Re: Hummel Inquiry

["John B. O'Donnell" <jackodonnell@xxxxxxxx>]

Doug Henwood wrote:
>
> Warren Mosler wrote:
>
> >Loans create deposits.  The banking system can always create new loans.
> >They don't need or have any use for 'deposits to make loans with.'
> >This is more explicit at the larger banks.  They make loans first and
> >then fund them.
>
> But only because there's enough money sloshing around the system. If the
> central bank decides not to validate the additional credit creation, things
> get crunchy, and loan expansion ceases (sooner or later, allowing for all
> the Minskian innovations).

I went a few rounds with Warren on this issue on one of the
newsgroups a while back without his convincing me of his
position. This is how things look to a banking practitioner, but
I still believe that it is a legal requirement that a bank have
funds to lend before it actually makes a loan. I also have no
doubt that Warren is correct that any bank worth its salt can and
will find funds to fulfill any loan promises it makes.

But practice is not necessarily the rule nor is it a limit on
what the rules can be. Yes, borrowing costs rise when funds
become more difficult to locate. Yes, banks will restrict their
lending under these circumstances and whether they attribute the
change to the rising cost or the lower "slosh" is irrelevant.
Yes, the CB will automatically convert any required reserve
shortages into discount window loans that may give the appearance
of having no control over credit expansion as Basil Moore claims.
However, a look at the low level of the _total_ amount of
discount window borrowing compared to typical _changes_ in money
supply should make it obvious that banks do not like to visit the
window. It isn't just price that keeps them away. It is because
the CB _can_ and _does_ limit money supply.

It is also true that none of the several measures of money supply
is not a good choice as the _measure_ to determine how much
_control_ [Open market activity or reserve requirements.] to
apply, nor are any of the several interest rates that can and
often are used as the _measure_ to make those determinations. The
best _measure_ to use for this purpose is the value of money.

There are several characteristics of each of the three
predominant available measures that are relevant to the choice:
1) Both money supply and value always react in the same direction
to a change in credit  / money availability. Interest rates
sometimes go one way and sometimes the other depending on
circumstances, especially inflation expectations.
2) Milton Friedman's proposal to use a steady state rate of
growth in the money supply was and is a violation of the very
evidence that he used to support this proposal. That is, if
economic growth is independent of money supply [which it is] then
the money supply growth must be independent of economic growth.
When I raised this issue during a period of correspondence I had
with him in the mid eighties, he decided I was not having a
discussion and called a halt to our correspondence. However, the
result of the attempt to impose his rule should be enough to
dispel any argument in favor of using the money supply as the
measure.
3) That the interest rate chosen to be the targeted level for
monetary policy is changed in response to inflation actuality
should be a clue to people with their heads screwed on right that
this is not a good choice of measure to decide CB open market
activity.
4) The correlations I show in my "Three Steps to Economic
Freedom" without any time lag between open market activity and
the rate of inflation demonstrate that money value can and should
be the chosen measure to make CB open market choices.

			-- jbod
___________________________________________________
Come visit and see a new economic perspective --
       http://www.geocities.com/CapitolHill/1067
           Comments/arguments welcome.
..