The fallacy of ‘exogenous’ money – Jens Weidmann edition
Update: see, about exogenous money and what might be called the ‘Weidmann fallacy’ also this speech by Jaime Caruana, general manager of the Bank for International Settlements.
from Merijn Knibbe
Jens Weidmann, boss of the Bundesbank, held a speech about money. The subject was highly interesting: money and inflation in Goethe’s ‘Faust’. The speech was interesting too – but for the wrong reasons. What’s the matter?
Economic statisticians basically use three different definitions of money:
* A modern neo-classical one, the ‘divisia’ definition
* An ‘Austrian’ one
* And an economic-statistical definition, used by central banks (see graph 14 of the September 2012 issue of the ECB Monthly bulletin)
I like the last one, as it uses double entry accounting which enables you to show where the money came from and where it went: different kinds of loans create different kinds of deposits. It also clearly shows that banks plus borrowers together create money out of thin air – money creation as a social act. This enables you to bring all kinds of social, legal and economic changes like the deregulation of mortgage markets into the analysis of money. But the modern neo-classical one (‘divisia’ money) and the Austrian one are consistent, too, in the sense that they are based upon a spelled out concept and sound operationalisation.
The concepts behind these definitions focus on ‘money as a means of exchange’, ‘transaction money’. As a consequence, ‘base money’ (liquid reserves of banks), which is not used for exchange is not included in the operational definition. For geeks and teachers of economics: see for the concept and a very recent change in the operational definition of the economic-statistical definition of money ‘Box 3′ of the September 2012 issue of the Monthly Bulletin of the ECB linked above.
But Jens Weidmann used neither of these definitions. Instead, he talked about base money, i.e. exactly the stuff which according to the traditions mentioned above should not be included in our definition of transaction money. Using base money as a concept means that Weidmann implicitly uses the (outdated) idea of a stable, mechanic relation between base money and transaction money. He explicitly states that central banks create ‘money’, as opposed to the idea that normal banks and borrowers do this. This is what’s called the ‘exogenous money’ view: a head of a central bank says ‘let there be more money’ – and there will be more money. And more base money mechanically leads to more transaction money (and inflation) according to this view. But alas, central bankers are not that powerful. Before 2008 the Irish and Dutch and Spanish real estate bubbles and, after 2008, the development of the balance sheets of the banks have made it abundantly clear that a top down increase of the amount of base money does not, in any mechanic sense, lead to or is needed for an increase in transaction money in the short and medium run. To the contrary. Increasing the amount of base money is somewhat like putting more money into an ATP machine, assuming that when you put more money into it people will take more money out of it. But the real mechanics are the other way around. When people take more paper money out of the machine the banks have to provide this: money is ‘endogenous’ (money inside the machine is owned by the bank and therefore defined as base money, when you take money out of it you buy this paper money with your deposit money or with an overdraft loan and it becomes part of transaction money). When the economy ‘asks’ for an increase in transaction-money, for instance because people want more and higher mortgages, banks will often provide this, regardless of the intentions of the head of the central bank. It is disheartening and even frightening that Weidmann still does not understand this.
What would this Goethe guy by the way have thought of all this? Well, we know. He clearly stated that double entry accounting was one of the most beautiful inventions of the human mind ever, “Welche Vorteile gewährt die doppelte Buchhaltung dem Kaufmanne! Es ist eine der schönsten Erfindungen des menschlichen Geistes, und ein jeder gute Haushalter sollte sie in seiner Wirtschaft einführen”!
Meta: Box 3 of the September issue of the Monthly Bulletin in fact accepts the Austrian idea of excluding MMF/CCP’s (Money Mutual Funds/Central Counterparties) shares from the operational definition of transaction money.