Author Archives: V. Ramanan

Holier Than Tobin?

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It sometimes happens that important insights of great contributors to an academic field are missed. One of the most important things in Monetary Economics is Tobin’s asset allocation theory which although is well known is sometimes poorly understood.

James TobinJames Tobin (Source: Econometric Theory)

But sometimes a holier-than-thou attitude can lead one to miss an important and insightful aspect of a work.

The blogger Winterspeak – well aware of some of Tobin’s work such as his paper Commercial Banks As Creators Of “Money” from  1963 has written as post A Bank is not a Financial Intermediary and concludes that

… This then is the conceptual fallacy at the heart of academic macro and what it thinks about banks, and it goes at least all the way back to 1963.

Winterspeak is stuck on a quote from Tobin-Brainard paper (1963) which says:

…the essential function of financial intermediaries, including commercial banks, is to satisfy simultaneously the portfolio preferences of two types of individuals or firms. On one side are borrowers, who wish to expand their holdings of real assets… On the other side are lenders who wish to hold part or all of their net worth in assets of stable money value with negligible risk of default.

This is also repeated in Tobin’s Commercial Banks As Creators Of “Money” which obviously states explicitly that loans create deposits and that the money mutliplier view is highly inaccurate:

According to the ‘new view’, the essential function of financial intermediaries, including commercial banks, is to satisfy simultaneously the portfolio preferences of two types of individuals or firms. On one side are borrowers, who wish to expand their holdings of real assets – inventories, residential real estate, productive plant and equipment, etc. – beyond the limits of their own net worth. On the other side are lenders, who wish to hold part or all of their net worth in assets of stable money value with negligible risk of default. The assets of financial intermediaries are obligations of the borrowers – promissory notes, bonds, mortgages. The liability of financial intermediaries are the assets of the lenders – bank deposits, insurance policies, pension rights.

Winterspeak is adamant about the usage of the phrase “intermediary” and that since banks create deposits out of thin air, they shouldn’t really be called intermediary and that Tobin’s views are equivalent to the loanable funds view. For the first part – maybe but Winterspeak seems to crucially miss out the mediating role played by banks in the portfolio allocation decisions of wealth owners such as households. See my comments in that blog.

First it is crystal clear that Tobin knows loans create deposits. Second, he presents a “new view” in which the distinction between “money” and “bonds” is blurred and this led him subsequently to his asset allocation theory. It is true that Tobin’s model was far from complete and this was improved substantially by Wynne Godley, but nevertheless Tobin’s insights were wonderful and the work of a genius.

Perhaps I would have worded what Tobin wrote differently if I were to teach this but this is just a matter of emphasis.

Perhaps “the essential function” is better worded with “an essential function” so that the reader doesn’t take it to mean that the concept I will come to,  isn’t taken to mean “the only function” or “the most essential function”.

The mediation role played by banks is related to the super-version of “loans create deposits” – asset purchases by banks also create deposits.

So when a bank purchases say a government bond from a household (or a mutual fund selling in response to redemptions by a household), banks create more deposits in the process. In the opposite case, there is a destruction of deposits.

Now suppose for some reason – such as improved animal spirits of entrepreneurs, firms borrow more from banks and the expenditures transfers funds to households. Coincidentally – for different reasons – households wish to hold less of their wealth in deposits and more in bonds or other securities. There is now a discrepancy and it is reconciliated by banks standing ready to sell bonds to households. This decreases the stock of money (monetary aggregate) in existence so that there is no discrepancy at all. There is of course another way in which this may happen – i.e., by price changes (of financial secruities and not that of goods and services) bringing supplies equal to demand but this needs a full course on asset allocation theory discovered by nobody else than James Tobin himself!!

Of course there are other ways. There is the reflux mechanism and more complicated mechanisms involving asset allocation theory such as higher issuance of equities by production firms. In the reverse case when households desire to hold more of their wealth in deposits, firms may need to borrow more from banks so that the “supply” of money is equal to the “demand”.

In contrast there is the Monetarist hot potato process which mainly relies on prices changes of goods and services. In ideas such as the asset allocation theory including the mechanism of the mediating role of banks is a blow to the Monetarist hot potato.

Of course there is the notion of convenience lending – one favoured by Basil Moore – in which household volitionally hold bank deposits non-volitionally but it is too artificial.

This mediating role of banks (and not the most important if you like) is also endorsed by some Post-Keynesian authors such as Wynne Godley and Nicholas Kaldor.

In an article In his essay Keynes And The Management Of Real Income And Expenditure, (in Keynes And The Modern World, ed. George David Norman Worswick and James Anthony Trevithick, Cambridge University Press, 1983), Wynne Godley says (p 151):

Even though I am not going in detail into monetary mechanisms it is worth drawing attention to the fact that the commercial banks’ role, apart from creating credit to finance certain kinds of expenditure, is to mediate the non-bank private sector’s portfolio choice, given the income flows and the central authorities’ funding policy.

Nicky Kaldor’s The Scourge Of Monetarism (Oxford University Press, 1982) is more clearer than simply stating:

As it is, a highly developed banking system already provides such facilities on an ample scale, since it is prepared to accommodate the public’s changing demand between different types or financial assets by altering the composition of the banks’ assets or liabilities in a reverse direction. If the non-banking public wishes to switch its holding of gilts for interest-bearing bank deposits, the banks are ready to supply such deposits at the minimum of inconvenience, and at the same time to place their surplus funds into the gilts which were previously held by the public. Similarly the banks provide easy facilities to their customers for switching balances on current accounts into interest-bearing deposit accounts, or vice versa. Hence, while the annual increment in the total holding of financial assets of the private sector (considered as a whole) is nothing more than the mirror-image of the borrowing requirement of the public sector (in a closed economy at any rate), neither the Government nor the banks can determine how much of this increment will be held in the form of cash (meaning notes and current deposits) and how much in the near-equivalents to cash (such as interest-bearing demand deposits) or in various forms of public sector debt. Thus neither the Government nor the central bank can control how much or the total financial assets the public prefers to hold in the form of ‘money’ on one particular definition or another.

Again in 1997 in Money Finance And National Income Determination Wynne Godley repeats himself although criticising Tobin but nevertheless realising the importance of his work – this time writing an explicit model for the whole thing which incorporates Tobin’s ideas:

… I am saying that (within strict limits e.g. concerning credit-worthiness) banks respond passively to the needs of business for loans and to the asset allocation activities of households (as well as providing the means of payment).

Conclusion

It is true that PKE authors and bloggers do have a much better understanding of monetary matters than mainstream economists but in trying to emphasise this point, sometimes they miss out on important matters. There is no need to say (as Winterspeak says “Tobin … sees … [banks as] something which brings efficiency and eases friction between the actual lender and borrower.”) especially when Winterspeak doesn’t seem to understand the mediating role of banks in the portfolio allocation decisions of financial asset owners which really has less to do with any “friction”. Perhaps the word intermediary is not the best but it is a minor point. In fact the ideas of the 1960s and later are missed by younger ones.

Jackson Hole Symposium Starts With The Money Multiplier

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The Jackson Hole Symposium organized by the Federal Reserve Bank of Kansas City has been getting a lot of attention these days. The main reason is that Ben Bernanke announced his intention of doing LSAP (QE) in this symposium a few years back.

One would have expected some improvement by economists on monetary matters but here is Robert Hall from Stanford University in the first talk titled The Natural Rate of Interest, Financial Crises and the Zero Lower Bound: 

… Every economic principles book describes how, when banks collectively hold excess reserves, the banks expand the economy by lending them out. The process stops only when the demand for deposits rises to the point that the excess reserves become required reserves and banks are in equilibrium. That process remains at the heart of our explanation of the primary channel of expansionary monetary policy …

When will economists learn? The above shows Hall has no clue whatsoever.

Also, a few economists concede that they have been incorrect about simple basics and causalities but dodge it by saying “you haven’t read the textbook” and so on – so quote the above line!

An Anti-Keynesian Central Bank Governor

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So the news is that Raghuram Rajan has been appointed as the Governor of the Reserve Bank of India and his three year term will start in September.

This is a bit surprising given that Indian government officials are not too free market fundamentalists as Raghuram Rajan. What is more disappointing is that Rajan completely denies that Keynesianism works.

For example Rajan wrote the last year in an FT piece (and which was also picked by Paul Krugman)

A general increase in government spending may be too blunt – greater demand in New York is not going to help families eat out in Las Vegas (and hence create more restaurant jobs there).

This is a total denial of Keynesianism. This is exactly what Keynes set out to disprove in the 1930s and unfortunately we have people denying this. A rise in domestic demand in New York will obviously lead to a rise in output in New York and New York employment as well as employment in Las Vegas because New Yorkers will purchase output of people in Las Vegas when their (New Yorkers’) incomes rise.

Also notice he singles out government spending and keeps private spending separate.

Instead Rajan offers supply side reasons for the economic mess. In an article for Foreign Affairs titled The True Lessons of the Recession he offers the following reasons:

In fact, today’s economic troubles are not simply the result of inadequate demand but the result, equally, of a distorted supply side. For decades before the financial crisis in 2008, advanced economies were losing their ability to grow by making useful things.

O.M.G.

Computers, mobile phones don’t count?

Rajan’s appointment is a bit surprising given that Indian officials are far from free market fundamentalists as Rajan. Perhaps Indian officials were too worried about the depreciation of the Rupee and appointed him? Seems to have helped for today at least – the Rupee hit all time lows during the day and has recovered sufficiently after the announcement.

USDINR - 6 Aug 2013

Chart via NetDania

Blog Security Tips

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There are two ways of writing a blog. The first is to use the free service of wordpress.com or blogger.com and the second is to have a host host your blog on which you run WordPress (which is different from “wordpress.com”). The advantage of the first is that you can start writing directly and not worry about techie things. The advantage of the latter is that it offers you a lot of flexibility but it comes with the headache of maintaining a few things.

Paul Krugman has a post on how Michael Pettis’ blog was hacked recently. In fact in the last 1-2 days, there was a huge rise in hacking activity according to Akamai. Even for my site which has far less traffic than Pettis, the number of attacks was huge and my host hosting millions of sites went down for 8+ hours (and is still recovering – although they won’t admit, I think it was a DoS attack because I remember seeing  “too many requests” on some screen). Krugman feels the hacking was for Pettis writing openly about China but methinks it was simply because of a huge rise in attacks in the past 48 hours.

For some – especially businesses such as travel companies – something such as what happened recently can mean a lot of lost revenue and clients complaining. But even for others, it can be difficult to recover old stuff. So here are some tips.

  1. Use Amazon Route 53 as your name server instead of using your hosts’ name server. with a low TTL such as 300 seconds or 15 minutes or whatever. If your account or the hosting company is hacked, you can always change DNS entries in Route 53 to either point it to a backup site or to completely remove access to your domain name. So if your domain name is example.com and someone hacks, you can use Route 53 to immediately redirect browser requests for example.com to some other IP address or block it completely.
  2. Do not use “admin” as your username. In fact there are some good WordPress plugins such as Better WP Security which – among many other things – lets you change your username and also hide the login screen so that it is known only to you. You can also ban IPs using the tool if you still see someone still trying to hack.
  3. Backup. If using WordPress, you need to backup two things – the database and the “uploads” folder.
  4. Cloudflare: Although I don’t use it, it seems like a good option for security and is free for normal usage.
  5. Something I missed.

Touch Wood.

Manmohan Violet Singh

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In a short recent speech, the Indian Prime Minister – the great man who steered the direction of the Indian economy in the early 1990s – says:

The purpose of the study of economics is not to provide settled answers to unsettled and difficult questions, but sometimes to warn economists and the world-at-large, how not to be misled by clever governments.

which is similar to what Joan Robinson once:

The purpose of studying economics is not to acquire a set of ready-made answers to economic questions, but to learn how to avoid being deceived by economists.

– in “Marx, Marshall And Keynes”, Occasional Paper No. 9, The Delhi School of Economics, University Of Delhi, Delhi, 1955.

I’d say Manmohan Singh doesn’t go as far as Robinson in putting the blame on economists themselves but I guess there is some amount of influence. But what Singh says is true – governments of advanced nations mislead the less advanced ones.

Also in the short speech:

I would like to say, that when we study economics, our impulse is not the philosopher’s impulse – knowledge for the sake of knowledge – but for healing that that knowledge may help to bring. These are the words of past thinkers: Wonder is the beginning of philosophy; but it is not wonder, but social enthusiasm, which revolts against the silence of fixed life, and the orderliness of the mainstream, which is the beginning of economic science.

Which is not not surprising since Manmohan Singh is influenced by Joan Robinson and Nicholas Kaldor. Here is a nice interview by the BBC’s Mark Tully from 2005 Architect Of The New India published in the October 2005 issue of the Cambridge University Alumnus Magazine. 

Here is an excerpt from the interview:

The thinking behind his solutions to India’s financial problems was first shaped at Cambridge by the theories of John Maynard Keynes. The great man had died almost 10 years before Manmohan Singh arrived but his legacy was still very much alive. ‘At university I first became conscious of the creative role of politics in shaping human affairs, and I owe that mostly to my teachers, Joan Robinson and Nicholas Kaldor. Joan Robinson was a brilliant teacher but she also sought to awaken the inner conscience of her students in a manner that very few others were able to achieve. She questioned me a great deal, and made me think the unthinkable. She propounded the leftwing interpretation of Keynes, maintaining that the state has to play more of a role if you really want to combine development and social equity.’

‘Kaldor influenced me even more; I found him pragmatic, scintillating, stimulating. Joan Robinson was a great admirer of what was going on in China, but Kaldor used the Keynesian analysis to demonstrate that capitalism could be made to work. So I was exposed to two alternative schools of thought. I was very close to both teachers, so the clash of thinking sometimes got me into difficulties. But that made me think independently.’

In Other News

The Reserve Bank of India announced some measures recently to curb the instability of the Indian Rupee:

The first announcement – effectively raising short term interest rates and which caught everyone by surprise – was on 15 July 2013:

The market perception of likely tapering of US Quantitative Easing has triggered outflows of portfolio investment, particularly from the debt segment. Consequently, the Rupee has depreciated markedly in the last six weeks. Countries with large current account deficits, such as India, have been particularly affected despite their relatively promising economic fundamentals. The exchange rate pressure also evidences that the demand for foreign currency has increased vis-a-vis that of the Rupee in part because of the improving domestic liquidity situation.

Against this backdrop, and the need to restore stability to the foreign exchange market, the following measures are announced:

…

On 23 July it further tightened monetary policy:

Over the last two months, the Reserve Bank of India (RBI) has undertaken several measures to contain the volatility in the foreign exchange market. Among them, some measures intended to check excessive speculation adding to undue volatility in market conditions were instituted vide the RBI’s Press Release No.2013-2014/100 dated July 15, 2013. These measures have had a restraining effect on volatility with a concomitant stabilising effect on the exchange rate. Based on a review of the measures, and an assessment of the liquidity and overall market conditions going forward, it has been decided to modify the liquidity tightening measures as follows:

…

There Is No Such Thing As A “Purely Economic” Problem That Can Be Settled By Purely Economic Logic

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… and politics and ideology will seep into it.

Tom Hickey writes a nice reply to Noah Smith’s blog post How Normal People See Macroeconomics.

Smith says:

I’ve been thinking about these differences for a while, and I’ve reached two major conclusions:

1. Normal people see macro as inherently political.

2. Normal people see macro as being mostly about redistribution rather than about efficiency….

The whole essay is like economists are doing something value free and that politics is not important. Joan Robinson nicely summarized the situation in her essay What Are The Questions (jstor URL):

The movement of the thirties was a attempt to bring analysis to bear on actual problems. Discussion of an actual problem cannot avoid the question of what should be done about it; questions of policy involve politics (laissez-faire is just as much a policy as any other). Politics involve ideology; there is no such thing as a “purely economic” problem that can be settled by purely economic logic; political interests and political prejudice are involved in every discussion of questions. The participants in controversy divide themselves in schools – conservative or radical and ideology is apt to seep into logic. In economics, arguments are largely devoted, as in theology, to supporting doctrines rather than testing hypotheses.

Smith writes as if what he is doing is good for the society as a whole – despite the fact that his own colleagues are pushing their own ideologies in policy which is bad for society as a whole.

Smith also writes:

Many people see the “-isms” of macro – “New Keyneisanism”, “New Classicalism”, etc. – as political advocacy rather than as dispassionate scientific attempts to explain the world around us….

But it is right – people like Greg Mankiw have pushed their agendas. What is wrong with “normal people’s view” on this? They are exactly right. Mankiw’s defending the 1% is a dispassionate scientific attempt?

And the above Robinson quote is actually a dispassionate description of the situation than Smith’s own!

Who is Smith trying to fool here?

In fact,

One of the main effects … of orthodox traditional economics was … a plan for explaining to the privileged class that their position was morally right and was right for the welfare of society.

– Joan Robinson, 1937, “An Economist’s Sermon”, Essays In The Theory Of Employment, The Macmillan Company

Smith also writes:

If monetarists or New Keynesians (is there a difference?) suggest monetary expansion, for example, a lot of readers see it instead as a liberal attempt to use inflation to redistribute money from rich creditors to poor debtors, while a few see it as a conservative attempt to boost the profits of big banks. Only a small minority seem to consider the question of whether monetary expansion is a Pareto efficient response to the business cycle. Because of this, monetarists like Scott Sumner often spend a lot of time “punching hippies” on every issue other than monetary policy, trying to avoid being tarred as hippies themselves for their lack of fear of inflation.

Whatever Pareto efficiency is.  But it is mainstream economists themselves who have promoted deflationary policies by selling them to the public that such policies are good for them. Monetarism was a scourge in the 1980s and has permanently distorted economists and the common man. Now he completely avoids history and presents the case as if (mainstream) economists want a rise in demand, not the normal people!

Nicholas Kaldor On Milton Friedman’s Influence

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Unlearning Economics has written a very nice post on Milton Friedman’s distortions.

It is unbelievable that people still believe in the quantity theory of money and the distortion appears to have been permanent. When Milton Friedman was rising in popularity, Nicholas Kaldor took him to task and while conceding to Kaldor that the stock of money is endogenous, Friedman still maintained the direction of causality from money to income.

One of Nicholas Kaldor’s best papers is The New Monetarism written in 1970 [1] in which he shows why the stock of money should be taken as endogenous and that Friedman’s causality is entirely incorrect. In that he also had a nice description of how Friedman’s influence was growing at the time:

… However, we now have a “monetary” counter-revolution whose message is that during this time we have been wrong and our forbears largely, or not perhaps entirely right: anyhow, on the right track, whereas we have been shunted on to the wrong track. This new doctrine is assiduously propagated from across the Atlantic by a growing band of enthusiasts, combining the fervour of early Christians with the suavity and selling power of a Madison Avenue executive. And it is very largely the product of one economist with exceptional powers of persuasion and propagation: Professor Milton Friedman of Chicago. The “new monetarism” is a “Friedman Revolution” more truly than Keynes was the sole fount of the “Keynesian Revolution”, Keynes’s General Theory was the culmination of a great deal of earlier work by large numbers of people: chiefly Wicksell and his followers, Myrdal and Lindahl in Sweden, Kalecki in Poland, not to speak of Keynes’s colleagues in Cambridge and of many others.

The new school, the Friedmanites (I do not use this term in any pejorative sense, the more respectful expression “Friedmanians” sounds worse) can record very considerable success, both in terms of the numbers of distinguished converts and of some rather glittering evidence in terms of “scientific proofs”, obtained through empirical investigations summarised in time-series regression equations. Indeed, the characteristic feature of the new school is “positivism” and “scientism”; some would say “pseudo-scientism”, using science as a selling appeal. They certainly use time-series regressions as if they provided the same kind of “proofs” as controlled experiments in the natural sciences. And one hears of new stories of conversions almost every day, one old bastion of old-fashioned Keynesian orthodoxy being captured after another:  first, the Federal Reserve Bank of St. Louis, then another Federal Reserve Bank, then the research staff of the I.M.F., or at least the majority of them, are “secret”, if not open, Friedmanites. Even the “Fed” in Washington is said to be tottering, not to speak of the spread of the new doctrines in many universities in the United States. In this country, also, there are some distinguished and lively protagonists, like Professor Harry Johnson and Professor Walters, though, in comparison to America, they write in muted tones and make more modest claims, which makes it more difficult to discover just what it is they believe in, just where the new doctrine ceases to be a matter of semantics and becomes a revelation with operational significance.

Also read Lunch With FT: Milton Friedman and William Keegan’s article written for The Observer: So Now Friedman Says He Was Wrong referring to the Financial Times article on Friedman finally conceding in 2003 that he was wrong all along.

[1]  Kaldor, N., 1970,  The New Monetarism, Lloyds Bank Review 97, pp. 1-18, also published in Kaldor, N., Further Essays in Applied Economics, London: Duckworth, 1978, pp. 1-21.

Thanks to Philippe for pointing out some spelling errors (mine) in the quote in the previous version of this post. 

Thomas Palley On International Coordination

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Thomas Palley has a new article Coordinate Currencies or Stagnate on international coordination of exchange rates. (h/t Matias Vernengo). He has a nice small critique of the Chicago school according to which “market forces” work toward resolving imbalances.

It is great such a thing has been raised because the importance of policy coordination (in general – monetary, fiscal and exchange rates) is often forgotten.

In an article Agenda For International Coordination Of Macroeconomic Policies, Tobin wrote [1]

Coordinate policies! So economists urge governments. Financiers, journalists, pundits, politicians take up the cry. Central bankers and finance ministers agree, as do presidents and prime ministers. They meet, they talk, they announce progress. It turns out to amount to very little…

But the global imbalance has worsened and it has now created a situation in which such coordination is more badly needed.

Wynne Godley had been warning of such things in the 2000s. In a 2005 article [2] with his collaborators, he wrote:

A resolution of the strategic problems now facing the U.S. and world economies can probably be achieved only via an international agreement that would change the international pattern of aggregate demand, combined with a change in relative prices. Together, these measures would ensure that trade is generally balanced at full employment…Those hoping for a market solution may be chasing a mirage.

I have also found the last words in academic literature very insightful [3]:

… It is inconceivable that such a large rebalancing could occur without a drastic change in the institutions responsible for running the world economy—a change that would involve placing far less than total reliance on market forces.

Time will tell how right he was 😉

References

  1. James Tobin, Agenda For International Coordination Of Macroeconomic Policies, Ch 24, p 633, Essays In Economics, Volume 4: National And International, The MIT Press, 1996.
  2. Wynne Godley, Dimitri Papadimitriou, Claudio Dos Santos and Gennaro Zezza – The United States And Her Creditors: Can The Symbiosis Last?, Levy Institute Strategic Analysis, September 2005. Link
  3. Wynne Godley, Dimitri Papadimitrou and Gennaro Zezza – Prospects For The United States And The World – A Crisis That Conventional Remedies Cannot Resolve, Levy Institute Strategic Analysis, December 2008. Link

Firestone Backfiring More

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So I happened to get a reply from Joe Firestone on my reply to his blog post.

I don’t have too much patience for going back and forth but a few points stand out.

I created a situation in which the current account balance of payments is at 4% of GDP, private sector balance is at 2% of GDP and the government budget balance at 2% surplus.

Joe Firestone thinks it is necessarily a contraction. Here is quoting him:

Ram, in the situation you’ve described, the Government is running a surplus of 2%, so it’s destroying net financial assets that would otherwise be flowing to the private sector if it had a smaller surplus, a balanced budget or a deficit. The budget surplus isn’t high enough, given the size of the trade surplus, for the Government to be causing a negative accumulation of NFAs in the private sector; but that doesn’t mean that the Government’s fiscal policy can be called “expansionary.” In fact, it’s contractionary relative to even a balanced budget, much less a deficit.

[boldening: mine]

First Firestone confuses “private sector”. According to him the private sector has a negative net accumulation of financial assets! (when given it has +2%!).

Second he fails to understand that the budget deficit is an endogenous variable – he has been conditioned to think that a surplus budget is necessarily contractionary. He cannot see that in the given situation fiscal policy can be expansionary. Firestone seems to compare it with a situation in which the budget would have been in deficit or surplus. Actually he should be comparing it with the previous periods. Moreover, even if compared to a situation where the budget could have been in balance or in deficit (future scenario) it doesn’t mean 2% surplus is more contractionary. All that matters is how the private sector responds to the expansion. A fast expansion can improve private sector expectations about the future and they may respond by higher production than the case if the government indicated a weaker expansion. [update: a fast rise in production due to a faster expansion – meaning a combination of higher expenditure and/or tax rate cuts may bring the budget into surplus because of higher total taxes resulting from higher national income, as compared to a less expansionary policy]. Plus there are other things such as deregulation, monetary policy etc. You cannot conclude 2% surplus is more contractionary than a balanced budget.

But more generally to the basic point, he concedes that net HPM creation is not NAFA even though this was an important point in his post.

So he says;

Ram:

Net HPM creation is not equal to private sector NAFA.

Again, I didn’t say or imply that it is. if you think I have, then please quote me.

Here is from his original post:

High-powered money includes cash money and reserves emanating from the Government, including the Federal Reserve. If there’s no deficit spending the Government is destroying as much money through taxation as it is spending/creating. And so, it is not doing any net high powered money creation.

He uses the example of a balanced budget to show that balanced budget does not do “net high power money creation” – as if a deficit does net high powered money creation.

Fact is even if the government is in deficit, the HPM created due to expenditure minus taxes is offset by bond issuance. So even a deficit doesn’t directly do any net high power money creation.

Now, imagine a closed economy situation with 10% reserve requirement instead of 0%. Also assume the private expenditure is rising relative to private income and the private sector is in near zero balance. This leads to higher domestic demand and higher bank borrowing. Banks will need more reserves due to higher borrowing to satisfy higher reserve requirements. In such a situation the central bank would provide HPM to banks but the government budget is balanced as a mirror image of the private sector balance.

So we have a situation in with a balanced budget and net HPM creation!!!

But some souls are forever confused!

Once again, fiscal policy is highly important and the most important thing driving real demand generally speaking but no overkills please.

Update:

There is the question – what is net high power money creation.

First, since the government’s expenditure, taxation and bond issuance and actions of the central bank lead to creation/destruction of HPM, net can simply mean the flow of high powered money or ΔHPM in any period of accounting. Here deficit is not needed for ΔHPM to be positive.

Second, Joe Firestone perhaps is thinking of non-borrowed reserves. Again, even in this situation, a deficit is not needed for non-borrowed reserves to be positive. Let us say in one period, the government’s budget balance is zero and banks require more reserves. In this case, the central bank can create HPM by outright purchases of government bonds, so again balanced budget doesn’t imply zero increase in nonborrowed reserves in any one period.

There is always a third possibility but then what is it?