Economists’ Weasel Words 2: The ‘Money Supply’

weasel-awardIn 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’.



4 thoughts on “Economists’ Weasel Words 2: The ‘Money Supply’

  1. NeilW

    The government itself has made the point in an even more sophisticated way – called the Whole of Government Accounts.

    I made the point over on Randy’s piece about ‘debt free’ money that the UK already has debt free money. You just have to look at the Whole of government accounts. There the Gilt Assets held by the central bank are cancelled automatically against the Gilt Liabilities held by HM Treasury and they disappear in a puff of consolidated accounting logic.

    I also made the point that you don’t need a central bank. Commercial banks are essentially required to offer the state a loan on terms and rates determined by the state. The state then pops the deposit created by that loan into the account of the person the state wants paid.

    The central bank can then be regarded as just a clearing house.

    So the state, as representatives of all individuals, takes out the loans with banks on its terms so you as an individual don’t have to take out loans on terms dictated by the bank. It’s like the best collective purchasing deal on the planet. The state gets to dictate what price it pays – if anything.

    Essentially would you rather have a student grant (where the state pays 0% interest and never has to repay the principal) or a student loan (where you pay the interest and principal on ‘commercial’ terms).

  2. NeilW

    Weasel Words are the point btw.

    One of the key points from the science of persuasion is the illusion of authority. So you have the fake Nobel prizes. You have the referenced articles where the references are never checked (and in fact are uncheckable). You have peer reviews amongst the same set of people with the same set of beliefs.

    Pretty much the same structure in other words as the Catholic Church (or Scientologists, or any other form of collective belief system).

    It’s all essentially the ‘ideological and substantive legitimating doctrine of the political theory of possessive individualism’

    The key point from the science of persuasion is that what you are talking about doesn’t have to be true. It just has to sound true and have the ‘appeal to authority’ credibility necessary.

    Once you understand that all of it is pseudo-logic that is designed specifically to *sound* true you get quickly to the point that critiquing it is probably a waste of time.

    There is no science or logic going on here. It’s all about selling a brand of beans.

    1. axdouglas Post author

      The logician Peter Geach once pointed out that people resent logicians for the same reason they resent accountants: both are paid to look for discrepancies.

      That insight helped me to see that logic and accounting are pretty much formally identical. No wonder economic orthodoxy rejects both.

    2. Rohan Grey

      “Once you understand that all of it is pseudo-logic that is designed specifically to *sound* true you get quickly to the point that critiquing it is probably a waste of time.”

      Or you go to law school and learn how to beat them at their own game! :p One of my favorite law professors used to say that the first course in every law school should be called “persuasion,” because that’s the essence of our trade.


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