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Societies for the History of Economics <[log in to unmask]>
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Tue, 8 Nov 2011 12:29:45 -0800
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"James C.W. Ahiakpor" <[log in to unmask]>
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It appears I still have not persuaded Robert Leeson to learn or employ 
the language of classical economics, what Alfred Marshall (1920, 60) 
calls "the language of the market-place," regarding saving, "capital," 
and investment.  Thus, he says:
> James writes:
>
> 1. When one recognizes that savings are spent, "and nearly at the same time too" (Smith, _WN_; see also Mill, _Works_, 2: 70), one would recognize that increased savings do not decrease "aggregate demand" (C + I + G).
>
> and
>
> 2. With a non-zero interest elasticity of demand for loanable funds, increased savings decreases interest rates and increases the quantity of loanable funds demanded to be spent.
>
> With respect to 1. If savings are hoarded by banks or used to buy second hand assets there is no net spending.
Sure enough, banks only lend a fraction of households' savings (deposits 
less reserves) to borrowers.  In that sense, there is always some cash 
hoarding by banks.  (There is no such thing as "banks being fully loaned 
up" as some analysts claim.)  So that variations in banks' economic 
reserves (otherwise called "excess reserves") do affect the amounts 
banks lend to borrowers to spend.  Robert's concern appears to be that, 
because the flow of spending decreases when banks increase their 
reserve-deposit ratio, banks should be prohibited from exercising their 
ability to change such reserves.

But banks hold economic (excess) reserves in order to manage their 
liquidity risk -- readiness to redeem on demand their customers' 
deposits in cash (Adam Smith, /WN/, 1: 323).  It serves the economy's 
proper functioning (and increased investment spending) that banks 
exercise good judgment in varying their economic reserves depending upon 
the degree of liquidity risk they face.  In more uncertain economic 
times, banks raise their reserve-deposit ratio.  They lower the ratio in 
more optimistic times.  If banks make the mistake of not holding 
adequate reserves and provoke a run because some customers could not 
redeem their deposits in cash, the whole system collapses.  That is the 
nature of a fractional-reserve banking system.  I quote Henry Thornton 
(1802), David Ricardo (1817), and J.S. Mill (1848) explaining this in my 
2010 /HOPE/ article, pp. 560-62.

On the other hand, the only way to prevent banks from varying the flow 
of spending through their variations of economic reserves is to impose 
the 100% reserve-deposit requirement.  But that requirement contracts 
the flow of loanable funds (and investment spending), as banks simply 
become custodians of the public's excess cash holdings.  We lose Smith's 
great insight of a fractional-reserve banking system providing us, as it 
were, a "wagon-way through the air" (/WN/, 1: 341) to economic 
prosperity by arguing the imposition of the 100% reserve requirement (a 
point the Austrian critics of fractional-reserve banking appear to miss).

All of the above -- banks lending their customers' deposits -- is lost 
on Keynes (1930, 1: 25-26) who argues that it is rather bank loans that 
create their customers' deposits, and who also subsequently declares 
that savings are not the source of loanable funds, a claim celebrated by 
Joerg Bibow with the declaration: “we [are] spared from those popular, 
but misguided, policy measures that stress, chronologically, saving 
before investing” (/HOPE/, 2000, 826) by accepting Keynes's view of the 
loanable-funds or savings supply and demand theory of interest as a 
fallacy.

Also, when a bank buys "second hand assets" what do the sellers do with 
their proceeds?  If they stashed them under the mattress, there 
certainly is no additional spending.  But why imagine that's all the 
sellers of second hand assets do with their proceeds?

Robert also claims that
>
>
> With respect to 2. The quantity of loanable funds is irrelevant when banks choose not to loan.
What do banks do with their customers' deposits?  Permanently lock them 
up in vaults?  Bank lending is like breathing to a living human-being.  
Banks may vary their rates of lending, but they never stop lending.  
Perhaps, we need to acquaint ourselves more with the business of banking 
and not stop acting like Keynes who would trust more his own intuition 
than what bankers themselves explain about their business.  Thus Keynes 
(1930, 1: 25) dismissed the explanation of "Practical bankers, like Dr. 
Walter Leaf ... that for the banking system as a whole the initiative 
lies with the depositors, and that banks can lend no more than their 
depositors have previously entrusted to them."  Short of borrowing from 
a central bank or issuing non-deposit IOUs, from where do banks find the 
funds to lend?

James Ahiakpor

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

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