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... or say they were I.T. terrorists wanting 1% higher inflation that the officially targeted rate. My point is I guess, is it even remotely possible that this sort of thing be carried out without the benefit of expectations? Can it be done on the down-low?

Nick @08:20
1. Yes, I don't know what Moore was thinking there, he didn't get away with it for long though, Howells and Goodhart were on to that. Sometimes I think that Moore is 'seeing' something profound, but struggling to get it into words. Some of his text is overlong as he searches for the right analogy.
2. Good point, and this one was mostly rejected by Chick etc. Although interestingly Kaldor claimed in 'The Scourge of Monetarsim' (p46) that an excess of credit money 'could never come into existence' which is a more extreme view. I like to think about the expenditure/income process and the cash/financing as being somewhat distinct which must have some implications for overdraft etc. Mark Hayes has some good ideas on this (see 'The loanable funds fallacy: saving, finance and equilibrium'). Taken to the extreme we only have the expenditure/income world without money of Arrow/Debreu. Mehrling's attempt to bring liquidity back (against the tide of complete markets and arbitrage pricing) is topical and interesting.
[Got to go, more later.]

Tom: around 3.15 is the key point.

Nick, got it. :D So "no" then, not possible.

Nick @08:33 There is Mehrling's book The New Lombard St which is a great analysis the GFC and shadow banking. Then The Inherent Hierarchy of Money comes at the idea of money from an interesting angle. He has two free courses on Coursera, enrolling gets you copy of the ebook. A critique of MMT: Modern money: fiat or credit?.

HJC: Thanks. Just read the Hierarchy paper. It's good.
I just realised: I'm having dinner with him tomorrow! Coincidentally.

Nick: I'd have to say that I'm very envious (of both of you!).

Demand for money is not the sum that people want to hold. Demand for money is expressed in the total amount of goods and services which are on sale and remain in inventories. Serving loans (or online loans whatever) is not the function of money in prospective economy.

Nick, are you saying in this post that the money supply is fully exogenous, even when the central bank is targeting interest rates?

Nick, also, how did you dinner with Mehrling go? Did you guys have an interesting converstation? What did you talk about?

Well yes, Nick, obviously if you pretend there aren't any commercial banks, the money supply by definition is exogenous. Endogenous money theorists would entirely agree with you. But that isn't reality. Reality is that there ARE commercial banks, and that those commercial banks - not the central bank - produce much of the money in circulation. It is the relationship between the central bank and commercial banks that determines the extent to which the central bank's price function controls the amount of money actually in circulation.

You've further departed from reality by ignoring risk on loans. If all lending is done by the central bank, anyone who wants a loan can have one regardless of their creditworthiness, and they never default, then the risk versus return profile that is in reality the primary driver of lending decisions does not exist. In which case the only consideration is the central bank's desire to ration the supply of money in the interests of controlling inflation. It would presumably do this by means of the interest rate.

It's a lovely model, and it does indeed prove that the supply of money determines demand when the supply is exogenous. But it unfortunately has nothing whatsoever to do with reality. The reality is endogenous money and a rather more complex supply-demand function.

Once again, what you are suggesting here is very close to the model in the IMF's Chicago Plan Revisited paper, where all money is exogenous, what little lending there is is government-backed and there is very little role for commercial banks (indeed I concluded that the banking system would end up being nationalized). This may be where your heart is, but it isn't what we currently have.

Frances, you write:

"Well yes, Nick, obviously if you pretend there aren't any commercial banks, the money supply by definition is exogenous."

I don't think that's what he's saying exactly: after all the borrowers still determine the supply curve for loan agreements. Nick very explicitly states that the quantity of money supplied is determined by both this curve (determined by borrowers: I specifically ask Nick about this in the 1st page of comments) and the supply function of money. Both "in conjunction" as Nick writes, determine the quantity of money supplied.

Frances, O/T: I have a very simple hypothetical (it's Scott's hypothetical actually) I've asked both Nick and Scott. They have different answers. Would you take a look at this short post and tell me what you think?
http://banking-discussion.blogspot.com/2014/03/toms-epsilon-example.html

Tom,

Yes, maybe I should be a little more careful with my use of the term "exogenous". I meant that if there are no commercial banks, then all money is by definition created by the central bank.

The crucial point is, though, that in a REAL banking system, banks do not have to lend. Demand from borrowers is not the sole determinant of the supply of loans. In my view the idea that banks are passive agents is one of the most pervasive and damaging economic errors. Any model that fails to take into account the fact that commercial banks can't be compelled to lend - and can't easily be prevented from lending, either - is fundamentally flawed.

I've commented on your post.

Frances,

Thanks for looking at my post! Also, you write:

"Yes, maybe I should be a little more careful with my use of the term "exogenous"."

I think that applies doubly to Scott! :D

Frances, I replied to some of your points. Thanks again.

Nick, I'd be interested to know how you got on with Perry Mehrling. I met him last year.

Nick, I attempted to illustrate the example you give in this post with a diagram:

http://banking-discussion.blogspot.com/2014/03/nick-rowes-example-from-sense-in-which.html

Nick, I had a thought about this sentence of yours (comments of previous post):

"...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 description in this post of:

"that the demand for money were perfectly interest inelastic"

"perfectly interest-elastic supply function, at an exogenously fixed rate of interest"

I tried to sketch what that looked like in two related plots:

http://banking-discussion.blogspot.com/2014/03/nick-rowes-example-from-sense-in-which.html

But it occurred to me that if the CB is "making loans" (i.e. buying loans from borrowers) and the borrowers are "taking loans" (i.e. selling loans to the CB), if we make the following replacements:

Replace "loans" with "bonds"
Replace "borrowers" with "bond-issuers"

Then we don't really have two supply curves, because you could say that the

"bond issuers determine a supply curve for bonds"

and the lender(s) (just one in this case: the CB), determine a "perfectly interest-inelastic *demand* curve" for bonds at an 'exogenously fixed rate of interest.'"

What do you think? We're back to a supply curve crossing a demand curve (my blue and green lines in the upper plot).

That's why I put "supply" in quotes on the horizontal green lines in the upper plot.

I love your example BTW, ...it's very interesting!

Nick,

I largely agree with what you're saying here as a description of how the stock of bank liabilities is determined, BUT this has nothing to do with bank liabilities being the medium of exchange.

Take your story but assume that apples are the medium of exchange (maybe by law). All exchanges must take place against apples. Banks make loans by issuing loan repayment tokens ("LRTs" or "deposits"). Loans can only be repaid by cancellation against LRTs. LRTs cannot be used for making payments. Borrowers have to sell LRTs for apples, which they use to buy other things. Savers use apples to buy LRTs, because LRTs keep better than apples - they don't go rotten. When they want to dis-save, they exchange their LRTs for apples with borrowers who need LRTs to repay loans.

The demand and supply functions in this example can work exactly as in yours, even though we are no longer talking about the medium of exchange. The real world relevance is that the supply determines demand story is a story about overall bank liabilities, not about balances available for payment. These are two very different things.

Frances: If you are saying that the banking system's behaviour is a lot more complex than "set r at some fixed exogenous level and give a loan of money to anyone who asks", of course it is!

The whole point of this post is to say that **even in that extreme case**, the stock of money is *not* determined by the quantity of money demanded.

I got on very well with Perry. Very knowledgeable. It was a very good mini-conference/roundtable.

Nick E: I think I'm following. But then the "banks" in your story don't create money. They seem to act more like guarantors of loans. They are non-bank financial intermediaries.

Nick Rowe,

This was a great post and even better discussion. It's not the easiest topic to follow for non-economists, but interesting nonetheless.

W. Peden: thanks!

Nick, you write in your title:

"The sense in which the stock of money is "supply-determined""

Supply of what? You say the supply of money. But what's wrong with looking at it like this (in the case of your highly simplified example with Md=L(P,Y)=P*Y):

"The sense in which the stock of money is loan-market determined: with both supply and demand curves for loan-pincipal-dollars"

What is supplied in the loan market? Well, like all other markets (in this example), non-money is traded for money. In this case the non-money is dollars of loan principal (which will sit on the CB's balance sheet as assets once the CB buys loans). The CB in this case buys all the dollars of loan principal (except perhaps those loan-principal dollars sold back to borrowers eventually when they pay down their loans). We can say the CB determines a demand curve for loans at an exogenously fixed rate of interest. But who determines the supply of loans? The borrowers (not the depositors). Now we have a nice normal situation with a borrower determined supply curve for loans, which is downward sloping when plotted with r on the y-axis and quantity supplied (measured in loan principal dollars) on the x-axis, crossing the perfectly interest-elastic demand curve for loans (determined by the CB) at a specific quantity of loan-principal dollars supplied/demanded. Demand curve crossing supply curve at a quantity demanded/supplied. What's there not to like about that? Like you say the average (aggregate) quantity of money demanded (across the whole economy: not just in the loan market) eventually moves to match the quantity of money supplied when Y and/or P eventually change accordingly. So I'm not changing your main message here: quantity of money supplied determines quantity of money demanded and not vice versa.

So the "supply" in your original title could just as well refer to the borrower determined supply curve for loans-principal-dollars (in your simplified example). But this only tells half the story... it doesn't mention the CB determined demand curve for loan-principal-dollars set at an exogenously determined fixed rate of interest.

I know that's not the language you used, but is there anything fundamentally wrong with looking at it that way?

"If the stock of money was determined by the quantity of money demanded, the central bank would be powerless to do anything that would cause the stock of money to increase. Cutting the rate of interest would not work. But we know it will work, provided the quantity of loans demanded depends on the rate of interest. By cutting the rate of interest, the central bank increases the quantity of loans from the central bank, which creates more money."

Tom Brown, how would you interpret that?

Plus, I would say 'provided the quantity of loans supplied depends on the rate of interest' and 'the central bank increases the quantity of loans to the central bank'.

zyxzyxooxwo

"Ignore risk on loans. Anyone who wants a loan from the central bank can get one, at the rate of interest r, and they never default."

Tom Brown, what is the capital requirement for the central bank under these conditions?

Too Much Fed,

First of all, I have a post up describing how I would interpret that (in addition to my comment above). I'll put a link in a follow up comment in case it causes it to go to spam, but if you Google

Nick's Rowe's example EconTrash

It should be the 1st hit. You write:

"Plus, I would say 'provided the quantity of loans supplied depends on the rate of interest' and 'the central bank increases the quantity of loans to the central bank'."

To the 1st part of that sentence, I agree, since the quantity of loans demanded by the CB is "perfectly interet-elastic." In the chart in my post, the horizontal green lines in the upper plot are these "perfectly interest-elastic" demand curves, but Nick refers to them as "money supply curves" so I put "supply" in quotes. The 2nd part of your sentence makes no sense. Do you have a typo there?

"Tom Brown, what is the capital requirement for the central bank under these conditions?"

There is no capital requirement: it's a central bank. It can do what it wants w/o regard to solvency. Don't tell Mike Sproul I wrote that!

Too Much Fed,

Here is the link I promised, but if not Google what I wrote above:
http://banking-discussion.blogspot.com/2014/03/nick-rowes-example-from-sense-in-which.html

Also, I guess I was being tricky there, the green horizontal lines I labeled 'Perfectly interest-elastic "supply" @ r0' and 'Perfectly interest-elastic "supply" @ r1' ... but I didn't specify what was being supplied, so you could take it as "money." But I still think it makes more sense to describe those as "demand for loan-principal dollars."

BTW, Too Much Fed (are you the same as "Fed Up?"... you should go by "Fed Up" here so we can refer to you as FU... Ha!... that's funny... I didn't mean it like that... it's just that "The Market Fiscalist" is always referred to as TMF, so that leaves me writing out your full moniker)

Anyway, there's a current discussion on Glasner's blog which relates to all this, and I'm fascinated to see if any conclusions are come to over there... I might very well change my interpretation in that blog post depending on that. It's Glasner's latest... I'll put the link in a follow up.

Here's the link:
http://uneasymoney.com/2014/03/31/can-there-really-be-an-excess-supply-of-commercial-bank-money/

'the central bank increases the quantity of loans to the central bank'

Typo? Maybe

The process of loan creation.

The central bank supplies "money" and demands loans. The borrower supplies the loan and demands "money". Once terms are agreed to, there is an asset swap. The loan goes to the central bank. The "money" goes to the borrower.

In accounting terms, the central bank creates "money" as an asset and a liability. The borrower creates the loan as an asset and a liability. Once terms are agreed to, there is an asset swap. The central bank has the loan as an asset and "money" as a liability. The borrower has "money" as an asset and the loan as a liability.

"There is no capital requirement: it's a central bank. It can do what it wants w/o regard to solvency. Don't tell Mike Sproul I wrote that!"

I believe there is a 0% capital requirement. I think solvency will matter. It probably is not the exact same as commercial bank solvency. Don't tell JKH you said that either. My guess (emphasis) is that Nick would say the central bank has a 100% capital requirement.

Too Much Fed, most of that makes sense. I don't get you on the 100% capital requirement though. Ideally the CB should have 0% equity I think. So assuming at least some of the loans it holds as assets have risk weighting > 0, then it achieves 0% capital as measured by equity / (sum of risk weighted assets). I suppose if all the loans were of zero risk, then it's indeterminate (i.e. 0/0). I'm assuming the interest proceeds it collects are redistributed back in the economy right away.

"But we know it will work, provided the quantity of loans demanded depends on the rate of interest. By cutting the rate of interest, the central bank increases the quantity of loans from the central bank, which creates more money."

Let's say that this way.

Cutting the rate of interest is an attempt at more debt (loans). Assume everyone has to borrow at the central bank.

Tom Brown, are those two the same?

Too Much Fed, in this example, yes I think they are the same things. That's why I drew my "borrower determined supply of loans" curve as downward sloping in my upper plot.

"Ideally the CB should have 0% equity I think."

What happens if the CB suffers losses?

"So assuming at least some of the loans it holds as assets have risk weighting > 0, then it achieves 0% capital as measured by equity / (sum of risk weighted assets)."

If the CB has no equity, it should not be able to make a loan/buy an asset with a risk weighting > 0. That would be just like a commercial bank short of bank capital.

Too Much Fed,

Assume the CB starts with 0 assets and 0 liabilities. It's equity is 0. I can then buy an asset at the market rate. Nothing is preventing it from doing this. After it makes the purchase its equity is still 0, and it can go on to purchase more assets if it wants. I'd claim it can even have its assets depreciate so that it has negative equity, and that won't stop it from purchasing more assets (unless it gets too out of whack and it becomes a political problem). Any temporary negative equity will soon be corrected by income from other assets.

Gotta go for now.

"Too Much Fed, in this example, yes I think they are the same things. That's why I drew my "borrower determined supply of loans" curve as downward sloping in my upper plot."

Ever see Nick's reaction when someone tries to say lower interest rates are about more debt?

"Assume the CB starts with 0 assets and 0 liabilities. It's equity is 0. I can then buy an asset at the market rate. Nothing is preventing it from doing this. After it makes the purchase its equity is still 0, and it can go on to purchase more assets if it wants."

CB equity = 0. It wants to buy a $100 asset with a 5% capital requirement. It should not be able to. Buying that asset would mean the CB needs $5 of equity.

"But we know it will work, provided the quantity of loans demanded depends on the rate of interest. By cutting the rate of interest, the central bank increases the quantity of loans from the central bank, which creates more money."

That statement needs to be correctly expanded to commercial banks.

"The supply (function) of money, and the demand for loans, together determine the quantity of money created, and that quantity created (eventually) determines the quantity of money demanded."

I think the loan part (which may actually be supply) and the quantity of "money" demanded need to be combined. If I have more "money" than I demand, I might reduce my supply of loans by paying down the principal of a bank loan.

Too Much Fed,

"I think the loan part (which may actually be supply) and the quantity of "money" demanded need to be combined. If I have more "money" than I demand, I might reduce my supply of loans by paying down the principal of a bank loan."

Nick Edmonds and I discuss that here:

http://tinyurl.com/mnpyk4t

He's got a good post on it too:

http://monetaryreflections.blogspot.co.uk/2014/03/the-demand-and-supply-of-money-and.html

Savers aren't necessarily the same as borrowers.

Too Much Fed,

I'm pretty sure capital requirements don't apply to central banks. Why do you think that they do?

https://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp392.pdf

THE ROLE OF CENTRAL BANK CAPITAL REVISITED

page 26 of paper / page 27 of .pdf

Also, the institution will immediately have to stop paying salaries
and pensions, etc. *** In case of a positive probability of withdrawal of the right to issue legal tender ***, central bank capital and profitability will thus matter. In the case of negative capital, the following issues will arise:

• The staff and decision making bodies of the central bank have incentives to get out of the negative capital situation by lowering interest rates below the neutral level, which in turn triggers inflation, and eventually an increase of the monetary base up till positive capital is restored.

• Negative capital weakens the bargaining position of the central bank towards the Government, since the Government’s admittedly somewhat remote threat to withdraw from the central bank the right to issue legal tender becomes more worrisome for the central bank. Thus, with negative capital, the central bank will tend to be more pliable towards the Government, even if it does not
want to ask the Government to re-capitalise it.

• The markets will have reasons to anticipate less stability-oriented behaviour of the central bank, which drives up inflationary expectations.

• The holders of the monetary base may also feel uncomfortable from the mere risk of losing their money in case that the central bank loses its right to issue legal tender – even if this central bank would never be tempted to trigger inflation.

One may thus conclude from this approach that the higher the likelihood of a central bank to lose its right to issue legal tender, the more important central bank capital becomes. As the likelihood of such an event will however never be zero, central bank capital will always matter.22 Once this conclusion is
drawn, one can start deriving, through simulations, which level of central bank capital is adequate to ensure a monetary policy aiming exclusively at maintaining price stability.

I suppose central banks could ignore capital requirements, but if they start losing "money", they could lose their special privileges.

I agree with the withdrawal of the right to issue legal tender part and most, but maybe not all, of the rest.

I'm going to argue that "the stock of money" is an incoherent concept. It's possible for money to be withdrawn from circulation and basically hoarded. Are my 1911 silver dollars part of the stock of money?

More relevantly, when a major bank decides to just sit on a large pile of electronic book-entry dollars -- permanently -- in order to "shore up its balance sheet", is that money part of the stock of money? Or do you count that as "money destruction" and count it on the supply side?

You have to be much more specific about what you mean by the stock of money. Money in circulation is not the same as money created. The stock of money total is determined by supply, but the stock of money *in circulation* has another effect associated with it. I suppose you could call it a supply effect, but I'm not sure it really is. I'm not sure it's a demand effect either. It's more similar to goods going bad due to spoilage. And that is modelled really badly by most models.

Also, the rate of interest isn't the price of "money". That's a slightly confused way of looking at it. It's the price of liquidity, to be more specific. Money is usually identified with liquidity, but liquidity is actually only associated with money *in circulation*, not with money on the sidelines... so... this sort of detail matters.

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