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 Personal Development for Smart People Forums Economics: a discussion on The Federal Reserve

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Economics: a discussion on The Federal Reserve

Quote:
 Originally Posted by Gabo Is there a way, other than through the Fed, to increase the total money supply? If so, please explain that process to me. (If there is no way, then how can productivity or anything else lead to an increase in total money?)

Absolutely, although out of context of the previous discussion this might not seem satisfying.

In short, one definitive way to increase the money supply without channeling more currency through the Fed would be to suffer a deflation.

But, for the long analysis:
The Quantity Theory of Money (found adequately portrayed on wikipedia) describes a relatively simple relationship between the money supply and other variables:

M x V = P x Y

M = the aggregate value of the money supply, known as M0, M1, and M2 in the US.

V = velocity of money, the rate at which the amount of currency in circulation 'changes hands' over a period of time.

P = an index of the price level, generally calculated via the Laspeyres Index in the US, which documents the change (growth) of a basket of goods over the previous year, or a base year further back.

Y = the approximate GDP, expressed in real terms (e.g. using the timeline of P, the year in which the index is based off of). In the wiki, Y is denoted as Q.

Classical and other long-run theories explain that analysis of such should be long-run, and thus we can hold V and Y constant - and we ignore them, as (admittedly outdated) the assumption is that GDP is stable, not growing.

Thus, we are simply left with M = P.

This would mean that the price level changes exactly with increases in the money supply (e.g. the rate of inflation).

However, classical ideology is somewhat outdated, and not exactly used to represent the short-run fully anymore. We know empirically that V is most definitely not fixed; the advent of credit cards and other forms of electronic payments have drastic affects on the velocity of the circulating currency, as people may buy on plastic and pay much later with assets that are not counted in the money supply (e.g. they are less liquid assets).

If we were to reverse these assumptions to the short-run, we could reverse these assumptions though and say that empirically and statistically, M and P are stable (or at least increasing at exactly the same rate). Thus, ignoring those two variables, we now see:
V = Y
Which implies that the measure of how many times currency changes hands is equal to the measure of our GDP. Seems somewhat of a no-brainer?

This creates the idea that increases in Y, or GDP, (due to technological advances, increases in productivity, etc) MUST lead to an increase in velocity of money; however, empirically we see that V fluctuates much differently than Y does.

Thus, we must relax a bit and bring P back into the equation. Price levels are referred to as *sticky* in the short-run (Keynesian), in the sense that despite sudden shocks to elements in the economy, wages don't suffer a sudden fall, 'menu prices' or list prices for businesses do not change quickly, and the price level in general does not move as quickly to compensate. THIS point is valued because it is proven empirically.

So, to reconcile the differences, mainstream economics combine the two into what is called "neoclassical", and uses elements of Keynesian logic primarily to discuss the macroeconomic problems.

Thus, we could indeed say that the money supply can increase without the Federal Reserve funneling in currency.

Deflation decreases P, which means that in real terms, there is now more real money supply than before.

Alternatively, a good portion of US currency actually resides outside of the US... were someone to go and gather up some of that currency, then of course the money supply would increase - but this would be a form of inflation, akin to simply printing money.

And furthermore, it is extremely possible for people to sell their larger and less liquid assets and move that wealth down into more liquid forms of wealth, which may further move down into liquid forms that are counted in the money supply (such as trading an asset that is relatively difficult to liquidate for a stake in the money market (in banks)).
Even though there are no dollar bills or coins exchanged, wealth has been transferred into a more liquid form that the Federal Reserve and other institutions count in the money supply, and thus the money supply has endogenously increased itself.

Perhaps the best illustration would be simply using the banking system to make a deposit. You deposit \$10, the reserve ratio is 10%, and the bank loans out \$9. If we simply stop right there, they money supply has increased by \$9 just in that first step - not to mention the interest that accrues on the \$9 loan.
The person who received the loan goes out and uses it (or not) to create value in the economy, is given currency in return for the value he has created, and comes back to pay off the loan + interest.

If you were to only look at the long-run aspect of this, then the \$9 wouldn't count as an increase in the money supply. However, the interest would, and whatever additional earnings that the \$9 loan was able to create by the debtor would also count as an increase in the money supply.

But, going back to our previous discussion, the Fed's market operations are attempts to structure and control the fluctuating money supply so that the dollar maintains its general level of wealth when we have changes to any one of the variables to the quantity theory of money (P x Y = M x V). They increase and decrease the money supply in an attempt to keep the value of our fiat currency stable, among other beneficial reasons.

Quote:
 Originally Posted by Gabo When the Federal Reserve loans money to banks, does it not help ensure financial security in a situation where that bank's actions have reduced their financial security? If it does ensure security, then doesn't it by consequence encourage banks to disregard their own safe practices, since they know they will be saved in the event of a poor decision?
I'll get back to this later .

 09-18-2009, 11:05 PM #2 (permalink) Senior Member   Join Date: Aug 2007 Location: Los Angeles Posts: 490 I agree with what you say, Rabbit, but I suppose I should have been clearer about the terms I used. Economists use many terms like "inflation", "money supply", etc. that don't actually mean the literal definition. When I used the term "total money supply", what I meant by that was the total number of dollars available to the economy, not the amount held by US citizens, not the value of that amount of money. The only way to change the actual, real amount of dollars in existence is through Fed policy, primarily open market operations. Depositing money in the bank does not actually increase the supply, it simply allows someone to use somebody else's money. Also, by "inflation" I mean an increase in money supply, and by "deflation" I mean a decrease in money supply. This is the definition originally used for those terms. Commodity prices change because of inflation and deflation, but the change in commodity prices isn't itself a change in money supply. Modern economists like to mix money inflation with changes in commodity prices in order to hide the real mark of inflation: change in money supply.
 09-18-2009, 11:19 PM #3 (permalink) Banned   Join Date: Jul 2008 Posts: 84 I'm don't know how to fully respond to that; I will politely ask you to reconsider your words, and let you know that what you've said is incredibly insulting. The definitions of these words are defined by the science. However you, or anybody else, wants to think they are defined, you are certainly allowed to. But you are dead wrong in saying that the words used in economic discourse don't mean the correct idea they are meant to express. You wouldn't go to the doctor and argue with them about what the term 'surgery' really means - if they tell you it's surgery, they are expressing terminology from the science they have mastered to express an operation that is defined by how they define surgery. And yes, the physical amount of pieces of paper that count as US dollars and coins that are recognized as legitimate currency are funneled through the Federal Reserve. But you are again dead wrong in saying that money supply is simply the total count of all these pieces of paper and pieces of metal out there. The actual definitive term for the money supply implies a valuation based on real value (not nominal). This valuation fluctuates in respect to many, many variables, such as inflation and various exchange rates (when viewed in a particular context), etc. Last edited by Rabbit; 09-18-2009 at 11:25 PM.
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Quote:
 Originally Posted by Rabbit The actual definitive term for the money supply implies a valuation based on real value (not nominal). This valuation fluctuates in respect to many, many variables, such as inflation and various exchange rates (when viewed in a particular context), etc.
It is pointless to value an object that has no inherent value.
Valuing the dollar simply means valuing what could be purchased with that dollar.

I will argue with terms when they are defined in a misleading manner. Any normal person reading the words "money supply" will assume such a term refers to a supply of money not the value of that money. I don't mind when sciences define terms to be more accurate, but I disagree when they do so to be misleading.

Inflation was classically used by economists to mean an increase in prices brought on by an increase in the supply of money or a decrease in purchasing power. Some people have taken to using the term to mean any increase in prices, regardless of the source. Because of this, you have newscasters complaining about deflation when, for instance, electronics prices decrease. This does not make sense.

Quote:
 You wouldn't go to the doctor and argue with them about what the term 'surgery' really means - if they tell you it's surgery, they are expressing terminology from the science they have mastered to express an operation that is defined by how they define surgery
If a doctor gave me a checkup and called it a routine surgery, I most certainly would argue the point with him. Likewise, if he attempted to give me an open heart checkup, I would argue that such a procedure is much more intense than a normal visit.

 09-19-2009, 07:19 AM #5 (permalink) Banned   Join Date: Jul 2008 Posts: 84 I should have known posting in this subforum was a bad idea from the onset. Yes, well, good luck with all of the forthcoming adventures of "People who have an advanced education in specific subject matter vs. You".
 09-19-2009, 04:03 PM #6 (permalink) Family Member   Join Date: Aug 2008 Posts: 2,756 Economy is not an exact science. Lots of debate enrich the evolutionary process in the process of perfecting economy. This debate gives birth to many schools of economics, including some heterodox schools. For example, movement for Post-Autistic Economics (PAE). Debate is quite a normal thing in economics. Even in medicine debate takes place. For example, in the past CPR was used when people had a heart attack, but nowadays it also may be used when people have an obstructed respiratory system. I am sure that if Gabo has a question you may be able to clarify. And I am sure we might be able to acknowledge your authority on the matter after you have properly clarified concepts and answered questions. Here or there you will find people with enough questions, and I am confident you will show your expertise. If you were a doctor, it is very likely that if a patient knows enough about medicine, he might be questioning you. It does not take place very often because there is an asymmetry of information, where doctor acts like God and patient acts like an obedient person, a situation that is responsible of market failure in health economics, something I am sure you know very well. But certainly a patient has the right to ask or even to question the treatment he has been given. For example, when 9/11 rescuers did not receive proper medical attention, one of the rescuers had about 9 types of pills. After Michael Moore took them to Cuba, Cuban doctors took away the medicines that patient did not need. So yes, even between doctors there are disagreements.
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Quote:
 Originally Posted by ar81 Economy is not an exact science. Lots of debate enrich the evolutionary process in the process of perfecting economy. This debate gives birth to many schools of economics, including some heterodox schools. For example, movement for Post-Autistic Economics (PAE).
Spot-on; there are indeed many 'schools' of economics that exist. But none of these other schools of economics are taught in American universities - only mainstream economics. This is a collection of the best models and theories that have been proposed, tinkered with, and revised over the past 200 years, but mostly in the past 70.

And the reason is because they are models and theories that an analyst can qualify, via mathematics, like a real science should.

This 'Post-Autisitc Economics' is a great school of econ for those who are too clumsy to learn advanced calculus and statistics, and would rather sit around debating pure incentive theory. You cannot qualify something with words - mathematics is the language of science and truth.

That is the main reason why 'Mainstream Economics' is the preferred school taught in the US and around the world - and even why it is used by all of the Economic Analysts, Researchers, and other professionals who work for the US Government, private institutions, and educational systems.

Quote:
 Originally Posted by ar81 If you were a doctor, it is very likely that if a patient knows enough about medicine, he might be questioning you. It does not take place very often because there is an asymmetry of information, where doctor acts like God and patient acts like an obedient person, a situation that is responsible of market failure in health economics, something I am sure you know very well. But certainly a patient has the right to ask or even to question the treatment he has been given.
Yes, I do happen to know quite a bit about the economics of healthcare in the US. The various problems with the US healthcare system are not, in any way, related to people being ignorant and obedient to abusive doctors. It's more about ignorant people overconsuming health inputs and the system of insurance that (unfortunately) entices these people to consume more than optimal.
And that is an entirely other topic - one which I will not discuss here.

I've given my response to the question, and I took a good hour to make a clear and concise write-up, using information I've learned from the best researchers, writers, and professors in the world.

If you don't like it, then go do some of your own research, and don't take my word for it. But don't read these smarmy 'best seller!' books off the front shelf of your local Barnes&Noble and then come running back to post about how I'm so wrong. If your quest is to disprove the modern mainstream neoclassical economic school of thought, then you have got *quite* a bit of work to do. Like I said, 200 years of ideas, and 70 years of hard revision and confirming. Good luck.

A textbook written by Mankiw or Solow would be a good place to start.

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Quote:
 And the reason is because they are models and theories that an analyst can qualify, via mathematics, like a real science should. This 'Post-Autisitc Economics' is a great school of econ for those who are too clumsy to learn advanced calculus and statistics, and would rather sit around debating pure incentive theory. You cannot qualify something with words - mathematics is the language of science and truth.
Hi Rabbit the people that claim that their arcane equations are the only true economics, are generally for the most part not rich. They always claim "no one could have seen this coming", when plenty of people from other schools saw it coming and made money from it. There is over 1 quadrillion dollars worth of derivatives floating around when world GDP is only 54 trillion and for the most part the proponents of advanced calculus and statistics still do not acknowledge the true crisis, instead claiming green shoots. The fancy degrees from Harvard mean nothing to me if the person relies on tenure for their income, and not skill in the markets. I suppose their archaic equations are useful for proprietary blackbox trading, but for the most part is not useful for the rest of us mere mortals. We have become a nation of paper shufflers, and aren't producing anymore. It's extremely depressing for the next 1-2 centuries we are going to be dominated by China and the BRIC alliance thanks to the proponents of "mathematics as the language of science and truth".

Last edited by jimbos123456; 09-19-2009 at 10:16 PM.

 09-19-2009, 11:22 PM #9 (permalink) Banned   Join Date: Jul 2008 Posts: 84 Haha ok. Conversation over. Thank you all for your enlightening inputs. I'm going to post in the more respectable and sane forums now.
 09-20-2009, 12:06 AM #10 (permalink) Senior Member   Join Date: Aug 2007 Location: Los Angeles Posts: 490 I truly wish to learn more about this subject, Rabbit. I find it very sad that you refuse to partake in a discussion simply because someone else has a very different opinion than you. Either you aren't willing to share knowledge that would answer our questions (and disprove our theories), or you are afraid to accept that your views might not be 100% right. My guess, based on the way you directly presented other info you had to offer, is that you are afraid of questioning your own views. If I hold a belief, I welcome everyone to share their opinions with me about it. Only then can I improve upon or change that belief until it becomes the one aligned with truth. The only reason to shun others that question your beliefs is if you are attached to the beliefs you currently have, and afraid of changing them. I would recommend you continue discussing the subject on these forums, because only through challenging your beliefs can you make sure they are accurate.
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Quote:
 Haha ok. Conversation over. Thank you all for your enlightening inputs. I'm going to post in the more respectable and sane forums now.
The mainstream schools of thought always blatantly disrespected the other schools of thought, without allowing any academic freedom, and friendly debate. I suppose it is their karma to lose all of their savings, left destitute, and thoroughly discredited later on.

Yale and Harvard endowments lose billions
http://www.nytimes.com/2009/09/11/bu...11harvard.html

The people from the other schools of thought are up 398% from 2001 merely by having an understanding of the constitution, and are thriving in the current environment. Those are the people that only used the basic strategies from their schools of thought. I hope you can open your eyes some day.

farewell

Last edited by jimbos123456; 09-20-2009 at 12:57 AM.

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Quote:
 Originally Posted by Rabbit Yes, I do happen to know quite a bit about the economics of healthcare in the US. The various problems with the US healthcare system are not, in any way, related to people being ignorant and obedient to abusive doctors.
I mentioned that there was a problem of asymmetry of information. Part of the problem is doctors abusing people for money, seizing asymmetry of information. Evidence? Doctors are the ones who prescribe.
BBC NEWS | Business | Pfizer agrees record fraud fine

Quote:
 Acting US attorney for the District of Massachusetts Mike Loucks said: "The size and seriousness of this resolution, including the huge criminal fine, reflect the seriousness and scope of Pfizer's crimes." The civil settlement also relates to allegations that Pfizer paid bribes and offered lavish hospitality to healthcare providers to encourage them to prescribe four of the company's drugs.
And of course, there is the other part of the problem caused by asymmetry of information regarding pricing, because perfect information is not a valid assumption.

So you are partially right, and I am partially right.

Economics is the social science that studies the production, distribution, and consumption of goods and services.
The problem of studying economics from a merely numeric view is that economics is not an exact science, as there is a behavioral component. You seem very well trained in mathematics, but you seem to miss the human (social/behavioral) side. Your math is neat, and I do not question that. But the problem comes with the interpretation of numbers, which may cause a non statistical bias.

A joke that I use to illustrate the problem of interpretation of numbers is this.

Correlation does not imply causation. So global warming and piracy are not connected.

The advantage of questioning your own beliefs is that belief adds non statistical bias, as beliefs filter reality in such a way that the picture becomes incomplete and probably flawed because incompleteness. Belief is what caused Greenspan to screw up and make the mistake he apologized for. If someone beliefs that rain dance causes rain of money, it may not happen, because economics is about behavior of people, not an exact science.

Beliefs could make people to have a bias.
The satirical protest that illustrates the problem of beliefs that add bias is the Flying Spaghetti Monster
Flying Spaghetti Monster - Wikipedia, the free encyclopedia
or the creation of entities centered around a belief
Flat Earth Society - Wikipedia, the free encyclopedia
One of the problems of Flat earth society is that it denies evidence as they consider any source that opposes as "not reliable", and they focus on beliefs.

What we are questioning here is not the math itself, but the meaning behind that math, which usually lead to beliefs.

The good thing about questioning is that it helps to enrich the meaning, and I bet that at some point you may even question the beliefs of statu quo authors who could be telling us Earth is flat, in their own way. Newton was the rule, until Einstein demonstrated that Newtonian physics was just a particular case. We all used to believe matter was solid, liquid and gas, but questioning beliefs leads to see that plasma is the most abundant state in the universe. A scientist who attaches to beliefs will have a problem.

Last edited by ar81; 09-20-2009 at 01:30 AM.

 09-20-2009, 01:37 AM #13 (permalink) Banned   Join Date: Jul 2008 Posts: 84 AR81: every single statement you make is a claim against certain aspects of microeconomics only. There are many aspects about the entire science, and the vast majority of which do not rely on the social sciences. You claim that 'economics is not an exact science'. I suggest you learn exactly what all of mainstream economics entails before making such generalized statements. As I have stated repeatedly before: if you really want to learn about how economics really works, then in the very least go out and study a textbook. I can't teach you economics in a few posts. Neither can any author who writes 'best sellers' or any publisher for BBC. Good day, gentlemen. Last edited by Michelle; 09-20-2009 at 07:49 AM. Reason: off topic
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Quote:
 Originally Posted by jimbos123456 The mainstream schools of thought always blatantly disrespected the other schools of thought, without allowing any academic freedom, and friendly debate. I suppose it is their karma to lose all of their savings, left destitute, and thoroughly discredited later on. Yale and Harvard endowments lose billions http://www.nytimes.com/2009/09/11/bu...11harvard.html The people from the other schools of thought are up 398% from 2001 merely by having an understanding of the constitution, and are thriving in the current environment. Those are the people that only used the basic strategies from their schools of thought. I hope you can open your eyes some day. farewell
In astrology, positions of planets can be calculated accurately (an exact science?). The problem comes with the "reading" of data to transform data into an interpretation.

The astrological chart they used was accurate, but probably they had the wrong oracle.

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Quote:
 And furthermore, it is extremely possible for people to sell their larger and less liquid assets and move that wealth down into more liquid forms of wealth, which may further move down into liquid forms that are counted in the money supply (such as trading an asset that is relatively difficult to liquidate for a stake in the money market (in banks)).
Quote:
 The only way to change the actual, real amount of dollars in existence is through Fed policy, primarily open market operations. Depositing money in the bank does not actually increase the supply, it simply allows someone to use somebody else's money.
The amount of M1 increases when you deposit money at your bank and the bank than loans out the money.
If you want a mainstream explanation of how the process works Modern Money Mechanics - Wikisource is a good source.

The thing you see as money supply is M0 or what is commonly called monetary base.
Quote:
 AR81: every single statement you make is a claim against certain aspects of microeconomics only. There are many aspects about the entire science, and the vast majority of which do not rely on the social sciences. You claim that 'economics is not an exact science'.
Which economists do predictions about the real world and afterwards share both there failures and successes after the events happened?
Most economic models are simply based on trying to explain data after events happened either through frequetist or bayesian methods while using the assumption that you already know that the data is gauss distributed (which it isn't, see Taleb).

What good did economics do us?
Expect of course crashing our financial system.

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Quote:
 Originally Posted by Brutha The amount of M1 increases when you deposit money at your bank and the bank than loans out the money. If you want a mainstream explanation of how the process works Modern Money Mechanics - Wikisource is a good source.
I understand that process, but I think the attitude that deposited money and borrowed money can be considered distinct, different amounts with regard to the money supply is ludicrous.

When you deposit your money in the bank, you should understand that while you retain ownership of the money, you do NOT retain possession of it.
When you borrow money from someone, you should realize that while you have possession of that money, you do NOT own it.

Depositing and loaning is a process that splits ownership and possession of money between two parties, but it does not and can not actually create more money. Having the attitude that it can is dangerous, as that makes it appear as if we have more money than we realistically do.

Quote:
 Which economists do predictions about the real world and afterwards share both there failures and successes after the events happened?
I think Peter Schiff is always very honest about the results of his predictions, but the vast majority of the time that is because his predictions are correct. While all the Keynesians were praising our economic prowess in 2005 and 2006, Schiff (who is of the Austrian school) was predicting the economic collapse of 2008.

 09-20-2009, 10:12 PM #17 (permalink) Banned   Join Date: Jul 2008 Posts: 84 I should point out that, like I've stated before, the whole picture is much more complex than what it seems from your viewpoint. There is a factor, or a 'function' (relatively), that is the counterpoint of money supply: money demand. It is a function of the aggregate demand to hold wealth in the form of liquid currency and relatively liquid assets (e.g. M1, which includes checking and savings accounts, etc). Real money supply is equilibrated in respect to the money demand function. And, given the various inputs to the model of money demand, it fluctuates often. This is how the actual money supply can change endogenously without the Fed physically adding or removing dollar bills and coins. And sorry, but that is indeed how the money supply works. Given the reserve ratio, the original money supply is multiplied by the inverse of the reserve ratio (called the 'money multiplier') given the existence of banks and loans. And again, there are two ways at which to look at loaned money and the money supply: both the short and long runs. Nonetheless, it might sound odd to you, but that is indeed how the monetary system works with a fiat currency. And that's not a bad thing at all - I believe you are misinterpreting it somewhere along the lines. I don't think people adopt some sort of 'ha-ha, I got a loan, now this money is mine!' mentality when borrowing.
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Quote:
 This is a collection of the best models and theories that have been proposed, tinkered with, and revised over the past 200 years, but mostly in the past 70.
That a good description of what they did the last 200 years and the most telling thing is that it doesn't include the thing science is about.
It doesn't include testing ideas in the real world.
Quote:
 I think Peter Schiff is always very honest about the results of his predictions, but the vast majority of the time that is because his predictions are correct. While all the Keynesians were praising our economic prowess in 2005 and 2006, Schiff (who is of the Austrian school) was predicting the economic collapse of 2008.
Peter Schiff isn't a economist in Rabbit's sense of the word. He doesn't hold a degree in economics.
He hasn't published anything in an economics journal.
Quote:
 Depositing and loaning is a process that splits ownership and possession of money between two parties, but it does not and can not actually create more money.
Because of laws passed by congress banks can create money in that process.
If I give loan you 10\$ that doesn't allow you to create money.
If I loan a bank 10\$ that allows the bank to create money. You might not like the law that allows commercial banks to create money, but they still do create money because they are allowed to do so.

We could question whether having such a law is a good or bad idea, but that's a different debate.

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Quote:
 Originally Posted by Brutha That a good description of what they did the last 200 years and the most telling thing is that it doesn't include the thing science is about. It doesn't include testing ideas in the real world.
When people claimed they had invented cold fusion, there was the problem of not being able to repeat the process elsewhere.
Not only testing is needed.
If you are to prove something, not only testing is required, you are required to be able to reproduce it.

For example, you may say that IQ tests measure intelligence. But if you solve the same IQ test 1000 times, at the very end you will get a higher IQ grade, not because you are smarter, but because it trained you, so you gained speed. So using an IQ test to demonstrate intelligence may not be reliable as scientific evidence, because the problem of repeatability.

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Quote:
 Originally Posted by Rabbit And again, there are two ways at which to look at loaned money and the money supply: both the short and long runs. Nonetheless, it might sound odd to you, but that is indeed how the monetary system works with a fiat currency. And that's not a bad thing at all - I believe you are misinterpreting it somewhere along the lines. I don't think people adopt some sort of 'ha-ha, I got a loan, now this money is mine!' mentality when borrowing.
There is a problem, because people who loan their money out to others expect to be able to withdraw it all at any time, and people who borrow money from others expect to be able to keep if when they are unable to pay it back.

I don't disagree with your definitions, and I think that measuring things like M1 etc. can be useful. What I would argue is that more effort should be taken to recognize deposits and loans for what they are, rather than pretend as if they allow multiple parties to have and utilize the same sum of money.

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