{"id":4218,"date":"2012-04-02T12:35:55","date_gmt":"2012-04-02T16:35:55","guid":{"rendered":"http:\/\/www.multiplier-effect.org\/?p=4218"},"modified":"2012-04-02T14:35:47","modified_gmt":"2012-04-02T18:35:47","slug":"krugman-vs-minsky-who-should-you-bank-on-when-it-comes-to-banking","status":"publish","type":"post","link":"https:\/\/blogs.bard.edu\/multiplier-effect\/krugman-vs-minsky-who-should-you-bank-on-when-it-comes-to-banking\/","title":{"rendered":"Krugman vs Minsky: Who Should You Bank On When It Comes to Banking?"},"content":{"rendered":"

Last week I explained<\/a> why Minsky matters, outlining his main contributions. This was, in part, a response to a blog post<\/a> by Paul Krugman that appeared to dismiss the importance of trying to find out \u201cwhat Minsky really meant.\u201d But, more importantly, it was a response to his defense of a simple model of debt deflation dynamics that left banks out of the picture. In Krugman\u2019s view, banks are not very important since all they do is to intermediate between savers and investors, taking in deposits and packaging them into loans.<\/p>\n

In my post last week I promised to go into more detail on Minsky\u2019s approach to banking. And right on cue, Krugman expanded on his views in this post<\/a>.<\/p>\n

Now, I know that Krugman\u2019s own specialty is not<\/em> money and banking, so one would not expect him to have a deep understanding of all the technical details.\u00a0\u00a0However, he is an important columnist and textbook writer, so if he is going to expound upon \u201cwhat banks do,\u201d he should at least have the basics more-or-less correct. But he doesn\u2019t. Indeed, his views are outdated by at least a century, or more. Can one imagine a science writer at the NYTimes presenting Newtonian physics as state-of-the-art?<\/p>\n

If there is any banking \u201cmysticism,\u201d it is what Krugman is presenting\u2014not what Minsky\u2019s followers are arguing. Yes, we need Minsky\u2014whose views even from the 1950s are far more relevant to today\u2019s real world banks than are Krugman\u2019s.<\/p>\n

I mean no disrespect here. Like the rest of Krugman\u2019s followers, I think he\u2019s one of the best columnists at the NYTimes\u2013and he covers a great range of topics with flair and good insight. But he cannot be trusted when it comes to money\u2014he just doesn\u2019t get it. What he is presenting is a strange combination of early twentieth century theory plus a throwback to a particular nineteenth century view that was based on an even older \u201cgoldsmith\u201d story. Let me explain.<\/em><\/strong><\/p>\n

From the 1920s a peculiarly American misunderstanding developed according to which the quantity of bank reserves issued by the Fed could somehow control bank lending and deposit creation. This was called the \u201cexogenous money\u201d approach (the money supply is \u201cexogenously\u201d controlled by the central bank through restriction of the quantity of reserves supplied). It became the starting point for Milton Friedman\u2019s monetarism\u2014which finally ended in the disastrous Great Monetarist Experiment of the early 1980s in the US and the UK in which the central banks tried formal targeting of growth of the money supply.<\/p>\n

It didn\u2019t work, and money targets were completely abandoned by all developed nation central banks by 1990.<\/p>\n

There was always another tradition, dating back to the Banking School of the early 19th<\/sup> century through Marx and then Keynes, and on to Schumpeter, Gurley&Shaw, Minsky, N. Kaldor, B. Moore and finally to yours truly at the end of the 1980s. It is called the \u201cendogenous money\u201d approach that insists central banks cannot control private money creation by banks through control over reserves.<\/p>\n

Very briefly, the idea runs like this. Modern central banks are responsible for maintaining a smoothly operating payments system, which among other things requires that bank liabilities clear \u201cat par\u201d (a one dollar deposit at Chase is valued the same as a one dollar deposit at Bank of America). The Fed makes sure that checks clear among banks and that depositors can use the ATM machines. That means banks must have reserves as required. So the Fed\u2019s control is based on \u201cprice\u201d, not \u201cquantity\u201d: it can set the interest rate at which it lends reserves to banks, but cannot determine the quantity.<\/p>\n

Further, in practice, bank reserve requirements are calculated based on deposits created up to six weeks previously. So the quantity of reserves that banks are required to hold in systems like the one we use in the US (with required reserve ratios) is always a function of historical deposits. Again, the central bank\u2019s control is price, not quantity. Finally, modern central banks work with interest rate targets (the Fed announces its fed funds rate target), which again means that the Fed can set the \u201cprice\u201d then supplies reserves as needed to hit the fed funds rate target.<\/p>\n

Still, it has taken US textbooks a long time to catch on, and Krugman is not the only textbook writer who still gets it wrong. (Notice I keep referring to the US\u2014textbook writers outside the US did a better job. For example, Charles Goodhart in the UK wrote a textbook a long time ago that got all this right.)<\/p>\n

But in his blog, Krugman\u2019s mistake goes well beyond this common textbook error. He argues that banks really do not create money \u201cout of thin air\u201d\u2014rather, they take in deposits and then lend them out. That is a mistake even the worst textbooks do not make.<\/p>\n

Let me just quote three relevant passages from Krugman that summarize his view:<\/p>\n

\u201cthe self-proclaimed true Minskyites view banks as institutions that are somehow outside the rules that apply to the rest of the economy, as having unique powers for good and\/or evil\u2026<\/em><\/strong><\/p>\n

First of all, any individual bank does, in fact, have to lend out the money it receives in deposits. Bank loan officers can\u2019t just issue checks out of thin air; like employees of any financial intermediary, they must buy assets with funds they have on hand. I hope this isn\u2019t controversial, although given what usually happens when we discuss banks, I assume that even this proposition will spur outrage\u2026<\/em><\/strong><\/p>\n

Yes, a loan normally gets deposited in another bank \u2014 but the recipient of the loan can and sometimes does quickly withdraw the funds, not as a check, but in currency. And currency is in limited supply \u2014 with the limit set by Fed decisions. So there is in fact no automatic process by which an increase in bank loans produces a sufficient rise in deposits to back those loans, and a key limiting factor in the size of bank balance sheets is the amount of monetary base the Fed creates \u2014 even if banks hold no reserves\u2026\u201d<\/em><\/strong><\/p>\n

We\u2019ll see below how much Minsky, himself, viewed banks as special. For now let us focus on Krugman\u2019s own views: banks cannot issue checks \u201cout of thin air\u201d but rather must use \u201cfunds they have on hand\u201d. And, further, banks are limited to the currency that \u201cis in limited supply\u201d, set by \u201cFed decisions\u201d.<\/p>\n

Krugman sets back monetary theory by at least a century.<\/p>\n

Scott Fullwiler has written a beautiful\u00a0analysis of Krugman here<\/a>.<\/p>\n

He goes through the balance sheets and counters Krugman point-by-point. There is no reason to repeat the detailed rebuttal here.<\/p>\n

Instead, I want to give a general overview of Minsky\u2019s approach to the nature of banking: what is it that banks do? Readers should first work through this, then go over to Scott\u2019s piece for the details, and then finally decide for themselves whether it is Minsky or Krugman who ought to be trusted on banks.<\/p>\n

But before proceeding look at it this way. A bank deposit is the IOU of the bank, showing up on the liability side of the bank\u2019s balance sheet. Banks have trillions and trillions of dollars of these IOUs on their balance sheets (in the US we have two banks each of which alone has issued $2 trillion in IOUs, and several others are not that much smaller). The IOUs are \u201ccontingent liabilities\u201d in the sense that the bank\u2019s creditors can insist on \u201cpayment\u201d or \u201cconversion to cash\u201d either on demand (\u201cdemand deposit\u201d) or after some waiting period (\u201ctime deposit\u201d) or after some specified event.<\/p>\n

Where Krugman goes wrong is that he thinks banks operate like \u201cmoney lenders\u201d that stand on street corners in Chicago\u2014taking in deposits of currency and then lending them out at a higher (usurious) interest rate. Banks supposedly then hold some of the cash as reserves to meet withdrawal of deposits. But since the Fed limits the quantity of cash, bank lending is limited.<\/p>\n

But how could that be so? In the first place, the math won\u2019t work. The total amount of cash in existence is less than a trillion dollars\u2014and estimates put at least half of that outside the US, used largely to finance illegal activities in black markets, gun running, and drug smuggling (which is also largely what cash is used for within the US). So, only a small fraction of the total cash is available for banks to receive in deposits in order to make loans. And yet they\u2019ve got trillions and trillions of loans on their balance sheets and have issued just as many IOUs.<\/p>\n

Think about the last time you went to a bank. Did you take a wheelbarrow of cash in for deposit, so that your friendly banker could make some mortgage loans?<\/p>\n

Honestly, I can remember only one time in the past five years when I made a significant deposit of cash. I had received some $4000 or so in cash travel reimbursement in Colombia (in a dark and somewhat scary underground money changer\u2019s office), and walked around the streets of Bogota with a huge and suspicious bulge of Ben Franklins in my pocket. With some relief, I made it back home and immediately deposited it in my local branch.<\/p>\n

Other than that, all of my cash transactions have gone the other way\u2014withdrawals from the ATM. And if you think about it, you rarely see anyone making a large cash deposit in any bank. Unless you\u2019ve got a large cash business (dealing drugs or picking up garbage), you just don\u2019t receive enough cash to keep your bank supplied in green paper.<\/p>\n

Actually what I see is that almost everyone who goes to the bank takes cash out<\/em><\/strong>! Banks supply cash, they do not receive it in order to make loans. So how could that work? Because whenever banks need cash to meet withdrawal, they do not turn to depositors, rather they call up the Fed. The Fed trucks cash to the banks to stock the ATMs. In turn, the Fed debits bank reserves held at the Fed (these are just the private banking system\u2019s \u201cchecking account\u201d held at the Fed).<\/p>\n

Now what if a bank is short reserves\u2014will the Fed refuse to send the cash? No. The Fed lends reserves to cover the cash needs. Otherwise the bank would have to close its doors\u2014refusing to meet demands for cash\u2014which would scare the bejeezus out of other depositors and lead to runs on banks. So except for occasional hiccups you do not find the ATM machines shut down or bank doors closed due to cash shortages. Indeed, all money and banking texts that I know of insist that the nonbank public determines the supply of cash\u2014since banks promise to supply it on demand, the Fed provides banks with all they need to meet withdrawals.<\/p>\n

It is the Fed that brings the wheelbarrows of cash to the banks\u2014NOT depositors. And the Fed supplies cash NOT so that banks can make loans. Rather, the cash is to cover withdrawals from deposits.<\/p>\n

Oh, where does the Fed get the reserves it credits to bank \u201cchecking accounts\u201d at the Fed? Out of thin air\u2014keystrokes. Where does the Fed get the green banknotes it trucks to the ATMs? Out of thin air\u2014keystrokes instruct the printing press to print more.<\/p>\n

Do you notice a pattern here? Money is always created out of \u201cthin air\u201d.<\/em><\/strong><\/p>\n

So Krugman has got to have this banking business all wrong. Whatever deposits you make into banks are almost entirely deposits of bank IOUs. It is all bank money. Where did it come from? Well, from banks. Where did they get it? They created it. How? Thin air.<\/p>\n

Look at it this way. You can write an IOU to your neighbor: \u201cI owe you five bucks\u201d. It is your financial liability and your neighbor\u2019s financial asset. Where did it come from? Thin air.<\/p>\n

Did you have to get cash first to write the IOU? No. Do you have to have $5 in cash in your pocket to write the IOU? No.<\/p>\n

Now, you do have to \u201credeem\u201d your debt at some point. Your neighbor presents your IOU to you for redemption and you cough up the cash, or you write a check on your bank deposit, or you provide something else of value that is mutually acceptable. When you satisfactorily redeem yourself, your neighbor hands back your IOU and you tear it up.<\/p>\n

In this process, you \u201ccreated money\u201d out of \u201cthin air\u201d; the \u201cmoney\u201d was your IOU denominated in dollars. (The money you created is destroyed when you repay your debt.)<\/p>\n

Now, you might object: but how can that be money? It was just my debt held by my neighbor. It didn\u2019t circulate. The neighbor could not buy anything with it. Yes, that could be true.<\/p>\n

On the other hand, it is conceivable that you are well-known and trusted across your entire neighborhood. In that case, the neighbor holding your IOU certainly might be able to pass it in payment for her own IOU to another neighbor (a \u201cthird party\u201d). In that case, this other neighbor can present it to you for redemption. Or, your neighbor might hire a local kid to mow the lawn\u2014and then the kid presents it for redemption. So, at least in theory, your IOU could circulate to pay debts or to buy services.<\/p>\n

As Minsky always said: anyone can create money; the problem is in getting it accepted.<\/p>\n

What we are getting at is degree of \u201cmoneyness\u201d. I am making no claim that your IOU is as good as a bank\u2019s IOU\u2014clearly that is not the case. Banks are special. Except for government\u2019s own currency, nothing fulfills money\u2019s functions as well as bank deposit IOUs.<\/p>\n

But the dividing lines have always been blurred and are much more blurred today with all the innovations by banks and other financial institutions\u2014what we now call \u201cshadow banks\u201d. For example, except in crisis, money market mutual funds\u2014issued by shadow banks\u2014are almost equivalent to bank deposits. In crisis, however, the government backstop provided to banks in the form of FDIC insurance and Fed lender of last resort promises make bank IOUs much better bets than shadow bank IOUs.<\/p>\n

So, unless you\u2019ve got Uncle Sam standing behind you, your IOUs will be \u201cless liquid\u201d and thus inferior \u201cmoney\u201d in comparison to bank deposits.<\/p>\n

(To be sure, there are other reasons banks are special including their specialization in underwriting\u2014determining credit-worthiness, although it is apparent that all too-big-to-fail banks have forgot how to do that. We won\u2019t go into all that now.)<\/p>\n

All of that is a preamble to Minsky. I first learned my money and banking from John Ranlett\u2014who used his own textbook (still a good resource if you can find it). And by coincidence, my colleague Stephanie Kelton also studied money and banking with Ranlett. While Ranlett did teach the \u201cdeposit multiplier\u201d, he understood this as a relation between reserves and deposits, not that banks literally accept deposits and then lend them out. Further, alone among most recent textbooks, his showed that government spending increases bank reserves (not a topic for today, but a point recognized by MMT) that, too, are \u201ccreated out of thin air\u201d.<\/p>\n

If only Krugman had studied Ranlett he\u2019d never have made such a serious error.<\/p>\n

Fortunately, I then went on to study with Minsky\u2014who probably had the deepest understanding of banking of any academic economist.<\/p>\n

Sometime around 1983 he handed me a paper by Basil Moore on \u201ccontemporaneous reserve accounting\u201d (later published in the Journal of Post Keynesian Economics<\/em>) and asked me to read it and tell him what I thought. The paper went through the Fed\u2019s attempt at targeting the money supply growth through control of reserves, and argued that even with its change to the procedures used to calculate required reserves (discussed briefly above) the Fed would fail. Basil argued that the Fed must accommodate bank demand for reserves, and went on to argue that we should think of the supply of reserves as \u201chorizontal\u201d at the interest rate target. Later, in 1988, he published a book with the title Horizontalists and Verticalists. <\/em>Under Minsky\u2019s direction, I went on to write a dissertation and book (Money and Credit in Capitalist Economies<\/em>) with a somewhat different approach to the same topic.<\/p>\n

No need to go into that now. But what is important is that an entire literature developed that carried the views of people like John Ranlett forward\u2014so that today among economists as well as policy makers the \u201cendogenous money\u201d view is dominant. It is easy to find quotes by economists at the Fed, the BIS, and the other international agencies involved in money and banking to back this up.<\/p>\n

What Krugman is presenting is the equivalent to 19th<\/sup> century physics\u2014so out-of-date that it is not only misleading but downright embarrassing. His views on central bank control of bank lending through quantitative constraints on reserves has been rejected over the past three decades by almost everyone working in this field. And his view that banks take in cash then make loans was abandoned sometime in the 19th<\/sup> century.<\/p>\n

(Finally, according to Krugman, \u201cin the end, banks don\u2019t change the basic notion of interest rates as determined by liquidity preference and loanable funds \u2014 yes, both, because the message of IS-LM<\/a> is that both views, properly understood, are correct.\u201d Yet the ISLM model\u2019s synthesis of liquidity preference and loanable funds theory was shown to be a logical confusion by Keynes back in 1937. In 1975 Duncan Foley showed that the model\u2019s stock-flow relations are suspect. Even John Hicks\u2014the creator of the model\u2014abandoned it as confused nonsense in the 1980s. And mainstream macro finally dropped the LM curve altogether in the \u201cNew Monetary Consensus\u201d developed since 1990. So he\u2019s way behind the times on that, too. But all of that is too wonky for a blog.)<\/p>\n

Let us turn to a summary of Minsky\u2019s view of money and banking. In many of his writings he emphasized six main points:<\/p>\n

    \n
  1. a capitalist economy is a financial system;<\/li>\n
  2. neoclassical economics is not useful because it denies that the financial system matters;<\/li>\n
  3. the financial structure has become much more fragile;<\/li>\n
  4. this fragility makes it likely that stagnation or even a deep depression is possible;<\/li>\n
  5. a stagnant capitalist economy will not promote capital development;<\/li>\n
  6. however, this can be avoided by apt reform of the financial structure in conjunction with apt use of fiscal powers of the government.<\/li>\n<\/ol>\n

    Central to his argument is the understanding of banking that he developed over his career. Here I will focus on Minsky\u2019s general approach to financial institutions and policy; I will not provide specific recommendations for policy reform.<\/p>\n

    According to Minsky, \u201cA capitalist economy can be described by a set of interrelated balance sheets and income statements.\u201d The assets on a balance sheet are either financial or real, held to yield income or to be sold or pledged. The liabilities represent a prior commitment to make payments on demand, on a specified date, or when some contingency occurs. Assets and liabilities are denominated in the money of account, and the excess of the value of assets over the value of liabilities is counted as nominal net worth.<\/p>\n

    Indeed, all economic units\u2014households, firms, financial institutions, governments\u2014can be analyzed as \u201cbanks\u201d since they all take positions in assets by issuing liabilities, with margins of safety maintained for protection. One margin of safety is the excess of income expected to be generated by ownership of assets over the payment commitments entailed in the liabilities. Another is net worth\u2014for a given expected income stream, the greater the value of assets relative to liabilities, the greater the margin of safety. And still another is the liquidity of the position: if assets can be sold quickly or pledged as collateral in a loan, the margin of safety is bigger.<\/p>\n

    If the time duration of assets exceeds that of liabilities for any unit, then positions must be continually refinanced. This requires \u201cthe normal functioning of various markets, including dependable fall-back markets in case the usual refinancing channels break down or become \u2018too\u2019 expensive.\u201d<\/p>\n

    If disruption occurs, economic units that require continual access to refinancing will try to \u201cmake position\u201d by \u201cselling out position\u201d\u2014selling assets to meet cash commitments. Since financial assets and liabilities net to zero, the dynamic of a generalized sell-off is to drive asset prices toward zero, what Irving Fisher called a debt deflation process.<\/p>\n

    Specialist financial institutions can try to protect markets by standing ready to purchase or lend against assets, preventing prices from falling. However, they will be overwhelmed by a contagion, thus, will close up shop and refuse to provide finance. For this reason, central bank interventions are required to protect at least some financial institutions by temporarily providing finance through lender of last resort facilities. As the creator of the high powered money, only the government\u2014central bank plus treasury\u2014can purchase or lend against assets without limit, providing an infinitely elastic supply of high powered money.<\/p>\n

    These are general statements applicable to all kinds of economic units. This is what Minsky meant when he said that any unit can be analyzed as if it were a \u201cbank\u201d, taking positions by issuing debt.<\/p>\n

    Yet financial institutions are \u201cspecial\u201d in that they operate with very high leverage ratios: for every dollar of assets they might issue 95 cents of liabilities; their positions in assets really are<\/em> \u201cfinanced\u201d positions. Further, some kinds of financial institutions specialize in taking positions in longer term financial assets while issuing short term liabilities\u2014that is, they intentionally put themselves in the position of continually requiring refinancing.<\/p>\n

    An extreme example would be an early 1980s-era thrift institution that holds 30 year fixed rate mortgages while issuing demand deposits. Such an institution requires continuing access to refinancing on favorable terms because the interest rate it earns is fixed and because it cannot easily sell assets. This can be described as an illiquid position which requires access to a source of liquidity\u2014Federal Home Loan Banks or the Fed.<\/p>\n

    Still other kinds of financial institutions\u2014investment banks\u2013specialize in arranging finance by placing equities or debt into portfolios using markets. They typically rely on fee income rather than interest. In normal circumstances they would not hold these assets directly, but if markets become disorderly they can get stuck with assets they cannot sell (at prices they have promised) and thus will need access to financing of their inventories of stocks and bonds. Some might hold and trade assets for their own account, earning income and capital gains, or might do so for clients.<\/p>\n

    Thus there are many kinds of financial institutions. Minsky distinguished among traditional commercial banking, investment banking, universal banking and public holding company models.<\/p>\n

    A traditional commercial bank makes only short term loans that are collateralized by goods in production and distribution. The loans are made good as soon as the goods are sold\u2014this is the model the old Real Bills doctrine had in mind. The bank\u2019s position is financed through the issue of short term liabilities such as demand and savings deposits (or, in the 19th<\/sup> century, bank notes). The connections among the bank, the \u201cmoney supply\u201d, and real production is close\u2014the sort of relation the quantity theory of money supposed.<\/p>\n

    Essentially, the firm borrows to pay wages and raw materials, with the bank advancing demand deposits received by workers and suppliers. When the finished goods are sold, firms are able to repay loans. Banks charge higher interest on loans than they pay on deposits\u2014with the net interest margin supplying bank profits.<\/p>\n

    Note that banks do not sit and wait for deposits in order to lend. Rather the process is precisely the reverse: the bank accepts the IOU of the firm that needs to pay for wages and raw materials, then creates a deposit (or in the old days, a bank note) that the firm uses for its purchases. As endogenous money types say: \u201cloans create deposits\u201d\u2014not in some metaphysical sense but in the sense that the bank \u201cbuys\u201d the IOU of the firm by issuing its own deposit IOUs. It \u201cfinances\u201d its position in the firm\u2019s IOU by issuing its own deposit IOU.<\/p>\n

    Once the firm finishes production and sells the output, it receives deposits and uses these to retire the short term loan. Following our discussion above, the firm \u201credeems\u201d itself by bringing back to the bank the bank\u2019s own IOUs; repayment of the loan \u201cdestroys\u201d the bank deposits (the loans and deposits on the bank\u2019s balance sheet are simultaneously debited).<\/p>\n

    Now it is likely that many of the sales the firm makes are to consumers who bank at some other bank, so the firm receives bank checks (or, in the old days, banknotes) drawn on other banks\u2014and submits these to its own bank. But the checks are cleared (either through the Fed or a private interbank settlement system) at par. So it is not necessary for the firm to return to its bank that bank\u2019s own IOUs\u2014the IOUs of any bank will do.<\/p>\n

    If deposits are to maintain parity (with each other and with cash), losses on assets must be very small because the commercial bank\u2019s equity must absorb all asset value reductions. It is the duty of the commercial banker to be skeptical; as Minsky loved to say, a banker\u2019s clich\u00e9 is \u201cI\u2019ve never seen a pro forma I didn\u2019t like\u201d\u2014borrowers always present a favorable view of their prospects. This is why careful underwriting is essential.<\/p>\n

    While it is true that loans can be made against collateral (for example, the goods in the process of production and distribution), a successful bank would almost never be forced to take the collateral. A bank should not operate like a pawn shop. As Martin Mayer says, banking has always been a business where profits come over time as borrowers pay principal and interest. He alludes to the morality of a loan officer, whose success depends on the success of the borrower. It goes without saying that betting on the failure of one\u2019s borrower is inimical to the duties of a commercial bank. (Memo to Goldman Sachs: pay attention.)<\/p>\n

    The banker holds the key\u2014he is the \u201cephor of capitalism\u201d, as Minsky\u2019s original dissertation advisor, Josef Schumpeter, put it\u2014because not only do entrepreneurs have to be sufficiently optimistic to invest, they must also find a banker willing to advance the wage bill to produce investment output.<\/p>\n

    By financing the wage bill of workers in the investment goods sector, commercial banks are promoting the capital development of the economy even if they do not actually provide finance for position-taking in investment goods. Hence, we can separate the issue of producing capital goods from ownership of them.<\/p>\n

    For Schumpeter, and for Minsky, the \u201cephor of capitalism\u201d breaks the simple circuit of production and consumption of wage goods\u2014in which banks simply finance production of consumer goods by workers whose consumption exactly exhausts the wage bill required to produce them. In other words, the ephor allows generation of profits by financing spending of those not directly involved in producing consumption goods.<\/p>\n

    To go further would get us into complicated matters. But the next step would be to discuss the role of the investment banker, who finances the long term positions in capital assets. This is a quite different activity, which allows savers to choose between holding liquid (financial) assets or positions in real assets (either directly by owning a firm, or indirectly through ownership of shares). Glass Steagall maintained a separation of the investment banking and commercial banking functions. Lines were blurred when we first allowed bank holding companies to own both types of banks, and then gutted and finally repealed Glass Steagall. For those interested in Minsky\u2019s views on all of this, see my piece at the Levy Institute<\/a>.<\/p>\n

    Let\u2019s recap.<\/p>\n

      \n
    1. Banking should not be described as a process of accepting deposits in order to make loans.<\/li>\n
    2. Rather, banks accept the IOUs of borrowers, then create bank deposit IOUs that the borrowers can spend.<\/li>\n
    3. Indeed, often the bank simply accepts the IOU of the borrower and then makes the payment for the borrower\u2014cutting a check in the name of the car dealer, for example.<\/li>\n
    4. Like all economic units, banks finance positions in their assets (including IOUs of borrowers) by issuing their own IOUs (including demand deposits).<\/li>\n
    5. Banks use reserves for clearing with other banks (and with the government\u2014a topic not covered here). Banks also use reserves to meet cash withdrawals by customers. Bank reserves at the central bank are debited when they need cash for withdrawal.<\/li>\n
    6. In some systems, including the US, the central bank sets a required reserve ratio. \u00a0But this does not provide the central bank with any quantitative controls over bank loans and deposits. Rather, the central bank supplies reserves on demand but sets the \u201cprice\u201d at which it supplies reserves when it targets the overnight interest rate. In the US the main target is the fed funds rate. Fed control over banks is all about price, not quantity, of reserves.<\/li>\n<\/ol>\n

      That gets us up to a 20th<\/sup> century understanding of banking. Krugman could benefit by standing on the shoulders of a giant like Minsky.<\/p>\n","protected":false},"excerpt":{"rendered":"

      Last week I explained why Minsky matters, outlining his main contributions. This was, in part, a response to a blog post by Paul Krugman that appeared to dismiss the importance of trying to find out \u201cwhat Minsky really meant.\u201d But, more importantly, it was a response to his defense of a simple model of debt […]<\/p>\n","protected":false},"author":208,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[112],"tags":[133,243,156,30],"class_list":["post-4218","post","type-post","status-publish","format-standard","hentry","category-modern-monetary-theory","tag-banking","tag-endogenous-money","tag-krugman","tag-minsky"],"jetpack_featured_media_url":"","_links":{"self":[{"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/posts\/4218","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/users\/208"}],"replies":[{"embeddable":true,"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/comments?post=4218"}],"version-history":[{"count":3,"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/posts\/4218\/revisions"}],"predecessor-version":[{"id":4220,"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/posts\/4218\/revisions\/4220"}],"wp:attachment":[{"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/media?parent=4218"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/categories?post=4218"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/tags?post=4218"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}