Neo-classical and Modern Monetary Theory – a balance sheet view by Dirk Ehnts Berlin School of Economics and Law this version: April 5th, 2012 Balance sheet economics by Dirk Ehnts Introduction What is this about? - understand the creation of money - understand how money and other financial assets are transferred and what implications this does have How does it work? - a balance sheet perspective is chosen together with doubleentry bookkeeping, inspired by Lavoie (2011) and conversations with the author in the same year Balance sheet economics by Dirk Ehnts A balance sheet: assets Institution money bonds stocks 100 300 500 liabilities equity external debt 100 800 baseline scenario: government with (independent) central bank, domestic currency, big country Balance sheet economics by Dirk Ehnts More balance sheets: assets banks liabilities assets government liabilities assets central bank liabilities assets households liabilities assets external sector liabilities Balance sheet economics by Dirk Ehnts Interdependent balance sheets, cleared through assets from higher level: central bank external sector banks corporate sector households How is ‚money‘ created in this financial web? Balance sheet economics by Dirk Ehnts GOVERNMENT (Treasury and Central Bank): Buys goods and services, gold, and assets; makes transfer payments $ FIAT MONEY $ Inside & Outside Money Source: Wray (1998, p.112) (Treasury Coin, Federal Reserve Notes, Bank Reserves) $ PRIVATE SECTOR (High Powered Money) $ HOARDS $ Credit Activity (Bank money, commercial paper, private bonds) HOUSEHOLDS Taxes (Treasury Coin, Federal Reserve Notes, Bank Reserves) Balance sheet economics by Dirk Ehnts The ‚Old‘ Monetary Theory View (I) assets central bank money loans to banks 100 50 50 assets money assets banks 150 savings 100 loan from CB 100 150 money liabilities 200 liabilities 200 50 increase in outside money (M) through ‚helicopter drop‘ of money (no inside money!) CB controls money supply! (reserve ratios?) Balance sheet economics by Dirk Ehnts The ‚Old‘ Monetary Theory View (II) assets central bank money bonds 200 100 100 assets money bonds stocks bonds banks 100 200 500 600 500 400 savings equity liabilities 200 300 liabilities 900 200 increase in government spending (G) does only affect asset composition (portfolio) of banks („crowding out“) Balance sheet economics by Dirk Ehnts The Modern Monetary Theory View (Ia): assets government money 100 assets central bank bonds 100 assets money loans assets money bonds money banks 90 90 savings deposits households 10 100 loans (net) liabilities 100 liabilities 100 liabilities 90 90 liabilities 0 Balance sheet economics by Dirk Ehnts The Modern Monetary Theory View (Ib): assets central bank bonds money 100 0 30 40 10 assets money loans reserves bonds money reserves banks 80 90 40 10 120 90 10 70 100 liabilities 100 10 liabilities savings deposits increase in government spending (G) (2nd round reserves after giving additional loans of 30 omitted) 90 120 90 Balance sheet economics by Dirk Ehnts The Modern Monetary Theory View (II): assets central bank bonds money 100 10 11 assets money loans reserves bonds money reserves banks 9 10 110 100 10 11 80 savings deposits equity increase in inside money (M) liabilities 100 10 11 liabilities 90 100 110 10 Balance sheet economics by Dirk Ehnts The Modern Monetary Theory View (III): assets central bank bonds money 100 120 10 30 assets money loans reserves bonds money reserves banks 10 30 100 10 60 80 liabilities 120 100 10 liabilities savings deposits equity increase in outside money (M, not G) 90 100 10 Balance sheet economics by Dirk Ehnts A comparison: money views ‚old‘ (IS/LM) and ‚new‘ (MMT): ‚old‘ ‚new‘ government spending displaces other assets 1:1 loans create deposits no ‚crowding out‘ per se bonds are sold or tax income received before gov‘ spending government spends, no ‚financing‘ by public needed, CB can monetize public debt (taxes, bonds: Δliquidity) monetary policy via control of money supply monetary policy via interest rate, changes in liquidity CB controls money supply (via reserves/multiplier) defensive operations to supply demanded reserves at target rate Balance sheet economics by Dirk Ehnts Literature Lavoie, Marc. 2011. The monetary and fiscal nexus of neo-chartalism: A friendly critical look. Wray, Randall. 1998. Understanding Modern Money:The Key to Full Employment and Price Stability. Aldershot and Lyme, NH: Edward Elgar