Sorry, but I have to snipe at Paul Krugman again. He’s once again (rightfully) berating the many economists who said QE would cause high inflation and wreck the world (the list is a veritable financial all-star team which is pretty interesting). At the same time, he’s claiming that his model and his 1998 paper from Japan got the crisis right. But were they right because they actually explained the dynamics at work? Or were they partially just luck? Well, gauging from the way the 1998 paper explains QE and bank lending, it’s 100% clear that he didn’t have the model or explanation correct at all:
“Banks, however, need hold only a fraction ar of their deposits in reserves and will hold no more than necessary; they lend the rest out (which is how consumers get the money for the deposits). So bank deposits will be a multiple 1/’rr of the monetary base”
For the millionth time, that’s just not how banks work. Banks don’t lend their reserves out so expanding the monetary base was NEVER going to result in consumers getting “the money for deposits”. Anyhow, I am a nobody even if I’ve been saying all of this for years. So instead of listening to me, listen to S&P’s Chief Economist who explained this yesterday:
“Banks Cannot And Do Not “Lend Out” Reserves”
Dr. Krugman’s model was right. But was it right because it’s good or was it right because it was less bad than the one’s some other economists use? I say it was only less bad. Luckily, some economists on Wall Street are starting to use better models. Models that are based on actual banking operations and not the fictional loanable funds based IS/LM models that resulted in some good predictions largely by sheer chance.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.