Posted by: Dirk | September 29, 2016

Bank Of Japan: mark it zero, dude!

cnbcAccording to a recent video feed by CNBC, the Bank of Japan has negative interest rates, scrapped monetary base targets and controls the yield curve. Actually, it communicated that 10y bonds will have a zero interest rate. As a look at recent data shows, the BoJ is clearly achieving what it has announced. Somehow, all of these things used to be in the territory of monetary cranks when monetarism ruled for a blip during the 1980s:

  • negative interest rates
  • no monetary supply targets
  • controlling the yield curve (long-term interest rates)

Now, they are all reality, in one of the biggest industrial powers of this planet. Sometimes, things change rather quickly. It is now monetary theory that has to adjust to the new world we live in.

Posted by: Dirk | September 22, 2016

Paul Romer’s new paper: The Trouble with Macroeconomics

The World Bank’s chief economist has generated quite a stir with his new paper, which can be downloaded here. This is the abstract:

For more than three decades, macroeconomics has gone backwards. The treatment of identification now is no more credible than in the early 1970s but escapes challenge because it is so much more opaque. Macroeconomic theorists dismiss mere facts by feigning an obtuse ignorance about such simple assertions as “tight monetary policy can cause a recession.” Their models attribute fluctuations in aggregate variables to imaginary causal forces that are not influenced by the action that any person takes. A parallel with string theory from physics hints at a general failure mode of science that is triggered when respect for highly regarded leaders evolves into a deference to authority that displaces objective fact from its position as the ultimate determinant of scientific truth.

Of course, this is the perfect opportunity to refer to my new book on “The Troubles Macroeconomics”, mainly financial crises and the mass unemployment that results when governments don’t come to the rescue. This is not an assumption but comes out of a careful reading of the way the balance sheets work. In my book, I look at the generation of central bank money, commercial bank deposits, fiscal and monetary policy, QE, the TARGET2 system and the way that real businesses operate. I think that this is the way to go forward since balance sheets are quite objective. In a new paper, I call this “the balance sheet approach“, which is a new paradigm inside of which both some neoclassical and some heterodox economists are operating.

Posted by: Dirk | September 15, 2016

Spanish government pays hefty price for bank bail-out

According to Agencia EFE, the bank bail-out in Spain has left a slight fiscal problem (link):

El Estado ha recuperado 2.686 millones de euros de los 61.495 millones de ayudas totales que otorgó desde 2009 al sector financiero, lo que supone veinte millones más que los contabilizados hace algo más de un año.

In English: The government has gained back only €2.7 billion of the €61.5 billion that was given as aid to the financial sector since 2009, twenty million more compared to what was accounted for a year ago. Germany only paid €15.8 billion to save its larger banks, according to Handelsblatt. So, what went wrong?

In times of crisis, central banker usually follow the rule of Bagehot and lend freely, against collateral and at high interest rates, to those who are solvent. This should solve the liquidity crisis but it also means that insolvent banks will be gone.

In Spain, this was not applied. In Spain, all banks were saved, probably because the vast majority of them were insolvent. After the real estate boom many banks had a bad portfolio of assets consisting of billions of euros in real estate loans that turned into non-performing loans. The consequence of this is that the Spanish government will not get its money back because it lend to insolvent banks that probably will never repay the loans that the Spanish government gave them (against bad collateral, mostly real estate, I assume).

During the time of crisis, politicians probably did this to save the Spanish banking system. Europe (the EU) was not willing to step in, with Merkel saying that banking bail-outs are a nation-state problem. Of course, it is still dubious why the Spanish government should have bailed out its banks.

The Spanish CTXT magazine now has an article out (link) that is named “El no rescate de Rajoy, o cómo los españoles rescataron a los bancos alemanes”, in English: “The non-rescue of [Spanish president] Rajoy, or how the Spanish people saved the German banks”. Spanish banks owed hundreds of billions to German banks via the interbank market at the time of the crisis, and this was what seems to have mattered in terms of policy-making.

Advertisement: I explain the workings of the interbank market in the euro zone in my new book titled “Modern Monetary Theory and European Macroeconomics“, if you want to see some balance sheets modelled after real world institutions.

I have just published a working paper online (link) with the above title. What would John Maynard have thought about the euro zone crisis, and perhaps more importantly, what would he have done? The answer, most people think, is in the General Theory (1936), which was published 80 years ago. Why this is correct, there are other writings by Keynes in which he summarizes his ideas in much shorter space. The one that my article dissects is his letter to FDR, the US president, from December 31 1933. It was published in the NY Times and can be read online (link). Keynes describes three possible ‘techniques of recovery’, but argues that only one would be available at that time. I think that this letter is probably the best source to answer the question about what John Maynard would have done if he’d lived today. His point is monetary: if the monetary circuit experiences a slowdown, some actor must add more deposits into the economy to create more income and hence more demand. How do you add deposits and hence income to the world economy? Well, there are only three options. If you don’t pick any of them, you are not making sense and the crisis will persist. I find his reasoning very persuasive.

You can read my article online following this link (to the ideas/repec database, where you find a link to the pdf file).

In his 1936 “The General Theory of Employment, Interest and Money”, John Maynard Keynes already recognized that the idea that savings finance investments is wrong. Savings equal investment indeed, which is written as S=I. However, the way that this identity (roughly: definition in the form of an equation) holds is exactly the opposite. Here are two paragraphs from his chapter 6 (source) with my highlighting:

Income is created by the value in excess of user cost which the producer obtains for the output he has sold; but the whole of this output must obviously have been sold either to a consumer or to another entrepreneur; and each entrepreneur’s current investment is equal to the excess of the equipment which he has purchased from other entrepreneurs over his own user cost. Hence, in the aggregate the excess of income over consumption, which we call saving, cannot differ from the addition to capital equipment which we call investment. And similarly with net saving and net investment. Saving, in fact, is a mere residual. The decisions to consume and the decisions to invest between them determine incomes. Assuming that the decisions to invest become effective, they must in doing so either curtail consumption or expand income. Thus the act of investment in itself cannot help causing the residual or margin, which we call saving, to increase by a corresponding amount.


Clearness of mind on this matter is best reached, perhaps, by thinking in terms of decisions to consume (or to refrain from consuming) rather than of decisions to save. A decision to consume or not to consume truly lies within the power of the individual; so does a decision to invest or not to invest. The amounts of aggregate income and of aggregate saving are the results of the free choices of individuals whether or not to consume and whether or not to invest; but they are neither of them capable of assuming an independent value resulting from a separate set of decisions taken irrespective of the decisions concerning consumption and investment. In accordance with this principle, the conception of the propensity to consume will, in what follows, take the place of the propensity or disposition to save.

This means that investment is financed by credit. When banks create new loans, new deposits are credited to the borrower’s account. These deposits are additional deposits that did not exist before. When spending, the investment takes place (and rises by some amount) and the seller of the goods are services that constitute the investment will received bank deposits. This is income not spend, which means that savings go up (by the same amount). Hence savings equal investment, but not because savings finance investment! Before Keynes, Wicksell and Schumpeter wrote about this as well, so it was common knowledge that loans finance investment and not savings. Today, we live in a dark age of macroeconomics and monetary theory since this insight has been forgotten by most of the discipline.

Posted by: Dirk | September 8, 2016

James May (formerly Top Gear) understands modern money!

James May was suggested to be the governor of the Bank of England by an elderly gentleman sitting on a British racing green sofa (h/t to S. Angrick):

James May suggests to sort out the deficit: “I’d find out how much it was, and then I’d write a check for that amount from the Bank of England”. [Laughter in the audience]

People laugh because they don’t understand the mechanics of modern money creation and the answer sounds kind of plausible but also probably too clever, I assume. Actually, the British government could finance its deficit exactly the way James May describes it. The Bank of England “writes a check” to the government, which means marking up its account at the Bank of England. In return, the Bank of England gets treasury bonds of the same value. Problem solved! The government cannot go bankrupt because it is supported by the Bank of England. In reality, the Bank of England is not allowed to buy treasury bonds (gilts) directly from the government or the institution running the sale on its behalf (UK Debt Management Office). However, it can and does buy it when existing gilts are on the market. So, James May has said something funny that is also very clever…

For those who are interested in understanding modern money in the context of the eurozone (crisis) I can recommend my new book published last month at Routledge.

Posted by: Dirk | September 7, 2016

Labour and SPD: return to Keynesian theory?

The ongoing malaise in the eurozone seems to resist any intents of monetary policy to improve the situation. As Keynes found in his “General Theory”, written in the aftermath of the Great Crash of 1929, in a depression only fiscal policy works. That, however, would change the distribution of income and wealth towards the non-rich, especially so since more employment creates higher wage demands. Both Labour Party in the UK and Social-democrat Party of Germany (SPD) had no mention of fiscal policy in recent years. Now, however, Jeremy Corbyn calls for “full employment and an economy that works for all” (link). Here is how he wants to get there:

We will create a million good quality jobs across our regions and nations and guarantee a decent job for all. By investing £500 billion in infrastructure, manufacturing and new industries backed up by a publicly-owned National Investment Bank and regional banks we will build a high skilled, high tech, low carbon economy that ends austerity and leaves no one and nowhere left behind. We will invest in the high speed broadband, energy, transport and homes that our country needs and allow good businesses to thrive, and support a new generation of co-operative enterprises.

Ralf Stegner, the most left-wing politician in the leadership of the SPD, is not as outspoken. His theses for a more just society do include some things like a public sector to provide work for long-term unemployed, but no mention is made of fiscal policy as a tool to create employment (link). The return of Keynesian ideas to European politics seems to be evolving slowly, step by step.

Posted by: Dirk | September 5, 2016

Debt and distribution in Anton Chekhov’s ‘Children’

I read the short story be Checkhov over the weekend, regarding by Tolstoy as one of his best according to my Wordsworth Classics edition. The story features debt and distribution as topics, with a children’s game evolving over one night. Sometime a short story contains more lessons than a chapter of a textbook, and this might be one of these instances. Here it is:

Papa and mamma and Aunt Nadya are not at home. They have gone to a christening party at the house of that old officer who rides on a little grey horse. While waiting for them to come home, Grisha, Anya, Alyosha, Sonya, and the cook’s son, Andrey, are sitting at the table in the dining-room, playing at loto. To tell the truth, it is bedtime, but how can one go to sleep without hearing from mamma what the baby was like at the christening, and what they had for supper?

The table, lighted by a hanging lamp, is dotted with numbers, nutshells, scraps of paper, and little bits of glass. Two cards lie in front of each player, and a heap of bits of glass for covering the numbers. In the middle of the table is a white saucer with five kopecks in it. Beside the saucer, a half-eaten apple, a pair of scissors, and a plate on which they have been told to put their nutshells.

The children are playing for money. The stake is a kopeck. The rule is: if anyone cheats, he is turned out at once. There is no one in the dining-room but the players, and nurse, Agafya Ivanovna, is in the kitchen, showing the cook how to cut a pattern, while their elder brother, Vasya, a schoolboy in the fifth class, is lying on the sofa in the drawing-room, feeling bored. They are playing with zest. The greatest excitement is expressed on the face of Grisha. He is a small boy of nine, with a head cropped so that the bare skin shows through, chubby cheeks, and thick lips like a negro’s. He is already in the preparatory class, and so is regarded as grown up, and the cleverest. He is playing entirely for the sake of the money. If there had been no kopecks in the saucer, he would have been asleep long ago. His brown eyes stray uneasily and jealously over the other players’ cards. The fear that he may not win, envy, and the financial combinations of which his cropped head is full, will not let him sit still and concentrate his mind. He fidgets as though he were sitting on thorns. When he wins, he snatches up the money greedily, and instantly puts it in his pocket. His sister, Anya, a girl of eight, with a sharp chin and clever shining eyes, is also afraid that someone else may win. She flushes and turns pale, and watches the players keenly. The kopecks do not interest her. Success in the game is for her a question of vanity. The other sister, Sonya, a child of six with a curly head, and a complexion such as is seen only in very healthy children, expensive dolls, and the faces on bonbon boxes, is playing loto for the process of the game itself. There is bliss all over her face. Whoever wins, she laughs and claps her hands.

Alyosha, a puffy, spherical little person, pants, snuffles, and stares open-eyed at the cards. He is moved neither by covetousness nor vanity. So long as he is not driven out of the room, or sent to bed, he is thankful. He looks phlegmatic, but at heart he is rather a little beast. He is not there so much for the sake of the loto, as for the sake of the misunderstandings which are inevitable in the game. He is greatly delighted if one hits another, or calls him names. He ought to have run off somewhere long ago, but he won’t leave the table for a minute, for fear they should steal his counters or his kopecks. As he can only count the units and numbers which end in nought, Anya covers his numbers for him. The fifth player, the cook’s son, Andrey, a dark-skinned and sickly looking boy in a cotton shirt, with a copper cross on his breast, stands motionless, looking dreamily at the numbers. He takes no interest in winning, or in the success of the others, because he is entirely engrossed by the arithmetic of the game, and its far from complex theory; “How many numbers there are in the world,” he is thinking, “and how is it they don’t get mixed up?”

They all shout out the numbers in turn, except Sonya and Alyosha. To vary the monotony, they have invented in the course of time a number of synonyms and comic nicknames. Seven, for instance, is called the “ovenrake,” eleven the “sticks,” seventy-seven “Semyon Semyonitch,” ninety “grandfather,” and so on. The game is going merrily.

“Thirty-two,” cries Grisha, drawing the little yellow cylinders out of his father’s cap. “Seventeen! Ovenrake! Twenty-eight! Lay them straight. . . .”

Anya sees that Andrey has let twenty-eight slip. At any other time she would have pointed it out to him, but now when her vanity lies in the saucer with the kopecks, she is triumphant.

“Twenty-three!” Grisha goes on, “Semyon Semyonitch! Nine!”

“A beetle, a beetle,” cries Sonya, pointing to a beetle running across the table. “Aie!”

“Don’t kill it,” says Alyosha, in his deep bass, “perhaps it’s got children . . . .”

Sonya follows the black beetle with her eyes and wonders about its children: what tiny little beetles they must be!

“Forty-three! One!” Grisha goes on, unhappy at the thought that Anya has already made two fours. “Six!”

“Game! I have got the game!” cries Sonya, rolling her eyes coquettishly and giggling.

The players’ countenances lengthen.

“Must make sure!” says Grisha, looking with hatred at Sonya.

Exercising his rights as a big boy, and the cleverest, Grisha takes upon himself to decide. What he wants, that they do. Sonya’s reckoning is slowly and carefully verified, and to the great regret of her fellow players, it appears that she has not cheated. Another game is begun.

“I did see something yesterday!” says Anya, as though to herself. “Filipp Filippitch turned his eyelids inside out somehow and his eyes looked red and dreadful, like an evil spirit’s.”

“I saw it too,” says Grisha. “Eight! And a boy at our school can move his ears. Twenty-seven!”

Andrey looks up at Grisha, meditates, and says:

“I can move my ears too. . . .”

“Well then, move them.”

Andrey moves his eyes, his lips, and his fingers, and fancies that his ears are moving too. Everyone laughs.

“He is a horrid man, that Filipp Filippitch,” sighs Sonya. “He came into our nursery yesterday, and I had nothing on but my chemise . . . And I felt so improper!”

“Game!” Grisha cries suddenly, snatching the money from the saucer. “I’ve got the game! You can look and see if you like.”

The cook’s son looks up and turns pale.

“Then I can’t go on playing any more,” he whispers.

“Why not?”

“Because . . . because I have got no more money.”

“You can’t play without money,” says Grisha.

Andrey ransacks his pockets once more to make sure. Finding nothing in them but crumbs and a bitten pencil, he drops the corners of his mouth and begins blinking miserably. He is on the point of crying. . . .

“I’ll put it down for you!” says Sonya, unable to endure his look of agony. “Only mind you must pay me back afterwards.”

The money is brought and the game goes on.

“I believe they are ringing somewhere,” says Anya, opening her eyes wide.

They all leave off playing and gaze open-mouthed at the dark window. The reflection of the lamp glimmers in the darkness.

“It was your fancy.”

“At night they only ring in the cemetery,” says Andrey.

“And what do they ring there for?”

“To prevent robbers from breaking into the church. They are afraid of the bells.”

“And what do robbers break into the church for?” asks Sonya.

“Everyone knows what for: to kill the watchmen.”

A minute passes in silence. They all look at one another, shudder, and go on playing. This time Andrey wins.

“He has cheated,” Alyosha booms out, apropos of nothing.

“What a lie, I haven’t cheated.”

Andrey turns pale, his mouth works, and he gives Alyosha a slap on the head! Alyosha glares angrily, jumps up, and with one knee on the table, slaps Andrey on the cheek! Each gives the other a second blow, and both howl. Sonya, feeling such horrors too much for her, begins crying too, and the dining-room resounds with lamentations on various notes. But do not imagine that that is the end of the game. Before five minutes are over, the children are laughing and talking peaceably again. Their faces are tear-stained, but that does not prevent them from smiling; Alyosha is positively blissful, there has been a squabble!

Vasya, the fifth form schoolboy, walks into the dining-room. He looks sleepy and disillusioned.

“This is revolting!” he thinks, seeing Grisha feel in his pockets in which the kopecks are jingling. “How can they give children money? And how can they let them play games of chance? A nice way to bring them up, I must say! It’s revolting!”

But the children’s play is so tempting that he feels an inclination to join them and to try his luck.

“Wait a minute and I’ll sit down to a game,” he says.

“Put down a kopeck!”

“In a minute,” he says, fumbling in his pockets. “I haven’t a kopeck, but here is a rouble. I’ll stake a rouble.”

“No, no, no. . . . You must put down a kopeck.”

“You stupids. A rouble is worth more than a kopeck anyway,” the schoolboy explains. “Whoever wins can give me change.”

“No, please! Go away!”

The fifth form schoolboy shrugs his shoulders, and goes into the kitchen to get change from the servants. It appears there is not a single kopeck in the kitchen.

“In that case, you give me change,” he urges Grisha, coming back from the kitchen. “I’ll pay you for the change. Won’t you? Come, give me ten kopecks for a rouble.”

Grisha looks suspiciously at Vasya, wondering whether it isn’t some trick, a swindle.

“I won’t,” he says, holding his pockets.

Vasya begins to get cross, and abuses them, calling them idiots and blockheads.

“I’ll put down a stake for you, Vasya! ” says Sonya. “Sit down.” He sits down and lays two cards before him. Anya begins counting the numbers.

“I’ve dropped a kopeck!” Grisha announces suddenly, in an agitated voice. “Wait!”

He takes the lamp, and creeps under the table to look for the kopeck. They clutch at nutshells and all sorts of nastiness, knock their heads together, but do not find the kopeck. They begin looking again, and look till Vasya takes the lamp out of Grisha’s hands and puts it in its place. Grisha goes on looking in the dark. But at last the kopeck is found. The players sit down at the table and mean to go on playing.

“Sonya is asleep!” Alyosha announces.

Sonya, with her curly head lying on her arms, is in a sweet, sound, tranquil sleep, as though she had been asleep for an hour. She has fallen asleep by accident, while the others were looking for the kopeck.

“Come along, lie on mamma’s bed!” says Anya, leading her away from the table. “Come along!”

They all troop out with her, and five minutes later mamma’s bed presents a curious spectacle. Sonya is asleep. Alyosha is snoring beside her. With their heads to the others’ feet, sleep Grisha and Anya. The cook’s son, Andrey too, has managed to snuggle in beside them. Near them lie the kopecks, that have lost their power till the next game. Good-night!

Posted by: Dirk | September 1, 2016

Nowhere to grow? US house prices rally has ended.

fredgraphThe last US recession was caused by falling house prices and collapsing demand due to lack of investment as house construction stalled. Since then, house prices wobbled a bit between 2009 and 2012 and then went up. Since March 2016, however, house prices have stalled (see figure provided by FRED2). While the actual economic situation in the US seems to be roughly ok – some observers talk about full employment – the future might bring some unpleasant surprises. Industrial production increased in the last two months (FRED2) but that probably is just some seasonal variation (even though the series is seasonally adjusted, in the last few years the summer months seem to have done exceptionally well).

I don’t want to call a recession, but the economic growth model of the US has relied quite a lot on real estate (before the boom) and then the recovery of real estate. What if house prices stall now, with the interest rate basically at zero? Well, both presidential candidates have budget deficits in their respective programmes, so that there seems to be some way out of the next recession – when it comes.

My book has just been published by Routledge. Here is the teaser from Routledge’s website:

This book provides a new methodological approach to money and macroeconomics. Realizing that the abstract equilibrium models lacked descriptions of fundamental issues of a modern monetary economy, the focus of this book lies on the (stylized) balance sheets of the main actors. Money, after all, is born on the balance sheets of the central bank or commercial bank. While households and firms hold accounts at banks with deposits, banks hold an account at the central bank where deposits are called reserves. The book aims to explain how the two monetary circuits – central bank deposits and bank deposits – are intertwined. It is also shown how government spending injects money into the economy.

Modern Monetary Theory and European Macroeconomics covers both the general case and then the Eurozone specifically. A very simple macroeconomic model follows which explains the major accounting identities of macroeconomics. Using this new methodology, the Eurozone crisis is examined from a fresh perspective. It turns out that not government debt but the stagnation of private sector debt was the major economic problem and that cuts in government spending worsened the economic situation. The concluding chapters discuss what a solution to the current problems of the Eurozone must look like, with scenarios that examine a future with and without a euro.

This book provides a detailed balance sheet view of monetary and fiscal operations, with a focus on the Eurozone economy. Students, policy-makers and financial market actors will learn to assess the institutional processes that underpin a modern monetary economy, in times of boom and in times of bust.

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