I just read the new book by Steve Keen, which is … a little red book. It is very readable and brings the reader up to the economic theory and reality of 2017. The focus is on private debt, and that is very important. The “smoking gun of credit” has been widely overlooked in the economics discipline over the last decades, which instead focussed on constraining public debt. For those that are interested in state-of-the-art economics of 2017, this is a very good book since it gives the reader some perspective at how we got where we are. What is disturbing is the fact that we did not rethink our economic theory and policy even though we clearly hit a wall in 2008/09. Most economies still rely on increasing private debt as the major mechanisms to ignite and sustain growth. The problem, of course, is that private debt cannot increase forever, and when it does not, a financial crisis plus a recession result. This, perhaps, would not be so bad, but the problem is that we are unlikely to repeat this cycle. Japan, so argues Keen, shows the way forward. The public will be afraid of debt, rightly so, and stop borrowing. This will change the way the economy functions since private sector spending will be reduced permanently. The public sector hence needs to increase spending to reduce resulting unemployment. It remains to be seen whether economists can make the intellectual jump into a new world of (private) “Debt Zombies”. Recommended!

German daily newspaper Die tageszeitung published my article on money creation last weekend (here). This is the translation from German into English (also available as a pdf):

(Translation of http://www.taz.de/!5422477/ by Dirk Ehnts, author)

Debate on money creation at the ECB

Money is created from nothing

The consequences are shocking. The mainstream view of economics is wrong – says German central bank Deutsche Bundesbank. This is a revolution.

Modern capitalism is impossible without money. We do not exchange goods against goods, but we buy goods with money. The interesting question for economics is hence: where is money coming from? The Bundesbank has now delivered an answer that is revolutionary: money is created from nothing – by booking processes inside banks. This may sound abstract at first, but the consequences are far-reaching. The Bundesbank says that the mainstream theory in academic economics is wrong. Millions of students at universities learn a fairy tale.

This fairy tale is spread by, for instance, Gregory Mankiw, whose textbook „Macroeconomics“ has sold millions of copies and is widely used at German universities. For Mankiw, banks are just middlemen, called intermediaries: they allegedly get money from savers that they then pass on to other customers.

This idea might sound reasonable, but has little to do with reality. Banks do not need savers to extend loans. They are not intermediaries, but create money by themselves. The Bundesbank says that unequivocally. The prose is a bit awkward, nevertheless it is worthwhile to read the main passage: „If a bank extends a loan, she books the credit to the customer connected to the loan as his deposit […] This refutes a widely held erroneous view in which the bank acts as an intermediary in the moment of lending, in which loans can only be funded by deposits that the bank has received from customers before.“ Harvard professor Gregory Mankiw with his theory of intermediation, so says Bundesbank, subscribes to „a widely held erroneous view“.

New money is born

Words like credit or deposit sound complicated, but one can imagine money creation like a scoreboard in a football stadium: first goals are scored, then the scoreboard is adjusted accordingly.

This is how banks, work, too: first, the bank signs a loan contract – and then the money is added to the client’s account. The money did not exist before, it is created through the extension of a loan.

Let us assume, that a customer applies for a loan of a thousand euros to buy a used car. Then the bank tops up his account. Done. New money is born. When the client repays the thousand euros – the money is gone again.

This insight has enormous consequences, because the Bundesbank says: the relationship between debts and savings is rather different from the view of the „Swabian housewife“. This figure of speech, which is generally known, thinks that saving is always good – and debs are to be avoided. The German language also suggests that loans are evil. The German word for debt – Schulden – instantly reminds one of the idea of moral sin – moralische Schuld. Who takes out loans is quickly regarded as disreputable.

 Two practical questions

As the Bundesbank has shown, loans are the driver of the economy. Without them we would have neither investment nor economic growth. Only when loans are taken out savings can be created. The world of the Swabian housewife is turned topsy-turvy: savings are accommodating items, seen from macroeconomic accounting.

Let’s stay with the banal example or a car purchase. When someone borrows a thousand euros to buy a used car – then money is created, which then is transferred to the seller, who now has additional savings of a thousand euros. These savings were created from nothing just like the loan. Or, in economese: The debt of one person are the financial wealth of another.

Two practical questions remain: If banks do not need savings to extend loans – why do we save at all? And why, at least in the past, high rate of interest were paid for savings deposits, if these are essentially superfluous?

To start with the savings: most Germans do know instinctively why they would like to save some money. They make provisions for the future. They save to buy a house, for old age or to finance their kids’ education. Firms also like to save. Profits only arise if income is higher than expenditure.

The Germans are saving

Households and firms hence save even when interest rates are low or zero. We can see this phenomenon now: Whereas many banks offer negative interest rates or raise account fees, the Germans continue undauntedly.

This leads us to the second question more urgently: why are there interest rates in the first place, if savings takes place anyway – and banks do not need those savings to extend loans?

The interest rate is a brake for credit creation and inflation. If money is created from nothing through the issuance of loans, then theoretically an infinity of money could be pumped out into the world. When people consume and invest without limited, at some point all factories and workers will be busy, and inflation starts to rise.

This is when central banks intervene: They raise the interest rate as soon as high inflation seems to occur. With interest rates rising, taking out more loans will not be attractive. Money creation is stopped for the time being.

What follows from this?

The Bundesbank has entered history books with her account of money creation – in Germany. Truth is, other central banks were quicker. The Bank of England wrote on her homepage in 2014 how money is created from nothing.

What follows from this politically? The Bundesbank remains silent on this issue. However, it is obvious that finance minister Schäuble’s „policy of a black zero“ – a balanced government budget – is just as wrong as the austerity policies of the Eurozone.

Recalling the Bundesbank’s presentation: Savings can only be created when loans are extended. Debt and wealth belong together. But this reality is ignored by most Germans and their finance minister. They rather trust their guts: They would absolutely like to save – but also reduce their public debt. That does not work. If Schäuble saves and avoids any creation of debt he prevents his citizens from building up new wealth.

It’s even worse in the Eurozone: The crisis countries are forced to slash their government spending and are supposed to not incur any new debts but pay off old ones. This also will not work.

Schäuble should start to borrow

Where do incomes come from which are needed to repay the debts? Who repays debts in matter of fact is saving. But savings can only exist if someone increases his debts.

Mainstream economists often mock this statement by claiming that it would be nonsense to fight a debt crisis with new debts. It may be paradox, but this is how the world of money works, as the Bundesbank has explained to us.

ECB president Mario Draghi, an experienced central banker, has understood much earlier than the Bundesbank that new public debts are needed. No speech, in which he does not call on the economically stronger Eurozone countries, mostly Germany, to engage in fiscal policy. What means is: Schäuble should finally take out new loans. There are enough investment projects worthy of financing. Everybody agrees that the internet is the economic future – yet powerful internet connections are lacking in many locations in Germany.

Also, there now is a brand-new investment project, which is mandatory: all university libraries need new textbooks on macroeconomics. Mankiw and the other mainstream economists have finally been paid off, since the Bundesbank spoke its mind.



works at the chair for macroeconomics at Technical University Chemnitz with a specialization on international economic relations. Routledge published his book „Modern Monetary Theory and European Macroeconomics“ in 2016.

Posted by: Dirk | June 12, 2017

Why I am a horizontalist

Once upon a time, there was a discussion about interest rates set by banks. Do banks:

  1. increase interest rates when they face a specially large demand or
  2. set interest rates and then ignore the demand for loans

The first position is called the verticalist position, the second the horizontalist. The following graph shows the Fed Funds rate, which is heavily influenced by the Fed (up to 100% if it wanted to!), and the bank prime loan rate. FRED explains that it is the “Rate posted by a majority of top 25 (by assets in domestic offices) insured U.S.-chartered commercial banks. Prime is one of several base rates used by banks to price short-term business loans”. The picture is only compatible with the horizontalist position:

 The idea then that when demand for loans is relatively high interest rates are hiked up seems empirically implausible. A more interesting story seems to be that almost every time interest rates are increased by the central bank a recession follows, as shown by the gray bars. While strong loan demand does not lead to increases in the interest rates of banks, at some point the central bank will intervene, very likely to stop inflation running away. If we add change in total credit to private non-financial sector we should have a more complete picture:


Posted by: Dirk | June 2, 2017

NYT Graph on income instability

The New York Times has a very nice graph on income instability (source):


This is relevant when it comes to investment in housing, I suppose. If your income is low and very volatile, then you can only afford to take out a loan if there is enough credit to bridge any gaps in income that you might experience. Of course it would also be interesting to disaggregate the data somewhat. Do these swings affect most people in those income classes or almost none, with those experiencing swings of income seeing very large changes in income? It would also be nice to see a distribution of income changes that makes clear whether these are increases or decreases. I have the slight feeling that the data above would not “smile” at us if we would take that into account.

It is often forgotten that economic well-being is not only about having a sufficient income, but also a stable one. With labor market deregulation, instability might have increased so that those in the lower income brackets are not able to enjoy their income but instead are saving as they seek to bridge any potential income gap in the future.

Posted by: Dirk | May 29, 2017

“If I watch a football match”

Sarah Bakewell’s new book “At the Existentialist Café” contains a nice description of reality and the perception of it:

If I watch a football match, I see it as a football match, not as a meaningless scene in which a number of people run around taking turns to apply their lower limbs to a spherical object. If the latter is what I’m seeing, then I am not watching some more essential, truer version of football; I am failing to watch it properly as football at all.

This connects to the issue of the way institutions work and influence our behavior. Institutions are mostly ignored in economics, but with the quote in mind one should say that this is not only wrong, but renders any economic analysis completely irrelevant. If we don’t understand institutions, we cannot understand human behavior. There are many, many games going on that are social in character and institutional in form: the way that political parties are constructed, the way that people move into certain neighborhoods because they have prestige, the way that people attend events, etc.

The same goes for capitalism. If it is not understood what the people inside (financial and non-financial) firms are aiming for, then we get wrong ideas about the way firms behave. We just learned in the last financial crisis that banks apparently have a problem because bankers can get some extremely high bonus payments during a boom that leave no incentive to think about the long-run. Just as in football, it is important who is the one determining who plays at what position and how much freedom that person has to make his plays. It is also important to think about the rule book and the penalties and who enforces them. These issue have something to do with power, and Sarah Bakewell and “her” existentialists would probably not miss that fact.

I will hold a course taught in English at Maastricht University’s summer school this late August. Students can get 2 ECTS if they pass the exam, but this is not mandatory. The course is based on my book “Modern Monetary Theory and European Macroeconomics”, which will come out as a soft cover version in late July (link). More information on the course can be found here here, applications can be submitted here until May 30th 2017. As of Sunday, only five spots are left, so don’t take too long to think about it! (Btw: last year’s first edition of the class scored 8.83 out of 10 in student evaluations.)

Yesterday, Spaniards were called to elect a new leader of the Socialist (well, Social Democratic) Worker’s Party of Spain (PSOE). Pedro Sánchez got the job with around 50% of the vote. He already held the top job, but stepped down when the PSOE decided to support the minority government of Partido Popular, the conservative party of Spain. This support was seen as treason by many on the left, adding to dissatisfaction with the party that had grown over the past few years. The government of Zapatero, which led Spain through the late boom and the early crisis (2004-2011), did literally nothing to stop austerity policies and then topped it all by giving a pardon to a banker that was having problems with the law. Having been to Spain many times, this was when most younger progressive people turned to look for alternatives, finding one in Podemos.

The reporting by UK newspaper “The Guardian” is of a different opinion:

The Socialists have suffered the fate of many of their leftwing peers across Europe as electioneering has been distorted by populist leaders from all sides of the political spectrum, leaving its base fractured and struggling for an identity.

That, I believe, is a complete myth. Socialists have suffered defeat everywhere in Europe because of their support for austerity policy. The Dutch worker’s party took a beating this year, losing more than 75% of its seats in parliament. The Socialist candidate in the French presidential elections (first round) did get nowhere near a possibility to run in the second round. Why? Hollande, the Socialist president, had been promising voters to end austerity but did not deliver.

The Guardian article continues:

Spain’s Socialists have chosen former leader and hardliner Pedro Sánchez to head the party again, a vote likely to make it harder for the ruling conservatives to secure the opposition support it needs in parliament to push through legislation.

He has pledged to take a firm stand against the ruling minority People party’s market-friendly, deficit-tackling policies.

Sánchez will lead the Socialists further left and place them in direct opposition to the PP, increasing the possibility of a hung parliament over key reforms, something prime minister Mariano Rajoy has warned would trigger a new general election.

This is a very odd passage. So if you oppose “market-friendly, deficit-tackling policies” you are a “hardliner”? The phrasing is very neoliberal. What is “market-friendly” supposed to mean in Spain for the conservatives? Transparency International reports:

“Corruption in Spain distorts policy making and hurts people’s basic rights for the benefit of a few. Just looking at recent scandals like the Pujol case in Catalonia, the linkages between the ruling People’s Party and the construction group OHL, the Gürtel case, the Bankia fraud and Rodrigo Rato, gives a sense of the scale of the problem,” said José Ugaz, Chair of Transparency International.

“This does not need to remain this way. Spain has the democratic maturity, the institutions and a vibrant population and can reverse this trend and stand up to corruption, including grand corruption,” added Ugaz.

Interesting. “Market-friendly” in the context of Spanish politics roughly translates into corrupt. And deficit-tackling policies? Does “The Guardian” still believe in the expansionary austerity myth? Have you seen what happens in Portugal next door, where according to The Economist “Portugal cuts its fiscal deficit while raising pensions and wages”?

Btw: Germany’s social democrats (SPD) cancelled their presentation of key policies with respect to the national election today, saying that they need more time to discuss the details. I wonder whether they are recalibrating in a Europe where the UK and Spain have real social democrats and Macron in France is at least demanding some real social democratic reforms. Neoliberal mumbo jumbo does not seem to work anymore for the European voters on the left. Maybe SPD did realize this a little late (but not too late)?

Posted by: Dirk | April 18, 2017

Keynes: rules or discretion?

I’m reading the Tract on Monetary Reform and it is quite interesting. The big question that could come up in the future for many small, open economies in what today is the Eurozone is: what to do after the euro is gone? Target an exchange rate, or the inflation rate, use discretion or follow rules – these are all very interesting questions that Europeans might be forced to answer in the coming years. Here is an excerpt from Keynes’ writings (last chapter):

If the Bank of England, the Treasury, and the Big Five were to adopt this policy, to what criteria should they look respectively in regulating bank-rate, Government borrowing, and trade-advances? The first question is whether the criterion should be a precise, arithmetical formula or whether it should be sought in a general judgement of the situation based on all the available data. The pioneer of price-stability as against exchange-stability, Professor Irving Fisher, advocated the former in the shape of his “compensated dollar,” which was to be automatically adjusted by reference to an index number of prices without any play of judgement or discretion. He may have been influenced, however, by the advantage of propounding a method which could be grafted as easily as possible on to the pre-war system of gold reserves and gold ratios. In any case, I doubt the wisdom and the practicability of a system so cut and dried. If we wait until a price movement is actually afoot before applying remedial measures, we may be too late. “It is not the past rise in prices but the future rise that has to be counteracted.”[1] It is characteristic of the impetuosity of the credit cycle that price movements tend to be cumulative, each movement promoting, up to a certain point, a further movement in the same direction. Professor Fisher’s method may be adapted to deal with long-period trends in the value of gold but not with the, often more injurious, short-period oscillations of the credit cycle. Nevertheless, whilst it would not be advisable to postpone action until it was called for by an actual movement of prices, it would promote confidence, and furnish an objective standard of value, if, an official index number having been compiled of such a character as to register the price of a standard composite commodity, the authorities were to adopt this composite commodity as their standard of value in the sense that they would employ all their resources to prevent a movement of its price by more than a certain percentage in either direction away from the normal, just as before the war they employed all their resources to prevent a movement in the price of gold by more than a certain percentage. The precise composition of the standard composite commodity could be modified from time to time in accordance with changes in the relative economic importance of its various components.

Posted by: Dirk | April 12, 2017

… and austerity for all! (Martin Schulz reloaded)

Many of my European friends ask me about Martin Schulz and the success of social-democrats at the polls. Since they are progressive, they hope for reforms in the eurozone to curb mass unemployment, stellar youth unemployment and social problems that exist in many crisis countries. I always had my doubts if Martin Schulz was the right person to end austerity and bring the Eurozone back on its path to prosperity and full-employment. Now these doubts have been confirmed by the FT:

Martin Schulz signalled he would not soften Germany’s pro-austerity stance if elected chancellor this year, a message that will disappoint those in the EU hoping the Social Democrat leader might usher in a change in Berlin’s policy on the eurozone. In his first encounter with the foreign press since being elected SPD leader last month, Mr Schulz projected a message of continuity, suggesting there would be no big shift in Germany’s insistence on debt reduction and structural reform if he replaces Angela Merkel as chancellor. He said Germany had a “great interest” in ensuring all EU member states achieved stable growth, “but to get there, certain reforms are needed in these countries”.

This means that for the Eurozone as a whole, the deflationary bias – all crises lead to cuts in wages and spending, which lower the rate of inflation – will continue. This will have an effect on the distribution of income and on employment as well as the financial crisis, since lower nominal incomes and more unemployment mean that it will be harder to repay debt.

I expect the Schulz effect to fizzle out before September. German social-democrats are on the same trajectory as their European comrades. They become a splinter party, trying to be progressive with a neoliberal mind set. The Netherlands, France, Greece, and (probably) soon Spain, depending on which leadership the party choses, show that the progressive left will reorganize along new lines.

Posted by: Dirk | April 3, 2017

Structuralist Macroeconomics

I have recently ordered a copy of “Structuralist Macroeconomics – Applicable Models for the Third World” by Lance Taylor. However, I did not read very far into the book. Let me explain why. On p. 12, chapter 2 – titled “Adjustment Mechanisms – the Real Side” – starts with the sentence:

“MACROECONOMICS begins with the notion that the value of saving generated by all participants in the economy must by one means or another come into equality with the value of investment in the short run.”

While most economists will probably nod their heads, I don’t. Informed by a book chapter written by Basil Moore (download) and my own research, let me point out the fundamental problems with this statement. The first is trivial, the second not so.

First, macroeconomics – for most economists, I assume – does not begin with saving. It should start with employment. Why do we care about macroeconomics? Because we care about unemployment. If we would not care about unemployment, why then do we have central banks that decrease interest rates to spur investment in times of economic recession or depression? Why do governments engage in deficit spending? It is obvious that any social science must first define a problem that it wants to analyze and then, hopefully, fix.

The second fundamental problem is connected to the definition of saving. Moore’s chapter title, which goes back to Warren Mosler, connects saving to investment, with the latter causing the former. Moore writes: “Saving is always identical to investment, irrespective of the time unit or the time period over which they are measured, or how investment is defined” (p. 8). If Mosler via Moore is correct that saving is the accounting record of investment, than the fundamental methodology of structuralist macroeconomics must be wrong.

Moore writes that in the world economy, not distinguishing government or private sector, there are only two types of goods: consumption goods and investment goods. World GDP equals consumption + investment, or – in letters – Y = C + I. From the expenditure side, people of the world can decide to spend their money on consumption goods or … not. So, in other words, world GDP equals consumption plus what is not consumed. If we define what is not consumed as savings, then we get Y = C + S.

Subtracting one equation from the other gives us either 0 = I – S or 0 = S – I. Both can be transformed into S = I. So, there we are! This savings to investment relationship is one of an identity, hence a definition: what we do not consume we call investment from the “real” perspective of use of goods and services and “savings” from the financial perspective. Moore says that “in reality there is no underlying ‘real’ economy that somehow lies below and exists independently of the nominal economy” (p. 20). So, investment equals savings all of the time everywhere, and only problems of accounting give us problems with the data that sometimes seem to show that savings do not match investment.

In summer 2014, I taught a course at Free University Berlin and told my students that ultimately savings depend on investment – except for the case where not spending creates an increase in inventory, which is marked as investment – and it was a popular sport over the term to come up with examples that would imply that savings rise without a corresponding rise in investment or vice versa. We did not find a single valid example.

I know from many conversations I had with students that the investment-savings inequality is very difficult to grasp and had my own problems in the context of planned investment / planned saving, but by now I am very certain. Students of macroeconomics have to understand this identity from the very beginning to save them the trouble of falling for the loanable funds fallacy and other concepts based on misperceptions about he working of a modern monetary system. I’m sure that “Structuralist Macroeconomics” has a lot of knowledge that can be used to improve things, but the way that the models are drawn up will make it difficult to extract the good stuff (on institutions and distributions, as I see it). Perhaps the good stuff can be explained using balance sheets and aggregation at the sectoral level? That might be a worthwhile initiative.

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