Monetary analysis versus real analysis: What are the main differences? Peter Bofinger Universität Würzburg and CEPR German Council of Economic Experts Motivation provided by John Maynard Keynes
• “Most treatises on the principles of economics are concerned mainly, if not entirely, with a real-exchange economy; and – which is more peculiar- the same thing is also true of most treatises on the theory of money. (…) • The theory which I desiderate would deal, in contradistinction to this, with an economy in which money plays a part of its own and affects motives and decisions and is, in short, one of the operative factors in the situation, so that the course of events cannot be predicted, either in the long period or in the short, without a knowledge of the behaviour of money between the first state and the last. And it is this which we ought to mean when we speak of a monetary economy. (…) • Everyone would, of course agree that it is in a monetary economy in my sense of the term that we actually live.(…) . The idea that it is comparatively easy to adapt the hypothetical conclusions of a real wage economics to the real world of monetary economics is a mistake.” John Maynard Keynes (1933), The monetary theory of production, in: C.W. XIV, pp. 408-411 Dominance of the real analysis in macroeconomics and especially in financial economics • Debate on low interest rates, „saving(s) glut“ and „secular depression“ • Microeconomics of banking (Freixas/Rochet) • DSGE models: Euler equation • International macroeconomics (Krugman/Obstfeld) • Fiscal policy: Overlapping generations models, theory of crowding-out • Theories of economic growth I. Theory Real analyis: The loanable funds model of the financial market • Larry Summers (2016): “Just as the price of wheat adjusts to balance the supply of and demand for wheat, it is natural to suppose that interest rates—the price of money—adjust to balance the supply of savings and the demand for investment in an economy.”
i i
Saving S0 S1 (≡Supply of funds) i 0 i0 i1 Investment I (≡Demand for funds)
S =I S, I, 0 0 S0=I0S1=I1 S, I, Volume of Lending Volume of Lending Real analysis: one-way flow of funds
Freixas, Xavier, and Jean-Charles Rochet (2008), Microeconomics of Banking Axioms of the Real Analysis
• Freixas/Rochet (2008): a model “with a unique physical good, owned initially by the consumers. Some of it will be consumed at date 1, the rest being invested by the firms to produce consumption at date 2.” • Saving, i.e. abandonnement of consumption, is the precondition for investment • Interest rate is the reward for saving units of the unique physical good tomorrow • Interest rate is a natural rate: unit of the unique physical good today • Banks and financial markets are pure intermediaries for the unique physical good The effects of household saving in an economy with money (Monetary Analysis) Household decides to save 1,000 Euro by reducing his consumption by 1,000 Euro.
Balance sheet of the household Assets Liabilities Bank deposits + 1,000 Net worth + 1,000
Balance sheet of the firm Assets Passiva Bank deposits - 1.000 Net worth - 1.000
Balance sheet of the bank Deposits household +1.000 Deposits firm - 1.000 Household saving in the Monetary Analysis
• Household saving does not generate additional funds. It simply redistributes existing funds (=bank deposits) from the corporate sector to the household sector. • Household saving has a negative impact on the liquidity position of the corporate sector and on corporate profits (PF ). • Kalecki equation
PF = 퐼퐹 + ∆푁퐹퐴퐹
∆푁퐹퐴F = − ∆푁퐹퐴 푂푇퐻퐸푅 푆퐸퐶푇푂푅푆
PF = 퐼퐹 − (푌퐻퐻 − 퐶퐻퐻) + 푇 − 퐺 + (푀 − 푋)
Household saving Government Current account deficit financial balance Monetary Analysis: real interest rate for saving = 0
Keynes: “It should be obvious that Germany: Real interest rate on saving the rate of interest cannot be a deposits and on bonds return to saving or waiting as 8 such. For if a man hoards his 6 4 3,15% savings in cash, he earns no 2 0,001% interest, though he saves just as 0 much as before. On the contrary, -2 the mere definition of the rate of -4
interest tells us in so many words
1969-07 1996-08 1967-06 1971-08 1973-09 1975-10 1977-11 1979-12 1982-01 1984-02 1986-03 1988-04 1990-05 1992-06 1994-07 1998-09 2000-10 2002-11 2004-12 2007-01 2009-02 2011-03 2013-04 2015-05 2017-06 that the rate of interest is the Real interest rate saving deposits reward for parting with liquidity Real interest rate bonds for a specified period.” (GT, p. 166) Average real interest rate saving deposits Average real interest rate bonds Anomaly of the Real Analysis: „Euler puzzle“
Canzoneri et al. (2007) „ (…) money market rates and the implied consumption Euler equation rates are negatively correlated.” Monetary analyis in a very simple model (IS/LM-AS/AD) • Multiple equilibria of saving and investment • Separation of the financial market from the goods market • Investment creates saving • Banks create money (Multiplier) • Interest rate is a money rate • Saving has no direct impact on the financial market Axioms of two incompatible paradigms Real Analysis Monetary Analysis Saving Source for financial funds: Standard - Irrelevant for the financial system. No commodity becomes available for impact on LM-curve. investment - Reduction of aggregate demand Financing Identical with saving Provision of demand deposits independently of saving Investment Requires saving Generates Saving Equilibrium of S and I One equilibrium Multiple equilibria (IS-curve, LM-curve, IS/LM, AS/AD) Units of the standard commodity in t+1 Units of money in t+1 Interest rate Real rate: Unit of standard commodity in t Money rate: Unit of money in t
Banks - Pure intermediaries - Originators of money - Deposits create loans - Loans create deposits Financial markets Identical with banks: Intermediaries Fundamentally different from banks: between savers and investors Redistribution of money created by banks Role of the central bank Powerless as it neither creates nor Powerful as it can control the supply of destroys the standard commodity money with its policy rate 13 Zero-lower bound
Real Analysis Monetary Analysis Monetary Analysis: Circular flow of funds Attempts to combine Real Analysis and Monetary Analysis
REAL MONETARY Wicksell (1898) Equilibrium: monetary rate equals Disequilibrium: monetary rate differs neutral rate from neutral rate Neoclasssical Synthesis “to the extent that prices are flexible Short-run e.g. Rachel and Smith (2015, p. 54) in the long-run, money is neutral, and only real factors have a lasting effect on long-run real rates” Borio and Disyatad (2011, p. 22) “Real factors determine at least the “Monetary and financial factors steady state equilibrium level of real determine the actual interest rates interest rates.” that prevail at any given point in time Krugman (2011) (…) the distinction between loanable funds and liquidity preference theories of the rate of interest – or, rather, the ability to see how both can be true at once, and the implications of that insight – seem to have been utterly forgotten by a large fraction of economists (…) Krugman and Woodford: How to derive the IS-curve from the loanable funds modell
Krugman (2011): “we imagine that a rise in GDP shifts the savings schedule out from S1 to S2, also shifts the investment schedule, Woodford (2010) and, as drawn, reduces the interest rate in the market for loanable funds” Higher income leads to higher interest rates
r S1 S2
I2
I1 S, I II. Why are interest rates so low? Real Analysis versus Monetary Analysis
Source: Rachel and Smith (2015) Larry Summers: “The essence of secular stagnation is a chronic excess of saving over investment.”
GDP growth rates 8 Excess saving/Saving(s) glut: 7 6 • Sex ante > Iex ante 5
% 4 • Sex ante + C > Iex ante + C 3 2 • Aggr. Supply > Aggr. Demand 1 0 Global demand deficiency 1980/1990 1990/2000 2001/2006 2000/2010 2010/2018 Saving(s) Glut Sec. Stagnation World Advanced economies Emerging market and developing economies
Source: IMF, WEO Database Excess saving of one sector (SA>IA) is possible, but it requires excess spending of a another sector (IB>SB)
Pubic sector balances (percent of GDP) Current account balances (USD billion) Public excess spending and Excess spending in advanced economies and private excess saving excess saving in developing economies 500 1 800 0 0 600 -500 -1 -1000 400 -1500 -2 GDP 200
-2000 -3 of Billion - -2500 -4 0
US$ -3000 -5 -200 -3500 Percent -6 -4000 -400 -4500 -7 -5000 -8 -600
-800
2002 2003 2001 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
2014 2018 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2015 2016 2017 Deficit advanced economies Deficit emerging and developing 1997 Percent of global GDP Advanced economies Emerging market and developing economies Low interest rate caused by an increase in the global propensity to save?
Gross saving rates 1980-2015 40
35
30
25
20
15
10
5
0
1992 2006 1980 1982 1984 1986 1988 1990 1994 1996 1998 2000 2002 2004 2008 2010 2012 2014 2016 2018 World Advanced economies Emerging and dev. Economies
Source: Rachel and Smith (2015) Problem 1: Household saving has declined
Source: Peter Chen, Loukas Karabarbounis, Brent Neiman, VoxEU 05 April 2017 Problem 2: Trends of gross and net saving differ
Gross saving rate and G7 real interest rate (1986-2014) Net saving rate and G7 real interest rate (1986-2014) 5 5 S
4,5 4,5
4 4
1986 3,5 3,5 1986
3 3 I 2,5 2,5
2 2
1,5 1,5 S 1 1
0,5 0,5
0 0 10 15 20 25 30 35 40 -1 0 1 2 3 4 5 6 7 8 -0,5 -0,5 I Problem 3: Early 1980s were an outlier
12,00
10,00
8,00
6,00
4,00
2,00
0,00
-2,00
-4,00
-6,00
Jul. 93 Jul. Jul. 54 Jul. 57 Jul. 60 Jul. 63 Jul. 66 Jul. 69 Jul. 72 Jul. 75 Jul. 78 Jul. 81 Jul. 84 Jul. 87 Jul. 90 Jul. 96 Jul. 99 Jul. 02 Jul. 05 Jul. 08 Jul. 11 Jul. 14 Jul. 17 Jul.
Jan. 10 Jan. Jan. 56 Jan. 59 Jan. 62 Jan. 65 Jan. 68 Jan. 71 Jan. 74 Jan. 77 Jan. 80 Jan. 83 Jan. 86 Jan. 89 Jan. 92 Jan. 95 Jan. 98 Jan. 01 Jan. 04 Jan. 07 Jan. 13 Jan. 16 Jan. Real rate 10 year Treasury Real rate Fed Funds Average Real Fed Funds Average Real Treasury Monetary Analysis: Focus on US-bond market
30-year indexed US-Treasury yield and change in outstanding US-bonds
5,00 (1998-2015)
4,50
4,00 1998 3,50
3,00 rate 2,50 2006
2,00 interest 2005 2004 2007 Positive supply shock until crisis Negative demand shock after crisis Real Real 1,50 („Financing glut“) („Borrowing dearth“) 1,00
0,50
0,00 0 5 10 15 20 25 -0,50 Change in outstanding US bonds (in percent of GDP)
Source: Securities Industry and Financial Markets Association Supply on the US bond market
Change in bond holdings (percent of GDP) Foreigners: net purchases of securitites in 20 the United States 200000 15 150000 10 100000 5 50000 0 0
-5
Jän.09 Jän.00 Jän.01 Jän.02 Jän.03 Jän.04 Jän.05 Jän.06 Jän.07 Jän.08 Jän.10 Jän.11 Jän.12 Jän.13 Jän.14 Jän.15 Jän.16 Jän.17 -50000 Jän.99
-10 -100000 Treasury Bonds and Notes US GOVT Agency Rest of the world; Domestic without Fed FED Corp Bonds Corp Stocks
Source: Board of Governors Source: US Treasury, tic data Demand side of the US bond market
Change in outstanding amount of (percent of GDP) 25
20
15
10
5
0
-5
-10
-15 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Corporate Public Mortgage related/Federal Agencies Money Markets/Asset backed
Source: SIFMA Real Analysis: Paradox of capital (Prasad et al. 2017) • (…) this paradox has, if anything, intensified over time. (…) the average income, relative to the United States, of capital-exporting countries has fallen well below that of capital-importing countries. In other words, capital has been flowing from poor to rich countries!
Capital Monetary Analysis: The paradox vanishes
US current account
100 0
-100
1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 -200 -300 -400 -500 -600 -700 -800 -900
US$-Deposits
Consumer goods
US$-Deposits
US$-Bonds Summary
• Real Analysis and Monetary Analysis are incompatible • Real Analysis is an inadequate model for a reality with money • The focus on the saver in Real Analysis is misguided. In Monetary Analysis banks and investors are the core actors • Low interest rates cannot be explained with a higher propensity to save, global „excess saving(s)“ or a global saving(s) glut • The Real analysis completely neglects the role of the central bank • Bond market data and flow of funds data provide very useful information that has not been exploited so far • It is time to save other fields of economics from the detrimental influence of the Real Analysis China‘s debt-driven growth model
Debt to GDP 300,0
250,0
200,0
150,0
100,0
50,0
Jul. 16 Jul. Jul. 06 Jul. 11 Jul.
Jan. 04 Jan. Jan. 09 Jan. 14 Jan.
Jun. 04 Jun. 09 Jun. 14 Jun.
Okt. 02 Okt. 07 Okt. 12 Okt.
Apr. 05 Apr. 10 Apr. 15 Apr.
Feb. 11 Feb. Sep. 05 Sep. 06 Feb. 10 Sep. 15 Sep. 16 Feb.
Dez. 01 Dez. 06 Dez. 11 Dez. 16 Dez.
Mai. 02 Mai. 07 Mai. 12 Mai. 17 Mai.
Aug. 03 Aug. 08 Aug. 13 Aug.
Mrz. 03 Mrz. 08 Mrz. 13 Mrz.
Nov. 04 Nov. 09 Nov. 14 Nov. Advanced economies: Credit to non-financial sector Advanced economies: Credit to private non-financial sector China: Credit to non-financial sector China: Credit to private non-financial sector Equilibria
LFT IS/LM-AS-AD • Financial market equilium • Goods market equilibrium (IS-curve) identical with goods market • Financial market equilibrium (LM- equilibrium (=neutral interest curve) rate) • IS/LM-equilibrium • IS/LM-equilibrium at full employment • AS/AD-equilibrium • AS/AD-equilibrium with minimal loss 퐿 = 푃 − 푃∗ 2 + λ (Y − YF)² „optimum interest rate“ (Keynes))