Roger is slowly getting to appreciate the points I've been making, but 
he still has some way to go.  He says:

> It is true that double-entry bookkeeping ensures that banks' demand deposit liabilities must equal their assets in the form of reserves plus loans (ignoring their loans financed out of time deposits), but that still doesn't make reserves themselves part of the money supply.
Perhaps the analogy of intermediate goods and GDP will help clarify.  
Does the production of apples, oranges, tires, cement, coal, crude oil, 
peppers, wheat, flour, etc., affect a nation's income (GDP)?  I don't 
know who would deny that all of those productions determine the income 
of a nation.  But do we count their values in the estimation of GDP?  
Only if they were bought for home consumption: final demand.  Otherwise, 
it's the apple juice and orange juice bought for consumption, the 
automobile bought at the dealership, gasoline purchased at the pump, 
bread bought at the grocery store, etc., that are counted in GDP.  Why? 
Because we want to avoid double-counting.

Same goes for bank reserves.  M1 = C + D.  But the D includes bank 
reserves on the assets side of the banks' balance sheet.  That is why we 
do not count C + R + D as the money supply.  My contention that bank 
reserves are a part of the money supply, *carefully considered* (my 
emphasis now), means just that.  Roger needs to read my statements fully 
in their context.

Roger again repeats the Friedman indictment of the Fed (1930-33) with:

> Reserves can, as you indicate, create demand deposits through banks' credit (lending) operations. But because the Fed did not fully accommodate the flight into cash (which it could have done if the Fed had actively sought an emergency relaxation of the 40% gold constraint that you rightly mentioned) the banks were naturally unwilling to maintain their loan portfolio. So the money supply (M1) collapsed and the government and the Fed were basically acquiescent.

I have been arguing that it is the modern definition of money that cites 
the means of payment (or medium of exchange) as its first identifier 
that has resulted in the Friedman mistaken criticism. Without keeping 
that point in mind, Roger can't appreciate the logic of my argument.  
So, let me restate it.  The Fed is responsible for creating money, the 
unit of account, or currency. It expanded that amount by 40 percent 
during 1930-33.  But it was not enough to counter the $8 billion 
contraction in demand deposits as the public rushed to convert their 
deposits into cash (increased demand to hoard).  I think the more 
accurate description of what happened would be to say that the Fed did 
not increase the money supply (currency) enough to meet its demand. It 
is misleading, indeed incorrect, to describe that episode as the Fed 
having cut the money supply by one-third.  I think there is a big 
difference in those descriptions.  Besides, the US didn't go off the 
Gold Standard that restrained the ability of the Fed to respond to the 
demand for currency adequately until June 1933. And the rules guiding 
what securities the Fed was authorized to purchase were not changed 
until the institution of the FOMC in 1935.

Also note that no central bank can control the quantity of the means of 
payment.  We don't ask permission from our central banks before 
withdrawing our deposits into cash.  And banks don't ask permission from 
a central bank before determining what proportion of the public's 
deposits with them they would hold back from lending (bank credit).  A 
simple recall of the modern money supply formula should make the point 
clear, I hope:  M1 = [(cu + 1)/ (cu + rd + re)]xH, where cu = 
currency-deposit ratio, rd = required reserve-deposit ratio, and re = 
economic reserve- or excess reserve-deposit ratio, and H = total 
currency (R + C) or high-powered money.   The central bank may vary H or 
rd.  But the public determines cu, whiles the banks determine re.  In 
other words, the money supply multiplier is not a constant.  How is it 
that a central bank should be blamed for not controlling M1, let alone 
M2?  (Indeed, monetary theorists and macroeconomists should be 
embarrassed drawing the M1 or M2 supply curve as a vertical line with 
the rate of interest on the Y-axis, but they are not!)

I wish Roger had provided the evidence for the claim that:

> Analogously, note that recent massive quantitative easing (increase in bank reserves) has been associated with so very little increase (indeed, occasionally negative increase) in the means of payment. The point is that the banks need to maintain their lending in order to maintain spending.
The M1 and M2 data I have seen for the period 2008-2013 have shown 
increases.  What does Roger mean by "the means of payment"?

Finally, I think Roger mischaracterizes experience with the following claim:

> In a Hawtreyan "credit deadlock" following a major financial crisis, banks are afraid to lend and the private sector unwilling to borrow. In such exceptional circumstances, Hawtrey - one of James's classical monetary heroes, and whose teaching assistant at Harvard in 1927-28 was Lauchlin Currie - himself conceded that there is a strong case for new money to be spent directly into circulation by the government. That is, through a temporary monetization of its spending instead of financing it through increased taxes or bonds issued to the private sector and bought out of the pre-existing money supply. That way, "crowding-out" can be obviated.

The day the private sector stops their "willingness to borrow" will be 
when nominal interests will get to zero all over the place.  That hasn't 
happened yet.  Had the US Fed not, unadvisedly, poured a great deal of 
credit (new money) into the financial system, interest rates would have 
sky-rocketed during the recent financial crisis.  A simple recall of the 
classical savings or "capital" supply and demand theory of interest 
helps one to appreciate the point.  Also, an understanding of the 
classical quantity theory of money that explains the price level by the 
supply and demand for money (currency or the unit of account) leads one 
to recognize the need for the Fed to increase its quantity of money to 
meet the demand (as the public rushed to redeem their financial assets 
into cash).  Without such an increase, the price level would fall (as it 
did), hurting businesses; nominal interest rates would rise (as did 
happen), further hurting businesses as their real debt burden rises.  It 
was the same logic (understanding) that prompted 12 Chicago University 
economists to sign a petition in 1932 urging the US government to 
undertake public works, funded by borrowing from the Fed, as a means of 
increasing the quantity of money (currency). Frank Taussig's /Principles 
of Economics/ taught that understanding at Harvard (where Currie 
studied) and argued the same during the early 1930s.  Sadly, it is the 
same quantity theory that Wicksell, Keynes, and some others have failed 
to understand in their explanation of what determines the price level 
and the proper role of a central bank.

James Ahiakpor

Roger Sandilands wrote:
> Thanks, James, for clarifying your own stance on "good" deflation, and for emphasising the importance of sustaining a non-deflationary rate of growth of the money supply, as defined narrowly by you.
>
> But I still question your contention that bank reserves are part of the money supply, which has led you to exonerate the Fed from blame for the Great Depression because it increased the money base by 25% after 1929. It is true that double-entry bookkeeping ensures that banks' demand deposit liabilities must equal their assets in the form of reserves plus loans (ignoring their loans financed out of time deposits), but that still doesn't make reserves themselves part of the money supply.
>
> Reserves can, as you indicate, create demand deposits through banks' credit (lending) operations. But because the Fed did not fully accommodate the flight into cash (which it could have done if the Fed had actively sought an emergency relaxation of the 40% gold constraint that you rightly mentioned) the banks were naturally unwilling to maintain their loan portfolio. So the money supply (M1) collapsed and the government and the Fed were basically acquiescent.
>
> Given the variability in the ratio of bank reserves to total loans (credit), the money supply (M1), credit, and spending (MV, exacerbated by a fall in V) move in very different ways. The "commercial loan" or "needs of trade" or "real bills" theory of central banking that characterised Fed thinking was at the heart of the mistakes they made, both in the run-up and during the Great Depression.
>
> Analogously, note that recent massive quantitative easing (increase in bank reserves) has been associated with so very little increase (indeed, occasionally negative increase) in the means of payment. The point is that the banks need to maintain their lending in order to maintain spending.
>
> In a Hawtreyan "credit deadlock" following a major financial crisis, banks are afraid to lend and the private sector unwilling to borrow. In such exceptional circumstances, Hawtrey - one of James's classical monetary heroes, and whose teaching assistant at Harvard in 1927-28 was Lauchlin Currie - himself conceded that there is a strong case for new money to be spent directly into circulation by the government. That is, through a temporary monetization of its spending instead of financing it through increased taxes or bonds issued to the private sector and bought out of the pre-existing money supply. That way, "crowding-out" can be obviated.
>
> - Roger Sandilands
> ________________________________________
> From: Societies for the History of Economics [[log in to unmask]] on behalf of James C.W. Ahiakpor [[log in to unmask]]
> Sent: Thursday, February 20, 2014 7:31 PM
> To: [log in to unmask]
> Subject: Re: [SHOE] FW: [SHOE] FW: [SHOE] Ahiakpor on Wicksell
>
> I will spare readers much repetition of my points that Roger has missed
> again.  I'd just like to correct two new misrepresentations of me by Roger.
>
> 1.  He says, "Admittedly, some (including, I believe, James and many
> "Austrians") would prefer that there be a fixed stock of gold as the
> nation's fixed money supply, and then to let prices fall ("good"
> deflation) as GDP increases."  This is the destination Milton Friedman
> reached in 1984 from not following the classical definition of money,
> which would be a central bank's currency as the equivalent of classical
> specie.  Hume was interested in sustaining the price level, preferably
> via the flow of international payments or monetary debasement, when the
> price level is falling.  I do not belong in the Austrian camp of arguing
> for a secular deflation.  My position is for the central bank to sustain
> the price level by targeting the demand for money, properly so defined,
> not credit.
>
> 2.  Roger writes: "These reserves are not part of the money supply, as
> almost every monetary theorist I know knows (apart perhaps from James),
> because they are not in circulation."  Now define M1 = C + D (currency
> plus demand deposits), and note that D = R + BC (reserves plus bank
> credit), then M1 = C + R + BC.  So that, although reserves are not in
> circulation, they are nevertheless part of the money supply, carefully
> considered.  They are the basis of bank credit extension, considered as
> modern money.  Get it?  That is also why modern money M1 is a
> commingling of classical money (H) with bank credit, that is, M1 = H + BC.
>
> James Ahiakpor
>
> Roger Sandilands wrote:
>> James Ahiakpor writes:
>>
>>       > I wish Roger Sandilands had paid a more careful attention to what I was
>> saying and the context in which I cited Francis Walker's objection to
>> the inclusions of the means of payment in the definition of money before
>> offering his intervention.  Alas, he merely confused issues.
>>
>> The context was Walker's objection to some of his predecessors' inclusion of checkable deposits in their definition of "money". Aware of this context, I disagreed with his objections and disagree with James's defence of Walker here.
>>
>>       > Indeed, Hume called paper money or notes, "counterfeit money,"
>> Smith referred to them as "promissory notes," while Thornton called them
>> "paper credit."
>>
>> Yes, but if James were to pay careful attention to the context of what Hume wrote, he would see that he did not object to paper money as such, only that private bankers were not to be trusted with its issue; instead it should be entrusted to a public [presumably central] bank. And it was important, noted Hume, with huge insight, that this money should not be increased "beyond its natural proportions to labour and commodities". In other words, the public bank should only increase the supply of this money in line with the real demand for it to finance the growth of real income. This would avoid a fall in its value and prevent it being "counterfeit".
>>
>> And, one could add, to enable the sovereign, rather than private bankers, to obtain the non-inflationary "seigniorage" that could legitimately be associated with the supply of paper money when "well regulated" (to quote Adam Smith in similar vein). Admittedly, some (including, I believe, James and many "Austrians") would prefer that there be a fixed stock of gold as the nation's fixed money supply, and then to let prices fall ("good" deflation) as GDP increases.
>>
>> Incidentally, capture of seigniorage for the public rather than private bankers, is part of the case for 100% reserves against demand deposits in commercial banks (proposed first by Currie and Henry Simons in 1934 and then by Irving Fisher). This would divorce the supply of money from the lending of money. Lending would then be restricted to the supply of genuine, interest-bearing savings - in banks or elsewhere - rather than via active transactions balances in banks qua banks. (Non-interest-bearing demand deposits are held mainly for the active transactions motive rather than the income motive for holding much less active, interest-bearing savings balances).
>>
>> James also refers to Milton Friedman's (1963) preference for M2 as the approprite definition of money. But that is why - contrary to Lauchlin Currie's much earlier empirical studies based on M1 (sadly ignored by Friedmand & Schwartz) - he failed to reveal any pro-cyclical variation in velocity in the 1920s despite having argued elsewhere that such was the a priori expectation.
>>
>> James also says: "When one pays with cash, one would have had to turn one's income first into cash before surrendering it to a vendor."  And he states that "Roger thus misses the above understanding of the difference between a check and money..."
>>
>> But, equally, when I ask my employer to pay me by transferring money from his bank account to mine, I am effectively - and more quickly - turning my income into a means of payment. Some I encash, but mostly I pay by cheque or, nowadays, with a card. (Of course neither the cheque nor the card are money. The money in my current account is my available, spendable money - and, pace James, each dollar recorded there is just as much a unit of account as a dollar bill.)
>>
>>       > By the time Currie came on the scene, the modern definition of money to
>> include savings or wealth (bank deposit) had become well established.
>>
>> Actually there was no official money supply series published in the USA before Currie constructed one for "A Note on Income Velocities" (QJE 1934) and in his "The Supply and Control of Money in the United States" (Harvard 1934). The Fed published series on "credit" (loans) but this differed widely - and misleadingly for policy - from the M1 series published by Currie.
>>
>> Nor can I accept James's criticism of F&S's (1963) for claiming (as did Currie 30 years earlier) that the Fed caused or made worse the Great Depression by allowing the money supply to fall by a third. This is because James focuses on the Fed's liabilities in the form of high-powered money or the monetary base, which increased by 25%. But this was (a) because of a huge flight into cash motivated by the desire to hoard (increase in unspent and unspendable savings), even though not all of this was accommodated by the Fed because emergency legislation was not passed to lift the gold constraint; and (b) because of the commercial banks' own desire to increase their reserve ratios. These reserves are not part of the money supply, as almost every monetary theorist I know knows (apart perhaps from James), because they are not in circulation.
>>
>> Thus, in conclusion, yes the money supply _did_ shrink - disastrously. A focus on the 25% increase in base money would hardly have helped those who argued for greater Fed activism in 1929-32!
>>
>>       > Friedman was able to confound the Keynesians by employing the
>> Keynesian broad definition of money to show how money matters: cut money
>> and an economy suffers.  But in the end he did classical economics a
>> great disservice by enshrining the fusion of money and wealth or credit
>> into the definition of money.
>>
>> Or, rather, I would say, by focusing on counter-cyclical M2 rather than pro-cyclical M1.
>>
>> Lastly, readers may be interested in an appreciative letter from Allyn Young to Edwin Cannan, June 22, 1926 in reply to Cannan's urging him to accept the Chair of Political Economy at the LSE. Young ended thus: "I can quite understand that you would have liked to have been followed by one of your own pupils, if that had been possible. Yet, although not a pupil of yours, I can at least put forth a claim to some measure of discipleship. Except for a few points in monetary theory (for example, I should hold that banks _do_ "create" deposits!) I think there would be very little difference between us."
>>
>> But what a difference there is in that caveat, James.
>>
>> - Roger Sandilands


-- 
James C.W. Ahiakpor, Ph.D.
Professor
Department of Economics
California State University, East Bay
Hayward, CA 94542

(510) 885-3137 Work
(510) 885-7175 Fax (Not Private)