Wednesday, January 11, 2012

Kaldor on Money Supply Endogeneity

Some of my posts starting in October 2010 (the most recent one is here, with some conceptual graphics) have focused on the endogeneity of the money supply independent from the broad Post-Keynesian observation that loans create deposits. That is, the dynamism of the economy (largely courtesy of the financial sector) seemingly allows households and businesses on aggregate to self-determine their portfolio composition -- i.e., how much "money" they hold -- independent of both government policy and private debt levels.

Whether due to lack of familiarity or considered relative unimportance, there seems to be very little attention to this dynamic in the MMT-oriented econoblogosphere, even among the "primary" MMT bloggers when they discuss QE. If money supply endogeneity were only about loans creating deposits, then one should still expect to see QE changing broad money supply from whatever trend(s) it was already on, since QE isn't generally assumed to change people's propensity to borrow or their rate of deleveraging. Here are two updated charts of the MZM (Money Zero Maturity) measure of broad money supply:

Money supply did not grow as much as the QE operations alone would suggest. The actual trends are very volatile (probably having to do with uncertainty and liquidity preference during recession and expanding financial assets in line with a growing economy during economic growth) and so it's difficult to say anything conclusive other than that QE did not provide a 1-to-1 increase or obviously "shift" the trend lines while active.

Ramanan recently posted two great quotes from Nicholas Kaldor's The Scourge Of Monetarism (Oxford University Press, 1982). First, via Ramanan (emphasis mine):
"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."
Kaldor certainly appears to have these concepts mastered (including financial sectoral balances) and this was 1982! It's amazing to me that virtually none of this could "rub off" onto the economics mainstream over a period of three decades! Ramanan quotes more interesting details from Kaldor in a second post (follow the link to read it).

This seems to me largely consistent with dynamics I've postulated. A copy and paste from my last post's summary of mechanisms:
Overview of Ways the Private Sector Can Reduce "Unwanted" Broad Money Supply:
  1. Replace loans (which create money) with non-bank borrowing (which does not create money) independent of total debt levels. Examples of non-bank debt include corporate bonds, peer to peer loans, securitized loan pools, housing agency debt, etc. Most of this post focused on this mechanism.
  2. Induce less bank lending by changing aggregated propensities to borrow. For example, many reports indicate a record number of cash buyers have been supporting the housing market. Logically, if there is an "excess" of deposits in the economy, then investors who would rather own other assets may outbid other potential buyers of those same assets who would have bought using debt. Thus, while QE's added money supply in this case doesn't eliminate existing bank loans, it serves to reduce the number of houses bought using bank loans, while at the same time other loans are continually being paid down. The net effect is that bank lending moves to a lower level than it would have been at had QE not occurred. Those who lost the bid for houses (who would otherwise have bought with a bank loan) might rent from the investors instead, so this point does not imply that QE will cause some to have no place to live.
  3. Banks can sell assets (treasuries, loans, etc) to the rest of the private sector. A net decrease in assets in this way causes a net decrease in broad money supply. To see how this works, visit the Macroeconomic Balance Sheet Visualizer, and choose the operation "Bank Loan" followed by "Bank Loan is Securitized" (which is one way banks sell assets to the non-bank sector).
  4. Banks can fund themselves with a higher portion of non-deposit liabilities (e.g., bonds) instead of deposit liabilities. This results in less broad money supply. As I understand it, this was part of the dynamic that RSJ described in this post.
I'm not sure whether I'm odd to find this stuff fascinating or whether my descriptions are not clear and/or don't seem credible (and I admit I still may have some things wrong!). It may just be that this is clearly less important than topics on "fixing" the economy's current primary problems. But I've considered putting together a mini step-by-step visualization on EconViz on this topic (when I can get to it) -- if anyone would find this beneficial in clarifying these interactions, please say so.


  1. Nicky Kaldor also said this in a conference on Keynes' 100th anniversary in 1983:

    "If there was such an excess ... the excess supply would automatically be extinguished through the repayment of bank loans, or what comes to the same thing, through the purchase of income yielding financial assets from banks."

    1. Well the second part of the quote is easy to agree with... The first part taken alone implies that an "excess" money supply could reduce propensity to borrow, which I've argued against (with one exception) -- but the quote could be missing some context.

      Thanks Ramanan.

  2. I'm very glad I stumbled across your blog (via TPC) -- you seem to be thinking along very similar lines to myself, following an epiphany I had a few nights ago. I was thinking about the loans-creating-deposits thing while looking at some charts of the money supply and realized that we're dealing with a *pull-based* system here, all the way through. It's not a money supply, it's a money demand! The private sector decides how much money it wants and the money supply grows to accommodate it, almost regardless of monetary policy (aside from the interest rate). One of the key points for me is that it really does matter whom supplies the money: if it's a bank then the non-financial sector takes on more debt; if it's the govt then the private sector acquires savings in the form of govt bonds. That's quite a difference!

    You've obviously spent much more time thinking through the ramifications of this, so I hope to read more in the future :)

  3. I would definitely find it helpful if you built this into EconViz!

    1. Good, because that's the plan! I've started work on a series of much shorter focused tutorials with interactive exercises... the first is just how loans create money, but I'll get to the broader money supply endogeneity topic at some point.

  4. hbl

    Like your work, and would welcome seeing more on EconViz.

    Have you looked at sectoral holdings of govt bonds over time? I don't think MZM is very compelling as a time series, not least becuase it excludes time deposits. The actual sectoral holdings of the stuff that the Fed has been buying through QE seems a better thing to look at to test your hypotheses regarding QE and endogeneity.

    I have to say, i continue to find your and rsj's theses compelling, although looking at UK sectoral data, you really don't see a big shift in bank holdings of bonds, as you would have expected.

    1. Hi Anders-

      At one point I did look at the treasury holdings of commercial banks over time, and possibly the other sectors too (I'm not remembering for sure). You're right, there wasn't much shift at least for the commercial banks... I'm not clear on who you were saying would have expected or not expected that result :) But that result seems to me consistent with these proposed dynamics.

      Interesting point on MZM... I agree it would be good to look at broader data sets. I occasionally start digging deeper and then decide it will be too time consuming given the low likelihood of specific enough data to form concrete evidence either FOR or AGAINST any of this! But maybe I'll eventually find and analyze other data that can shed some light...