Home > Uncategorized > Cecchetti and Kharroubi on the non-neutrality of money

Cecchetti and Kharroubi on the non-neutrality of money

Is money ‘neutral’? Is it just a veil over ‘real’ transactions? Or does it affect the level and composition of ‘real’ expenditure? Stephen Cecchetti and Enisse Kharroubi recently published an article which in a very net way shows that money (and credit) is non-neutral. It’s not a veil. It’s part of the essence of our economy. The abstract:

We examine the negative relationship between the rate of growth of the financial sector and the rate of productivity growth. Using a panel of 20 countries over 30 years, we establish that there is a robust correlation: the faster the financial sector expands, the slower the real economy grows. We then proceed to build a model in which this relationship arises from the fact that investment projects that are easier to pledge as loan collateral have lower productivity. As the financiers improve their ability to recover collateral in default, entrepreneurs expect credit to grow more quickly. As a consequence, they choose to invest in more pledgeable/less productive projects, reducing productivity growth. We take this theoretical prediction to the data and find that financial growth disproportionately harms industries the less tangible their assets or the more R&D intensive they are. “

  1. June 1, 2016 at 3:13 pm

    Do you know if anyone has researched a possible monetary system where the collateralised asset is not loans on large durable assets but the instant stock of non-durable value-add?

    For example one like this: I catch a fish worth $1, the banking system gives me (or someone) $1 to match. You fry and serve the fish making it worth $2, so you added $1 of value, the banking system creates another $1 somehow. Yanis eats the fish, paying $4, of which $2 is tax and gets destroyed.

    • June 2, 2016 at 2:55 pm

      I did something along these lines: http://www.paecon.net/PAEReview/issue70/Kowalik70.pdf

    • June 11, 2016 at 11:40 am

      I’ve been arguing a credit card system does just about this. What’s missing is the need for Yanis to [be motivated to] rear a cow to earn his £4, and you to catch another fish.

      I wish I’d got round to reading Michael’s paper when it was first published: its as good an analysis of the issue of money being a re-presentation as I’ve come across.

      I’ve argued much the same, but in (to this audience) the way-out terms of the fundamental difference between physical and information science (spelled out by C E Shannon in terms of the physical carrying information), and of the scientific [now programming] language Algol-68 distinguishing its data [representations] not only from from its physical variables (storage addresses, “holes to put data in”) but also from modes of interpretation (types of variable) and the procedures/temporary storage necessary to operationalise such interpretations using physical switching logic. I’ve gone on from agreeing with Michael about monetary re-presentation of value to doing so in terms of complex numbers and within an economy characterised as a PID control servo (macro) or in detail a computer-like network coordinating many such (micro).

      If money has to be circulated, I really like Michael’s wanting to tax the right things; what’s missing is discussion of whether it needs to be circulated. In the physical model of a battery-operated electric circuit it appears to at the macro level but at the micro level in fact it doesn’t. An electron reaching one plate in the battery releases a physical atom which migrates to the other side to balance its effect. In the long run the battery has to be replaced or recharged via an externally powered electron circuit. Likewise, one can run up debts in a credit card system but in the end one has to earn one’s keep.

  2. June 2, 2016 at 5:05 am

    1. The deeper question is WHY is Veil of money so often and so confidently asserted when it is exactly the opposite of the truth, and furthermore, this is EASILY verifiable empirically? The answer is that those who have the power to create money create these myths in order to obscure the reality. See my earlier post on this blog: https://rwer.wordpress.com/2016/04/26/the-veil-of-money/

    • jlegge
      June 2, 2016 at 7:12 am

      Fair comment

  3. June 9, 2016 at 6:01 pm

    I have spent a bit of time studying the paper recommended here, “Why does financial sector growth crowd out real economic growth?” by Stephen G Cecchetti and Enisse Kharroubi of the Bank of International Settlements. As someone originally trained in physics this paper strikes me as embodying everything that is wrong in economics. One day I want to publish a longer analysis of the problems, as I see it, with this paper, but here I’ll content myself with just a few remarks.

    The problem starts with the title “Why does financial sector growth crowd out real economic growth?” The verb “crowd out” is transitive and strongly implies causality, so we already have an answer to the question the paper sets out to address, which is whether there is a causal link between financial sector growth (in scientific terms the independent variable, X) and decreased productivity (the putative dependent variable Y). Now, it is perfectly scientific to take the data and observe that in developed nations during a certain period there is a negative correlation between Y and X. It is good science also to search for a causal link, a mechanism, under certain conditions of period and location, between X and Y. The paper suggests a number of such mechanisms, though no claim is made that the list is exhaustive. Instead, very early on, we are informed as to the authors’ choice of mechanism, a causal chain that runs roughly like this.

    (1) As the financial sector grows greater funding is available; (2) entrepreneurs choose projects on the basis of projected future funding opportunities; (3) entrepreneurs face a trade-off between return and size as returns are lower the larger the project (4) because entrepreneurs know that future funding will be greater than present funding they choose larger projects; (5) therefore as the financial sector grows productivity decreases.

    Step (1) is easily verifiable and uncontroversial. Steps (2), (3) and (4) are unproven assumptions of the authors. Step (5) is what the authors set out to prove. If we don’t agree with assumptions made in steps (2), (3) and (4) then we cannot agree with the conclusions, however much maths is thrown at us. But let us think a little more about the intervening steps in the alleged causal chain. How could we establish beyond doubt that entrepreneurs choose projects on the basis of projected future funding opportunities? Through a thorough survey-based research programme. How could we establish beyond doubt that entrepreneurs recognise the trade-off between return and size when choosing projects? Through another thorough survey-based research programme. How could we in any case establish beyond doubt that larger projects yield lower returns? By looking at the data. But it does not occur to the authors to do any of these things. Therefore the alleged causal chain appears to have no substance to it.

    When I first read the paper it struck me, as do so many papers in economics, as an elephant (the maths, the models etc), balancing on a road-cone (the assumptions). After a while I thought of something less robust than a road-cone: a meringue. The meringue in this case is steps (2), (3) and (4).

    Nothing in this paper convinces me that there is in fact any causal flow from X to Y, any reason at all to think that financial sector growth during a certain period in the developed world is causative of slowing or reversing productivity (where it is not in other periods and in the developing world). As a trained scientist I must consider that both X and Y may, for example, be variables dependent on some other factor Z, or that there is no causal relation at all.

    • June 9, 2016 at 8:24 pm

      “… any reason at all to think that financial sector growth during a certain period in the developed world is causative of slowing or reversing productivity…”,mikeralphking.

      Yet, financial sector growth using “credit money with an interest attachment” must,
      must eventually cause a slowing and/or a reversal of productivity. There is no way new production can every repay all the debt of present production without additional financial sector growth. When the financial sector then slows it’s growth (decreasing loans) there is and always will be one result-Bust. Justaluckyfool, IMHO, based on an interpretation of
      writings of Michael Hudson (Interest) and Frederick Soddy (The Role Of Money)

      • June 10, 2016 at 8:57 am

        Hi Carmen. I suspect that your comments are based on the belief that credit money extends beyond savings. Yet if you carefully examine the aggregate balance sheet for the UK private banks for example you will see that deferred consumption as implied by all the instruments on the liabilities side (sight deposits, time deposits, certificates of deposits, bonds in issuance, equity capital, retained profit, etc) add up to slightly more than all the loan-engendered spending implied by all the instruments on the assets side (loans, corporate and government paper, derivatives, etc), the difference being reserves. In other words savings always slightly exceed loans, and therefore the growth of the financial sector has no direct implications at all for productivity.

      • June 10, 2016 at 9:08 pm

        First, thanks for your “due examination and analysis”.
        Do I believe, “.. that credit money extends beyond savings.”, absolutely.
        If you do not, please explain how a bank(A) can make a loan for $10 million with a 10% reserve requirement or 10% capital requirement and have that check honored when it is deposited at another bank(B), thereby creating for bank(B) a $10 million asset.
        Bank(A) has with this alchemy, on its books the $1 M (res./cap req.) plus a note for $10 M with a potential maybe even $10 M future profit income.
        As Soddy would say, “So elaborately has the real nature of his ridiculous proceeding been surrounded with confusion by some of the cleverest and most skilful advocates the world has ever known, that it still is something of a mystery to ordinary people, who hold their heads and confess they are ” unable to understand finance “.
        It is not intended that they should.”(The Role Of Money)
        PLEASE: “Believe nothing merely because you have been told it…But whatsoever, after due examination and analysis,you find to be kind, conducive to the good, the benefit,the welfare of all beings – that doctrine believe and cling to,and take it as your guide.”- Buddha
        CHALLENGE SODDYISM..
        Read the first 70 pages…Free Download:
        ** ONE OF THE BEST OF THE BEST-
        “The Role Of Money”
        .*** why not read and challenge a Noble Laureate ?
        ******Excerpt from http://en.wikipedia.org/wiki/Frederick_Soddy

        “In four books written from 1921 to 1934, Soddy carried on a “quixotic campaign for a radical restructuring of global monetary relationships”[this quote needs a citation], offering a perspective on economics rooted in physics—the laws of thermodynamics, in particular—and was “roundly dismissed as a crank”[this quote needs a citation]. While most of his proposals – “to abandon the gold standard, let international exchange rates float, use federal surpluses and deficits as macroeconomic policy tools that could counter cyclical trends, and establish bureaus of economic statistics (including a consumer price index) in order to facilitate this effort” – are now conventional practice, his critique of fractional-reserve banking still “remains outside the bounds of conventional wisdom”[this quote needs a citation]. Soddy wrote that financial debts grew exponentially at compound interest…”

        Free download-
        http://archive.org/stream/roleofmoney032861mbp/roleofmoney032861mbp_djvu.txt
        IMHO,” Quote Frederick Soddy (The Role Of Money) ” It is important to realize that whichever way it
        works it is a case for the bank of ” Heads I win,
        tails you lose “…”…(U)sually by some such lying phrase as ” Every
        loan makes a deposit “. (Comments by Justaluckyfool ( http://bit.ly/MlQWNs )

      • June 11, 2016 at 9:16 am

        Hi Carmen. Let us imagine for a moment that economics was in fact a science. You hold the belief that for the private banking sector loans exceed savings, presumably by some wide margin, though you do not specify it. I believe that for the private banking sector savings exceed loans by a small margin, that of reserves. In a true science, while we might differ on our hypotheses, we would agree on one thing: what empirical data we should draw on to settle the argument.

        So, my question to you is this: do you or do you not agree that we can use central bank statistics collected from the private banking sector to settle the argument? If so, well, I have the statistics from both the Bank of England and the Federal Reserve System and these statistics support my position. If not, what data do you believe we should draw on?

        Note that if you do not believe that there is any data out there to settle the question then the question remains outside of the realm of science and economics remains merely the realm of opinion.

      • June 11, 2016 at 9:57 pm

        RE: “So, my question to you is this: do you or do you not agree that we can use central bank statistics collected from the private banking sector to settle the argument? If so, well, I have the statistics from both the Bank of England and the Federal Reserve System and these statistics support my position. If not, what data do you believe we should draw on?”
        But the ” statistics from both the Bank of England and the Federal Reserve System “…
        FALSE, they are based upon there math using a negative amount as a positive
        asset entry.
        The ‘temporary money created out of thin air’ is transformed into ‘genuine receipted wealth’ by making it a deposit as an asset.
        Quote Soddy, ” ” It is important to realize that whichever way it
        works it is a case for the bank of ” Heads I win,
        tails you lose “…”…(U)sually by some such lying phrase as ” Every
        loan makes a deposit “.
        “Genuine and Fictitious Loans.
        For a loan, if it is a genuine loan, does not make a deposit,
        because what the borrower gets the lender gives up, and there is no increase in the quantity of money, but
        only an alteration in the identity of the individual owners of it. But if the lender gives up nothing
        at all what the borrower receives is a new issue of money and the quantity is proportionately
        increased. So elaborately has the real nature of this ridiculous proceeding been surrounded with
        confusion by some of the cleverest and most skilful advocates the world has ever known, that
        it still is something of a mystery to ordinary people, who hold their heads and confess they
        are ” unable to understand finance “. It is not intended that they should.”
        ” But if, instead of trying to puzzle it out along the lines of ” what you get for money “, these people will reverse the procedure, as in this book, and do so on the
        of ” what you give up for it “, the trick is clear enough.
        …The aggregate of the cheque-accounts, exclusive of genuine time-deposits, represents in units of money value, as stated, what the owners of money (not the borrowers of it) dealing with the banks are owed on demand in goods and services from the nation in which the money is legal tender.
        These vast sums of money are entirely of the bank’s creation in the first instance. When the bank pretends to lend their money they do not reduce the amount of the claims of the owners to goods and services on demand by a farthing. They do not inform them that they can no longer draw
        it out as it has been lent to others ! They create among the general body of vendors who supply goods and services, in exchange for the cheques the banks authorize their borrowers to draw, new claims on the community for goods and services. When these cheques are paid into the vendors’ accounts they create new deposits at the banks. When the borrowers repay their
        loans and balance their accounts, they withdraw money for the purpose from those to whom they sell goods and services, and by cancelling their overdrafts this money then disappears from existence, just as unaccountably as it made its appearance…
        …We have only to substitute physical counters or receipts to show the utter dishonesty of the accounting. For if a man surrenders a physical money token, whether to lend it to somebody else or to buy something with it from somebody else, there’s an end of it so far as he is concerned. He cannot ever lend or spend it again. He has to earn another or wait till his loan falls due before
        he can get another back to lend or spend again.”(The Role Of Money).

        Please believe, Justauckyfool has no valid opinion on economics, and wishes only-
        to know, ‘Did Soddy get it right ?’
        Quote Soddy,”… every monetary system must at long last conform, if it is to fulfil its proper role as the distributive mechanism of society. To allow it to become a source of revenue to private issuers is to create, first, a secret and illicit arm of the government and, last, a rival power strong enough ultimately to overthrow all other forms of government.”
        Please,
        Free download-“The Role Of Money” by Frederick Soddy
        https://archive.org/stream/roleofmoney032861mbp/roleofmoney032861mbp_djvu.txt

  4. June 12, 2016 at 9:03 am

    I have read Soddy and he is wrong, just as dozens of other thinkers on this subject, all honourable attempts to understand a complex system, but all failed. The essence of their failure is to believe that banks extend more credit than there are savings, without then establishing some empirical method to test their hypothesis. The hypothesis concerns the private banking sector and two eminently quantifiable entities, i.e. savings and loans. Banks must publish these figures by law, and central banks collect these figures and sum them to obtain sector-wide data. If your hypothesis also includes a subsidiary hypothesis that this data is false, and you have no other way of collecting it, then your theory remains unfalsifiable, as much as it remains unproven.

    At a stroke therefore you have removed your hypothesis from the realm of science and confined it the realm of opinion, or worse, superstition.

    God help economics.

    • June 12, 2016 at 12:59 pm

      More to the point, Mike, God have mercy on economists! Do liars and those naive enough to believe everything bankers and politicians tell them deserve help?

      There are several ways of showing that bankers extend more credit than there are savings. My favourite is that the house I bought 47 years ago for £4,500 sold last year for £485,000: somewhat improved but basically the same house, which is what I turned my savings into by as quickly as possible paying off the mortgage I was legally subjected to. Another much more significant one is also a reference to what the credit is used to buy. Mankind is not only devouring Nature’s savings but doing so to the point of eating its seed-corn too.

      God have mercy on today’s financiers, economists, lawyers and politicians and help the rest of us appreciate what He has given and care gratefully for what little They are leaving us.

      • June 12, 2016 at 3:47 pm

        The value of the Mona Lisa has gone up. What has that got to do with banking? My £20,000 new car hit a tree and is worth £500 scrap. What has that got to do with banking?

      • June 12, 2016 at 5:32 pm

        If the “owner” of the “more valuable” Mona Lisa was prepared to mortgage it to obtain credit, he could obtain more “credit” (or to be truthful, he could have his credit limit increased). If you bought your new car via a bank loan and wrote it off, the
        bank would still insist on you paying them what the car dealer had accepted as your credit, even though you now had no savings in the car’s form of tangible collateral to insure you against them legally taking the mere credit limit the bank had provided you with as being the bank’s credit. Of course the bank would prefer people to pay for this up front by taking out comprehensive insurance to cover you against this risk.

        [Incidentally, it seems there is “Nothing found” at the link to mikeralphking”].

  5. June 12, 2016 at 11:11 pm

    As Einstein said, “Make it simple”.
    Why does the Fed demand 10% reserves / doesn’t that allow banks to create out of thin air
    90% of the loan ? What is so difficult to understand ? The bank can lend someone $10 million, the borrower can deposit that check and spend that $10 million even before the lender is required to show it has $1 million in “reserves or capital.”
    BTW…residential real estate loans are over $17 TRILLION.
    What if they were to fail ? No problem; they are ‘bank assets’ just subtract $17 trillion
    from the asset column and go about daily business; just do not attempt to get your asset,
    the money you own, out of any bank .
    “Duh”, there’s FDIC $250,000 guarantee ! (a fund that has less than $100 million in it)
    BTW, not to worry, the Fed may be catching on, they may be starting to ask for 25%
    capitalization.
    Reading your reply, I am hopeful that someday you-would-be-correct ; It would be
    100% capitalization- a perfect solution.

  1. No trackbacks yet.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s