Readers with long memories will recall Paul Krugman describing interest in the history of economic thought as “Talmudic scholarship” (see figure 1), and dismissing it with an emphatic “I Don’t Care”.
“So, first of all, my basic reaction to discussions about What Minsky Really Meant – and, similarly, to discussions about What Keynes Really Meant – is, I Don’t Care,” Krugman said in 2012. “I mean, intellectual history is a fine endeavor. But for working economists the reason to read old books is for insight, not authority; if something Keynes or Minsky said helps crystallise an idea in your mind – and there’s a lot of that in both mens’ writing – that’s really good, but if where you take the idea is very different from what the great man said somewhere else in his book, so what? This is economics, not Talmudic scholarship.”
Figure 1: Krugman's "Talmudic Scholarship" reference rates highly – at least in my Google!
So it was rather notable that Krugman recently decided to undertake some Talmudic scholarship himself, pulling out two James Tobin papers from half a century ago to dismiss the proposition that banks matter in macroeconomics.
Now as someone who takes the history of economic thought seriously – predominantly because economics has done an abysmal job of learning from its own history, let alone from its empirical failures – I am delighted to see Krugman delving into the scholarly canon. And on this foray, he emerged apparently triumphant: two papers by Tobin 50 years ago clinched the case he makes today that banks don’t matter to macroeconomics:
“All the points I’ve been trying to make about the non-specialness of banks are there. In particular, the discussion on pp. 412-413 [of Commercial Banks As Creators of “Money”] of why the mechanics of lending don’t matter — yes, commercial banks, unlike other financial intermediaries, can make a loan simply by crediting the borrower with new deposits, but there’s no guarantee that the funds stay there — refutes, in one fell swoop, a lot of the nonsense one hears about how said mechanics of bank lending change everything about the role banks play in the economy.
“Banks are just another kind of financial intermediary, and the size of the banking sector — and hence the quantity of outside money — is determined by the same kinds of considerations that determine the size of, say, the mutual fund industry.”
There’s no doubt that these 1960s papers (this one in particular) by Tobin support Krugman’s argument that banks are just one kind of financial intermediaries amongst many, and deserving of no special importance in macroeconomics. You can see that Krugman’s modern description of lending being a transfer from “more patient” to “less patient” agents (in which banks are immaterial and can be ignored “WLOG – without loss of generality”) as an echo of Tobin’s argument from 50 years ago – a view that Tobin was careful to describe as a new one, and not the orthodoxy at the time:
“According to the “new view”, the essential role of financial intermediaries, including commercial banks, is to satisfy simultaneously the portfolio preferences of two types of individuals or firms. On one side are borrowers, who wish to expand their holdings of real assets … beyond the limits of their net worth. On the other side are lenders, who wish to hold part or all of their net worth in assets of stable money value with negligible risk of default.”
So yes, if Tobin’s “new view” circa 1963 is the last word on the role of banks in macroeconomics, then to switch to a sporting metaphor, it’s a game, set and match – and perhaps even Championship – for Krugman and the Loanable Funds view of money, while I and all of the Endogenous Money crowd should put our economic racquets away and take up macramé instead.
Only Tobin 1963 isn’t the last word – and not even from Tobin. To jump back to the religious metaphor, there’s yet more in the Tobinic Talmud, and I suggest that Krugman moves on from the Old Testament scholarship he undertook in reading Tobin the Younger, and consider the New Testament of Tobin the Elder. For starters, take a look at the counterpointed excerpts in Table 1taken from the 1963 paper that Krugman relies upon (the first column), and a paper from 1982 that Nathan Tankus discovered in his excellent riposte to Krugman’s post.
Table 1: Comparing Tobin 1963 with Tobin 1982
The difference between the Old and New Tobin is as stark as that between the Old and New Testament. Not only is there an emphasis on the uniqueness of banks in that 1982 paper, Tobin also makes copious use of T-accounts and double-entry bookkeeping to explain why banks do matter. So just as the Testament message moved from “An eye for an eye” to “Turn the other cheek”, Tobin moved from “banks don’t matter and the belief that banks create money is a shibboleth”, to “banks are crucial to macroeconomics and they can and do create money”.
And whereas Tobin the Younger imagined that newly created bank money could be taken out of the system in a form other than bank deposits or cash, Tobin the Elder realises that those are the only two options at the systemic level. Individuals might get out of bank deposits into (say) gold, but to do so they transfer money from their deposits in one bank into the deposits of the gold dealer in another bank. The only way for money not to be held in a bank is for it to be converted into some other kind of asset that is not a bank liability first. The only candidate here is cash – notes and coins – which you can insist on when you make a withdrawal (you might insist on gold instead, but a bank is under no obligation to deliver it in response to your withdrawal).
Notably, as Cullen Roche pointed out in his reply to Krugman (there were so many on this one that Frances Coppola referred to it as “Open season on Krugman”), both Tobin 1963 and Tobin 1982 agree that banks can create money by a double-entry procedure, creating a loan and a deposit at the same time. Tobin 1982 states that “when a bank makes a loan to one of its customers it simply credits the amount to the borrower's account”; the 1963 version was a more abstruse “a bank can make a loan by “writing up” its deposit liabilities”. The difference was that Tobin the Younger dismissed this as unimportant, whereas Tobin the Elder saw it as significant.
An interesting addendum in deciding ‘what Tobin really meant’ – which in this case is the question ‘did Tobin support Loanable Funds or Endogenous Money?’ – is some correspondence he undertook with one of the doyens of the endogenous money approach, my friend and colleague Stephanie Kelton who is the chair of the Economics Department at the University of Missouri Kansas City. Tobin wrote to her spontaneously in response to a Levy Institute working paper of hers on money which was emphatically in the Endogenous Money camp (see figure 2). His one criticism of the paper at that stage was not that in it she decided to “follow Minsky and treat the creation of money as a balance sheet operation”, but that it didn’t cite his dictionary entry on money in The New Palgrave – though she did cite his 1998 book Money, Credit, and Capital .
So what was Tobin doing, initiating correspondence with, and commenting on papers (Stephanie notes that Tobin suggested the quote on page 160 of The Role of the State and the Hierarchy of Money) by someone whose views on money would be described by Krugman today as “Banking Mysticism” – and whose views were clearly at odds with those expressed in Tobin’s 1960s papers, on which Krugman is relying today? Could it be that in the years after he wrote those papers dismissive of the importance of banks, his views shifted, and he was no longer an adherent of the Loanable Funds perspective that Krugman today champions?
Figure 2: Tobin's letter to Stephanie Kelton (then Bell) in response to The Hierarchy of Money
So which Tobin do you believe? The brash youngish Tobin, who in that 1963 paper made it clear that he was putting forward “A more recent development in monetary economics”, a “new view” in place of an old one, and to whom banks were irrelevant? Or the older Tobin who returns to the preceding view that banks are a crucial aspect of capitalism (and who then attempts to present this traditional view in a more modern Neoclassical model) which is revived by today’s Endogenous Money theorists, and who initiates correspondence with a “Banking Mystic”?
I suggest you believe neither, but consider simple logic, and also consider which perspective makes sense of the empirical data. On both fronts, the ‘banks don’t matter’ view is a total loser – as Tobin the Elder came to appreciate. I'll outline more on this in an article tomorrow.