Gaze Not Into the Abyss: The KfW, Mitchell and Ramanan’s Misreading

gaze abyss

Ramanan is attacking the Chartalists again. And as usual he assumes a stupidity on their part that, well, what was that Nietzsche quote again?

Battle not with monsters, lest ye become a monster, and if you gaze into the abyss, the abyss gazes also into you.

I’m not going to spend very much time on this because it’s just silliness. But we may as well nail it down for the record. Ramanan writes,

In other words, Prof. Mitchell seems to present a story in which the German government is using KfW as a tool to have a higher budget deficit than what it shows in its own books but it is in fact the opposite. This is because the combined entity KfW + Government of Germany has a lower deficit than the deficit of the government of Germany.

Eh, no. Mitchell was presenting a story in which the KfW was engaged in extending credit to the private sector — just as Ramanan says. This then allows for an increase in aggregate demand without the government having to engage in deficit spending. Thus, Mitchell’s story goes, economic activity is buttressed by the KfW so that the government doesn’t have to do the heavy lifting. Mitchell states this clearly at the very beginning of the piece when he writes,

[The KfW] has since grown (and diversified) into one of the largest banks in Germany (taken its main business units into account) and pumps millions of Euros in the domestic economy and the export sector (via IPEX, its 100 per cent owned subsidiary)… It is a major reason why the federal deficit has been reduced without scorching the German economy. (My Emphasis)

So, what’s the problem with this? Simple. The KfW is, for all intents and purposes, a government institution. Mitchell writes,

The company is run by an Executive Board who are “appointed and dismissed” by the Board of Supervisory Directors (Article 6).

Guess who is the Chairman of the all-powerful Board of Supervisory Directors?

None other than our sudoku-playing Bundesfinanzminister (Federal Minister of Finance), Dr Wolfgang Schäuble. The Board is packed with Federal government ministers, which is appropriate given the bank is state-owned.

Other features of the legal status of KfW:

1. It distributes no profits but allocates surpluses to reserves attributable to the shareholders (government) (Article 10).

2. It has the same status as the central bank with respect to taxes – that is, it doesn’t pay them.

The Kfw is thus unambiguously a state institution and provides loans at lower than commercial rates because its bonds are considered of equal status to the German government’s own debt-issues.

See the cheating here? The KfW, for all intents and purposes, is a government institution and has full government backing. The KfW is like a sort of shell company for extending credit that is effectively the same as if the government had to pay for these projects given that the board of the KfW is filled with government folks and the bonds are backed by the government. The trick is that this borrowing doesn’t appear on the government balance sheet so, given a level of aggregate net expenditure equal to,

[Government Deficit + KfW Lending],

the Federal deficit is lower than it would otherwise be if the government had to foot the bill for all this expenditure.

Ramanan writes,

For Mitchell’s claim on the deficit to be valid, KfW should be a net borrower each year of a big size. For the claim on the public debt, KfW’s net indebtedness should be large. Unfortunately for Mitchell, KfW is a net lender to the private sector and the rest of the world sector in the flow sense and a net creditor in the stock sense.

It is clear that he has simply not understood Mitchell’s argument. The lesson here? If you have an emotionally-charged gripe with some theory or other you should be all the more fastidious in trying to understand the argument of said theory before you criticise it. Otherwise there is ample chance that you will get carried away with yourself.

Anyway, I have no problem with what the KfW does per se. Nor, I think, does Mitchell. Government-backed development banks are an excellent means for providing aggregate net expenditure to the economy through government-directed lending without giving rise to government debts that cause hysteria among austerity hawks and politicians. Mitchell’s point is that Germany is being hypocritical in this regard because they are calling for contraction in net expenditure in the periphery. I agree. They are.

Addendum: More misreading

As readers ca see from the comments section Ramanan came on here and began to put words in my mouth. He made multiple claims about what I was supposedly saying that I never, in fact, said. He now has added to his post with some strange arguments. I will deal with the two main points here. The first one is in response to me saying that if the KfW did not lend then the government would have to engage in expenditure to keep the level of output up. Ramanan responds,

First, the government would not have to “foot the bill for this expenditure” if it were to lend directly to the private sector on its books because the lending would not be “expenditure” but a loan by the government and it would be making a profit on it. The loan would not add to the budget balance even if the government were to directly lend.

Yes, this is also a possibility. The government could lend directly. This is another counter-factual. But it is highly unlikely to actually happen.

His second point,

Further Pilkington seems to assume that another counter-factual in this case is less borrowing by the private sector and hence lesser private expenditure. No! this counter factual is the private sector borrowing from other banks – i.e, private banks. Why would German firms find difficulty in borrowing if they happened to show their creditworthiness to KfW?

This indicates that Ramanan thinks that lending and spending by the private sector is not determined by institutional issues and is only determined by their desire to lend. I think this shows clearly Ramanan’s weakness understanding institutional and political issues as they relate to economic issues. In short: I don’t think that he fully grasps how industrial policy works. In actual fact, in such ventures the government and the private sector team up and engage in undertaking activities together. That is what appears to be happening here.

 

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About pilkingtonphil

Philip Pilkington is a London-based economist and member of the Political Economy Research Group (PERG) at Kingston University. You can follow him on Twitter at @pilkingtonphil.
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43 Responses to Gaze Not Into the Abyss: The KfW, Mitchell and Ramanan’s Misreading

  1. Ramanan says:

    “Eh, no. Mitchell was presenting a story in which the KfW was engaged in extending credit to the private sector — just as Ramanan says. This then allows for an increase in aggregate demand without the government having to engage in deficit spending.”

    Your error is assuming that those firms would not have received credit otherwise.

    The thing is that they receive some subsidies – ie loans at lower rates. The subsidy is the fiscal part and not the amount of lending. it is nothing like what Mitchell says.

    “The trick is that this borrowing doesn’t appear on the government balance sheet so, given a level of aggregate net expenditure equal to,

    [Government Deficit + KfW Lending],”

    Strange mix of lending and spending – typical of MMT.

    “The lesson here? If you have an emotionally-charged gripe with some theory or other you should be all the more fastidious in trying to understand the argument of said theory before you criticise it”

    It is Mitchell who is rabble rousing here. Mine is a simple accounting check on his wild theories.

    • NeilW says:

      The government has outsourced the lending to firms to a commercial bank that it owns. So money that is lent is directly as horizontal commercial bank money via balance sheet expansion (DR Loans CR firm account) rather than induced commercial bank money via the vertical central bank money circuit (DR CB Reserves, CR firm account).

      So only the commercial bank’s balance sheet expands, rather than the govt sector *and* the commercial bank – as would be the case with direct govt lending.

      It’s a mistake you tend to make on the accounting with a vertical circuit.

      • Nick Edmonds says:

        That doubling up is just a function of the fact that the public cannot hold reserves and you’re assuming the lending is funded with additional reserves. It doesn’t arise in things like Funding for Lending which are structured as stock loans over bills.

      • NeilW says:

        “and you’re assuming the lending is funded with additional reserves”

        No I’m not. I’m simplifying so I can fit the point in a comment box – rather than a fifteen page academic paper covering all the angles.

        “It doesn’t arise in things like Funding for Lending which are structured as stock loans over bills.”

        The back-filling half of the equation is asynchronous from the lending system. It’s not a good idea to confuse the two.

      • Nick Edmonds says:

        Not sure exactly what you mean by that second part. With FFL, the transfer of bills is the lending – it’s not lend, then issue bills – there are no entries on the reserve account at all. Obviously FFL is funding for banks, not end users, but if the government was to lend to a non-bank in that way then there would be no gross up of commercial bank balance sheets, not even for a scintilla. It would be exactly like commercial bank lending, i.e. lending your own liabilities.

      • NeilW says:

        FFL comes after the actual lending. Lending to the end client, and then making the books add up due to the operation of the payment systems are discontinuous operations.

      • Nick Edmonds says:

        OK, so I know what you meant now. But I don’t think that changes things. Per my last comment, if the public sector were to fund the non-bank private sector by stock loan of bills, that’s all there is. The public sector doesn’t then need to fund the position and there are no payments to match up. After all, part of the reason for doing FFL that way is to avoid exactly the issue that you highlighted in your first comment.

      • NeilW says:

        The Bills would still end up on the Treasury balance sheet, and the firm would owe the Treasury instead and be on the balance sheet. I don’t think you’d get them off balance sheet at the end points – not under any accounting policy I’m aware of.

        It’d be the same if the firm took the loan out at the commercial bank and drew it all out in used fivers. Then the corresponding asset would be directly with the central bank (or possibly the Treasury if you live in a weird jurisdiction).

        All of which is just accounting trickery to shrink intermediate balance sheets and doesn’t really help in reality. You can’t really spend Treasury Bills. You have to liquidate them which means acquiring bank deposits and associated CB reserves to facilitate transfer. And suitcases full of used fivers are a bit risky.

      • NeilW says:

        “so there is no addition to overall reserves. It’s not just accounting trickery.”

        There isn’t a finite amount of reserves. It grows and shrinks depending upon the amount of money that needs to be moved around – primarily via repo of Gilts and Treasury Bills as required. In other words turning government sector funny money into actual government sector money on demand.

        It is just accounting trickery. The government sector issues a different type of paper money and tries to pretend its not really money. It’s a ludicrous state of affairs when there is no public purposes achieved by operating like that.

      • Nick Edmonds says:

        Well the point is to issue a type of money that can be held by anybody instead of one that has to be held by banks, which I agree is just to work within the existing regulatory infrastructure. I’m not endorsing it, I’m just saying why they do it and what the accounting implication is. And I agree, there are asynchronous ways of achieving the same result.

  2. Ramanan says:

    In other words, it is like the MMT NFA arguments around QE that it is an asset-swap not “spending”. The loan is an asset-swap and not spending.

    The KfW is not “pumping millions” as Mitchell says, the firms would have obtained finance elsewhere if not from KfW. The counterfactual is not less expenditure resulting from the loans. The counterfactual is borrowing from elsewhere.

    • Really? The firms would have obtained that credit elsewhere? Do you have evidence of this? Could you provide it, please?

      And what about the low-rate subsidies? What are they all about?

      There’s a lot of questions here, Ramanan. I think you should just admit when you’re wrong and read Mitchell’s stuff properly next time.

      • Ramanan says:

        “The firms would have obtained that credit elsewhere? Do you have evidence of this?”

        Because German firms are highly competitive. Why would they have troubles borrowing?

        The subsidies would be profits of a bank of a similar size less the actual profit of KfW. Check the profits of German banks.

        The trick in all this is to get the accounting right. Your analysis confuses income/expenditure flows with financial flows.

        Once again, get your accounting right. Post coming up.

      • You think that German firms would have borrowed and spent without the government members of the board of KfW pushing for this in a low-demand environment? That’s a very un-Keynesian view of industrial policy, Ramanan. Why is it that when you criticise MMT you often end up defending orthodoxy?

        Also, save your energy. We all understand the accounting aspects of this. But neither Mitchell nor I discussed accounting. We were purely interested in expenditure and who is pushing for that expenditure.

        Instead of writing a post on accounting that is entirely irrelevant to the present conversation why not instead list all the times that you’ve ever admitted that you got something wrong. I would imagine that it wouldn’t take very long. Unfortunately for you, everyone else recognises when you muck your arguments up. Sorry.

      • NeilW says:

        That’s the key to it. Investment spending is Investment spending – wherever it is initiated from.

        If you avoid the central bank circuit you avoid one set of balance sheet expansion and that looks better on the public sect debt figures when they are produced.

        Arguably you could say that all commercial banks that have an account at the central bank are instances of the government sector getting monetary expansion ‘off-balance sheet’.

        That is after all the argument the 100% reserve crowd make.

  3. JCM says:

    Shouldn’t we also realize the fact that the whole banking sector has been in terrible shape after the crisis and many banks have tried to repair their balance sheets, thus adjusted their risk criteria for loans. That means loans are harder to get and especially the kind of loans that small and medium size businesses need (not having sufficient collateral often stands in the way of getting loans approved).

    Having a government-owned bank extending credit, at lower prices, on uncollateralized loans, would probably be a meaningful advantage for businesses in Germany – especially if businesses in other countries don’t have such credit opportunities.

    • Of course, but from his comment Ramanan seems to imply that only the interest rate matters in lending operations. Or does he know better and he’s just desperate to win the argument… hmmm…

  4. Ramanan says:

    No 100% reserve crowd mistake on my part. plus no mistake on whatever this means:

    “It’s a mistake you tend to make on the accounting with a vertical circuit.”

    Pilkington counts the expenditure made subsequent to the loan making as public expenditure which it is not. It is private expenditure in either the case the government lends directly or if it lends via KfW. Even in the case the private firm borrows from a private bank, it is private expenditure.

    Whether is is “investment spending” or not is not relevant here.

    You are right that the KfW’s balance sheet expands due to the lending. But if the KfW hadn’t been there, some other private bank would have lent whose balance sheet would have expanded. There are more than 1 counterfactuals here and you cannot specifically choose one to suit your political purposes.

    At any rate, loan making by KfW is not government expenditure whether it is counted as part of the government or not.

    • Pilkington counts the expenditure made subsequent to the loan making as public expenditure which it is not.

      Where did I say this, Ramanan? Please provides sources otherwise no one will take you seriously and they’ll just conclude that you’re making stuff up to distract from that train-wreck of a post you did in response to Bill Mitchell’s post on the KfW.

      • Ramanan says:

        Where did you say this? As a direct interpretation of your statement.

        “The trick is that this borrowing doesn’t appear on the government balance sheet so, given a level of aggregate net expenditure equal to,

        [Government Deficit + KfW Lending],

        the Federal deficit is lower than it would otherwise be if the government had to foot the bill for all this expenditure.”

      • That statement says that [Government Deficit + KfW Lending = Aggregate Net Expenditure], you dumb-dumb. Can you read or what?

    • Ramanan says:

      “you dumb-dumb. Can you read or what?”

      No. Because immediately you use the addition to count it as an increase in the government deficit.

      Which it is not.

      In fact, if KfW is counted as part of the government, it would contribute to a reduction in deficit because of its profits.

      • Nope. Government deficit is separate from KfW lending. I was quite clear about that. I said that the two together was Aggregate Net Expenditure. I said nothing about the source of that expenditure (which is private in the case of the KfW).

        You’re just making up strawman arguments because of your awful post. Stop digging the hole, dude. You’re deep enough in. I’m going to ignore you now. You can engage in shoddy academic practice and making stuff up elsewhere.

      • Ramanan says:

        There’s no strawmen.

        You add government deficit and KfW lending to show that the deficit would have been higher if KfW were to be part of the government and since Germany counts it as different and hence you say the deficit is lower. But no it is just the opposite.

        And in return, I get this abusive rant from you for pointing out your simple mistakes!

      • You need a course in reading comprehension or something dude. And I’m not going to provide it on here for free.

      • NeilW says:

        R,

        It boils down to this.

        Is spending higher because KfW is there, and is KfW there due to government policy – which means that spending is higher because of government policy, but ‘off balance sheet’ from the govt point of view.

        If not, then you are implicitly relying on a financial crowding out argument, and arguing that development banks serve no purpose.

  5. Ramanan says:

    “You think that German firms would have borrowed and spent without the government members of the board of KfW pushing for this in a low-demand environment?”

    Oh puhleez not more conspiracies to defend one conspiracy theory.

    “We all understand the accounting aspects of this. But neither Mitchell nor I discussed accounting. ”

    When you are making accusations about deficits etc, you are doing accounting. The original Mitchell article said smokes-and-mirrors accounting which means “Germany is doing gimmicks, here’s the right accounting”.

    • That’s not what Mitchell said. You should learn to read better before you go around writing embarrassing posts that make you look like you don’t know how development banks work.

      Hey everybody: Ramanan doesn’t think that industrial policy matters! He thinks that large firms make loans based on the rate of interest! Hahahahaha!

      I don’t think that Kaldor would approve, Ramanan. But then again, you do sound awfully marginalist sometimes — usually when you’re trying to evade the implications of some half-baked rant against MMT economists that you cobble together without reading the source properly.

  6. D. Sangster says:

    Ramanan is correct.

    Apart from general tendency of MMT to conflate spending and lending, the fiscal and deficit exposure of the government here is the contingent credit risk and corresponding government equity exposure associated with the lending operation – not the broad funding for the bank – and Ramanan is clear on these points.

    • I didn’t see Bill Mitchell say anything to the contrary. Nor did I. Both of us were quite clear that this is a government-backed lending operation that is then aggregated into private sector debt.

      Say, Mr. Sangster, you wouldn’t happen to have a gripe against MMT that might be impairing your objectivity or anything, would you? I’m just checking is all…

      • NeilW says:

        Lending induces spending. That’s sort of the point.

        If you want to model the lending-spending relationship just see Treasury as running an overdraft at the central bank, and there you have it. Spend and lend.

        I can’t see where this idea that lending is somehow special and magical comes from (particularly the mysticism around collateral). Can you explain the viewpoint Phil?

      • I don’t really care to. Because I somehow doubt that the commenter is interested.

  7. Detroit Dan says:

    Well said Mr. Pilkington.

    In my experience, conversations involving Ramanan often end up as a hopeless mish-mash of personal invective and economics. It becomes impossible to separate the two, and much time is wasted…

    • Ramanan’s problem is that he doesn’t criticise things he thinks wrong… he criticises things that he doesn’t like. His rational faculties are basically driven by his emotions. That accounts for what you highlight.

  8. Oliver says:

    The two (or more) of you are talking past each other…

    To have a meaningful discussion, you must first identify your counterpart’s position.

    Ramanan has identified the wrong counterfactual from Mitchell’s writing. It is clearly not direct lending, but direct spending by government. The argument is that lending by KfW that is not counted towards a deficit replaces the same amount of spending that would have counted towards the deficit.

    On the other hand, the reason that Ramanan cannot or doesn’t want to see the implied counterfactual may have to do with the fact that he doesn’t consider it a valid counterfactual. From what I can tell, the main argument is that with lending the causality runs from borrower to lender. Endogeneity of the moneysupply, anyone? So it is wrong to accuse Ramanan of implying that business borowing is a function of the interest rate. He is saying the opposite. The borrowing would have happened regardless of ownership and interest rate. And it is the ownershiop of KfW that gives government a cut in profits, thus reducing deficit vis the counterfactual of no ownership…

    Spending, on the other hand, to the extent that it is discretional and not just the result of falling tax receipts (the endogenous part of the budget), can be considered to run from spender to receiver – a push relation, representative e.g. of industrial policy.

    So it is wrong to imply, like Mitchell does, that one can be considered a replacement of the other.

    • NeilW says:

      “The borrowing would have happened regardless of ownership and interest rate. ”

      Which is a crowding out argument. In which case why do you need development banks at all?

      The fact that development banks exist demonstrates clearly that the borrowing would not have happened regardless.

      • Oliver says:

        Not sure about the crowding out point, but I agree with the second point.

        I guess the question is to what extent it helps to look at it from a chartalist perspective. The relevant measure is not an amount of NFA outstanding but the fact that per government mandate and per government guarantee, there is a bank that lends into markets that would otherwise be underfunded.

        It’s the static, quantity theory implication of the chartalist perspective, namely that a larger stock of outstanding money is the desirable position that triggers the emotional reaction. When in fact it is the dynamic and qualitative implication of funding into underfunded markets, even if that means a larger reflux of tax revenue vs. the unfunded counterfactual, that captures more of what’s going on.

        I’m sure Mitchell and the rest of the MMT folks understand this, but the way it’s framed is sometimes misleading.

      • Oliver says:

        Correction: I meant revenue, not tax revenue.

      • Neil is right. If the lending would take place anyway then why have anything like a development bank? Given that these exist all over the world there must be a reason that they do. In actual fact, they extend financing to companies that might not otherwise take the financing (or might not receive it). It looks like what KfW is doing is lending on favourable terms to German companies to encourage investment and all this is done with full government backing. That is Mitchell’s argument.

        Also note that Ramanan has changed his argument about three times now. He’s gone from talking about the KfW absorbing government debt — a bizarre claim that no one made in the first place — to saying that the lending would have taken place anyway without the KfW — which implicitly means that development banks serve no purpose and that the fact that the KfW is tied to the government makes no difference to the outcomes of its lending.

      • Oliver says:

        You’re right, it makes no sense.

        The difference between lending and spending is that the deficit looks like a definite loss while an outstanding loan is considered an asset because there’s always the hope it may be paid back. Never mind that a deficit could turn into a surplus in the next period if the investements are successful and nevermind that loans may never be paid back.

        One thing about loans vs. spening is that the prior provide more direct feedback about the success or failure of the projects being funded. Of course one can always choose not to register or not to communicate that feedback.

        I suspect it’s those psychological differences that Mitchell is alluding to with his remark about accounting gimmicks.

      • Yes, exactly.

        The key points here are as follows:

        (1) Without the lending extended by the KfW Germany would require a higher deficit to maintain the same level of aggregate demand.

        (2) This lending by the KfW is effectively government lending.

        (3) Without the KfW would the lending be undertaken by private banks and would the companies take on the loans? I think there is good reason to suspect that this is not the case. It looks to me like the Germans are engaging in industrial policy using government backed/subsidised loans to float aggregate demand.

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