Friday, June 14, 2013

Simpler


My economics is simple. For me, money breaks down to what's circulating and what isn't. (Money that's in savings isn't circulating.) Pretty simple definition. Some might say simplistic. It's not.

Anyway, much discussion these days involves base money and reserves and other forms of narrow money, narrower than circulating money. So I scratch my head a lot, and keep quiet sometimes, maybe not enough. And I look at the Wikipedia table when I need to, and I try to remember details about money.

So.

With recent activity still fresh in my mind, I want to take another look at Steve Roth's The Fed is not “Printing Money.” It’s Retiring Bonds and Issuing Reserves.


My recent post started out as a look at the definition of base money:

As the MB column [in the Wikipedia table] indicates, base money is made up of three parts: Notes and coins in circulation, Vault Cash, and Reserves not physically present in banks.

If you walk into the bank with a dollar in your pocket, that dollar counts as "Notes and coins in circulation". If you deposit the dollar, it changes to "Vault Cash". It is still part of base money, but now it counts as Reserves...

If that dollar then for some reason gets sent to the Fed it is still base money and it is still reserves, but now it is "not physically present in banks".

That's the relation between the three components of base money.

Pretty simple. Based on standard definitions. My goal is to understand this aspect of the economy as it is commonly understood. By contrast, Steve Roth's goal seems to be to change the definitions. It's right there in the title of his post! He writes:

I’m going to go even farther than Dow and say: the Fed is not printing money... The Fed is issuing new reserves and exchanging them for bonds.

Reserves are not “money” in any useful sense.

Yes, that's how the Fed issues new reserves: It exchanges them for stuff. For a hundred years before Roth wrote those words, the Fed would buy stuff -- bonds, say -- with newly created money, and that new money was considered reserves, and the reserves were part of a narrow base upon which a broader supply of money was built.

Now, for some reason, issuing reserves is not to be considered "printing money"???

Hey, the economy changes. Sometimes definitions need to be updated. And sometimes people get things wrong and definitions have to be corrected. I can live with all of that.

But it's important to begin by understanding things as they are commonly understood, and to understand them simply, and to see if it all still makes sense when simplified.

For if you do not begin by understanding things that way, you cannot know if those things are right or wrong.


Our economy *has* changed. One of the things that changed is we now pay interest on reserves. I mean, the Fed now pays interest on reserves.

That makes sense in a way, because reserves are like money in a savings account, and we get interest on our savings.

Does that change make it true that reserves are not money?

No. It makes reserves more like money in a savings account. And that makes sense too, because people who know better than me say that reserves are money that is not being spent. Or I don't know, maybe they just say that reserves are not spent, omitting the fact that reserves are money.

But are reserves money?

No, reserves are shoes. The dollar in your pocket is money, the circulating part of base money. When you deposit that dollar in the bank it is still money, the vault cash part of base money. But when your bank deposits that dollar in its bank, in the Fed, it is the reserves part of base money but it magically stops being money and starts being shoes.

Of course reserves are money.


The economy is complex in the sense that everything is part of it and everything comes into play one way or another. People who fail to simplify things sufficiently are liable to confuse themselves because of this complexity.

Steve Roth has confused his thoughts on reserves with other things. He finds it convenient to say that reserves are *not* money because he has in mind to use that thought to support his views on inflation and monetizing debt. Roth writes:

It doesn’t make sense to say that the Fed is “monetizing” the debt (because reserves aren’t money).

But peoples fears of inflation, right or wrong, have no bearing on the definition of reserves. If reserves are money, then reserves are money regardless of your view of inflation.

These are two separate issues, what reserves are, and whether the recent massive expansion of reserves will lead to inflation. Two separate issues. Steve Roth wants to argue that the massive expansion won't cause inflation because it isn't monetizing debt. So he finds it convenient to change the definition that says reserves are money.

The argument is awful. The logic is worse.

3 comments:

The Arthurian said...

Descartes:
... people who do not allow their thought to be distracted by various objects at the same time, but always concentrate it in attending to the simplest and easiest particulars, are clear-headed.

geerussell said...

No. It makes reserves more like money in a savings account. And that makes sense too, because people who know better than me say that reserves are money that is not being spent.

That's really not what reserves are. Reserves are not a pool banks can draw on to spend the way a savings account is. Reserves are final settlement for bank deposits.

Bank deposits are what we spend. Bank deposits are what we convert to circulating cash. Reserves neither create nor constrain bank deposits. That's why it's correct to distinguish between reserve issuance and "printing money".

Suppose the decided to just arbitrarily mark up every bank's reserve account to 100% of deposits. With a keystroke, many multiples of issuance over what's currently in the system. What private actor would be able to increase their spending as a result?

Certainly not you. From your perspective reserves are inside the black box of the banking system and irrelevant. You go to look at your balance of bank deposits and it's the same as it was the day before. Not the bank either. It has a larger pool of reserves with which to settle deposit transactions but the increase in reserves didn't create more deposits or cause more transactions. Yet the capacity to spend more is exactly what most people have in mind as the outcome when they talk about "printing money".

Of course reserves are money but specific types of money have different roles and functions. Simplifications ignoring this don't make sense when simplified and lead to common misunderstandings.

The Arthurian said...

"Of course reserves are money but specific types of money have different roles and functions. Simplifications ignoring this don't make sense when simplified and lead to common misunderstandings."

Well I'm glad we agree that reserves are money. What was it Steve Roth said?

"(because reserves aren’t money)."

Yeah, that was it.

//

Are you saying that I should not try to simplify things? That's what you seem to be saying here.