Home > Uncategorized > Ulrich Bindseil, former head of the ECB liquidity management department, debunks ECB monetary policy

Ulrich Bindseil, former head of the ECB liquidity management department, debunks ECB monetary policy

from Merijn Knibbe

Wow. The most scathing criticism of the European Central Bank (ECB) money growth target and monetary policy I’ve read thus far is written by Ulrich Bindseil, ECB Deputy Director General of Market Operations and former head of liquidity management, and is published by… the ECB, in 2004. (Hat tip: Jesse Frederik)!

The idea: Central Banks can’t control the supply of money. They can either control interest rates (the price of money) or try to control the quantity of money – which they can’t. And surely not both. See this post for some additional literature. The European Central Bank however still has an official money growth target based upon the idea that the ECB can control the quantity of money, which they explain as follows (a quote from the 2011 “The monetary policy of the ECB” document which is linked on the Home Page of the ECB (p. 55).

“The way in which monetary policy exerts its influence on the economy can be explained as follows. The central bank is the sole issuer of banknotes and bank reserves, i.e. it is the monopoly supplier of the monetary base. By virtue of this monopoly, the central bank is able to influence money market conditions and steer short-term interest rates.”

A view of the world which, according to Bindseil, is nonsensical. He calls this the Reserve Position Doctrine and goes on to state that:

13. The lessons from the rise and fall of RPD

From today’s perspective, the rise and endurance of RPD, a fallacious doctrine on a key concept of monetary policy (the operational target), and its continued popularity in textbooks and some more recent academic work, are rather astonishing. This paper tried to explain the phenomenon of RPD. Academics developed theories detached from realityreality, without resenting or even admitting this
detachment. Economic variables of very different nature were mixed up and precision in the use of the different concepts (e.g. operational versus intermediate targets, short-term vs. long-term interest rates, reserve market quantities vs. monetary aggregates, reserve market shocks vs. shocks in the money demand, etc.) was often too low to allow obtaining applicable results. The dynamics of academic research and the underlying incentive mechanisms seem to have lacked a permanent pressure on monetary economists to investigate the realities of day-to-day work of central banks. From today’s perspective, one could feel that academic economists unconsciously colluded in their distaste for re-questioning the applicability of macro-economic models on day to-day implementation of monetary policy, and their lack of willingness to study the actual features of money markets and monetary policy operations. As Goodhart (2001) puts it: “large parts of macro-economics are insufficiently empirical; assumptions are not tested against facts. Otherwise, how could economists have gone on believing that central banks set H [the monetary base] and not i? In so far as the relevant empirical underpinnings of macro-economics are ignored, undervalued or relatively costly to study, it leaves theory too much at the grasp of fashion, with mathematical elegance and intellectual cleverness being prized above practical relevance.” Unfortunately, it needs to be admitted that the list of RPD inspired papers that contain empirical (econometric) analysis is long. Indeed, most of the more recent papers in the Poole-1970 tradition, as reviewed by Walsh, 2003, fall into this category. Also, a major work in terms of supporting the return to SID, namely Woodford (2003), is primarily of theoretical nature. One may therefore want to conclude that the decline of RPD suggests that empirical analysis (at least in the sense of econometric analysis) is neither sufficient, nor necessary, to correct mistaken avenues in economics. Central bankers failed to resist the reality-detached theories of academics, or even promoted them as they got convinced or as the theories served their aim to mask their responsibility for short term interest rate and thus for economic developments. It is an interesting, but difficult question to disentangle in how far exactly the adoption of RPD as official Fed doctrine on monetary policy implementation was deliberate “play-acting” to mask responsibility, and in how far it was just reflecting convictions. Goodfriend (2003) argues that the denial of responsibility was the dominating factor in the 1920s, and for instance Goodhart (2001) and Mishkin (2004) argue so for the 1979-82 episode. At the same time, there are arguments speaking in favour of the theory that many senior central bank officials believed sincerely into RPD. Originally non-public documents, such as FOMC transcripts of the 1979-82 episode, suggest this interpretation. Also statements as the one reported above from Warburg (1930), who, no longer being in service, was outspoken on the weaknesses of the Fed, while at the same time advocating RPD, seem to support the hypothesis that Fed officials believed at least partially in RPD. More importantly, one needs to admit that the majority of US monetary economists (and e.g. Keynes) were convinced of RPD, without any political economy explanation for that, and if academics were, why should central bank senior officials not have been as well? Of course, central bankers are more directly confronted to reality, but academics could have and often indeed looked at money markets and central bank procedures as well (again, Keynes is an example). If we can imagine academic economists to have been honestly convinced by some theory we believe today to be wrong, the same should probably not be denied to central bankers. In sum, it appears difficult to estimate the general degree of conscious play-acting by central bankers in their supposed RPD practice, probably also since it varied considerably across individuals and time. It seems also noteworthy that both groups, academic economists and central bankers, showed little interest in studying well-documented historical experience (e.g. Bagehot, 1873, King, 1936, Sayers, 1976). Overall, the 20th century thus seemed to have witnessed in the domain of monetary policy implementation a strange symbiosis between academic economists stuck in reality-detached concepts, and central bankers who were open to such concepts, partially since they allowed to avoid explicit responsibility. Masking responsibility seemed to be of particular interest whenever the central bank’s policies were strongly des-inflationary and thus causing recession and unemployment (in the US in 1919-21 and in 1979-82). If one wants to find out how the detour via RPD could have been avoided, it may appear natural to compare again the Fed and the Bank of England in the early 1920s, as the latter easily resisted, but the former did not. While one would probably not want to praise today and wish back the lack of transparency and accountability of the old Bank of England, it seems clear that major weaknesses of the Fed relative to the Bank of England, that we would still name weaknesses today, were its lack of independence, excess decentralisation, and lack of experience. Once the Fed had fallen into the trap of RPD (including a below-market rate discount rate), the experience that it would accumulate was rather opaque, and the likelihood that Bank of England experience would be considered declined more and more as the Fed developed its own traditions. As we want central banks to be accountable and transparent, the main conclusion we have to draw maybe, one more time, the need of central bank independence. If the Fed would have been fully independent from the US Government at least directly after WW1, it would probably have had far less incentives to deny the validity of well established central bank technique, namely that short term interest rates are the operational target of monetary policy.

Again: wow.

  1. January 29, 2012 at 7:16 pm

    Mr. Bindseil’s article proves that economists and bankers live in a dreamworld. No wonder the whole “science” of economics and monetary practice is so miserably ineffective. This is quite surprising given the utter simplicity and obviousness of what they both overlook.

    Money is created by retail banks as a “loan” to a borrower. In truth THE BORROWER CREATED THE MONEY by PROMISING TO PAY IT BACK TO THE BANK. Therefore every dollar, pound, euro or whatever that is created as bank credit has a FIXED APPOINTMENT TO BE PAID BACK to the retail bank that created it.

    But everyone treats this bank credit as if it were “money” and expects that this money will LAST FOREVER and GROW WITH INTEREST. Thus the whole monetary and economic system is based on a FUNDAMENTAL CONTRADICTION and IMPOSSIBILITY that economists and bankers seem to ignore altogether.

    All bank credit money is “same money lent twice”… lent once into existence as a “loan” and a second time as a “deposit” in the banking system (loan to the bank). As long as bank credit remains “twice-lent” it will never be available to be earned debt-free by the original borrower and extinguished as a Principal payment on the loan that created it.

    Deposits of existing bank credit “money” may be lent again as loans of existing money by non-bank lenders. Non-bank lenders rolling their ball of money like a snowball to make it bigger make it impossible for multiple money-creation loans to be repaid, as the Principal created by the money-creation loans is NOT available to be earned debt-free (systemically) by the borrowers that created it.

    It is a simple matter to prove that “twice-lent” money is the root of monetary instability, even in the theoretical case of ZERO interest. Whenever the growth of new “loans” slows down, there must be MATHEMATICALLY INEVITABLE DEFAULTS that lead into a DEFLATIONARY DEATH SPIRAL and Depression.

    Periodic slowdowns are inevitable. Therefore THE SYSTEM IS DESIGNED FOR PERIODIC CRASHES, in which borrowers lose their collateral due to mathematical impossibility alone. The greater the loan-creation “acceleration”, the bigger the subsequent crash will be when loan creation decelerates.

    Only simple grade school arithmetic is needed to make this proof. Therefore it is feasible for anyone with the willingness to do so to examine and attempt to prove or refute my thesis. I have invited several economists, including members of this Journal to do so. So far my thesis stands unchallenged.

    I invite the entire roster of this Journal to REFUTE my thesis.

    The Banking System, Itself, is the ROOT CAUSE of Money System Instability by Paul Grignon to be found at moneyasdebt.net.

    If anyone knows Mr. Bindseil, please pass my challenge on to him as well.

    Paul Grignon, creator of the animated Money as Debt movie trilogy.

    • Anonymous Economist
      January 30, 2012 at 8:08 pm

      Paul, I suspect you are committing a stock/flow consistency error. Debt is a stock. Interest is a flow of revenue to the bank. Importantly, there is also a flow of expenditure by banks to the private sector (paying for tellers, bank machines, rent, private jets, lobbying, etc.) Banks are not black holes.

      Consider a two sector model with banks and households. Suppose bank lending to households is exactly balanced by repayment. These are flows. Integrate their difference over time and you get the level of debt. Suppose also that bank expenditure is exactly balanced by interest paid on debt. These are also flows, determined by the stock of debt. Both sectors are earning sustainable positive income, debt being rolled over continuously. This simple model shows that a debt-money system with positive interest is theoretically sustainable once you take into account continuous time.

      See Steve Keen “Solving the Paradox of Monetary Profits” for details on the basic model, and his other works for more sophisticated models.

      • January 31, 2012 at 4:02 am

        Dear Anonymous Economist,

        I “suspect” you didn’t read my analysis, nor have you seen my movies, as you are arguing what my analysis disproves as if you think I must be unaware of it. I have constructed 3-D models of the situation you describe for my movies and shown it to be a fallacy, just as the P < P+I "shortage" so many people get upset about is imaginary.

        Steve Keen emailed me to say he has read my analysis and thinks there is an error with "same money lent twice" but has yet to refute it.

        You could be the first.

      • Dave Taylor
        January 31, 2012 at 12:31 pm

        Anon., I am sure you are committing a logical error, for a debt is not a stock, it is the absense of a stock.

        Paul, I certainly baulk at the terminology of “same money lent twice, but I understand what you are saying. Logically, the bank’s money AT THE TIME IT IS LENT is an empty concept – a reference to a reference, see Russell’s Paradox – whereas the borrower’s promise to pay it back refers to future real value. Sure what the banker lends out should be returned, so its actually being turned into real value by a shopkeeper etc can be accounted for, but we shouldn’t be paying the banker something extra for nothing. He is of course entitled to the cost of printing the money and a little for his time and machinery, but that’s about it. We owe the shopkeeper as the representative of society, not the bank, and if the money we repay is recycled by the bank, it is recycled empty, for it has done its job: it has been turned into real debt and our debts have been put on record in our account. If it has been put on record as a credit to the banks account, that’s fraud.

  2. January 30, 2012 at 4:39 am

    The only way you can keep the system going is to “fix the figures” which is now being done creatively both in the visible and invisible financial system.
    And if Big Brother have us all cowering before his might, who is there to challenge his numbers?

  3. January 31, 2012 at 5:41 pm

    Sorry Dave, but that is not what I am talking about. I do wish someone would address my actual proof instead of their own assumptions .

    My proof identifies several simple and purely mathematical causes of money system instability, all of which can be categorized as one or another form of “same money lent twice” (or n times). My proof specifically addresses why the system collapses in the absence of debt-growth. It explains the current crises as part of the banking system itself, AS DESIGNED, regardless of any particular circumstances that trigger these crises, and even in the complete absence of interest.

    Not once have I read any similar analysis in 13 years of study. Yet it is so simple and so obvious it can be explained to a child in a few words. One might even say it is “axiomatic”.

    My movies have already reached tens of millions of people worldwide, and since 2009, when it was first published, no one has even attempted to refute my theorem.

    You too could be the first.

  4. Anonymous Economist
    February 1, 2012 at 12:24 am

    My apologies, I have not in fact seen your movie or read your work.

    Unfortunately, I deal a lot with the crowd who gets upset about P < P + I, so explaining Keen right off the bat is a sort of automatic response whenever I hear a similar line of reasoning. I still suspect you have a stock/flow consistency error, but I will look further in to this (and, yes, debt is still a stock – it is integrated over time – even if it is the counterpart of another stock – bank credit.)

    Also, I think you should take a page from the MMT book and avoid using the term "money" except in a general sense. "Same money lent twice" is a bizarre and confusing term for what sounds like double-entry bookkeeping. Bank credit, cash, and settlement balances are more precise terms which would help alleviate the confusion.

    • Anonymous Economist
      February 1, 2012 at 12:39 am


      Nevermind the comment about the term “money”, I see you’ve done a decent job of using more precise language on your site.

  5. February 1, 2012 at 1:00 am

    This is the URL for the initial 14 minute segment of Money as Debt III – Evolution Beyond Money.

    P <P+I is dealt with in the first chapter and "same money lent twice " is explained in the second.

    I have to use the term money because the same dynamic can also potentially arise using gold coins or paper cash.

  6. Dave Taylor
    February 1, 2012 at 3:29 am

    There are of course none so deaf as those who don’t want to hear. The integral of zero is zero, Anon (to say nothing of repeating yourself, increasingly often, adding no information). I had seen your films, Paul, and only quibbled about your choice of words; but there is more than one way of skinning a cat, and perhaps the same thing needs saying in different ways to so that different types of people can see the point at issue.

    P < P + I emphasises the infinity causing mathematical failure of the present system (which would be indefinitely put off, incidentally, were the I to represent a transaction cost instead of a percentage). Paul's argument is elegant and emphasises the dynamic of the system, assuming money IS debt and doesn't merely represent it; he's got it, but I think he will find the studies leading up to Lonergan's "Macroeconomic Dynamics" were fishing around for the same thing. Mine understands what money is in terms of its communication within macro flow paths between different types of function within the economy; it shows how most of the money is not "not being spent" but stored by being recycled uselessly, buying and selling fictitious entitlements in the stock markets. Helge's "fixing the figures" and the ancient practice of Jubilees are two ways of fixing the system, but another (mine) is to give each other credit as we need it (as when I give a hitch-hiker a lift); recognising such "lifts" as our debt, gratefully keeping account of them and what we have done to repay them – much, indeed, as we do now. Our personal or business accounts will be automatically extinguished when we or our projects die. That way, as with yours, Paul, our money doesn't get recycled, but nor is there any need for stock market securities and National Debts.

  7. Hepionkeppi
    March 3, 2012 at 5:46 pm

    Paul Grignon, I appreciate your animations and work you have done informing general public.

    That said, you entire thesis rest on an asumption there can be shortage of money ‘things’ that answer to the description of monetary units.

    Whereas theory of chartalism or modern monetary theory as it is nowadays called teaches us that government creates money as it spends, and it leaves net money balances in the hands of the private sector as it spends more than it taxes.

    Therefore there only can be ‘general shortage of money’ as a result of bad policy decisions. Appropriate conduct of policy is to provide more money ‘things’ as there is need for them. But this is not widely understood among policymakers. Unfortunately it is hardly understood at all.

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