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Philip

It seems you are presenting a false dichotomy. To reference Nick's illustration via Supply x Demand curves, I read your point to be that only shifts in the demand curve function impact broad money. Isn't this obviously unrealistic?

Nick's position seems to be that demand pull and supply push can both impact expansion of base money into broad money; and this seems hardly debatable.

In an earlier post, Mark A. Sadowski addressed the false choice between two worlds of endogenous and exogenous money theories. If endogenous money is, as you've characterized, solely a function of the demand curve, then the opposite, exogenous money, would be solely a function of the supply curve. But who is arguing on behalf of the latter?

If shifts of supply and demand curve functions both impact broad money, then their relative elasticities inform the multiplier of base money in doing so.

"if the central bank increases the supply of reserves, this should (all else equal) lower the interbank rate"

that's correct, and it applies to nudging the trading rate back to a prevailing target rate, other things equal

"which should then lead to further lending and thus more deposits (simply because the funding rate is lower"

that is not correct in the case of risk (i.e. capital based) lending - i.e. core loan operations

it is correct in the case of risk free or near risk free lending associated with the reserve management function - the interest rate arbitrage effect happens very quickly through activity in near risk free instruments - otherwise know as money market operations in the reserve management context

"the central bank can simply change the corridor by changing its floor (IOR) and ceiling (LLR) rates"

that's correct and it applies to a change in the target rate, other things equal

the multiplier is an entirely separate analysis and the post Keynesian story is the correct one there

JKH - I agree with all of that. I was trying to be diplomatic and lead the horse to the water. With respect to that not being the case with capital-based lending - you are also correct. But bringing in capital-based analysis is an added layer of complexity I assumed wasn't being discussed. I was also trying to figure out a plausible reason why Nick was insisting bank lending would expand.

Nick

The article contained the following logic - which I interpreted you as endorsing: "The sellers of the assets will be left holding the newly created deposits in place of government bonds. They will be likely to be holding more money than they would like, relative to other assets that they wish to hold. They will therefore want to
rebalance their portfolios"

If a seller didn't want dollars, why would they sell? It seems the act of selling was the portfolio re-balancing. Is it that perhaps there are 2 types of sellers, where seller (1) prefers to ultimately rebalance to higher yielding assets while seller (2) prefers rebalancing to dollars?

Assuming there are 2 sellers, then I may conclude that the expansionary impact of the OMO known as QE would be limited by ratio of seller (1) to seller (2).

JKH,

I think a follow-up comment of mine may be in the spam filter...

"that's correct, and it applies to nudging the trading rate back to a prevailing target rate, other things equal"

I disagree that it's necessarily for nudging back to a target rate, all else equal. It can apply to changing the target rate, all things equal. Under full information, I reject the assertion that the interbank rate necessarily changes just based on what the central bank says due to some type of arbitrage. I've seen you say this before. Something actually has to change - either the quantity of reserves, the corridor rates, reserve requirement, etc. Don't need to debate this here though - can do it elsewhere.

JKH / ATR

Please describe, briefly, capital-based lending ... We talking basic collateralized commercial lending to support working capital? If so, why does the reduction of rates not lead to more of this type of lending? I would think the reach for yield would lead to *more* lending in this market. Isn't the capital-based lending spigot the first to be shut of when money tightens?

ATR,

I'm glad we agree on most of it - thought we would.

On the nudging - didn't we debate this at that Fullwiler post (I think it was you - unless there are two of you)? Anyway, probably a question of fairly small degree, and yes - lets leave it.

On the capital - the nuance there is that the nudging in the context of an existing target rate leads to very rapid fire money market transactions that require very little if any capital allocation and therefore are very suited to pure interest rate adjustment activity - this is invisible to the rest of the bank including core risk lending operations that require capital allocation in a more strategic mode. It's the change in the target rate setting (e.g. vertical corridor shifts) that changes the fundamental setting for risk based lending based on the general level of interest rates.

And yes Nick - those rapid fire money market transactions DO constitute a hot potato market - but a very special hot potato market in the context of central bank interest rate management

And yes Nick - I know you hate the term 'money market', but its hallowed institutional terminology coined specifically of course to piss off monetarist economists

:)

Philip:

On the issue of reverse causality, Steve Keen and other post-Keynesians are fond of this quote by former VP of the NY Fed, Alan Holmes (made during the era of the ascendancy of monetarism):

"The idea of a regular injection of reserves-in some approaches at least-also suffers from a naive assumption that the banking system only expands loans after the System (or market factors) have put reserves in the banking system. In the real world, banks extend credit, creating deposits in the process, and look for the reserves later."

It's too bad that Keen et al. never mention that the very next sentence following that quote is:

"The question then becomes one of whether and how the Federal Reserve will accommodate the demand for reserves. In the very short run, the Federal Reserve has little or no choice about accommodating that demand; over time, its influence can obviously be felt."

The point Nick is trying to clarify is exactly the same as the one Holmes is highlighting at the end of the statement about the short- and long-run of monetary policy.

Nick: Please answer yes or no if you agree with Holmes's statement...;)

ATR,

Just noticed your:

"Something actually has to change - either the quantity of reserves, the corridor rates, reserve requirement, etc."

Absolutely - the corridor rates or the announced target rate has to change at least

On the reserve quantity issue, the perfectly vertical demand curve is theoretically pure IMO, and it is difficult to separate out the reserve change due to the existing target-effective rate differential and the reserve change due to the target rate change, but I'm prepared to give a bit on the empirical likelihood that there's some reserve easing at the same time - I think that might have been Fullwiler's view - but let's leave it (as long as I get the last word in here - lol)

circuit:

"The question then becomes one of whether and how the Federal Reserve will accommodate the demand for reserves. In the very short run, the Federal Reserve has little or no choice about accommodating that demand; over time, its influence can obviously be felt."

critical distinction:

the multiplier debate has to do with the order of provision of reserves that are required to support deposits according to some required reserve ratio - the accommodation explanation there is the post Keynesian one - deposits before reserves

the accommodation argument in that follow up sentence has to do with the provision of the level of excess reserves, which is an issue of controlling the effective rate relative to the target rate, and which occurs in real time

two different accommodation streams, which can be seen in the flow of funds data

"But the more monetarist side should acknowledge that the quantity of reserves does not have to increase to lower the interbank rate. The central bank can simply change the corridor by changing its floor (IOR) and ceiling (LLR) rates. It can also change the reserve requirement (although this method isn't so much used in practice)."

I'm not sure that this has ever been disputed by any monetarist ever. Milton Friedman was the earliest person (whom I've read) to discuss IOR, as part of his plans for changing the US financial system.

W. Peden,

As I interpreted him, Nick Rowe (not Milton Friedman) was insisting over at Monetary Realism that while the central bank may be supplying reserves to accommodate the demand of banks in the short-run 8-week period, they must restrict the quantity of reserves they supply to maintain their inflation target in the long-run (assuming it initially left target). This is not necessarily true. If the central bank is controlling inflation through their interest rate policy, they can change interest rates to achieve their inflation target without changing the quantity of reserves. They *could* change quantity of reserves, but they don't have to.

So the point is that if you think inflation can be controlled by changing interest rates, this need not involve changing the quantity of reserves. The central bank can change interest rates by doing other things.

BTW, I'm not the one who brought up changing interest rates to control inflation. Nick did:

"No! Have these guys never heard of inflation targeting? The BoE does not sit idly by, happily “supplying” whatever is demanded at a fixed rate of interest. If banks decide to lend more, and this increases spending and pushes inflation up above target, *************the BoE will raise that rate of interest, precisely because the BoE cannot keep inflation on target if it simply lets reserves be “supplied on demand” at a fixed rate of interest.*************

They have an ant’s eye-view of the economy. They really need to step back and see the big picture. Any increased demand for reserves that is a result of actions that would lead to inflation rising above target will be met with a refusal to supply *any* additional reserves. The BoE will raise the rate of interest to make the supply curve of reserves perfectly inelastic in that case."

ATR,

I don't think that this is very interesting, nor does it have anything to do with monetarism.

JKH,

It's pretty clear what Holmes is saying here. Regardless of how difficult it is for the Fed (say, under the pre-2008 regime) to control the money stock in the short term (Nick's 6 to 8 weeks), the central bank can nevertheless control the growth of the money stock within a narrow band over a 6 to 12 months period. In my opinion, if the Fed can do that, then the deed is done. Studies have show that it can. That's how monetary policy works. Holmes was right. And if I understand Nick correctly, he is also right on this issue. BTW, I enjoyed =your recent post.

W. Peden,

I couldn't care less if you think it's "interesting." I wasn't attempting to get in a debate about monetarism, but I did use the word 'monetarist' because it seems many of those in disagreement here align with monetarist beliefs. What I was doing was correcting an error I think that Nick made near the beginning of the debate.

OK, Nick, this is just too interesting to me! Sumner responded to the same question (I provide a link to the version I asked him above), and here's his one line response:

http://www.themoneyillusion.com/?p=26355&cpage=2#comment-323611

Do you agree?

Nick, this is just too interesting to me! Sumner responded to the same question I asked you (a link to what I asked Sumner is above), and here's his one line response:
http://www.themoneyillusion.com/?p=26355&cpage=2#comment-323611
Do you agree?? I don't know how to reconcile his response with the one you've given me, so if you do agree, how do I reconcile them?
Thanks for your patience! (and don't worry about fishing my other post out of spam, it's a repeat of this one)

Nick, two of mine in spam: they're copies of each other (the 2nd one slightly better): it must be the link I included... At first I thought it was because I had a URL in my information for the 1st one that it went to spam. No need to resurrect them both (or to keep a copy of this comment for that matter). Thanks! (Please take a look, it's very short! ... and I think it relates to your post here. Thanks!)

I'm on your spam list again: three short ones in there: only #2 is worth rescuing. Thanks!!!

ATR,

I don't think it's an interesting mistake, if it was made, because doesn't relate to the underlying issues. There's nothing in monetarism that denies the possibility of changing reserve requirements or introducing IOR.

Hi Nick,
You noted:
"But what matters is their acknowledgement that the demand for base money (central bank money) is a consequence of the amount of broad money commercial banks have created. May I make a small simplifying assumption? May I assume that the demand for base money is proportional to the stock of broad money, other (real) things equal? Because that's the only way we can assume that commercial banks maximise profits and so only care about real things and don't suffer from money illusion. Thanks! [ ...] But hang on! You have just agreed (sort of) that the demand for base money is some proportion r of the stock of broad money. So in equilibrium, when the actual stock of base money is equal to the quantity of base money demanded, the stock of broad money must be a multiple 1/r of the stock of base money. And if the central bank shifts the supply function of base money $1 to the right, that must increase the equilibrium stock of broad money by $(1/r). Just like the first-year textbook says it will!"
The bank of england says that the causality goes from M to R not from R to M. While they will be proportional (because of reserve req and settlement needs) the proportionality does not say anything about causality. The last sentence of your quote is getting to the point of contention. Can the central bank control the monetary base? In practice it can't, all supply is defensive once there is a targeted interest rate and a given interest rate target to coincide with any quantity of reserves (all demand driven, i.e. the central bank supplies at will).
The BoE says the money multiplier is wrong because in terms of theory not an identity, i.e, BoE makes specific assumptions about the behavior of M and R given r and assumes that M causes R. The money multiplier story starts with the central bank injecting excess reserves in the system (this is not possible in practice because the interest rate would fall below target), and then banks uses those excess reserves until there exhausted (wrong too because bank don't wait for reserves to provide advances of funds; they create IOUs that promise CB currency on demand and then turn to the central bank as needed; CB provides as much as needed and does not try to control any quantity target).
On a final note, QE is about targeting (in a loose way) long-term rates instead of just short-term rate. It is all about interest rate not quantity of reserves.

circuit,

thanks

then I'll dissociate my comment entirely from Holmes and not question that

but on a stand-alone basis, the statement is factual for the pre-2008 Fed - assuming the Fed is aiming for a target Fed funds rate in the short term

its how it works at the operational level - two accommodation streams

circuit: given most central banks' current operating procedures (very short term targets), I would basically agree with Holmes there. But those operating procedures are not written in stone, so he is not strictly correct when he says the Fed has "no choice" in the very short run. The Fed chose those operating procedures. It could have chosen something else. Nobody forces the central bank to buy (Robert Mugabe etc. aside).

ATR: if a central bank (or a commercial bank) pays interest on its money, then a change in that rate of interest will shift the demand curve. Just like a subsidy paid to buyers of apples will shift the demand curve for apples.

(I checked the spam filter, but nothing there. Either Stephen has already fished it out, or it's on the previous page of comments.)

And I am quite happy to go beyond supply and demand theories of the determination of the stock of money. I have done so in previous posts. Because there is something very peculiar about the demand for a medium of exchange. Money is not like refrigerators and other consumer durables. People will voluntarily buy more money even if they have no plans to hold more money. For example, someone will borrow money because he plans to spend it, not because he plans to hold it. A seller of money can create an excess supply of money in a way that a seller of regrigerators cannot create an excess supply of refrigerators. But I don't think Michael Woodford would be a good source to help examine this fundamentally disequilibrium question. Funnily enough, I'm actually closer to Steve Keen on this than I am to equilibrium theorists. But that would take me beyond the scope of this post.

Philip: if you are indeed comfortable with supply and demand curves, why the problem with BOTH supply AND demand curves determining quantity, and thinking this amounts to "evasion", and objecting to my "forays" into demand and supply?

Everyone: BTW, whenever I said "8 weeks" I really meant "6.5 weeks". My arithmetic was wrong. One year divided by 8 = 6.5 weeks between Fixed Announcement Dates, roughly.

Eric Tymoigne is correct

In order to achieve clarity on the multiplier issue, you must unpack excess reserves from required reserves through the same time line and then look at two different causality flows that apply to each component of that unpacking over that same time line

There are two accommodation streams

1) The CB supplies excess reserves as necessary in order to target the effective rate to the policy target rate (assuming pre-2008 Fed for example)

2) It supplies increments to required reserves - with a lag - to respond to the deposit growth that gives rise to the incremental reserve requirement - and it does this automatically in order to ensure that the operations that apply to the first type of accommodation aren't mucked up by a sudden dearth of required reserves due to a jump in that requirement

Eric: "The bank of england says that the causality goes from M to R not from R to M."

But as I said in my post, the Bank of England should have its knuckles rapped for muddling "supply" and "quantity supplied". And so should you, when you say: "In practice it can't, all supply is defensive once there is a targeted interest rate and a given interest rate target to coincide with any quantity of reserves (all demand driven, i.e. the central bank supplies at will)."

That interest rate target will not be exogenous with respect to all changes in M. Because the BoE targets (supposedly) a fixed inflation rate, not a fixed interest rate. And even if it did target a fixed interest rate, that is precisely its supply function of reserves. Even if the supply curve of apples is perfectly elastic, the position of that supply curve co-determines, along with the demand curve, the quantity of apples bought-and-sold.

Dustin,

Talking there about basic capital requirements for banking and bank risk taking of all types

(Basle is one of the regulatory frameworks)

Lower rates may result in increased lending in the core credit risk book, but its got nothing to do with reserves

Its about the effect of lower rates on demand and decisions on how banks allocate their available capital in responding to that demand

Nick: "If a central bank never has a balance sheet (except for the building it occupies), for any value of anything, and so never does anything, and is expected never to do anything, how can it target anything?"

By setting the interest rate it would pay on base money ("would" since base money doesn't exist, but could).

But as I think about that answer, I see a flaw in my logic. In order to completely eliminate the demand for base money, there must be a cost to holding it (higher than privately produced money). That contradicts my answer, which assumes no extra cost.

Conclusion: although a central bank could make its balance sheet arbitrarily small, there would still be a money multiplier. Still, I stand by my assertion that a central bank doesn't *need* a money multiplier, even though one will always exist.

Ok the quantity supplied is demand-driven (shift in demand curve leads to change in equilibrium quantity to go for the textbook version). While the central bank may shift the horizontal supply curve upward (raise the interest rate target) that target: 1- does not correspond to any specific quantity of reserves (a high rate can be achieved with large among of reserve and a low target can be achieved with a very little quantity of reserve; again quantity demanded will determine what the quantity supplied is; central bank as no say here as long as it targets rates) 2- is not changed with the quantity of M but with other considerations such as inflation.
Point 2 brings us to another point of contention: is the quantity theory of money valid? Does M causes P? If one follows the endogenous money approach definitely the answer is NO. P (or gP) is not explained by M (or gM). And P may cause M

Max: "Still, I stand by my assertion that a central bank doesn't *need* a money multiplier, even though one will always exist."

That sounds roughly right to me. (Though I'm not precisely sure what exactly it means!)

Eric @05:59: making allowance for your typos ;-), I think we are maybe now on the same page.

The traditional QTM says that a change in M causes an equi-proportionate change in P. And if the central bank is not targeting M, but something else, the traditional QTM is not so much "invalid" as beside the point, or talking about a purely hypothetical world. But we can easily re-define the traditional QTM to make it applicable.

For example, if the central bank targets the price level, then we simply reverse the causality. "A doubling of the price level target will double the stock of money".

And we can redefine it again for an exchange rate target. "A doubling of the target price of forex will double both P and M." And so on.

But we must always bear in mind that the central bank's ability to target (e.g.) the price level ultimately depends on the fact that it controls its own balance sheet, and that its liabilities are the medium of account, and it can buy or sell its money at will to implement that target (or some other target). The Bank of Canada can target the price level (if it wants); the Bank of Montreal cannot target the price level, even if it wanted to, because it has a fixed exchange rate with the Bank of Canada.

Philip: you asked what I teach?

In second year macro, I teach that the LM curve is (roughly) vertical, and the AD curve is (roughly) horizontal, because that is what an inflation targeting Bank of Canada will choose.

First year is a bit tougher. I give them a verbal story of both base target and interest rate target, so they can make sense of the overnight rate target announcements every 6.5 weeks, tell them these are different ways of thinking about the supply curve, then M target diagram, then talk about an inflation target.

Nick, either your spam filter hates me you put me on your block list. :D I left a series in their, only one of which is worth saving (the 2nd one). Trying a different IP address.

How embarrassing: I just now noticed the "Next" button :(

Tom: I just checked the spam filter, and there's nothing there. And I didn't block you.

Check back on the previous pages of comments. I saw your comments there.

Nick, sorry, I'm a dufus... I'm so used to ending up in your spam filter, that I didn't even notice the "Next" button at the bottom of the page. More than 50% of my posts are me wrongly complaining about being spammed. Here's the only one I really wanted you to look at:

March 15, 2014 at 04:51 PM

http://worthwhile.typepad.com/worthwhile_canadian_initi/2014/03/one-general-theory-of-money-creation-to-rule-them-all.html?cid=6a00d83451688169e201a511860e56970c#comment-6a00d83451688169e201a511860e56970c

feel free to erase the rest.

Nick: Yes, I'll go along with your qualifier. Indeed, the CB could choose to implement any number of operating procedures, as long as they are acceptable to the elected governing politicians. Thanks!

JKH: Apologies for my previous quick response. To be clear, I agree with everything you wrote, including the part about the CB's strategy to control the effective rate. I simply pointed to Holmes's statement as an attempt to show that Nick's point is consistent with the notion of reverse causality found in the endogenous money approach. Based on Nick's answer, I think the two views are similar after all. As for the multiplier story, I'm fine saying it's wrong. It's just that my view on this is informed by Basil Moore's book, which mainly critiques the multiplier story on the causality aspect. Today (post-2008), in my opinion, this issue is not as clear-cut seeing as the Fed has considerable control over change in deposits, even in the short-run, as a result of its asset purchases. That said, I'm fine saying the concept is irrelevant, though I agree with Mark's view that models aren't meant to be perfect descriptions of reality. Thanks!

Nick, I meant to write in my comment above:

"Yes, I'll go along with your qualifier. Indeed, the CB could choose to implement any number of operating procedures, as long as THE IMPACT OF THESE PROCEDURES ON THE ECONOMY are acceptable to the elected governing politicians."

Obvious, I know...

Nick-

I'm nearly certain that the Woodford work I’m referring to is not of the nature you’re already familiar with. Just give it a skim, please. You can skip to page 21, maybe even a bit after. The goal is to get through pages 33-38.

“if a central bank (or a commercial bank) pays interest on its money, then a change in that rate of interest will shift the demand curve. Just like a subsidy paid to buyers of apples will shift the demand curve for apples”

That is correct, but what does this refute? My argument is that even though you’re correct that the central bank’s inflation target guides their interest rate target setting in the long-run, you’re incorrect that the central bank necessarily has to change the quantity of reserves in order to make the future path of interest rates consistent with their inflation target.

We don’t have to bring interest on money into this. We can just consider changing the ceiling rate. Here’s a simple sequence. Say there are X reserves in the system, and the prevailing interbank rate is 3% - consistent with the central bank’s interest rate target. IOR = 0% and the ceiling rate = 6%. Then say lending picks up, to a degree that would raise inflation above target. Say the central bank thinks it needs to raise the interbank rate to 4% to bring inflation back down to target. You insisted before that the central bank must toggle with the quantity of reserves somehow to get inflation under control. I am telling you, via Woodford’s models, that that is not necessarily the case. The central bank can change its ceiling rate until the 4% rate falls out (up or down, depending on the shift of the demand schedule once lending picks up), without ever changing IOR from 0%. The new 4% interbank rate should then do the work to get inflation where the central bank wants it, and the central bank never had to change the quantity X reserves.

circuit,

thanks for the clarification

Nick, I also have a thread going with Sadowski on Sumner's site (under his version of your post here: i.e. on the BoE paper). We're discussing the money multiplier. He gives a version which looks like this: (1+c)/(r+c). I'm trying to work out a simple example there. If you have any thoughts, I'd LOVE to her them. Thanks!
http://www.themoneyillusion.com/?p=26355&cpage=2#comment-323668

ATR: OK, I will try to read it. But let me guess: if I give away free out-of-the-money put options with my apples, that will shift the demand curve for my apples?

Dustin: "If a seller didn't want dollars, why would they sell?"

Very good point, that finally takes us beyond supply and demand analysis. Short answer: because money is the medium of exchange. When I sell my house for $100,000, it does not (usually) mean I want to hold $100,000 sitting in my chequing account. I plan to buy something else. When a bank extends a loan, and creates a deposit, it does not (usually) mean that someone demands extra deposits; they demand whatever it is they plan to buy with that deposit.

Roughly speaking, it is not the demand curve for *money* that interacts with the supply curve to determine the stock of money; it is the supply curve of the thing that the bank is buying that interacts with the bank's supply curve of money. It is at this point that we see the total breakdown of the idea that the stock of money is "demand-determined". The demand curve that meets the bank's supply curve is not the demand curve for money. Banks could create extra money even if the demand curve for money is perfectly inelastic. Suppliers of money can "force" more money into existence than people want to hold, because money, unlike other assets, is the medium of exchange.

This is Yeager's point against Tobin. This is what creates the hot potato.

ATR: OK, you mean this bit in Woodford (page 35)?:

"To simplify, we shall treat the interbank market as a perfectly competitive
market, held at a certain point in time, that occurs after the central bank’s last open-market operation of the day, but before the banks are able to determine their end-of-day clearing balances with certainty. The existence of residual uncertainty at the time of trading in the interbank market is crucial;39 it means that even after banks trade in the interbank market, they will expect to be short of funds at the end of the day with a certain probability, and also to have excess balances with a certain probability.40 Trading in the interbank market then occurs to the point where the risks of these two types are just balanced for each bank."

No problem. Canadian terminology: currently the overnight rate target is 1.00%, the bank rate is 1.25%, and the deposit rate is 0.75%. The BoC normally keeps that same symmetric spread, precisely to keep those risks balanced. But in principle, if the risks of having a shortage or an excess after the interbank market closes are non-zero, that gives the BoC three independent instruments: the stock of reserves; the bank rate, and the deposit rate.

If the corner store stays open later than the supermarket, and there's a risk that I might need apples after the supermarket closes, my demand for apples depends on the price at the corner store. If the corner store raises its price, holding constant the price at the supermarket, I might buy more at the supermarket, to reduce the risk I will run out of apples late at night and need to buy more from the corner store.

In Quebec we call corner stores "depanneurs", which literally means "those who fix outages". The bank rate is the price at the depanneur.

I remember discussing this idea of the balancing of risks, before the Bank of Canada set up the current symmetric system paying interest on reserves, with my late colleague TK Rymes, back in the 1980's. IIRC it was David Longworth at the Bank of Canada who was doing the analysis about balancing of risks back in the days preceding the payment of interest on reserves, and that lead to the current symmetric system. (The Bank of Canada was a decade or two ahead of the Fed in all this.)

It's a fair point, and one I was ignoring. But I don't think it is what is really at issue in the argument with the soi-disant "endogenous money" people. The issue is that they need to look beyond the 6.5 week period. Just as history is not "just one damn fact after another", so monetary policy is not "just one damn interest rate after another". The Bank of Canada's (set of 3) interest rate target(s) is not exogenous with respect to everything that is affecting the demand for base money.

Tom: you really do need to distinguish between the *demand* for reserves going to zero and the *supply* of reserves going to zero. (And *both* supply and demand going to zero.) I read you one way, and Scott read you the other. It's supply AND demand.

Very cool, Nick. Thank you for reading. You may be right this departs from the issue at argument with the endogenous money people - even though I align very much with what the BoE said and what many of the endogenous money people say :). But I did just realize that I could use this same argument against 'the CB must supply reserves at will to maintain the target' people as well: the central bank could instead change their corridor rates or reserve requirements to maintain the target, without defensively supplying more or less reserves. They might argue they already know this, but then they should be more careful when they make their arguments.

But do you think it is at all relevant to the debate regarding the extent to which controlling the long-term quantity of base money is relevant to controlling inflation? If interest rates can be manipulated sufficiently to control inflation without altering the quantity of base money, that must have some implications for you?

"This means that an adjustment of the level of overnight rates by the central bank need
not require any change in the supply of clearing balances, as long as the location of the
lending and deposit rates relative to the target overnight rate do not change. Thus under a
channel system, changes in the level of overnight interest rates are brought about by simply
announcing a change in the target rate, which has the implication of changing the lending
and deposit rates at the central bank’s standing facilities; no quantity adjustments in the
target supply of clearing balances are required."

Nick,

"Tom: you really do need to distinguish between the *demand* for reserves going to zero and the *supply* of reserves going to zero. (And *both* supply and demand going to zero.) I read you one way, and Scott read you the other. It's supply AND demand.'

So no change in the steady state price level then?

"Suppliers of money can "force" more money into existence than people want to hold, because money, unlike other assets, is the medium of exchange."

Is it not important to distinguish here between income and loans? Everyone wants more income to the point that banks could give away money without getting anything in return (donating money). But only a fraction of the money a bank gives out is actual income and that is coming out from excess capital. Below that to create money a bank has to loan it out which depends on the demand for loans. So don't we have two different demand curves?

Nick, just to be crystal clear we're talking about my question here to Scott:

http://www.themoneyillusion.com/?p=26355&cpage=3#comment-323558

I don't want my rat's nest of comments to confuse...

Nick, BTW, when visualizing both supply and demand going to zero, I'm seeing a supply curve and a demand curve crossing and going to zero (moving downwards simultaneously). The problem I'm having is that "price" is normally on the x-axis right? But the price of MOA is fixed at unity, so isn't it a vertical curve? How can we tell if the supply curve ever "goes to zero?"

Tom: economists normally put price on the Y axis, and quantity demanded and supplied on the X axis. (Yes, I know we are weird about that, and it violates all standard conventions, but there are historical reasons why we do it the "wrong" way, and now we are stuck with it.)

The "price" of the MOA is 1/P, where P is the price of goods in terms of the MOA. The vertical axis has (say) 1/CPI. Do the two curves cross at one point, and do they "cross" at 1/P = infinity (P=0)? Scott is assuming you meant the supply curve is vertical at Qs=0, and the demand curve is a rectangular hyperbola, so P=0 is the only solution.

But this is off-topic, and I have other fish to fry.

Odie: "Is it not important to distinguish here between income and loans?"

The distinction between income and loans is obvious.

What is important is to distinguish between the demand for money and the demand for loans. Google "the demand for money".

ATR: I left a longer comment on your post.

Yep, the Bank of Canada has 3 rates of interest for the 6.5 week period. And when we get into arguments about the BoC setting *the* rate of interest, and whether the stock of money is demand-determined at *the* rate of interest, and the role of the central bank's supply function, we often ignore the two spreads between those 3 rates of interest. Because the BoC nearly always keeps those spreads constant at 25 basis points each side of the overnight rate target.

I see those two spreads as affecting the demand function for reserves. Shift either of those spreads (unless the risks of having positive or negative reserves are zero) and the central bank can shift the demand curve for reserves. But even if we held those two spreads constant, I think I would still be having the exact same argument with the "the supply of money is determined by demand" people.

Nick, thanks... you blew my mind a bit there... I'll have to think about that more, but back to my quasi-on-topic question above:

So no change in the steady state price level then? (re: my "epsilon" example)

BTW, I really appreciate your help on this.

Thank you for the lengthy response, Nick; it answers a lot but leaves me with much to consider.

Quick clarification - you said: "it is the supply curve of the thing that the bank is buying that interacts with the bank's supply curve of money"

Is that a typo, or are we really talking about 2 supply curves? I've never considered this type of thing.

Nick,

“But hang on! You have just agreed (sort of) that the demand for base money is some proportion r of the stock of broad money. So in equilibrium, when the actual stock of base money is equal to the quantity of base money demanded, the stock of broad money must be a multiple 1/r of the stock of base money. And if the central bank shifts the supply function of base money $1 to the right, that must increase the equilibrium stock of broad money by $(1/r). Just like the first-year textbook says it will!”

Almost all of that base money consists (“normally”) of currency held outside the banks. And the central bank is short the option to provide that currency. The public is long the option to purchase it at par, with bank deposits valued at par (and the commercial banks purchasing it with reserves at par, acting mostly as pass-through agents in this context).

In that sense, the stock of base money (almost all of it normally) is always equal to the quantity of base money demanded - because of that option.

So it seems to me the central bank in effect has no supply curve – other than the demand curve that it must replicate because it is short the option.

How does the central bank shift a supply curve for currency that it doesn’t determine?

I expect you will disagree with this in some way, but could you tell me why - and how would you conceive of the central bank's supply curve for currency (and therefore for most of the monetary base in normal circumstances)?

thanks

Dustin: that was not a typo. See my new post, for an example of what I mean. (In that new post, the central bank is buying non-monetary IOUs in exchange for money, which means that people are supplying non-monetary IOUs to the central bank, and their supply of non-monetary IOUs, in normal language, is their demand for loans. So it is the central bank's supply of money, plus the demand for loans, that determines the stock of money. If the bank were buying apples, it would be the supply of apples, plus the supply of money, that determine the stock of money.)

JKH: Here is a way of thinking about it that will be most compatible with your way of thinking about it (I think). (I don't agree with everything I will say here, and it's very crude, but that doesn't really matter for this particular point.)

Put the rate of interest on the vertical axis, and quantity of reserves on the horizontal axis. The central bank has a horizontal supply curve of reserves (it sets a rate of interest). There is a downward-sloping demand curve for reserves. The quantity of reserves is determined where the supply and demand curves cross.

Start in equilibrium. Then the bank decides to increase the price level. It shifts the reserve supply curve vertically down (cuts the target rate of interest), so the quantity of reserves expands, the price level starts to rise, then when the price level is where the central bank wants it to be, it shifts the supply curve back up again. Because the price level is now higher, the demand curve for reserves (which depends on the price level) will also have shifted up/right.

In my own way of thinking, the idea that the supply curve is horizontal doesn't really work, because if the central bank cares about the price level, which depends upon M, and if the quantity of reserves demanded depends upon M, the supply curve will need to slope up to keep the price level determinate. But that doesn't really matter for my point here.

Nick,

I asked about currency demanded by the public. Would you treat currency the same way as reserves?

Sorry JKH. I misread you there. But it would be the same. Add the quantity of currency demanded plus the quantity of reserves demanded to get the base money demanded. Then the central bank's supply curve is the supply curve for base money.

Nick,

Let me set aside the reserve piece for now - for separate consideration.

Suppose we strip out reserves from the total base.

So we have supply and demand for currency to deal with.

That downward sloping demand curve for currency makes intuitive sense (even) to me – liquidity preference and all that stuff (I think).

Suppose we interpret that horizontal curve simply as the current interest rate setting of the CB – and not as a supply curve.

Then I think that amounts to my option interpretation – where the quantity of currency both demanded and supplied is uniquely determined by the intersection of the interest rate and the demand curve, and where the supply curve could be interpreted as essentially lying on top of the demand curve – i.e. matching it because it is essentially a short option position in whatever ends up being the quantity of currency demanded along the demand curve.

Does that make any sense?

In the long run we are all dead.

Nick, you write:

"Roughly speaking, it is not the demand curve for *money* that interacts with the supply curve to determine the stock of money; it is the supply curve of the thing that the bank is buying that interacts with the bank's supply curve of money."

and

"...the central bank is buying non-monetary IOUs in exchange for money, which means that people are supplying non-monetary IOUs to the central bank, and their supply of non-monetary IOUs, in normal language, is their demand for loans."

As you know, I love the idea of a supply curve for loans (partly) determined by the borrowers. However, my problem with the above is when you bring up the "normal language" replacement for "supply [curve?] of non-monetary IOUs," namely "demand [curve?] for loans."

But in the next post when I asked you who determines the "demand [curve] for loans" you said "the borrowers."

But the borrowers are NOT demanding loans, they are demanding money! I think it's fair to describe them as either determining the "supply curve for loans" or the "demand curve for money" but NOT the "demand curve for loans."

What's wrong with that logic? It's the bank that should determine the "supply curve for money" or the "demand curve for loans."

If I'm right though (which I'm 99% sure that not), then we now have TWO demand curves for money: The one that moves to match supply, and the one that helps determine the "stock of money."

Where have I gone wrong?

Tom: if i want to borrow an extra $100,000 to buy a house, that is a demand for a loan. That does not mean I want to hold an extra $100,000 in cash or in my chequing account from now on. I want to spend it.

Google "The Demand for Money".

The last line should read:

"The one that eventually moves to match the stock of money supplied (so that stock of money supplied the stock of stock of money demanded) and the one that helps determine the stock of money supplied in the first place."

I Googled that yesterday, and read the wiki article. Is that the one you recommend? I understand your hot potato logic, I just don't get the "normal" language: the bank is the one demanding the loans, not the borrowers. All the borrowers have to trade for loans is more loans, so why would they demand them? Say firm X is trading A to firm Y in exchange for B, can't we say the following four statements apply:

1. X has a supply curve for A
2. X has a demand curve for B
3. Y has a supply curve for B
4. Y has a demand curve for A

X = borrowers
A = loans
Y = banks
B = money

No?

You're either saying 1. is equivalent to 4., (but 1. is determined by X and 4. by Y., so I don't think that's it)

Or you're adding a 5th line which doesn't fit the pattern above:

5. X has a demand curve for A

I realize B (money) is special, but it actually changes the symmetry of the statements above?

If X is demanding A, then what are they willing to trade (supply) for it? All they have is A.
The language says they want to trade A for A, but why not keep the A they already had?

... or think of it this way: replace "loans" with "bonds."

How can

"the bond issuer's supply curve for bonds"

be equivalent to

"the bond issuer's demand curve for bonds"

or

"the bank's (bond buyer's) demand curve for bonds"

I think I see what you're saying: there's not two demand curves. There's really just one curve we're talking about here, and it's a supply curve. It's just that the so-called "normal" language to describe it is totally screwed up. I'm going to use "bond" for "loan" and "bond issuer" for "borrower" to high-light the silliness of the normal language convention:

So the logical way to say it what you presented 1st:
"The bond issuer has a supply curve for bonds"

The "normal" way to say that makes no sense, but by convention it refers to the same curve above:
"The bond issuer has a demand curve for bonds"

Is that right?

"Here is my general theory: when the central bank buys something, with central bank money, the money supply expands, because whoever sold them that something now holds extra money. Done. It does not matter whether the central bank buys a bond, or a computer, or whatever. Hell, it could just give the money away to its favourite charity (helicopter money), and the result would be the same."

If the CB does an open market operations ("as buying with central bank money") it changes it's balance sheet and thus the amount of reserves. That changes the price of the reserves and the price of the assets purchased. The price (yield) change might stimulates the economy.

Now the helicopter drop is, as I see it, a different beast. It is also a kind of tax relief and thus should be accounted as a fiscal policy tool? The cash will again change the CB's balance sheet and add the reserves but at the same time it will give more purchasing power (being charity) for the households?

I guess it doesn't matter so much which sector, banks or household, the government is dealing with but how it affects the private balance sheets. Giving out money, dropping cash, will be a tax break and thus higher private wealth, more aggregate demand. That has a different effect than buying stuff at the market price.

Jussi,

"That changes the price of the reserves and the price of the assets purchased."

The price of 1 dollar of reserves is fixed at $1 by definition. By what measure are you saying the price changed? By 1/(the general price level)? Measured in 1/$? In other words, do you really mean the value of reserves changes as measured against all other products?

I just meant the interest rate, which I guess can be said to be the price of the reserves, is changed by the higher supply.

"Suppliers of money can "force" more money into existence than people want to hold, because money, unlike other assets, is the medium of exchange."

I think this is an important idea as this as said would create the hot potato effect.

But I'm not sure I totally get the idea. I can see how currency can be forced to be hold (e.g. tax break / helicopter drop). But that is a small part of the money (even though I admit I'm not sure how it is defined here). So I guess that is not what Nick means here? I think most of the money is deposits but the amount of deposit is dictated by the amount of credit/loans ("loans create deposits"), isn't it? And loans comes with a price and thus cannot be forced into existence? Can you (anyone) please elaborate? Are the banks part of the suppliers?

Jussi, imagine the central bank buys $10 of assets. Then $10 will be forced into existence that didn't previously exist. It doesn't matter who sells the assets. If a bank sells them, the new money will exist as reserves. If a non-bank sells the assets, then both $10 of net new reserves and $10 of net new deposits will be created. But the deposit is both an asset (to the seller) and a liability (to the bank).

In terms of typical aggregates, MB goes up by $10 regardless of who sells the assets, but M1 only changes (increases by $10) if a non-bank sells.

This could happen even if the banks had $0 in loans on their books and $0 in deposits prior to the asset sale.

However, nobody's equity changed. That's a difference between a helicopter drop (giveaway from the central bank) and an asset sale. In a helicopter drop, the CB's equity goes down and the private sector's equity goes up by the same amount.

Jussi, yes banks are part of the suppliers of broad money (M1). So they can force money into existence in a manner similar to the central bank: buy buying something. It doesn't matter what they buy. Typically they buy loans from borrowers, because that's how banks make their money. Think of a borrower as selling an agreement to pay back the principal with interest (almost like the borrower is selling a bond to the bank). But money is created when a bank buys donuts too... or pays it's electric bill.

The difference between a bank forcing money into existence and a central bank is that a commercial bank's objective is to maximize profits. It may not be profitable for it to force money into existence. Because the bank doesn't control everything: the people selling the donuts and the people selling the loans determine the supply curve for those items.

The central bank doesn't have to worry (too much) about solvency and not at all about profits, so it can buy what it likes w/o regard to whether or not it's a smart "business move." But practically they do have to worry about politics, and accumulating too much risk or negative equity could cause congress to do something.

Thanks Tom,

I can see now how the CB can buy things/t-bills from the public and force money into existence. And then sellers will try to get rid of extra cash buy something until the new money is used to pay back a loan and thus destroyed? A hot potato!

What about the case where the CB buys assets from the banks? Banks cannot get rid off the reserves as a sector and thus the forced new base money mainly just sits on the reserve accounts?

Jussi,

"I can see now how the CB can buy things/t-bills from the public and force money into existence. And then sellers will try to get rid of extra cash buy something until the new money is used to pay back a loan and thus destroyed? A hot potato!"

You are correct that it's possible that the new deposits are used to pay off old loans, however, that's two things happening. Consider the case where there are no existing deposits or loans. Now if the CB buys $X of reserves, there'll be $X more money. If the asset sellers were non-banks, then there'll be $X more deposits too. Since there are not loans to repay, those deposits aren't going anywhere. And even if there were loans to repay, the $X in reserves aren't going anywhere... until the CB reverses itself, and sells $X of assets.

"What about the case where the CB buys assets from the banks? Banks cannot get rid off the reserves as a sector and thus the forced new base money mainly just sits on the reserve accounts?"

Whatever the CB buys and whomever it buys it from, this will create reserves at the banks. And those reserves will not go away unless the CB sells the assets again OR deposit holders in the bank remove their deposits in the form of cash.

Take a look at this blog post of mine. There's an interactive spreadsheet in the middle that you can play with, and I think this should answer all you questions:

http://brown-blog-5.blogspot.com/2013/08/banking-example-11-all-possible-balance.html

So yes, banks can get rid of the reserves: either through selling to the CB (should they be willing to buy), or through cash withdrawals, should depositors be willing to withdraw their deposits in cash. Also there's the issue of other Fed deposit holders and intergovernmental agencies and foreign trade which I'm ignoring for simplicity (and because I don't know how to all the accounting for that... I take stab at part of that in the next two blog posts):

Jussi, sorry, but I really screwed this sentence up:

"Now if the CB buys $X of reserves, there'll be $X more money. If the asset sellers were non-banks, then there'll be $X more deposits too."

I should have written:

"Now if the CB buys $X of assets, there'll be $X more reserves. If the asset sellers were non-banks, then there'll be $X more deposits too."

Jussi, my comment above is in reference to a comment that didn't make it through the spam filter. Perhaps because I included a link to my blog. But you can find the link by Googling the following:

banking example #11

It should be the first on the list. There's an interactive spreadsheet in the middle that should answer all your questions. Plus I draw out a set of simplified balance sheets with simple formulas in them which should also help (the interactive spreadsheet just implements the formulas)

Nick,
I have expanded the comment I wrote in this thread and turned it into a guest blog post at Insecurity Analyst blog:
http://insecurityanalyst.blogspot.co.uk/2014/03/draghi-is-guiding-interest-rates-yellen_18.html

Has anyone read about the Quantity Theory of Credit by Richard Werner (1992, 1997), see also his book New Paradigm in Macroeconomics, Palgrave Macmillan, 2005, or the article in 2012 International Review of Financial Analysis?

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