Keynes’ ‘Human’ Apple

The point needs emphasising because the art of thinking in terms of models is a difficult–largely because it is an unaccustomed–practice. The pseudo-analogy with the physical sciences leads directly counter to the habit of mind which is most important for an economist proper to acquire.

I also want to emphasise strongly the point about economics being a moral science. I mentioned before that it deals with introspection and with values. I might have added that it deals with motives, expectations, psychological uncertainties. One has to be constantly on guard against treating the material as constant and homogeneous in the same way that the material of the other sciences, in spite of its complexity, is constant and homogeneous. It is as though the fall of the apple to the ground depended on the apple’s motives, on whether it is worth while falling to the ground, and whether the ground wanted the apple to fall, and on mistaken calculations on the part of the apple as to how far it was from the centre of the earth.

But do not be reluctant to soil your hands, as you call it. I think it is most important. The specialist in the manufacture of models will not be successful unless he is constantly correcting his judgment by intimate and messy acquaintance with the facts to which his model has to be applied.

J. M. Keynes to Harrod, 10 July 1938

Monetary Mysticism

Normally, I’d give such things a pass. But there are monetary mysticists – the Neochartalists (“MMTers”) – who make a big issue of a few monetary things. In a post on banking, Eric Tymoigne such mystical things:

Throughout this blog I will not the use the words “loan” “lender” “borrower” “lending” “borrowing” when analyzing banks (private or Fed) and their operations. Banks don’t lend money, and customer don’t borrow money from banks. Words like “advance” “creditor” “debtor” are more appropriate words to describe what goes on in banking operations.

The word “lend” (and so “borrow”) is really a misnomer that has the potential of confusing—and actually does confuse—people about what banks do.

So banks do not make loans?

But that’s not the main point in my post. It is the other claim:

  • Point 2: The Fed does not earn any money in USD

When the Fed receives a net income in USD it is not receiving any money/cash flow, i.e. its asset side is not going up. What goes up is net worth.

[highlighting: mine]

Such things are also closely related to claims by the Neochartalists that “taxes don’t fund government expenditure” or “taxes don’t fund anything”. The claim “the Fed does not earn any money in USD” is quite silly.

If you were to ever do an honest-to-goodness calculations with such things, you’ll notice that items accounts receivable and accounts payable are important things. In the simplest example, the Federal Reserve holds government bonds as assets and has bank reserves or settlement balances of banks and currency notes on liabilities. So the Fed is accruing interest on bonds it holds and has payables on interest on banks’ settlement balances. The system of national accounts 2008, has a nice explanation on para 7.115:

The accrual basis of recording

Interest is recorded on an accrual basis, that is, interest is recorded as accruing continuously over time to the creditor on the amount of principal outstanding. The interest accruing is the amount receivable by the creditor and payable by the debtor. It may differ not only from the amount of interest actually paid during a given period but also the amount due to be paid within the period.

So the Federal Reserve’s assets can indeed go up along with net worth because of interest income. It will reflect in accounts receivable in assets. When an actual interest payment is received, it is a transaction in the financial account of the system of national accounts. Then, accounts receivable falls and so do liabilities but net worth doesn’t change. More generally, the Fed may also make advances to banks as the banking system as a whole can lose reserves for paying interest. There is absolute no need for the kind of mysticism that Neochartalists do.

Edit 1, Jan 23, 2016, 2:19pm UTC :  detail about transaction in the financial account added. 

Proof Of Infinitude Of Primes Using The Irrationality Of π

So a new largest prime number has been found.  It is

274,207,281 −  1

Of course we know that there is an infinitude of primes, so the number above is just the largest known.

A standard proof is via contradiction. Assume there is a largest prime pn . Then it can be shown that the number p1p2p3pn + 1 is also a prime, contradicting our assumption that there is a largest prime.

Yesterday I found another proof from Wikipedia which is fascinating. There is a formula:

π/4 = 3/4 × 5/4  × 7/8 × 11/12 × 13/12 × 17/16 × 19/20 × 23/24 × 29/28 × 31/32 × …

The numerator is all primes (except 2), one after the other. The denominator is the nearest multiple of 4 of the numerator.

We know  π is irrational. If there are a finite number of primes, the right hand side is a rational number, which doesn’t makes sense since the left hand side is irrational. Hence the right hand side is an infinite product. Hence there is an infinitude of primes!

National Accounting As Atheism

The title of this post isn’t supposed to be taken seriously. It’s just a playful poke on Eric Lonergan’s post mentioned below.

On his blog, Sample Of One, Eric Lonergan has a post tiled Accounting as religion: Buffett, Derrida, and MMT. The post ends with the following line:

… but money is not a liability of the state.

Eric’s post is arguing with the Neochartalists but my post here has nothing to do with Neochartalism. I always find it amusing when people go “money is not the liability of the state, even though it’s technically a liability” and so on. I am going to take a different track here and make an argument like James Tobin’s brilliant 1963 paper Commerical Banks As Creators Of “Money” . I explained Tobin’s brilliant analysis in a post James Tobin, Banking And The Widow’s Cruse.

For this, I will go to a scenario in an open economy:

  • £ is the local currency and $ is the foreign currency.
  • Suppose foreigners hold £1bn in currency notes among other claims on residents. Of course in real life nobody holds £1bn in cash notes but I can always make my case more realistic.
  • Suppose the exchange rate £/$ is falling and the foreign exchange market is nervous and runaway expectations are building up on the exchange rate.
  • This forces the “£-central bank” to intervene.
  • The central bank has less foreign reserves, i.e., $s and hence asks the government treasury to issue $-denominated debt equivalent £1bn. This is done to obtain proceeds to make a sale of $s in the fx markets, with the hope that it reverses the direction of expectations.
  • The central bank sells $s worth £1bn in the foreign exchange market.
  • Foreigners who held £1bn in currency notes are the counterparties.

So liabilities have been dollarized.

Now in this story, the net asset position of the £-nation hasn’t changed. The net international investment position is the same. Only the composition of liabilities. However people who claim that “currency is not really a liability” will agree that the government has a liability in $s. In their way of counting, there is an additional liability (after netting). But that doesn’t make sense. I just walked you through transactions of equal monetary exchanges. If you think

money is not a liability of the state.

do you not see a self-inconsistency here?

In other words, the potential for liability dollarization makes accounting items such as currency notes, reserve balances at the central bank etc. as a liability in a true sense.

Moral of the post: Always start with the open economy.

Kaldor And Oil

…  a more fundamental proposition [is] that any large change in commodity prices – irrespective of whether it is in favour or against the primary producers – tends to have a dampening effect on industrial activity; it retards industrial growth in both cases, instead of retarding it in the one case and stimulating it in the other. There are, as I shall now show, two reasons for this. It is partly a consequence of the fact that whilst a fall in commodity prices tends to be an effective instrument in moving the terms of trade against the primary producers, a rise in commodity prices is not likely to be nearly as effective in moving the terms of trade in their favour. It is partly also a consequence of an asymmetry in the behavioural consequences as between a gain and a loss of real income, the result of which is that any sudden shift in the distribution of world income, caused by a change in the terms of trade, is likely to have an adverse effect on industrial demand (in real terms).

The important cause of the first asymmetry is that while commodity prices are demand-determined, industrial prices are cost-determined, and because of that the rise in commodity prices has a very powerful inflationary effect operating on the cost side. The rise in the price of basic materials and fuels is passed through the various stages of production into the final price with an exaggerated effect – it gets ” blown up ” on the way by a succession of percentage additions to prime costs which mean, in effect, an increase in cash margins at each stage. This causes (initially) a rise in the share of profits in the value added by manufacturing which in itself is a powerful factor (in countries where trade union power is strong) in causing pressure for wage increases. Added to this is the price-induced rise in wages caused by what Sir John Hicks called “Real Wage Resistance” – the reluctance of workers to accept a cut in their standard of living (which is not paralleled by similar reluctance to accept a rise). For these reasons a swing in the terms of trade in favour of the primary producers is not likely to last for long. The industrial sector with its superior market power, resists any compression of its real income by countering the rise in commodity prices through a cost-induced inflation of industrial prices.

Moreover – and here we come to the second reason mentioned above – the inflation itself has a deflationary effect on the effective demand for industrial goods in real terms, partly because the rise in the profits of producers in the primary sector is not matched by a rise in their expenditure – this was particularly marked on the present occasion through the vast accumulation of financial assets by the oil producers – and partly because the governments of most, if not all, of the industrial countries are likely to react to their domestic inflation by fiscal and monetary measures which reduce consumer demand and put a brake on industrial investment. Thus the rise in commodity prices may well result in a wage/price spiral-type of inflation in the industrial sectors which in turn causes industrial activity to be restricted. The latter tends to eliminate the shortages and thereby reverse the trend in commodity prices. A good example of this has been the U.S. inflation of I972-3, which was clearly cost induced but not wage-induced; it was caused by the rise in commodity prices (with wage rises trailing behind the rise in living costs) and which led to strongly restrictionist monetary policies in order to counter the inflation, which in turn brought about a considerable economic recession. (Somewhat later similar restrictionist policies were adopted by governments of other leading countries, such as Germany and Japan.)

If the above analysis is correct, the market mechanism is a highly inefficient regulator for securing continuing adjustment between the growth of availabilities and the growth in requirements for primary products in a manner conducive to the harmonious development of the world economy.

The emergence of commodity surpluses which should, in principle, lead to accelerated industrialisation may have a perverse effect by diminishing effective demand for industrial products. Similarly the emergence of shortages which should accelerate the growth of availabilities of primary products through improvements in the terms of trade may lead instead to an inflation of manufacturers’ prices which tends to offset the improvement in the terms of trade, and by its dampening effect on industrial activity, worsens the climate for new investment in both the primary sector and the industrial sector.

– Kaldor, Nicholas. 1976. “Inflation and Recession in the World Economy”. The Economic Journal 86 (344). [Royal Economic Society, Wiley]: 703–14. doi:10.2307/2231447. Link

J. W. Mason And Alan Greenspan On Monetary Policy

J. W. Mason has a fantastic article titled The Fed Doesn’t Work For You in Jacobin: Reason In Revolt. I especially liked the lines where he points out economists’ inconsistency while worrying about rising wage share in the national income as coming from “demand” but explaining the fall in the share over the last 30-40 years as something “structural”.

There’s a funny disconnect in these conversations. A rising wage share supposedly indicates an overheating economy — a macroeconomic problem that requires a central bank response. But a falling wage share is the result of deep structural forces — unrelated to aggregate demand and certainly not something with which the central bank should be concerned.

Contrast that to Alan Greenspan who spoke recently after the Federal Reserve rate hike (h/t JKH):

A Conversation With Alan Greenspan

Greenspan talks of the money multiplier in response to a question by a lady about the Federal Reserve’s monetary policy after having conceded that he doesn’t understand how it works! To be more accurate he says that interest paid on reserves has helped in broad money not multiplying. But this explanation is as bad as the notion of the money multiplier.

The Phrase “Financial Intermediary” In National Accounts

A lot of times heterodox economists and bloggers complain about the usage of the phrase “financial intermediary” when talking about banks. Such as this one from 2016. The reason given is: “because loans make deposits”. In my opinion, this is counter-productive. While it’s true loans make deposits, it is irrelevant to whether banks should be termed financial intermediaries or not. In fact, that is standard usage. The System of National Accounts 2008, on para 4.101 says:

Financial corporations can be divided into three broad classes namely, financial intermediaries, financial auxiliaries and other financial corporations. Financial intermediaries are institutional units that incur liabilities on their own account for the purpose of acquiring financial assets by engaging in financial transactions on the market. They include insurance corporations and pension funds. Financial auxiliaries are institutional units principally engaged in serving financial markets, but do not take ownership of the financial assets and liabilities they handle. Other financial corporations are institutional units providing financial services, where most of their assets or liabilities are not available on open financial markets.

[italics and boldening in original]

Further 4.106 says:

In general, the following financial intermediaries are classified in this subsector:

a. Commercial banks, “universal” banks, “all-purpose” banks;

b. Savings banks (including trustee savings banks and savings and loan associations);

c. Post office giro institutions, post banks, giro banks;

d. Rural credit banks, agricultural credit banks;

e. cooperative credit banks, credit unions; and

f. Specialized banks or other financial corporations if they take deposits or issue close substitutes for deposits.

Heterodox economists use national accounts and flow of funds more often than orthodox economists who build their theory around a production function, so it is surprising that they vehemently oppose the usage of the phrase “intermediary” for banks. More importantly, the debate is not just semantics but also about “aggregate demand”. The ones who dislike the phrase “intermediary” seem to think that non-bank lending doesn’t have effects on aggregate demand. Funnily, while asserting others use the “loanble funds model”, they are themselves making such errors in their mental model.

Perhaps the term “financial intermediary” is used in the national accounts because it is centred around the production process. At the same time – of course – attention is equally given to finance. So there is nothing really to gain by trying to ban the usage of the phrase “intermediary” for banks.

Aside: IE users should upgrade their browser to IE11. 

Microsoft is going to stop support for old IE browsers. From now on, it will support the latest version only, unlike earlier when it was supporting several versions simultaeneously. So using old browsers will expose you to security risks. Websites’ codes are also browser dependent, so it is possible that my site won’t work with old IE soon. So please upgrade to IE11.

Or do something geeky. Pick up Chrome Canary or the Firefox Nightly build. But IE11 is not bad. It’s superfast.

Happy New Year!

Anwar Shaikh’s New Book

Anwar Shaikh is one of the few economists who had warned about cracks in the foundations of growth of the US economy and the world economy as a whole and that it will lead to a crisis in the 2000s. He has a new book titled Capitalism: Competition, Conflict, Crises. It will be published around February next year.

Capitalism - Competition, Conflict And Crises

The book and 1024 pages and looks like a huge analysis of all ideas in economics. You can preview the table of contents at here. The book is published by Oxford University Press and the book’s page at OUP is here.

Anwar Shaikh is a very knowledgeable economist. In an interview to Ian Macfarlane, Wynne Godley says how much he learned about neoclassical economics from Anwar Shaikh. They then put up a paper titled An Important Inconsistency at the Heart of the Standard Macroeconomic Model. Wynne Godley considered it one of his most important papers. I like the paper and want to sometime rework it in a slightly different way to show that neoclassical economics makes no sense at all.

Anwar Shaikh

Anwar Shaikh, Levy Institute, May 2011, Photograph by me.

New Enhanced Financial Accounts In The Federal Reserve’s Flow Of Funds (Z.1) Report

The Federal Reserve produces quarterly data for the financial accounts of the United States (earlier called “flow of funds”). There are a few notable additions termed enhanced financial accounts, which are in the process of being added. Some additions are details about money market mutual funds, off-balance sheet items of depository institutions, such as unused commitments, letters of credit and derivatives. This is the chart from the Federal Reserve’s FEDS note Off-Balance Sheet Items of Depository Institutions in the Enhanced Financial Accounts


meisenzahl-fig1-20150828-624x652This data is probably not new but has been added in the report. Indeed it was one of the important points of Basil Moore’s book Horizontalists and Verticalists.

Basil Moore - Horizontalists And Verticalists - Loan Commitments

Moore has a sophisticated way of saying things (pages 24-25):

In making a loan commitment a bank should be viewed as a participant in forward rather than spot lending markets. Viewed as a seller of contingent claims, banks themselves obviously can excercise only limited control over the volume of their lending.

On page 186 of Moore’s book, he also notes that Keynes talks about this in his book A Treatise On Money:

Keynes insists that cash facilities of the public includes unused overdraft facilities, “of which we have no statistical record whatever” (JMK, 5, p. 37). He then concludes, “Thus the cash facilities, which are truly cash for the purposes of the theory of the value of money, by no means correspond to the bank deposits which are published” (JMK, 5, p. 38).

Tracking Keynes’ writing Moore concludes that although Keynes talked of unused overdraft facilities, he fails to recognize its importance in theory. Moore says (p. 203):

Keynes then returned to the issue of unused overdraft facilities, without, however, recognizing that this was the key to the endogeneity of the money stock:

[Keynes]: In Great Britain the banks pay great attention to the amount of their outstanding loans and deposits, but not to the amount of their customers’ overdraft faclities … it means that there is no effective pressure on the resources of the banking system until the finance is employed … there is no superimposed pressure resulting for planned activity over and above the pressure resulting from actual activity. (JMK, 14, pp. 222-23).

Honestly, I am not sure what Keynes is trying to say in all this. Moore is quite clear in his book. It’s still nice to know that Keynes discussed all this. Perhaps he wanted to say something more but couldn’t translate his thoughts in words. But if you can interpret Keynes, do tell me!

Krugman’s 45 Degree Rule

Recently, Paul Krugman reminded us of his “45 degree rule” on his blog Conscience Of A Liberal. This was a reference to his paper in 1989 which was a rediscovery of Thirlwall’s Law from 1979 [1] which states that the long run rate of growth of any country is constrained by the rate of growth of exports divided by the income elasticity of imports. Krugman rediscovered this law but interpreted the causality in the opposite way. This shouldn’t be surprising because in neoclassical economics, growth is explained by a production function and it is then difficult to interpret the causality in Thirlwall’s way. In an essay [2], John McCombie explains:

Krugman (1989) rediscovered Thirlwall’s Law, which he termed the 45-degree rule, as empirically ε/π = y/z or, when the (log) of the former is regressed on the (log) of the latter, the coefficient is unity or the slope of the line is 45-degrees. (Krugman provides some empirical evidence providing further confirmation of this empirical relationship). Like McCombie and Thirlwall (1994), he rules out sustained changes in the real exchange rate as a factor in bringing the balance of payments into equilibrium. Consequently, it is necessary to explain why the rule holds. The Keynesian explanation is that it is growth rates that adjust to maintain the balance of payments in equilibrium, but this is rejected by Krugman on “a priori grounds” that it is “fundamentally implausible.” He continues that “we all know that differences in growth rates among countries are primarily determined in the growth rates of total factor productivity, not differences in the rate of growth of employment; it is hard to see what channel links balance of payments due to unfavourable income elasticities to total factor productivity growth” (Krugman, 1989, p. 1037).

The Krugman article is instructive because it goes to the heart of the question about the direction of causation. Drawing on new trade theory, monopolistic competition, and the importance of increasing returns, he argues that faster growth leads to increased specialisation and the production of new goods for sale in overseas markets. Thus high “export elasticities of demand” are due to a dynamic supply side and rapid growth, rather than vice versa.

[x is the growth of the volume of exports, π is the domestic income elasticity of demand for imports, ε is the world income elasticity of demand for exports, and z is the growth of world income]

For a more forceful defence of Thirlwall’s Law, see McCombie’s paper.

In my opinion, the causality runs in both directions. However I am more sympathetic to Thirlwall and McCombie. And because the causality runs in both directions, there is still a balance-of-payments constraint. Complex economic dynamics still benefit richer nations and immiserate others. To an extent, this is already present in Kaldorian models. Growth brings in rise in productivity and this effects price competitiveness and hence beneficial to balance of payments generally. However, I also consider the income elasticity as being affected by growth at home and abroad.


  1. Thirlwall, A. P. (1979) ‘The Balance of Payments Constraint as an Explanation of International Growth Rate Differences’, Banca Nazionale del Lavoro Quarterly Review, March.
  2. McCombie, J.S.L. (2011) ‘Criticisms and defences of the balance-of-payments constrained growth model: some old, some new ‘, PSL Quarterly Review, vol. 64 n. 259 (2011), 353-392. (Can be previewed on Google Books here)