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Paul Gambles,
Director MBMG
Investment Advisory |
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How a Central Bank contradicts itself, part 2
Endogenous money
Foremost among those economists who have long rejected the
‘state-of-the-art’ in their models, and refused to teach it in their
classrooms, is Professor Steve Keen: a long-time proponent of the
alternative view, endogenous money - i.e. that everyone in the economy has a
role in affecting the value of currency, not just central banks.
Anyone who heard Prof. Keen speak in Bangkok last year would have seen him
show very simply that his endogenous money beliefs stand up to real-world
tests, whereas neo-classical models did neither and also failed the common
sense test. The ‘man on the Clapham omnibus’ knows that borrowing your way
out of debt while your returns are dwindling makes no sense.
Dr. Terzi suggests that, “The views expressed in the BoE publication do not
come out of the blue. Several studies have recently challenged the notion of
the money multiplier. The fact that this is now stated by a central bank
marks good progress in the understanding of monetary operations, especially
in light of conventional wisdom having inspired a number of erroneous
interpretations during the banking and financial crisis.”
The BoE article also stated that another common “misconception” about QE was
that it “involves giving banks ‘free money’ “; it also explains how the
amount of central bank money (banknotes and bank reserves) is fixed by the
demand of its users and not by the central bank “as it is sometimes
described in some economics textbooks.”
The article then seems to try to underplay its own admissions or re-think
policy. As Dr. Terzi points out, “The BoE makes two accurate statements
regarding central bank money (banknotes and bank reserves): 1) it is not
chosen or fixed by the central bank; 2) it does not multiply up into loans
and bank deposits.” This would seem to imply that a central bank does not
control the money supply.
However, the BoE concludes that a central bank can “influence the amount of
money in the economy. It does so in normal times by setting monetary policy
- through the interest rate that it pays on reserves held by commercial
banks with the Bank of England. More recently, though, with Bank Rate
constrained by the effective lower bound, the Bank of England’s asset
purchase programme has sought to raise the quantity of broad money in
circulation. This in turn affects the prices and quantities of a range of
assets in the economy, including money.”
This came as a surprise to Dr. Terzi: the Swiss-based economics professor
suggests that more work needs to be done in understanding the linkages
between policy actions and their results, in terms of how changing interest
rates impact bank lending and thus the money supply and the overall economy.
“This view that interest rates trigger an effective ‘transmission mechanism’
is one of the Great Faults in monetary management committed during the Great
Recession.”
“There are various channels through which interest rates influence demand,
output, and the price level, yet none is empirically strong, and some work
in different directions,” he adds. “Bank lending is primarily pro-cyclical,
as a famous quote attributed to Mark Twain explains effectively (“A banker
is a fellow who lends you his umbrella when the sun is shining, but wants it
back the minute it begins to rain”), and the Global Crisis proved central
banks to be powerless in trying to reverse this course. The reality is that
the level of interest rates affects the economy mildly and in an ambiguous
way. To state that monetary policy is powerful is an unsubstantiated claim.”
Please Note: While every effort has been made to
ensure that the information contained herein is correct, MBMG Group
cannot be held responsible for any errors that may occur. The views of
the contributors may not necessarily reflect the house view of MBMG
Group. Views and opinions expressed herein may change with market
conditions and should not be used in isolation.
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