Home > The Economics Profession > The IMF gets radical?

The IMF gets radical?

from Steve Keen

An IMF working paper has received a lot of attention recently – and not for the usual reasons. Whereas the IMF is usually criticised for being dogmatic about free market economics and effectively beholden to the banks, this paper is being both praised and criticised for wanting to radically reform them.

This clearly isn’t official IMF policy, but the fact that it has been released by the IMF is noteworthy, and the paper deserves careful attention. It is an enormous paper, not just in length (56 pages of text) but also in the range of topics covered, and it will take at least three posts to do it justice. In this one, I’ll focus on its analysis of today’s monetary system.

I had better declare an interest at the outset. I have met chief author of the paper, Michael Kumhof, at several conferences now – twice at the American Monetary Institute, once at INET in Berlin, and once at Ireland’s Institute for International Affairs – and I consider him a friend. What I especially like about Michael is his intellectual openness. Though he works strictly in the neoclassical paradigm, unlike the vast majority of neoclassical economists, Michael is open to other approaches. Most importantly, Kumhof takes money, debt and banks seriously, whereas most neclassical economists delude themselves about banks with the naive “loanable funds” model

This realistic perspective on banking is the hallmark of the first, very literary, section of the paper, which discusses both the actual mechanisms of money creation now and the historical debate about the nature of money and the proper role of banks. I do urge everyone to read this section, since it is so rare to have the actual practices of banking realistically discussed in a formal academic paper, let alone one issued by the IMF.

The contrast between Kumhof and Jaromir Benes (the paper’s co-author) and run-of-the-mill neoclassicals like Paul Krugman on the role of banks is quite stark. Krugman stated the essence of the Loanable Funds model in his opening salvo on my primer on Minsky earlier this year:

“If I decide to cut back on my spending and stash the funds in a bank, which lends them out to someone else, this doesn’t have to represent a net increase in demand.”

Benes and Kumhof describe this perception of banks as mere intermediaries between savers and borrowers as the hallmark of someone who doesn’t understand banking:

“The critical feature of our theoretical model is that it exhibits the key function of banks in modern economies, which is not their largely incidental function as financial intermediaries between depositors and borrowers, but rather their central function as creators and destroyers of money. A realistic model needs to reflect the fact that under the present system banks do not have to wait for depositors to appear and make funds available before they can on-lend, or intermediate, those funds. Rather, they create their own funds, deposits, in the act of lending. This fact can be verified in the description of the money creation system in many central bank statements, and it is obvious to anybody who has ever lent money and created the resulting book entries.”

Table one shows a very parsimonious vision of the “resulting book entries” for both models – abstracting from all intermediate steps.

Table 1: Parsimonious comparison of Loanable Funds and Bank Lending

Banking sector
Models of Lending

In Krugman’s “loanable funds” model, all the action is on the liabilities side of the banking system’s ledger: money is taken out of ‘Patient’s’ deposit account (a debit, shown as DR in the table) and transferred to ‘Impatient’s’ (a credit, shown as CR). Patient’s deposit account falls and patient has less spending power; Ipatient’s account has risen and he/she has more spending power, and in the aggregate, the two cancel each other out. Neither new money nor additional spending power has been created (except at the margin, if Impatient is a spendthrift and Patient is a miser).

In Kumhof’s model, there’s action on both sides of the ledger: the banking sector’s level of loans rises by $X, and the deposit account of the “Impatient agent” (to use Krugman’s terminology for borrowers) is credited with $X. Money and additional spending power has been created pari passu with additional bank debt. Impatient’s spending power has risen, without any offsetting fall in patient’s spending power. Bank reserves also play no role in the process (they have a transitory role in a slightly more complicated example here, but the end result is the same).

Kumhof’s model accords with the “endogenous money” approach that I take, and as he notes emphatically in the paper, this is the actual process of lending that some central banks have been trying to get academic economists to understand for decades – and so far to no avail. He cites two central bank papers that add to my arsenal of similar statements. Here’s the one from the New York Fed:

“Suppose that bank A gives a new loan of $20 to Firm X, which continues to hold a deposit account with bank A. Bank A does this by crediting Firm X’s account by $20. The bank now has a new asset (the loan to Firm X) and an offsetting liability (the increase in Firm X’s deposit at the bank). Importantly, bank A still has $90 of reserves in its account. In other words, the loan to Firm X does not decrease bank A’s reserve holdings at all.”

One wonders how much longer neoclassical economists like Krugman will continue to dismiss such views as the province of “Banking Mystics”. To Kumhof’s great credit (pardon the pun), his is the first theoretical neoclassical paper to acknowledge the actual nature of banking, and to try to take this into account in a mathematical model.

I’ll cover the model in a future post, but there’s also much more to the literary section of the paper that is worth reading – in particular, his treatment of the history of money, banks, debt, and Debt Jubilees. I’ll cover those issues next week.

  1. November 12, 2012 at 5:32 pm

    Steve Keen,
    Illustrate that the establishment are conpersons first. Show people this:

  2. November 13, 2012 at 11:53 am

    I would like to see the IMF commission research into the proportion of global debt which is predicated on land values:o)

  3. Mysjkin
    November 14, 2012 at 12:10 pm

    If banks don’t have to borrow from each other or from depositors, why do they do it then? I mean, according to you they can create money out of nothing, so why would they bother attracting funds from other people? How can banks make losses if the money they use for loans is created ex nihilo?
    How could German banks influence the lending behaviour of Spanish banks, if the Spanish banks can create money out of nothing? What about some banks in Southern European countries that have no problems with capital requirements but still are unwilling to extend credit? And why would they give bonds as collateral to the ECB to borrow money from the ECB, if they can create money ex nihilo? How do these things fit in endogenous money model?

    • December 5, 2012 at 6:41 pm

      Mysjkin asks: If banks don’t have to borrow from each other or from depositors, why do they do it then?

      They have to is the reason.

      Example: The bank creates a $100 promise of legal tender on demand for the borrower who spends it at the seller’s business. This $100 can be secured by collateral like a mortgage or be unsecured like student loan, line of credit and credit card debt. The seller deposits the $100 promise of legal tender on demand back into the bank (where else can you store bank credit?). The bank doesn’t need any legal tender at all as long as the promise of legal tender on demand remains indefinitely deferred as a deposit. The central bank exists to supply the legal tender if demanded.

      All banks do the same thing, so from a system wide perspective, the banking system is the same thing as one bank. Money is created from the borrower’s promise to pay it back. Very little else is relevant.

      If “we” includes the national taxpayer and “banks” includes the central bank then this statement is literally true “Banks can create as much money as we can borrow” or another way, the banker says “If IOU what you owe me then you have money that you owe me.”

      9 min animated explanation:

      What the Heck is a Bailout?

      My full analysis which is consistent with (and goes beyond) the IMF paper’s analysis
      (thank you Kumhof and Benes!)


  4. November 14, 2012 at 2:12 pm

    Mysjkin, they make their books balance by demanding title deeds (e.g. of stcks and shares or deeds of ownership of a house) as the condition of their creating money out of nothing. They make profits by charging interest (rent) for the imaginary value of the money they have created by writing an amount of credit in a bank account, and by inflating the prices of the mortgaged securities. That works well when the mortgagees are being conned into thinking their assets are increasing in value; the bank can then lend more money for more speculative activies. The problems arise when the bubble bursts and the nominal value of the securities falls to a more realistic level, way below what the bank has lent out. The banks’ books no longer balance and all those who have been storing their entitlement to money in the banks thinks they may not get their money back. This time round governments have mortgaged their countries to enable the banks to balance the books. The sane way would have been to write down the loans they have financed in proportion to the deflation of the bank’s unjustified nominal value. The banking system has after all given nothing: only a few days use of a credit limit facilitating transactions. They have in return been claiming on-going entitlements to other people’s property until not just the money has been paid back but sometimes much more than that in “interest”.

    The problem of the Spanish banks and the obtuseness of the German ones is that of the self-fulfilling prophecy. Because people have been conned into believing that money is valuable, they will act like it is and powerful governments will unnecessarily enforce austerity on people whose governments have cash flow problems, even those engineered by speculators gambling with other people’s property and livelihoods.

  5. Jan
    November 15, 2012 at 12:04 pm

    If a bank lends for example 1000 euro to a customer, and after this fact borrow the necessary reserves, how much will they borrow? Do they borrow funds that cover the full 1000 euro or only the fraction that is needed for the reserve requirement? How, for example, does this mechanism work when there’s no reserve requirement, like in Sweden?

  6. November 15, 2012 at 1:47 pm

    Jan, banks will only borrow the necessary monetary reserves from each other if they have to. What they usually try to do is cover the lending by borrowing back from the borrower not monetary things but things of real value like the title deeds of your property. The game is to encourage you to borrow more by inflating the price of your property, then to sieze the real assets when the price deflates, your income declines and you aren’t covering your borrowing. Banking is only a sideline here: the real business is pawnbroking. And you can read that both ways: if the expendable pawn is your title deeds they are brokering them, and if you are the pawn they are hoping to break you.

  7. Jan
    November 15, 2012 at 3:31 pm

    Michael Hudson writes:

    “Bankers also create credit freely – when they make a loan and credit the customer’s account, in exchange for a promissory note bearing interest. Today, these banks can borrow reserves from the government central bank at a low annual interest rate (0.25% in the United States) and lend it out at a higher rate. So banks are glad to see the government’s central bank create credit to lend to them.”


    What exactly does the central bank lend to banks? According to you, nothing? But what does Hudson mean?
    I must emphasize that I am not criticizing the theory of endogenous money creation. I haven’t received much formal training in economics. I am just trying to understand the world of finance and economic processes.

  8. November 15, 2012 at 7:29 pm

    Jan, thank God I haven’t received much formal training in economics either.

    I found the Michael Hudson piece spendid, especially his focus on engineering deflation by storing e.g. $450 billion just in Swiss bank accounts. Where he differs from me is that he hasn’t spotted that the banks (central or otherwise) do not lend credit but authorise a credit limit. The actual credit is given by the providers of real goods and services, who are able to bank authorisations of real credit of equivalent value. The US and UK governments have been authorising credit It is not that the banks do nothing. They lend nothing in the sense that what they provide is a service, not valuable goods, and you cannot lend a service, you do it. They do us a disservice by authorising credit to speculators and conning us into paying cumulative monetary interest to them instead of helping regenerate the real wealth our nation has given us on tick.

    I don’t expect you to believe this because I say it. I’m not just parroting something I heard. I worked it out for myself when I heard the story of Henry VIII borrowing money to arm his flag-ship Mary Rose, which sank before it got out of Portsmouth harbour. Henry was the indebted Merchant of Venice whose heart Shakespeare’s moneylender Shylock had no legal right to cut out, but sadly, it was his government which reauthorised usury.

    • November 16, 2012 at 9:15 am

      Jan, sorry for the abruptness of the above, also the inflation of Hudson’s “reported $45 billion”, I was due to go out. If there seems little connection between Hudson and the Mary Rose, let me remind you of Newton’s apple. That’s just the way discoveries happen sometimes. I would have provided you with the link to “The Money Makers” video, which details the evidence, but I see that has been nobbled. after what has happened to the BBC since the Kelly affair I’m not surprised.

      What does Hudson mean by ‘reserves’ when he says “Today, these banks can borrow reserves from the government central bank at a low annual interest rate (0.25% in the United States) and lend it out at a higher rate”? At one time it would have been entitlement to the gold in Fort Knox, but now there isn’t any. More recently it would have been as debt backing the issue of guilt edge bonds, whereby the government committed the nation to repay (with interest) money borrowed from (in my view credit authorised by) the central bank. From what Hudson says here it seems the authorisation has gone by means of bank deposits rather than debts, but short of the national Treasuries becoming a bank of last resport, where did the deposits come from? And what did they physically consist of? I cannot believe the trillions amount to anything more than electronic authorisation of credit in the central bank’s reserve account. With the widespread availability of debit and credit cards, what would be the point of printing trillions of dollar notes for the causal purchases which are all they are used for now?enough circulating

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