I will be teaching the intro macro chapter on monetary policy and the role of the Fed in a few weeks. For the 4 years or so I've been teaching I've always had concerns about the best way to teach 'the money' chapter because, frankly, most all of the 'money' chapters I've seen in many intro texts (Mankiw, Case, Hall, etc) really could be torn from the book's binding and probably the students would be better off.
I hate how the 'money' chapter discusses the role and makeup of the Fed while ignoring its history (why we have it, etc.) and comparing to how other economies in the past and present model their financial systems.
I hate how the 'money' chapter just nonchalantly shrugs off any discussion of endogeneity of money by saying explicitly, "it doesn't matter because either way the Fed is who influences interest rates." Of course the laughable absurdity of that statement hits me on so many levels since that statement implies something as true that is not at all always true in dynamic time-space, it implies aggregation of interest rates into 'the interest rate' is just a simplifying assumption, it implies that money demand is lesser or just not important - and it implies that the forms that money demand takes (as a positive force for growth or as a negative force that creates boom/bust cycles and instability) are unnecessary to know. Finally it implies 'money' as defined by circulated currency and demand deposits is the only thing that matters - any notion of credit demand or money created through credit demand is ignored. In sum, these chapters absurdly perpetuate the fallacy of composition and the idea that aggregation and simplification are wholly beneficial to learning and understanding our financial system.
Basically, the 'money' chapter can be said to teach a misleading (and now outdated) view of the role of the Fed, combined with the completely ridiculous and fallacious ideas of what is important about our financial system. The only thing students seem to take away from this chapter is that what's important is the ability for the Fed to create money via our fractional reserves system.
So now my dilemma. Over the last few years I've tried to teach from the text, and supplement with some basic concepts of uncertainty and its effect on money demand and our financial institutions. I've supplemented some basic Austrian ideas of how the Fed may be dynamically perpetuating mal-investments.
But I'm sick of saying one thing and having my text book say and focus on something completely different. Should I just ignore the chapter completely and risk my students missing a question or so on the Departmental final, should I present my concerns to Sr. professors, or should I just keep doing what I'm doing? It's getting to the point where I not only feel its a detriment to the students, but I literally feel ashamed when I teach the 'money' chapter. Does it have to be this way?
Thoughts?
19 comments:
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I think money can not be explained in a single chapter, but requires a book to be adequately addressed. Hands down the best money book ever written is Geoffrey Ingham's The Nature of Money.
First of all, I do not like using the term money. I think it is most useful to talk about specific things, are we talking about bank liabilities (deposits), reserves (created by the central bank and used to pay taxes, and meet reserve requirements, cash in the vault and your wallet), credit (money that is spent with the expectation it will be paid back with interest), money substitutes etc..
The first thing you must do when teaching about money is to define it's roles. The textbook usually does a good job at defining this: medium of exchange, store of value, means of unilateral payment (settlement), unit of account (measure of value). Money must do all these things for us to get things done.
Modern capitalist money comes from private banks and government deficits. Banks produce it in response to credit ratings that enhance inequality via variable interest rates. Damn it I can't include everything i want to in a short comment, here is a good reading assignment for your students:
http://books.google.com/books?id=8RlwmttM6rEC&lpg=PP1&dq=inauthor%3A%22Geoffrey%20Ingham%22&pg=PT73#v=onepage&q=&f=false
correction: http://books.google.com/books?id=8RlwmttM6rEC&pg=PT71&dq=inauthor:%22Geoffrey&source=gbs_toc_r&cad=4#v=onepage&q=&f=false
The monetary system has changed completely since Nixon shut the gold window in 1971, and most texts have not caught up. Have look at Alternative Approaches to Money by L Randall Wray , also his book Understanding Modern Money.
In talking about money the vertical-horizontal relationship of the government as currency issuer, which is not financially constrained in a fiat system, has to be distinguished from currency users — households, firms and states in the US , which are revenue constrained. The horizontal level involves the commercial banking system that creates credit money by lending (loans create deposits). The difference between government money and bank money is significant, because bank money (loans create deposits) nets to zero. Everyone's bank money is someone else's loan; government currency issuance creates non-government net financial assets.
Currency issuance through government (Treasury) disbursements increases non-government net financial assets and taxation reduces NFA. Debt issuance (Treasury securities) simply drain excess reserves, allowing the central bank (Fed) to hit its target rate in the overnight interbank market. The currency issuer is not financially constrained and so neither "funds" itself with taxation nor "finances" itself with borrowing under a nonconvertible floating fx monetary regime. The standard texts are still geared to the former convertible fixed rate system. so myths like the analogy between household finance and government finance get perpetrated. See Warren Mosler, 7 Deadly Innocent Frauds for a good teaching aid.
Bill Mitchell's deconstruction of Mankiw's chapter on the monetary system might also be of interest.
The complacent students sit and listen to some of that
Students probably need to know abut the mainstream theory, both for the departmental exam and also because it's the mainstream theory they will confront later in life, even if they don't go on in economics. But they should also know why it is wrong, in that it does not represent the way in which the monetary system actually works. Bill clears this up.
You might also be interested in his Studying macroeconomics – an exercise in deception and Money multiplier and other myths
many thanks to you guys for the plethora of information that I have not used/seen before. I still have my dilemma, but at least now I have more stuff to work with.
I do somewhat disagree with:
"Importantly, debt issuance is a monetary operation to deal with the banks reserves that deficits add and allow central banks to maintain a target rate. Mankiw doesn’t tell his students anything about this essential monetary operation."
Most mainstream texts note the difference b/w debt that is monetized (as described above) and debt that is not monetized (which then must pull funds from the private sector. This seems to argue that all debt must be monetized. I'm not seeing how that must logically follow from anything. This is very much akin to our previous discussions regarding the savings/investment gap and the deficit. I still think there is a simultaneity here (that the causation is/does not have to be one way or the other).
Garth, read the Bill Mitchell posts and you will find that loanable funds and crowding out are only applicable under a fixed money stock, such as the gold convertibility and fixed rate pre-1971 monetary system. They don't apply in the present nonconvertible floating fx system where government injects the net financial assets through currency issuance that are used to purchase its subsequent debt issuance.
The way it actually works under the present nonconvertible floating rate regime is that if the US government runs a deficit when it disburses money as net financial assets into the economy, then a political constraint, not a financial one, requires an offset through corresponding debt issuance. Thus, the government offsets its deficit by issuing the corresponding amount in Treasuries. To call this "borrowing" is silly because the government doesn't need to borrow to "finance" its money creation by currency issuance. It accomplishes this by simply by marking up spreadsheets at the Treasury and the Fed. What actually happens is that the reserve accounts of commercial banks at the Fed, which function like deposit accounts in the commercial banking system, are marked down (drained) when the commercial banks switch asset form of their holdings from excess reserves to another asset form (Tsy's) that bears interest. (This is comparable to switching one's money from a deposit account to a time account at a commercial bank to earn interest.) Thus, the NFA that the government injected into the economy flows into government securities that bear interest, further increasing non-government NFA.
That is to say, the government's disbursements (Treasury checks) create reserves in the FRS as assets of the commercial banks when the Treasury's checks clear as they are deposited in the commercial banks. This is an increase in non-government net financial assets. It leads to excess reserves that would be loaned by the commercial banks in the interbank overnight market, affecting the Fed's target rate, unless drained by OMO or Treasury issuance, or else the Fed's offering a support rate equal to the target rate. If a support rate is not offered, the banks won't want to hold excess reserves that earn no interest, so they buy the Treasury that are being offered in offset.
Thus, there is no competition for funds in the non-government (horizontal) economy because money creation is a vertical operation that occurs between government as currency issuer and non-government as currency user. The government's currency issuance provides the NFA that are then switched to Treasury securities, the interest on which further adds to the net financial assets of non-government. Of course, this doesn't imply that the same deposits that are created by the government disbursements are switched directly for Tsy's. That's not the case. But the macro effect of the currency and Treasury issuance in offset is a switch of reserves in the interbank system and Tsy's.
The text books don't tell about this, since the system they describe no longer exists in today's world of fiat money and they haven't caught up yet. Bill Mitchell and Randy Wray are working on a textbook now that sets the record straight. But until that is released, those teaching economics will have to supplement the existing texts with an update and correction.
This is called modern monetary theory (MMT) aka Neo-Chartalism. See the blogs of Bill Mitchell, L. Randall Wray, Scott Fulwiler, Marshal Auerback, Warren Mosler, and Winterspeak. There are also a number of working papers by these and others writing in the field that are available (free) at The Levy Institute and the Center for Full Employment and Price Stability
What would be the alternative to the absense of the Fed? Congress making monetary policy. Their track record at that would be even worse than fiscal policy. The Fed in the modern world, or at least in Congress' sights, looks to be the government institution responsible for all economic calmity, including those Congress has resposnibility for. How about this for a course title: How the Fed because the whipping boy institution for a lazy and indecisive Congress.
The Federal Reserve serves the President and Congress the same way military intelligence serves their organizations war fighting abilities. The beauty of having districts is to hone in on the differing sections. The Fed was never meant to be the cure all. Can you imagine not having it? Teach from that prospective.
Danny L. McDaniel
Lafayette, Indiana
...interesting. I've read some of Wray's stuff before and quite a bit on monetary circuit theory, but never really got that much in depth with MMT. I'll definitely study up.
Garth, two new blog posts aimed at people how know nothing that you may be able to use for your class:
Mitchell, Barnaby, better to walk before we run
Wray, The Federal Balance Sheet Is Nothing Like Your Household Balance Sheet, So You Shouldn't Freak Out About Debt
There's also a paper by Warren Mosler, 7 Deadly Innocent Frauds, that is also introductory.
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