The Creators of Inside Money

Inhaltsverzeichnis

1. Frontmatter

2. Chapter 1. An Overview of a Financial System

   D. Gareth Thomas, David S. Bywaters

   Abstract

   This introductory chapter presents the scope of the book and summarizes its main theme, the role of commercial banks in supplying inside money with loans to the economy in addition to outside money. The focus is on the relevant agents that compose a monetary system along with updated data, for example on the saving ratio.

3. Chapter 2. The Money Supply

   D. Gareth Thomas, David S. Bywaters

   Abstract

   In particular the need is to develop a monetary model that goes beyond the traditional theory of a barter system, or one with one-commodity used as money to proxy the ‘workings’ of a modern-day economy, with credit. The assumption of money neutrality is dropped along with the mistake of treating the medium of exchange as a ‘veil’. A proper study of money and credit supply must involve a tripartite system of agents in the form of depositors (which includes households and firms), retail banks and the monetary authorities. They determine the money supply process within the economic system together. It is the interaction of these economic actors that determines the supply of money in the form of a monetary multiplier that supports the real economy. Compared with the previous study, the data has been revised along with the presentation of the mathematical formulations to enhance greater understanding of the analysis and the contribution of the agents involved in the endogenous process. It also now includes an historical review of the literature on money and credit that leads to the loanable funds model.

4. Chapter 3. The Adjustment Process of the Money Multiplier and the Loanable Funds Model

   D. Gareth Thomas, David S. Bywaters

   Abstract

   This section shows how the retail banks can create (or destroy) loans and liabilities in the form of money credit, depending on lending opportunities, interest rates and the prevailing winds of uncertainty and perceived credit risk. This inside money supplied by commercial banks is the main ingredient of the supply, whereas the outside money supplied by the Central Bank is the minor one. Retail banks create inside money by creating deposits when they make a loan. The loan is later destroyed when the customer completes its repayment. Banks use available reserves in the form of internal profits from interest payments, the selling of financial assets and securities, buying reserves from other banks as well as reserves held at the Central Bank or borrowing from it in order to generate profit in the form of interest payments from the geometric process of credit growth and this represents a cumulative (or diminishing) process based on monetary circuitism. Demand is then matched with the supply, so that the rate of interest on borrowing can be determined.

5. Chapter 4. The Demand for Money Holdings by Firms and Households

   D. Gareth Thomas, David S. Bywaters

   Abstract

   This part of the theory examines the desire of agents, for example households and firms, to hold wealth and assets in the form of money balances by identifying the three motives for holding the medium of exchange, which is also a store of value in the form of saving. This will provide a clear description of the nature and origins of liquidity demand, which goes on to show how it can be met by the various banking institutions, providing current and time deposits in competition to other interest-bearing assets such as government bonds. Once the scissors of demand and supply of saved money are applied to the decisions to save within the banking sector, then the rate of interest on saving will appear as a crucial component of the model. In this revised version, there are significant changes to the presentation from the original first edition.

6. Chapter 5. The Rate of Interest and the New Monetary Theory of Loanable Funds

   D. Gareth Thomas, David S. Bywaters

   Abstract

   Four components of rates of interest on both savings and borrowings are analysed here, as in the first edition; a real factor, an inflationary element, a liquidity component, and a risk segment. Then the new monetary model is built on the endogenous loanable funds supply, which is partially controlled by the commercial banks, and partially by the central bank, with the agents’ demand for these funds. The revised presentation of this chapter will apply the model to the financial crisis of 2007/08 with the reserve- and cash-deposit ratios and money multiplier as key elements of the study.

7. Chapter 6. The Term Structure of Interest Rates

   D. Gareth Thomas, David S. Bywaters

   Abstract

   Commercial banks do have some control over the endogenous money supply, so they partly determine the market rates of interest on saving on various terms or time periods to maturity through a mark-up on the ‘bank’ (or base) rate set by the Central Bank, such as the Federal funds rate in United States of America. The links between the rates, including those on government bonds, implies that they could well be formed by the term structure either through the expectations theory or some configuration of it. This part of the study has been radically transformed to include thoughts on the application of term structure to forecasting of the real economy, taken up empirically in the next chapter.

8. Chapter 7. An Econometric Study of the Term Structure and the Real Economy

   D. Gareth Thomas, David S. Bywaters

   Abstract

   This completely new chapter investigates U.S.A. data on GDP growth, interest rates and expectations from Livingstone and Michigan surveys using econometrics to show evidence that the expectations theory could be the basis of term structure. The work goes on to explore how well differences in U.S.A. interest rates at different maturities explain up-coming GDP growth, and to show the importance of the empirical inversion of interest-bearing assets in determining subsequent states of the economy and the risk of recession over the course of the loanable funds cycle. In a sense, this work explores the monetary policy transmission mechanism in the U.S.A. It is all entirely new to the book.

9. Chapter 8. The Loanable Funds Cycle and the Variability of the Deposit Base

   D. Gareth Thomas, David S. Bywaters

   Abstract

   The re-evaluated assessment of this chapter lays the foundation for Minsky’s theory, which exposes the states of the economy through evolutionary time: expansion and significant progress, then downturn either in the form of recession with negative development (or growth recession) or full-blown depression with heightened uncertainty and risk that seems uncontrollable, which could be the case in the current pandemic crisis. At some stage in the future, the economy may go into recovery mode from Darwin’s “survival of the fittest” account of intense market competition, travelling back to the expansion stage with fresh consumption and investment opportunities to explore and exploit on account of Schumpeter’s process of creative destruction. This cycle has significant implications for the variability of the banking sector’s deposit base, which can be modelled within the later chapter ten, using the catastrophe framework to explain abrupt changes in money as loanable funds in relation to the build-up of uncertainty and default risk within the monetary economy. Clearly, the mark-up and the cycles of activity will affect the banks’ deposit base, which in turn determines their profit maximisation and the extent of their financing to individual consumers and firms with loans.

10. Chapter 9. Modern Portfolio Theory Applied to the Loanable Funds Market

    D. Gareth Thomas, David S. Bywaters

    Abstract

    This is another completely new chapter using modern portfolio theory applied to households, firms and commercial banks to fully explain in theoretical terms what happens in the market for loanable funds. Its objective is to analyse the micro foundations of the demand for loanable money as a medium of exchange, store of value and a source of funding within the consumption and production functions and the motives of individual consumers and firms in search of loans. The vital role of the commercial banking system in providing the supply of loanable funds by means of the creation of private money through current accounts within the real economy is modelled by their profit maximisation. It also relates to hedge, speculative and Ponzi borrowers, whether households or firms, (or borrowers with differing levels of risk) and extends the analysis to commercial banks to determine the mark-up that drives the actual level of the rate of interest on borrowing. It shows how that mark-up varies with perceptions of risk (in particular of default on the debts) by commercial banks.

11. Chapter 10. A Catastrophe Model of Commercial Banks’ Finance Within the Loanable Funds Cycle

    D. Gareth Thomas, David S. Bywaters

    Abstract

    This chapter has been extensively re-written to apply the key technique of modern portfolio theory from the previous chapter, together with the concept of certainty equivalence from stochastic control theory, to a catastrophe theory model of the function of perceptions risk and uncertainty. This allows the theory to expose the full effect of the credit phases of Minsky’s theory and the possibility of the catastrophic moment leading to recession or depression, triggered by changing perceptions of risk and uncertainty by commercial banks. This links to the deposit base embodied in the components of the money multiplier, which is driven by the mechanism of credit creation (or extinction) of loans. The variability of the deposit base is largely dependent on perceptions of default risk by commercial banks and the state of the economy in terms of the cyclical growth of GDP, intertwined with the credit cycle, which arises from the multiple equilibria of catastrophe theory. The assignment of variables here is quite different to what it was in the first edition.

12. Chapter 11. Rebuilding the Theoretical Model of Inflation with Loanable Funds

    D. Gareth Thomas, David S. Bywaters

    Abstract

    The core concepts of price, output and inflation and expectations that underpin the credit cycle in Chapters 8 and 10 are now explained consistently using aggregate demand and supply, which is used to explain the growth of loans, and consequently, to explain the endogenous flow of the money supply with inflation, or, too much money chasing too few goods (and services). Now put this into reverse. Deflation can happen because of rapid growth of real output, but it can also be caused by the desires of commercial banks to avoid default risk, and because of the consequent loss to the economy of access to credit. The analysis here will show that in recent years, concerning the great financial crisis, the lender of last resort interventions have just about staved off economic depression, but the demand management and fiscal policies described as austerity have perpetuated the current fragility of the economy with growing income inequality. Government policy reactions to the coronavirus epidemic may renew these problems. For example, the U.K. policy of channelling financial assistance to business through commercial bank loans has been relatively slow to work, and unsuccessful. Inequality in many economies has been increased by aiding ‘standard’ jobs and businesses, but often not those in the ‘gig’ economy.

13. Chapter 12. The Effect of the Coronavirus Crisis on the Creators of Inside Money and the Real Economy

    D. Gareth Thomas, David S. Bywaters

    Abstract

    Again, this is a completely new chapter to the book. The objective of this section is to take the analysis developed in Chapter 11 and to apply it to the economic implications of the Pandemic crisis of 2020 on the real economy and its aftermath effects on the future course of inflation and growth, which is leading to a recession of economic activity with significant effects on employment and expected output.

14. Chapter 13. System Stability and Conclusions

    D. Gareth Thomas, David S. Bywaters

    Abstract

    The book’s conclusions are now based on analysis of the properties of the new model, which explains the monetary system. They trace the development of catastrophes in the form of repeated financial instability leading to inflation and deflation over the course of history, as the economic system evolves. The cycle either speeds up, or it slows down, improvements and progress in our standard of living.

15. Backmatter