Introductory
Our concern, as always, is to understand and verify how money should circulate to meet the rectilinear primary process of production and sale. We seek a normative theory which scientifically explains, rather than merely describes, the current, purely dynamic economic process. The scientific explanation will be in the form of the objective relations of explanatory velocities and accelerations to one another. These explanatory conjugates will be abstract correlations defined by their functional relations among themselves – rather than descriptions – no matter how literary and vivid – of conditions, states, and events as they are related to us and affect us for better or worse. Our goal is to achieve a scientific explanation yielding norms to which we must adapt.
It is critical that bloggers and TV commentators have a reliable normative theory and framework of the economic process, if they venture to comment upon or to criticize the present relations among concomitant, dynamic flows constituting the economic process. In particular, the analyst must have a firm grasp of the following points.
- explanatory terms are implicitly defined by the functional relations of the terms among themselves
- theoretically normative concomitance, solidarity, and keeping pace of the explanatory flows constituting the equilibrated circulation of money in two (or more) monetary circuits:
-
- Outlays to workers at all income levels by units of enterprise who produce goods and services for sale
- Incomes – as the obverse of Outlays – received by workers at all income levels
- Expenditures of Incomes to purchase goods and services
- Receipts by units of enterprise of the Expenditures for purchase
- The existence of tiers of income of workers having average propensities to consume, among whom the changes of interest rates, employment, and incomes relative to levels of prices will effect winners migrating upward through the income tiers to higher levels of purchasing power and losers falling downward through the income tiers to lower levels of purchasing power. (See CWL 15, 134)
I’ = Σwiniyi (CWL 15, 134)
dI’ = Σ(wdni + ndwi)yi (CWL 15, 134)
- Phases in the expansion of the productive process – proportionate, surplus, and basic – having shifting requirements to satisfy the condition of equilibrium
G = c”O” -i’O’ = 0 (CWL 15, 49-55)
and, thus, of the ratio of basic income to total income and the ratio of surplus income to total income.
I’/(I’ + I”) (CWL 15, 132 and 148)
I”/(I’ + I”) (CWL 15, 132 and 148)
- the proper coordination of flows of products and of payments to avoid inflation
… positive or negative transfers to basic demand (D’-s’I’) and consequent similar transfers to surplus demand (D”-s”I”) belong to the theory of booms and slumps. (CWL 15, 64]
(Ideally)… the dummy must be constant in exchange value, … The alternative to constant value in the dummy is the alternative of inflation and deflation. Of these famous twins, inflation swindles those with cash to enrich those with property or debts, while deflation swindles those with property or debts to enrich those with cash; [CWL 21, 37-38]
It is now necessary to state the necessary and sufficient condition of constancy or variation in the exchange value of the dummy. To this end we compare two flows of the circulation: the real flow of property, goods, and services, and the dummy flow being given and taken in exchange for the real flow….Accordingly, the necessary and sufficient condition of constant value in the dummy lies in its concomitant variation with the real flow. (CWL 21, 38-39)
- The normative correlation of magnitudes and frequencies of production turnovers with the magnitudes and frequencies of associated payments
in every unit of enterprise there is some determinate turnover magnitude and turnover frequency. The magnitude of the turnover depends upon the number of items handled at once and the selling price of each item. The frequency of turnover depends upon the period of production plus any time lag involved in sales and collection. (CWL 15, 58-59)
… real analysis (is) identifying money with what money buys. … If you want to treat money that doesn’t make a difference, you can have a beautiful liberal monetary theory. But it doesn’t say the way the thing works. [CWL 21, Editors’ Introduction, xxviii quoting Lonergan]
- the divergence of properly proportionate flows of products and money – such as the fiscal and monetary authorities have recently erroneously effected and which the ignorant psycho-political fad of Modern Monetary Quackery advocates – effects inflation and deflation which leave in their wakes purchasing-power winners and purchasing-power losers.
- the road up of boom followed by the corrective road down of slump, contraction, layoffs and lower incomes is ended when the ratio of basic income to total income and the ratio of surplus income to total income equal the requirements of the phase of the dynamic process. (Click here)
Greg Mankiw’s Blog
On Wednesday 4/5/2023 Greg Mankiw’s blog (click here) featured a piece entitled “The Importance of Teaching Fractional Banking.” Greg wished to make a fine point and he succeeded; he briefly treated the subjects of fractional reserves and the quantity theory of money. We wish to expand on what Greg said. Here are some excerpts from Greg’s blog, followed by our comments:
Greg:
“I was recently chatting with someone who teaches introductory macroeconomics. … He does not teach the students about money creation under fractional reserve banking, which he considers an unnecessary technicality, but he does teach them the following two statements about inflation.”
Greg’s first statement quoting friend: “If the Fed lowers the interest rate on reserves, that policy stimulates economic activity in the short run and, via the Phillips curve, increases inflation.”
Our Comment:
The policy might stimulate; but how weak, strong, or counterproductive might the stimulus be?
Similarly a lowering of interest rates may encourage the expansion of basic industry; but it also will encourage the expansion of well-intentioned but not well-thought-out innovations, the number of bankruptcies, etc. What is needed is the egalitarian shift in incomes, that will compensate for the previous and shorter anti-egalitarian shift, and will produce the things that people really need and can learn to purchase without the help of self-seeking advertisers. [CWL 15, 141 ftnt 198]
Any intended stimulus would depend upon a) the magnitudes of the new Smith-to-Jones interest payments relative to Smith’s and Jones’s prior and intended magnitudes for preferred uses, b) the prospects of eventual repayment of purchasing power of principal, c) existing productive capacity and whether there is really a need for more and greater capacity, d) the status of the normative implementation of the basic expansion, which should normatively exploit, on behalf of all, the fruits of previously-installed better and more efficient capital equipment. All this is to ask, Is the supposed and vaunted Phillips Curve correlation a cumulatively verified correlation, or is there theory and evidence of non-correlation such that it has been debunked; is the Phillips Curve reliable or is it a hoax? Is it an erroneous assumption and oversimplification which is relied upon at one’s peril?
Greg quoting and stating:
Greg’s second statement quoting friend: “In the long run, the quantity theory of money explains inflation.”
Greg:
“I agree with both of these statements …, But consider: How does one explain the transition from the short run to the long run?”
Our Comment:
The consideration of the short run and the long run is legitimate but tends to throw the analyst off the track. The analyst should focus primarily on the normative equilibrium vs .a possible distortion and disequilibrium in the current dynamic process.
Taking into account past and (expected) future values does not constitute the creative key transition to dynamics. Those familiar with elementary statics and dynamics (in physical mechanics) will appreciate the shift in thinking involved in passing from equilibrium analysis (of a suspended weight or a steel bridge)…to an analysis where attention is focused on second-order differential equations, on d2θ/dt2, d2x/dt2, d2y/dt2, on a range of related forces, central, friction, whatever. Particular boundary conditions, “past and future values” are relatively insignificant for the analysis. What is significant is the Leibnitz-Newtonian shift of context. [McShane, 1980, 127]
The immanent intelligibility constitutes an abstract, completely explanatory theory of what always is the normative, current, purely-dynamic, objective process – called variously Functional Macroeconomic Dynamics, Macroeconomic Field Theory, or Relativistic Macroeconomic Dynamics.
The immanent intelligibility of the economic process to be understood, formulated, and taught always is the intelligibility of a purely-dynamic process.
The dynamic current process; and is understood and theoretically constructed “in terms of indeterminate point-to-line and point-to-surface and higher correspondences.”
Thus the productive process is a purely dynamic entity. We began by saying how broadly the term was to be taken. But it is also necessary to insist how narrowly. It is not wealth, but wealth in process. … It is none of its own effects, if by effects are understood what has been completed. It is neither the existence nor the use of durable consumer goods, of clothing, houses, furnishings, domestic utensils, personal belongings, or indeed any item of private or public property that can be listed as a consumer good and has passed beyond the process to become an element of the community’s standard of living. On the other hand, with regard to producer goods a distinction has to be drawn: they are in the process as a means of production; they are in the process in the sense that labor is in the process or that management is in the process, namely, their use forms part of the process; but once they are completed they are no longer under process, any more than labor or management is under process and being produced. … factories and machinery, railways and power units, warehouses and offices are in the productive process only while being produced; once they are produced, they themselves have passed beyond the process to enter the category of static wealth, even though their use remains a factor of production. (CWL 15, 21-22)
Taking into account past and (expected) future values does not constitute the creative key transition to dynamics. Those familiar with elementary statics and dynamics (in physical mechanics) will appreciate the shift in thinking involved in passing from equilibrium analysis (of for example a suspended weight or a steel bridge)…to an analysis where attention is focused on second-order differential equations, on d2θ/dt2, d2x/dt2, d2y/dt2, on a range of related forces, central, friction, whatever. Particular boundary conditions, “past and future values” are relatively insignificant for the analysis. What is significant is the Leibnitz-Newtonian shift of context. [McShane, 1980, 127]
… The analysis that insists on the indeterminacy (of point-to-indeterminate-future-line) is the analysis that insists on the present fact: estimates and expectations are proofs of the present indeterminacy and attempts to get round it; and, to come to the main point, an analysis based on such estimates and expectations can never arrive at a criticism of them; it would move in a vicious circle. It is to avoid that circle that we have divided the process in terms of indeterminate point-to-line and point-to-surface and higher correspondences. [CWL 15, 28]
The productive process is, then the aggregate of activities proceeding from the potentialities of nature and terminating in a standard of living. Always it is the current process, and so it is distinguished both from the natural resources, which it presupposes, and from the durable effects of past production. (CWL 15, 20)
In the purely current process, in every unit of enterprise there is some determinate turnover magnitude and turnover frequency. The magnitude of the turnover depends upon the number of items handled at once and the selling price of each item. The frequency of turnover depends upon the period of production plus any time lag involved in sales and collection. In general, each unit of enterprise first estimates demand, which determines both rate of payments received and rate of supply; in the second place, it estimates turnover frequency from its conditions of production and of sale and, caeteris paribus, selects a more rapid rather than a less rapid frequency; in the third place, it finds its turnover magnitude determined by the other two factors. The estimate of demand comes first, because there is no use producing without selling. The estimate of frequency comes second, because a more rapid frequency is, in the main, an advantage but one can never have as rapid a frequency as one pleases. Finally, turnover magnitude is left to be determined by the other two factors, because turnover magnitude is the easiest to control of the three. (CWL 15, 58-59)
The current estimates regard the future but determine the current levels of production in the always-current unitary process, wherein reside the concomitance, solidarity, interdependencies, continuity and equilibrium in which we are interested for the purpose of reliable and cumulatively-verifiable explanation and management.
in every unit of enterprise there is some determinate turnover magnitude and turnover frequency. The magnitude of the turnover depends upon the number of items handled at once and the selling price of each item. The frequency of turnover depends upon the period of production plus any time lag involved in sales and collection. (CWL 15, 58-59)
Greg:
The only way I know to answer this question (regarding the transition from the short run to the long run”) is that a lower interest rate on reserves increases bank lending and expands the money supply by increasing the money multiplier. But if students don’t know about how banks create money under fractional reserve banking, they are not equipped to understand this logic.
Our Comment:
One must not confuse the potential maximum money multiplier, which is the reciprocal of the reserves percent, and the actual money multiplier, which the banking system and its borrowers effect by negotiating how much is actually borrowed.
A changing interest rate is double-edged. Again, allowing for and considering Lonergan’s contextual assumptions about the money supply:
Similarly a lowering of interest rates may encourage the expansion of basic industry; but it also will encourage the expansion of well-intentioned but not well-thought-out innovations, the number of bankruptcies, etc. What is needed is the egalitarian shift in incomes, that will compensate for the previous and shorter anti-egalitarian shift, and will produce the things that people really need and can learn to purchase without the help of self-seeking advertisers. [CWL 15, 141 ftnt 198]
The following is taken from The Ineptitudes in Central Bank Manipulations. (click here)
Traditional theory remains current mistaken theory.
Traditional theory looked to shifting interest rates to provide suitable adjustment of the rate of saving W to the phases of the pure cycle. In the main we shall be concerned with factors that are prior to changing interest rates and more effective. [CWL 15, 133]
… it can be argued that a) this view (of correction by manipulating rates) was not sufficiently nuanced in its estimate of the requirements of the productive process, b) that it missed the magnitude of the problem, and c) that it tended to lump together quite different requirements. … [CWL 15, 140, ftnt. 197]
The difficulty with (traditional) theory is that a.) it lumps together a number of quite different things and b.) it overlooks the order of magnitude of the fundamental problem… [CWL 15, 141-144]
Though the adequate human adaptation to the demands of the process is understood to be a shift among incomes, instead the inadequate strategy of variations of interest rates is “felt” to be the answer. The Fed is charged by an ignorant Congress to correct disequilibria with a double-edged, counterproductive tool.
(Functional Macroeconomic Dynamics’) account (of the monetary distributions scientifically distinguished as basic and surplus incomes) springs from a (scientific) characterization of possible types of productive rhythms which lead (in turn) to the (scientific) specification of the adequate human adaptation to the (intrinsically cyclical) demands of the process, and also to (an identification and) determination of inadequate strategies of adaptation such as variations of interest rates, varieties of taxation and monetary policy. [McShane, 1980, 125]
Re a) the nuance: The economic process is nuanced by phases with different requirements of income distribution. The process, as a process, advances, and its requirements for nuanced adjustments in income distribution change. Again,
The difficulty with (traditional) theory is that a.) it lumps together a number of quite different things and b.) it overlooks the order of magnitude of the fundamental problem… [CWL 15, 141-144]
The requirements of an expanding productive process are that pure surplus income has to keep increasing in the surplus phase of an expansion, that it has to keep decreasing in the basic phase of the expansion, and that it vanishes when the cost of replacements and maintenance absorbs the whole of surplus. [CWL 15, 140, ftnt. 197]
Re b) the magnitude:
(in a surplus expansion,) it would take enormous interest rates backed by all propaganda techniques at our disposal to effect the negative values of dwi (w here symbolizes the propensity to consume of an income stratum i) that are required interval after interval as the surplus expansion proceeds; what is needed is something in the order of ‘incentives to save’ that is as rapid and as effective as the reduction of purchasing power by rising prices. … [CWL 15, 141-144]
Re c) the lumping together and treating a double edge as a single edge: Higher interest rates increase savings to a minor extent, but they damp large, long-term investment to a major extent.
The ineptitude of the procedure arises not only from its inadequacy to effect a redistribution of income of the magnitude required … the effect of raising interest rates to encourage savings (for investment) is not to keep the rate of saving and the productive process in harmony as the expansion continues but simply (and counterproductively) to end the expansion by eliminating (by discouragingly higher charged interest costs) its long-term elements. [CWL 15, 141-144]
Congress and The Fed along with their advisors from academia are stuck in the illusion that the interest rate is a single-effect, external magic lever to be operated from outside the system. In reality, the normative interest-rate relation is implicitly contained in – i.e. internal to – the normative functional flows in any phase of the process. Any manipulation of the normative functional flows induced by manipulation of short-term interest rates or by open-market operations will be double-edged, producing some definite, but not-precisely-predictable, asymmetric double effect in the non-systematic manifold of economic events.
One must not confuse the potential maximum money multiplier, which is the reciprocal of the reserves percent, and the actual money multiplier, which the banking system determines by how much it actually lends.
Also again, it is important to distinguish the actual money multiplier from the maximum possible multiplier under the Central Bank’s current reserve requirements. The maximum money multiplier would be the reciprocal of the percentage reserve requirements; e.g. if the reserve requirements were 20% or 10% of the monetary base, the maximum multiplier would be 5 or 10 respectively: 1/.2 = 5 ; and 1/.10 = 10. The banking system would likely effect an actual multiplier of less than the maximum.
Greg:
The bottom line: The traditional pedagogy about how banks influence the money supply remains important if students are to understand the economics of inflation.
Our Comment: We agree. The traditional pedagogy does remain important because the proper money supply is that amount which affords proper magnitudes and frequencies of payments with the magnitudes and frequencies of the real economic turnovers which constitute real production and exchange.
Greg:
Update: This post generated more than the usual amount of confusion and misdirection on Twitter. So let me explain my logic more slowly:
.2. It is useful for students to know that cutting the interest rate on reserves is expansionary for aggregate demand and, over time, inflationary. That is, it raises P.
.3. To complete the story, you need to explain how cutting the interest rate on reserves raises M.
.4. To be sure, lower interest rates increase the quantity of money demanded. But you also must explain the quantity of money supplied.
Our Comment:
Again, one must not confuse the potential maximum money multiplier, which is the reciprocal of the reserves percent, and the actual money multiplier, which the banking system determines by how much it actually lends. The maximum money multiplier would be the reciprocal of the percentage reserve requirements; e.g. if the reserve requirements were 20% or 10% of the monetary base, the maximum multiplier would be 5 or 10 respectively: 1/.2 = 5 ; and 1/.10 = 10. The banking system would likely effect an actual multiplier of less than the maximum.
The multiplication of money is not automatic. The banking system may choose how much of the allowed monetary expansion it effects, depending upon its assessment of the borrower and the borrower’s projects. Also, there may not exist the demand for borrowing money allowed by the fractional reserve system. If potential borrowers a) are operating well below capacity, b) recently completed a significant expansion of capacity, and c) are struggling financially, they may not be interested in what fractional-reserve banking would allow.
Greg:
.6. Cutting the interest on reserves (unlike open-market operations) does not change B [.5. The money supply M equals m*B, where m is the money multiplier and B is the monetary base (currency plus reserves)]. So if it changes the money supply M, it must work through the money multiplier m.
Our Comment:
OK.
Greg:
.7. One cannot understand the money multiplier m without understanding fractional reserve banking. (Under 100-percent-reserve banking, m is fixed at 1.)
Our Comment:
OK.
Again, the multiplication of money is not automatic. First, the banking system may choose how much of the allowed monetary expansion it effects, depending upon its assessment of the borrower and the borrower’s projects. Second, There may not exist the demand for borrowing money allowed by the fractional reserve system. If potential borrowers are a) operating well below capacity, b) recently completed a significant expansion of capacity, and c) are struggling financially, they may not be interesting what fractional-reserve banking would allow.
Also, consult the following URLs whose titles are embedded in the address.
https://functionalmacroeconomics.com/2021/09/30/hows-she-cuttin/
https://functionalmacroeconomics.com/2021/10/22/stagflation-demystified/