In a previous post I proposed that the term ‘printing money’ gives way to a grammatical fiction. I didn’t mean that the term is devoid of sense or even of reference. My problem is that people’s use of the term doesn’t match the definition they give of it (the same problem Wittgenstein had with terms like ‘pain’). Is that really a grammatical fiction? I don’t know. Let’s just say that terms like these are weasel words.
Here are more weasel words: ‘the money supply‘. Again, the term can be given various perfectly precise senses. And, unless you want to be difficult about the ‘social ontology’ of money, its reference need never be in question. But again, the way people use it rarely matches the definition they give of it.
So what is the money supply? It’s all the money in existence within a given currency zone. And what is money? All sorts of different things are classified as money for different purposes: cash, reserve accounts, deposits of various sorts, credit card and other revolving debt, money market funds, certain types of corporate bonds, etc. etc.
Life is short, so let me just distinguish between two senses of ‘money supply’. One is the total amount in reserve accounts at the central bank. Call this money(r). The other is the total amount in demand deposits – bank deposits from which people can easily spend. Call this money(d).
Let me give an example of how ‘money supply’ gets used as a weasel word.
I recently had a conversation with somebody who told me he believed in ‘fiscal austerity plus monetary easing’. He defined ‘monetary easing’ as ‘increasing the money supply’. Thus his idea appears to be a version of something over which there has been a lot of fussing in certain circles. Roughly: rather than pursuing fiscal stimulus by having the treasury run a deficit, why not have the central bank just ‘create money’ and give it out to people? Increase ‘the money supply’ rather than the deficit.
People who like this policy say that it would work as an economic stimulus. People who don’t like it say that it would be inflationary. Neither think very carefully about what they mean.
What does it mean for the central bank to ‘create money’? The central bank can, of course, credit the reserve accounts of banks, usually by lending against collateral. But this only increases the money(r) supply. Money(d) is the money that people actually spend; reserves cycle around in interbank settlements. So if we’re talking about something that could either work as economic stimulus or drive inflation, we must be talking about increasing the money(d) supply – say by crediting people’s bank accounts.
How can the central bank increase bank deposits? The only way to directly increase net bank deposits is to borrow from a bank. With a few legal adjustments, the central bank could do this. It could instruct banks to credit accounts up by a certain amount and then credit up their reserve accounts by a corresponding amount without taking any collateral. Very fancy, but remember that reserves are just liabilities of the central bank. So this operation actually amounts to the central bank taking out loans from the banks and then putting the new deposits into people’s accounts.
Don’t forget, either, that reserves are (in most countries at least) nominally backed by government debt. So the end result of the above-described operation is the same, in terms of the portfolio adjustments, as that of a fiscal deficit.
What happens when the treasury runs a deficit? Through a bamboozling chain of intermediaries, it issues a liability, gets a bank deposit, and then transfers the deposit into somebody else’s account – whoever it spends with. If its bonds are sold to banks, the operation has the same result as the central bank operation described above. The treasury’s liabilities differ from central bank reserves in their term structures and interest rates. But that difference has nothing to do with the fact that one asset class is called ‘the money supply’ and the other is not. And, again, since reserves are nominally backed by treasury debt anyway (thus they can be used to cancel tax liabilities to the treasury), we’re ultimately talking about two classes of treasury liabilities.
If that’s not enough for you, financial accounting courses teach that it is standard practice, when one unit holds a controlling interest in another, to consolidate them together onto a single balance sheet. In the UK, just as one example, HM Treasury certainly holds a controlling interest in the Bank of England. So we can consolidate them together into one accounting unit called ‘the State’ (Neil Wilson has made the same point in a more sophisticated way).
Now monetary expansion, of the sort described above, means that the State creates assets (bank deposits) for people by issuing liabilities to banks. A fiscal deficit, on the other hand, means that the State creates assets (bank deposits) for people by issuing liabilities to banks.
Oh no – where did the difference go? In sensible accounting terms, it never existed.
So the person who told me he liked ‘fiscal austerity plus monetary easing’ was saying the logical equivalent of: ‘I like fiscal austerity plus fiscal expansion’. Well, I suppose everybody likes that; the crucial question is which of the two is to hold the dominant proportion. We shouldn’t allow good counsel on that question to be darkened by vain discourse about ‘the money supply’.