The term ‘money’ has multiple meanings. In everyday speech, people might say, “Bill Gates has a lot of money”. In that case, they are using in the term interchangeably with wealth. In other cases, people might talk about how the Fed creates (base) money, or how commercial banks create (deposit) money. That’s an entirely different concept, as bank deposits are not net wealth. I have no idea whether or not Bill Gates has a lot of cash or money in bank accounts, but he certainly has a lot of wealth.
When people talk about the Federal government spending “money”, they are implicitly referring to money as a real asset, real cash balances. When they talk about the Fed creating money, they are discussing a nominal asset.
All of this is useful background to a recent FT article by Thomas Hale, discussing “magic money trees”:
In a wide-ranging attack on the economics profession published in the New York Review of Books, David Graeber, the anthropologist, paid particularly close attention to the concept of money.
He pointed to Theresa May’s claim, during the UK general election in 2017, that “there is no magic money tree,” which was part of the debate on austerity and government spending:
The truly extraordinary thing about May’s phrase is that it isn’t true. There are plenty of magic money trees in Britain, as there are in any developed economy. They are called “banks.” Since modern money is simply credit, banks can and do create money literally out of nothing, simply by making loans. Almost all of the money circulating in Britain at the moment is bank-created in this way.
Graeber, reviewing a new book from Robert Skidelsky, goes on to cite a Positive Money poll showing most politicians “don’t know” where money comes from. The think-tank, which has generally spearheaded a view of the economy predicated on the above observation about money creation, also drew on this precise reference to the May speech in 2017, here.
We’re not saying May is right on government spending. But is the magic money tree meme, which has circulated widely, a useful or insightful way to think about banks? The answer is straightforwardly no, irrespective of your politics.
Hale does an excellent job explaining why banks are not actually magic money trees, in the sense of being able to create unlimited amounts of money. But there’s a bigger problem with the Graeber comment, he implicitly confuses money as a medium of exchange with money as wealth. Theresa May was obviously referring to money in the sense of wealth—real resources available to governments. Governments have no trouble creating lots of money in the sense of medium of exchange; look at Venezuela and Zimbabwe. But those countries are not able to finance a lavish welfare state, despite their ownership of “magic money trees”.
Governments need real resources to finance expensive government programs, not just “money”. A government’s monopoly on printing fiat money does provide it with a modest profit, which can be used to finance government spending. But that’s already factored into the budget. Unless you favor radically higher inflation rates, then the revenue from money creation will remain trivial relative to the size of the modern state. And even if the government is willing to engage in hyperinflationary policies, the resources from money creation (called ‘seignorage’) remain far too small to finance the spending plans of the left.
Here’s the best way to think about the issue. The central bank has a policy objective, or target. The monetary policy that achieves that target will produce some revenue as a side effect. The government is already spending that revenue; it is already a part of the budgeting process. Don’t look to money creation as a source of additional government revenue.
I’m actually pleased that the left is using the metaphor “magic money tree”. I may be a former academic with my head in the clouds, but I think I have a pretty good idea how average voters would interpret spending promises that were to be financed with magic money trees. So please, don’t stop using that metaphor.
HT: Sam Bowman
READER COMMENTS
Benjamin Cole
Nov 20 2019 at 11:56pm
Money trees “remain far too small to finance the spending plans of the left.”
Well, or the right? The US spent $6 trillion to $8 trillion in Iraq-Afghanistan in outlays and incurred liabilities. Borrowed money all the way through.
Beyond that, money-financed fiscal programs are what allowed Japan to largely sidestep the Great Depression, the only developed nation to do so. Unfortunately, they were very, very right-wing, bent on militarization and imperialism. But despite the huge misallocation of funds, Japan’s economy grew through the 1930s.
It sure is hard to tell the difference between 1) money-financed fiscal programs, and 2) fiscal deficits concurrent to QE. Michael Woodford says there is no difference, as does Adair Turner. One is burro and the other is donkey.
And now banks have unlimited reserves, and if they do not, the Fed prints up a few hundred billion and injects it fast and quick. So banks create money, but that is not inflationary, but when a government creates money, that is inflationary?
Well, as my Uncle Jerry used to say, “If you are not totally confused, then probably you do not understand what is going on here.”
Todd K
Nov 21 2019 at 6:37am
That’s because those governments never planted true magic money trees…
Phil H
Nov 21 2019 at 7:19am
This is more of a linguistic point than an economic one, but it’s interesting what this magic money tree idea tells us about the word magic. In order to be magic, in the sense that Scott is using, it would have to be utterly unconstrained.
I rather think that banks *are* magic, and I understand Scott’s position to back that up, in that if growth is a little slow one year, (central) banks can make up the shortfall with extra money and extra inflation, and this will have the added benefit of stabilising the economy and encouraging more growth. Which sounds pretty magic (as in amazing and beneficial) to me – just like TVs and phones and planes and internet. But it’s not magic (as in subject to no constraints), because it has to be done in a purposeful, controlled way. It’s a technology, not magic.
robc
Nov 21 2019 at 7:53am
Any sufficiently advanced technology is indistinguishable from magic. — Arthur C Clarke
Scott Sumner
Nov 21 2019 at 12:04pm
Your description of my views is correct only if by “growth” you mean NGDP, not RGDP. There is nothing magic about the idea that increasing the supply of something reduces its value. That’s EC101.
Phil H
Nov 21 2019 at 2:10pm
Thanks Scott… In that case I have misunderstood your view.
As I understand it, you favour NGDP targeting. I always assumed that you favour NGDP targeting because it will in fact lead to better (or at least more consistent) RGDP growth.
Is that not the case? If not, then what is the motivation for using NGDP targeting?
Scott Sumner
Nov 22 2019 at 6:09pm
I do not believe that NGDP targeting will lead to faster growth. I do believe that RGDP growth will be more stable if NGDP growth is more stable—not a very a controversial opinion.
Phil H
Nov 23 2019 at 3:51am
Thanks, Scott. I suppose that helps answer my question… But I have to admit, it leaves me somewhat confused. You yourself have said that you have conducted a years-long campaign to raise awareness of NGDP targeting as a macroeconomic strategy, with the ultimate aim of having the central bank adopt this strategy. Is it really right that you’ve devoted a considerable portion of your time to this goal, even though you don’t think it will improve growth?
Perhaps this is not the right place. I will try to go and read more of your past writing.
Thaomas
Nov 21 2019 at 7:44pm
What’s point of NGDP policy if not to maximize real income growth? I understand the Fed’s legal obligation to seek maximum employment and stable prices to be in pursuit of maximum real income growth.
Garrett M
Nov 22 2019 at 9:35pm
Even if NGDP targeting wouldn’t increase the rate of RGDP growth, it would still be valuable if it reduced the variability of RGDP growth.
Thaomas
Nov 21 2019 at 8:33am
But in a recession, both the the monetary authority and governments DO have magic money trees.
The monetary authority can return the economy to full employment and the target (hopefully the optimum) price level trend and governments have the opportunity to invest in activities than have positive NPVs. [Such opportunities may exist outside of recessions but while real borrowing rates are low and many prices exceed marginal costs (“stuck” there because of “sticky prices), there will be more such opportunities than when the economy is on a full employment optimal price level trend path]
So May was diametrically wrong about austerity. As Keynes explained 80 years ago, full employment is the time for austerity; during recessions (the time required for the monetary authority to get the economy back on the full employment-optimal inflation path) governments have and should use their magic money trees.
Scott Sumner
Nov 21 2019 at 12:07pm
Thaomas, No, it is you who are wrong. She wasn’t talking about macroeconomic stabilization, she was talking about funding government programs. There is no magic money tree to fund government programs.
And of course the UK was not in recession during 2017, when she made the comment.
Thaomas
Nov 21 2019 at 7:37pm
I took her reference to “austerity” to refer to the policy of the Cameron government while she was in the Cabinet, NOT to follow the NPV criteria during the recession.
Brian Donohue
Nov 21 2019 at 10:24am
Excellent. Printing money does not create wealth.
Edward Zimmer
Nov 21 2019 at 1:43pm
Below are 6 statements that I see as facts that appear to define a magic money tree. Please explain which of my 6 statements are not factual.
1) GDP is the measure of our productive economy.
2) GDP is the sum of household, business and government spending (and likewise the income of those sectors equals that spending, because ALL spending is someone else’s income).
3) Our economy depends on household spending (2/3 of GDP).
4)That spending is limited by household income (which comes only from those three sectors).
5) Business provides that income to the extent demand (business opportunity) exists, and government provides the rest (by way of bookkeeping entries to household bank accounts).
6) All that’s important to the economy is maintaining this flow, and with a fiat currency (whose value, by definition, depends ONLY on currency-users perception), there are no limits other than that perception.
Don Geddis
Nov 21 2019 at 3:23pm
You aren’t carefully distinguishing real from nominal. The “measure of our productive economy” is real GDP. The “sum of spending” is nominal GDP. These are different things, not the same thing.
Saying “our economy depends on household spending” is not a meaningful claim. “Depends on” is not an economic term, except in the trivial sense that our economy “depends on” everything, including business and government spending (and real resources, and trade, and climate change, and…). You seem to think you have made a more specific statement, but I can’t make out what it might be.
There are plenty of limits in the economy, other than “perception” and the “flow” of nominal spending. The economy also has real limits, which come from limits on real resources.
Edward Zimmer
Nov 21 2019 at 4:20pm
Just what I would expect from an economist – obfuscation & avoidance. (I’m an engineer, not an economist.) No factual response to which of my statements are not facts.
Lorenzo from Oz
Nov 21 2019 at 4:38pm
Nominal GDP is the flow of income from/expenditure on production of goods and services in a given time period.
Real GDP is the Nominal GDP to which a deflator has been applied to adjust for changes in prices so as to get a measure of actual quantities of production over a given time period.
They really, really are not the same thing. One is derived from the other.
(And you might want to look up the Dunning-Kruger effect.)
Demand, in a monetised economy, is expressed through money. But supply constraints remain real. (Pun intended.) In fact, much effort goes into thinking about getting around supply constraints. Getting more bangs for the buck.
It is why expansion of knowledge was so crucial for economic take off. Particularly expansion of knowledge about how to use energy, because it made much more energy available.
Encouraging such knowledge, and using such knowledge, that gets into culture and institutions.
China invented the compass, printing (and paper) and gunpowder. The three inventions that both Francis Bacon and Adam Smith thought had been transforming the world. But they did not transform the world when they were in Chinese hands.
So, there is so much more going on than flow of funds/spending …
Don Geddis
Nov 21 2019 at 10:38pm
“Just what I would expect from an economist – obfuscation & avoidance. … No factual response to which of my statements are not facts.”
Ah. I see. You’re just trying to “win” an internet argument, not actually discuss economics.
The direct answer to your question is: each of your statements 1-6 are “not facts”. You use undefined and ill defined terms, so there isn’t even a coherent reference to what your claims might be. (Whether any given statement of yours is true or false in the world, depends greatly on what definitions we happen to choose for your poor choice of words.)
“Not facts” is probably the right label for all of your statements. If they were more coherent, they might even be “wrong” or “false”. But they aren’t coherent enough. Your claims have reached the rarely seen “not even wrong” state.
KevinDC
Nov 22 2019 at 1:14pm
Well for one, the point that you’re conflating nominals and reals is hardly obfuscation or avoidance. It’s a pretty direct response that gets at the core of why your outline is incorrect.
But more importantly, this is a good example of why having some epistemic humility when dealing with topics outside your area of expertise is a good life choice. I read this and I was immediately reminded of Scott Alexander revisiting his review of Alasdair MacIntyre’s book After Virtue:
Similarly, if you’re an engineer without any particular expertise in economics, and what economists say seems (to you) like it’s somehow off the mark, what is more likely? That you’re the lone genius who can see the hidden truth that economists don’t actually know any economics? Or that maybe you’re the one who’s missing something?
Christophe Biocca
Nov 21 2019 at 4:49pm
False. GDP (nominal or real) is just one convenient way to measure productive activity. It fails to capture consumer surplus, which means it is only a proxy measure for what we actually care about (the old saw about GDP falling when someone marries their housekeeper is a good example, this very site covers what’s wrong with the reasoning).
Only the sales of final goods. So people employed in intermediate products (bauxite extraction, for example) don’t directly show up in GDP calculations.
“Our economy” is awfully ill-defined, but let’s pick a few possible meanings:
– Consumer welfare: False, consumer welfare depends on production (ie. the availability of goods for purchase). To see what happens when households have money, but goods are not available, there are tons of historical and a few contemporary examples.
– Employment: Mostly false, since any household switching from spending to saving will simply shift resources from production of consumption goods to production of capital goods. The money doesn’t just disappear.
If you have a different meaning in mind, let me know.
False. You can’t eat money.
robc
Nov 21 2019 at 6:18pm
He left out (X-M), so I think that makes the rest false too.
Jens
Nov 22 2019 at 6:38am
“””
False. GDP (nominal or real) is just one convenient way to measure productive activity. It fails to capture consumer surplus, which means it is only a proxy measure for what we actually care about (the old saw about GDP falling when someone marries their housekeeper is a good example, this very site covers what’s wrong with the reasoning).
“””
I think from Pigou comes the bon mot, that the national income sinks, if someone marries his cook. (A somewhat outdated, patriarchal view, which, of course, assumes that the housewife is still cooking after marriage and is not being paid for it). What always surprises me, however, when economists or economically interested discussants point out this fact, that in discussions about economic issues, so little is said about the aspects of good life that are obviously not measured by GDP and related metrics.
As far as I know, in the times of people like Pigou or Colin Clark, it was still a real challenge to establish such a measure as the GDP at all. But today this is not the case any more and there are actually quite a lot of statistics and indexes dealing with happiness, well-being or health, for example. (I did not include the term equality in this list, because then perhaps someone would say that this is my personal preference and that it would therefore be quite subjective for me to insert that preference as a measure here. Interestingly enough, this accusation is hardly put forward with the terms I have mentioned).
Why is there – my subjective impression – few economists who are concerned with the efficient production and multidimensional optimization of these other metrics? You could certainly say that economics is limited to goods and services. But then this task would have to take on another discipline. In fact, one sometimes gets the impression that this focus actually serves a different purpose. At least, I have the impression that many economists in technical texts prefer to write about GDP, while they like to report on all the other elements of the good life in prose and anecdotes.
Christophe Biocca
Nov 22 2019 at 10:18am
I see a few problems with those indices:
– Defining an index requires you to decide what to weight and how. This is far from a trivial exercise (cato’s alternate education ranking is a good example of how dramatically rankings can change.
– The scale is often ill defined. It gives you an ordinal ranking, with the exact numerical scores being harder to gauge (what does moving up 3 points on a 10 point happiness scale mean?).
– Even if you have a well defined, cardinal measure of some good thing, it will probably be too narrow to capture overall welfare, so you’ll need to aggregate it with other measures. And that requires deciding what the appropriate tradeoff between health/education or any other pair of measures is, to flatten your multidimensional ranking back to one scale. Otherwise you’ll be unable to compare outcomes unless one strictly pareto-dominates the other.
Jens
Nov 23 2019 at 5:35am
I see a few problems with those indices:
…
Thank you. I am reasonably clear about the problems, paradoxes and cycling behaviour that arise in the aggregation of preference lists. At first, my point was simply that it is much easier nowadays to collect and process data.
But generally one should not be deterred by the theoretical and logical problems and not use them as a manslaughter argument. Ultimately, living in a confined space or on a small planet, you have to agree with others on something, no matter how big or awkward the theoretical difficulties are that modeling implies. Gödel does not mean that you can not talk about truth in or out of mathematics. Above all if you specialize in a line of argumentation that goes like “it has absolutely no sense whatsoever to begin with” and emphasize relativity of everything you should also expect that someday someone comes around and thinks it would actually be better if one just puts this whole project “humanity” to an end. After all the planet is unique and special even without people. And the problems of economics, human medicine and the political (and a few more) could be solved all at once, by simply setting the denominator to 0 in all relevant relations.
Also I have no doubt that it is a good thing when people who live with bow and arrow suddenly receive vaccinations and refrigerators. But the crucial point in this context is actually that the arguments put forward also massively restrict the usefulness of a proxy such as GDP for good life. If it is so difficult to measure and agree about good things, then the excessive emphasis and use of a certain metric – that is even at best only vaguely correlated with the good things – means that danger is very great, that the rest of the space of evaluations and possibilities of good things is strongly neglected by this habit (or propaganda). And after all that’s the point of Henderson (and apparently you too).
Jens
Nov 23 2019 at 5:38am
I forgot .. A few year ago John Quiggin wrote a nice parabel about two schools of thought. I think that fits somehow in this context.
https://johnquiggin.com/2003/07/23/public-choice-marxism/
AT
Nov 22 2019 at 7:42am
No 6 is wrong. The value of fiat currency doesn’t only depend on perceptions.It also depends on the government forcing taxpayers to provide goods and services to money holders.
Scott Sumner
Nov 22 2019 at 6:15pm
I’m not sure if you are referring to nominal or real GDP. So let me just say that monetary policy determines the flow of NGDP and supply side factors determine the growth rate of RGDP. Things like consumer spending don’t determine either, they respond to GDP.
NGDP and RGDP are radically different entities, so it’s important to specify which one you are referring to. For example, in 2008 Zimbabwe’s RGDP fell while its NGDP rose by something like a billion-fold.
Edward Zimmer
Nov 22 2019 at 3:13pm
More gibberish. At least I’ve satisfied myself that the economics discipline(?) (at least in macroeconomics) is as thoroughly inept as it appears to be to an outsider. A few random points:
GDP is the ONLY reliable MEASURE of the productive economy, as it derives from real data submitted by businesses & trade groups. And NIPA is the best methodology for conducting that measure (despite its sampling of the data & the necessary estimates due to lack of data) because of the quantity of data, the consistency in its processing & the use of double-entry accounting as a continuing check on the processing.
Criticism of my words (& lack of definitions) comes as no surprise as use of uncommon definitions appears to be economists’ primary tool in promoting their own points of view & in arguing with each other. Suffice it to say that my use of words conforms with their common public definition.
I purposefully left out (X-M) because it’s inconsequential to the picture I’ve painted. Likewise, whether I’m using GDP as real or nominal is irrelevant. NGDP is the measure of what the actual economy is doing. If I wish to create make-believe comparisons with the past, some version of RGDP gives me a way to present the image I wish. And I’m not trying to “win” an internet argument. I’m giving an outsider’s point of view of what I see as gross incompetence which all are free to ignore as they wish.
Your confusion over the meaning of “the economy” is especially telling. The economy is simply the financial relationships between the household, business & government sectors. And with a fiat currency, it’s only the TRANSACTIONS among those sectors (ie, the economy’s GDP/GDI earnings statement) that has any real (operational) meaning. The attempt to account an accumulation of these tokens (as in the Fed’s FOFA program) is sheer idiocy (& I suspect sometime in the future will be looked back on as “counting the number of angels that fit on the head of a pin”).
I believe I painted (in those 6 statements) an accurate picture of how our economy really works. And I can understand why its simplicity causes such consternation among economists. If you’re honest with the public, they’ll see how little value you’re adding to their welfare. And they’ll see how much harm you’re actually causing them. They’ll see how government is perfectly capable (economically) of providing sufficient tokens to its citizens to ensure their welfare (food, housing, education, transportation, healthcare…) and that it’s only you, holding this truth from them, that is standing between them & the “good life”. There really is a “magic money tree” available – if economists would simply do their job or step aside.
Christophe Biocca
Nov 22 2019 at 4:13pm
Ask the folks in Venezuela how abundance of money (m2 growth of 9,797.9% year over year this October) has solved all their problems.
You can’t eat money. I’m quite serious.
Mark Z
Nov 22 2019 at 10:55pm
But you can use it a kindling, paper, toilet paper, and substitutes for other useful goods. And since money thus has value as a commodity in its own right, and the central bank can clearly print an infinite amount of it, that means scarcity is a myth. MMT proven true.
Scott Sumner
Nov 22 2019 at 6:28pm
You said:
“Likewise, whether I’m using GDP as real or nominal is irrelevant.”
You’ve just trashed the entire economic profession from the outside. That’s fine. But if you are going to do so, and want to be taken seriously, then you better not say that the distinction between real and nominal is irrelevant.
You said you are an engineer. Here’s an analogy. If you are given the dimensions of a bridge, is it irrelevant whether the numbers you are provided are in feet or meters? The dollar is the measuring stick in economics. If its value changes rapidly, then the distinction between real and nominal variables becomes huge (see Zimbabwe, or even America in the 1970s). It would be like the length of the measuring stick used in engineering changing over time.
KevinDC
Nov 23 2019 at 9:47am
“People within economics keep saying things that make no sense to me, an engineer. This can’t be because I’m the one who’s misunderstanding anything. The only possible reason is that the entire profession is filled with inept people who don’t know anything about their own field. There can be no other possible explanation for why they don’t agree with me.”
Reading this made me feel embarrassed for you. More than anything it reminded me of creationists who insist evolution is self evident nonsense because biologists are fools who think complex life came about by “random chance.” And when you try to point out to them that there’s a really important difference between “random chance” and “natural selection,” they just double down and insist the distinction is irrelevant. They have really, truly failed to grasp the very basic concepts involved and that leads them to feel like they can confidently reject an entire field of study and dismiss everyone who studies it as obvious fools. Michael Huemer said it well in a talk I saw him give “If you think the entire community of experts are all wrong about their own field of specialization, and especially if you think that while not being able to accurately replicate their arguments, then you’re almost certainly the one who’s wrong.”
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