It is only fair that those countries that export more than they import to/from the US build up stocks of U.S. treasuries, and it is not a problem if people know what’s happening and are aware that US economic policy today means that more of GDP produced tomorrow will be sent abroad. In times of a depressed economy, this might not be a big issue, but in times of a booming economy there might be some inflationary pressures.

Let’s not worry about the problems of the future upswing while the US economy still has an employment to population ratio way below where it was before the crisis. For those looking for an insider’s view on fiscal management, this book can be recommended.

Posted by: Dirk | July 14, 2014

(Book review) In praise of debt

I have thought long and hard about whether to review a book here which is available in German (Lob der Schulden) and French (Éloge de la dette) only. Here it is. Nathalie Sarthou-Lajus published her book in 2012 in French and 2013 in German. All references are taken from the German version. Sarthou-Lajus thinks that debt is not bad, but can be a good thing. There are some things which you cannot pay for, and this does not have to be something negative (p. 13). Being in debt can unsettle an individual, but that does not have to lead to bankruptcy. She thinks that debt is part of every human relationship, and moving into the creditor position by giving something up can lead to a life of freedom. After the equation of debt with evil, this is a very refreshing perspective.

On page 31, Sarthou-Lajus writes that individual freedom is not enough to ensure the well-being of everyone. The government, the nation has the debt of granting assistance to those in need. Historically, these rights of individuals against their nation was added after the French Revolution. After the Great Financial Crisis, we would have to rethink the relationship between state and individual along these lines. She picks up this line of thought again on page 47, arguing that although the subjects of democracy can learn to become autonomous, they will never become truly independent and autarkic. A subject would not be self-alienated just because it depends on others. This, I think, is a defense of the social.

Sarthou-Lajus ends her very thoughtful book with a praise of debt, which can connect individuals over generations and build a social fabric. However, she also says that we need to be free from some debts, to give up on relationships, in order to give some new impulses to our lives and flourish according to our own wishes. I am tempted to say that what holds for individuals also holds for nations, but fallacies of composition would surely arise, making things more complicated for whole societies.

Posted by: Dirk | July 12, 2014

Just one graph: how Japan stabilizes its economy

japanSource: Ministry of Finance, Japan

Posted by: Dirk | July 11, 2014

Krugman misreads Wicksell

It was nice to see Paul Krugman mention one of the best economists that we had, Knut Wicksell from Sweden, not once but twice. He was very influential, Keynes before his General Theory was building his work on Wicksellian theory. His major work “Interest and Prices” (1898) can be downloaded at archive.org. Krugman writes:

Wicksellian analysis is an older tradition; it argues that there is at any given time a “natural” rate of interest in the sense that keeping rates below that level leads to inflation, keeping them above it leads to deflation.

I have always considered these approaches essentially equivalent: the Wicksellian natural rate is the rate that would lead to full employment in a Keynesian model. I have, in fact, treated them as equivalent on a number of occasions, e.g. here.

This statement is correct, up to a point. Keynes, just like Wicksell, was concerned with problems of economic depression. The marginal efficiency of capital from Keynes indeed looks quite similar to Wicksell’s natural rate of interest. However, Wicksell had more than one definition of the natural rate, and saying that the two concepts are the same is a simplification. Note that in his 1898 monograph Wicksell writes the following:


Keeping in mind that consumer prices and commodity prices are not the same – Wicksell also writes about worker wages, land rent and profits – it is open to debate what the natural rate of interest actually is meant to say. With the Keynesian marginal efficiency of capital the definition is the following (GT, ch. 11):

WHEN a man buys an investment or capital-asset, he purchases the right to the series of prospective returns, which he expects to obtain from selling its output, after deducting the running expenses of obtaining that output, during the life of the asset. This series of annuities Q1, Q2, … Qn it is convenient to call the prospective yield of the investment.

Over against the prospective yield of the investment we have the supply price of the capital-asset, meaning by this, not the market-price at which an asset of the type in question can actually be purchased in the market, but the price which would just induce a manufacturer newly to produce an additional unit of such assets, i.e. what is sometimes called its replacement cost. The relation between the prospective yield of a capital-asset and its supply price or replacement cost, i.e. the relation between the prospective yield of one more unit of that type of capital and the cost of producing that unit, furnishes us with the marginal efficiency of capital of that type. More precisely, I define the marginal efficiency of capital as being equal to that rate of discount which would make the present value of the series of annuities given by the returns expected from the capital-asset during its life just equal to its supply price. This gives us the marginal efficiencies of particular types of capital-assets. The greatest of these marginal efficiencies can then be regarded as the marginal efficiency of capital in general.

It is not said that the ‘equilibrium’ amount of investment leads to full employment, quite the opposite. Keynes argues for a socialization of some part of investment (GT, ch. 24):

Furthermore, it seems unlikely that the influence of banking policy on the rate of interest will be sufficient by itself to determine an optimum rate of investment. I conceive, therefore, that a somewhat comprehensive socialisation of investment will prove the only means of securing an approximation to full employment; though this need not exclude all manner of compromises and of devices by which public authority will co-operate with private initiative. But beyond this no obvious case is made out for a system of State Socialism which would embrace most of the economic life of the community. It is not the ownership of the instruments of production which it is important for the State to assume. If the State is able to determine the aggregate amount of resources devoted to augmenting the instruments and the basic rate of reward to those who own them, it will have accomplished all that is necessary. Moreover, the necessary measures of socialisation can be introduced gradually and without a break in the general traditions of society.

It is not obvious how this fits with Wicksell’s natural rate concept. However, there is a more important gap in Krugman’s understanding of Wicksell. Krugman had a debate with Steve Keen in which Krugman defended the idea of loanable funds, whereas Keen held the idea of endogenous money. Loanable funds theory says that banks have to have savings (deposits, alternatively reserves) before being able to lend, whereas the idea of endogenous money says that banks lend without having to collect savings (deposits) first. If reserves are required, they will be acquired later. What is interesting is that Wicksell is firmly rooted in the endogenous money camp, and might even be called the grandfather of endogenous money. Here is a quote from Wicksell (1898, p. 85):

wicksell2This is a refutation of the idea of loanable funds. Banks do not act as intermediaries, Wicksell indirectly writes, but ‘no matter what amount of money may be demanded from the banks, that is the amount which they are in a position to lend…’. Banks ‘have merely to enter a figure in the borrower’s account to represent a credit granted or a deposit created’. So, banks do not collect savings from those that have too much money in order to lend those loanable funds to those that need money.

Knut Wicksell deserves to be lifted from obscurity. The crisis of economics is the crisis of non-Wicksellian economics. In Wicksell, as in Keynes, we look at a monetary circuit and inter-temporal problems. In non-Wicksellian economics, we are always in inter-temporal equilibrium and hence there are no financial crisis, no defaults and not even assets or liabilities nor are banks modelled.


Three authors from Newcastle, Australia, namely James Juniper, Timothy Sharpe and Martin Watts, have just published a paper asking why Post-Keynesians (PKs) do not integrate Modern Monetary Theory (MMT) into their school. They write:

In this paper we argue that the incorporation of MMT principles enhances the post-Keynesian framework, principally with respect to understanding the distinction between sovereign and non-sovereign economies and the role of the payments system. These have major consequences for the conduct of macroeconomic policy which has assumed increased importance since the advent of the crisis.

Having just taught a course using balance sheets to explain money and credit, I tend to agree with that statement. The methodological framework of MMT – discussing balance sheet (mechanics) – is sound and not trivial. It helps to provide the ‘microeconomic foundations’ to any macroeconomic approach.

A nice framework to write a textbook on international economics would be the following methodological structure:

  1. discuss balance sheets of entities like central bank, banks, government, private sector (MMT)
  2. discuss national income and product accounts, flow of funds and balance of payments (identities)
  3. discuss macroeconomic models based on the sectoral – private, public and external sector – approach (PK/SFC)

I personally think that there should not be a dividing line between MMT and PK. They do not disagree over the major issues when it comes to the description of the economic system. Differing policy recommendations are not a reason for a split between the two. In a world with uncertainty, policy prescriptions will never coincide. The discussions between MMT and PK are fruitful, and I have learned a lot from both sides. So much so that I would find it incredibly hard to align myself to either camp. I like the balance sheet approach of MMT, SFC models and Minsky’s discussion of debt, but also the circuitist approach, the PK work on inequality and financialization and the compensation thesis.

Canadian economist Marc Lavoie has published a 2nd edition of his ‘Foundations’: New Foundations of Post-Keynesian Economics. The chapter on essentials of heterodox and post-Keynesian economics is available as a pdf online (for free). His 70 pages on the subject are more dense (70 pages) but also less fun to read than Steve Keen’s Debunking Economics. For those interested in the wider picture, I recommend A short history of economic thought by Bo Sandelin, Hans-Michael Trautwein and Richard Wundrak (112 pages). After having read all three books (except the last chapter on inflation in Lavoie), I think that these three or any close substitutes should become required reading for all students of economics. The menu of problems is much wider than what is offered in textbooks (mainly: inflation-bad, public debt-bad, etc.), as is the methodological variety. While the books deal mainly with macroeconomic problems, there are some connections to micro. Micro and macro are two scales which should take into account each other, so I would recommend these three books also to the empirical microeconomist. The economy is a system, and partial equilibrium thinking should be understood as a very, very large simplification which has to be taken with caution. If we were all in equilibrium, the world would not be so exciting.

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