Posted by: Dirk | December 10, 2014

Wicksell – a Keynesian?

Rereading good books is always a pleasure, and one often discovers passages that shine in a new light given that the book has not changed but one’s mind has. Knut Wicksell’s Interest and Prices contains a section towards the end which is very interesting:

wicksell98Is it just me or is Wicksell saying that if banks do not provide enough bank deposits (by lending), then the state should take over this task? If that is so, doesn’t a state bank with the goal of creating deposits to aim at stability of prices resemble fiscal policy, which is a traditional Keynesian recipe?

This state bank would actually resemble a Treasury more than a modern central bank, if one remembers that Wicksell wrote his book in 1898 (and in German). A modern central bank cannot directly create deposits. They can indirectly create deposits through buying assets from the non-bank privat sector, but that it s shotgun policy because it is very difficult to target. When a central banks buy government securities, how do they know who is owning them? Banks or non-banks, it is impossible to forecast who is selling when the central bank is buying.

The modern Treasury could provide what Wicksell calls ‘a worthy activity for the State.’ It can create sovereign bonds, which it then deposits at the central bank in exchange for reserves, which are deposits at the central bank. It can then spend those reserves into the economy, thus creating additional deposits for the households and firms. This is the difference between the fiscal authority – the Treasury – and the monetary authority: the former can spend money and create deposits, the latter can lend money (reserves) to banks but it cannot create deposits. To create deposits, banks are necessary. Wicksell describes a pure credit system which is very close to the world we live in today:


Returning to the topic from above, if these banks fail to create an adequate amount of deposits (to sustain the price level), then Wicksell argues that the State should take over that ‘worthy activity’. If one understands Wicksell in this way, then Wicksell has provided even stronger foundations for later Keynesian economics and the economics of Keynes than is generally attributed.

These dead, old economists – there is still so much life in them!


  1. by stable prices, does Wicksell mean zero inflation?

    • More or less, yes. Wicksell wrote in a period where deflation was the problem more than inflation, so I guess a zero inflation rate would have been just fine for him. Wicksell wrote about a natural rate of interest that would lead to a stable price level. His book can be downloaded for free, I do recommend reading it. It describes many things, among them the creation of loans and deposits by banks and also the logic behind inflation targeting.

      • New Keynesians today refer to the ‘Wicksellian natural rate’ as an interest rate at which you have stable inflation, rather than zero inflation. But stable inflation implies rising prices, which is quite different to a stable price level. Any idea why they do this?

      • I don’t think there is a definitive answer to this question. Why does the ECB target 2% inflation and not 0% or 4%? Financially, a bit of inflation is good for the debtors, but then the central bank controls the nominal interest rate structure anyway. You want 2% inflation with a nominal 4% interest rate, or a 4% inflation rate with a nominal 6% interest rate? Since the real interest rates should be the same (ex-post), it doesn’t make much difference. Also, externally the nominal exchange rate can adjust, if the price level moves up/down too far. Probably it is a good idea to keep prices stable in order to minimize transaction costs (including costs through herding behavior and speculation).

  2. “A modern central bank cannot directly create deposits”

    Surely it would be possible for a central bank to buy assets (such as government bonds) directly from the non-bank public, without buying from primary dealers. Say it bought a govt bond from you, it would simply make a payment to your bank account. It would credit your bank’s reserve account and your bank would credit your deposit account.

    Similarly, the central bank could lend money directly to non-banks.

    • Please read my next sentence where I describe what you describe. Also, the central bank cannot directly lend to non-banks because non-banks do not have accounts at the ECB. The ECB credits these accounts to increase the amount of reserves when they buy financial assets from the market. The ECB is not allowed to open accounts for firms or households, as Article 17 states quite clearly: “Accounts with the ECB and the national central banks
      In order to conduct their operations, the ECB and the national central banks may open accounts for credit institutions, public entities and other market participants and accept assets, including book entry securities, as collateral.”
      As it stands, the ECB cannot lend money directly to non-banks.

      • you wrote: “When a central banks buy government securities, how do they know how is owning them? Banks or non-banks, it is impossible to forecast who is selling when the central bank is buying”

        I don’t see why that should necessarily be the case. Say, as a hypothetical example, the central bank contacts you directly and offers to buy your government bonds. It then makes a payment to your bank account. This is done like any other payment to a bank account. The central bank instructs your bank to credit your account and simultaneously makes a payment to your bank’s reserve account (i.e. credits your bank’s reserve account).

        “the central bank cannot directly lend to non-banks because non-banks do not have accounts at the ECB”

        The Fed does buy government bonds from, and lend directly to, non-bank primary dealers who do not have reserve accounts at the central bank.

        When the Fed lends to non-bank primary dealers, it credits their bank’s reserve account and their bank credits their deposit account. In turn the primary dealers deposit collateral into the Fed’s account at the bank.

        So technically the central bank could lend money to anyone in this way.

        Similarly I could lend money directly to you even though I am not a bank and you don’t hold a deposit account with me. I could do this by simply making a payment to your bank account – i.e. I instruct my bank to pay your bank, your bank then credits your account and the banks then settle the transaction between themselves with reserves.

      • I can’t see how the central bank can contact individuals to make deals over the counter. How can you make sure that they don’t buy my grandfathers coin collection at $1 million?Central banks deal on markets, not outside them. Buying assets from individuals is nothing that a central bank will be happy to do. Theoretically they could do it, but practically they really, really don’t want to go there. It looks dodgy and will excite the gold bug crowd.

        About the primary market dealers without a reserve account: technically, the bank can give us all bank accounts with a trillion dollars on it. There is no technical problem in creating large numbers in spreadsheets, so from the technical perspective I agree with you. If the Fed would want, it could given whatever money it wants to anyone! But this means that you disregard all laws and procedures, which would upset anyone working on law. So, practically, the Fed cannot lend money to anyone in this way. Becoming a primary market dealer is not easy neither: “Specifically, in evaluating participation in the New York Fed repo operations, the New York Fed will expect a primary dealer to bid in every operation commensurate with its size, and its bid rates should be reasonable when compared to the range of rates in the market, taking into account market volatility and other risk factors. In other open market operations, the New York Fed will expect a primary dealer to bid, or otherwise participate, in operations at levels commensurate with its size and presence in the market.”

        That you can lend me money – thanks, but I am ok – is not the issue. Banks can lend reserves to each other, too. Anybody at the same level can lend to each other: banks to banks, private sector to private sector, Pay Pal account owner to Pay Pal account owner. The issue is whether the central bank can lend to you. And this, under current rules and operations, they cannot do. Not because it is technically impossible, but because the rules do not allow it.

        However, there is an institutions that belongs to the state that can create unlimited amounts of deposits (outside the eurozone, though) and that is government. These, then, are fiscal operations and require a government to have a majority in parliament to get through the budget. Even though de jure it is sometimes not so clear, the government can de facto spend all the money it wants.

  3. Solution to your problem is state owning a bank and allowing state bonds to be used as reserves. Something like Postal banks, of KfW in Germany or Fannie Mae, Fredie Mac initialy were state owned untill 1980s when they were privatized. They could issue their own bonds and sell to public and other banks in order to get more cash for requierd reserves.
    Once those banks have reserves they can issue loans in unlimited ammounts in order to finace investemtns and refinance bad loans (bad for users) under any level of interest rates. This is what can be done when banks become zombies and are afraid to issue more loans or due to already ongoing deflation which in itself makes any new loan too risky to issue, except to corps that enjoy monopoly power.

  4. Going back even further in history, they had a credit crunch in Ancient Rome and solved it by opening the state coffers and distributing money to everyone. Has economics advanced one iota since that time?

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