OK, OK, so I don\’t do macro

Or at least I don\’t do macro very well. But this seems ridiculous:

A policy of undermining the scarcity of capital through low interest rates

It\’s an astonishing thought that you can increase the supply of something by lowering the price of it.

Duncan does respond:

I’m arguing, with Keynes and lots of post-Keynesians, that ‘capital’ isn’t a commodity.

It can be created almost at will by banks. Given this it isn’t scare and therefore should be cheaper.


If banks can simply create capital almost at will then why in buggery is Lloyds launching a £25 billion rights and capital raising issue?

Clearly there\’s me not understanding some point about the macroeconomics that Duncan is proposing but at first glance this looks like the result of way too many of those spliffs that Professor \”Sacked\” Nutt thinks should be more available.

6 thoughts on “OK, OK, so I don\’t do macro”

  1. Tim,

    You understand macro far more than you let on. Not that you’re usually right of course…

    What I’m arguing (again alongside Keynes) is that capital (unlike land or labour) isn’t a scare resource.

    Banks can lend at will (to a large extent) – one bank making a loan to an individual creates the deposits that fund the loan – in the system as whole. This is the thing about fiat money. UI give you that the finance system is currently clogged up.

    Given that money and capital are not essentially limited, there is little use for the unproductive rentier. It’s a historical development that should eventually get squeezed out of the system. The interests of workers and industrialists are aligned here. It’s as if oil could be created at will but only by certain ecnomic actors. In this sense wouldn’t we limit the price of oil – and wouldn’t that create more demand? And hence a higher volume of oil?

    The political problem preventing this economic reform is the power of finance capitalism.

    I’ll be posting more on this theme over the next week or two. But once again – this isn’t something I’ve just invented – it’s quite an old idea.

    Anyway – that’s a bit long for a comment.

  2. Duncan,

    I should probably think on this some more, but at first glance this looks all kinds of wrong to me.

    “The power of finance capital relies on the notion that capital is scare – because of this it can charge a rate of interest. ”

    But if capital isn’t scarce, how come financiers are powerful? Can so much power really rest on a “notion”? You must be saying financiers “artificially” making capital scarce, is that right?

    Capital – let’s talk in terms of money people are willing to allocate to saving in various forms – certainly is scarce, and the supply of it certainly does respond to the returns from saving.

    The banks may be able to “create capital at will” by leveraging up, but they cannot do this without consequence or cost. More to the point, in the context of what kind of finance we want, we don’t want to base our thinking on the idea that reserve ratios can tend to zero – don’t we want to move in the opposite direction? And, if I increase leverage it’s absolutely crucial that the expected returns on my loans remain high enough and safe enough to cover me – I can’t just lower interest rates and disregard expected returns (risk) just because I think I can “create capital at will” – if I tried, I might quickly find my ability to create capital at will curtailed. Global financial markets are big enough so that any creditable bank can effectively always get their hands on as much capital as they need for working capital purposes (as distinct from large re-capitalization events), but you only get access to wholesale markets once the wholesale market have confidence they can supply you with capital and get a return.

    “More importantly it can choose where to allocate this capital dependent not on the needs of the wider economy but on the likely return.”

    What? OK it’s well known that private returns can deviate from social returns (externalities etc.) and the thing to do there is change the prices to align the private with the social … once that’s done allocating capital based on returns is in the interest of the wider economy. The wider economy would not be helped if firms with negative expected real returns were allocated capital.

    who is the “unproductive rentier” here? Intermediating between savers and borrowers, and taking capital allocation decisions is not “unproductive”.

    Now of course the financier may have pricing power and be able to charge monopolistic prices for his or her “intelligence and determination and executive skill” (to quote your Keynes quote – note that if capital is not scare, intelligence may be) but that doesn’t mean they are in essence unproductive rentiers. Apple charges too much for its computers; it is not unproductive.

    I’d be interested in increasing competition and hence reducing rents in the market for loans, isn’t that market already pretty competitive? Do you have any way of quantifying pricing power (a Lerner index, perhaps) in this market?

    So, what are you proposing, imposing interest rate ceilings? How would that work – don’t interest rates vary with risk, so you’d specify a maximum interest rate for some quantified risk level?

    What do you mean by “low” interest rates – look at the spread between the rate banks pay on savings and the rate they charge on loans. This spread covers operating costs and also generates returns on capital. How small would you set this spread?

    I really fail to see how this will “undermine the scarcity of capital” – if you change the average returns on capital, you change how much banks will want to leverage up, you change how the wholesale markets will behave, you change everything. Capital is unlimited in the sense you mean, conditional on it producing a positive return. If you change that, you change supply.

    You say you are raising an old idea, but unless I have misunderstood you, I would not expect Keynes to endorse the idea that some sort of intervention to lower interest rates would “undermine the scarcity of capital”.

    Not to mention the fact that real interest rates are already set (influenced) by central banks, and I didn’t notice the finance sector being undermined much during periods of low real and/or nominal interest rates.

    Separately, there is the question of whether some of the things investment banks do amount to rent extraction (prop trading) but I don’t see that’s relevant to your post.

    All that said, I heartily support the idea of the left wing taking the trouble to understand what the finance sector does and asking whether it could do things differently.

  3. Luis,

    Thanks for a very detailed reponse.

    I’ll post something up at my place responding fully – although it will probably be tomorrow, rather than today.

  4. Forgive a dumb mining engineer for sounding a bit lost here, but aren’t we confusing “capital” with “money”?

    As I understand it “capital” is the value of everything we have. Unless we actually increase that by improving the stuff we have, making more stuff or nicking someone else’s stuff our capital is a fixed thing. Money is just the way we express the value of that stuff.

    So if Britain has a shedload of stuff and simultaneously the BoE has 100 trillion pounds in circulation, on paper that means Britain’s stuff is worth 100 trillion quid. The relationship of the pound to the dollar, the euro and the yen reflects the relative values of those country’s stuff to the amount of money they each have in circulation.

    But what if one day the BoE decides to print 10 trillion more pounds? On paper the worth of Britain is now 110 trillion. But unless the qualtity/value of stuff that Britain has changes, from the outside, the value of Britain hasn’t changed. For things to remain in balance the value of the pound versus the dollar, the euro etc therefore has to drop proportionally.

    Banks can create “money”, but they can’t create “capital” – that requires human endeavour, ingenuity or thievery.

  5. RM

    You are right. You can make a distinction between stocks of capital goods (houses, factories, land etc.), whose value is measured in money, and flows of capital goods (building houses, factories etc.) which is paid for with money, and think of that banks as middlemen that direct the flows of new capital*.

    Real economic resources are scarce, and cannot be conjured out of thin air, specifically not by printing money, nonetheless when, say, a firm goes to a bank to get a loan to buy a machine, the bank doesn’t have to find somebody else (a saver) to forgo consumption and supply the money, it can just increase its leverage (this is what Duncan’s getting at – via fractional reserve banking, banks can expand the money supply without the BoE printing any new notes), and in doing so can affect what happens in the real economy.

    But this is where I either don’t understand what Duncan is proposing, or if I do, where i part company from him. Banks might be able to “create money” and supply capital (in the sense of money that will turn into capital goods) over a range, but they cannot do so without limit, cost or consequence. By increasing leverage and creating money, banks can be expansionary, just like the BoE could be expansionary by printing new money, but neither is a path to prosperity, and if they run ahead of the real economic growth, both are inflationary.

    Creating money in the banking sector may change the pattern of economic activity, just like expansionary monetary policy has real consequences, and perhaps for a while, cheap money would cause human endeavor to apply itself to the creation of capital goods, but that has an opportunity cost (they aren’t doing something else) and it also has consequences for inflation (which can be seen as a tax that reallocates from savers to borrowers).

    * ignoring the fact that banks also finance installed capital without any flow of new capital; this can be thought of as “renting” capital – and also ignoring loans for consumption)

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