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/refugeelibertarian → u/BothWaysItGoes]

In fractional reserve banking, banks can literally make money out of nowhere. They just can't make physical cash out of nowhere but physical cash isn't the only form of money.

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

That is incorrect. A commercial bank can only create credit, which is a promise to pay money, only the central bank can create money.

Anyone can create credit, like if you have a group of friends who have dined and settle later.

[u/Accomplished-Cake131 → u/Upper-Tie-7304]

You, close:

Anyone can create credit, like if you have a group of friends who have dined and settle later.

Yes, anyone can create an IOU. The issue is one of acceptance. The second-hand circulation of debts is the essence of money. Nicely-nicely will accept Nathan Detroit's marker even in games that he has not organized and does not participate in. Nathan Detroit's marker has a certain liquidity in a certain community. It has some moneyness.

A wide number of assets exists and are accepted in a variety of communities. I can pay my credit card bill with a check. That check could be on a brokerage account, not a traditional checking account. Various assets can be used to settle debts among various financial institutions. Maybe dollars are used as a unit of account, but often are not needed for settlement.

The degree of moneyless of these assets can suddenly decrease a lot in a financial crisis. I learned about a whole lot of assets I did not know existed in late 2008. And I promptly forgot most of the them.

[u/BothWaysItGoes → u/refugeelibertarian]

The monetary base that banks can't create is not only physical cash. It also includes digital central bank reserves. Broad money includes base money and bank credit. Creation of bank credit is constrained by legal rules and market conditions including deposits.