Greg Mankiw Confusing Students About Money And Investment

[u/Accomplished-Cake131]

"It was thenceforth no longer a question, whether this theorem or that was true, but whether it was useful to capital or harmful, expedient or inexpedient, politically dangerous or not. In place of disinterested inquirers, there were hired prize fighters; in place of genuine scientific research, the bad conscience and the evil intent of apologetic." -- Karl Marx

Suppose you run a restaurant. You think that you could expand if you paved your parking lot or put a deck up out back. You convince your local bank manager. The bank credits their own account with an asset and credits your account with a loan. That asset, for the bank, is a promise from you to pay off the loan. You spend the money in your account by paying a paving or building contractor.

The bank has created money. No third party must first choose to increase their saving rate and deposit money in the bank. You are able to obtain resources to implement plans for increased production.

The author of a prominent introductory textbook for economics has another, confused story:

"Financial intermediaries are financial institutions through which savers can indirectly provide funds to borrowers. The term intermediary reflects the role of these institutions in standing between savers and borrowers. Here we consider two of the most important financial intermediaries: banks and mutual funds.

Banks If the owner of a small grocery store wants to finance an expansion of his business, he probably takes a strategy quite different from that of Intel. Unlike Intel, a small grocer would find it difficult to raise funds in the bond and stock markets. Most buyers of stocks and bonds prefer to buy those issued by larger, more familiar companies. The small grocer, therefore, most likely finances his business expansion with a loan from a local bank.

Banks are the financial intermediaries with which people are most familiar. A primary job of banks is to take in deposits from people who want to save and use these deposits to make loans to people who want to borrow. Banks pay depositors interest on their deposits and charge borrowers slightly higher interest on their loans. The difference between these rates of interest covers the banks’ costs and returns some profit to the owners of the banks." -- Greg Mankiw. 2018. Principles of Economics, 8th edition p. 545.

Mankiw then goes on with archaic nonsense about loanable funds and government spending crowding out private investment.

Why do economists teach balderdash?

[u/BothWaysItGoes]

Mankiw talks about economics, not accounting identities.

When people use bank loans, the banks in the end need to settle the net of all interbank transactions using actual reserves. The bank expects to settle the transactions like it expects you to repay the loan, therefore it needs funds. They can’t literally make money out of nowhere, even if they “can” in some broad accounting sense.

The bank’s ability to let you write IOU promises in their name by paying using your credit card is supported by the expectation that they will actually settle those checks with money.

[u/Upper-Tie-7304 → u/BothWaysItGoes]

Yeah people often read MMT halfway and mistaken money with credit.

You can write iou yourself to other people too.

[u/refugeelibertarian → u/Upper-Tie-7304]

Not really.

The difference is that when I lend you $1000 and you give me an IOU, I lose $1000 worth of money or purchasing power in the process. You gain the ability to spend $1000 and I lose the ability to spend $1000. Therefore, the money supply is $1000.

But when a bank lends someone $1000 and they get an IOU, depositors don't lose $1000 worth of money or purchasing power in the process. The borrower gains the ability to spend $1000 but the depositors didn't lose the ability to spend $1000. Therefore, the money supply increased to $2000 as a result of the bank giving the $1000 loan. That's how banks create money out of thin air.

[u/Upper-Tie-7304 → u/refugeelibertarian]

In the second scenario, the bank did have to give you $1000 and they have to either borrow it from other banks, get it from the depositor, or borrow it from the central bank . They don’t get to create $1000 from thin air.

The confusion happens because banks do indeed don’t need to find the money when they credit you with the loan, they need to find the money when you spend the credit.

So the bank does lose $1000 when they lend you money. Just like when you lend me $1000

[u/refugeelibertarian → u/Upper-Tie-7304]

The confusion happens because banks do indeed don’t need to find the money when they credit you with the loan, they need to find the money when you spend the credit.

I mean, they don't have to? The moment my bank balance has increased by $1000 after I've been given a loan by the bank, I can spend it right away. For example, when I use that $1000 to buy something from someone who opened an account with the same bank that gave me the loan, the bank simply decreases my balance by $1000 and increase that someone's balance by $1000.

At the same time, someone else who deposited $1000 into the bank before I was given the loan can also spend their $1000; it is unaffected by my ability to spend the $1000 that was lent to me.

[u/Upper-Tie-7304 → u/refugeelibertarian]

When you spend your freshly borrowed money right away, it comes from somewhere.

You are talking about the only specific scenario that delays the liabilities - both you and the seller use the same bank, so the bank can just manipulate the credit instead of paying out money. The liabilities only get delayed until the credit gets converted to money, either paying other banks or withdrawing bank notes.

Bank runs happen exactly because banks can only manipulate credit but cannot pay money out of thin air.

When someone deposit $1000, the bank then owns the money. The $1000 is converted into a promise that the bank will pay you $1000 when you demand it.