Posted by: Dirk | January 23, 2018

The Euro – Evolution and Prospects (2001/2018)

Having just taken a quick look at the CEPR publication “Reconciling risk sharing with market discipline: A constructive approach to euro area reform” (link), I am reminded that many economists still do not grasp the functioning of the fiscal and financial system. The paper is full of theoretical flaws and the policy advice hence is mistaken. Instead of letting markets have more power and government less, I think that we should do one of two things:

  1. Give sovereignty back to national governments by allowing them to finance their spending in a way that bankruptcy is not an option.
  2. Create a European fiscal institution – or Treasury – which sells bonds that are risk-free and that deals with unemploymnt in the Eurozone, filling in the role of deficit spender.

I have just read the 2001 book “The Euro – Evolution and Prospects” by Philip Arestis, Andrew Brown and Malcolm Sawyer. The authors write on page 121:

The euro has, of course, ushered in a single monetary policy. At the same time it has constrained national fiscal policy (via the Stability and Growth Pact) and it has made exchange rate revaluation impossible for the individual EMU countries. It is widely recognised that this arrangement requires a high degree of convergence of the patently very diverse economies of the Eurozone. Without such convergence, it will enforce inappropriate economic policies on its member states, constrain automatic and discretionary fiscal stabilisation, and negate room for manoeuvre in the face of economic asymmetries. In addition, a heavy burden of co-ordination is placed upon the European Central Bank (ECB) and the Eurosystem, through the need to pursue a coherent monetary policy, and to be perceived as so doing. The question of the performance of the Eurosystem and the ECB will first be addressed below, then the issue of convergence will be taken up.

This seems to me a prescient analysis, which of course does not square at all with the proposals that the authors of that CEPR paper make. It is time to give more freedom to the fiscal parts of the Eurozone institutions, not less. If you are not thinking in that direction, I believe that nothing good can come out of it.

Europe is not about risk-sharing with market discipline. It is about ensuring the economic and social well-being of its citizens. We tried risk-sharing with market discipline, and we failed. Governments should not be punished by financial markets, but by voters. Time to move on. The authors of that book write on their last page:

[P]olicy must be enabled to play its vital role in overcoming aggregate demand asymmetries and uneven processes of cumulative causation through coordination of fiscal and omnetary policy, within a transformed institutional setting.

That’s what we need to do.

Posted by: Dirk | January 22, 2018

Lecture tonight at Hamburg University

Tonight at 6PM I will give a lecture with the title Modern Money Theory and European Macroeconomics – an Alternative to the Policy of Austerity?. It takes place at room S27 at Von-Melle-Park 9, Hamburg University. The lecture is part of a series organized by AK Plurale Ökonomik Hamburg and will be held in English. More information is available here.

Posted by: Dirk | November 14, 2017

Why Latin American Nations fail – new book

I have seen that Matías Vernengo and Esteban Pérez Caldentey have edited a new book on Latin American development, or rather, it’s failure to develop properly. The book is available here, where the introduction can be read for free. The book is especially interesting because it is a reply to the New Institutionalist approach, which is severely flawed according to the authors. In a teaser article at the WEA, they write:

Given their importance, we believe institutions deserve a broad, critical and multidisciplinary approach beyond the property rights approach, which could then provide a basis for alternative policy recommendations. This is what we try to show in the book and in its different sections and chapters. The book is divided into two sections. The first highlights several key problems associated with New Institutionalist arguments and, in particular, with the way it is applied to view and understand Latin American development.

The New Institutionalist approach provides a limited view of comparative historical analysis failing to read and understand history on its own terms. An illustrative example is Acemoglu and Robinson´s characterization of the Spanish and English colonizations as being extractive and inclusive respectively when in fact the historical record shows that both types of colonizations were at times extractive and inclusive. The more recent historical experience of Japan in the post-WWII era, South Korea and some other Asian nations such as Singapore shows that economic success was not based on inclusive institutions.

Also, the New Institutionalist view overplays the role of the market and downplays the role of the state in the process of economic development. Several institutions of the developmental state that promoted industrialization, including the bureaucracies that managed macroeconomic and commercial and industrial policies, development banks, publicly funded or directly public universities and research institutes were central in many experiences of development, and were also part of the Latin American experience until the debt crisis of the early 1980s. The reversal of many of these policies after the crisis, and the predominance of the Washington Consensus, have not led to vigorous growth as New Institutionalist views would have indicated.

The discussion of Acemoglu and Robinson – authors of “Why Nations fail” – should be very interesting.

Posted by: Dirk | October 17, 2017

MMT, Tajikistan and foreign bond investors

One criticism of Modern Monetary Theory (MMT) that I hear very often is that it applies only to the US or the countries with hard currencies that can issue bonds on international bond markets. Apart from the fact that selling bonds to foreigners is not a plus – unless you need foreign exchange – there is a market for lower-income emerging economies indeed, as the NYT reports:

This year, lower-income emerging economies are expected to issue close to $10 billion in government bonds, according to the I.M.F., more than the past two years combined.

Of all of them, a recent $500 million bond offering by Tajikistan, a landlocked former Soviet republic that has rarely interacted with global investors, was the most curious. Tajikistan is paying investors an interest rate of just over 7 percent for 10 years, and the deal was a quick and easy sell for the country’s bankers, with demand several times the amount of money secured.

This is not investment advice, but the point rather is: even small emerging economies can sell bonds to foreign investors. There is nothing magical about the US and other “hard currency” countries in terms of government bond issuance. The countries are special since forex markets trade their currencies widely, so that exchange rates are less jumpy. That, however, is a different point!

Posted by: Dirk | August 30, 2017

Keynes on Savings and Investment

Geoff Tily in his paper on Keynes (pdf) has this quote (from the Collected Writings):

S = I at all rates of investment. Y either definable as C+S or as C+I. S and I were opposite facets of the same phenomenon they did not need a rate of interest to bring them into equilibrium for they were at all times and in all conditions in equilibrium. (CW XXVII, pp 388–9)

This is very enlightening. The “General Theory” also contained the issue of savings and investment, but the quote above nails it. There is no “supply” and “demand” for capital, hence savings and investment do not need anything to move so that there can be equilibrium.

From my point of view, this is one of the strongest rejections of neoclassical macroeconomics and it stands until this day. In a monetary economy, there is no “savings good” that needs to be produced before it can be “invested”. I = S “at all times” – there cannot be a disequilibrium between saving and investment.

What is correct on the national level must hence be correct on the international level. We cannot have global excess savings, since they are always equal to investment. Mario Draghi, when he said last year … (my highlighting)

It is this phenomenon – the global excess of savings over profitable investments – that is driving interest rates down to very low levels. And so the right way to address the challenges raised by low rates is not to try and suppress the symptoms, but to address the underlying cause.

… is wrong about the inequality of savings and investment on a global level. However, he is right in seeing low interest rates as a symptom and not the cause. Lack of aggregate demand is what has led to low rates of inflation, and hence low interest rates in order to stimulate demand.

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!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.

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