tag:blogger.com,1999:blog-8702840202604739302.post8457328821545288437..comments2024-03-28T03:38:53.734-07:00Comments on MacroMania: On Cochrane's dream of equity-financing bankingDavid Andolfattohttp://www.blogger.com/profile/12138572028306561024noreply@blogger.comBlogger42125tag:blogger.com,1999:blog-8702840202604739302.post-46736672833529761062016-05-18T11:32:19.091-07:002016-05-18T11:32:19.091-07:00"I would much rather have a stable base money..."I would much rather have a stable base money, and have banks issue a macroeconomic derivative that pays in terms of this stable base, than have the base fluctuate because the central bank is working too hard as a backstop."<br /><br />It seems to me that if the conditions of lender of last resort function of the central bank to the commercial banks are:<br /><br />1) Valid demand deposit and <br /><br />2) Solvency and <br /><br />3) Price inflation target<br /><br />then the system works one way.<br /><br />If the conditions of lender of last resort function of the central bank to the commercial banks are just:<br /><br />1) and 2) but not 3) then system works a different way.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-70034770252141458402016-05-17T13:45:55.798-07:002016-05-17T13:45:55.798-07:00If the banks keep the loans, and also denominate d...If the banks keep the loans, and also denominate deposits in dollars, then they need a lot of equity to absorb potential losses. Securitization seems to facilitate the search for cheaper forms of funding. Government funding might a relatively efficient form, because the central bank enjoys convenience yield on its liabilities, which are always information insensitive. The government doesn't need to worry as much about solvency because it issues base money.<br /><br />All I can say about inflation targeting is that government taking on the risk of these loans interferes with that goal. I would much rather have a stable base money, and have banks issue a macroeconomic derivative that pays in terms of this stable base, than have the base fluctuate because the central bank is working too hard as a backstop. But I am not a central banker and am relying heavily on my own model of how this works, and people with direct experience could probably say a lot more.Anwerhttps://www.blogger.com/profile/08277173974258559733noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-35866311695808858522016-05-17T12:08:18.958-07:002016-05-17T12:08:18.958-07:00Why does someone need to buy the securitized loans...Why does someone need to buy the securitized loans?<br /><br />Before talking about gold targets or NGDP targets, my question above needs answered.<br /><br />Now for the real kicker, does the price inflation target have anything to do with the lender of last resort function (of the central bank to the commercial banks)?Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-61379677904426060012016-05-16T22:19:24.353-07:002016-05-16T22:19:24.353-07:00It might be useful to widen the discussion using P...It might be useful to widen the discussion using Perry Mehrling's concept of dealer of last resort. Bank shareholders own the loan origination business - they profit every time someone borrows money to buy a house. Someone needs to buy the securitized loans - we can let the central bank do this during a crisis. It can keep buying MBS later on if it has trouble generating sufficient inflation. Ultimately, the central bank owns a lot of the real estate, maybe a lot of corporate debt as well. Is that how it works now?<br /><br />Instead of buying that toxic junk, I would much rather have the central bank buy a lot of gold and keep it in its vaults. Stabilize things by signing a gold treaty with other central banks. Inflation and nominal interest rates might rise, and then it can go back to its normal job of fiddling with interest rates to stabilize the macroeconomy. If they want to get fancy they can use Nick Rowe's gold window in combination with Scott Sumner's NGDP futures contracts to do NGDPLT.Anwerhttps://www.blogger.com/profile/08277173974258559733noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-30903027991062203902016-05-16T20:24:59.521-07:002016-05-16T20:24:59.521-07:00Under my scenario along with an ECB type central b...Under my scenario along with an ECB type central bank, entities sell demand deposits to the commercial banks for currency. The commercial banks do not have enough currency. The ECB type central bank uses its lender of last resort function and provides the currency. Instead of the commercial banks needing to shrink their balance sheets to attempt to get more currency, the commercial banks sell those demand deposits to the ECB type central bank. That means the ECB type central bank expands its balance sheet, while the commercial banks do not need to shrink their balance sheets. This maintains the fixed exchange rate between currency and demand deposits.<br /><br />The ECB type central bank ends up owning all of the demand deposits. I would not consider that owning the commercial banks.<br /><br />Now for the real kicker, does the price inflation target have anything to do with the lender of last resort function?<br /><br />Sorry for the late reply.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-16870972913137362702016-05-14T11:56:11.843-07:002016-05-14T11:56:11.843-07:00That's a good question! If the central bank ac...That's a good question! If the central bank actually does this, it will basically own the banks and we end up with socialism. Can you see any way out?Anwerhttps://www.blogger.com/profile/08277173974258559733noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-60046130580259280232016-05-14T09:00:11.399-07:002016-05-14T09:00:11.399-07:00What if there is no question about solvency and ev...What if there is no question about solvency and everyone wants to use currency and no one wants to use demand deposits?<br /><br />With a bank, there will probably be a shortage of currency. Will the central bank use its lender of last resort function to supply more currency?Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-8126065625913738562016-05-13T23:10:54.887-07:002016-05-13T23:10:54.887-07:00Yes, this is one of the problems with negative rat...Yes, this is one of the problems with negative rates: many people decide that it's better to keep their money under the mattress than at a depository institution. But rates still haven't fallen so low for this to be a big problem, so far.Anwerhttps://www.blogger.com/profile/08277173974258559733noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-47843391542923658342016-05-13T20:54:00.603-07:002016-05-13T20:54:00.603-07:00What if there is no question about solvency and ev...What if there is no question about solvency and everyone wants to use currency and no one wants to use demand deposits? That means the bank is not losing customers to other banks.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-76412150408368488782016-05-12T20:37:34.916-07:002016-05-12T20:37:34.916-07:00That probably means that the bank is losing custom...That probably means that the bank is losing customers to other banks that provide better services. Cochrane would be very happy with competition in finance. His proposal is meant to prevent banking panics and rapid withdrawals.Anwerhttps://www.blogger.com/profile/08277173974258559733noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-73709104134707994152016-05-11T18:30:02.519-07:002016-05-11T18:30:02.519-07:00What if there is no question about solvency? Every...What if there is no question about solvency? Everyone believes the bank is solvent.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-7194708988526669722016-05-11T01:15:23.257-07:002016-05-11T01:15:23.257-07:00The usual reason people do that is that there is s...The usual reason people do that is that there is some question about the solvency of the bank. Cochrane's narrow banking proposal aims precisely to eliminate that possibility.Anwerhttps://www.blogger.com/profile/08277173974258559733noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-61344745211906667092016-05-10T20:21:43.214-07:002016-05-10T20:21:43.214-07:00"But this is probably not the best way to thi..."But this is probably not the best way to think about "deposits." I sometimes like to say that banks don't take deposits--they create deposit liabilities. Related to this notion, the banking system does not "lend out cash." The banking system funds its assets (including loan creation/acquisitions) by creating DDLs. (At the individual level, banks need to acquire cash to fund their operations only to the extent they want or need to meet some reserve requirement). Cash finds its way into circulation whenever the owners of DDLs exercise the redemption option embedded in the DDL contract. Alright, with this out of the way, let me continue."<br /><br />What happens if no one wants to hold demand deposits? That means the borrowers who receive the demand deposits immediately redeem the demand deposits for currency and everyone uses currency.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-63006066386365200362016-05-10T04:22:30.386-07:002016-05-10T04:22:30.386-07:00Let us imagine an economy with no fractional reser...Let us imagine an economy with no fractional reserve. Let's say everyone uses precious metals.<br /><br />People sometimes lend or borrow this metal money, but the overall supply and demand of these services may be far from optimal. This economy could be in a permanent credit crunch with everyone paying a big cost of opportunity for investments not made and services and goods not available.<br /><br />A group of benevolent aliens lands and sets up a lending business. They have access to unlimited backing - a 20 mile asteroid made entirely of precious metals. But they do not want to flood the market with credit. That would only create overinvestment followed by bankruptcies. They effectively control the market interest rate and try to keep it in a range that promotes sustainable growth.<br /><br />The benevolent aliens also notice that the market for savings is not performing so well. People want better instruments to set aside some of their income towards retirement. So they provide that. They obviously also end up as the preferred provider of payments and transfers to people can stop carrying purses full of heavy metals.<br /><br />But nobody knows that the alien ship suffered a malfunction. They are stranded and cannot get to their asteroid or anywhere else. They have enough deposits from their savings and transfer activities that they can continue lending. Nobody needs to know - unless there is a run on their bank. Their (now fractional) metal-backed notes are an effective currency and everyone enjoys the increased liquidity and savings services they provide.<br /><br />In what ways is this scenario similar to our current banking system and in what ways is it different? <br /><br />One obvious difference is that our bankers are not exactly benevolent aliens and neither are the regulators supposed to keep them in check.OREN Thttps://www.blogger.com/profile/06854541971430934278noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-25845301298104274982016-05-06T14:11:09.224-07:002016-05-06T14:11:09.224-07:00Yes, everyone is using a different mental model. W...Yes, everyone is using a different mental model. With some people I would omit the word "bank" from the discussion and ask them to consider differences between ETFs and closed-end funds, and their comparative effects on systemic stability. Instead of talking about "money" I would simply ask if ETF liabilities should be standardized. Ah but here a reference to banking history would be useful.Anwerhttps://www.blogger.com/profile/08277173974258559733noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-47332576161781829002016-05-06T10:21:46.832-07:002016-05-06T10:21:46.832-07:00You're not missing anything. But I tailor my a...You're not missing anything. But I tailor my arguments to my audience. I'm assuming that the proponents of 100% reserve banking don't have the same understanding of banks that I do -- and that explaining that view is too much for a blog comment.<br /><br />--syntheticassets (csissoko)Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-51989974854775686592016-05-04T20:06:49.843-07:002016-05-04T20:06:49.843-07:00I'm trying to think back to discussion with yo...I'm trying to think back to discussion with you a year ago. You pointed out that if we require equity finance for all investments, there is a cash-in-advance constraint: funds must be raised before they can be invested. And then you note that monetary finance is a good way to relax this constraint. But the option of monetary finance only exists because of the way that our payment system is structured around banks. Am I missing something?Anwerhttps://www.blogger.com/profile/08277173974258559733noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-10636438214379604782016-05-04T16:42:37.826-07:002016-05-04T16:42:37.826-07:00Anwer,
I get that. My point is that we can for ar...Anwer,<br /><br />I get that. My point is that we can for argument's sake grant Cochrane and Musgrave the claim to have stabilized the payments system. They still have to convince us that they have found a workable means of funding business activity. For the purpose of this part of their argument I don't see how the fact that banks issue money is relevant.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-67890223975966543662016-05-04T03:54:39.326-07:002016-05-04T03:54:39.326-07:00Good post.
Cochrane’s idea is a variation on the ...Good post.<br /><br />Cochrane’s idea is a variation on the generic idea of the Chicago Plan of the 1930’s. It’s basically a bifurcation of existing banking into one entity (or entities) that offer demand deposits, and a complementary banking system that offers other types of liabilities or equity, although I guess Cochrane is interested in the equity only variation.<br /><br />The demand deposit entity(s) has government credit on the asset side. The companion system has private sector credit for the most part. These two systems must clear payments with each other, so that depositors can switch between holding demand deposits and funding private sector credit. <br /><br />The equity only version is an extreme case. Other versions allow matched term funding (not demand deposits) of private sector assets, so that liquidity risk is substantially reduced - but not entirely eliminated due to credit risk on private sector assets and eventual repayment obligations. The general idea of the Chicago plan and its descendants can be interpreted as tightened versions of what banks already do in managing liquidity risk according to their asset liability profiles. In that context, book equity is considered to be the best form of long term liquidity protection over a continuum of funding sources – consistent with Cochrane’s idea.JKHhttps://www.blogger.com/profile/06322177539880818556noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-26060497107655643482016-05-03T06:48:55.008-07:002016-05-03T06:48:55.008-07:00"They would be performing an equivalent servi..."They would be performing an equivalent service by acting as licensing agents whose job is to verify the quality of the promises I issue (imagine an Andolfatto-IOU stamped as "BoA approved.")"<br /><br />Isn't that called a Banker's Acceptance? Angelo Melinonoreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-2346467374877487182016-05-02T22:46:39.225-07:002016-05-02T22:46:39.225-07:00I don't think it's true that investors sel...I don't think it's true that investors selling the stock can't force a company into bankruptcy. A good deal of "banking" type service is about funding short term mismatches between cashflows in and out (I assume companies will have some sort of fixed liability like, as mentioned by David, payroll).<br /><br />We are then talking about a company covering a shortfall by issuing new equity, perhaps then buying it back when cash rich. If the equity value is driven down by mass selling then the company can go bankrupt, not because the old equity holders ask to redeem their equity at par, but because they can't raise enough money to meet payroll.<br /><br />As David correctly points out, the issue is liquidity, not solvency.Adam Phttps://www.blogger.com/profile/16316584837610367439noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-32185072732335913542016-05-02T21:57:19.708-07:002016-05-02T21:57:19.708-07:00It might be that discussion of liquidity spirals s...It might be that discussion of liquidity spirals started recently, and you caught on to this idea quickly while others still have a focus on ideas that are better established (like bank runs). But there is also the fact that money is the basis of the payments system, and this makes it a greater concern during crises. I remember some talk that during the Lehman bankruptcy the payments system was at risk of going down without government intervention. Losses from other fire sales might also be quite large, but without causing this particular systemic problem.Anwerhttps://www.blogger.com/profile/08277173974258559733noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-24792453439155783342016-05-02T21:34:18.239-07:002016-05-02T21:34:18.239-07:00I don't get what's magical about money as ...I don't get what's magical about money as a liability. Banks offer immediacy and are leveraged. Under current SEC regulations (though not necessarily intended by the Investment Act of 1940) mutual funds too offer immediacy and may be leveraged (through derivatives exposure). Both are subject to fire sales and disastrous losses for investors. (Look up Oppenheimer Core Bond Fund.)<br /><br />Given the immediacy offered by investment funds, why does it matter that banks issue money? Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-75606578210180370662016-05-02T21:22:43.584-07:002016-05-02T21:22:43.584-07:00Ralph I see that as another missing dimension of e...Ralph I see that as another missing dimension of elasticity. Banks make loans in dollars, which are quite fixed. Indeed the Keynesians warn us about deflationary spirals, where the debt obligations actually grow in real terms during economic downturns. Instead of preventing banks from issuing money, it should be a better, more loss-absorbing money that is connected with aggregate output.Anwerhttps://www.blogger.com/profile/08277173974258559733noreply@blogger.comtag:blogger.com,1999:blog-8702840202604739302.post-63254267650497910092016-05-02T21:11:27.485-07:002016-05-02T21:11:27.485-07:00“That doesn't yield a very elastic money suppl...“That doesn't yield a very elastic money supply.” Well if an elastic and privately issued money supply served a purpose, I’d be all for it. Unfortunately the reality is that the major gyrations in the money supply brought about by private banks simply stoke booms and exacerbate recessions. I.e. private banks act in a pro-cyclical fashion.<br /><br />Central banks then have to counteract that with countervailing changes in the amount of base money: witness the huge increase in the amount of base money since the crisis - all down to interest rate reductions and QE. In short, we’d be better off without the elasticity that comes from private banks and putting “elasticity decisions” – to coin a phrase - in the hands of central banks. <br />Ralph Musgravehttps://www.blogger.com/profile/09443857766263185665noreply@blogger.com