Deficit Owls | A Capital Markets Argument For Endogenous Money @deficitowls5296 | Uploaded January 2017 | Updated October 2024, 1 hour ago.
Professor Perry Mehrling outlining an argument by Fischer Black on why the money supply must be endogenous.
Fischer Black made the argument that the money supply (by which we mean the liabilities of commercial banks) must grow or shrink along with prices in the asset markets for securities if individuals are to be able to keep their portfolios balanced at the risk levels they desire. Let's see how it works.
Suppose there are two people, Risky and Safe, and each have $100 worth of wealth. Risky likes to take risks, and is actually going to borrow money to invest *more* than this amount into a market portfolio of assets. He borrows $50, and uses this plus his pre-existing wealth to buy $150 worth of the market portfolio. His wealth is therefore allocated 150% to the market portfolio, 0% to a bank account.
Safe isn't as comfortable taking risks, and chooses to allocate his wealth differently. He puts $50 in the market portfolio and holds the other $50 in his bank account, so that his wealth is allocated 50% to the market portfolio and 50% to the bank.
Now let's suppose that, for whatever reason, the price of the market assets goes up 10% (maybe somebody elsewhere decided to allocate wealth from the bank to the market portfolio, pushing up the price). This results in wealth gains for both Risky and Safe: the value of Risky's market investment has gone from $150 to $165, and the value of Safe's has gone from $50 to $55.
However, this has also altered the allocations of both Risky and Safe's portfolio. Safe previously had $100 net worth allocated to $50 risky asset, for a 50% allocation. Now he has $105 net worth allocated to a $55 asset, or a 52.4%. He portfolio is now too risky, and he'd like to sell some of the risky assets off to bring it back to the 50% allocation. Meanwhile, Risky previously had $100 net worth (+ $50 loan) allocated to $150 risky asset, for a 150% allocation. Now he has $115 net worth (+ $50 loan) allocated to $165 asset, or a 143.5% allocation. His portfolio is now not risky enough, and he'd like to buy more risky assets to bring it back to the 150% allocation.
Risky needs to take out a bigger loan and use it to buy assets. Safe would like to sell assets and obtain deposits for them. This will only be possible if banks can expand the money supply to accommodate this. The bank makes a loan and creates deposits and gives them to Risky. Risky will use these to buy the some of the market portfolio from Safe, who will end up holding the deposits. Both portfolios will have rebalanced and the money supply (the stock of bank deposits) will have increased.
For more info on how loans create deposits, see here: youtube.com/watch?v=G7-j3kDvB04&t=3s
Watch the whole lecture here: coursera.org/learn/money-banking/lecture/Tyk7H/finance-view-risk
Take the whole course here: coursera.org/learn/money-banking/home/welcome
Follow Deficit Owls on Facebook and Twitter:
facebook.com/DeficitOwls
twitter.com/DeficitOwls
Professor Perry Mehrling outlining an argument by Fischer Black on why the money supply must be endogenous.
Fischer Black made the argument that the money supply (by which we mean the liabilities of commercial banks) must grow or shrink along with prices in the asset markets for securities if individuals are to be able to keep their portfolios balanced at the risk levels they desire. Let's see how it works.
Suppose there are two people, Risky and Safe, and each have $100 worth of wealth. Risky likes to take risks, and is actually going to borrow money to invest *more* than this amount into a market portfolio of assets. He borrows $50, and uses this plus his pre-existing wealth to buy $150 worth of the market portfolio. His wealth is therefore allocated 150% to the market portfolio, 0% to a bank account.
Safe isn't as comfortable taking risks, and chooses to allocate his wealth differently. He puts $50 in the market portfolio and holds the other $50 in his bank account, so that his wealth is allocated 50% to the market portfolio and 50% to the bank.
Now let's suppose that, for whatever reason, the price of the market assets goes up 10% (maybe somebody elsewhere decided to allocate wealth from the bank to the market portfolio, pushing up the price). This results in wealth gains for both Risky and Safe: the value of Risky's market investment has gone from $150 to $165, and the value of Safe's has gone from $50 to $55.
However, this has also altered the allocations of both Risky and Safe's portfolio. Safe previously had $100 net worth allocated to $50 risky asset, for a 50% allocation. Now he has $105 net worth allocated to a $55 asset, or a 52.4%. He portfolio is now too risky, and he'd like to sell some of the risky assets off to bring it back to the 50% allocation. Meanwhile, Risky previously had $100 net worth (+ $50 loan) allocated to $150 risky asset, for a 150% allocation. Now he has $115 net worth (+ $50 loan) allocated to $165 asset, or a 143.5% allocation. His portfolio is now not risky enough, and he'd like to buy more risky assets to bring it back to the 150% allocation.
Risky needs to take out a bigger loan and use it to buy assets. Safe would like to sell assets and obtain deposits for them. This will only be possible if banks can expand the money supply to accommodate this. The bank makes a loan and creates deposits and gives them to Risky. Risky will use these to buy the some of the market portfolio from Safe, who will end up holding the deposits. Both portfolios will have rebalanced and the money supply (the stock of bank deposits) will have increased.
For more info on how loans create deposits, see here: youtube.com/watch?v=G7-j3kDvB04&t=3s
Watch the whole lecture here: coursera.org/learn/money-banking/lecture/Tyk7H/finance-view-risk
Take the whole course here: coursera.org/learn/money-banking/home/welcome
Follow Deficit Owls on Facebook and Twitter:
facebook.com/DeficitOwls
twitter.com/DeficitOwls
