Money supply: M0, M1, and M2

WEBVTT
Kind: captions
Language: en

00:00:00.496 --> 00:00:02.120
What I want to explore
in this video is

00:00:02.120 --> 00:00:04.560
the different ways of
measuring the amount of money

00:00:04.560 --> 00:00:06.730
we have in circulation.

00:00:06.730 --> 00:00:09.190
So we're going to start
things with our Central

00:00:09.190 --> 00:00:10.630
Bank in the US.

00:00:10.630 --> 00:00:13.360
This would be the
US Federal Reserve.

00:00:13.360 --> 00:00:17.340
And let's say that
they print $4.

00:00:17.340 --> 00:00:19.830
And we're going to focus, just
for visualization purposes,

00:00:19.830 --> 00:00:21.400
on that they're
doing it physically.

00:00:21.400 --> 00:00:23.244
They could also do
it electronically.

00:00:23.244 --> 00:00:25.160
But we're just going to
focus on the physical.

00:00:25.160 --> 00:00:27.118
And the way that they
get this into circulation

00:00:27.118 --> 00:00:29.100
is it they'll take
these $4 and they'll

00:00:29.100 --> 00:00:32.240
go buy securities in the
open market, normally

00:00:32.240 --> 00:00:34.310
very safe and very
liquid securities.

00:00:34.310 --> 00:00:36.540
Liquid means it's very
easy to buy and sell

00:00:36.540 --> 00:00:38.500
those securities in
large quantities.

00:00:38.500 --> 00:00:40.050
For example,
government treasuries

00:00:40.050 --> 00:00:43.880
is a liquid security,
or liquid asset.

00:00:43.880 --> 00:00:45.761
PEZ dispensers would
not be a liquid asset.

00:00:45.761 --> 00:00:47.510
If I bought a billion
dollars worth of PEZ

00:00:47.510 --> 00:00:49.780
dispensers it would be very
hard for me to sell-- one

00:00:49.780 --> 00:00:51.960
it would be very hard for me
to buy a billion dollars worth.

00:00:51.960 --> 00:00:53.668
And it would be even
probably even harder

00:00:53.668 --> 00:00:57.060
for me to sell a billion dollars
worth in any short or medium

00:00:57.060 --> 00:00:58.042
timeframe.

00:00:58.042 --> 00:01:00.500
So the Central Bank goes out,
and let's say they go and buy

00:01:00.500 --> 00:01:03.210
one liquid security for $4.

00:01:03.210 --> 00:01:05.300
So this is a security
right over here.

00:01:05.300 --> 00:01:07.510
And the person that they
bought the security from

00:01:07.510 --> 00:01:09.152
decides to deposit it in a bank.

00:01:09.152 --> 00:01:11.110
They could either directly
deposit it in a bank

00:01:11.110 --> 00:01:12.630
or they could use
that money that they

00:01:12.630 --> 00:01:14.600
got from selling their
security to buy things,

00:01:14.600 --> 00:01:16.183
and the person they
bought things from

00:01:16.183 --> 00:01:17.330
could deposit it in a bank.

00:01:17.330 --> 00:01:19.371
But one way or another we
can imagine it all gets

00:01:19.371 --> 00:01:21.050
deposited in a bank.

00:01:21.050 --> 00:01:22.810
So this is our private bank.

00:01:22.810 --> 00:01:26.900
I'll call this private
bank number one.

00:01:26.900 --> 00:01:30.760
So now all of these
dollars are transferred

00:01:30.760 --> 00:01:34.960
to private bank number one.

00:01:34.960 --> 00:01:38.040
And they are no longer--
the Federal Reserve,

00:01:38.040 --> 00:01:40.250
or the Central Bank,
in the general case,

00:01:40.250 --> 00:01:42.380
is no longer in
possession of them.

00:01:42.380 --> 00:01:44.114
They've been transferred
right over here.

00:01:44.114 --> 00:01:45.530
And I want to cross
these out just

00:01:45.530 --> 00:01:48.540
so we can keep track of things.

00:01:48.540 --> 00:01:51.670
Now when they deposit it
in private bank number one,

00:01:51.670 --> 00:01:55.000
they said, well, I need three
of these dollars on demand.

00:01:55.000 --> 00:01:56.880
And I want to write
checks against them.

00:01:56.880 --> 00:02:00.979
So they put three of these
dollars in a checking account.

00:02:00.979 --> 00:02:03.270
There are at three of these
dollars a checking account.

00:02:03.270 --> 00:02:13.390
So checks up too-- so
write checks up to $3.

00:02:13.390 --> 00:02:15.490
And so they can get a
little bit more interest,

00:02:15.490 --> 00:02:17.090
and the bank's willing to give
a little bit more interest

00:02:17.090 --> 00:02:18.923
on a savings account
because they don't have

00:02:18.923 --> 00:02:22.530
to keep the reserves, they
put $1 into a savings account.

00:02:25.214 --> 00:02:27.630
And they cannot write checks
against that savings account.

00:02:27.630 --> 00:02:29.296
Now there are special
circumstances now,

00:02:29.296 --> 00:02:32.380
but for simplicity, let's just
say that they cannot write

00:02:32.380 --> 00:02:32.880
checks.

00:02:32.880 --> 00:02:34.921
There are some that have
restricted check writing

00:02:34.921 --> 00:02:36.200
and things like that now.

00:02:36.200 --> 00:02:38.920
So this bank says, OK,
well, this dollar, I

00:02:38.920 --> 00:02:40.920
don't have to even have
any reserves against it.

00:02:40.920 --> 00:02:42.128
I could loan out this dollar.

00:02:42.128 --> 00:02:43.680
And the person they
lend it to, let's

00:02:43.680 --> 00:02:47.130
say that they immediately go and
deposit it into another bank.

00:02:47.130 --> 00:02:50.830
So they immediately go and
deposit this in private bank,

00:02:50.830 --> 00:02:52.550
I'll call this private bank two.

00:02:52.550 --> 00:02:54.920
So it's no longer
in private bank one.

00:02:54.920 --> 00:02:57.120
Let me draw a private bank two.

00:02:57.120 --> 00:03:00.880
Private bank two is
a right over here.

00:03:00.880 --> 00:03:04.690
Private bank number two.

00:03:04.690 --> 00:03:07.470
And they deposit it
into a savings account

00:03:07.470 --> 00:03:10.540
in private bank number two.

00:03:10.540 --> 00:03:12.710
And let's say all of
this, out of all of this,

00:03:12.710 --> 00:03:15.460
the bank says, well,
this is a demand deposit,

00:03:15.460 --> 00:03:16.960
I have to keep some reserves.

00:03:16.960 --> 00:03:18.640
This is a fractional
reserve system.

00:03:18.640 --> 00:03:21.670
But I can lend out, in the
US, I could lend out up to 90%

00:03:21.670 --> 00:03:22.270
of this.

00:03:22.270 --> 00:03:24.000
And maybe this bank is a
little bit more conservative,

00:03:24.000 --> 00:03:25.680
They only lend out 2/3 of this.

00:03:25.680 --> 00:03:27.737
So they lend out
$2 out of these $3

00:03:27.737 --> 00:03:29.570
And let's say the person
they let it do also

00:03:29.570 --> 00:03:31.910
happens to deposit it
in private bank number

00:03:31.910 --> 00:03:33.700
two, just coincidentally.

00:03:33.700 --> 00:03:40.060
So these two also end up
in private bank number two.

00:03:40.060 --> 00:03:45.250
And so they're no longer
in private bank number

00:03:45.250 --> 00:03:48.760
one, although this person could
still write checks up to $3.

00:03:48.760 --> 00:03:50.420
And now here in
private bank number

00:03:50.420 --> 00:03:52.045
two-- and let's say
these are deposited

00:03:52.045 --> 00:03:53.590
in a checking account.

00:03:53.590 --> 00:03:58.260
These are deposited right over
here in a checking account.

00:03:58.260 --> 00:04:00.910
Now private bank number two,
it can do a couple of things.

00:04:00.910 --> 00:04:03.160
In this checking account it
has to keep some reserves.

00:04:03.160 --> 00:04:04.310
Let's say it's even
more conservative.

00:04:04.310 --> 00:04:06.018
It only decides to
lend out half of this,

00:04:06.018 --> 00:04:08.280
even though it
could lend out 90%.

00:04:08.280 --> 00:04:11.264
And so it lends out
one of these dollars.

00:04:11.264 --> 00:04:13.680
And the person that they lend
it to just takes that dollar

00:04:13.680 --> 00:04:15.860
and they put it in their wallet.

00:04:15.860 --> 00:04:17.360
So they just put
it in their wallet.

00:04:17.360 --> 00:04:19.594
And they could also lend
out this entire savings.

00:04:19.594 --> 00:04:21.010
And let's just say
that the person

00:04:21.010 --> 00:04:24.370
that they lend that
$1 in savings to also

00:04:24.370 --> 00:04:25.370
puts it in their wallet.

00:04:28.370 --> 00:04:30.790
And notice, the original
$4 are still there.

00:04:30.790 --> 00:04:32.890
One, two, three, four.

00:04:32.890 --> 00:04:35.870
Now, and just to be clear,
this person right over here can

00:04:35.870 --> 00:04:37.420
write checks up to $3 .

00:04:37.420 --> 00:04:39.290
And this person
right over here can

00:04:39.290 --> 00:04:43.770
write checks-- let me do
that same checking account

00:04:43.770 --> 00:04:53.350
color-- they can
write checks up to $2.

00:04:53.350 --> 00:04:55.780
Now let's think about the
different forms of money

00:04:55.780 --> 00:04:56.770
there are here.

00:04:56.770 --> 00:04:59.500
Well, we could think of money in
a very, very narrow way, which

00:04:59.500 --> 00:05:03.200
is just what did the Central
Bank print, or create

00:05:03.200 --> 00:05:07.210
electronically as electronic
reserves of its member banks?

00:05:07.210 --> 00:05:08.710
But for simplicity
here you can just

00:05:08.710 --> 00:05:11.060
think about the physical
currency that it printed,

00:05:11.060 --> 00:05:12.610
its base money.

00:05:12.610 --> 00:05:17.410
And so that, often, is just
referred to as base money.

00:05:17.410 --> 00:05:19.370
And in the US and
other countries

00:05:19.370 --> 00:05:21.310
it's often the same thing as M0.

00:05:21.310 --> 00:05:23.640
There's slight differences
from country to country.

00:05:23.640 --> 00:05:26.560
And in this example, as soon
as they printed it and put it

00:05:26.560 --> 00:05:29.090
into circulation, that was $4.

00:05:29.090 --> 00:05:31.460
We had $4 of base money.

00:05:31.460 --> 00:05:33.770
And that's obvious because
as soon as they printed this

00:05:33.770 --> 00:05:35.311
and they bought the
security with it,

00:05:35.311 --> 00:05:38.610
and it was in circulation, that
$4 could be used to buy things.

00:05:38.610 --> 00:05:41.770
It could be used to
facilitate transactions.

00:05:41.770 --> 00:05:44.050
Now that clearly isn't
all of the stuff that

00:05:44.050 --> 00:05:47.460
can be used as money in this
little universe we created.

00:05:47.460 --> 00:05:50.130
This guy, you have the
$4 but these people

00:05:50.130 --> 00:05:52.540
can also write checks
right over here.

00:05:52.540 --> 00:05:55.360
And so we can have a slightly
broader definition of money.

00:05:55.360 --> 00:05:57.350
And over here, we
will call it M1.

00:05:57.350 --> 00:05:59.850
And here, there's a couple of
ways you could think about it.

00:05:59.850 --> 00:06:02.300
You could think about it as
all of the currency that's

00:06:02.300 --> 00:06:05.700
in people's pockets plus all of
the check writing capabilities.

00:06:05.700 --> 00:06:07.200
So if you view it
that way it, would

00:06:07.200 --> 00:06:11.340
be this $2 plus $5 of
check writing capabilities

00:06:11.340 --> 00:06:12.520
right over here.

00:06:12.520 --> 00:06:14.660
So you could have $2
of physical currency

00:06:14.660 --> 00:06:17.520
that's in people's wallets,
not in bank reserves,

00:06:17.520 --> 00:06:24.400
plus the $5 of check
writing capability,

00:06:24.400 --> 00:06:26.460
which would give you $7.

00:06:26.460 --> 00:06:28.580
Another way you
could view it, you

00:06:28.580 --> 00:06:35.390
could view it as M0
plus checkable deposits.

00:06:35.390 --> 00:06:37.396
I'll just write checks
here, plus-- well

00:06:37.396 --> 00:06:39.770
I'll write-- checkable deposits.

00:06:39.770 --> 00:06:41.410
But if you do that,
you are now double

00:06:41.410 --> 00:06:43.620
counting because
some of the M0 is

00:06:43.620 --> 00:06:46.002
reserves in the
checkable deposits.

00:06:46.002 --> 00:06:47.960
Or you could say some of
the checkable deposits

00:06:47.960 --> 00:06:50.110
is held as reserves for M0.

00:06:50.110 --> 00:06:53.155
So then you would have to
subtract out the bank reserves.

00:06:56.880 --> 00:06:59.239
And so then you would
get $4 because we

00:06:59.239 --> 00:07:01.280
don't want to double count
these right over here.

00:07:01.280 --> 00:07:04.200
You would get M0 is $4.

00:07:04.200 --> 00:07:06.420
And I want to do that in white.

00:07:06.420 --> 00:07:10.690
M0 is $4.

00:07:10.690 --> 00:07:16.080
The checkable deposits is $5.

00:07:16.080 --> 00:07:17.580
Let me do that in the pink.

00:07:17.580 --> 00:07:19.610
Plus the $5.

00:07:19.610 --> 00:07:22.070
And then you would want to
subtract out the reserves.

00:07:22.070 --> 00:07:24.270
And the reserves here, there
are $2 of the reserves.

00:07:24.270 --> 00:07:27.080
So minus $2.

00:07:27.080 --> 00:07:30.920
And you would get
yourself back to the $7.

00:07:30.920 --> 00:07:33.420
And the whole point of this is
so you're not double counting

00:07:33.420 --> 00:07:35.878
something, you're not double
counting this right over here,

00:07:35.878 --> 00:07:41.430
as part of checkable
deposits and part of the M0.

00:07:41.430 --> 00:07:43.480
You're not using this twice.

00:07:43.480 --> 00:07:45.660
It's not part of the base money.

00:07:45.660 --> 00:07:48.010
It is both the base money
and checkable deposits.

00:07:48.010 --> 00:07:49.790
And we don't want
to count it twice.

00:07:49.790 --> 00:07:51.272
So the simplest
way to think about

00:07:51.272 --> 00:07:53.480
is, well, what can be used
in this broader definition

00:07:53.480 --> 00:07:55.110
to facilitate transactions?

00:07:55.110 --> 00:07:57.410
These $2 in people's
pockets, and this ability

00:07:57.410 --> 00:07:59.550
to write up to $5 of checks.

00:07:59.550 --> 00:08:02.160
So that's this view
right over here.

00:08:02.160 --> 00:08:04.120
And if we want to get
even broader than that,

00:08:04.120 --> 00:08:06.806
we can get to
something called M2.

00:08:06.806 --> 00:08:08.680
And here we could say,
OK, what's immediately

00:08:08.680 --> 00:08:12.280
usable to facilitate a
transaction right now?

00:08:12.280 --> 00:08:14.260
So that would be our M1.

00:08:14.260 --> 00:08:16.250
So that would be our $7 of M1.

00:08:16.250 --> 00:08:19.400
Plus things that can be
easily converted to M1.

00:08:19.400 --> 00:08:21.220
So for example, these
savings accounts

00:08:21.220 --> 00:08:23.110
can be easily converted
to checking accounts.

00:08:23.110 --> 00:08:24.530
It might only take
a couple of days.

00:08:24.530 --> 00:08:25.920
There might be
some restrictions.

00:08:25.920 --> 00:08:27.025
But it can be converted.

00:08:27.025 --> 00:08:29.400
And when it gets converted
will change the bank's reserve

00:08:29.400 --> 00:08:30.770
requirements a little bit.

00:08:30.770 --> 00:08:33.360
But it will allow, if
this person converts it

00:08:33.360 --> 00:08:36.169
they will have the ability
to write more checks.

00:08:36.169 --> 00:08:38.909
So M2 includes M1
plus things that

00:08:38.909 --> 00:08:40.740
are very easy to convert to M1.

00:08:40.740 --> 00:08:45.515
And so they'll include things
like savings accounts, money

00:08:45.515 --> 00:08:47.640
market accounts, which I
won't go into detail here.

00:08:47.640 --> 00:08:49.190
But they're really kind
of similar in that you

00:08:49.190 --> 00:08:50.470
get slightly higher
interest, but there

00:08:50.470 --> 00:08:52.440
are restrictions on your
ability to access it.

00:08:52.440 --> 00:08:56.480
But it's not too hard to turn
it into checking accounts.

00:08:56.480 --> 00:09:00.070
And small dollar value
time deposit, CD accounts.

00:09:00.070 --> 00:09:02.070
But for the sake of
simplicity, in this example,

00:09:02.070 --> 00:09:03.990
it would be the saving accounts.

00:09:03.990 --> 00:09:09.620
So it would be our
$7 of M1, plus the $2

00:09:09.620 --> 00:09:11.180
of savings accounts
right over here.

00:09:15.527 --> 00:09:17.110
So this is just to
give you a picture.

00:09:17.110 --> 00:09:18.190
When someone talks
about the money

00:09:18.190 --> 00:09:19.380
supply you really
have to say, well,

00:09:19.380 --> 00:09:20.504
what are you talking about?

00:09:20.504 --> 00:09:23.680
The most typical one is that
you're really talking about M1,

00:09:23.680 --> 00:09:27.060
because this is the stuff that's
directly usable to facilitate

00:09:27.060 --> 00:09:27.880
transactions.

00:09:27.880 --> 00:09:29.588
Things like the ability
to write a check,

00:09:29.588 --> 00:09:31.520
or dollar bills in
someone's wallet.

00:09:31.520 --> 00:09:35.310
But they might be talking about
base money, M0, narrow money,

00:09:35.310 --> 00:09:36.930
always of referring
to the same thing,

00:09:36.930 --> 00:09:38.070
especially in the United States.

00:09:38.070 --> 00:09:40.410
Or they might be referring
to something even broader.

00:09:40.410 --> 00:09:41.785
And there are
broader definitions

00:09:41.785 --> 00:09:44.400
even than M2,
although M3, they've

00:09:44.400 --> 00:09:45.720
stopped reporting about it.

00:09:45.720 --> 00:09:48.630
But M3 would have things
that are a little bit further

00:09:48.630 --> 00:09:51.760
from being true money, from
being a checking account.

00:09:51.760 --> 00:09:53.980
But they are already
fairly liquid

00:09:53.980 --> 00:09:56.130
and so they'll include
other types of assets.

00:09:56.130 --> 00:09:57.880
But the Fed has
stopped reporting

00:09:57.880 --> 00:10:00.420
this in the recent past.

00:10:00.420 --> 00:10:04.130
So these are the ones that
are typically referred to.


Full reserve banking

WEBVTT
Kind: captions
Language: en

00:00:00.580 --> 00:00:02.684
Narrator: I do want to
clarify that the whole point

00:00:02.684 --> 00:00:04.416
that I'm showing these
weaknesses in Fractional

00:00:04.416 --> 00:00:06.744
Reserve lending isn't to argue that it

00:00:06.744 --> 00:00:09.250
necessarily has to go away or that it is

00:00:09.250 --> 00:00:11.802
somehow unviable.

00:00:11.802 --> 00:00:13.670
It's clearly viable,
it's the system that most

00:00:13.670 --> 00:00:15.669
market economies, actually
all that I know of,

00:00:15.669 --> 00:00:17.005
use today.

00:00:17.005 --> 00:00:18.666
The reason why I am
doing it is to show that

00:00:18.666 --> 00:00:20.875
it's not the only type
of system that we really

00:00:20.875 --> 00:00:23.493
should scrutinize any
systems that we have in place

00:00:23.493 --> 00:00:27.162
to realize that they
aren't a law of physics,

00:00:27.162 --> 00:00:29.742
that we have to have
Fractional Reserve lending.

00:00:29.742 --> 00:00:31.999
That in order to have this system function

00:00:31.999 --> 00:00:34.400
there has to be engineering in place

00:00:34.400 --> 00:00:36.543
and there still are some drawbacks,

00:00:36.543 --> 00:00:38.936
the un-stability in order to combat that

00:00:38.936 --> 00:00:41.004
you need to have central bank insurance

00:00:41.004 --> 00:00:42.478
and you also have to have the central bank

00:00:42.478 --> 00:00:45.231
as a lender of last resort of reserves.

00:00:45.231 --> 00:00:46.333
The bad incentives ... and these are

00:00:46.333 --> 00:00:48.673
well documented, these
aren't just coming from me.

00:00:48.673 --> 00:00:53.332
Bad incentives, if you
were looking to invest

00:00:53.332 --> 00:00:55.091
in any other type of investment company,

00:00:55.091 --> 00:00:56.584
someone who is taking your money

00:00:56.584 --> 00:00:58.396
and investing it on your behalf,

00:00:58.396 --> 00:01:00.085
they would typically be talking about how

00:01:00.085 --> 00:01:01.799
good they are at investing money.

00:01:01.799 --> 00:01:04.087
Most, when you're looking
at Commerical banks

00:01:04.087 --> 00:01:05.471
that's not what they're talking about

00:01:05.471 --> 00:01:06.935
because they know that
that's not what consumers

00:01:06.935 --> 00:01:08.799
care about because of the insurance there.

00:01:08.799 --> 00:01:11.265
They will talk about
things like how easy it is

00:01:11.265 --> 00:01:13.601
to access your money with their ATM's

00:01:13.601 --> 00:01:15.064
and their online banking,

00:01:15.064 --> 00:01:17.087
how low their fees are.

00:01:17.087 --> 00:01:18.462
They won't even bring up the idea that

00:01:18.462 --> 00:01:20.339
hey, we're lending your
money and we're lending it

00:01:20.339 --> 00:01:23.136
in really, really, responsible ways.

00:01:23.136 --> 00:01:24.739
It is also well documented by having a

00:01:24.739 --> 00:01:26.277
Fractional Reserve lending system,

00:01:26.277 --> 00:01:28.825
it is putting a significant
amount of the money

00:01:28.825 --> 00:01:31.824
creation system, essentially
the checkable deposits,

00:01:31.824 --> 00:01:34.267
it's putting it in the
hands of private banks

00:01:34.267 --> 00:01:37.109
as opposed to the central
banking authority.

00:01:37.109 --> 00:01:39.868
With that out of the way
you're probably saying

00:01:39.868 --> 00:01:41.731
are there any other alternatives.

00:01:41.731 --> 00:01:43.266
I'm not advocating one or the other,

00:01:43.266 --> 00:01:44.801
but I'm just showing you that this is not

00:01:44.801 --> 00:01:47.265
necessarily the only
way that we would have

00:01:47.265 --> 00:01:49.062
to set up our banking system.

00:01:49.062 --> 00:01:51.346
In fact, the original
way is the alternative.

00:01:51.346 --> 00:01:54.536
The original way would
be Full Reserve banking.

00:01:54.536 --> 00:01:59.840
(writing) full, full
reserve, reserve banking.

00:01:59.840 --> 00:02:01.550
It is exactly what it sounds like,

00:02:01.550 --> 00:02:03.842
which is that a bank would have to ...

00:02:03.842 --> 00:02:06.668
if someone puts reserve or cash dollar

00:02:06.668 --> 00:02:09.602
or federal reserve notes in their demand

00:02:09.602 --> 00:02:12.004
deposit account then the
bank would just have to

00:02:12.004 --> 00:02:13.321
keep it there.

00:02:13.321 --> 00:02:15.335
If I have a bank, right over here,

00:02:15.335 --> 00:02:18.406
(drawing) If I have a bank

00:02:18.406 --> 00:02:20.811
and if I were to put $3.

00:02:20.811 --> 00:02:24.606
(drawing) $3, 3 federal reserve notes here

00:02:24.606 --> 00:02:27.273
3 federal reserve notes here.

00:02:27.273 --> 00:02:29.901
If I were to say that this is in my ...

00:02:29.901 --> 00:02:31.481
I want to have this on demand.

00:02:31.481 --> 00:02:33.225
I want to be able to go to the bank at any

00:02:33.225 --> 00:02:35.269
moment in time and be able
to take these things out

00:02:35.269 --> 00:02:37.397
then the bank would have to keep all

00:02:37.397 --> 00:02:38.798
of these reserves there.

00:02:38.798 --> 00:02:41.297
You might say, well then
how will lending happen

00:02:41.297 --> 00:02:42.528
and all the rest?

00:02:42.528 --> 00:02:44.133
In order for lending to
happen the bank would

00:02:44.133 --> 00:02:46.880
have to say hey, look,
you're not going to need

00:02:46.880 --> 00:02:48.466
them to have all of this on demand,

00:02:48.466 --> 00:02:51.003
why don't you keep some
fraction of this on demand,

00:02:51.003 --> 00:02:55.310
maybe it's this dollar
bill right over here

00:02:55.310 --> 00:02:56.930
and the rest of these, we, the bank,

00:02:56.930 --> 00:02:58.678
will literally borrow that from you.

00:02:58.678 --> 00:03:00.421
This isn't an actual foreign concept.

00:03:00.421 --> 00:03:02.260
When you go buy a certificate of deposit

00:03:02.260 --> 00:03:04.600
at a bank, when you put your money in a CD

00:03:04.600 --> 00:03:06.796
at the bank that's essentially
what the bank is doing.

00:03:06.796 --> 00:03:08.533
They are borrowing that money from you,

00:03:08.533 --> 00:03:09.863
they're making it explicit.

00:03:09.863 --> 00:03:10.966
They're not saying that that money will be

00:03:10.966 --> 00:03:11.837
on demand.

00:03:11.837 --> 00:03:13.397
They're saying this is a timed deposit

00:03:13.397 --> 00:03:16.141
that this money, you
are giving it to us now

00:03:16.141 --> 00:03:17.885
and then you can get it back in 6 months,

00:03:17.885 --> 00:03:19.811
or a year, or 2 years or whatever.

00:03:19.811 --> 00:03:20.884
Usually the longer the duration,

00:03:20.884 --> 00:03:23.040
the longer you keep your
money ... you lock your

00:03:23.040 --> 00:03:24.723
money in with them the higher the interest

00:03:24.723 --> 00:03:25.719
they would pay.

00:03:25.719 --> 00:03:27.883
They'll say, look, this is on demand

00:03:27.883 --> 00:03:30.056
(writing) This is on demand, that's in a

00:03:30.056 --> 00:03:31.386
demand deposit.

00:03:31.386 --> 00:03:33.452
Then this right over here,
you will loan it to us,

00:03:33.452 --> 00:03:36.044
this is a time deposit.

00:03:36.044 --> 00:03:38.055
(writing) This is a time deposit.

00:03:38.055 --> 00:03:40.872
Then the bank could loan this money out.

00:03:40.872 --> 00:03:43.789
It could loan these reserves out.

00:03:43.789 --> 00:03:47.290
This loan process would not increase

00:03:47.290 --> 00:03:49.323
the money supply, so that
money could be loaned

00:03:49.323 --> 00:03:51.656
out maybe to someone
else and maybe that gets

00:03:51.656 --> 00:03:53.723
deposited in another bank
and maybe in a demand

00:03:53.723 --> 00:03:58.322
deposit, it gets deposited right over here

00:03:58.322 --> 00:04:00.185
in a demand deposit.

00:04:00.185 --> 00:04:01.627
You might say, well isn't this just like

00:04:01.627 --> 00:04:02.872
Fractional Reserve lending?

00:04:02.872 --> 00:04:04.877
Now you have $5 in the system.

00:04:04.877 --> 00:04:08.461
The difference is, is
that no one can now use

00:04:08.461 --> 00:04:12.462
this perceived money
right over here as money.

00:04:12.462 --> 00:04:14.530
You wouldn't be able to write checks

00:04:14.530 --> 00:04:15.701
against this money right over here.

00:04:15.701 --> 00:04:17.589
You could write it against this over here

00:04:17.589 --> 00:04:18.451
and that's okay.

00:04:18.451 --> 00:04:20.320
You could write a $1 check and it's backed

00:04:20.320 --> 00:04:22.990
by this $1 of reserves so you're not

00:04:22.990 --> 00:04:24.518
creating any new money.

00:04:24.518 --> 00:04:25.922
The only reserves here that really can

00:04:25.922 --> 00:04:29.116
act as money or be used to back checks

00:04:29.116 --> 00:04:31.977
are now the original $3.

00:04:31.977 --> 00:04:35.192
(writing) The original $3 here.

00:04:35.192 --> 00:04:37.190
The value of this type of a system,

00:04:37.190 --> 00:04:38.562
and there are drawbacks to it,

00:04:38.562 --> 00:04:40.516
the main drawback is, that the bank is not

00:04:40.516 --> 00:04:42.396
going to be able to make any money on its

00:04:42.396 --> 00:04:45.592
demand deposits so it
will probably have to

00:04:45.592 --> 00:04:47.557
charge higher fees to customers to

00:04:47.557 --> 00:04:49.148
keep their money.

00:04:49.148 --> 00:04:50.317
They'll say, hey I'm
safeguarding your money,

00:04:50.317 --> 00:04:51.780
I'm putting it in a vault for you,

00:04:51.780 --> 00:04:53.920
I'm making it accessible
to you through checks,

00:04:53.920 --> 00:04:56.251
through ATM's so I'm going to charge you

00:04:56.251 --> 00:04:58.984
more money for me to essentially

00:04:58.984 --> 00:05:00.134
safeguard your money.

00:05:00.134 --> 00:05:01.463
Right now what banks are doing

00:05:01.463 --> 00:05:03.792
and Fractional Reserves system is like,

00:05:03.792 --> 00:05:05.659
hey, we'll do all of
these services for you

00:05:05.659 --> 00:05:08.296
for a lot less, sometimes even free if you

00:05:08.296 --> 00:05:10.053
keep a large enough deposit with them.

00:05:10.053 --> 00:05:11.719
We're going to hold your money for you,

00:05:11.719 --> 00:05:14.388
we're going to keep it accessible on ATM,

00:05:14.388 --> 00:05:16.793
we're going to give you a bank ATM card

00:05:16.793 --> 00:05:18.720
and all of these things.

00:05:18.720 --> 00:05:20.627
The reason why the bank is able to do that

00:05:20.627 --> 00:05:22.253
is because they're essentially doing ...

00:05:22.253 --> 00:05:24.127
they're lending out a
significant fraction of

00:05:24.127 --> 00:05:25.938
your money and getting interest on it

00:05:25.938 --> 00:05:27.389
and that's how they're making money.

00:05:27.389 --> 00:05:29.512
Here it just becomes much more explicit.

00:05:29.512 --> 00:05:32.027
The bank is saying, look,
on this right over here

00:05:32.027 --> 00:05:34.176
we are doing a service
for you, we are holding

00:05:34.176 --> 00:05:36.265
your money, we are keeping it on demand

00:05:36.265 --> 00:05:38.068
from wherever you want to access it

00:05:38.068 --> 00:05:39.859
and over here you are
doing a service for us,

00:05:39.859 --> 00:05:41.300
you are lending us your money

00:05:41.300 --> 00:05:42.959
and then we are going
to lend it out probably

00:05:42.959 --> 00:05:45.653
for higher interest so
that way we can make

00:05:45.653 --> 00:05:48.503
money off of it.

00:05:48.503 --> 00:05:50.056
Obviously if we were
to convert to some type

00:05:50.056 --> 00:05:52.995
of a system like this,
there wouldn't be as

00:05:52.995 --> 00:05:56.398
much money being created
or actually no money

00:05:56.398 --> 00:05:58.928
would be created by this lending process.

00:05:58.928 --> 00:06:01.483
So, the central bank
or whoever the monetary

00:06:01.483 --> 00:06:02.996
authority is in the country would have to

00:06:02.996 --> 00:06:05.428
essentially print more
money to have the money

00:06:05.428 --> 00:06:07.796
available to essentially be the grease

00:06:07.796 --> 00:06:09.198
in the economy.

00:06:09.198 --> 00:06:11.696
Just to make it clear
that this isn't a fringe

00:06:11.696 --> 00:06:14.994
idea, that this is
essentially what banking was

00:06:14.994 --> 00:06:16.587
until the mid 14th Century.

00:06:16.587 --> 00:06:18.727
It was the Venetian bankers
who first brought up

00:06:18.727 --> 00:06:20.453
the idea of Fractional Reserve lending

00:06:20.453 --> 00:06:22.390
and there were some very mainstream banks

00:06:22.390 --> 00:06:26.975
that did full reserve
lending into the 1800s.

00:06:26.975 --> 00:06:29.411
As The Great Depression
got longer and longer,

00:06:29.411 --> 00:06:32.742
in 1939 some very serious
economists proposed

00:06:32.742 --> 00:06:37.056
a reversion back to Full Reserve banking.

00:06:37.056 --> 00:06:39.464
They even articulated
exactly how it would do

00:06:39.464 --> 00:06:43.396
and how it would not introduce too many

00:06:43.396 --> 00:06:46.479
interruptions to the economy.

00:06:46.479 --> 00:06:48.152
Although, anything like
this would be dangerous

00:06:48.152 --> 00:06:50.819
because you introducing
a whole new way of doing

00:06:50.819 --> 00:06:52.479
things and you don't know exactly what

00:06:52.479 --> 00:06:54.105
the repercussions will be on the economy.

00:06:54.105 --> 00:06:55.465
If you want to read their proposal

00:06:55.465 --> 00:06:56.733
it's actually quite fascinating.

00:06:56.733 --> 00:06:58.666
In just reading their proposal you'll get

00:06:58.666 --> 00:07:00.666
more depth on how the
monetary system works.

00:07:00.666 --> 00:07:02.750
It's written by mainstream economists.

00:07:02.750 --> 00:07:04.235
Do a Google search for

00:07:04.235 --> 00:07:07.735
A Program for Monetary Reform.

00:07:08.280 --> 00:07:12.803
(writing) ... for
Monetary, monetary Reform.

00:07:12.803 --> 00:07:16.256
It was written in 1939, so you can also do

00:07:16.256 --> 00:07:17.626
a Google for that.

00:07:17.626 --> 00:07:19.393
On Wikipedia there is
actually the full text

00:07:19.393 --> 00:07:21.658
of A Program for Monetary Reform.

00:07:21.658 --> 00:07:23.887
When it was published it was supported

00:07:23.887 --> 00:07:26.587
actually by a majority
by mainstream economists

00:07:26.587 --> 00:07:30.423
to go to a Full Reserve banking system.


Weaknesses of fractional reserve lending

WEBVTT
Kind: captions
Language: en

00:00:00.996 --> 00:00:02.269
Voiceover: What we're going
to talk about in this video

00:00:02.269 --> 00:00:07.859
are the negatives of
fractional reserve lending.

00:00:07.859 --> 00:00:11.127
And the biggest negative of
fractional reserve lending,

00:00:11.127 --> 00:00:12.611
and these are all related,

00:00:12.611 --> 00:00:14.354
is that it's fundamentally unstable

00:00:14.354 --> 00:00:16.210
unless you have a lot of engineering

00:00:16.210 --> 00:00:17.987
on the part of central
banks and governments

00:00:17.987 --> 00:00:19.495
to make it more stable.

00:00:19.495 --> 00:00:22.967
Unnatural things have to be put

00:00:22.967 --> 00:00:24.745
in place to make it stable.

00:00:24.745 --> 00:00:26.912
And the reason why I say it's unstable

00:00:26.912 --> 00:00:29.654
is because all of these
depositors have been promised

00:00:29.654 --> 00:00:32.500
that their money is safe and sound,

00:00:32.500 --> 00:00:35.874
that at any point they
can come to the bank

00:00:35.874 --> 00:00:38.274
and get their money. It's on demand.

00:00:38.274 --> 00:00:41.536
But a good fraction of that
money is being lent out.

00:00:41.536 --> 00:00:43.738
You can imagine, let's say
that all of these banks

00:00:43.738 --> 00:00:45.909
are lending out the money responsibly,

00:00:45.909 --> 00:00:47.674
but let's say this bank
something shady happens.

00:00:47.674 --> 00:00:50.221
It lends out money in a really bad way

00:00:50.221 --> 00:00:51.663
and it doesn't get it back,

00:00:51.663 --> 00:00:53.005
or maybe it's even worse.

00:00:53.005 --> 00:00:55.041
Maybe there's some type
of fraud taking place

00:00:55.041 --> 00:00:57.003
where executives were embezzling money.

00:00:57.003 --> 00:00:59.164
Whatever. These are good
actors within a fractional

00:00:59.164 --> 00:01:00.493
reserve lending system.

00:01:00.493 --> 00:01:01.510
This is a bad actor.

00:01:01.510 --> 00:01:02.789
It made a bad loan.

00:01:02.789 --> 00:01:04.744
Now all of a sudden this money is gone.

00:01:04.744 --> 00:01:07.252
If you don't have any support from central

00:01:07.252 --> 00:01:09.045
banks or from governments,

00:01:09.045 --> 00:01:10.872
now all of these customers
are going to say,

00:01:10.872 --> 00:01:12.669
"Wait, I heard something
shady happened at this bank."

00:01:12.669 --> 00:01:14.592
They're all going to show up at this bank

00:01:14.592 --> 00:01:18.486
all on the same day and
they're going to say,

00:01:18.486 --> 00:01:20.217
"Give us back our money."

00:01:20.217 --> 00:01:21.891
Then it will be pretty
clear that their money

00:01:21.891 --> 00:01:23.805
actually was not available,

00:01:23.805 --> 00:01:25.638
that it was lent out, some of it was lost.

00:01:25.638 --> 00:01:29.822
They will be very upset,
these people right over here.

00:01:29.822 --> 00:01:32.200
It's not just bad for this bank.

00:01:32.200 --> 00:01:34.314
It's not just bad for this bank.

00:01:34.314 --> 00:01:37.004
It doesn't even have to be that this bank

00:01:37.004 --> 00:01:39.071
actually did anything fundamentally bad.

00:01:39.071 --> 00:01:42.404
If even rumors start to spread
that something at this bank

00:01:42.404 --> 00:01:44.074
is a little bit fishy,

00:01:44.074 --> 00:01:46.162
you could imagine every one
of these bank's customers

00:01:46.162 --> 00:01:48.538
showing up when that news
report hits and says,

00:01:48.538 --> 00:01:50.050
"Give us back our money."

00:01:50.050 --> 00:01:51.936
They'll say, "Well I can give
you back 10% of your money.

00:01:51.936 --> 00:01:54.760
"The other 90% has been lent out."

00:01:54.760 --> 00:01:57.218
That won't just affect this bank.

00:01:57.218 --> 00:01:59.554
As soon as these people
try to go get their money

00:01:59.554 --> 00:02:01.070
and they're not able to see it,

00:02:01.070 --> 00:02:02.942
then the rest of the economy,

00:02:02.942 --> 00:02:04.403
all the other actors in it will say,

00:02:04.403 --> 00:02:07.423
"Wow, the banking system isn't
as solid as I thought it was."

00:02:07.423 --> 00:02:08.982
So all of these other banks,

00:02:08.982 --> 00:02:10.565
and maybe there wasn't
any news report written

00:02:10.565 --> 00:02:12.172
about them and they
didn't do anything shady.

00:02:12.172 --> 00:02:14.424
All of their customers are
going to start showing up.

00:02:14.424 --> 00:02:16.842
They're going to say,
"Well, you promised me

00:02:16.842 --> 00:02:18.572
"that my money is available on demand,

00:02:18.572 --> 00:02:20.353
"well I'm demanding it right now."

00:02:20.353 --> 00:02:22.397
Of course they're not
going to be able to get it

00:02:22.397 --> 00:02:25.691
because their money was being lent out.

00:02:25.691 --> 00:02:27.906
The situation that you
have right here is called

00:02:27.906 --> 00:02:29.666
a run on banks.

00:02:29.666 --> 00:02:31.753
You know banks lent out 90% of the money

00:02:31.753 --> 00:02:34.903
and so really people
cannot get access to it.

00:02:34.903 --> 00:02:38.353
You can imagine this is a
very, very, very bad situation.

00:02:38.353 --> 00:02:40.266
You can have major bank failures.

00:02:40.266 --> 00:02:42.344
A lot of lending starts to be ...

00:02:42.344 --> 00:02:44.586
The whole banking system
essentially has to unwind

00:02:44.586 --> 00:02:48.200
in some way and it would probably throw

00:02:48.200 --> 00:02:50.207
the economy as a whole into something

00:02:50.207 --> 00:02:54.614
of a downward spiral.

00:02:54.614 --> 00:02:58.839
So the way that governments
attempt to address this issue

00:02:58.839 --> 00:03:01.211
and in particular it's
usually the Central Bank,

00:03:01.211 --> 00:03:02.873
is they say, "Okay we'll insure banks."

00:03:02.873 --> 00:03:05.581
That's why you'll often
see at the front door

00:03:05.581 --> 00:03:07.751
of a bank you'll see FDIC,

00:03:07.751 --> 00:03:10.481
which means Federal Deposit
Insurance Corporation,

00:03:10.481 --> 00:03:12.424
which means that the
federal reserve is insuring

00:03:12.424 --> 00:03:13.755
that bank.

00:03:13.755 --> 00:03:15.271
So for whatever reason,

00:03:15.271 --> 00:03:17.337
it's usually up to some
amount of deposits,

00:03:17.337 --> 00:03:19.345
if one of these scenarios happens

00:03:19.345 --> 00:03:21.927
and the bank does not
have the money on hand,

00:03:21.927 --> 00:03:23.601
the Federal Reserve will say,

00:03:23.601 --> 00:03:28.231
"Okay, we'll just make sure
that you have the money."

00:03:28.231 --> 00:03:30.411
It's not an easy process
and it takes some time

00:03:30.411 --> 00:03:33.744
but eventually the Federal
Reserve will give them the money.

00:03:33.744 --> 00:03:36.735
But that by itself
creates another problem.

00:03:36.735 --> 00:03:39.534
So that creates really the second problem

00:03:39.534 --> 00:03:46.239
is bad incentive, or nonmarket,
I would say discipline.

00:03:46.239 --> 00:03:48.084
Bad incentives.

00:03:48.084 --> 00:03:50.734
Because in a traditional
system if I was giving

00:03:50.734 --> 00:03:52.942
my money to someone and
they were going to go

00:03:52.942 --> 00:03:54.318
and lend it to someone else,

00:03:54.318 --> 00:03:56.382
I would really care how
they're lending that money.

00:03:56.382 --> 00:03:58.117
I would really care how they're managing

00:03:58.117 --> 00:03:59.577
their business.

00:03:59.577 --> 00:04:02.404
I would want transparency in terms of what

00:04:02.404 --> 00:04:05.563
investments they're making and
how safe they are etc, etc.

00:04:05.563 --> 00:04:08.897
But in a situation where
all of the banks have this

00:04:08.897 --> 00:04:10.571
FDIC insurance,

00:04:10.571 --> 00:04:13.988
they essentially are back
stopped by the government.

00:04:13.988 --> 00:04:16.764
Now all of the sudden when
customers go to the bank

00:04:16.764 --> 00:04:18.316
they're like, "You know
what? I really don't

00:04:18.316 --> 00:04:19.820
"care what you do with my money.

00:04:19.820 --> 00:04:22.422
"I have FDIC banking so all I really care

00:04:22.422 --> 00:04:25.213
"about is if you have cute kittens on your

00:04:25.213 --> 00:04:27.233
"checkbooks and you have lots of ATMs.

00:04:27.233 --> 00:04:28.801
"You have very impressive
looking buildings."

00:04:28.801 --> 00:04:31.146
They really wouldn't
scrutinize the financials.

00:04:31.146 --> 00:04:33.605
So you don't have that
market incentive anymore

00:04:33.605 --> 00:04:36.254
for banks to say, "Hey
look, we are good shepherds

00:04:36.254 --> 00:04:37.388
"of your money.

00:04:37.388 --> 00:04:39.320
"Look at where your
assets are being spent.

00:04:39.320 --> 00:04:40.963
"We want the market to scrutinize us onto

00:04:40.963 --> 00:04:43.233
"whether we are making good loans

00:04:43.233 --> 00:04:44.900
"or we are making bad loans."

00:04:44.900 --> 00:04:49.670
The third problem with
fractional reserve lending

00:04:49.670 --> 00:04:51.646
is that because of
fractional reserve lending,

00:04:51.646 --> 00:04:53.534
you're giving the private banking system

00:04:53.534 --> 00:04:56.335
a good deal of control
over the money supply.

00:04:56.335 --> 00:04:57.817
If they lend more,

00:04:57.817 --> 00:05:03.403
so lending translates into
more money in the money supply

00:05:03.403 --> 00:05:04.957
or the other way around,

00:05:04.957 --> 00:05:06.703
if lending were to go away,

00:05:06.703 --> 00:05:09.561
that would mean contraction of
money in the lending supply.

00:05:09.561 --> 00:05:12.486
The problem with this is
when the economy is weak.

00:05:12.486 --> 00:05:16.407
Let's say you have a recession,

00:05:16.407 --> 00:05:21.615
standard monetary policy
arguments you would say,

00:05:21.615 --> 00:05:23.345
you want to increase the money supply.

00:05:23.345 --> 00:05:25.408
Maybe you want to lower
interest rates so that

00:05:25.408 --> 00:05:28.710
people will borrow and start
to consume or invest again.

00:05:28.710 --> 00:05:32.473
So you want during a
recession, you want more money.

00:05:32.473 --> 00:05:34.045
What's going to happen?

00:05:34.045 --> 00:05:35.710
Central Bank tends to do that.

00:05:35.710 --> 00:05:37.543
When it is clear that
it is in a recession,

00:05:37.543 --> 00:05:40.549
the Central Bank will
attempt to print more money.

00:05:40.549 --> 00:05:42.457
But in a fractional
reserve lending system,

00:05:42.457 --> 00:05:44.809
that's only part of the
money supply equation.

00:05:44.809 --> 00:05:47.713
You also have the lending and
when you're in a recession,

00:05:47.713 --> 00:05:50.637
lending goes back.

00:05:50.637 --> 00:05:52.094
So this is what you want.

00:05:52.094 --> 00:05:53.741
You want this.

00:05:53.741 --> 00:05:55.223
Central Bank might do it.

00:05:55.223 --> 00:05:57.066
That is what you want.

00:05:57.066 --> 00:05:59.311
The reality is in a recession the banks

00:05:59.311 --> 00:06:00.589
are going to get scared.

00:06:00.589 --> 00:06:02.342
They're going to see their loans go bad

00:06:02.342 --> 00:06:04.368
and you have less lending.

00:06:04.368 --> 00:06:07.469
It's going to essentially have the exact

00:06:07.469 --> 00:06:09.384
opposite effect of what you want.

00:06:09.384 --> 00:06:13.514
You're going to have less, and
I should put money in quotes.

00:06:13.514 --> 00:06:15.081
It depends on how you define money

00:06:15.081 --> 00:06:17.035
but you have less money in circulation.

00:06:17.035 --> 00:06:18.736
The opposite happens in the boom.

00:06:18.736 --> 00:06:21.089
The economy is down
and out in a recession.

00:06:21.089 --> 00:06:23.301
It's going to be even worse
when that lending dries up.

00:06:23.301 --> 00:06:25.420
There's going to be even
less money in circulation.

00:06:25.420 --> 00:06:27.370
It's going to be even harder for people

00:06:27.370 --> 00:06:29.030
to get access to capital.

00:06:29.030 --> 00:06:30.808
The opposite is true in a boom.

00:06:30.808 --> 00:06:33.535
I'm running out of real
estate on my screen.

00:06:33.535 --> 00:06:39.069
In a boom when the economy is
well heated or overheating,

00:06:39.069 --> 00:06:42.074
Central Bank will say,
"Hey let me take a little

00:06:42.074 --> 00:06:43.697
"bit of that fuel out of the fire."

00:06:43.697 --> 00:06:48.492
So what you want is less
money and Central Bank

00:06:48.492 --> 00:06:51.205
might do that by taking
securities it owns,

00:06:51.205 --> 00:06:52.808
selling it in the open market

00:06:52.808 --> 00:06:54.545
and then it takes that cash and it could

00:06:54.545 --> 00:06:56.542
even discontinue that cash,

00:06:56.542 --> 00:07:00.173
and that's what Central Bank could do.

00:07:00.173 --> 00:07:01.612
Central Bank could actually act on this.

00:07:01.612 --> 00:07:03.257
In a boom banks get even more confident.

00:07:03.257 --> 00:07:05.527
They get less risk and
start understating the risk

00:07:05.550 --> 00:07:10.069
and so the reality is
you have more lending.

00:07:10.069 --> 00:07:12.801
It essentially puts more
... which is more money.

00:07:12.801 --> 00:07:15.671
More money in the system and essentially

00:07:15.671 --> 00:07:17.347
adding more fuels to the flame

00:07:17.347 --> 00:07:20.475
in an economy that is
already getting overheated.

00:07:20.475 --> 00:07:23.143
So a lot of times this
fractional reserve lending

00:07:23.143 --> 00:07:26.283
might lead to the money creation process

00:07:26.283 --> 00:07:28.206
going in the exact opposite
direction that you want

00:07:28.206 --> 00:07:31.025
it to go if you really wanted to moderate

00:07:31.025 --> 00:07:34.000
the fluctuations in the economy.


Overview of fractional reserve banking

WEBVTT
Kind: captions
Language: en

00:00:00.464 --> 00:00:01.880
What I want to do
in this video is

00:00:01.880 --> 00:00:06.937
give an overview of how money
is created in most market based

00:00:06.937 --> 00:00:09.270
economies, and even a little
bit of a discussion of what

00:00:09.270 --> 00:00:11.420
really is money.

00:00:11.420 --> 00:00:13.711
And we can go into much
more depth in future videos.

00:00:13.711 --> 00:00:15.210
And I think in many
videos I already

00:00:15.210 --> 00:00:17.620
have gone into a much
more technical depth.

00:00:17.620 --> 00:00:20.560
In most market based
economies right now

00:00:20.560 --> 00:00:24.230
there is a central bank, which
is essentially the actor,

00:00:24.230 --> 00:00:25.410
they do many things.

00:00:25.410 --> 00:00:27.960
They often will be a
regulatory agency as well.

00:00:27.960 --> 00:00:31.120
But their main role is to
have the right to print money,

00:00:31.120 --> 00:00:33.960
and to put that money
into circulation.

00:00:33.960 --> 00:00:36.630
And I'll rely heavily
on the model of the US.

00:00:39.350 --> 00:00:40.620
That's hard to read.

00:00:40.620 --> 00:00:44.260
The central bank
in some countries

00:00:44.260 --> 00:00:46.890
is formerly part
of the government.

00:00:46.890 --> 00:00:49.240
In other countries,
it's pseudo-independent.

00:00:49.240 --> 00:00:49.880
In the US.

00:00:49.880 --> 00:00:51.970
It's more of the
pseudo-independent flavor

00:00:51.970 --> 00:00:57.510
of a central bank, although
obviously closely connected

00:00:57.510 --> 00:00:58.540
with the government.

00:00:58.540 --> 00:01:01.220
The US Federal Reserve,
a lot of the leaders

00:01:01.220 --> 00:01:04.430
are appointed by the government.

00:01:04.430 --> 00:01:06.890
It's excess profits go
back to the government.

00:01:06.890 --> 00:01:10.040
And so obviously it has very
close ties to the government.

00:01:10.040 --> 00:01:12.157
But when the central bank
decides to print money,

00:01:12.157 --> 00:01:13.490
it literally can just create it.

00:01:13.490 --> 00:01:15.740
It could literally
print physical money.

00:01:15.740 --> 00:01:17.520
Or it can create
electronic money,

00:01:17.520 --> 00:01:20.240
which has the same exact effect.

00:01:20.240 --> 00:01:23.000
So let's say the central
bank, it goes out there

00:01:23.000 --> 00:01:27.170
and it goes out there
and it prints three--

00:01:27.170 --> 00:01:29.320
and we'll just focus on
the physical right now.

00:01:29.320 --> 00:01:31.400
It's a little bit
easier to conceptualize.

00:01:31.400 --> 00:01:34.310
And it just goes out there and
it prints three physical dollar

00:01:34.310 --> 00:01:34.839
bills.

00:01:34.839 --> 00:01:36.380
Now it has to figure
out, how does it

00:01:36.380 --> 00:01:37.560
get it into circulation?

00:01:37.560 --> 00:01:39.090
How does it get it
into the economy?

00:01:39.090 --> 00:01:41.480
And it does not just
put it into a helicopter

00:01:41.480 --> 00:01:43.330
and drop it from
that helicopter.

00:01:43.330 --> 00:01:45.680
Sometimes, in certain
circumstances,

00:01:45.680 --> 00:01:53.070
it can lend to this directly to
banks, certain types of banks,

00:01:53.070 --> 00:01:53.850
member banks.

00:01:53.850 --> 00:01:56.670
But the typical way that
this enters circulation

00:01:56.670 --> 00:01:59.910
is that the central bank will
use this newly created money,

00:01:59.910 --> 00:02:03.140
this newly created
reserves I should say,

00:02:03.140 --> 00:02:05.755
to go out into the open
market and buy securities.

00:02:05.755 --> 00:02:08.690
And they typically buy very
safe securities, typically

00:02:08.690 --> 00:02:10.130
government debt.

00:02:10.130 --> 00:02:11.560
So they will go
out there and they

00:02:11.560 --> 00:02:12.865
will put this into circulation.

00:02:15.850 --> 00:02:19.300
And in exchange they
are buying securities

00:02:19.300 --> 00:02:20.500
from the open market.

00:02:20.500 --> 00:02:23.370
So then these securities
from the open market

00:02:23.370 --> 00:02:25.910
will go to the central bank.

00:02:25.910 --> 00:02:31.390
So these are securities, or
maybe we could call them bonds.

00:02:31.390 --> 00:02:35.140
And once they do that, then
whoever had these before,

00:02:35.140 --> 00:02:37.170
whoever was the owner of
the securities before,

00:02:37.170 --> 00:02:38.003
they just sold them.

00:02:38.003 --> 00:02:39.440
Now they have
these dollar bills.

00:02:39.440 --> 00:02:42.825
And they could either directly
spend those dollar bills

00:02:42.825 --> 00:02:44.950
or they could deposit those
dollar bills in a bank.

00:02:44.950 --> 00:02:46.449
If they spend the
dollar bills, then

00:02:46.449 --> 00:02:48.772
whoever they gave those
dollar bills to at some point

00:02:48.772 --> 00:02:50.230
would want to
deposit it in a bank.

00:02:50.230 --> 00:02:53.680
Some way, by buying
these securities,

00:02:53.680 --> 00:02:55.690
someone now has
these dollar bills.

00:02:55.690 --> 00:02:58.580
And they will deposit
them in a private bank.

00:02:58.580 --> 00:02:59.880
So let's draw that.

00:02:59.880 --> 00:03:05.120
So right over here
is a private bank.

00:03:05.120 --> 00:03:07.410
And now it has the dollar bills.

00:03:07.410 --> 00:03:09.900
It has these reserves now.

00:03:09.900 --> 00:03:12.760
It has the reserves.

00:03:12.760 --> 00:03:15.360
Now, that's not the
end of the story.

00:03:15.360 --> 00:03:17.730
This money can now be lent.

00:03:17.730 --> 00:03:20.050
And this is key,
because this is what's

00:03:20.050 --> 00:03:23.200
typical in most
market economies where

00:03:23.200 --> 00:03:25.490
they have fractional
reserve lending.

00:03:25.490 --> 00:03:34.690
So fractional reserve lending,
which is a bit strange,

00:03:34.690 --> 00:03:37.200
because you are telling the
person who just deposited

00:03:37.200 --> 00:03:40.290
this money right here, that
you can go at any time and you

00:03:40.290 --> 00:03:41.310
can take this money out.

00:03:41.310 --> 00:03:42.840
We've got this money for you.

00:03:42.840 --> 00:03:43.590
You can trust us.

00:03:43.590 --> 00:03:45.340
You don't have to be
paranoid about what's

00:03:45.340 --> 00:03:46.870
going on with this money.

00:03:46.870 --> 00:03:48.710
But the reality
is that this bank

00:03:48.710 --> 00:03:51.570
is allowed to keep only a
fraction of these reserves,

00:03:51.570 --> 00:03:55.420
and lend to the rest of it out.

00:03:55.420 --> 00:03:58.172
In order for this system
to not be super fragile,

00:03:58.172 --> 00:04:00.130
the Central Bank then
also insures these banks.

00:04:00.130 --> 00:04:02.020
But we'll talk about
that into more depth.

00:04:02.020 --> 00:04:02.520
But here.

00:04:02.520 --> 00:04:04.520
I just want to show you
how the money is created

00:04:04.520 --> 00:04:06.914
in this fractional
reserve lending system.

00:04:06.914 --> 00:04:08.330
So this bank right
over here says,

00:04:08.330 --> 00:04:09.870
well I have to keep a
little bit of these reserves

00:04:09.870 --> 00:04:10.940
in case that guy comes.

00:04:10.940 --> 00:04:13.557
The probability of
all my customers

00:04:13.557 --> 00:04:15.890
coming on the same day and
asking for all of their money

00:04:15.890 --> 00:04:16.589
is low.

00:04:16.589 --> 00:04:18.880
I just have to keep a little
bit for whoever does come.

00:04:18.880 --> 00:04:20.760
And then the rest of
it I can lend out,

00:04:20.760 --> 00:04:23.060
even though I promised everyone
that all of their money

00:04:23.060 --> 00:04:24.260
is available.

00:04:24.260 --> 00:04:26.440
And so they lend
it out to whoever

00:04:26.440 --> 00:04:29.870
needs to borrow that money,
who looks like a decent risk.

00:04:29.870 --> 00:04:31.870
And those people might
not spend it immediately.

00:04:31.870 --> 00:04:33.729
And so they would
deposit it into a bank.

00:04:33.729 --> 00:04:35.520
Or they might spend
that money immediately.

00:04:35.520 --> 00:04:37.350
They by a factor,
or they buy a car.

00:04:37.350 --> 00:04:38.670
They do something with it.

00:04:38.670 --> 00:04:41.124
And whoever they bought
that new thing from,

00:04:41.124 --> 00:04:42.790
those people now have
the money and they

00:04:42.790 --> 00:04:44.530
will deposit it into a bank.

00:04:44.530 --> 00:04:46.690
And so this newly
lent money will then

00:04:46.690 --> 00:04:48.350
end up in perhaps another bank.

00:04:48.350 --> 00:04:50.340
It could even be the same bank.

00:04:50.340 --> 00:04:58.004
So that will also end up
in a bank, right over here.

00:04:58.004 --> 00:04:59.670
And now this bank,
it can also only keep

00:04:59.670 --> 00:05:02.190
a fraction of the reserves
and lend out the rest.

00:05:02.190 --> 00:05:05.090
And for simplicity, in
most banking systems,

00:05:05.090 --> 00:05:07.610
they only have to keep
on the order of about 10%

00:05:07.610 --> 00:05:10.310
of the reserves in house, and
the rest they could lend out.

00:05:10.310 --> 00:05:10.920
But over here.

00:05:10.920 --> 00:05:12.600
I'm keeping much
larger reserves just

00:05:12.600 --> 00:05:15.637
for the sake of making it
easy to draw this diagram.

00:05:15.637 --> 00:05:17.220
So this bank right
over here, maybe it

00:05:17.220 --> 00:05:18.690
decides to keep
this dollar bill,

00:05:18.690 --> 00:05:21.020
and it could lend this
one right over here out.

00:05:21.020 --> 00:05:23.410
And once again, when it
lands that dollar bill,

00:05:23.410 --> 00:05:25.704
it will end up
somehow-- the person

00:05:25.704 --> 00:05:27.870
they lend it to might keep
it in a bank temporarily.

00:05:27.870 --> 00:05:29.410
Or they might immediately
buy something.

00:05:29.410 --> 00:05:31.090
And when they buy something,
it will eventually

00:05:31.090 --> 00:05:33.464
end up in a bank because the
person they bought something

00:05:33.464 --> 00:05:34.910
from will deposit that money.

00:05:34.910 --> 00:05:36.730
And so it could end
up in another bank.

00:05:40.259 --> 00:05:42.300
And now this is interesting,
and in future videos

00:05:42.300 --> 00:05:44.760
we'll go into more of the math
of exactly how much money is

00:05:44.760 --> 00:05:45.520
being created.

00:05:45.520 --> 00:05:49.650
And it's an interesting
mathematical problem.

00:05:49.650 --> 00:05:52.540
Actually, it's a sum of an
infinite series, and all that.

00:05:52.540 --> 00:05:53.970
And you can look
that up if you're

00:05:53.970 --> 00:05:56.290
interested in those ideas.

00:05:56.290 --> 00:05:59.570
But the basic idea here is even
though the central bank printed

00:05:59.570 --> 00:06:03.020
three units of base money,
$3.00 right over here,

00:06:03.020 --> 00:06:05.430
there's a lot more
money in the system.

00:06:05.430 --> 00:06:08.692
You have this guy, who made this
deposit, thinks he has $3.00.

00:06:08.692 --> 00:06:10.150
This person thinks
they have $2.00.

00:06:10.150 --> 00:06:12.020
This person thinks
they have one.

00:06:12.020 --> 00:06:14.930
So just in this example over
here, we have one, two, three,

00:06:14.930 --> 00:06:17.240
four, five $6.00.

00:06:17.240 --> 00:06:23.864
So just right over here we
have $6.00 in this system.

00:06:23.864 --> 00:06:25.780
And you might say, well,
is this really money?

00:06:25.780 --> 00:06:26.940
This is deposited.

00:06:26.940 --> 00:06:29.120
This guy thinks he has
it, but he's not using it.

00:06:29.120 --> 00:06:30.770
If he had to use it he
would have to withdraw it,

00:06:30.770 --> 00:06:32.686
and then the bank wouldn't
be able to do this.

00:06:32.686 --> 00:06:35.200
And this is where checking
accounts are really important.

00:06:35.200 --> 00:06:38.150
I'm assuming that these were
on demand checking accounts.

00:06:38.150 --> 00:06:40.046
So this guy, the
reason why he's not

00:06:40.046 --> 00:06:41.920
going to withdraw this
money, is he can still

00:06:41.920 --> 00:06:44.540
use it as money
by writing checks.

00:06:44.540 --> 00:06:47.680
So if this guy, let's say this
is all the money that he has,

00:06:47.680 --> 00:06:50.960
and he decides if he really
needs to buy an apple.

00:06:50.960 --> 00:06:54.970
And that Apple costs $1.00.

00:06:54.970 --> 00:06:57.900
So this is my drawing of
an apple right over here.

00:06:57.900 --> 00:07:01.540
He does not have to withdraw
this $1.00 out of the bank.

00:07:01.540 --> 00:07:02.810
He can write a check.

00:07:02.810 --> 00:07:06.090
So right now he has claims to
all three of these dollars.

00:07:06.090 --> 00:07:10.460
He can write a check to
the apple vendor, so $1.00.

00:07:10.460 --> 00:07:14.030
He writes a check, gives
it to the apple vendor,

00:07:14.030 --> 00:07:17.200
and now he'll get the apple, so
this check is acting as money.

00:07:17.200 --> 00:07:19.610
And now the apple vendor
will have the rights to one

00:07:19.610 --> 00:07:21.045
of these dollars
right over here.

00:07:21.045 --> 00:07:22.920
And now the apple vendor
could write a check.

00:07:22.920 --> 00:07:25.450
So this dollar never has to
leave the banking system.

00:07:25.450 --> 00:07:27.310
But because of checks
it is essentially

00:07:27.310 --> 00:07:31.190
enabling-- this check writing--
is enabling these transactions

00:07:31.190 --> 00:07:31.950
to occur.

00:07:31.950 --> 00:07:33.690
So it's still
enabling, either you

00:07:33.690 --> 00:07:36.520
could view it as it's still
acting in some forms of money

00:07:36.520 --> 00:07:38.170
because the rights
to it can change,

00:07:38.170 --> 00:07:40.310
even though it's sitting out
in here and it's been lent.

00:07:40.310 --> 00:07:42.685
Or you could say that it's
enabling the writing of checks

00:07:42.685 --> 00:07:45.340
that are acting as
some form of money.

00:07:45.340 --> 00:07:47.190
And the whole reason
I want to do this,

00:07:47.190 --> 00:07:48.648
I'm going through
this exercise, is

00:07:48.648 --> 00:07:50.874
to show you that the amount
of money in circulation

00:07:50.874 --> 00:07:52.290
isn't really in
the Central Banks,

00:07:52.290 --> 00:07:54.590
or not directly in the
Central Bank's control.

00:07:54.590 --> 00:07:57.120
They can definitely decide,
hey I'm going to print money,

00:07:57.120 --> 00:07:59.029
buy securities, put
it into circulation.

00:07:59.029 --> 00:08:01.070
Or if they want to take
money out of circulation,

00:08:01.070 --> 00:08:03.336
they can decide to
sell these securities.

00:08:03.336 --> 00:08:04.960
And then when they
sell the securities,

00:08:04.960 --> 00:08:06.906
maybe this guy will
buy them, those dollars

00:08:06.906 --> 00:08:08.280
will go back to
the Central Bank.

00:08:08.280 --> 00:08:10.196
And maybe they could put
it out of commission.

00:08:10.196 --> 00:08:12.290
But you have this whole
effect right over here.

00:08:12.290 --> 00:08:14.080
If you have more
lending occurring,

00:08:14.080 --> 00:08:17.210
if the banks are feeling very
confident, then more of this

00:08:17.210 --> 00:08:18.000
will happen.

00:08:18.000 --> 00:08:20.800
You will get more of this--
the multiplier effect

00:08:20.800 --> 00:08:21.860
of this lending.

00:08:21.860 --> 00:08:23.770
And if less lending
is happening,

00:08:23.770 --> 00:08:27.273
then you could potentially
see all of this contract.


Risks of Keynesian thinking

WEBVTT
Kind: captions
Language: en

00:00:00.472 --> 00:00:02.870
Voiceover: In the last video
we had a little bit of review

00:00:02.870 --> 00:00:05.203
of classical economics
and then we talked about

00:00:05.203 --> 00:00:07.403
how Keynesian thinking was a departure,

00:00:07.403 --> 00:00:09.473
especially, and why it
might have made sense

00:00:09.473 --> 00:00:11.453
in the context of the Great Depression,

00:00:11.453 --> 00:00:13.536
where the economy was operating well below

00:00:13.536 --> 00:00:14.703
its potential.

00:00:14.703 --> 00:00:15.951
What I want to do -

00:00:15.951 --> 00:00:18.535
It may be true anytime that
the economy is operating

00:00:18.535 --> 00:00:20.136
well below its potential.

00:00:20.136 --> 00:00:21.370
What I want to talk about in this video

00:00:21.370 --> 00:00:24.136
is how Keynesian thinking
can sometimes be dangerous.

00:00:24.136 --> 00:00:25.702
One thing I do want to
emphasize over the course

00:00:25.702 --> 00:00:29.067
of this video is Keynesian
policies are often associated

00:00:29.067 --> 00:00:31.804
with people on the left,
with policies on the left,

00:00:31.804 --> 00:00:34.119
democrats in the United States.

00:00:34.119 --> 00:00:37.069
The republicans also, for the most part,

00:00:37.069 --> 00:00:38.869
especially mainstream republicans,

00:00:38.869 --> 00:00:41.003
especially the last
several administrations,

00:00:41.003 --> 00:00:43.804
they have practiced what
can only be described

00:00:43.804 --> 00:00:45.138
as Keynesian policies.

00:00:45.138 --> 00:00:47.704
When the economy started
to recede, they tried

00:00:47.704 --> 00:00:51.119
to stimulate it by shifting
aggregate demand to the right

00:00:51.119 --> 00:00:52.869
somehow and we'll talk about
that they tried to do it

00:00:52.869 --> 00:00:54.703
in a slightly different
way, through tax cuts,

00:00:54.703 --> 00:00:56.804
instead of government spending increases,

00:00:56.804 --> 00:01:00.004
but it was Keynesian in
its underlying thinking.

00:01:00.004 --> 00:01:02.870
Now just as a bit of a
backup, I'm going to talk

00:01:02.870 --> 00:01:05.204
a little bit more about that
cycle that we talked about

00:01:05.204 --> 00:01:06.137
in the last video.

00:01:06.137 --> 00:01:10.620
If you have person A, person
B, person C, and person D

00:01:10.620 --> 00:01:11.953
or maybe their firms.

00:01:11.953 --> 00:01:17.403
B supplies A, A supplies D, D supplies C,

00:01:17.403 --> 00:01:20.008
and C supplies B, and for
the sake of simplicity,

00:01:20.008 --> 00:01:23.138
we said that they're all
supplying 2 units of their good

00:01:23.138 --> 00:01:26.170
and service to each other.

00:01:26.202 --> 00:01:29.619
Let's just say that C has a
bad dream, feels pessimistic,

00:01:29.619 --> 00:01:33.536
ate something bad and all of
a sudden isn't feeling good

00:01:33.536 --> 00:01:35.369
about the future and wants to buy less,

00:01:35.369 --> 00:01:36.137
just out of caution.

00:01:36.137 --> 00:01:37.536
Maybe he wants to hoard a bit of cash,

00:01:37.536 --> 00:01:40.806
just in case C needs it.

00:01:40.806 --> 00:01:45.140
He buys a little bit
less from D, but D says,

00:01:45.140 --> 00:01:47.536
"Gee, my business is
bad, now I can't afford

00:01:47.536 --> 00:01:50.284
"as many goods and
services," buys less from A,

00:01:50.284 --> 00:01:53.005
A does the same thing from
B, and then B's business

00:01:53.005 --> 00:01:57.203
is bad, so buys less stuff
from C, goods and services

00:01:57.203 --> 00:02:01.314
from C, and now C feels
like they're psychic,

00:02:01.314 --> 00:02:02.848
even though we see that it was actually

00:02:02.848 --> 00:02:06.585
a self-fulfilling prophecy,
that C's pessimism actually led

00:02:06.585 --> 00:02:08.917
to that reality actually occurring.

00:02:08.917 --> 00:02:11.119
In a worst case, it actually
could get worse and worse.

00:02:11.119 --> 00:02:13.480
C could say, "Wow, I was
pessimistic and I was right.

00:02:13.480 --> 00:02:14.896
"My business actually did get bad."

00:02:14.896 --> 00:02:18.918
Maybe it even got worse
than C had expected

00:02:18.918 --> 00:02:21.674
and then C could then say,
"I'm going to buy even less.

00:02:21.674 --> 00:02:26.507
"Maybe I'm only going to
buy a half from D now,"

00:02:26.507 --> 00:02:28.423
and then D says, "Maybe I'm
only going to buy a half

00:02:28.423 --> 00:02:31.174
"from A," and that cycle
could go down and down

00:02:31.174 --> 00:02:33.130
and down until each of them
are just buying exactly

00:02:33.130 --> 00:02:35.596
just what they need to get
by, even though they all

00:02:35.596 --> 00:02:37.532
could be producing more,
the economy could be

00:02:37.532 --> 00:02:39.464
producing more and could
be wealthier and they all

00:02:39.464 --> 00:02:41.331
could be way better off.

00:02:41.331 --> 00:02:45.864
This is, at least in my mind,
a pretty good description

00:02:45.864 --> 00:02:47.486
of what happens in a depression,

00:02:47.486 --> 00:02:49.664
especially the Great Depression.

00:02:49.664 --> 00:02:52.798
So there might be a
rationale to say, "Hey, look,

00:02:52.798 --> 00:02:55.598
"why doesn't the government
come here at some point

00:02:55.598 --> 00:02:58.866
"in this economy and stimulate demand?"

00:02:58.866 --> 00:03:00.653
Why doesn't the government come here?

00:03:00.653 --> 00:03:02.820
Let's say B is already buying 1 from C,

00:03:02.820 --> 00:03:06.819
the government comes and
says, "Hey, I'll buy another 1

00:03:06.819 --> 00:03:10.389
"from C," and then C says,
"Hey, things are good again.

00:03:10.389 --> 00:03:15.455
I can buy 2 from D," D can buy 2 from A,

00:03:15.455 --> 00:03:18.990
and then A can buy 2 from
B and then B can buy 2

00:03:18.990 --> 00:03:22.020
from C and so things have gotten back

00:03:22.020 --> 00:03:23.389
to their potential state.

00:03:23.389 --> 00:03:24.791
The economy is revving.

00:03:24.791 --> 00:03:26.519
In an ideal state, the
government would say,

00:03:26.519 --> 00:03:28.353
"Hey, my work is done now.

00:03:28.353 --> 00:03:31.520
"I can now take a step
back and I don't want

00:03:31.520 --> 00:03:32.853
"to overheat the economy.

00:03:32.853 --> 00:03:34.603
"I don't want to push
aggregate demand too far

00:03:34.603 --> 00:03:39.055
"to the right and cause
inflation," so they will take

00:03:39.055 --> 00:03:40.186
a step back.

00:03:40.186 --> 00:03:42.456
The danger here is that
this is not so easy

00:03:42.456 --> 00:03:43.656
for governments to do.

00:03:43.656 --> 00:03:45.603
This was some type of stimulus, some type

00:03:45.603 --> 00:03:46.990
of government spending.

00:03:46.990 --> 00:03:50.353
Although maybe it was a tax decrease,

00:03:50.353 --> 00:03:52.056
so maybe B could've
increased their demand,

00:03:52.056 --> 00:03:54.186
but either way, once you
do a policy like this,

00:03:54.186 --> 00:03:55.790
and let's say it was government spending,

00:03:55.790 --> 00:03:57.519
it's very hard to unwind.

00:03:57.519 --> 00:03:58.853
This government spending might have been

00:03:58.853 --> 00:04:00.721
for a project that some people like,

00:04:00.721 --> 00:04:02.520
it might have employed many, many people.

00:04:02.520 --> 00:04:03.789
Those people are voters.

00:04:03.789 --> 00:04:05.853
They're not just going to
sit there while you cancel

00:04:05.853 --> 00:04:08.185
this government project.

00:04:08.185 --> 00:04:11.603
There's a risk that maybe
there is a justification

00:04:11.603 --> 00:04:14.521
for a Keynesian policy,
but when it's time to undo

00:04:14.521 --> 00:04:17.185
that Keynesian policy,
to undo that stimulus,

00:04:17.185 --> 00:04:18.604
it's very hard to do it.

00:04:18.604 --> 00:04:20.537
It's kind of a sticky policy.

00:04:20.537 --> 00:04:22.516
What you might have is when times are bad,

00:04:22.516 --> 00:04:25.984
you do Keynesian stimuli,
but when times are good,

00:04:25.984 --> 00:04:28.516
you're not willing to undo it
and if that Keynsian stimuli

00:04:28.516 --> 00:04:30.693
involves more and more deficit spending

00:04:30.693 --> 00:04:32.275
or more and more government spending,

00:04:32.275 --> 00:04:34.611
then the government size
is just going to grow

00:04:34.611 --> 00:04:36.650
relative to the economy, or
the deficit is just going

00:04:36.650 --> 00:04:38.193
to grow relative to the
economy and you're never going

00:04:38.193 --> 00:04:41.861
to unwind it, because
unwinding is unpopular.

00:04:41.861 --> 00:04:44.108
I want to be clear that this
is true of both the left

00:04:44.108 --> 00:04:45.112
and the right.

00:04:45.112 --> 00:04:48.047
In the stereotypical
sense, the left might say,

00:04:48.047 --> 00:04:50.778
"Hey, let's do a Keynesian
stimulus by spending more,"

00:04:50.778 --> 00:04:53.248
so the government spends
more and let's hold

00:04:53.248 --> 00:04:56.049
our revenue constant, our tax revenue,

00:04:56.049 --> 00:04:57.715
let's hold it constant.

00:04:57.715 --> 00:04:59.649
Obviously, the government
would have to borrow

00:04:59.649 --> 00:05:02.597
more money to fund this, or
sometimes they might even

00:05:02.597 --> 00:05:05.398
increase taxes if they actually
wanted to be more purist

00:05:05.398 --> 00:05:07.730
about it, but this is
the variety that you see

00:05:07.730 --> 00:05:09.328
and this would be a true stimulus.

00:05:09.328 --> 00:05:12.061
This is using the fiscal
lever to put more demand

00:05:12.061 --> 00:05:14.326
in the economy, but in
the right you often see

00:05:14.326 --> 00:05:15.551
the other side.

00:05:15.551 --> 00:05:18.326
You see taxes being
lowered, essentially saying

00:05:18.326 --> 00:05:19.468
instead of the government spending it,

00:05:19.468 --> 00:05:21.472
why don't we let people
decide where to spend it

00:05:21.472 --> 00:05:24.741
and they might spend it
in a more efficient way,

00:05:24.741 --> 00:05:26.742
but it's going to be a
stimulus, because spending

00:05:26.742 --> 00:05:27.991
is held constant.

00:05:27.991 --> 00:05:30.825
Then you have the double
where you do both sides

00:05:30.825 --> 00:05:32.794
of it, where you lower the taxes,

00:05:32.794 --> 00:05:34.657
you lower the inbound revenue,

00:05:34.657 --> 00:05:36.414
and you increase spending.

00:05:36.414 --> 00:05:39.194
This is true, this has been
done by both republican

00:05:39.194 --> 00:05:40.832
and democratic administrations.

00:05:40.832 --> 00:05:42.794
Lowering taxes, but
then going and starting

00:05:42.794 --> 00:05:45.261
a hugely expensive war and obviously

00:05:45.261 --> 00:05:46.575
this would increase deficits.

00:05:46.575 --> 00:05:48.432
There might even be a
justification for doing any

00:05:48.432 --> 00:05:52.825
of these, a Keynesian
justification if the economy truly

00:05:52.825 --> 00:05:55.993
is operating well below its potential.

00:05:55.993 --> 00:05:58.194
The tough thing is it might be justified,

00:05:58.194 --> 00:06:01.075
you actually don't know
exactly where that potential is

00:06:01.075 --> 00:06:03.460
and you might not be able
to unwind this once you get

00:06:03.460 --> 00:06:05.075
to your potential and
then you might overheat

00:06:05.075 --> 00:06:07.073
the economy, might lead to inflation,

00:06:07.073 --> 00:06:10.594
and that actually might
undermine the productivity

00:06:10.594 --> 00:06:12.537
of the actual economy.

00:06:12.537 --> 00:06:15.258
The other negative of a Keynesian mindset

00:06:15.258 --> 00:06:17.126
is what happens over the long run.

00:06:17.126 --> 00:06:19.323
In the short run this
might make a lot of sense.

00:06:19.323 --> 00:06:22.159
Let's prime the pump, let's
get the cycle to happen

00:06:22.159 --> 00:06:24.407
in the right away again,
but in the long run,

00:06:24.407 --> 00:06:26.409
it's essentially just trying
to get people to consume

00:06:26.409 --> 00:06:27.491
and consume more.

00:06:27.491 --> 00:06:29.063
You'll often hear, when
the economy slows down

00:06:29.063 --> 00:06:30.742
a little bit, you'll hear the president,

00:06:30.742 --> 00:06:32.575
you'll hear politicians
say, "Hey, we're just trying

00:06:32.575 --> 00:06:33.741
"to get people to spend more

00:06:33.741 --> 00:06:36.128
"through some combination
of these Keynesian policies.

00:06:36.128 --> 00:06:37.792
"We're going to lower taxes,
we're going to increase

00:06:37.792 --> 00:06:40.460
"spending,"but you'll never hear them say,

00:06:40.460 --> 00:06:42.074
"Hey, we want people to save more,

00:06:42.074 --> 00:06:43.459
"so that we can invest more,

00:06:43.459 --> 00:06:47.261
"so that in the classical
sense we can increase

00:06:47.261 --> 00:06:49.491
"our total productive capacity."

00:06:49.491 --> 00:06:51.927
The US has gotten a free pass on this,

00:06:51.927 --> 00:06:54.194
because the US has been
doing, essentially,

00:06:54.194 --> 00:06:56.407
the deficit spending has been able to do

00:06:56.407 --> 00:07:00.992
the Keynesian stimuli and
that's why the US consumer

00:07:00.992 --> 00:07:03.324
keeps spending more and
more, saving less and less.

00:07:03.324 --> 00:07:05.077
The government is doing the same thing,

00:07:05.077 --> 00:07:07.159
but the US has also
been getting investment

00:07:07.159 --> 00:07:09.492
because it's the foreigners
who've been saving

00:07:09.492 --> 00:07:11.126
and then plowing that
money and they've been,

00:07:11.126 --> 00:07:13.928
essentially, investing
in the US, so that the US

00:07:13.928 --> 00:07:17.260
could increase its productive
capacity, but that is a risk

00:07:17.260 --> 00:07:20.325
for a country if it's not
blessed with that free pass

00:07:20.325 --> 00:07:22.861
that the US has gotten for
the last several decades

00:07:22.861 --> 00:07:25.075
is that when you have some resources,

00:07:25.075 --> 00:07:26.909
so in a given year, you
have some resources.

00:07:26.909 --> 00:07:28.075
Let's say it's your time.

00:07:28.075 --> 00:07:31.833
You could either hunt and eat rabbits

00:07:31.833 --> 00:07:34.826
or you could spend your time to invent

00:07:34.826 --> 00:07:36.530
new rabbit trapping devices.

00:07:36.530 --> 00:07:38.593
This is the hunting and eating the rabbits

00:07:38.593 --> 00:07:40.927
and this is spending some time to go

00:07:40.927 --> 00:07:42.742
and figure out ways to be more productive

00:07:42.742 --> 00:07:44.993
at hunting rabbits,
building some bow and arrows

00:07:44.993 --> 00:07:46.258
or something like this.

00:07:46.258 --> 00:07:48.462
You always have a tradeoff
between consumption

00:07:48.462 --> 00:07:50.393
and investment.

00:07:50.393 --> 00:07:52.593
Keynesian policies,
they're all about, hey,

00:07:52.593 --> 00:07:55.196
let's get consumption as high as possible

00:07:55.196 --> 00:07:57.260
and that might be a good
idea in the short run,

00:07:57.260 --> 00:08:00.194
especially if we are operating
well below our potential,

00:08:00.194 --> 00:08:03.124
well below our full capacity utilization,

00:08:03.124 --> 00:08:05.128
but it could be a risk in the
long run, if you don't get

00:08:05.128 --> 00:08:08.196
the free pass, because you
might have underinvestment

00:08:08.196 --> 00:08:11.198
and in the classical sense,
you're never able to move

00:08:11.198 --> 00:08:13.467
your potential to the right.


Keynesian economics

WEBVTT
Kind: captions
Language: en

00:00:00.737 --> 00:00:02.071
Voiceover: What I want to do in this video

00:00:02.071 --> 00:00:04.471
is start introducing and
we've already talked about him

00:00:04.471 --> 00:00:05.138
a little bit.

00:00:05.138 --> 00:00:06.737
So actually they've
already been introduced,

00:00:06.737 --> 00:00:09.737
but maybe flesh out a little
bit more Keynesian thinking.

00:00:09.737 --> 00:00:12.294
This right here is a picture
of John Maynard Keynes

00:00:12.294 --> 00:00:14.138
and I often mispronounce him as Keynes,

00:00:14.138 --> 00:00:15.138
because that's how it's spelled,

00:00:15.138 --> 00:00:17.471
but it's John Maynard Keynes.

00:00:17.471 --> 00:00:18.876
He was an economist who did a lot

00:00:18.876 --> 00:00:21.804
of his most famous work
during the Great Depression,

00:00:21.804 --> 00:00:24.877
because in his view,
classical models did not seem

00:00:24.877 --> 00:00:28.210
to be of much use during
the Great Depression.

00:00:28.210 --> 00:00:30.543
To understand this a little bit better,

00:00:30.543 --> 00:00:34.804
let's compare purely
classical aggregate supply

00:00:34.804 --> 00:00:37.806
aggregate demand models to maybe one

00:00:37.806 --> 00:00:38.805
that's more Keynesian.

00:00:38.805 --> 00:00:40.404
Some of what we've talked about -

00:00:40.404 --> 00:00:41.210
Keynesian, I should say.

00:00:41.210 --> 00:00:43.404
I already did my first mispronunciation.

00:00:43.404 --> 00:00:46.005
One that's a little bit more Keynesian.

00:00:46.005 --> 00:00:48.270
Keynesian right over here.

00:00:48.270 --> 00:00:50.337
In some of the conversations,
we've already begun

00:00:50.337 --> 00:00:52.637
to introduce a little bit
of Keynesian thinking,

00:00:52.637 --> 00:00:53.734
but in this video we're going to try

00:00:53.734 --> 00:00:56.406
to show the difference between the two

00:00:56.406 --> 00:00:58.403
and it's not to say that one
is right or one is wrong.

00:00:58.403 --> 00:01:00.737
In fact, Keynesian felt
that in the long run,

00:01:00.737 --> 00:01:02.805
the classical model actually made sense,

00:01:02.805 --> 00:01:04.403
but he also famously said,

00:01:04.403 --> 00:01:06.604
"In the long run we are all dead."

00:01:06.604 --> 00:01:08.604
I also want to emphasize
that this isn't a defense

00:01:08.604 --> 00:01:10.018
of Keynesian economics.

00:01:10.018 --> 00:01:12.473
There are some points
to what he has to say,

00:01:12.473 --> 00:01:13.684
but there are other schools of thought.

00:01:13.684 --> 00:01:15.686
Unfortunately, they
often get very dogmatic,

00:01:15.686 --> 00:01:18.020
but they also have some reasons to be wary

00:01:18.020 --> 00:01:19.937
of Keynesian economics
and we hope to go over

00:01:19.937 --> 00:01:22.355
some of that in future videos.

00:01:22.355 --> 00:01:23.604
In this one, we just want to understand

00:01:23.604 --> 00:01:25.604
what Keynesian economics is all about

00:01:25.604 --> 00:01:27.770
and how it really was
a fundamental departure

00:01:27.770 --> 00:01:29.674
from classical economics.

00:01:29.674 --> 00:01:31.535
In classical economics, I'm going to use

00:01:31.535 --> 00:01:35.103
aggregate demand and
aggregate supply in both.

00:01:35.103 --> 00:01:38.538
This is classical, this is
price, this right over here

00:01:38.538 --> 00:01:42.020
is real GDP and I'm going to do it

00:01:42.020 --> 00:01:44.871
for the Keynesian case, as well.

00:01:44.871 --> 00:01:50.105
This is price and this
right over here is real GDP.

00:01:51.601 --> 00:01:55.870
In both views of reality, or both models,

00:01:55.870 --> 00:01:58.104
you have a downward sloping
aggregate demand curve

00:01:58.104 --> 00:01:59.538
for all the reasons
that we've talked about

00:01:59.538 --> 00:02:01.604
in multiple videos.

00:02:01.604 --> 00:02:05.937
That's aggregate demand right over there.

00:02:05.937 --> 00:02:08.538
We've already seen it,
the classical view is that

00:02:08.538 --> 00:02:14.105
in the long run, an
economy's productivity,

00:02:14.105 --> 00:02:17.536
or productive capacity,
or its output shouldn't

00:02:17.536 --> 00:02:19.736
be dependent on prices.

00:02:19.736 --> 00:02:22.203
We've seen the long run
aggregate supply curve

00:02:22.203 --> 00:02:23.536
something like this.

00:02:23.536 --> 00:02:26.805
This is the aggregate
supply in the long run,

00:02:26.805 --> 00:02:30.537
or sometimes you'll have
long run aggregate supply.

00:02:30.537 --> 00:02:32.437
Sometimes it'll be referred to that.

00:02:32.437 --> 00:02:35.886
Saying, look, all prices
are, they're a way to signal

00:02:35.886 --> 00:02:37.803
what people want and demand
and things like that,

00:02:37.803 --> 00:02:39.870
but at the end of the
day, prices and money,

00:02:39.870 --> 00:02:41.804
they're just facilitating transactions.

00:02:41.804 --> 00:02:44.070
You go to work and you
get paid and all that,

00:02:44.070 --> 00:02:45.870
but then you go and use
that money to go and buy

00:02:45.870 --> 00:02:47.870
other things that the economy produces,

00:02:47.870 --> 00:02:50.538
like food and shelter and transportation.

00:02:50.538 --> 00:02:53.537
All money is is a way of
facilitating the transactions,

00:02:53.537 --> 00:02:55.870
but the economy, in theory,
based on how many people

00:02:55.870 --> 00:02:58.469
it has, what kind of technology it has,

00:02:58.469 --> 00:03:01.019
what kind of factories it has,

00:03:01.019 --> 00:03:03.536
what kind of natural resources
it has, it's just going

00:03:03.536 --> 00:03:05.602
to produce what it's going to produce.

00:03:05.602 --> 00:03:08.203
If you were to just
change aggregate demand,

00:03:08.203 --> 00:03:12.019
if the government were to print money

00:03:12.019 --> 00:03:14.138
and aggregate demand were to -

00:03:14.138 --> 00:03:15.871
and just distribute it from helicopters,

00:03:15.871 --> 00:03:18.269
in this classical model,
you would just have

00:03:18.269 --> 00:03:20.437
aggregate demand shift to
the right, but you have

00:03:20.437 --> 00:03:22.924
this vertical long run
aggregate supply curve

00:03:22.924 --> 00:03:25.122
so the net effect is it
didn't change the output

00:03:25.122 --> 00:03:26.318
in this classical model.

00:03:26.318 --> 00:03:28.117
All that happens is that the price goes

00:03:28.117 --> 00:03:30.784
from this equilibrium price
to this equilibrium price

00:03:30.784 --> 00:03:31.783
over here.

00:03:31.783 --> 00:03:33.605
You have the price would go up

00:03:33.605 --> 00:03:35.855
and you would just experience inflation

00:03:35.855 --> 00:03:38.938
with no increased output
and there's multiple ways

00:03:38.938 --> 00:03:40.717
you could've shifted that
aggregate demand curve

00:03:40.717 --> 00:03:41.450
to the right.

00:03:41.450 --> 00:03:44.272
You could have a fiscal
policy where the government,

00:03:44.272 --> 00:03:47.051
maybe it holds its tax revenue constant,

00:03:47.051 --> 00:03:50.938
but it increases spending, or it goes

00:03:50.938 --> 00:03:51.985
the other way around.

00:03:51.985 --> 00:03:55.688
It does not decrease, it
doesn't change its spending,

00:03:55.688 --> 00:03:56.937
but it lowers tax revenue.

00:03:56.937 --> 00:03:59.188
Either of those, it tries to
pump money into the economy

00:03:59.188 --> 00:04:01.520
and pushes that aggregate
demand curve to the right.

00:04:01.520 --> 00:04:03.783
In this purely classical
view, it says in the long run,

00:04:03.783 --> 00:04:06.604
that's not going to be any good,
just will lead to inflation.

00:04:06.604 --> 00:04:08.783
The only way that you
can increase the output

00:04:08.783 --> 00:04:11.650
of economy is by making
it more productive.

00:04:11.650 --> 00:04:14.604
Maybe making some
investments in technology,

00:04:14.604 --> 00:04:16.022
make the economy more efficient,

00:04:16.022 --> 00:04:18.522
maybe your population grows.

00:04:18.522 --> 00:04:21.522
The only way is to really
shift this curve to the right

00:04:21.522 --> 00:04:26.984
on the supply side right over here.

00:04:26.984 --> 00:04:29.450
Keynes did not disagree with
that, but he sitting here

00:04:29.450 --> 00:04:31.191
in the middle of the
Great Depression, saying,

00:04:31.191 --> 00:04:34.920
"Look, all of a sudden
people are poor in the 1930s.

00:04:34.920 --> 00:04:37.917
"Factories did not get blown
up, people didn't disappear.

00:04:37.917 --> 00:04:40.022
"In fact, there are
factories that want to run,

00:04:40.022 --> 00:04:41.938
but they are being shut
down, because no one

00:04:41.938 --> 00:04:42.982
"is demanding goods from them.

00:04:42.982 --> 00:04:44.718
"There are people who
want to work, but no one

00:04:44.718 --> 00:04:46.272
"is asking them to work.

00:04:46.272 --> 00:04:48.188
"They could work and produce
wealth that could then

00:04:48.188 --> 00:04:49.270
"be distributed to -

00:04:49.270 --> 00:04:52.272
"But no one's demanding
for them to do it."

00:04:52.272 --> 00:04:55.117
He suspected something weird was happening

00:04:55.117 --> 00:04:58.850
with aggregate demand,
especially in the short run.

00:04:58.850 --> 00:05:01.522
In a very pure, very,
very short run model,

00:05:01.522 --> 00:05:04.856
I know we have talked about a short run

00:05:04.856 --> 00:05:07.520
aggregate supply curve
that is upward sloping.

00:05:07.520 --> 00:05:10.450
Something that might
look something like that.

00:05:10.450 --> 00:05:12.916
That is actually starting to put some

00:05:12.916 --> 00:05:15.452
of the Keynesian ideas into practice.

00:05:15.452 --> 00:05:18.385
What I like to think of
is something in between,

00:05:18.385 --> 00:05:21.056
but if you think in the
very, very, very short term,

00:05:21.056 --> 00:05:23.702
Keynes would say prices are
going to be very sticky.

00:05:23.702 --> 00:05:28.654
Especially in the short
run, and I'll call it

00:05:28.654 --> 00:05:32.388
the very short run, you have,

00:05:32.388 --> 00:05:36.786
especially if the economy's
producing well below

00:05:36.786 --> 00:05:38.785
its capacity, like it seemed to be doing

00:05:38.785 --> 00:05:44.721
during the Great Depression,
prices are sticky.

00:05:44.721 --> 00:05:46.458
That makes intuitive sense.

00:05:46.458 --> 00:05:48.210
If the economy's trying to get overheated,

00:05:48.210 --> 00:05:49.626
people are being overworked, you want them

00:05:49.626 --> 00:05:51.460
to work more, hey, I want overtime.

00:05:51.460 --> 00:05:53.326
You want factories to operate
faster, people are going

00:05:53.326 --> 00:05:54.059
to start -

00:05:54.059 --> 00:05:56.544
The utilization is high, people
are going to start charging

00:05:56.544 --> 00:05:59.326
more and more, but if I'm
unemployed and I'm desperate

00:05:59.326 --> 00:06:01.794
to work, I'm not going
to ask for a pay raise.

00:06:01.794 --> 00:06:04.725
If my factory is at 30%
utilization and someone wants

00:06:04.725 --> 00:06:06.876
to buy a little bit more, that's
not the time that I'm going

00:06:06.876 --> 00:06:08.460
to say, "Hey, I'm going
to raise prices on you."

00:06:08.460 --> 00:06:10.292
I'll say, "Yeah, exact same price.

00:06:10.292 --> 00:06:12.662
"You want another 5% of
my factory to be utilized?

00:06:12.662 --> 00:06:14.376
"Sure, that sounds great."

00:06:14.376 --> 00:06:16.794
In the very short run,
it has the opposite view

00:06:16.794 --> 00:06:19.595
of the aggregate supply curve
than the classical model.

00:06:19.595 --> 00:06:23.482
It says at any level of
GDP in the short run,

00:06:23.482 --> 00:06:25.669
prices won't be affected.

00:06:25.669 --> 00:06:27.203
It won't be affected.

00:06:27.203 --> 00:06:30.702
So in this model right over
here, this is aggregate supply

00:06:30.702 --> 00:06:34.620
I'll call it, in the very short run.

00:06:34.620 --> 00:06:37.952
You can debate what short
run or very short run means,

00:06:37.952 --> 00:06:39.803
whether we're talking
about days, weeks, months,

00:06:39.803 --> 00:06:42.786
or even a few years here,
but once you start looking

00:06:42.786 --> 00:06:44.402
at the world this way,

00:06:44.402 --> 00:06:45.736
then something interesting happens.

00:06:45.736 --> 00:06:48.203
In this model right over
here, the only way to increase

00:06:48.203 --> 00:06:51.868
GDP was on the supply side.

00:06:51.868 --> 00:06:54.738
In this model right over
here, the only way to increase

00:06:54.738 --> 00:06:58.369
GDP is on the demand
side, to actually either

00:06:58.369 --> 00:07:01.005
through monetary policy, print more money,

00:07:01.005 --> 00:07:04.725
or through fiscal policy, lower taxes

00:07:04.725 --> 00:07:09.131
while holding spending
constant or maybe do both,

00:07:09.131 --> 00:07:10.657
essentially deficit spending.

00:07:10.657 --> 00:07:12.923
Someway, without holding taxes constant,

00:07:12.923 --> 00:07:14.925
but the government's
spending more, whatever.

00:07:14.925 --> 00:07:20.057
Shift the curve to the right
and that might be a way

00:07:20.057 --> 00:07:24.324
to increase the overall output.

00:07:24.324 --> 00:07:26.858
Keynes' real realization was that, look,

00:07:26.858 --> 00:07:28.857
the classical economist
would tell you if you have

00:07:28.857 --> 00:07:32.124
a free and unfettered market,
the economy will just get

00:07:32.124 --> 00:07:34.754
to its natural, very efficient state.

00:07:34.754 --> 00:07:36.670
Keynes says, "Yes, that is sometimes true,

00:07:36.670 --> 00:07:38.754
"but that's sometimes not true."

00:07:38.754 --> 00:07:40.091
We'll talk about different cases.

00:07:40.091 --> 00:07:41.857
By no means do I think the Keynesian model

00:07:41.857 --> 00:07:43.587
is the ideal and I don't think even Keynes

00:07:43.587 --> 00:07:45.191
would have thought the Keynesian model

00:07:45.191 --> 00:07:46.457
describes everything.

00:07:46.457 --> 00:07:48.458
Depends on the circumstance.

00:07:48.458 --> 00:07:49.587
Keynes would say, "Look, let's think

00:07:49.587 --> 00:07:52.724
"of a very simple idea."

00:07:52.724 --> 00:07:57.255
You have person A, person
B, person C, and person D.

00:07:57.255 --> 00:08:01.004
Let's say person A sells
to person B, person B sells

00:08:01.004 --> 00:08:04.125
to person C, person C sells to person D,

00:08:04.125 --> 00:08:06.323
and person D sells to person A.

00:08:06.323 --> 00:08:08.392
Let's say that they're
all selling two units

00:08:08.392 --> 00:08:11.592
of whatever good and
service that they offer.

00:08:11.592 --> 00:08:16.004
For whatever reason, let's
say C, all of a sudden,

00:08:16.004 --> 00:08:18.124
just got a little bit
pessimistic, had a bad dream,

00:08:18.124 --> 00:08:19.586
woke up on the wrong
side of the bed and says,

00:08:19.586 --> 00:08:20.670
"You know what?

00:08:20.670 --> 00:08:21.920
"I'm not feeling so
good about the economy.

00:08:21.920 --> 00:08:24.192
"I'm going to hold off
from my purchase from B.

00:08:24.192 --> 00:08:27.086
Instead of two units, I'm
going to purchase one unit.

00:08:27.086 --> 00:08:30.524
Well, B says, "Well,
gee, my business is bad.

00:08:30.524 --> 00:08:33.170
"Now I'm only going to purchase one unit."

00:08:33.170 --> 00:08:35.170
A does the same thing for the same reason,

00:08:35.170 --> 00:08:36.392
D does the same thing.

00:08:36.392 --> 00:08:38.839
Now it all came back to C and now C says,

00:08:38.839 --> 00:08:41.198
"Wow, I was right, that
dream was predictive."

00:08:41.198 --> 00:08:43.170
It was a self-fulfilling prophecy.

00:08:43.170 --> 00:08:45.004
Now they're going to operate in this state

00:08:45.004 --> 00:08:46.858
and there might not be any
natural way to get them

00:08:46.858 --> 00:08:49.658
bumped up to that state
where they're all buying

00:08:49.658 --> 00:08:53.671
two units from each other
without maybe some outside,

00:08:53.671 --> 00:08:54.924
especially some government act

00:08:54.924 --> 00:08:56.253
or maybe all of a sudden saying,

00:08:56.253 --> 00:08:58.340
"Hey B, if C doesn't want
to buy two, I'm going

00:08:58.340 --> 00:08:59.588
"to buy two temporarily."

00:08:59.588 --> 00:09:01.254
There are dangers to this, huge dangers,

00:09:01.254 --> 00:09:03.190
and we'll talk about
that in future videos,

00:09:03.190 --> 00:09:05.524
but then someone else,
let's say the government,

00:09:05.524 --> 00:09:07.203
tries to shift the aggregate demand curve

00:09:07.203 --> 00:09:08.592
through fiscal policy and they say,

00:09:08.592 --> 00:09:12.063
"Hey, I'll buy one from you, B."

00:09:12.063 --> 00:09:14.327
Then B says, "Okay, now
I can buy two again,"

00:09:14.327 --> 00:09:17.994
and A can buy two again and
then D can buy two again

00:09:17.994 --> 00:09:19.365
and then C can buy two again.

00:09:19.365 --> 00:09:21.060
Then in an ideal world,
and this is the danger

00:09:21.060 --> 00:09:22.793
of the government, the
government would step back

00:09:22.793 --> 00:09:24.729
and say, "Okay, everything is fine again.

00:09:24.729 --> 00:09:26.279
"I don't have to buy this."

00:09:26.279 --> 00:09:28.615
As we know, it's very
hard once the government

00:09:28.615 --> 00:09:31.029
starts spending money in
some way, to actually cut

00:09:31.029 --> 00:09:33.065
this spending right over here.

00:09:33.065 --> 00:09:36.531
This was the general
idea behind the Keynesian

00:09:36.531 --> 00:09:37.531
versus the classical.

00:09:37.531 --> 00:09:39.460
He says, "Look, there are circumstances,

00:09:39.460 --> 00:09:41.595
"like the Great Depression,
where the economy

00:09:41.595 --> 00:09:44.192
"is operating well below its potential

00:09:44.192 --> 00:09:46.865
"and in those circumstances,
you need to have

00:09:46.865 --> 00:09:50.930
"a stimulus on the demand
side, not just a supply side."

00:09:50.930 --> 00:09:52.779
The correct answer, as with all things,

00:09:52.779 --> 00:09:54.726
is probably something in between.

00:09:54.726 --> 00:09:58.207
A probably more accurate
model is something like this.

00:09:58.207 --> 00:09:59.939
Let's draw ...

00:09:59.939 --> 00:10:05.933
This is price, this is
real GDP right over here

00:10:05.933 --> 00:10:08.017
and we'll still draw our downward sloping

00:10:08.017 --> 00:10:12.267
aggregate demand curve and
the more accurate thing

00:10:12.267 --> 00:10:14.019
might look something like this.

00:10:14.019 --> 00:10:15.790
Let's say that this is the absolute

00:10:15.790 --> 00:10:19.117
theoretical maximum output,
if everyone in the country

00:10:19.117 --> 00:10:20.906
isn't sleeping, the
factories are just being run

00:10:20.906 --> 00:10:23.739
to the ground, that's the
absolute theoretical output.

00:10:23.739 --> 00:10:25.918
Let's say that this is its potential.

00:10:25.918 --> 00:10:28.115
Just a healthy state where the economy

00:10:28.115 --> 00:10:29.490
might be operating.

00:10:29.490 --> 00:10:33.582
The real medium run
supply curve or short run

00:10:33.582 --> 00:10:35.654
aggregate supply curve.

00:10:35.654 --> 00:10:38.851
This is aggregate supply
in the very long run.

00:10:38.851 --> 00:10:41.582
This is the long run aggregate supply.

00:10:41.582 --> 00:10:44.051
The best model would be
something that's in between

00:10:44.051 --> 00:10:45.990
and might look something like this.

00:10:45.990 --> 00:10:48.322
Our aggregate supply curve
might look something like -

00:10:48.322 --> 00:10:50.330
I want to do it in a different color.

00:10:50.330 --> 00:10:51.740
Let me do it in magenta.

00:10:51.740 --> 00:10:56.850
It might look something like this.

00:10:56.850 --> 00:11:00.115
For whatever reason, maybe
someone has a bad dream

00:11:00.115 --> 00:11:01.795
or a bunch of people have a bad dream

00:11:01.795 --> 00:11:04.490
or something scary
happens, aggregate demand -

00:11:04.490 --> 00:11:06.517
The stock market crashes,
something happens,

00:11:06.517 --> 00:11:09.050
aggregate demand shifts over there.

00:11:09.050 --> 00:11:11.321
When we're out here, now all of a sudden

00:11:11.321 --> 00:11:13.914
our output is well below
potential, we have a lot

00:11:13.914 --> 00:11:16.916
of excess capacity and now
the Keynesian ideas seem

00:11:16.916 --> 00:11:17.917
maybe they'll make sense.

00:11:17.917 --> 00:11:18.914
Maybe there should be

00:11:18.914 --> 00:11:21.000
some outside stimulus happening.

00:11:21.000 --> 00:11:23.740
On the other side, if we're
performing well at potential,

00:11:23.740 --> 00:11:26.250
then all of a sudden the
government wants to do

00:11:26.250 --> 00:11:28.201
Keynesian policies and
we'll see in future videos,

00:11:28.201 --> 00:11:29.164
the government will always want

00:11:29.164 --> 00:11:31.582
to do Keynesian policies,
even if they're not justified.

00:11:31.582 --> 00:11:36.248
It will push aggregate demand out here

00:11:36.248 --> 00:11:37.657
and then the net effect is,

00:11:37.657 --> 00:11:39.450
especially the more
vertical this is, the more

00:11:39.450 --> 00:11:41.989
this net effect will be true,
that you really just get

00:11:41.989 --> 00:11:44.186
more inflation and you
don't really get a lot

00:11:44.186 --> 00:11:45.914
of increase in output.

00:11:45.914 --> 00:11:48.017
It really depends on the circumstance,

00:11:48.017 --> 00:11:50.715
but an aggregate supply
curve that starts flat

00:11:50.715 --> 00:11:53.585
at low levels of output
and then gets higher

00:11:53.585 --> 00:11:55.654
and higher slope and
becomes almost vertical

00:11:55.654 --> 00:11:57.849
in your high levels of
output, this is probably

00:11:57.849 --> 00:12:00.572
a better model that
takes into consideration

00:12:00.572 --> 00:12:04.133
both the classical and
the Keynesian ideas.