James Tobin: Are Banks Special?

     What's interesting is that Tobin's 1963 paper Commercial Banks as Creators of Money was cited as showing that he knew that loans created deposits-ie, they don't depend on bank reserves. However, Krugman argued that to the contrary Tobin makes his point. 

      "Thank you, Matthew Klein! In the course of critiquing Robert Hall’s paper for Jackson Hole, he mentions and links to another half-century-old paper by James Tobin, Commercial Banks as Creators of “Money” (pdf), that I had forgotten about, and is even more precisely on point than the Tobin-Brainard piece I’ve been citing."

       "All the points I’ve been trying to make about the non-specialness of banks are there. In particular, the discussion on pp. 412-413 of why the mechanics of lending don’t matter — yes, commercial banks, unlike other financial intermediaries, can make a loan simply by crediting the borrower with new deposits, but there’s no guarantee that the funds stay there — refutes, in one fell swoop, a lot of the nonsense one hears about how said mechanics of bank lending change everything about the role banks play in the economy."

       "Banks are just another kind of financial intermediary, and the size of the banking sector — and hence the quantity of outside money — is determined by the same kinds of considerations that determine the size of, say, the mutual fund industry."

     http://krugman.blogs.nytimes.com/2013/08/24/commercial-banks-as-creators-of-money/?_r=2

     So Tobin seems to be a kind of Zero Hour of the debate over banking as he gets that loans create deposits yet still in the end held to the idea that banks are not special but are just 'financial intermediaries.'

     Interfluidity sums up the debate well:

     "There has been a recrudescence of blogospheric argument on the nature of commercial banks, whether they are best considered “financial intermediaries” not unlike mutual funds or insurance companies, or whether they are something different, in particular, whether their ability to issue liabilities that are near-perfect substitutes for base money renders them special in macroeconomically important ways. See e.g. Cullen Roche, Winterspeak, Ramanan, and Paul Krugman."

    "If banks are mere intermediaries between savers and borrowers, it may be reasonable to abstract them out of macroeconomic models and simply focus on the preferences of borrowers and savers and the price mechanism (interest rates) that ultimately reconcile those preferences, perhaps with “frictions”. If banks are special, if they have institutional characteristics that affect the macroeconomy in ways not captured by the stylized preferences of borrowers and savers, then it may be important to model the dynamics of the banking system explicitly."

     Interfludity argues that the Krugman-Tobin view is not-as some endogenous money proponents might think incoherent. 

     "I want to unpack this just a bit. First, please don’t misunderstand the argument. Tobin’s, and by extension Krugman’s, point is not the facile argument sometimes made, that loans don’t meaningfully create deposits because a bank needs to fund the loan when the deposit created by a loan is spent or transferred. That is true of an individual bank, but not of the banking system as a whole, the object to which Tobin correctly devotes his attention. It is an entirely uncontroversial fact that when the banking system net-increases its lending it creates new deposits, regardless of whether an individual lender’s balance sheet expands permanently or ephemerally."

      "Tobin’s argument was that this mechanical capacity of the banking system to “create new money” by net-lending ultimately doesn’t matter very much, because the non-bank private sector has a preferred portfolio of assets, of which bank deposits are a single component, and the net-lending of the banking system is constrained and ultimately determined by the non-bank sector’s desires. If the banking system somehow ramped up its lending in ways that create more bank deposits than the non-bank sector wished to hold, the nonbank sector would pay down bank loans until its preferred portfolio was restored. This is a perfectly coherent view, a view fully cognizant of the mechanics of bank lending and deposit creation, under which there is nothing fundamentally important about banks. Everything that matters is captured by the portfolio preference of nonbanks, so a macro modeler might reasonably ignore the details of the banking system and simply model the portfolio choice of the nonbank sector."

     Still, Interfludity makes the crucial point that because an argument is not incoherent doesn't make it accurate. 

     "However, that a view is coherent doesn’t mean that it is accurate. The weakness of the Tobin/Krugman view is that common Achilles Heel of macroeconomic models, aggregation. In order for banks not to matter, it must be reasonable to model the nonbank private sector as if it were a unified actor with preferences independent of the behavior of the banking system. It’s easy to offer plausible accounts under which this would not be the case."

      Ramanan has a good piece on the banking issue too, though it's not entirely easy to see which side he falls on. He kind of dismisses Krugman, but he does think that something very important came out of Tobin's paper.

      "The blogger Winterspeak – well aware of some of Tobin’s work such as his paper Commercial Banks As Creators Of “Money” from  1963 has written as post A Bank is not a Financial Intermediary and concludes that

… This then is the conceptual fallacy at the heart of academic macro and what it thinks about banks, and it goes at least all the way back to 1963.

     "Winterspeak is stuck on a quote from Tobin-Brainard paper (1963) which says:

…the essential function of financial intermediaries, including commercial banks, is to satisfy simultaneously the portfolio preferences of two types of individuals or firms. On one side are borrowers, who wish to expand their holdings of real assets… On the other side are lenders who wish to hold part or all of their net worth in assets of stable money value with negligible risk of default.

     "This is also repeated in Tobin’s Commercial Banks As Creators Of “Money” which obviously states explicitly that loans create deposits and that the money mutliplier view is highly inaccurate:

According to the ‘new view’, the essential function of financial intermediaries, including commercial banks, is to satisfy simultaneously the portfolio preferences of two types of individuals or firms. On one side are borrowers, who wish to expand their holdings of real assets – inventories, residential real estate, productive plant and equipment, etc. – beyond the limits of their own net worth. On the other side are lenders, who wish to hold part or all of their net worth in assets of stable money value with negligible risk of default. The assets of financial intermediaries are obligations of the borrowers – promissory notes, bonds, mortgages. The liability of financial intermediaries are the assets of the lenders – bank deposits, insurance policies, pension rights.

    "Winterspeak is adamant about the usage of the phrase “intermediary” and that since banks create deposits out of thin air, they shouldn’t really be called intermediary and that Tobin’s views are equivalent to the loanable funds view. For the first part – maybe but Winterspeak seems to crucially miss out the mediating role played by banks in the portfolio allocation decisions of wealth owners such as households. See my comments in that blog."

    "First it is crystal clear that Tobin knows loans create deposits. Second, he presents a “new view” in which the distinction between “money” and “bonds” is blurred and this led him subsequently to his asset allocation theory. It is true that Tobin’s model was far from complete and this was improved substantially by Wynne Godley, but nevertheless Tobin’s insights were wonderful and the work of a genius."

   "Perhaps I would have worded what Tobin wrote differently if I were to teach this but this is just a matter of emphasis."

      "It is true that PKE authors and bloggers do have a much better understanding of monetary matters than mainstream economists but in trying to emphasise this point, sometimes they miss out on important matters. There is no need to say (as Winterspeak says “Tobin … sees … [banks as] something which brings efficiency and eases friction between the actual lender and borrower.”) especially when Winterspeak doesn’t seem to understand the mediating role of banks in the portfolio allocation decisions of financial asset owners which really has less to do with any “friction”. Perhaps the word intermediary is not the best but it is a minor point. In fact the ideas of the 1960s and later are missed by younger ones."

     Here is what Cullen Roche has to say about Tobin 1963:

     "The Tobin paper itself refutes (in at least one part) the false causality of the textbook money multiplier, which is good to see for a paper written in 1963. So Krugman can’t be refuting anything so far, using Tobin."

    "Second, consider the claim that banking is unique. I can think of perhaps one blogosphere case where this issue has been tightly bound with “loans create deposits”, and that case is largely a matter of presentation style. But consider the aspect of banking uniqueness more generally. There is definitely a role for banking that is unique in finance and economics. A good description of it permeates the book Monetary Economics by Wynne Godley and Marc Lavoie. This has to do with the critical role of revolving bank loans used in the financing of business inventories. Indeed, this aspect is expressed in a formal way through the interpretation and adaptation of circuit theory within a post Keynesian context. This aspect is essential to understanding the critical role of banks in economic expansion. It is true in advanced G&L models, and it is true in the real world. In general, workers must be paid before they can buy the output of the economy. The rudiments of circuit theory help explain how that happens through bank lending and deposit creation. Economic expansion requires banks. Krugman/Tobin doesn’t touch on this essential process. If it did, it would negate its own conclusion."

     "Now, consider how Krugman/Tobin attempts to refute the importance of these aspects of banking – whether conflated or separate."

    "The main point made by Krugman in his post and in the Tobin paper to which he refers is a strangely benign one. The general point made in the Tobin paper is that banking expands in the same way that other financial intermediaries do – according to economic opportunities. But who is denying this in claiming the importance of either aspect of banking above? It is surely an obvious point to those who have unpacked the two ideas that Krugman considers jointly. Somehow, the grand conclusion of Krugman/Tobin seems to be that banks must price their loans and deposits in such a way that banking can be an economically viable enterprise, in the same way that other institutions price their assets and liabilities toward the same objective. Again, who would think otherwise, in that general sense?"

    "Krugman/Tobin seems to imply that those who observe “loans create deposits” are sufficiently short sighted to think that this point having been made is also the end of the process. In other words, that these loans and deposits once they’ve been created should remain on bank balance sheets forever. Who would think such a thing? It is interesting that the perception of the intellectual damage done by “loans create deposits” itself doesn’t consider the possibility that the reverse mechanics are equally obvious to those who make the initial point – i.e. that deposits are regularly used to pay down the loans that originally created them, and that in this specific context it is also true that deposits may be used to “destroy” loans. It is interesting if not amusing that those who don’t directly acknowledge what goes on in bookkeeping terms when a prospective borrower goes into a bank branch and successfully negotiates a bank loan then proceed to double up by looking away from what goes on when the same person returns to repay his loan. The idea that deposits are used to pay down loans is not only common place in real world banking, but it is also fundamental to formal circuit theory and its application within post Keynesian economics. What Tobin would not have been in a position to be aware of 50 years ago is that is that the focus of modern post Keynesianism makes this dynamic crystal clear in a rigorous accounting sense – an accounting presentation that covers a galaxy of institutional possibilities with flow of funds analyses that extend Tobin’s succinct summary of same in much more detail. However, in the hubbub of considering this overall financial flow of funds, we are led to believe by Krugman/Tobin that those who understand that loans create deposits don’t understand that deposits can destroy loans in the process of loan repayment."

      http://monetaryrealism.com/krugman-and-tobin-on-banking/

      While I know this is a utilitarian argument if we say that banks aren't special we're stuck with long run monetary neutrality and other Neoclassical dead ends which I think we want to go beyond-admittedly I'm arguing from means and ends here, that's what a utilitarian argument is. The banking system certainly seems special or unique in the sense that without it the economy can't fund it's investment. This certainly makes it different from just another market for goods and services. Indeed, as long as we believe that banks aren't any different we are free to come up with all these models based on barter which it seems to me clear we need to transcend.