La asignatura de Economía de Bachillerato

As some very rare ‘Monetary Keynesians’^^ such as Victoria Chick, Hyman Minsky and Paul Davidson have pointed out, the credit facilities provided by commercial banks to the economy may be granted beyond the level that would ensure monetary equilibrium. In other words, the relationship between money and output might be affected by an excess of bank credit, which would thus contribute to the inflationary

We borrow this felicitous expression from Desai (1989: 172; 1992: 120). It echoes the Monetary Analysis approach that Schumpeter (1954/1994: 276-288) used to oppose to Real Analysis. A brilliant exposition o f both approaches can be found in Rogers (1989).

rise in goods and assets prices in actual markets. Linking the conflict inflation approach to the real bills doctrine^*, Davidson (1988: 166-168) maintains that the banking system can theoretically provide support to, if not generate, inconsistent claims on available output. More precisely, when he states that wage increases might be granted beyond changes in (average) labour productivity, Davidson holds the banking sector as co-responsible for the issue of so-called ‘inflation bills’. As he puts it, ‘[a]ny healthy banking system apparatus which meets the needs of trade can be subverted to create an elastic currency of “inflation bills” rather than “real bills”’ (Davidson 1988: 167). So much so that, in the view of Burdekin and Burkett, ‘Post Keynesian models of the endogeneity of the stock and velocity o f credit-money with respect to firms' money wage bills are really particular specifications of the monetary accommodation of excess income claims’ (Burdekin and Burkett 1996: 33)^^.

The monetary accommodation (by banks) of excess, or inconsistent, income claims is thus considered an inborn feature of endogenous-money systems, and must therefore be pursued further here to assess its macroeconomic character in respect of inflationary pressures.

Excess credit facilities and inflation: a reconsideration

In the face o f ‘endogenously changing financial practices’ (Palley 1996: 219), microeconomic theories of bank behaviour have been continuously revised, and improved, to account for those phenomena related to the bank intermediation

The real bills doctrine has been traced back to Adam Smith's Wealth of Nations, where one can read that ‘a real bill o f exchange [is] drawn by a real creditor upon a real debtor, and (...) as soon as it becomes due, is really paid by that debtor’ (Smith 1776/1970: 402). As Green notes, ‘echoes of the real bills doctrine reverberate in modem monetary theory’ (Green 1987: 101). This is essentially because money emission is traditionally understood as if it were an exchange between a bank's lOU and a non-bank ‘bill’, which may be backed by ‘titles to real value or value in the process of creation’ (p. 101), or it might not. See e.g. Sargent and Wallace (1982) and de Boyer (1998: 65-67, 74-75).

process'^®. As a matter of fact, since the rapid development of liability management‘s banks in general have been inclined to lend following a policy of aggressive expansion of their balance sheets, each time the new credit facility is deemed profitable for their business strategy (Chick 1986: 115-118). Recently, in a series of papers, Howells (1995, 1996, 1997, 1999) has depicted this state of the art very clearly. He namely points out with cogency that what Davidson describes as ‘needs of trade’ (see above) are not the exclusive causal factor of bank lending^^. ‘Certainly the idea that new bank lending originates solely with firms and reflects their production plans now seems very naive’ (Howells 1996: 113). The relative increase in speculation, and hence in total spending, with respect to the value of current output is indeed a reality of modern capitalist economies which can no longer be denied^^. Howells's conclusion ‘is that bank lending results in a monetary expansion that may be quickly accommodated by multiplier-assisted increases in income, or it may not’ (Howells 1995: 96). In simple terms, if the new loans granted by banks are not associated with goods and services newly produced, the question Howells forcefully raises is to determine whether or not the ‘deposits created by essentially speculative activity have

See Screpanti (1997) for a recent attempt to work out a structural theory of endogenous money from a microeconomic point of view, where ‘the core business of bank activity is identified in the transformation o f generic risk’ (p. 567).

‘Broadly speaking, liability management refers to the ability o f banks to increase their lending activity by borrowing funds which appear on the liability side o f their balance sheet, without having to dispose o f their marketable assets — mainly Treasury bills’ (Lavoie 1992: 212). See Moore (1989: 13-20) and Goodhart (1989a: 30-32) for a discussion on tlie importance o f liability management in the evolution o f modem banking.

See also Howells and Hussein (1998, 1999).

As Keynes already observed (partly quoted in Howells (1999: 105)), speculative transactions ‘need not be, and are not, governed by the volume o f current output. Tlie pace at which a circle of financiers, speculators and investors hand round one to anotlier particular pieces of weaith, or title to such, which they are neither producing nor consuming but merely exchanging, bears no definite relation to the rate of current production. The volume of such transactions is subject to very wide and incalculable fluctuations, easily double at one time what it is at another, depending on such factors as the state of speculative sentiment; and, whilst it is possibly stimulated by the activity and depressed by the inactivity of production, its fluctuations are quite different in degree from those o f production’ (Keynes 1930: 47-48). See also Chick (1994).

any impact on the economy, different from the impact of deposits created in the wake of production’ (Howells 1996: 113).

In order to explore carefully the macroeconomic significance of this concern, let us analyse a stylised example of excess credit. As in Howells's work, let us focus on agents' borrowing to purchase second-hand housing assets, although any kind of speculative (that is, purely financial) demand for loans will do here. For the sake of exposition we shall assume that a single deposit bank represents the whole network of commercial banks, and that the bank-accommodated demand for loans exceeds by 10 percent the deposits corresponding to, and resulting from, the monetisation o f current production. There are no pre-existent deposits. So, if a worker (or any income holder, IH, if we allow for income redistribution within the economy) asks for, and obtains, a bank loan in order to purchase a second-hand housing asset whose price exceeds the worker's (or the income holder's) deposit, in bookkeeping terms the situation may be represented as follows (Table 5.1).

Table 5.1 A speculation-led excess of bank credit

Bank

liabilities assets

Worker (IH) 100 Firm 100 Seller 110 Worker (IH) 100

Borrower 10

As explained in Chapter 4 (see e.g. Table 4.3), the first double entry (1) is the result of the monetisation of the worker's current output, which occurs at the level of, say, 100 money units according to Keynes's principle of effective demand illustrated earlier on. Current income holders, IH, thus have a purchasing power of 100, saved

in the form of a bank deposit until consumption takes place"^. Now, if the bank were to grant a credit of 10 to current income holders (for instance, to our worker) for, say, a house purchase (see e.g. Howells (1997: 431-432)), entry (2) would be recorded in the bank's bookkeeping as soon as the purchase is made'^^. Yet, maintaining that for any bank loan there is a corresponding deposit is only saying the obvious fact that any double entry affects identically, at one and the same time, the assets side and the liabilities side of a balance sheet. As a result of the payment, in fact, the 10 units of money borrowed by the bank's client are instantaneously deposited by the seller of the house, who will have to choose the form in which he prefers to hold his wealth (expressed by a sum total of deposits equal to 110)^^. If he decides to buy existing and/or newly issued financial assets, the corresponding deposit is transferred to some other unspecified agents, who will then face a similar choice. Be that as it may, the ‘last holder’ of the deposit will spend it on the market for produced goods and services, so that, in our stylised example, 110 units of money will be used to purchase the very same output the production of which gave rise to a (wage-earners') deposit of 100 — in this example, no other output is available for purchase.

Assuming, to simplify what does not affect analysis, that total current output (worth 100) is sold at a price of 110 to the ‘last holder’ of the deposit which results from the credit granted to the borrower, the corresponding transactions are recorded as follows (Table 5.2).

Recall that when consumption occurs, income holders spend their deposits and thus extinguish the firm's debt, which was recorded either towards the bank or with respect to its own wages fund (working capital). In either case the firm is able in fact to cover on the product market tlie previously disbursed factor costs.

As Keynes (1930: 42) remarked in A Treatise on Money, one ought to bear in mind that the amount of a customer’s unused overdraft does not appear anywhere at all in a bank's statement of its assets and liabilities.

It is worth while to emphasise here that this subjective choice is necessarily subsequent to the deposit automatically formed at the very instant the payment is made.

Table 5.2 The macroeconomic result of excess credit facilities

Bank

liabilities assets

(1) Worker (IH) 100 Firm 100 (2) Seller 110 Worker (IH)

Borrower 100 10 (3) Client C 110 Seller 110 (4) Firm 110 Client C 110 Firm 10 Borrower 10

Entry (3) records the purely financial transaction between the seller of the house and another client, C, of the bank (the ‘households buy from households’ case in the words of Howells (1997; 431)). It depicts the fact that the seller's liquidity preference leads him to buy some kind of financial assets from another household. Entry (4) records instead the result of the ‘households buy from firms’ case (p. 431), and epitomises the consumption of current output (sold at a mark-up over its production costs)^^. The overall result is that the firm makes a profit (10) because of the presence of a net borrower within the economy; this might lead one to infer that an inflationary pressure has been generated by the bank's excessive lending. In other words, there is an excess of aggregate demand, caused by too much money chasing too few goods. The observed increase in output prices (and hence the firm 's ‘windfall’ profit) should be sufficient proof of the likely consequences of the ‘passing around’ o f ‘extra- money’, using De Vroey's (1984: 384-389) language which we shall consider later

Note that in both entries (3) and (4) client C might also be a firm, selling financial claims in order to purchase other firms' output. Within tlie time-dimensional sequence depicted by entries (2) and (5), we would therefore experience the case where ‘households buy from households and lend to firms’ (Howells 1997: 431).

on. To quote Howells again, ‘[u]nless everyone has an overdraft, unwanted deposits may continue to circulate. It is precisely this that gives rise to those repercussions on prices, quantities, of goods, assets or whatever’ (Howells 1995 : 94).

The worries raised by Howells are legitimate, and certainly deserve careful attention by all those concerned with income distribution among economic agents. We indeed already noted in passing that the functional distribution of income has a close link with economic growth, too"*^. We may even claim that the latter is probably path- dependent on the former. No-one could in fact deny today that the investment of (purely speculative) profits in (perhaps off-shore) financial markets is a less productive activity, at least in terms of employment, than what has become conventional to label ‘physical’ investment. Surely, purely financial transactions can generate no additional income, but only transfer existing income among the parties (both in space and time). Only production can give rise to a net income within the national economy as a whole. This thesis, however, does not focus on economic growth. Nor does it focus on the distribution of income. It aims in fact at investigating the origin and cure of inflation, as well as at evaluating (as a by-product) recent monetary research, theory, and policy.

So, to focus on inflation, we have to concentrate attention on ‘the inflationary potential of a banking system on which there appear to be few constraints’ (Chick

1986: 122). As pointed out by Chick, ‘[t]he banks' aggressive lending activity may contribute to inflation’ (p. 123), because the balance between assets and liabilities in the banks' account is not sufficient to prevent excessive credit to be granted"^^.

In this connection, as every economist knows, several authors have studied the relationship between inflation and growth. See e.g. the survey paper by Driffill et al. (1990), and Barro (1996).

A similar point has been raised by De Vroey in connection with unsuccessful business ventures, when he maintained that the endogeneity o f money is ‘not a sufficient guarantee o f the eventual correctness o f private money creation decisions’ (De Vroey 1984: 388). See also Smithin (1997: 397-398), who emphasises the role o f bank credit for consumption purposes (beyond the need for the firms' initial finance). On the concept o f ‘initial finance’, and its link to ‘final finance’, see Lavoie (1987: 69) and Graziani (1990: 14-16), who elaborate on Keynes's (1937) Economic Journal finance motive. See also Chick (1996: 14) for the importance to distinguish ‘finance’ from ‘funding’.

Moreover, the widespread use of liability management and the pursuance of credit policies inspired by this business strategy have further enhanced the lending power of commercial banks, which have no innate structural device to prevent the financial bias towards inflation (p. 124)^^. All this, indeed, should be worrying enough to consider attentively the nature of credit-induced deposits with only a remote link to production. In short, is this superfetation of bank credit definitively inflationary for the national economy? Is the firm 's profit (equal to 10 in the above example) irremediably inflationary, because it is due to an over-emission of money? Are income holders alienated, because their deposits are allegedly spoiled by the banks' sales- or profit- max imisation policies beyond a kind of notional threshold determined by the income- generating finance process à la Davidson (1988)?

Certainly these concerns are justified, in so far as they highlight the fact that the relationship between money and current output could be altered by excess bank credit. However, from a fundamentally macroeconomic point of view, using the Schmitt terminology^^ their object may be assigned the label of ‘benign inflation’, in the precise sense that this kind of alteration of the money-output relationship is not irreparably inflationary. In other words, the inflationary effect of excess bank lending is not cumulative in time. Let us attempt to explain why, referring to the stylised example made above.

When a borrower is granted credit, he actually engages himself to repay the loan back at the due date (inclusive of any interest payment agreed upon). The bank's recording of this loan in the assets side of its balance sheet testifies that the borrower relinquishes simultaneously a financial claim, perhaps by simply acknowledging his debt, i.e. by endorsing the loan agreement in front of the banker. Now, what is the final object of the claim disposed of by the borrower and recorded within the bank's

See also Minsky (1975: 121-124). See Schmitt (1984: 192-198).

assets? This claim is a title to a future income that the borrower will earn and pay back into the lending bank. Indeed, as Cencini argues, ‘the working of our banking systems is such that overdrafts of private banks are reduced to an advance’ (Cencini 1995: 62). As such, the monetisation by banks of borrowers' claims, as in entry (2) in Tables 5.1 and 5.2, does not irremediably modify the relationship between money and output. The increase in existing bank deposits entailed by the advance of a borrower's future income will be matched, in fact, by a correspondingly identical reduction of money income when the borrower reimburses the bank.

The importance of this argument is likely to impel us to prove our conclusion further, or more firmly. Consider the consequence of the loan repayment for the macroeconomy. When the excess of bank credit (which we know to be an advance of future income) over the value of current real goods falls due (say, in period n), the borrower has to surrender an equivalent part of his period-n income^^ Clearly, if the loan granted in period 1 must be repaid in period 2, a period-2 income has to be transferred from the (period-1) borrower to the bank^^. And when the reimbursement of an outstanding bank loan occurs, an equivalent deposit is simultaneously extinguished; a destruction also noticed by Howells, when he claims that ‘[o]nly actions that cause repayment of loans cause a reduction in deposits’ (Howells 1995: 100). Now, there is no real need to illustrate this destruction in bookkeeping terms, to infer that the reduction in (for instance) period-2 deposits amounts to an identical decrease in total demand. In fact, since any demand can only be exerted through an

This does not imply that the borrower is the original holder of the income used to reimburse the bank. It might well be the case that this income has to be borrowed from period-n income holders. In this case, the borrower once again anticipates a future (period n+m ) income, so that there simply is a substitution o f due dates, leaving the overall situation unaffected. In what follows, we assume therefore that the borrower can repay liis debt in period n with no further commitment, since the opposite hypothesis is not germane to the present analysis.

This is the link that money provides between the present and the future, as noted by Keynes (1936: 293). More recently, Minsky (1994: 154-155) has reasserted the link that financial relations provide between the past, the present and the future, enabling deficit-spending units to consume today what they will earn in the future.

expenditure of bank deposits^^, destruction of the latter ipso facto reduces current demand by the same amount. So, whilst in period-1-like cases total demand may be increased by excess bank credit such as to create an inflationary gap, in period-2-like situations this gap is compensated by a disequilibrium of the opposite algebraic sign, total demand falling short of the level established by the monetisation of current (that is, period-2) production. ‘Hence, even if we claimed that private bank overdrafts are a cause of inflation since they modify the relationship between money and current output, we would have to add that the discrepancy between demand and supply which it causes is not seriously worrying, for it is bound to be compensated for in the following periods’ (Cencini 1995 : 63).

This conclusion may be strengthened by three different arguments, each of them stressing the benign character of ‘credit-led’ inflation. Firstly, ‘[a]t any particular time, existing loans are being repaid while new loans are being demanded’ (Howells 1995: 90). Present-day monetary production economies are indeed so complex that in any period of time new credit facilities are provided simultaneously with the repayment of outstanding loans^^, ‘so that the positive gap between demand and