“We’re in a liquidity trap, with interest rates up against the zero bound. This means that conventional monetary policy is’nt sufficient.” Paul Krugman, The Conscience of a Liberal, November 13, 2009
“There is the possibility, for the reasons discussed above, that, after the rate of interest has fallen to a certain level, liquidity-preference may become virtually absolute in the sense that almost everyone prefers cash to holding a debt which yields so low a rate of interest. In this event the monetary authority would have lost effective control over the rate of interest. But whilst this limiting case might become practically important in future, I know of no example of it hitherto (my italics).” John Maynard Keynes, The General Theory of Employment, Interest, and Money 1936
The concept of the liquidity trap, as outlined by Keynes, and developed by his early disciples, is one aspect of the theory of liquidity preference. Liquidity preference is a theory of the demand for money. Individuals have a certain transactions and a certain precautionary preference for holding money over bonds, because of money’s property of liquidity. They have a speculative preference for holding money over bonds when their expectations are that interest rates are likely to rise, bringing down upon the holders of bonds significant reductions in the value of their bond portfolios.
If this speculative fear is sufficiently high, the demand for money becomes infinite. In such circumstances, the monetary authority cannot lower interest rates on bonds by selling money in exchange for bonds on the open market. If this liquidity trap occurs under conditions of recession, the monetary authorities cannot stimulate the demand for investment by lowering bond rates of interest. In such circumstances, increasing government expenditures appears to be an attractive mechanism for returning the economy to full employment equilibrium. As Keynes emphasized, he knew of no such situation ever having occurred in the real world.
I do not know whether Paul Krugman has ever read Keynes’s General Theory; but if he has done so, he has mis-understood its message. For what Paul Krugman identifies as a liquidity trap is a supply side, not a demand side phenomenon. There is no evidence whatsoever that the demand for investment at current interest rates (incidentally Treasury notes with more than three years to maturity are nearer to 4 per cent than to zero in nominal terms, Mr. Krugman) is inadequate to move the economy to full employment equilibrium.
Evidence suggests that small firms are desperate for loans from the banks at current interest rates, but cannot obtain them because the big banks will not lend. The big banks will not lend, not because they are are short of high-powered money (Bad Ben Bernanke has drenched the economy in high-powered money), but because their balance sheets are rock-bottom rotten and they are trying to use Bernanke money to bring their financial ratios back from insanely low levels. The big banks are in such a situation because they are loaded down with toxic mortgage-based securities despite Bad Ben destroying the balance sheet of the Fed in a buying spree of such assets that would put a drunken sailor to shame.
So the monetary problem confronting the Fed is not demand-based. It is not a liquidity trap problem at all. It is a money supply problem. It is an inability to move high-powered money through the money multiplier into the supply side of the equation. The major error, both of the Bush and the Obama administrations, was a failure to allow market process to work, to allow the big banks to go under, to use FDIC insurance to move depositors into new good banks, unencumbered by toxic assets, yearning to make money by issuing good loans to would-be entrepreneurs. The problem lies with government, with the Fed and with the FDIC who conspire to prop up failure and to impede success. Is that not always the socialist way, Mr. Krugman? Is that not exactly why the collapse of the Evil Empire exposed the failure of socialism, and the success of laissez-faire capitalism?
Is that not the fundamental fallacy of the conscience of a liberal in the sense that you and other Americans misdefine that precious term, Mr. Krugman?
Hat Tip to Maggie
Tags: bank failures and toxic assets, John Maynard Keynes, liquidity trap, marginal efficiency of capital, Paul Krugman, speculative demand for money, the money multiplier, under-full-employment equilibrium
Charles Rowley's Blog 
February 15, 2010 at 10:34 am |
So, if Krugman who is supposed to be Keynesian, has misunderstood Keynes in regard to the liquidity trap, then what else has he and others misunderstood with regard to Keynesian theory.
The one thing I liked about Keynes is that he was an observer. He readily acknowledged that his theory could be wrong because he wrote about what he had observed.
The point here is the scholars who came after Keynes should have been trying to either prove or disprove Keynes and by doing so they should have been developing sound economic theory where circumstances have changed.
It seems to me that Krugman and his ilk do not understand that we are now in a period of stagflation. In fact it seems that they do not understand stagflation and neither do they know the kind of policies that are necessary to kick start an economy that has fallen into stagflation – they seem to only understand the failed Marxist ideology.
The first period of stagflation that was observed is that of the period from 1973-1983 (rough estimate of the period involved). Some will argue that this particular period of stagflation was due to the oil shocks, yet that is not really correct, since the oil shocks happened just as the stagflation was hitting. It means that some other factor is at play. We have hit a second period of stagflation and it has been evident since about November 2008.
During the previous period of stagflation similar conditions existed, including the failed expansionary policies of govt. In fact these expansionary policies, – Whitlam in Australia, LBJ in the USA – more than likely made things worse, and helped the prolonging of the period known for stagflation. Well it seems since these policy makers learn nothing from the past, not only have we hit another period of stagflation but the same errors are occurring!!! In each case it seems that the expansion of the welfare state has had a direct impact upon the prolonging of the stagflation.
What I find so frustrating is that Krugman has his doctorate, and he has a Nobel prize in economics, yet he does not understand some very basic Keynesian ideas. He does not seem to have any understanding of stagflation, even though the term has been around since the early 1970s and for that reason he does not seem to be able to grasp that the normal Keynesian answers will not work because we are facing a situation where there is: high unemployment, continuing inflation and stagnant business activity – and a wage-price spiral.
February 15, 2010 at 3:41 pm |
[…] My GMU colleague Charles Rowley offers some helpful observations on the liquidity trap and todayR…. […]
February 15, 2010 at 4:43 pm |
Standard new Keynesian money-macro is somewhat similar to the economics of Keynes. Like Keynes, the assumption is that monetary policy is implemented by a central bank setting a short term interest rate. And monetary policy impacts real output and prices because real expenditures is impacted by interest rates. (In the modern approach, it is real interest rates that impact real expenditure. Keynes didn’t pay much mind to the distinction.)
I would think that the term “liquidity trap” should be limited to Keynes’ notion of bearish bond speculators accumulating money balances and keeping bond from falling. But, it is being used to mean “the central bank cannot lower its policy rate below zero.”
Krugman has been challenged on “liquidity trap” lingo before and he responds that what he means by that is that “open market operations using short term government bonds cannot lower short term nominal interest rates.” In other words, if the Fed buys T-bills, it cannot lower the Federal Funds rate.
I don’t really think that the toxic assets on large bank balance sheets are preventing them from lending to small businesses with good profit opportunities. It is true that small businesses that have poor sales cannot borrow money to tide them over until the economy improves. It is true that laid off workers who have little capital cannot start businesses with a bank loan. I don’t believe that it is true that a small business with strong sales and profits cannot get bank credit.
The problem with the economy is that nominal expenditures are approximately 10 percent below their long term growth path. Business don’t have strong nominal sales. Most measures of nominal wages show that they have increased. The GDP deflator has increased too, though it is about 1.5 percent below trend. Still, that leaves real expenditure about 8.5 percent below trend.
Since the Fed isn’t purchasing short term bonds, there is no liquidity trap. (The Fed is buying long term government bonds and government insured mortgage backed securities.) But, it is true that Fed cannot cut its policy rate much more than .25 percent. And that is what this “liquidity trap” lingo is used to mean these days.
Modern macro is based on three equations–a policy rule for the Federal Funds rate, an aggregate demand function that relates the output gap to the policy rate adjusted for inflation. And a phillips curve that relates inflation to expected inflation and the output gap.
Monetary policy only fits in through changes in the policy rate, which is currently set at a range between 0 and .25. What else can they do?
If it were really correct that there are tremendous profit opportunities for a sound bank, and there are plenty of businesses making great profit and could use funds to expand, then small banks, which would be relatively easy to adequately capitalize should be able to expand rapidly. They should be growing by leaps and bounds. Selling FDIC insured deposits, selling stock, and making loans to all the profitable small businesses.
Aggregate lending is down because of low loan demand. Failing small businesses are complaining because no one will tide them over. Budding entrepreneurs are complaining that no one will lend them start up money. Duh. That is not the sort of loans banks typically make. Banks are happy to lend into growing sectors of the economy. With nominal expenditures depressed, there are few growing sectors of the economy.
That is the way I see it.
February 15, 2010 at 4:58 pm |
Maggie,
I believe even Keynes misunderstood Keynesian theories!
Krugman et al, in their understanding of their monetary theory, always ignore the “borrower of last resort” – the government.
If (for whatever reason in our fantasy) there is a systemic reason why businesses will not borrow money at near-zero interest rate, there will always be a government some where that is more than willing to borrow money and spend it frivolously into the economy.
Liquidity trap is a wholly improbably fantasy in a world of governments.
February 15, 2010 at 5:55 pm |
Bill,
I would disagree with a couple of your statements.
Your belief that a small business with a good history can get a loan is unsupported.
It has been amply documented that historical financial strength does not carry the demonstration as it would have before the economic disaster.
One need only go back a few years – every pundit and rating agency gave the “Big Banks” their highest and best ratings.
If these agencies can be so wrong then there is no measure that a lender can trust – historical business is no longer an accurate predictor of future repayment.
Hence, the banks are not loaning until, it seems, the economy systemically gets better, or they are ‘motivated’ by a change of policy within the FED.
We will see this come true more powerfully in the next 12 to 24 months as the commercial credit bubble is coming due. Already the predictions are coming in for a +$1 trillion loss.
The banks are not reissuing loans and holding high excessive reserves so to shield themselves from these upcoming defaults.
Your assumption that there are plenty of business making a great profit and sound banks would be eager to lend is faulty.
Banks are very concerned of the up coming defaults. They risk the existence of the bank and banks are very willing to forgo profit and take losses in the short to mid-term to ensure their survivability for the long term. They read the same graphs as you or I and the upcoming commercial credit bubble and the Alt-A loan bubble are very scary to them. Those that survive these spikes may see their future much better – but not today.
Thus, your conclusion that there is a shortage of loan demand is faulty.
http://research.stlouisfed.org/fred2/series/CMDEBT?cid=97
..shows a small drop in total debt…
But this graph demonstrates the business problem:
http://1.bp.blogspot.com/_K3ry7Q_rEB4/S0Ysu68hacI/AAAAAAAAAIY/YvSVDJlqlM0/s1600-h/8janusloans2.bmp
Though loans for real estate and other loans (hard security backed loans) had a small drop, operation loans and lines of credit for businesses was severely curtailed.
There is ample demand for new loans, but even greater motivation based on a fear of the future by the banks not to make them.
February 15, 2010 at 7:34 pm |
@Black Flag
🙂 thanks.
I agree that the commercial credit bubble is coming due. There are already signs that this is about to happen. I have heard anecdotal evidence regarding shopping malls that are now empty and a lot of businesses already disappearing.
I am thinking that it is not just about being able to obtain credit that is behind this, but something else – a lack of confidence due to what is happening in Washington D.C. might indeed be spurring this along.
I agree that it is “fear of the future” that is the motivation for banks not to make the loans.
Either way, the Krugman analysis and conclusions are wrong since he wants more government interference and government spending, which will of course not only fuel the stagflation but will cause it to be prolonged, just like it was prolonged in Australia in the period 1973-1983.
February 15, 2010 at 7:55 pm |
Commercial lending has decreased about 18 percent from its peak.
Nominal nonresidential investment has dropped 21 percent. Both are about 300 billion.
I am not sure exactly why banks would think that excess reserves would protect them from the consequences of bad commercial real estate loans. Do you think that FDIC insured banks will suffer runs? How will reserves paying a quarter percent help banks maintain a capital cushion when their commercial real estate loans are written down? I suppose it might be something about capital regulations.
Anyway, the solution is to buy a small bank whose total assets is small. Sell new FDIC insured CDs and fund all of these profitable loans you imagine that exist.
Of perhaps you don’t imagine that they exist. But my point is that the problem is business sales are bad. And that is why banks don’t want to make loans. It is fear of default of the new loans, not worry about default on existing loans and some notion that not making loans now will help protect the bank against losses on existing loans.
February 15, 2010 at 8:30 pm |
These comments raise a lot of interesting points. My feeling is that the big banks, those who needed TARP monies especially, are inhibited by a climate of pessimistic expectations exacerbated by turmoil in Washington. One of the functions of banks in normal times is to discover entrepreneurial talent among their clientele and move it into the market-place. I sense that there is a lot less of that now, except perhaps in the smaller local banks not encumbered by sub-prime mortgages. There also seems to be a dearth of bank venture capital to drive mergers and take-overs.
I am not an expert in this field and I really welcome the kind of comments that you are all providing.
February 15, 2010 at 8:54 pm |
Bill,
Loan defaults de-leverage the fractional reserve system as powerfully as the system provided the exorbitant profits, and as such applies leveraged pressure on their reserve requirements with the FED.
With a very large threat of defaults, the banks are choosing to retain excessive reserves with the FED in advanced so that they are not forced into an insolvent position of trying to borrow from the inter-day lending facility between banks to maintain their reserve requirements exactly at the same time there is a massive and systemic default of loan portfolios (such as the commercial credit bubble popping) effecting all the banks at essentially that same time.
FDIC protects depositors, not the banks themselves. There would be no reason for most depositors to see risk in such a default. But the risk of default is against the banks, not its depositors.
The banks are not pounding excess reserves into the FED to the tune of $1.2 trillion over and above their legal requirements for the interest rate. One must consider that 18 month’s ago, the excess reserves were at $2 billion, 8 months ago exploded to $800 billion and now currently sit another 40% higher than that – at +$1 trillion. This is not insignificant.
http://research.stlouisfed.org/fred2/series/EXCRESNS
The excess reserves are there to forestall the massive de-leveraging of ~$1 trillion of commercial loans potentially falling into default over the next 12 to 18 months.
Your solution of consolidation of small banks is currently underway.
However, I do not believe this is a positive thing.
Expanding what is already a monopolistic cartel is not a good thing, and centralizing decision making into head offices in New York and further away from the actual borrower is a very large negative for me, in my opinion.
Further, you misunderstand my point.
I did not speculate on the profit of loans or not. My point was specific. No matter if such profitable loans exist, the economy systemically is far too high a risk for banks to lend into. Thus, they are not.
And in your last paragraph you end up agreeing with me regarding bank loans.
Your previous post stated that you believed the problem was demand side – that there was a drought in loan demand.
Now, you reverse your position and believe the problem is supply side – that the banks do not want to loan!
My point in discussing the excess reserves was to present that there is more than enough incentive for the banks to get back into business of loaning. You had suggested that a few FED manipulations could do the trick – but my point was that such a thing was wholly unnecessary.
What trick do you need to rent money at 3/4/5% or more instead of holding it @ 0.25%?? None.
Therefore, if it is NOT being exercised, something else must be systemically wrong, thus I explained it by fear of current market conditions (which you agree) and potential de-leveraging of Federal Reserve system due to default.
Cheers!
February 15, 2010 at 11:03 pm |
Pointing out Paul Krugman got something wrong in economics is like shooting fish in a barrel.
February 16, 2010 at 12:19 am |
OK, Blackflag.
I can see that you don’t understand how this works.
Bank reserves are not the same thing as bank capital. Reserve requirements aren’t the same thing as capital requirements. Fractional reserve banking and leverage are not at all the same thing.
Bank loans will reduce banks’ capital and they will have trouble meeting capital requirements. There will not be an increased demand for bank reserves and accumulating reserves won’t help banks meet capital requirements. Confusing reserves and capital is a common error. Capital is net worth, not some kind of asset.
Anyway, I don’t believe that the reason for the depressed economy is that banks with bad loans on their balance sheets are unable to make loans to profitable firms. The problem is that the quantity of money is too low relative to the demand to hold money at a level of nominal expenditure consistent with its past growth path.
The result is firm’s sales are poor and losses are heavy. The demand for loans by profitable firms is low. The demand for loans by weak and failing firms is irrelevant.
If nominal expenditure recovers, then commercial lending will expand.
Nearly all expenditure is financed out of current income. There is always enough income generated to purchase all of the current output. Credit is about shifting funds between and among households.
Perhaps I am missing something. Perhaps you have a better understanding than you have shown above. If so, I apologize.
P.S. Check out my blog. You will see that I keep track of these figures.
February 16, 2010 at 2:19 am |
Blag Flag writes:
“Your solution of consolidation of small banks is currently underway.
However, I do not believe this is a positive thing.
Expanding what is already a monopolistic cartel is not a good thing, and centralizing decision making into head offices in New York and further away from the actual borrower is a very large negative for me, in my opinion.”
As a friend of mine put it during the 1990s, not entirely tongue in cheek, there’s nothing wrong with the banking system that about 4000 bank mergers wouldn’t cure. Banking is very far from a monopolisitc cartel (whatever that actually is). The commercial banking system is very competitive in the U.S. with lots of regional and mom-and-pop banks.
In just the last month I found out about two fairly new banks here in the People’s Republic of New York, Global Bank and Gotham Bank of New York. There was an uptick the last year or so in bank failures–just Schumpeter’s creative destruction at work, helped along of course by Bad Ben, and before him by Easy Al.
February 16, 2010 at 2:34 am |
Bill,
When a bank has a default on a loan, this impacts its reserve requirements.
To get us both back on the same page;
If a loan defaults, the bank has to meet new capital requirements, for its assets have declined. The asset that has disappeared is, of course, the loan. We agree here, I believe.
It must sell new shares of stock to investors to raise cash (an asset). If it cannot (or does not want to), then it must call in loans in order to meet reserve requirements (convert one asset of high risk, a loan into an asset of zero risk, cash) – under this formula:
Capital requirements = Core Capital / Assets
Core Capital is weighted due to risk – with cash at 0%, no risk and government bonds at say 5%, mortgage loans, at say, 50%, and other loans and assets, such as credit card loans, perhaps at 100%.
The Asset divisor is Total capital minus deposits – as deposits are a banking liability.
As Federal Reserve-placed funds represents cash as far as calculating the Core Capital – an increase is the excess reserves significantly improves the capital ratio of said bank.
Thus, a loss of capital due to defaulted loans (loss of asset) can be offset by an increase in “cash on hand” (increase of asset) – held as excess reserves with the FED. If a bank does not lend its cash, it improves its Capital requirement ratio.
Do we agree here?
So, as a banker, you can say:
“I see this coming. My customers are going to default. I cannot raise new capital. I cannot call in other loans, for my customers cannot repay. So, I will increase excess reserves at the FED.”
And that is exactly what they are doing.
But there is a cost. They forgo the rent of this money as loans. They remove themselves from the carry trade: borrow short @ 0.25% and lend long at 5%. They would rather pay 1% to depositors and lose money then risk the lending into this market place.
The bankers are trapped – not by new loans – but by the threat of old loans – as I noted, the Commercial Real Estate and Alt-A bubble that is looming.
The risk of this exposure causes bankers to increase their reserves so to maintain their requirements – preventing them from lending this money to new customers.
The fractional reserve system – which puts out a magnitude more money out as loans then held in reserves leverages this stake tremendously. It does not take many defaults to risk the entire asset base of a bank at a 9/1 ratio (or whatever ratio exists presently).
I hope my explanation has repaired any confusion my previous post may have caused.
I do not agree, obviously, with your assessment.
There is always a borrower – and more so at artificially low interest rates. I cannot agree that profitable firms feel faint at the risk of borrowing money at 3%.
February 16, 2010 at 2:51 am |
Bill
“A monopolistic cartel (whatever that actually is).”
A monopoly is created by some sort of government writ, preventing free entry of competitive services or goods into a market. This is established either by direct prohibition (as exampled by Postal Services) or by licensing, patent or copyright grants.
A cartel is a set of companies or persons operating in collusion that sets a price for goods and services between them independent of free market forces. Cartels achieve their greatest control over a market when operating within a monopoly. The latter could be referred to as “monopolistic cartel”
In 1960, there were nearly 13,000 independent banks. By 2005, the number
had dropped in half, to about 6,500. In 1960, the ten largest banks held
21 percent of the banking industry’s assets. By 2005, this share had
grown to almost 60 percent. This has only accelerated during the banking crisis where the larger banks have been bailed out, but smaller ones left to die on the vine – their depositors paid out by the FDIC, and their assets assumed by the majors at pennies to the dollar.
In any market devoid of free entry of competition, that market will distort to every higher costs and reduced quality. If that market is banking, reduced quality is measured by increasing risk exposure.
This is risk is accelerated if the bank is further protected from asset removal such as depositor bank runs by such programs as the FDIC. Depositor bank runs indicate that the risk a bank has undertaken threatens the assets of the depositor. If that risk is removed, the natural control is removed as well.
February 16, 2010 at 4:17 am |
Dr. Woosley, (as there seems to be a sudden influx of Bill’s lately 🙂 )
I will be a regular reader of your comments on your blog.
Thank you for your invite!
Cheers!
February 16, 2010 at 9:29 am |
Even if the number of banks has dropped by half, I would still hardly call the American banking industry a cartel. Most of that drop is probably accounted for by the repeal of unit banking or other anti-branching laws during the 70’s and 80’s. The US banking industry has ALWAYS been ‘over-populated’ because of those regulations and what we’re seeing is the US industry going back towards a global norm.
Well, that, and the ones on top are benefiting immensely from their close and personal relationship with Uncle Sam.
February 16, 2010 at 3:03 pm |
Micheal,
The banking industry is a monopoly and a cartel. There is no free entry into that market without a government grant.
You, personally, can open a grocery store in a town, but you, personally, will not be able to open a bank.
The FED, as private corporation owned by the largest banks, wholly and singly controls access to the US banking system by specific legislation and grant from the US government. I do not know a better definition of a monopoly than this.
I completely agree with your final sentiment – bankers are immensely enriched by the intimate relationship between their private corporation – the FED – and the government.
February 16, 2010 at 3:50 pm |
Black Flack,
Yes, there are monopolistic entry requirements, but Michael M.’s point overrides yours by a long shot. There are far too many banks in the U.S., as any bank industry analyst worth his CFA would tell you.
Of course, regulations often cause market distortions, such as too wide a spread between what savers make on time deposits and what banks earn on those deposits. A recent Bloomberg Business Week article discussed the gory details of this.
But that is a different issue from the textbook monopoly curves of a standard micro text monopolist, cutting prices, driving all competitors to the wall, etc. Which doesn’t exist in the real world.
(Can you name one monoplist that doesn’t have its monopoly thanks to the government? I’ll answer: You can’t.)
Patents, copyrights, etc. are monopolies, rip off consumers and lead to monopoly rents. Banks, for all their government-imposed flaws, are not monoploy providers in the standard micro text sense, at least as I was taught. A commercial bank market of 6,000 suppliers is hardly a monopopy or oligopoly. Even my Ralph Nader-loving-monopoly/oligopo
ly-denouncing micro prof would have admitted as much.
February 16, 2010 at 4:22 pm |
Just to solidify my point about banks and monopolies, consider the market for barbers and hair stylists. These occupations are regulated ostensibly to help consumers; of course the real reason is to provde another avenue for the theft-and-murder gang known as the State to steal. A free market legal outfit (the Instutite for Justice?) created waves a few years ago when it defended some minority beauticians who were prevented from working thanks to regulations in Washington, Sin City.
That aside, I don’t think anyone would describe the markets for barbers and hair stylists as monopolies or ologopolies. How many barbers are there in your neighborhood? 1000?
February 16, 2010 at 4:36 pm |
Hi Bill,
By what measure do you claim there are “too many” of any business in a market place? How do you judge? What criteria? What method do you propose is best in calculating the exact right amount? How did you get your information to make such judgment? What timescale? Is your information accurate to current conditions or is merely a picture of the past? … and so on.
In any market place, the free market system is the best in such
determinations. Its natural ebb and flow of entry and exit of suppliers and consumers manages the OPTIMUM organization of that market.
Any market that receives government force disrupts this natural flow and will create massive inefficiencies and distortions.
Banking is absolutely no different a market place than any other good or service and as such suffers from government manipulation and distortion as any other good or service, causing massive inefficiencies, increase in costs, and decrease in quality and choices for the consumer.
It appears that your argument regarding the impact of monopolies relies on your observation of the number of tentacles – failing to see that the monopoly exists in the core of the body – the brain – the Federal Reserve.
No bank in the USA operates outside of the Federal Reserve system. It matters not how many ‘branches’ exist – they all operate under the system fixed to a cartel.
February 16, 2010 at 5:06 pm |
I agree that the Fed is a monopoly. That’s a real monoply because it has a legalized monopoly of supplying money. Most historians have claimed that the U.S. has been overbanked with commercial banks. For example, 8000 of them failed in the Great Depression.
That was a result of the Fed’s monopoly, but there wasn’t a monopoly of commercial banks, not by a long shot, even if they benefitted by monopolisitc regulations restricting entry into the market.
So say there were 15,000 banks before it began, then 7000 after it ended. (I don’t have the exact figures.) Neither figure by itself is evidence of a monopoly of commercial banking services, which include a lot more than the quintessential function of what a bank of issue (e.g. the Fed) does .
February 16, 2010 at 5:17 pm |
Bill,
Again I ask – by what measure does one use to say “a market is over serviced or under serviced or perfectly serviced?” to provide a means to manipulate by design such a market?
I do not see a concern in a free market place where suppliers go out of business and other suppliers flourish. That is how it is supposed to work.
It appears to me that you believe if a bank fails, it means the system failed.
If a bank, in a free market, fails – it indicates the bank was not satisfying consumer needs appropriately or as completely as other banks. Great! The market moves as it should, eliminating banks that do not solve problems and sustains those that do.
The problem with the banking monopoly is that the FED picks and chooses which tentacles live or die. It will maintain life support on its favorites – making them immune to the market force – and allow others to die – by its own whims and desires and not those of the market place.
The consequence can only be a centralization of banking into favored hands that operate with immunity in the market place.
For me, that is not a good thing.
February 16, 2010 at 6:05 pm |
Black Flag (of anarchy? If so, bully for you!)
The failure of some banks could well be caused by bad regulation, but in general I’m all for Schumperterian creative destruction. Certainly clusters of bank failures (or failures of other types of firms) is evidence of government intervention. The wave of S&L failures in the early 80s was caused by bad regulations. Some no doubt would have failed in a free market, but they weren’t operating in a free market.
You write:
“The problem with the banking monopoly is that the FED picks and chooses which tentacles live or die. It will maintain life support on its favorites – making them immune to the market force – and allow others to die – by its own whims and desires and not those of the market place.”
The real problem is not so much the Fed’s picking and choosing (after the fact?), but the fact that it has a monopoly of money issue in the first place, with all the consequences that entails for both banks and the overall economy. Abolish that and allow the private supply of money, then banks will succeed or fail on their own bottoms. That would be a good thing.
February 16, 2010 at 6:07 pm |
[…] Says: February 15, 2010 at 10:34 am | Reply So, if Krugman who is supposed to be Keynesian, has misunderstood Keynes in regard to the […]
February 16, 2010 at 6:22 pm |
Bill,
The Black Flag Story.
While there are plenty of symbols for Peace (the dove, olive branch, the Line and the Y) and for countries and war, etc., I found none that represented Freedom that did not entangle some sort of nationalistic sentiment or government symbol (eagle, flag, liberty statute, etc.)
I asked a popular writer who often wrote about freedom and free markets and asked him what he thought would be the true symbol of ‘freedom’.
He answered succinctly:
“Whatever is the opposite of surrender”
So I picked the opposite of a white flag.
I do understand that freedom equates to ‘anarchy’ for many people.
We are wholly aligned in our belief about private money.
End the FED!
Cheers!
May 1, 2010 at 3:21 am |
Capital markets are unstable. In the past there was no way to make them stable. But today we have computer power that can be used to make them stable.
By using the greater computer power of today we can have a much higher turn over of capital in the capital market. This higher turnover will make the market harder to game or control and the market will no longer have the unstable run ups or declines. Who can change or control the market when say 20% of the capital is trading each day?
So now that we have the compute power to provide for all these transactions that will smooth out the market how do we force people to turn over at a rate of 20% a day? Easy, put a cap gains tax of 0% (zero) on all gains of 7 days or less and put a cap gains tax of 90% of all gains of more than 7 days.
The likes of Yahoo, Micosoft and/or Sun Micro Systems will give us the systems that will provide automated software agents to support turning over one’s investments every 7 days (based on the specs you give the agent).
A system like this will make the financial markets work as smoothly as the local fruit market.
May 1, 2010 at 10:58 pm |
Martyn
An attempt to use a finite calculation on a system that is inherently infinitely complex will most certainly lead to believing in actions upon this system that will ultimately create massive disruptions. Since these are actions of human beings, such belief threatens the survival of civilization and man himself.
Economic systems, like climate systems, are never in equilibrium. It is inherently chaotic and turbulent.
As a result of its unimaginable complexity, all mathematics is simply inadequate to predict the effect of a change in one of the hundreds and hundreds of things that affect the economy.
Yet at the same time, the economy is also ruled by massive negative feedback loops. “As quantity goes up, price goes down – as quantity goes down, price goes up”.
The greater the velocity away from equilibrium, the stronger the forcing via these negative feedback loops to push back toward equilibrium – yet, the system will never rest at any equilibrium state.
Like nature, the economy works best by letting it work – naturally.
Free market systems, free of violent coercive power, are the optimum solution to the questions of scarcity and resource allocation.
Any attempt to manipulate by design to achieve some demand of “more than optimum” will only guarantee a far less adequate result – including the potential to destroy society itself.
August 27, 2010 at 12:56 pm |
My one question is why everyone needs to guess why banks aren’t lending. Surely these highly-regulated institutions have volumes of data that can be analyzed. Surely THIS IS KNOWABLE. Why are we not getting real data????????
August 27, 2010 at 3:12 pm |
Medusa,
They are not lending because they are afraid of losses in the marketplace.
I think their fear is well placed.
September 24, 2010 at 1:49 am |
Keynes contributed many ideas but the core idea is that supply side economics is wrong. Fiscal stimulus to increase effective demand was seen as the only path to recovery. Monetary expansion was seen as “pushing on a string” because the problem of stagnation isn’t quantitative restrictiveness per se but the lack of profitable outlets for investment due to low effective demand for goods and services. Hence, it was essential to approach the demand side and not the supply side or attempt quantitative easing with monetary adjustments. It is fairly clear that with the decline in real incomes of the middle class demand is low. Between 2001 and 2008, real median annual income declined from $51,356 to $50,303, the first time real median income declined in a business cycle upturn.
http://www.cbpp.org/cms/index.cfm?fa=view&id=2914
It is true that the banks could lend to small businesses and that toxic assets are no obsticle to lending to profitable concerns. The problem is that as unemployment stays high, small businesses, which employ about half the workforce, are not financially stable and their earnings from sales not assured. The idea behind the stimulus was to generate effective demand sufficient to close the output gap and restore GDP growth. Right now capacity utilization is at an historic low. Investment is recovering but not making jobs due to oursourcing and labor saving technology. A federal jobs program is needed. We need full employment.
March 13, 2011 at 12:33 pm |
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April 17, 2011 at 11:23 am |
You make several interesting points in this blog:
1. The problem during recession is a supply-side problem
2. The problem of money is the problem of converting reserves into money through the money multiplier
3. It is not that firms do not wish to borrow but that banks do not wish to lend during a recession because their balance sheets have a big hole in them.
But you are wrong in saying that the error does not lie with Keynes. In an article I put online today I show that the liquidity preference argument works only with currency and not in a system with banks. Further, because the idea of liquidity preference is incorrect, Keynes’s thesis that the problem during recessions is one of aggregate demand collapses.
The article can be seen at http://www.philipji.com/paul-krugman-and-the-liquidity-trap.html
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