Review of a book by Joseph E. Stiglitz and Bruce Greenwald, Cambridge University Press, 2003
Towards a
New Paradigm in Monetary Economics
by
William
Krehm
Joseph Stiglitz, once a high official of the World Bank, has achieved renown for his independent critique within the very den of orthodoxy. However, in this imperfect world, even relative heterodoxy carries its price tag. “The material was originally presented at the Raffaele Mattioli Lectures, established by Banca Commerciale Italiana in association with Universita Commerciale Luigi Bocconi as a memorial to the cultural legacy of Raffaele Mattioli, for many years chairman of the bank. This explains the almost lyric naivete of such shrewd investigators in dealing with such delicate issues as the sifting of economic information by banks, and the headlong characterization of the statutory reserves certain countries still require the banks to redeposit with their central banks as “taxes.”
But despite all that accommodation, in the preface we read: “We would be remiss not to acknowledge the vibrant intellectual atmosphere inside the World Bank, in which the ideas presented here were debated, challenged, and adopted and adapted as we confronted the most dramatic set of economic events of the last half of the twentieth century – the global financial crisis; but we would also be remiss if we did not express our sense of frustration at the attempts of the US Treasury and the IMF to suppress open discussion of these ideas. There cannot be meaningful democracy without transparency and without open public discourse of vital issues that affect the lives and livelihoods of the citizens.” To which we can only add our “Amen.”
At times, our reading of this in some respects rewarding book, left the impression that even while asserting these laudable principles, the authors are inclined to accept the view that transparency itself is a market and rarely a perfectly free one at that.
But first of all our applause for the substantial merits of the work. “Professional economists give money an equally mixed review. The monetarists – whose enormous popularity in the early 1980s seems subsequently to have waned – place money as a central determinant of economic activity. By contrast, in the classical dichotomy [of supply and demand], money has no real effects, a view which has been revived in real business cycle theory. Monetary economics has been a curious branch of economics. At times, its central tenet seems to be that it is a subject of no interest to anyone interested in real economics; at other times, it moves front and center....
“The central thesis of this chapter is that the traditional approach to monetary economics, based on the transaction demand for money, is seriously flawed [in that] it does not provide a persuasive explanation for why – or how – money matters. Rather, we argue that the key to understanding monetary economics is the demand and supply of loanable funds, which in turn is contingent on understanding the importance, and consequences of banks. We argue, in particular, that one should not think of the market for loans as identical to the market for ordinary commodities, an auction market in which the interest rate is set simply to equate the demand and supply of funds. That some loans are not repaid is central. A theory of monetary policy which pays no attention to bankruptcy and default is like Hamlet without the Prince of Denmark. Thus, a central function of banks is to determine who is likely to default, and in doing so, banks determine the supply of loans.... While banks are at the center of the credit system, they are also part of a broader credit ‘general equilibrium’ – a general equilibrium whose interdependencies are as important as those that have traditionally been discussed in goods and services markets.”
The big fly afloat in that otherwise enticing broth, is the frequency with which banks before and during the age of Eliot Spitzer have graced the defendants’ dock in celebrated cases such as Enron.
Not infrequently the enquiries disclosed our banks’ part in the design and execution of derivative games that made possible a double sets of books. (Could this perhaps be excused as a derivative of double entry bookkeeping?) It certainly has done little for the information that is the special function of banks to provide according to the authors’ new model.
On the other hand, though muted, there is an awareness of the obstacles that have been thrown up against their new model of openness. “Many developing countries have been placed under strong pressures to open up their financial systems – a marked change in their institutional structure. Most of the arguments for this make standard appeals to an institution-free analysis – more competition increases economic efficiency [no matter what the institutions may be]. A closer look at the impact of such reforms on the domestic banking system, and on the flow of credit to small and medium-size enterprises, suggests many circumstances in which these policy reforms have adverse consequences.” That undoubtedly contributed to the displeasure of the US Treasury and the IMF.
Stiglitz is in fact a little all over the map. I quote: “Establishing a form of Say’s law for government debt, Stiglitz showed that if the government reduced taxes and increased its debt, the demand for government bonds increased by an amount exactly equal to the increase in supply.” The original Say’s Law assured believers that there could not be such a thing as overproduction, because in this best of economic systems the very production of a commodity produced the market for its sale. We thought that the Great Depression and Keynes had knocked the wind out of Say’s sails.
To add to the confusion of leaning on Say’s Law, the authors adopt yet another verbal usage of the dominant financial sector: “remember the characterization of reserve requirements as a tax on borrowing by the bank.” The statutory reserves require banks to redeposit with the central bank a percentage of the deposits they take in from the public – the highest in the case of deposits into their chequing and short-term accounts. These could well be remembered in quite different connections – in their historical context as “seigniorage,” a reference to the ancestral crown’s monopoly in coining precious metal which has now been surrendered in large degree to our banks. Or it could be remembered as an alternative to raising interest rates to fight a rising price level which might or might not be real inflation – i.e., resulting from an excess of demand beyond what supply could fill. What practically all economists concur in is ignoring that price indexes may also rise not because of an excess of demand, but because of urbanization, population increase, and technological development that require more infrastructures and a more highly educated population. All these create the need for more public services as a proportion of total production. That leads inevitably to a deeper layer of taxation embedded into our prices. Thirty-five years ago I identified this under the name of “social lien” to distinguish it from “market inflation” that does indicate an excess of demand over market supply.
But the words we speak can smuggle in great institutional change – especially when privileged groups find these useful.
Thus, we find on page 279, in discussing the bank crisis of the latter 1980s, the authors reach the conclusion that “lower interest rates also reduced the banks’ seigniorage.” That can only refer to the excess the banks lend out over the cash in their vaults. The Bank for International Settlements’ Risk-based Capital Requirements had in 1988 declared the debt of OECD members – the most developed countries – to be risk-free requiring no extra capital to acquire. The Statutory Reserves, unlike the case in Canada, do continue in the US on a very reduced scale, applicable only during banking hours, The interest meters in the case of government bonds that are declared risk-free tick on 24 hours a day, whether the bank doors are closed or open. And that cute innovation reduces the seigniorage regained by the state that had had the free use of the statutory reserve twenty-four hours every day – to match the uninterrupted ticking of the bond interest. In Canada the statutory reserves were abolished outright, though not very publicly, in 1991.
Significantly the term “seigniorage’ harks back to when the ancestral sovereigns held a monopoly in coining gold and silver. And the significance of the bailout of the banks that the book discusses at this point is that the creation of money, once a sovereign privilege, has now been transferred to the banks. The term “seigniorage” is clearly derived from the Italian for “master” and informs us who is now master in the great counting house.
So significant a redistribution of the national income amounted to a shift in the power structure of the nation. Only that could explain how so soon after the bailout of the banks from their gambling losses in the 1980s the firewalls that the Roosevelt bank reform of 1935 that prevented banks from acquiring the other financial sectors were abolished. These other financial sectors – stock brokerages, mortgages, insurance – had their capital pools to meet the needs of their own businesses. But the banks lusted such liquid reserves to expand their cash base on which they could exercise their growing powers of money creation given them by the end of their statutory reserves. Significantly, banks, brokerages, mortgage, and finally insurance and re-insurance conglomerates have featured as star defendants in the investigations of fraud launched by Attorney-General of New York Eliot Spitzer, and the SEC.
None of these issues are spotlighted in the book. Seigniorage, of course, had always been shared with banks and the government. The BIS Guidelines of Capital Requirements and the decrease of the statutory reserves, merely changed the proportions of the sharing sharply to the advantage of the banks. But never before have I encountered the use of the term “seigniorage” referring to the banks’ part of the take. That in itself. I suppose, should earn the authors high marks for frankness up to a point.
And that instance is not unique. For example on page 291 we read:
“When [Fed Governor Alan] Greenspan seemed to support Bush’s tax proposals, questions were raised not only about his economic judgment, but also his political judgment, and the arguments he gave (the notion that eventually the surpluses would eliminate the supply of government debt, which would have adverse effects on the conduct of monetary policy) did little to help.
“If monetary policy must rely on the credibility of the central bank and the central banker, then it is indeed a fragile instrument. For it may increasingly be the case that this particular emperor has no clothes, or is, at the very least, scantily clothed, and while such assertions are seldom made in polite circles, there is a growing suspicion that this may indeed be the case.”