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| Elijah and the Widow of Zarephath |
The phrase widow's cruse is defined as "an inexhaustible supply of something," which in turn is a reference to an obscure Bible story. Flip to I Kings 17:7–16 and there is a short passage in which the prophet Elijah asks a destitute widow to make him a loaf of bread. The Lord blesses the widow saying that the "jar of flour will not be used up and the jug of oil will not run dry until the day the Lord sends rain on the land."
What Tobin was referring to in his paper is that unlike the widow and her jug of oil, commercial banks aren't blessed with the ability to expand their liabilities indefinitely. When it comes to bank deposits, there is an "economic mechanism of extinction as well as creation, contraction as well as expansion."
Modern central bank's, on the other hand, do have such a cruse. Once central bank liabilities are created, there is no way for the economy to get rid of the excess. The hot potato analogy "truly applies", noted Tobin, because central bank money cannot be extinguished.
We know that the actions of any institution in possession of a widow's cruse will have major macroeconomic effects. With its cruse, a central bank can create excess media of exchange which, as it is passes from hand to hand, pushes up nominal income. An increase in quantities and/or prices is the only release valve for unwanted exchange media. A commercial bank, which has no cruse, might create an excess of deposits but this will not have any lasting influence on nominal income. After all, if the public doesn't desire new deposits, this excess will either quickly reflux back to the issuer, or it will displace competing deposits created by another bank and these deposits will reflux. To keep its deposits suspended in the economy will require a commitment of resources (say a superior interest rate). But resources are finite, unlike the widow's cruse.
Central banks didn't always have cruse. As David Glasner reminds us, when a central bank's liabilities, say those of the Bank of England, were convertible into gold, the Bank couldn't issue in excess of the public's desire for central bank notes. Unwanted notes would quickly return back to the Bank, inhibiting the Bank from having any macroeconomically important effects. The Bank of England, much like a modern commercial bank, could affect neither prices nor quantities via excess note issuance.
So what are the sufficient conditions for having a cruse? Consider that there are all sorts of financial instruments that can be expanded indefinitely. A company can continue issuing corporate stock, for instance, as long as it wants. To crib from Tobin, any expansion of corporate assets will generate a corresponding expansion of corporate liabilities, or in this case, equity. The mechanism for the creation of stock does not have an equivalent mechanism for the extinction and contraction of said stock. Without an instant-convertibility clause, stock is a perpetual instrument, much like modern central bank money. [For more along this line, see Money: is it immortal or does it die young?].
Despite its perpetual nature, I don't think that a stock-issuing company is blessed with a widow's cruse. An exogenous increase in the quantity of an individual company's stock will only affect relative asset prices; it won't change an economy's nominal income. To paraphrase Tobin, the burden of adaptation to an increase in the quantity of a corporate stock is not placed on the entire economy. This is because prices in an economy are not denominated in units of a given corporate stock, but in dollars, pounds, or whatever. Central bank money, on the other hand, is the economy's unit of account. The entire economy is burdened by the necessity of adapting to an increase in its supply.
So what does it take to have a widow's cruse? Two things. The liabilities of the issuer must be perpetual and non-convertible upon demand. Secondly, shops and markets must use those liabilities as a unit of account. Only when these two conditions will a widow's cruse have emerged. Commercial banks pass the latter but fail the former. Stock-issuing non-financial corporations pass the former but fail the latter. Only modern central bank money is both.
The oil and flour coming out of the jar are nobody's liability, but paper/deposit dollars coming out of a private or central bank are the issuer's liability. More flour will make the price of flour drop, but as paper/credit dollars are issued, the issuer gets assets of equal value, and the dollars will hold their value whether they reflux to their issuer or not.
ReplyDeleteAh, but the convenience yield provided by a financial asset is not the issuer's liability. Just like more flour causes flour prices to drop, more convenience-providing units causes the convenience yield to drop.
DeleteOh thanks!
DeleteHi, Mike! Is it not the case that as paper/credit dollars are issued, the issuer indeed gets assets of equal value, and the dollars will hold their value, but against *those backing assets*; that doesn't mean that the dollars have to hold their value against other products on markets, does it? (And I would think that one need not necessarily subscribe to the full Quantity Theory for the latter to occur.)
ReplyDelete- George Machen
Good to hear from you George!
DeleteCorrect. If we started in a world where silver was widely used as money, and if banks started issuing paper/credit dollars that were denominated in oz. of silver, then the monetary demand for silver would fall, silver would lose value, and the dollars that were denominated in those oz. would also fall.
But once people stop carrying physical silver as money, then silver will be reduced to its 'use value'. At this point, further issuance of paper/credit dollars (for assets of equal value) will not reduce the demand for silver any further, so silver will hold its value as more paper/credit dollars are issued.
I had a post on this here:
ReplyDeletehttp://www.concertedaction.com/2013/08/26/james-tobin-banking-widows-cruse/
Duly noted.
DeleteJP: Good post. But I disagree with one thing:
ReplyDelete"Central banks didn't always have cruse. As David Glasner reminds us, when a central bank's liabilities, say those of the Bank of England, were convertible into gold, the Bank couldn't issue in excess of the public's desire for central bank notes. Unwanted notes would quickly return back to the Bank, inhibiting the Bank from having any macroeconomically important effects."
If the central bank's liabilities are convertible on demand into apples, all that means is that there cannot be an excess demand or excess supply of apples. If the central bank's liabilities are convertible on demand into gold, all that means is that there cannot be an excess demand or excess supply of gold. In neither case it doesn't mean there cannot be an excess demand or excess supply of money. "The market for money" is the market for every single other good. By setting the wrong price for apples, the central bank can create an excess supply or demand for money and an excess demand or supply for all other goods. By setting the wrong price for gold, the central bank can create an excess supply or demand for money and an excess demand or supply for all other goods.
In this case, monetary policy *is* setting the price of apples (or gold), and that *does* have macroeconomically important effects.
"In this case, monetary policy *is* setting the price of apples (or gold), and that *does* have macroeconomically important effects."
DeleteI agree that the old Bank of England could change monetary policy by increasing or decreasing the price at which it redeemed gold. Redeem for fewer ounces, and everyone will want to quickly rid themselves of notes in favor of goods. But as long as it kept its redemption policy fixed, I think that any excess amount of notes would quickly return to the Bank and have no important effects.
"Redeem for fewer ounces, and everyone will want to quickly rid themselves of notes in favor of goods"
DeleteWhy exactly? Say 1 note = 1 ounce, then the bank reduces it to 1 note = 0.5 ounce. My money is now worth less is terms of gold. Why do I suddenly want to go and spend more of my money on goods than before?
James, the moment the reduction is announced you'll want to go out and spend your notes before their value falls. You might be able to sell them to someone for 1 oz instead of 0.5oz because that person doesn't know about the announcement yet. Or you may try and sell it for 1oz of other goods because prices are sticky. When people are not 100% irrational and prices are sticky, the adjustment will happen over a period of time. If not, it'll happen immediately. The 1933 adjustment took a few months to occur.
Delete"100% irrational" or "100% rational?"
DeleteIf not, how does that logic work? Let's turn it around:
When people are either 100% irrational or prices are not sticky, the adjustment will happen immediately.
So people being 100% irrational is a sufficient condition to make prices adjust immediately?
Whoops. 100% rational.
DeleteJP, Sorry to nitpick, but your lovely illustration has the wrong prophet and the wrong widow. The prophet who performed the miracle with the widow's cruse of oil was not Elijah, but his disciple Elisha. See II Kings 4:1-7.
ReplyDeleteDavid, could it be that there are two Bible verses involving widow's cruses? 1 Kings 17:7-16 mentions a widow and a jug that is perpetually full, and as you point out, II Kings 4:1-7 does too. The first involves Elijah and the second Elisha. I'm not sure which verse the painting is alluding to.
DeleteDon't worry JP. There are a lot of economists out there (I won't mention any names.) who thought that "widow's cruse" was just a typo for "widow's curse".
DeleteThat stock comparison is a very interesting one.
ReplyDeleteThe way I see it, Tobin’s mechanism in the case of banks relative to other financial intermediaries simply means that banks cannot monopolize the production of liabilities. Otherwise, the entire financial system would be taken over by banks, and because loans create deposits, the cruse would be fully operative. I’m not sure it’s absolutely necessary that an existing stock of deposits “flee” the bank and because of that specifically cause bank balance sheet contraction in favor of NBFI balance sheet expansion. It just requires that the trajectory of bank balance sheet expansion slow relative to the counterfactual. In that sense, I’m not sure it requires that the liabilities of the bank even be redeemable – although in this case they are, because they happen to be the medium of exchange, which is what Tobin in fact was deemphasizing.
It seems to me that a parallel argument holds in the case of stock. Stock is obviously not redeemable at the option of the holder. But it doesn’t have to be, in order for the same non-monopoly feature to take hold and prevent a pure cruse effect. The corporation will stop issuing stock because it will stop expanding its assets – because the ROE hurdle rate won’t be available – because there is competition. I think that’s similar to the Tobin argument in the case of banks.
Make any sense?
Hi JKH, what is the definition of widow's cruse that you're using? We may be using different ones.
DeleteI'm borrowing from Tobin when I say that a modern central bank enjoys a widow's cruse because if "the economy and the supply of money are out of adjustment, it is the economy that must do the adjusting." By corollary, I think it's fair to say that an institution does not enjoy a cruse if the economy does not have to adjust to an excess supply of that institution's issued liabilities.
"Otherwise, the entire financial system would be taken over by banks, and because loans create deposits, the cruse would be fully operative."
Even a monopoly bank or group of banks don't have a widow's cruse, so long as they maintain convertibility into some underlying medium like base money or gold. The ability to settle these liabilities by "putting" them back to the issuer when they are no longer desired (rather than spending them) means that the economy (ie all prices and quantities) is never required to take on the burden of adjusting to an overflow of deposits.
On the other hand, say that bank note/deposit convertibility is for some reason or other removed. Without the escape route of convertibility into underlying settlement media, any excess issuance of bank deposits can only be rectified by the economy doing all the adjusting, either though higher prices and/or quantities. That this is the case even if banks are competitive reiterates the point that monopoly is not a necessary condition for having a widow's cruse.
As for stock, if one firm monopolizes the entire economy, and it issues excess stock/equity, a lower stock price will be the result. But as long as the economy doesn't use that stock as a unit of account, then the economy as a whole doesn't need to adjust -- the stock price takes on the entire burden of adjustment
So that's why I put importance on both unit of account + convertibility in defining whether an institution has a cruse or not, and not monopoly/competition. But that could be due to my particular definition of widow's cruse -- I'm open to alternative definitions.
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ReplyDeleteI was motivated to investigate the data base of the Federal Reserve. How, I wondered, does the widow's cruse relate to what we might call "money supply"?
ReplyDeleteMost MMT'ers would agree that the annual deficit of the Federal Government adds to money supply. This can be plotted from the difference between FGEXPND and FGRECPT.
I did not find tracking the loans to be so easy. Most mortgage loans (which are the long term loans granted by banks) are moved away from banks into the hands of government via the Government Sponsored Agency route. I decided to use the data series AGSEMPTCMDODFS, using the annual change to make the data comparable to Federal Receipts.
Shorter term loans are carried by the banks and seemed to be captured by the data series LOANS. Again, I used the annual change to make the data comparable to Federal Receipts.
The money supply change from banks would be the sum of series AGSEMPTCMDODFS plus LOANS, using the annual change.
A two trace graph, showing bank generated and deficit generated annual money supply change can be found at
http://research.stlouisfed.org/fred2/graph/?g=lVI.
From the graph, I looks to me like, with the help of government, banks have a widow's cruse that is good for many years, but seems to fail for some reason.
From the graph, we can also see that when loans are expanding the money supply, government does less borrowing.
These data series may not be the best to use for this purpose. The data seem to support the contention that limitations exist on bank ability to create money supply, but banks seem to be able to continue expanding for long time periods before failure.
Thanks for the post.
Hi JP,
ReplyDeleteI sought to use the definition of “widow’s cruse” that I thought was embedded in the Tobin essay. In tackling the subject of corporate stock, I took some risk in being provocative about something I hadn’t thought through in its entirety. I’ve been pondering this, without complete coherence, but here are a few thoughts:
Your reflux or destruction criterion for disproving the existence of a widow’s cruse makes sense – both in terms of deposits being disintermediated from banks to NBFI liabilities, and deposits being converted into government money.
But my reading of the Tobin essay is that his criterion is more complex than that.
I think in fact his primary criterion is flow origination or creation based – in the sense of an unlimited flow supply of loans creating deposits. The reflux destruction criterion is stock based – something that causes an outright contraction of something already in existence at a point in time. I think a reflux destruction criterion of any kind is only a secondary consideration for Tobin.
(Of course, I use “stock” here in the sense of stock/flow, not the later sense of corporate sense.)
On the flow origination side, the cruse fails at the level of price competition. Tobin describes a process whereby banks cease to see attractive opportunities. That restricts the supply of loans and deposits at origination. "Unlimited supply” fails in this sense.
Tobin refers to the reflux destruction criterion sporadically through the essay. The “hot potato” reference is on page 2. It recurs in the “fountain pens and printing presses” section. But the origination criterion seems to be consistent throughout. For example, it seems to be the dominant of the two even in the actual “widow’s cruse” section.
In a sense, the reflux destruction criterion is more onerous as a definitional requirement than the flow creation criterion. In theory, the banking system can expand indefinitely, without any money supply contraction, while the NBFI system also expands using the money supply available to it for medium of exchange purposes. In theory, under a smooth system, there need not be either disintermediation reflux or central bank money reflux, and Tobin’s limited supply criterion is still exhibited through price competition at flow origination.
Put another way, the flow creation criterion is necessary and sufficient for the widow’s cruse to fail. The reflux destruction criterion is sufficient for the widow’s cruse to fail, but not necessary. It is a stronger restriction in terms of defining widow’s cruse failure.
I think Tobin uses both in his definition. But I don’t think he acknowledges the sufficiency of the flow origination criterion.
So it's the flow origination criterion that I carried over to the case of corporate stock – how its issuance is constrained by the economics of the cost of capital in the same way that asset-liability pricing constrains the ultimate result for bank intermediation. In fact, the two are necessarily complementary in the case of bank issued stock. Banks stop lending and creating deposits when they can’t meet their required cost of capital hurdle rate under feasible pricing. This constrains flow origination for the entire balance sheet, allowing NBFIs to seek out their own assets that suit their liabilities. If that were not the case, banks would eventually accumulate all non-deposit financial assets and become the financial system, including all of its issued equity.
I’d be interested in your feedback. I may end up doing a post on this, although people are probably exhausted on this topic by now.
P.S.
I’m not sure I see a direct reference in Tobin’s paper to the criterion of particular reflux from bank deposits to central bank money. It’s as if he had bigger fish to fry in terms of comparing banks to NBFIs.
I think you're right that Tobin focuses on creation of deposits rather than destruction into central bank money. I have probably been getting ahead of myself in my post and mixing Tobin with free bankers like Glasner and Selgin who for obvious reasons have spent a lot of time working out the mechanisms of a competitive money supply.
DeleteIn any case, I see what you mean with your example of corporate stock. Yes, issuers are constrained by the cost of capital, so they can't create stock willy nilly. It would seem to be the same with competing banks.
The classical argument against your point ... "the flow creation criterion is necessary and sufficient for the widow’s cruse to fail" ... is that the absence of convertibility leaves the price level undetermined, or unanchored. See David Glasner here, for instance:
"by failing to make explicit how he conceived that the price level and nominal income were determined, Tobin left his analysis incomplete, thereby allowing critics to charge that he had left the price level and nominal income undetermined or specified, in Keynesian style, by some ad hoc assumption."
Banks issuing inconvertible bank notes are not isolated actors -- their actions influence the general price level. On the other hand, banks issuing convertible bank notes, firms issuing stock, and other financial intermediaries don't influence the price level. The question therefore arises... are banks necessarily limited by a widow's cruse if they can push prices higher?
For instance, any amount of deposits accidentally overissued may find a legitimate holder at a higher price level, insofar as people have a demand to hold a fixed real quantity of liquid balances. The overissuer has been spared the necessity of increasing deposit rates.
One of the earliest monetary battles was on this very matter, incidentally -- the bullionist vs antibullionist debate.
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ReplyDeleteThis comment has been removed by the author.
ReplyDeleteI decided to take another look at the widow's cruse issue, taking a new tack. I looked first at an economy without derivative loans and then at an economy with banks and loans as we know them today. The post can be found at
ReplyDeletehttp://mechanicalmoney.blogspot.com/2013/09/the-widows-cruse-and-derivative-loans.html
My conclusion was that the widow's cruse is like a rainbow, it does exist but vanishes when conditions change.
Roger, thanks for the post. I've put a link to it and will go read it now.
DeleteThe combination of the government making bonds out of thin air and spending the money it gets from selling bonds and the central bank making money out of thin air and buying bonds clearly makes for new money. The net result of these two things is the government spending money out of thin air.
ReplyDeletehttp://howfiatdies.blogspot.com/2013/09/two-similar-cases.html
Very interesting post. I struggle most with the necessity of the 'unit of account' criteria, and relatedly, the hot potato effect. Things I will need to continue to chew on. I'm hesitant to pour my thoughts on it here until they crystallize a bit more. However, I do sort of feel like the issuance of equity seems has the potential to boost nominal income, through a wealth effect of sorts (may not be using the proper terminology, but the idea I am going for is that I may feel like I have more wealth to my name, so I consume more. Aggregate demand is boosted, and in turn, prices.).
ReplyDeleteIn any case, highly respect your knowledge on money matters and your blog. With the intention of not spamming your comments section, I started a blog, with my first post addressing something that I think is related to the 'widow's cruse' debate, although perhaps not in as deep as far as addressing what the implications for macroeconomic outcomes are. If interested: http://macromoneymarkets.blogspot.com/2013/09/why-calling-banks-financial.html