Roger writes: "In times of severe depression the banks may not be  
fully loaned up. Then reserves are excess to legal requirements.  
Expansionary monetary policies by themselves may then be inadequate"  
such that expansionary fiscal policies become necessary.

Maybe so. But now that at least one central bank, namely the Federal  
Reserve, pays interest on excess reserves, it possesses the power to  
avoid the problem Roger mentions. If banks aren't lending out their  
excess reserves, the Fed can lower the interest rate on those reserves  
into negative territory so that it becomes a penalty rate, or Gesell  
tax, on excess reserves. To escape the penalty rate, banks will either  
lend out their excess reserves or use them to purchase assets having a  
positive yield. Either way, the formerly idle excess reserves will be  
injected into active circulation. Stimulative monetary policy may then  
work, perhaps obviating the need for fiscal stimulus.

Thomas Humphrey

On Nov 4, 2011, at 8:08 AM, Roger Sandilands wrote:

> I broadly agree with James Ahiakpor on this, except that his  
> reference (to D H Robertson, 1940) is not the only one given in this  
> thread.
>
> I referenced Lauchlin Currie's Supply and Control of Money in the  
> United States (Harvard, 1934) esp. chapter VII on reserve  
> requirements of commercial banks. There he berates the pro-cyclical  
> nature of non-uniform reserve requirements against demand deposits  
> (DDs) in different classes of bank, as well as the way that reserve  
> requirements against time (savings) deposits (TDs) affect the supply  
> and control of money. Thus an increased propensity to save destroys  
> part of the nation's money supply in the sense of actual means of  
> payment (cash plus transaction deposits) by increasing banks'  
> required reserves whenever DDs are transferred into saving deposits.  
> If there were no reserve requirements against TDs the transfer from  
> DDs would have no effect on the money supply, assuming the banks  
> remain fully loaned up.
>
> In times of severe depression the banks may not be fully loaned up.  
> Then reserves are excess to legal requirements. Expansionary  
> monetary policies by themselves may then be inadequate. This is  
> where fiscal deficits can play an essential complementary role if  
> financed with new money created by the central bank, thus restoring  
> the circular flow. Even Ralph Hawtrey -- a name usually linked with  
> the "Treasury View" that fiscal deficits merely crowd out private  
> spending -- exceptionally agreed on this. (Currie, by the way, was  
> Hawtrey's assistant at Harvard in 1927-28.)
>
> Regarding James's point that Robert is wrong to insist that S = I  
> only if banks exclusively finance capital goods, note that if banks  
> instead lend part of the community's _gross_ savings to finance  
> consumer credit, the community's _net_ saving is correspondingly  
> lower. In that sense Keynes is right: net S = I, especially if "I"  
> includes changes in inventories.
>
>
>
> But whether lending for consumption or for capital investment, James  
> is right that the banks would in both cases be playing their vital  
> role in maintaining the circular flow. The question, however, is  
> whether at times like the present they are able and willing to find  
> sufficient credit-worthy _private sector_ borrowers.
>
>
>
> As Larry Summers wrote in yesterday's Financial Times, at such times  
> "the doctrine of expansionary fiscal contraction is an oxymoron".
>
> - Roger Sandilands
>
> --------------------------------------------------
> Responding to Michael Perelman's query, Robert Leeson wrote:
>> Q: As C took a hit after 2007, did I pick up the slack?
>>
>> A: Under current arrangements financial intermediaries have the  
>> discretion to take S and not transform it into capital  
>> expenditure.  This discretion must be abolished.
>>
>> RL
> This is the unfortunate conclusion to which adherence to the  
> language of
> Keynes's economics leads.  One first has to be clear that Keynes meant
> different things by "saving" and "investment" than most people
> (particularly in the marketplace) understand these concepts to mean.
> Thus, Jérôme de Boyer responded to Roger Sandiland's explanation of  
> the
> failure of savings to be transformed into investment because of banks'
> excess reserves by declaring that "the equation I=S concerns the goods
> market, not the financial market or banking."  But were one to keep in
> mind that saving is the purchasing of interest or dividend assets,
> including bank deposits, one would have recognized the dead end to  
> which
> the Keynesian formulation that Jérôme restated leads.
>
> Also, investment is the employment of savings or loanable funds in
> production, and thus entails much more than just the purchasing of
> capital goods, the definition Keynes (_GT_) uses, and most in  
> economics
> continue to use.  But the Keynesian definition of investment leads to
> the analytical impediment to recognizing that savings do not  
> necessarily
> have to be spent on capital goods for them to continue in the
> expenditure stream.  I think it is such poverty of Keynes's economics
> that led to Robert's unfortunate declaration that the discretion of
> banks to vary how much of the public's savings (deposits) they hold in
> reserves and thus do not lend or get turned into "capital expenditure"
> be abolished.
>
> Finally, an alternative to Keynes's thinking about income creation,
> consumption, saving, and investment would have led to a different
> question than Michael asked or a different response from Robert.  That
> alternative is that consumption, as Adam Smith long explained in the
> _Wealth of Nations_, “is the sole end and purpose of all production …
> The maxim is so perfectly self-evident, that it would be absurd to
> attempt to prove it.”  That is why consumption is a more stable
> component of expenditures out of income.  Isn't that is what Milton
> Friedman's permanent income hypothesis was supposed to have taught us?
> Thus, if consumption took a hit, as Michael asserted, income creation
> must first have taken a hit.  Even if some people curtail their rate  
> of
> consumption because of fears about losing their jobs, they would be
> inclined to save more (purchase interest-earning assets) rather than
> merely hoard cash.  As a matter of fact, the acquisition of bank
> deposits has increased since the fall of 2008 and interest rates have
> fallen (partly in response to the Federal Reserves' credit creation).
> Adherence to Keynes's economics or his language makes it difficult to
> make sense of the evidence, but the economics Keynes disputed, namely,
> the economics of the classics enables one more clearly to interpret  
> the
> economic record.  Consumption spending does not lead income creation,
> the causality is in the opposite direction.  How can we all consume  
> that
> which no one has produced?
>
> My reaction to Robert's original query about S = I was to ask him to
> read Dennis Robertson's 1940 book, _Essays in Monetary Theory_.  In  
> it,
> Robertson explains how Keynes's terminology led to his own analytical
> difficulties.  Not having seen any other references to Robert's  
> request,
> I'm inclined to suggest that reference now.   I have incorporated
> Robertson's insights into my "Keynes on the Classics: A Revolution
> mainly in Definitions" in _Keynes and the Classics Reconsidered_  
> (1998),
> a volume to which Robert himself contributed.
>
> James Ahiakpor
>
> --
> James C.W. Ahiakpor, Ph.D.
> Professor
> Department of Economics
> California State University, East Bay
> Hayward, CA 94542
>
> (510) 885-3137 Work
> (510) 885-4796 Fax (Not Private)