Jamie Galbraith: How Jason Furman and Lawrence Summers Reinforce a Destructive, Debunked Mainstream Paradigm to Support Deficit Spending

Naked Capitalism has the post Jamie Galbraith: How Jason Furman and Lawrence Summers Reinforce a Destructive, Debunked Mainstream Paradigm to Support Deficit Spending.

Here is an excerpt from Yves Smith’s introduction to the article.

The fact that the Washington Post depicted an article by Jason Furman and Larry Summers pumping for deficit spending as evidence of an “intellectual revolution” shows how bad a grasp most commentators have on economics. As the post by Jamie Galbraith describes long form, the Furman/Summers argument was incoherent and relied on the “loanable funds theory” (loans come from existing savings and are therefore limited; interest rates serve to balance supply and demand) that was debunked by Keynes nearly 100 years ago.

Here is an excerpt from the Galbraith article itself.

FS therefore arrive at a correct conclusion – interest rates will remain low indefinitely – by a route that requires them to argue that the world has changed in some fundamental, relevant (“structural”) way, for which no evidence exists. The effect is to leave in place an incoherent theory of interest rates, which does not even claim to explain the phenomenon – low long-term rates – that their paper is trying to address. But a correct and viable explanation, as above, of a form long-ago explained carefully by no less than John Maynard Keynes, is readily available and wholly sufficient.

Some times it amazes me how the people who claim to be experts can get things so wrong. In this case it is Larry Summers who continues to be wrong year after year. It is nice to see James Galbraith confirm my thinking that John Maynard Keynes is still correct about some very fundamental economics.

This discussion of the “loanable funds theory” gives me an opportunity to state my explanation of what is wrong with the “loanable funds theory”. In my own quirky way, I explain that private banks do not create money when they make a loan. They create a promise of money to the borrower. As long as the promise of money circulates among customers of the bank, the promise never needs to be fulfilled with actual USA money. If the promised money is given to someone outside the private bank’s customer base, then and only then does the promise of money need to be fulfilled. The bank has many ways to fulfill that promise that I won’t describe here.

The larger the bank is, the smaller the fraction of its promises of money will ever leave its own customer base. Also the money going out is mostly offset by money flowing in from other banks’ customers giving money to the original bank’s customer for deposit in the original bank. Very little of all the private banks’ promises of money ever have to be realized in actual Federal Reserve Bank USA money. Some of that realization will come from “loanable funds”, but not even all of it.

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