Martin Wolf poses the question (http://blogs.ft.com/martin-wolf-exchange/2010/04/01/hello-world/#comments):
Anyway, what do readers think of the Austrian analysis? In particular, what does it imply about the future of the global monetary and global financial systems and about the right way to respond to financial crises when they occur?
The comments section went into overdrive. The unfortunate thing, from where I sit, is the complete inability on the parts of the respondents to even correctly state the Austrian case. Absent this knowledge, the respondents go with the next best thing: erecting a straw man. Insofar as I could tell, there was no Austrian participation in the thread, which is a shame considering how off many of the respondents were.
Here are some of the most egregious misrepresentations. I've italicized inaccuracies or insufficiencies:
One 'Charlie Browne' had this to say:
One 'James DeLong', probably the same individual we all know and scratch our skulls over dropping the more friendly diminutive 'Brad', made the following claims and counterclaims, some of which are real howlers:
Let me give eight propositions that I think of as "Austrian," meaning that they have been maintained by some "Austrian" somewhere and somehow, and assess them:
(1) IF THE FEDERAL RESERVE HAD FOLLOWED A "SOUND" MONETARY POLICY--"SOUND" MEANING THAT IT SHRANK THE STOCK OF HIGH-POWERED MONEY AT THE SUM OF THE TREND GROWTH RATES OF THE INSIDE MONEY MULTIPLIER AND OF VELOCITY--THEN WE WOULD NOT HAVE FINANCIAL CRISIS OR BIG RECESSIONS.
Status: FALSE. Requiring trend deflation at the rate of labor force and labor productivity growth in order to keep nominal spending without a trend would be more likely to generate waves of universal bankruptcy, deep financial crises, and big recessions than our current system.
(2) SPECULATION AND LACK OF PRUDENCE IN FINANCIAL MARKETS LED TO OVERBUILDING IN HOUSING IN THE MID-2000S.
Status. TRUE.
(3) OUR ONLY SIGNIFICANT PROBLEM IS GOVERNMENT: IT WAS FECKLESS AND OVEREXPANSIONARY GOVERNMENT POLICY LED TO THE SPECULATION AND THE BUBBLE THAT CREATED THE PROBLEM.
Status. FALSE. It is certainly the case that sufficiently austere policy can keep any bubble from ever arising, but the costs of such policy are high. And periods in which monetary policy is overexpansionary are periods in which households, feeling flush, expand their consumption spending and create consumer price inflation. There was no wave of rising consumer price inflation in the 2000s.
(4) OUR ONLY SIGNIFICANT PROBLEM IS GOVERNMENT: IT WAS GOVERNMENT GUARANTEES OF FANNIE, FREDDIE, OF COMMERCIAL BANKS, AND OF TOO-BIG-TO-FAIL UNIVERSAL BANKS THAT WERE THE ONLY SIGNIFICANT CAUSES OF OUR CURRENT PROBLEMS.
Status: FALSE. We had financial crises and recessions like this long before we had FANNIE, FREDDIE, or commercial bank deposit insurance. And the princes of Wall Street and the shareholders of our universal banks now all wish that they had emulated Jamie Dimond and Lloyd Blankfein and gone short the subprime mortgage market in 2006. "Heads we win--tails the government pays" was not in the forefront of the minds of those whose wealth was invested in the bank stocks that have still lost much more than half their value since the summer of 2007.
(5) BECAUSE OF OVERBUILDING IN HOUSING, WE WERE DOOMED TO HAVE A PERIOD OF HIGH UNEMPLOYMENT AS THE ECONOMY REBALANCED ITSELF AND TRANSFERRED RESOURCES OUT OF THE HOUSING CONSTRUCTION SECTOR.
Status: FALSE. There is generally no period of high unemployment when resources are transferred out of consumption-producing sectors into investment goods-producing sectors. There is no necessity that the transfer of resources out of investment goods-producing sectors be accompanied by high unemployment. The business of shifting resources between sectors is pretty much orthogonal to the business of maintaining near full-employment and proper capacity utilization. Indeed, high unemployment and low capacity utilization are much more obstacles than aids to sectoral readjustment and reallocation: how can the market figure out where resources have their best economic use when no use produces a profit on the market?
(6) OUR CURRENT PROBLEMS ARE THE RESULT OF THE NEED TO TRANSFER RESOURCES OUT OF HOUSING CONSTRUCTION AND RESTORE TREND GROWTH EQUILIBRIUM BETWEEN THE SECTORS.
Status: FALSE. The housing sector adjustment is over. We are now back to trend in the number of houses. And we are well below trend in new houses being built. If this period of depressed economic activity were primarily a way of transferring resources out of housing construction and shrinking the housing capital stock and the house-building industry back to its sustainable long-run trend size, the period of depressed economic activity would be over.
(7) EXPANSIONARY MONETARY POLICY IS UNWARRANTED BECAUSE IT WILL ONLY BOOST SHORT-TERM EMPLOYMENT IF IT WILL ONLY LEAD TO ANOTHER BOUT OF ASSET PRICE INFLATION AND A BIGGER RECESSION DOWN THE ROAD.
Status: FALSE. See "crying 'Fire! Fire!' in Noah's Flood..."
(8) EXPANSIONARY FISCAL POLICY IS UNWARRANTED BECAUSE IT WILL ONLY BOOST SHORT-TERM EMPLOYMENT IF IT LEADS TO ANOTHER BOUT OF ASSET PRICE INFLATION AND A BIGGER RECESSION DOWN THE ROAD.
Status: FALSE. See "crying 'Fire! Fire!' in Noah's Flood...
Whew!
Stirling Newberry calls us all racists. Here's his full transcript:
Austrian economics is a stopped clock, it has been predicting that this year would be the year of financial crisis every single year. That there will be downturns, even large ones, is a metaphysical certainty, it is no proof of the value of a school of thought to predict economic turmoil every year. As for the prescription, namely that a Pareto Optimal economy is unstable and therefore we should consign ourselves to living in perpetual starvation to avoid the excesses of prosperity sounds rather much like their opposite numbers on the far left: there will be consistent misery for everyone.
In addition to the numerous other sins of Austrian economics, the lack of an organic relationship in a modern economy between the rate at which gold can be extracted, and the rate at which capital can be created, means that an Austrian gold standard would be more, not less, unstable than asset based systems of money. There is also the small problem of disguised racism: the period which Austrians point to as being the golden age of economic growth with low inflation, was the period of the imperialization of Africa and India, and their system leads to inconvenient events, such as mass famines. These can be shown in both theory and in empiric means.Austrianism has an appeal because it holds on to the one real factor which both neo-classical and Keynesian frameworks would like to deny: namely the importance of periodic rents based on the cost of shifting capital away from commodities which have a low substitution. What Austrianism recognizes is that in the presence of credit, rents can be expanded dramatically, to the point where it is profitable to be profligate with scarce inputs, as a way of avoiding payment of high rents. This goes back to the time-money trade off which Smith notes as the basis for ground rents. The solution, again noted by Smith, is to tax said ground rents. The Austrian solution is to make them permanent by linking to gold, but limiting the quantity of money. However, this has always failed in the past, because what happens is what just happened: when the limits of hard currency are reached, a soft currency is created, and then used to persuade the political authority to bail out bets made in soft currency, lest the economy grind to a halt. Austrianism isn't the cure, it is the disease. Austrians then, while the world marches towards their own free market fundamentalism, complain of insufficient purity as the cause for failure. They do not believe they can fail, only be failed by the morally flabby creatures known as human beings that surround them.
One 'Jomiku' finds the Austrian view of fractional reserve banking "irrational":
The issue is contained in your list of principles; you move from the sensible (inflation-targeting has issues) to the nearly irrational (denial of fractional reserve banking). One could accept the latter only by discarding modern society. It may be a "neat" idea in a vacuum but it isn't tied to reality except in the sense that it's an unworkable, science fiction-like, alternative universe.If you simplify Austrian thought, you of course find some nice ideas about the business cycle and its extremes. If you then set up a straw man - like the foolish great moderation theory that what is now must always be - the of course those ideas look better. But Austrian economics isn't valuable in the real world. It provides a nice view of certain ideas but has little policy implication. You point to liquidationism. That is one area where the GOP seems at times Austrian; their rather odd proposal that we send "too big to fail" institutions through bankruptcy as though they aren't "too big to fail" is somewhat counter to fact. I mean specifically that if the failure of institutions causes genuine systemic risk then the system is highly unlikely to insist on liquidation because some principle was established that this is theoretically the right thing to do. Real world wins.
Luis Arroyo opines:
Charlie Brown is in my opinion completely right, except he doesn’t say that the Austrians are, in general, too much arrogant; as arrogant as Marxists are. It is quite impossible to have a discussion with them: they have got the Holy Grail that Hayek personally had deposited in their hands before his Ascension to the Presence of the Father. This holy grail is gold standard, a True dogma.In fact their predictions have the same fate than the Marxists’: sooner or later, they find a case to fit their simplistic theory. Their reductionism (all we need is gold standard) has been refuted by history. Everybody has a good reason to critics the central Banks and financial system: included Marxist; but this justified critic is not sufficient to throw off capitalism. reality is far more complex, and this complexity is not easy to fit in Theory. But it is innegable that Theory has advanced a lot since Hayek times (a so dogmatic guy that if I remember well, he didn´t recognize Friedman, who was in his oppinion a Keynesian). In general the Austrian only recognize ohter member of the group.
For them the last fifty years of academics has nothing to say about the world. So, they have a good excuse not to read and investigate. Pure and dangerous dogma very atractive for non enconomist.More dangerous than Keynesian, of course.
Luis helpfully returns to steer us to a Brad Delong strawman demolishing session:
I recommend the Brad de Long article about the position of Austrian and "liquidationism" when the Great Deflation of the thirties in:
http://econ161.ber...louch_Crash14.html
Very interesting to know the opinion off Hayek & Co. pro-deflationism/liquidationism: Similar to well known marxian one "the worse the better". For example, From London, Friedrich Hayek found it:...still more difficult to see what lasting good effects can come from credit expansion. The thing which is most needed to secure healthy conditions is the most speedy and complete adaptation possible of the structure of production. If the proportion as determined by the voluntary decisions of individuals is distorted by the creation of artificial demand resources [are] again led into a wrong direction and a definite and lasting adjustment is again postponed.The only way permanently to 'mobilise' all available resources is, therefore to leave it to time to effect a permanent cure by the slow process of adapting the structure of production...
In summation, Luis tells us that the Hayekian point of view is:
NON SENSE
Tapatista envisions the regulatory apparatus that would typify an Austrian's ideal government:
As such I think the Austrian model supposes, then, a sane state, with rational regulations and policies and interventions (or just tolerable price levels and behaviours) - which we often don't have - and it talks about monetary and fiscal policy, I suspect, in this implied context. I might be wrong.
Anyway back to whether 'to let be or not to let be', surely the question has to be what would cause least harm, and to just let volatility run riot and balance the books irrespective of demand, surely that would create a thousand Lehmans?
Steve Bannister is, I think, taking the piss:
Austrian economics is mostly ideology masquerading as economics. There is nothing fundamentally useful about letting the poorest people starve.Financial and monetary crises, if accompanied by recessions, should be met with as massive as necessary fiscal and monetary reactions to salvage employment and demand, which are fundamentally critical in modern well managed economies. Then the fiscal and monetary players should be crushed back to Glass-Stegall levels with merciless regulation. Capital requirements, handcuffs if warranted, and all that. I am with Volcker...the only economically useful financial innovation of the last 40 years is the ATM.If there is too much money in the private financial system searching for bubbles, it should be taxed away.
Monty Jeeves ingeniously conflates Austrians and Monetarists:
If I might be allowed to put in my two (recklessly devalued, courtesy, inter alia, of the Greenspan/Bernanke Fed) cents' worth, it has usually been painful to watch economists' brains endeavouring to work, much like Mr. Wooster's. What passed/passes for Keynesian economics is inherently inflationary, and the Austrian/Friedman explanation of what makes the world go smoothly round is much too much hot air, not to say anthropogenic greenhouse gases. As factions of slaves to contending defunct ideas contend as to how many people can have how much of what particular wool brand pulled over their eyes how much of the time, more and more wool product exports, like so many other manufactures, come from the People's Republic of China. Nudge, nudge, wink, wink, say no more.
Charles Monneron says:
It is not only the "Austrian tradition" that forewarned that "inflation-targeting is inherently destabilising; that fractional reserve banking creates unmanageable credit booms; and that the resulting global “malinvestment” explains the subsequent financial crash", the "Minsky tradition" did it to, and I don't think that they would want to be categorized as Austrian !
As far as the possible solutions that Austrian analysis bring to the problem of designing a resilient and stable economic and financial system, my biggest concern is that its "sound money" requirements, first, a commodity based currency, second, 100% reserve banking,third a prohibition of maturity transformation, are presented as logically equivalent and thus unseparable. In my opinion, this is wrong, and this confusion is particularly damaging.First, it is perfectly possible to implement 100% reserve banking or prohibition of maturity transformation within a fiat currency system. Associating the last two requirements automatically to a commodity based currency system is just a convenient red herring to avoid them, because of the obvious shortcomings that a gold standard has (I.e. it is relatively easy to foment a "cornering" of credit through physical hoarding of the commodity). Second, 100% reserve banking is not enough to prevent a liquidity crisis, as it only prohibits funding of long assets with on-demand deposit only, but would still allow for, say, a 10-year mortgage to be funded with rolling 3-months CDs. As the collapse of short term funded RMBS-linked SIVs showed, this is not a functional way of doing business. Again, this inefficiency is a convenient red herring to avoid the third requirement (prohibition of maturity transformation) that IS the real answer to financial stability problems."Popular Austrians" such as Ron Paul are not actually helpful in that regard as they mainly promote the first and second requirement of sound money (probably because it is easier to explain to the public) and thus leave them exposed to easy critics from the mainstream economic profession. They play the role of "useful idiots" to a banking sector who fears like the plague the disappearance of its exorbitant privilege to print private money AND have it de facto fungible with central bank money ; something that the prohibition of maturity transformation would achieve. That even "liberal" economists like Paul Krugman think that funding long term assets with short term liabilities is a "natural" feature of a PRIVATE banks is just a testimony of how the intellectual hijacking of the economists profession by the financial sector is complete. (seehttp://krugman.blo...-be-narrow-minded/ )Finally, complete prohibition of maturity transformation, whereas it is by banks or non banks, still leaves the economic system vulnerable to sudden change of investor's mood and subject to the "dictatorship" of the rentier class that Keynes rightly identifies as the common enemy of all others : in a nutshell, hoarding of credit remains still possible. This is why maturity transformation should be authorized to one and one agent only : the Central Bank owned by the Sovereign. Maurice Allais showed that maturity transformation was logically equivalent to money creation. In a fiat currency system, it is therefore natural that the monopoly of money creation translates into a monopoly of maturity transformation. As a consequence, the Central Bank finds itself managing the whole interest rate curve, not just the short rate, and can even intervene on the credit curve. Such intervention would surely be seen as anathema from "Popular Austrians" but at least it could be under democratic control, without the pressure of reckless private agents saying "refinance us, or else the sky will fall"."Sound money with Keynesian characteristics" is the way to go.
Wow. An interest rate under democratic control. Unheard of in Austrian circles.
Augustin Dufatanye, unfamiliar with the methodology and proscriptions of the Austrian School, nonetheless has advice for Austrians regarding deficiencies in their analysis:
To me it appears that the Austrian econimics has the making of an ill-equipped charlatan who is nonetheless so damningly right about the diagnostics, but falls short however in providing the right cure to the desease. The sad part of this school is its perennial attempt to gather mankind around the fantasy prediction that a tabula rasa of a laissez-faire approach is the answer to world economic ailments. How so wrong!
Notwithstanding its condemnation to the Pareto Optimal being pursued by mainstream economics, the Austrian economics fails to appreciate the fact that -in the ideal world- the role of governments' fiscal and central banks' monetary policies are part of the homeostasis, without which irreparable chaos would be guaranteed in most events. While the argument advanced by the Austrian economics against concept such as mathematical modelling of esoteric terms like risk and returns, maybe the school should seek to sort out first how to deal with externality issues such as the effect of information asymetry altogether. As to the praxeology method advocated by the Austrian economics to underpin valid economic theories, this sounds as if to say that "economics science should be sent back to its origins"...
PDF, whose moniker may just be the catalyst that compels me to make the jump from Adobe's increasingly unstable software to ePub, had this to say:
may i quote? the superficiality of the austrian analysis results from the fact that it makes of the credit expansion and contraction,which are mere symptoms of the boom and bust periods,the real cause of those periods.and anyway those bourgeois optimists never dreamt of forecasting a crisis.
He may be quoting someone. He didn't say who.
Home.verb has issues:
First Austrian economics has a one-size-fit-all approach. This approach makes the theory attractive for readers or believers who remain on the surface.
Economics consists of a carpet of disciplines where the patterns change constantly and therefore requires unabated observation and thought. People don't really like to think and when it becomes to difficult they want a thread to hold on.
Even Keynes was charmed by the book "The Road to Serfdom". Hayek sent him the book (as he admired Keynes and would never have dared to challenge him alive) and Keynes answered "I wish the world was like that".Secondly years ago I read the article "Keynes the Man (as rotten as his economics)". Someone who plays the man instead of the ball doesn't deserve my attention. No further comments here.During this crisis I noticed that little opposition came from the Austrian corner when it concerned the rescue of the financial sector, while fierce reactions came when the government started its broad based programs to revive the economy.
I cannot undo my impression that the aficionados of Austrian economics promote our Victorian based society where a ruling elite pulls the strings.
Someone who "plays the man" doesn't speak for an entire ideological school of thought, yet home.verb sees that as an invitation to respond in kind and then smugly deem himself above the fray.
Duvinrouge informs us that the choice is between socialism and barbarism:
Martin Wolf appears to believe that the Austrians have a good explanation of the cause of recessions but the wrong solution.
I would argue the opposite.The reason Austrians (& Keynesians & Monetarists) fail to adequately explain the business cycle is due ultimately to having economic theories based upon a subjectivist understanding of value.As Marx pointed out, the Classical economists (including Smith & Ricardo) mistakenly used actual amounts of concrete labour in individual commodities as the basis of their labour theory of value.What they needed to do was to have social, abstract labour labour as the basis for value.Social labour is the expenditure of human labour-power insofar as such expenditure is socially necessary.
The value of a commodity does not represent the amount of labour actually expended by a given individual, but that portion of social labour that is credited to that commodity. It is only in exchange that the producer finds out how much labour-time was socially necessary.This is precisely what exchange does: it validates the socially necessary character of the labour-power expended in producing a particular commodity as that commodity is compared in the market with others.Since value is a purely social phenomenon it cannot find any direct natural expression, but can only be expressed in the relation between commodities.This is the value that lies behind money.But that is not to say that prices (for the economy as a whole) always reflect underlying value.Exchange-value (aggregate prices) can diverge from value.This is where we come to the concept of fictitious capital & where Marxists & Austrians almost share common ground.
The primarily source of fictitious capital would seem to be the fiat monetary system - the printing of US dollars.
This is what has enabled capitalists to ignore the true underlying fall in the rate of profit.Because the printing of US dollars it what ultimately lies behind the speculative bubbles in asset prices which support reported profit rates - a Ponzi scheme.The world's monetary systems are being debased in an attempt to prevent the huge devaluation of capital that is required to restore profit rates based upon productive capital.The scale of the devaluation require is very difficult to estimate.But it may be so high as to cause a world revolution - hence Wolf's reluctance to accept the Austrian 'creative destruction'.The problem is Wolf & the Keynesians have no solution.This is because Keynesian fiscal stimulus can only work in the short-term if productivity increases enough to effectively compenstate the 'borrowing' from future generations.Today with energy prices on the up productivity is probably going into reverse.Hence more pressure of profitability & more assaults on the workers.Socialism or barbarism.
Copper.w, despite being sympathetic, just doesn't get it:
The public sector in many countries became bloated during this time, so bloated that the private sector can no longer afford to support its huge weight. I know many Austrians want to abolish central banks because of their destabilizing effect on the world economy. My feeling is that before abolishing them we should try populating the monetary policy committees of central banks around the world with Austrian economists and see where it takes us.
Erwin.mahe mistakes Austrians for the mainstream economists who have removed humans from economics and replaced them with mathematical theorems:
I will just repost here an answer I gave to one of the readers of The Thaler's Corner regarding austrians economists:
" I do indeed do not talk easily about austrian economics, although I am a regular reader of Mises and his consorts.
I have this nasty feeling that they live on another planet, full of sytems, and empty of humans. When you mix morality with money, as these austrains-malthusians do, you usually endup wtih big catastrophes, as the deflation of the 20s in Europe (and not the weimar hyperinflation, contrary to common thinking) showed us...
RueTheDay believes Austrians don't account for externalities:
There are many problems with Austrian economics (and I say this as a former supporter of it).
The first problem (which it largely shares with neoclassical economics) is that it is at its core a barter model of the economy. Money is a medium of exchange and nothing more. Money is not a store of value. One of Keynes' key insights was that people may demand money for its own sake, not merely to conduct transactions, but also as a precaution against future uncertainty. This is expressed in the GT as liquidity preference.Second, Austrians generally either assume externalities don't exist or, when they can't, pretend that they are insignificant enough to be safely ignored. Hayek was an exception here, and acknowledged that the existence of "neighborhood effects" particularly in densely populated areas, meant that libertarian preferences for enforcing simple rules around property and contracts would be woefully inadequate in the real world (hence his support for the common law system).Finally, Austrian capital theory is built around assumptions known to be false and logically inconsistent, like a "single natural rate of interest" and "an average period of production".
Zanon:
Austrian economics, like mainstream macro, believes that banks lend out reserves.This is false. Therefore Austrian economics is not helpful talking about this crises.
I could go on and on. But that's an inefficient use of my time. What this thread brings to light is the unfamiliarity most people have with the Austrian School. This unfamiliarity does not prevent them from commenting on the caricature it has been reduced to (and by whom, well, I couldn't say). This thread and the discussion it engendered can only be improved by participation from actual Austrians and I invite you all to visit it. Krugman received a good slapping around and I was surprised to see that the discussion that generated his comments didn't receive the same kind of attention. Once again, visit it here:
http://blogs.ft.com/martin-wolf-exchange/2010/04/01/hello-world/#comments
I am seeing many ideas here which don't even sound remotely Austrian.
Robert Brager: Zanon: Austrian economics, like mainstream macro, believes that banks lend out reserves.This is false. Therefore Austrian economics is not helpful talking about this crises.
Could someone please clarify what the Austrian position is on bank lending? I must have been mistaken but I was under the impression that Austrian's believe banks lend out reserves and deposits.
edit: I just skimmed through Rothbard's "the Mystery of Banking" and he begins by stating that banks lend from initial 'money' that they have accumulated. Later on he states that if the central bank 'injects' reserves into the banking system as a whole, then this will see an increase in demand deposits above this initial amount (p. 136). To me it seems as though his position is that banks lend out reserves.
Sorry to bump the thread but I'd really like to know the Austrian position on how banks lend (see post above).
Thank you
mash: Sorry to bump the thread but I'd really like to know the Austrian position on how banks lend (see post above). Thank you
Try "What has Govt Done to Our Money" by Rothbard, very short readable book, free in pdf form on this site [and mp3].
If that's too long, there is a video on this site about the Fed that has the Austrian position
Finally, I can give you what I know [not the most reliable] in about 30 seconds:
The USA, like the rest of the world, has Fractional Reserve Banking. Which means for every $100 someone deposits in the bank, the bank is allowed to keep that money in the bank as a reserve, and write checks to borrowers for $1,000. In other words they have to keep 10% of the loans they lend in reserve, in case some depositor wants his money back.
Rothbard and probably most Austrians consider this outright fraud. One poster here, Esuric, seems to think it's OK as long as depositors know what they are signing up for.
I beleive this scheme is considered inflationary by Austrians, since the classic definition of inflation is any increase in the amount of money in circulation.
My humble blog
It's easy to refute an argument if you first misrepresent it. William Keizer
Thank you for the reply Smiling Dave.
I will have a look for that book by Rothbard.
In your model where does the initial $100 come from? Is this a financial asset with no liability?
I'd also like to add that only a few countries have reserve requirements. A lot of countries such as Australia and Canada have no reserve requirement. Does this in any way change the model?
mash:In your model where does the initial $100 come from? Is this a financial asset with no liability?
The man in the street walks in with a $100 bill and deposists it. If it's not put into a CD, he has the right to withdraw it at any moment. The bank gambles that he won't. I am guessing that in accounting terms there's an asset of $100, cause they have his money, and a liability of $100, because they owe it to him.
mash:I'd also like to add that only a few countries have reserve requirements. A lot of countries such as Australia and Canada have no reserve requirement. Does this in any way change the model?
It makes the bank that much more of a fraud [if you accept that the whole concept is a fraud] and that much more at risk of not being able to meet their obligations. Meaning if there is a run on the bank they won't have any money to give to the depositors. Of course if the banks are insured by the govt, the taxpayer will give the depositors the money back. Bottom line, it's pretty much the same idea.
Smiling Dave: mash: Sorry to bump the thread but I'd really like to know the Austrian position on how banks lend (see post above). Thank you Try "What has Govt Done to Our Money" by Rothbard, very short readable book, free in pdf form on this site [and mp3]. If that's too long, there is a video on this site about the Fed that has the Austrian position Finally, I can give you what I know [not the most reliable] in about 30 seconds: The USA, like the rest of the world, has Fractional Reserve Banking. Which means for every $100 someone deposits in the bank, the bank is allowed to keep that money in the bank as a reserve, and write checks to borrowers for $1,000. In other words they have to keep 10% of the loans they lend in reserve, in case some depositor wants his money back. Rothbard and probably most Austrians consider this outright fraud. One poster here, Esuric, seems to think it's OK as long as depositors know what they are signing up for. I beleive this scheme is considered inflationary by Austrians, since the classic definition of inflation is any increase in the amount of money in circulation.
This isn't right - what happens is the bank can lend out $90 of that deposit, it gets lent out to someone else, who spends it, the new receiver very likely deposits $90 in the same or another bank, that bank can lend out $81, and so on and so forth.
With a 10% reserve ratio, the most in new loans that could be created from an initial new deposit of $100 into the banking system would be $900 (90+81+72.~ + ...), and that's assuming that each loan was fully spent and deposited by the new receivers of money.
If a bank could lend out $1000 on a $100 deposit, then when that was deposited in another bank, that bank could lend out $10,000, when that was deposited, the next bank could lend out $100,000, which really doesn't make any sense.
I don't see why anyone here doesn't just sign up, sign on and kick some ass there.
I would be happy to do it myself, it's just that my knowledge of Austrian Economics and economics in general is limited.
WisR:This isn't right -
Yep, I stand corrected.
Thank you for the reply,
Smiling Dave:The man in the street walks in with a $100 bill and deposists it. If it's not put into a CD, he has the right to withdraw it at any moment. The bank gambles that he won't. I am guessing that in accounting terms there's an asset of $100, cause they have his money, and a liability of $100, because they owe it to him.
WisR:This isn't right - what happens is the bank can lend out $90 of that deposit, it gets lent out to someone else, who spends it, the new receiver very likely deposits $90 in the same or another bank, that bank can lend out $81, and so on and so forth. With a 10% reserve ratio, the most in new loans that could be created from an initial new deposit of $100 into the banking system would be $900 (90+81+72.~ + ...), and that's assuming that each loan was fully spent and deposited by the new receivers of money.If a bank could lend out $1000 on a $100 deposit, then when that was deposited in another bank, that bank could lend out $10,000, when that was deposited, the next bank could lend out $100,000, which really doesn't make any sense.
mash:Have you ever asked a bank manager if this is the case?
I looked up "fractional reserve banking" in Wiki, and the chart there seems to be exactly what Wisr is saying.
Thank you for the reply Smiling Dave,
Smiling Dave:I looked up "fractional reserve banking" in Wiki, and the chart there seems to be exactly what Wisr is saying.
Summary: people are lazy and pretend to know what they do not.
mash: Thank you for the reply Smiling Dave, Smiling Dave:I looked up "fractional reserve banking" in Wiki, and the chart there seems to be exactly what Wisr is saying.I don’t believe that wikipedia is a valuable source for anything to do with economics, unless you want a mainstream view. The money multiplier as presented by Wisr and the wikipedia article is nothing but an ex post accounting identity. It doesn’t say anything about causation. It is an identity expressing the ratio of base money to bank money.The model of deposit creation presented is a simple stylized textbook model. Here is what the 6th Governor of the Reserve Bank of Australia, Ian Macfarlane had to say:“When the dust has settled and statistic collected, it will be seen that there is reasonable relationship between the cash base … and bank deposits. It is this relationship that has traditionally been referred to as the multiplier between money base and money supply, but as the forgoing suggests, causality between the two variables is a complicated process and not a mechanical one, as estimated equations for the multiplier would imply. The main channel of causality thus runs from interest rates to deposit growth and then to cash or bank reserves. The multiplier shows a simply supply relationship but that is because it leaves out the chain of causality” (Macfarlane, 1984, p. 116)I’d suggest having a read of the following as well, at least to get some perspective on where I am coming from:Money Multiplier and other mythshttp://bilbo.economicoutlook.net/blog/?p=1623Another important point is that there isn’t a scare supply of reserves, central banks will accommodate the demand for reserves to ensure that the inter-bank payment system operates smoothly and with minimal volatility.My question for you, how can a bank lend out reserves, when the only way you can have reserves is by having an account at the central bank?Source:Macfarlane, I. (1994) Methods of Monetary Control in Australia, Reserve Bank of Australia Bulletin, 110-23.
Even if central banks accommodate demand for reserves (and they do, no doubt about it), it doesn't change the fact that the total amount of loans is dependent on the amount of reserves. If the central bank didn't help out, a bank that had taken on too many new loans would have to find some other way to satisfy reserve requirements (either legal ones, as is the case in our current system, or market based ones if there was no central bank and other forms of government support for the banking sector) - if the central banks wanted to tighten, banks would be very limited by the reserves available.
All of this doesn't really get to the heart of the issue, which is that the Federal Reserve manipulates the amount of reserves and total money supply to its hearts content (albeit in a handed and imprecise way). Just because they can change the amount of reserves available to accommodate new loans doesn't mean that reserves aren't the limiting factor - ask anyone whether they would prefer to get cold hard cash at the ATM, or an IOU from the Federal Reserve.
mash:My question for you, how can a bank lend out reserves, when the only way you can have reserves is by having an account at the central bank?
Step back and think what a bank would be lending out if we had some kind of commodity based system where deposits could be exchanged for the base commodity. They would be lending out a claim to xx amount of gold, silver, whatever (whether or not this was exchanged for the actual 'reserves' of the given commodity is beyond the scope of this discussion), and they would in a very real sense be limited by the amount of reserves on hand, so long as customers were allowed to exchange their deposits for the commodity on demand.
Changing the nature of the money may make it very easy to manipulate the amount of reserves, but the reserves still serve the same purpose. Otherwise money itself (cash, ultimately the reserves we keep talking about) ceases to mean anything. If banks aren't limited by the amount of reserves in the system, they are really limited by nothing
Here is from the article you linked:
These loans are made independent of their reserve positions. Depending on the way the central bank accounts for commercial bank reserves, the latter will then seek funds to ensure they have the required reserves in the relevant accounting period. They can borrow from each other in the interbank market but if the system overall is short of reserves these “horizontal” transactions will not add the required reserves. In these cases, the bank will sell bonds back to the central bank or borrow outright through the device called the “discount window”. There is typically a penalty for using this source of funds.
At the individual bank level, certainly the “price of reserves” will play some role in the credit department’s decision to loan funds. But the reserve position per se will not matter. So as long as the margin between the return on the loan and the rate they would have to borrow from the central bank through the discount window is sufficient, the bank will lend.
You're admitting that without access to loans at the discount window or other ways of getting money from the Federal Reserve (there are many new ways these days after TARP, not the standard two we learn in our macro textbooks), banks would have to stop making new loans. They would be limited by the reserves available in the system. I'm not denying that the Federal Reserve changes the reserves available - and just because a bank can first make a loan and then obtain reserves from another bank does not change the fact that reserves are the main limiting factor to how much in loans can be available at any given time (the other being the reserve requirement itself)
From that article:
The monetary base does not drive the money supply. In fact, the reverse is true.
The monetary base forms the real limit because without lending from the federal reserve, banks will have to stop making new loans beyond what the present amount of reserves will allow. It only seems like the money supply (lending) drives the monetary base because the Federal Reserve interferes directly in the process, increasing the amount of reserves available (whereas in a commodity based system, the amount of reserves is limited to the actual amount of the commodity in existence).