"GDP" is Complete Nonsense.

[doug6zj9]

I have long thought that GDP was deeply flawed as a measure of anything meaningful.  Now I see it is even worse than I thought.  I read this guy weekly and I think he is outstanding.

http://www.financeandeconomics.org/Arti ... nsense.pdf

[craigr]

I will read the article, but I've thought that GDP as a measure of an economy was worthless for quite some time. As I posted in another thread, you can have a country with high GDP but it can still be a toilet.

Here is a chart of GDP growth from Japan and Myanamar from 1961 to today. By these gross measures Myanamar looks like a great place to live. Where the reality is that it is a third world economy with third world problems:

Japan vs. Myanamar GDP

[moda0306]

I think this is where libertarians and environmentalists minds meet.

Definitely a topic worth discussing.  I don't measure my life or happiness based upon how much I produce or consume... why should we as a nation.  The idea that our government should engineer maximum GDP every year seems perverted.

[stone]

doug6zj9, your link has one bit that didn't seem right to me : "This being the case, GDP in Year 1 obviously will be exactly the same as in Year n, irrespective of the actual economic activities in those years."

-Like the author, I'm all for a sound money set up and would think it sensible to have say exactly one trillion USD each with a serial number and no credit money creation. Nevertheless, I don't agree that GDP would always be the same under such a system. The turn over rate (velocity) of the money would determine what the GDP was. If everyone started employing each other as life coaches and so the dollars exchanged hands rapidly, then GDP would be high. If everyone instead just chatted to each other in a non-commercial capacity and kept the money in their pockets, then GDP would be lower. There would be exactly the same amount of money but the turn over rate would mean different GDP figures.  

[moda0306]

Isn't credit money creation a very natural creation of the private sector?  To me, this idea that fractional reserve banking is some giant fraud executed by the government is a bit much.

We had fractional reserve banking during the gold standard, and the very fact that you receive interest on savings implies that you are supplying a system of loanable funds.  Not that everyone explicitly understands this, or that government hasn't influenced it, but I simply don't understand the attempt to make it into some kind of government fraud.  It's a free and natural process between people with money (gold or green) to loan that want interest and businesses & individuals with time to work and a skill to bring to market, but no money in their hands to buy what they need (or want).

[RickV42]

moda0306,

I think loaning money (gold or green) that has been saved (dollar saved/dollar loaned), as the basis for what I think of as a "natural economy" can be ok.  But creating money to loan from nothing or with little true economic backing (fractional reserve lending) I think is a problem.  

First, it drives resources to be used above and beyond what would be otherwise be used in a natural economy without fractional reserve lending. So it helps to enable things like unsustainable resource comsumption and wars - as the resources wouldn't otherwise be comitted for those purposes (or more accuratley could still happen but would draw down from funding used in other areas of the economy).

Fractional reserve lending allows the existing money to be used many times at once, loaning the same dollar out 9 times - in other words, having our cake and eating it too.  So no one really has to make hard choices in the near term about what to fund - it can all be done!      Great for the economy but not so good for sustainability, among other things.

Second, fractional reserve lending creates greater instability as it drives larger bigger booms and busts then would otherwise occur. It is a form of super leverage.

Third, it creates far more interest AND credit than can be paid back (without defaulting or inflating away), than a "natural economy" could produce. The only means of payment then become even more fractional reserve borrowing, default or inflation.

Fourth, it creates higher levels of inflation than what would occur in a natural economy, which hurts those who do not have access to credit or those who are on fixed  incomes.  It also drives peopel to speculate in order to keep up (more so than a natural economy).

[moda0306]

Rick,

I think you might be accidentally mischaractarizing the nature of fractional reserve lending... "dollar saved dollar lent" IS fractional reserve lending, though not without a bit of a thought process.

When someone earns a dollar and decides to put it in the bank, they do so with the understanding, and in a way even the expectation, that the bank has the right to loan out XX% of the money to somebody else.  This IS fractional reserve banking.  Person A saved a dollar and the bank has the right to loan some of it given the terms of their agreement on the account.

Now lets say Person A saves $10,000 at Money Bank.  Money Bank then lends (20% reserve requirement) $8,000 to person B. Person B could go to Mexico and open a restaurant, go vacation in China, or more likely spend it in the U.S... I mean I doubt he borrowed it to simply keep it in the bank earning .5% interest... so lets assume he goes and buys a car.

Person C sold him the car.  Now, Person C has $8,000, and only if they choose to enter into the same type of contract with the bank... any bank... that Person A did will the $8,000 be lent back out.  Are we to deny this person the ability to earn interest on a savings account because the money he was paid with was lent by somebody else?

The thing is, we SO entrust banks with our money that it appears that the same $ is being lent out over and over, but really, what's happening is every recipient of borrowed dollars that chooses to keep them in a bank is re-entering that same contract with the bank, and shouldn't be denied the right to do so.

So, yes, if Money Bank gets the $8,000 from Person C, they will now have another $6,400 they can loan out, but that's by no means fraud or government trickery, it's simply another person trusting the banking system to keep enough money so their aren't self-fulfilling runs on the bank, and lend out the rest so we can earn some interest on our cash.

Now, today, the supply of loanable funds is so much higher than the demand for debt that banks are paying horrible interest rates... the are well above any reasonable reserve requirements, and have no reason to pay interest as their's little demand for the money we're giving them to hold for us.

Maybe the banks should offer a 100% reserve option where we pay them to store our cash for us, but to call fractional reserve banking a fraud is taking it way too far... real people are choosing to reloan out their money with some basic reserve requirement left behind, and to deny them that right would be extremely inappropriate.  It's their money... if they want to put it back in the same bank that loaned it out it's their choice... they should be able to earn interest just like the rest of the depositors.

[RickV42]

In your example, which I follow on an individual basis, isn't the end result of the system the fact that more debt is created than original savings ($24.4k vs. $10k)?

The system appears to allow the same asset to be lent multiple times over to many different people, each with a claim to ownership at the same time.

Some interesting reading on the debate:  http://globaleconomicanalysis.blogspot. ... tutes.html

[Gumby]

The system appears to allow the same asset to be lent multiple times over to many different people, each with a claim to ownership at the same time.

Rick,

I know it seems like money is lent out multiple times over, but in reality it doesn't work like that.

Here's a paper from the New York Fed that shows us that the text-book description of the money multiplier we all learned in school is false:

http://www.federalreserve.gov/pubs/feds ... 041pap.pdf

Money, Reserves, and the Transmission of Monetary Policy: Does the Money Multiplier Exist?
...

The role of reserves and money in macroeconomics has a long history.  Simple textbook treatments of the money multiplier give the quantity of bank reserves a causal role in determining the quantity of money and bank lending and thus the transmission mechanism of monetary policy. This role results from the assumptions that reserve requirements generate a direct and tight linkage between money and reserves and that the central bank controls the money supply by adjusting the quantity of reserves through open market operations.  Using data from recent decades, we have demonstrated that this simple textbook link is implausible in the United States for a number of reasons. First, when money is measured as M2, only a small portion of it is reservable and thus only a small portion is linked to the level of reserve balances the Fed provides through open market operations.  Second, except for a brief period in the early 1980s, the Fed has traditionally aimed to control the federal funds rate rather than the quantity of reserves.  Third, reserve balances are not identical to required reserves, and the federal funds rate is the interest rate in the market for all reserve balances, not just required reserves.  Reserve balances are supplied elastically at the target funds rate.  Finally, reservable liabilities fund only a small fraction of bank lending and the evidence suggests that they are not the marginal source data for the most liquid and well-capitalized banks.  Changes in reserves are unrelated to changes in lending, and open market operations do not have a direct impact on lending. We conclude that the textbook treatment of money in the transmission mechanism can be rejected.  Specifically, our results indicate that bank loan supply does not respond to changes in monetary policy through a bank lending channel, no matter how we group the banks.

Our evidence against the bank lending channel at the aggregate level is consistent with other recent studies such as Black, Hancock, and Passmore (2007), who reach a similar conclusion about the limited scope of the bank lending channel in the United States, and Cetorelli and Goldberg (2008), who point out the importance of globalization as a way to insulate the banks from domestic monetary policy shocks.  Our findings are also consistent with the predictions of Bernanke and Gertler (1995) from over a decade ago that the importance of the traditional bank lending channel would likely diminish over time as depository institutions gained easier access to external funding.

Our evidence against the bank lending channel at the micro level is consistent with Oliner and Rudebusch (1995), but it contrasts previous findings of a lending channel for small, illiquid, or undercapitalized banks (see Kashyap and Stein (2000), Kishan and Opiela, (2000) and Jayartne and Morgan (2000)).  What is common in all these studies is that their sample periods cover the period prior to 1995, when reservable deposits constituted the largest source of funding.  As we have shown in Table 3, this is no longer a feature that characterizes bank balance sheets in the post-1994 period.  Furthermore, Kashyap and Stein (2000) and Kishan and Opiela (2000) interpret a change in the sensitivity of bank lending to monetary policy as evidence of a bank lending channel. We argue that changes in the sensitivity of bank loans may of funding, either.  All of these points are a reflection of the institutional structure of the U.S. banking system and suggest that the textbook role of money is not operative. While the institutional facts alone provide compelling support for our view, we also demonstrate empirically that the relationships implied by the money multiplier do not exist in the stem from the demand side, and that a better test for the lending channel is to check whether bank loans are financed by reservable deposits. Our findings suggest that this is not the case.

In general, our results echo Romer and Romer (1990)’s version of the Modigliani-Miller theorem for banking firms.  They argue that banks are indifferent between reservable deposits and non-reservable deposits.  Hence, shocks to reservable deposits do not affect their lending decisions, and changes to reserves only serve to alter the mix of reservable and non-reservable deposits.  Our findings in this paper support the argument that shocks to reservable deposits do not change banks’ lending decisions.

Since 2008, the Federal Reserve has supplied an enormous quantity of reserve balances relative to historical levels as a result of a set of nontraditional policy actions.  These actions were taken to stabilize short-term funding markets and to provide additional monetary policy stimulus at a time when the federal funds rate was at its effective lower bound.  The question arises whether or not this unprecedented rise in reserve balances ought to lead to a sharp rise in money and lending.  The results in this paper suggest that the quantity of reserve balances itself is not likely to trigger a rapid increase in lending.  To be sure, the low level of interest rates could stimulate demand for loans and lead to increased lending, but the narrow, textbook money multiplier does not appear to be a useful means of assessing the implications of monetary policy for future money growth or bank lending. (emphasis added)

Source: http://www.federalreserve.gov/pubs/feds ... 041pap.pdf

San Francisco Fed President John C. Williams also spoke of the non-existant Money Multiplier:

http://www.frbsf.org/publications/econo ... 11-17.html

Furthermore, the St. Louis Fed measures the M1 Money Multiplier, and guess what?...

[align=center][/align]

...The M1 Money Multiplier has been dropping for years, and officially tanked in 2008. It is dead in the water right now. As you can see from the chart, it's actually below 1.0, which means that no money is multiplied. Any number multiplied by a number less than one actually DECREASES the result. It's extremely difficult for the Fed to create inflation if banks won't lend.

Not coincidentally, Japan's Money Multiplier died years ago:

http://www2.e.u-tokyo.ac.jp/~seido/outp ... han_18.pdf

[moda0306]

I would agree that yes, you are correct, the end result is a quasi-exponential expansion of credit.

This is a result of a society that seems to want to supply most of its cash to a system that will earn them interest, or at the very least won't put up on them a fee for holding their cash.

While it's important for people to realize the structural flaws of a system built up too much on credit, it is, in my observation, a very natural product of the private sector... if a private sector a bit dim on the risks of loaning their money to the banks.

I read your example, and it basically reiterates most anti-fractional reserve banking comments I've read.

I think what we need to realize is that any attempt to earn interest on savings, deposits, bonds, etc is an expansion of credit.  The holder of that debt has the right to do the exact same thing once they receive the credit (assuming they are abiding the terms of the loan).

For good are bad, we are accustomed to trusting our banking system to have enough cash for us to pull out and HATE paying fees to banks... I can't imagine a 100% reserve banking system would be supported by that many people, and in a clumsy way already exists within our homes and safe-deposit boxes.

[lazyboy]

Here's a quote from Robert F. Kennedy about GNP taken from a speech he gave in 1968:

And this is one of the great tasks of leadership for us, as individuals and citizens this year.  But even if we act to erase material poverty, there is another greater task, it is to confront the poverty of satisfaction - purpose and dignity - that afflicts us all.  Too much and for too long, we seemed to have surrendered personal excellence and community values in the mere accumulation of material things.  Our Gross National Product, now, is over $800 billion dollars a year, but that Gross National Product - if we judge the United States of America by that - that Gross National Product counts air pollution and cigarette advertising, and ambulances to clear our highways of carnage.  It counts special locks for our doors and the jails for the people who break them.  It counts the destruction of the redwood and the loss of our natural wonder in chaotic sprawl.  It counts napalm and counts nuclear warheads and armored cars for the police to fight the riots in our cities.  It counts Whitman's rifle and Speck's knife, and the television programs which glorify violence in order to sell toys to our children.  Yet the gross national product does not allow for the health of our children, the quality of their education or the joy of their play.  It does not include the beauty of our poetry or the strength of our marriages, the intelligence of our public debate or the integrity of our public officials.  It measures neither our wit nor our courage, neither our wisdom nor our learning, neither our compassion nor our devotion to our country, it measures everything in short, except that which makes life worthwhile.  And it can tell us everything about America except why we are proud that we are Americans.

http://www.jfklibrary.org/Research/Read ... -1968.aspx

[MediumTex]

Great post above Gumby.

Interesting stuff.

[moda0306]

lazyboy,

Great quote.

[RickV42]

moda0306,

Good points and am in total agreement with rights of individuals to seek whatever return they would like.    It could be though that the results of the system would generate some long term issues (and seems like they are).  Reminds me of the tragedy of the commons or perhaps similar in some ways to some environmental issues - great on an individual basis, especially if it is you, but not so sustainable when everyone is doing it.

Interest rates you earn on deposits might actually be higher with no (or less) fractional lending as supply of lendable money would decrease.

To bring it around to OP, I also think the GDP is off a tad.

[RickV42]

Gumby,

My point of reference when saying deposits lead to expanding credit was the past 30-40 years where the the multiplier was above 1. 

I totally agree that as of lately, money is not multiplying, credit is shrinking, and reserves do not lead to expanding credit. 

The fractional reserve engine in reverse gear.  Beep, beep, beep, beep.

[stone]

Gumby, MMTers also say that the money multiplier idea is nonsense. That doesn't mean that bank lending does not create extra money, it simply means that that extra money is not created in proportion to the monetary base. The constraints on the amount of money creation by private banks are whether it is worth the banks' while in terms of the loans having a chance to be repaid (ie the credit worthiness of borrowers) and, if that is not constraining, then the amount of bank capital relative to the bank capital requirements (Basel III). When a bank makes a loan, that loan is newly conjured up money. That process creates a multitude of competing claims over the same pool of available resources (labor and natural resources). That drives bubbles and collapses.
If you wanted to avoid having money creation by bank lending then you could instead have loan companies that sold bonds and issued stock in order to raise the money they lent much as venture capital trusts do now.

[Gumby]

Gumby,

My point of reference when saying deposits lead to expanding credit was the past 30-40 years where the the multiplier was above 1. 

I totally agree that as of lately, money is not multiplying, credit is shrinking, and reserves do not lead to expanding credit.   

The fractional reserve engine in reverse gear.  Beep, beep, beep, beep.

Yes, but you gave an example of money being loaned out 9 times over. That's fantasy. Even over the past 30-40 years, the money multiplier was never even close to that.

[Gumby]

Gumby, MMTers also say that the money multiplier idea is nonsense. That doesn't mean that bank lending does not create extra money, it simply means that that extra money is not created in proportion to the monetary base. The constraints on the amount of money creation by private banks are whether it is worth the banks' while in terms of the loans having a chance to be repaid (ie the credit worthiness of borrowers) and, if that is not constraining, then the amount of bank capital relative to the bank capital requirements (Basel III). When a bank makes a loan, that loan is newly conjured up money. That process creates a multitude of competing claims over the same pool of available resources (labor and natural resources). That drives bubbles and collapses.
If you wanted to avoid having money creation by bank lending then you could instead have loan companies that sold bonds and issued stock in order to raise the money they lent much as venture capital trusts do now.

All I'm saying is that there's never been any evidence that the money multiplier actually created very much money. Look at the data. The money multiplier has always been weak and/or declining — barely above 3x at its highest.

And any money that is created is also recorded as a liability on the bank's balance sheet that needs to be repaid — it's not like the money loaned by a bank is ever a permanent part of the money supply. The money multiplier is a very weak effect — nothing close to what people imagine it is.

[moda0306]

Gumby,

Combine that with the fact that this is a relatively natural operation of the private sector (though obviously influenced by the fed & FDIC) I really don't see wht there is to scream about.

We'd very likely see the same phenominon in a gold-standard banking system with little government oversight, though it would likely be relatively prone to bank runs, which would probably limit it.

But it seems to me the FDIC is a user fee based service paid by banks and therefore savers... it adds a lot of stability to the banking system... are austrian economists calling for the end of it because it is a catalyst to debt-expansion?

[stone]

Gumby I agree, as the amount of monetary base has been increased by QE, all that has happened has been that the turnover rate has decreased. Although M1 hasn't been more than 3x M0,  M2 (ie including savings deposits) is much larger isn't it?.
http://en.wikipedia.org/wiki/File:Compo ... supply.svg

Afterall, even monetary base is not permanant. It can be reduced by taxation (budget surplus)

[stone]

What would be a sensible measure of whether things are on the right track? Would infant mortality rate do the trick?
http://en.wikipedia.org/wiki/List_of_co ... ality_rate

That seems to link in with "prosperity" rather than "activity" and so make more sense and be harder/impossible to manipulate via inflation etc. If everyone is burning each others houses down and then rebuilding- then that will increase GDP but increase infant mortality.

[Gumby]

Gumby I agree, as the amount of monetary base has been increased by QE, all that has happened has been that the turnover rate has decreased. Although M1 hasn't been more than 3x M0,  M2 (ie including savings deposits) is much larger isn't it?.
http://en.wikipedia.org/wiki/File:Compo ... supply.svg

Afterall, even monetary base is not permanant. It can be reduced by taxation (budget surplus)

Right. But, it's not just since QE. There is definitely an inverse correlation between the monetary base and the money multiplier. That trend has been happening for decades:

[align=center][/align]

In fact, the money multiplier was greatest (only briefly above 3x) when interest rates were high and the monetary base was much lower.

[RickV42]

Gumby,

Depending on what money supply is examined - the multiplier was much greater than 3.

I beleive the broader meaures of money relate more to economic activity than the narrower measures.  Also, money once created, can be moved into many different forms and duration of money/holdings, much of which  is not captured in narrower measures.  This is especially true over the past 10-15 years.

An older chart I found  (it has no source and I couldn't find updated one) shows multiplier for MZM:  
http://2.bp.blogspot.com/_b6CLevEGCD0/S ... iplier.JPG

As of late, I am right with you in agreeing that money is not expanding as fast as it was in past (in fact it is probably contracting) and would suspect if graph was updated it would be continuing its down trend.  As you understand banks are now sitting on reserves and not lending.  

But this not how it usually works as the current situation only happens when peak credit absorbtion is acheived.

[Gumby]

Gumby,

Depending on what money supply is examined - the multiplier went greater than 3.

I beleive the broader meaures relate more to economic activity than the narrower measures.

An older chart I found  (it has no source and I couldn't find updated one) shows muliplier for MZM:  
http://2.bp.blogspot.com/_b6CLevEGCD0/S ... iplier.JPG

Rick,

A MZM multiplier isn't what you were talking about just a few posts ago.

You were specifically talking about "fractional reserve lending," which is specific to the commercial banking system. You were talking about "deposits." To now switch over to a MZM multiplier (which the Fed doesn't even use), is to completely change the topic to assets in hedge funds and money market funds.

Within our fractional reserve banking system, the money multiplier has always been weak at best.

There's a good reason why MZM is never used by the Fed to show the money multiplier. A MZM money multiplier tells us nothing about how reserves affect commercial banking deposits. You won't find a MZM multiplier from the St. Louis Fed research or in any Fed papers or reports. MZM itself is not an ideal measure of the money supply because it includes instruments that aren't actually money at all. MZM includes Money Market Funds (which are often invested in Commercial Paper, Repos, Bonds or Treasuries), assets at hedge funds, and other zero maturity financial instruments that can easily be converted into money — but aren't actually money themselves.

I'm just confused at your point now. Are you critical of fractional reserve lending (even though there was never much of a multiplier within the commercial banking system), or are you really just critical of the high-leverage shadow banking system? They are two different things.

I can't find any evidence of the money multiplier ever being a problem within the fractional reserve banking system. However, I would agree that 40:1 leverage on Wall Street is terribly dangerous (and I think most people would agree as well).

[RickV42]

Gumby,

Starting with my point of view, I agree 40/1 leverage is bad.

I also think (and consider I may be wrong) that fractional reserve lending may be bad over time given my assumption that large multiples of what is saved is lent.  You provided a great graph of M1 showing that fractional lending does multiply the money supply, but only to a limited degree.

My counter point (really just trying to clarify my own understanding) is I’m not sure M1 truly reflects the full expansion (or now contraction) of money&credit (combined) in the economy as it measures primarily only commercial banks and hence my attempt to use MZM.

I am viewing money from a practical standpoint of money/credit that is held/available as one available lump which is spendable and I think the whole lump expands/contracts with fractional reserve lending, and moves the economy with it.  While I understand MZM does not reflect true money, I believe it is close in showing the broadest measure of money, money&credit, in the economy that is still available.

I need to work on making clearer the expansion of spendable money&credit and better show the link/effect that fractional lending has in driving it. 

I appreciate discussion and help clarifying thoughts.  One question, where does the 40/1 leverage that Wall Street uses come from?