Steve Keen Doesn't Get Marshall

Well, of course he doesn't

Alfred Marshall’s grand vision of economics was that you did the maths to check your logic. Then you translated all of that into English and burnt the maths. Steve Keen won’t do it that way for of course Marshall was a neoclassical and that’s just wrong, see?

Keen did once try to insist that I followed along with one of his papers - he was showing that there are no free markets, there are only oligopolies and therefore everything must be controlled by politics - and was most put out when I said well, yes, that’s mathematically true but useless.

For his contention was that as we’ve never got an infinite number of producers (nor consumers) therefore that model of free markets - which relies upon no individual producer or consumer having pricing power, which in itself implies an infinite number - therefore neoclassical economics was all wet. His maths was fine for that’s all true too. Except for the bit where if we analyse markets which we know are oligopolistic and then see how many producers we need for them not to be then the number seems to be about 5 or 6. True, true, 7 supermarkets doesn’t mean a wholly perfectly free market with profits no higher than the cost of capital but it’s pretty damn close. Close enough for either jazz or the economics of public policy.

The maths is for working through the logic not a replacement for it.

Which brings us to the latest, that everyone’s theories of money, the macroeconomy and the rest are wrong. There’s a freebie book on the point:

Money and Macroeconomics from First Principles, for Elon Musk and Other Engineers

By Steve Keen

Super, eh?

Today, all businesses and banks manage their finances via double-entry bookkeeping. To paraphrase Musk’s quip about physics, with respect to money, double-entry bookkeeping is the law, and everything else is fraud.

Analyzing the economy using double-entry bookkeeping results in vastly different conclusions about how the economy should be managed than those that Musk is currently reaching by reasoning from analogy.

See? See?

Double-entry bookkeeping has a conservation law, which accountants call “the Accounting Equation”. They express this as “Assets equal Liabilities plus Equity”, but it is better expressed in conservation form:

Assets - Liabilities - Equity = 0

Or, of course, and we’ll get to a stage where this is important:

Liabilities + Equity = Assets

No, this is important because this is how every bank balance sheet works.

Keen goes on:

Lots and lots of lovely maths.

There are two opposing models of banking used by economists:

• Loanable Funds, in which banks function as intermediaries between savers and borrowers. This is taught by almost all economics textbooks—see for example Mankiw 2016, pp. 71-77), (Samuelson and Nordhaus 2010a, pp. 454-465); and

• “Endogenous money” (McLeay, Radia, and Thomas 2014, p. 15), in which banks create money by creating debt. This model has been endorsed by the Bank of England (McLeay, Radia, and Thomas 2014), and the Bundesbank (Deutsche Bundesbank 2017). It can be traced back to Irving Fisher (Fisher 1932, p. 15), Joseph Schumpeter (Schumpeter 1954, pp. 1110-1117), and Hyman Minsky (Minsky, Nell, and Semmler 1991).

Anyone who’s ever had any contact with Keen will know he endorses the theory that isn’t in all the major textbooks. Obviously. No point in being the renegade bringin’ da truf to da youf if it’s the same as in the textbooks now, is there?

Advocates of the BOMD model of banking reject the Loanable Funds model as structurally incorrect. Banks are not intermediaries, they assert, but loan originators. This was a minority and non-mainstream position in economics, until it was endorsed by some Central Banks after the Global Financial Crisis (McLeay, Radia, and Thomas 2014; Deutsche Bundesbank 2017).

There is, of course, much more maths around but it’s all irrelevant because it’s not being used to check the logic here. For while that first stage of the endogenous money theory is correct it’s also irrelevant. Simply doesn’t matter. Because, as we’ve noted, a bank balance sheet reads:

Liabilities + Equity = Assets

To simplify. Loanable funds is how building societies used to work. Mrs Miggins made her monthly mortgage payment, as did the other 500 borrowers. That meant that the building society now had 500x (OK, 501x) monthly payments to hand. That meant the bank could now issue another mortgage and so they’d call up the person first on the waiting list and say your application is now approved. Issuance of new mortgages was limited by repayment of past-loanable funds.

Of course we don’t do anything like that these days. A likely prospect wanders in, the loan is approved, the bank makes a debit and a credit and we’re done - endogenous money creation rulz!

Except, obviously, that loan is then spent. Some portion of those loans will be spent outside the bank. Sure, mebbe the seller also banks at the same bank and the money just roundtrips and then:

Liabilities + Equity = Assets

Endogenous Rulz!

But sometimes the loan will be sent off to another bank. Which means the originating bank books are unbalanced:

Liabilities + Equity = Assets

They’ve the asset, the loan note. They’ve the capital they started with. But they’ve no longer the liability, the deposit. In the way that banking works this means the bank is bust. Many such tragedies!

Also in the way that banking works the bank has until 4,30 pm each day to rectify this. It must attract a deposit to make the books balance.

Yes, yes, of course there’s a flow of money in and out all through the day. No one goes out matching exactly deposit to loan book. But at 4.30 pm the books must balance:

Liabilities + Equity = Assets

Might be that someone has sold some other and different house and deposits. Maybe it’s wage, or pension, day and lots of recipients of wages and or pensions bank there. Or, obviously, the bank can borrow from another bank - the interbank market.

But, at 4,30pm

Liabilities + Equity = Assets

So while the lending decision is not taken because there are spare funds in the bank - loanable funds - the lending decision is taken on the basis that the bank can attract deposits to make the books balance. We can even say that endogenous money creation is true until 4.30. But past that it ain’t. Because the books must balance, the bank must attract deposits to meet its loans. We’re back in loanable funds territory even if we’ve the timing slightly off the classic theory.

Banks don’t need deposits to be able to lend. OK. Banks do need deposits to finance their loan book. We’re in loanable funds territory.

Now that’s rather more a critique of the wilder shores of MMT than it is specifically of Steve Keen. But the critique of Keen is that he has so much fun doing all the maths that he never does sit down and think of the logic for a bit.

So, now for some actual logic. We’ll start with a fact. Lloyds Bank pays £19 billion a year in interest to depositors. £19 billions reasons there why we might conclude that Lloyds Bank needs depositors and deposits. That is, loanable funds is closer to reality than endogenous money creation. Banks are intermediaries etc.

OK, to disprove intermediaries, the necessity of deposits, loanable funds theory, we need an alternative reason for Lloyds to pay £19 billion a year in interest.

Cool. So, what is it?