We should be clear about something with regards to the Bank of England’s report on endogenous money – it did not confirm anyone’s “school of thought” or endorse a specific school. All it did was describe how modern banking works. This understanding, which is known as endogenous money, has existed for a long time and the Bank of England is not the first bank, entity or group of researchers to understand it. At the same time, we should not diminish the importance of the research by claiming that “everyone” or even many people already understand these matters.
The reason I bring this up is because I was reading this post titled:
“The Bank Of England Goes Austrian?”
The author goes on to claim that Austrian economics already understands the concept of endogenous money and that the Bank of England is merely regurgitating what Austrians have long known. This is not only misleading, but it diminishes why the research matters in the first place.
First of all, we should be very clear that many modern day Austrian economists did not understand the importance of endogenous money. For instance, in this 2009 article prominent Austrian Economist Robert Murphy made the case for high inflation stating:
“In order to keep those reserves from working their way back into the hands of the general public (where they can start pushing up prices), the Fed will have to raise the interest rate it pays to persuade the banks to keep the reserves parked at the Fed. But this simply postpones the day of reckoning, as the troublesome stockpile of excess reserves grows even faster.”
He shows a chart of M1 surging higher due to QE and concludes:
“I still believe that Bernanke’s unprecedented infusions of new reserves will lead to rapid price increases. These increases may not show up in the price of US financial assets, but they will rear their ugly heads at the gas pump and grocery checkout.”
This never happened of course. But that’s not what’s important. The more important part is that this is classic loanable funds and money multiplier thinking. In other words, it is a total misinterpretation of something like the Bank of England’s report. And this is a cornerstone of Austrian economics. As Mises stated in his text “Human Capital”:
“saving and the resulting accumulation of capital goods are at the beginning of every attempt to improve the material conditions of man; they are the foundation of human civilization. Without saving and capital accumulation there could not be any striving toward non-material ends.”
And this is why we see so many Austrian economists argue that savings must be higher in order to have a healthy economy or worse and that interest rates must rise in order to fuel greater saving. In the Austrian world we must all save more before we can become better off. This is not necessarily true though. As I explained previously:
“saving does not necessarily finance investment. Let’s say I spend $100 on your candy bar and you save that income immediately. Your saving is $100 if even for the briefest moment. In other words, your income not consumed is $100. If you then consume $50 on dinner then you dissave $50 via consumption. But that dissaving becomes someone else’s saving immediately. In other words, your saving does not increase aggregate saving because your spending is someone else’s saving. But let’s say a firm invests $100 in plants and equipment. The firm has not dissaved. The firm has invested. In this case, the firm has $100 in plants and equipment and the seller has $100 in new income. Indeed, it is often investment that creates saving. I assure you Keynes understood this point even if he wasn’t technically a trained economist.”
One of the primary ways that firms and households finance investment is via the banking system and tapping into this endogenous money source. This story does not remotely reflect the cornerstones of Austrian economics where we must all save more in order to be able to spend more.
In other words, if there are Austrians who understand endogenous money and how this relates to savings, investment and loanable funds then they certainly don’t communicate it very well because if they did understand it they’d call themselves “Keynesians”.
- The Biggest Myths in Economics
- Understanding Why Austrian Economics is Flawed
- Bad Inflation Bets and Why They Were Bad
- Keynesian Myths and Misunderstandings
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.