Eichner’s monetary economics Ahead of its time

1. Eichner’s monetary economics Ahead of its time Marc Lavoie University of Ottawa

2. The received wisdom on Eichner’s work on monetary economics • “Most, or maybe all, of Eichner’s analysis doesn’t really come to grips with the nature of money and the financial system”. (Sawyer in King, 1995) • “… in the area of monetary theory and macrodynamics [Eichner] barely scratched the surface”. (Davidson 1992)

3. The thesis of this paper • On the contrary, Eichner was very much concerned with monetary economics and the financial system. • In addition he did put forward four key concepts which are now at the forefront of post-Keynesian monetary economics. • Thus, Eichner, like Joan Robinson, has been unfairly ignored in monetary economics

4. The four key monetary theory concepts highlighted by Eichner • The starting point of monetary theory is the demand for credit, not the demand for money; • Central banks pursue essentially defensive operations when intervening on the open market; • The liquidity pressure ratio of banks plays an important role throughout the economy; • An understanding of the economy can only be acquired by going beyond the standard national income and product accounts, that is by making use of the flow of funds accounts.

5. The starting point:credit

6. Credit availability to avoid financial crises • “Post-Keynesian short-period models emphasize the importance of credit availability – as determined by the central bank – in enabling business firms and other spending units to bridge any gap between their desired level of discretionary spending and the current rate of cash inflow. Credit availability is important in determining not only discretionary spending but also liquidity crises and the number of bankruptcies.... Thus it is credit availability – or the degree of ‘liquidity’ pressure throughout the economy – that becomes the critical monetary factor in a post-Keynesian short-period model, not the stock of money”. (Eichner 1979, 40-1).

7. An integration of real and monetary factors • For instance, Eichner (1987, pp. 660-1) relates household consumption to stocks of financial assets and to the availability of credit, interest rates on consumer loans and the loan amortization duration.

8. Money, or rather credit, does matter! • “The amount of funds available to finance investment depends far more on the lending policies of the banks, including the central bank, than on the willingness of households to forego consumption” (Eichner 1987, p. 138). • “If additional investment is going to be undertaken, it can only be financed ... through bank loans” (Eichner 1987, p. 836-7).

9. Focus on credit, not money • “It is the demand for credit rather than the demand for money that is the necessary starting point for analyzing the role played by monetary factors in determining the level of real economic activity” (Eichner 1985, 99) • “Eliminating the money stock from the model has the further advantage that it avoids any need to distinguish the ‘demand’ for money from its supply. It also renders moot the question of how the money stock is to be defined .... Indeed the only disadvantage is that it would mean abandoning the LM-IS framework that has dominated macroeconomics .... But then that might not be such a disadvantage” (Eichner, 1985, 110)

10. A debt monetary economy • “The amount of funds available to finance investment depends far more on the lending policies of the banks, including the central bank, than on the willingness of households to forego consumption” (Eichner 1987, p. 138). • “If additional investment is going to be undertaken, it can only be financed ... through bank loans” (Eichner 1987, p. 836-7). • “The only way the amount of funds circulating as checkable deposits can be increased is if some nonfinancial sector is prepared to increase, not its net savings but rather, its net debt” (Eichner 1987, 824)

11. Rejection of the standard textbook money multiplier • “Banks are not inclined to approve bank loan applications just because they have excess reserves. They will, in fact, be willing to grant loans only to those who can demonstrate that they are ‘credit-worthy’, and once this demand for loans has been satisfied, no additional credit is likely to be extended” (Eichner 1987, p. 854).

12. The liquidity pressure ratio

13. Eichner, for good or for worse, believed in the persuasion power of econometrics. • Eichner constructed a post-Keynesian econometric model of the American economy. • One of the blocks of this model consisted of the monetary-financial block, which gave rise to a series of interesting and original empirical findings. • As early as 1979, Eichner and his research assistants found a new variable, the liquidity pressure ratio, that seemed to perform well in the regressions of several equations. • Originally, this liquidity pressure ratio was described as the difference between the growth rate of bank loans and the growth rate of base money.

14. Main definition of the liquidity pressure ratio • The “lending capacity of the commercial banking system”, • “The ratio of bank loans to bank deposits” (Eichner 1985, p. 99). • More formally, the variable that explains the cyclical evolution of investment expenditures or of personal consumption on durables is the discrepancy between the actual degree of liquidity pressure and its secular or trend value (Forman, Groves and Eichner, 1984).

15. A useful variable • The empirical relevance of the degree of liquidity pressure in explaining the future evolution of discretionary expenditures, as well as the future level of bank loans and some interest rates, including the federal funds rate, is mainly attributed to credit rationing. • Eichner (1985, p. 105) says that the amount of bank deposits “measures the lending capacity of the commercial banking system”, and thus that when the degree of liquidity pressure decreases (relative to its trend value), “the commercial banking system will become less liquid and less capable of providing credit”

16. Similarity with Godley’s bank liquidity ratio • Godley’s bank liquidity ratio is defined as the bills to deposits ratio, or the ratio of defensive assets to liabilities (it is also some kind of secondary reserves ratio, since bills can be sold to the central bank to obtain reserves if these are lacking). The bank liquidity ratio is thus the converse of the degree of liquidity pressure. • According to Godley, when the federal funds rate and hence the Treasury bills rate moves up, hence when the central bank is pursuing a non-accommodating policy, the bills to deposits ratio drops. • Simulations clearly show that the bank liquidity ratio is strongly reduced, and hence the degree of liquidity pressure moves up with a reduction in government expenditures.

17. The defensive role of the central bank This insight is obtained not through high theory but through his empirical work

18. There is no relationship between open market operations and bank reserves • “No matter what additional variables were included in the estimated equation, or how the equation was specified (e.g., first differences, growth rates, etc.), it proved impossible to obtain an R2 greater than zero when regressing the change in the commercial banking system’s nonborrowed reserves against the change in the Federal Reserve System’s holdings of government securities ....”(Eichner, 1985, pp. 100, 111).

19. A defensive and accommodating behaviour • “The Fed purchases or sales of government securities are intended primarily to offset the flows in and out of the domestic monetary-financial system and thereby hold bank reserves constant”. • “The Fed’s primary objective, in conducting its open market operations, is to ensure the liquidity of the banking system. This means that its open market operations necessarily consist, for the most part, of two elements: (1) defensive behavior, and (2) accommodating behavior” (Eichner 1987, 847).

20. Eichner’s views are consistent with current PK monetary economics • His description of the operations of the Fed is consistent with that of PKE Mosler (1996-97), Wray (1998), Bell, Fullwiler (2003, 2006). • It is also consistent with the descriptions of the operations of the Bank of Canada (Lavoie 2005) or that of the ECB (Bindseil 2004).

21. Eichner has a horizontalist viewpoint • “It is clear that the Fed is able to set the short-term interest rate at whatever level it wishes .... The Fed is fully able to determine the [federal funds rate] – along with the other short-term interest rate, the Treasury bill rate .... (Eichner 1987, p. 857) • This has been pointed out by Rochon (1999) and Carvalho and Oliveira (1992).

22. Flow of funds analysis

23. Copeland and the quadruple entry principle • And indeed in the recommended readings of Chapter 2, Eichner (1987, p. 108) does refer to the research of Copeland, the US creator of flow-of-funds analysis. It confirms that Eichner was indeed attempting to put together a synthesis of Cambridge Keynesian economics and Institutionalist economics. • Eichner (1987, pp. 810-838) devotes nearly 30 pages to flow of funds analysis in the chapter on money and credit of his main book, with more than a dozen tables reproducing flow of funds consequences of various decisions by economic agents. • The very first of these tables (Eichner 1987, p. 811) illustrates the quadruple accounting entry principle first put forth by Morris Copeland.

24. Eichner at the vanguard of stock-flow consistent analysis • Eichner “almost alone among economists – recognized that the flow-of-funds approach provides a much more useful analytical tool for explaining economic processes than the national income accounts”. Davidson (1992, p. 189) • Eichner (1987, 863) was favourably impressed by the work of Godley and Cripps (1983). He recommends the book to his readers, besides making use of it by drawing on some of its tables. • Eichner was in the vanguard of the post-Keynesian movement to bring back flow of funds analysis to the fore (Godley (1999); Lance Taylor (2004); Dos Santos (2006); Godley and Lavoie (2007

25. Conclusion • Alfred Eichner’s contribution to post-Keynesian or to heterodox economics extends way beyond his contribution to pricing theory and the behaviour of the megacorp; it also includes monetary theory. • The key monetary concepts highlighted by Eichner in the 1980s are key features of modern post-Keynesian monetary theory, while they were not necessarily so at the time of Eichner’s writings. • Hence Eichner’s monetary theory was ahead of its time.