Andrea Terzi is a Professor of Economics at Franklin University Switzerland and Research Associate at the Levy Economics Institute of Bard College, New York. He also lectures in Monetary Economics at Catholic University, Milan.
Rethinking Economics spoke to him about the use of standard textbooks to teach the the role of banks in the monetary system.
Andrea, what is your experience with using textbooks when teaching macro and monetary economics?
I have long been teaching undergraduate courses in macro and monetary economics, and I always found the most popular textbooks only partially helpful. Hence, in those courses where I still have a textbook, I always complement the main text with a reading list and my own lecture notes.
Do you feel this position is shared by other economics instructors?
Whilst before the Global Financial Crisis I felt I belonged to a minority of instructors unhappy with most monetary economics textbooks, in the last ten years a growing community of economists and students have become critical of the way monetary economics is taught in most universities. Yet, not much has changed in the teaching of money and finance after the crisis. Although the latest editions of many popular textbooks now include sections or boxes discussing the most recent developments in monetary policy, such as quantitative easing or negative interest rates, it seems that for most of them there is still a long way to go. The call for action in the recently published open letter by Rethinking Economics is a response to this.
What is it that you find most disappointing with textbooks in monetary economics?
One major flaw comes immediately to mind. It is the money (or deposit) multiplier. When teaching Macroeconomics and Money and Banking, I ask undergrads to skip that chapter. I do not want my students to learn blindly the principle that banks’ lending is constrained by the amount of available (excess) reserves. At the graduate level, in our new Master’s program, I plan to discuss this principle and explain where it comes from and why it is flawed.
Is it not true that the majority of monetary experts today agree that the money multiplier is wrong?
All monetary experts today agree that this principle is not applicable to contemporary fiat currency systems. Central Banks publications explain that they do not set minimum reserve requirements to control how the money supply ‘multiplies’ but set reserve requirements for ‘operational reasons’. At times, central banks do not even set minimum reserve requirements. Yet, for many years, the irrelevance of the money multiplier was only discussed in technical papers. In 2004, the Journal of Economic Education would still publish a paper aimed at providing a pedagogical apparatus to teach the money multiplier with a “solid micro-foundation”. Then, in 2014, a Bank of England educational publication finally explained its flaws in less technical terms.
In 2014, you wrote an article praising the Bank of England publication, but pointing out some shortcomings of the BoE analysis.
It was very important that a central bank explained, in plain language, that what they call “money supply” depends on bank lending, not on the monetary base. And that bank lending is not constrained by the quantity of “high powered money”. I questioned in that article, however, the way they explained why the national currency is accepted as a final means of settlement in private contracts, and I found their view of the power of monetary policy overly optimistic.
But didn’t the Bank of England definitively clarify this point so that textbooks would discontinue the misleading interpretation of reserve-constrained bank lending?
Yes and no. The BoE publication is in my reading list for undergraduates. But I have not seen a clear sign that the money multiplier is disappearing from textbooks. In today’s world, where money markets seem to require a quantity of central bank money that is much bigger than minimum reserve requirements, the continued inclusion of the money-multiplier as the default textbook teaching is becoming grotesque.
How can course creators justify misleading students in such a way?
I heard one successful textbook author saying that he does not believe the money multiplier is applicable, yet he and his publisher fear that dropping that chapter would cut sales, as most instructors do not want to change the way they teach. This is a bit frustrating.
Indeed, it is. And is that all?
There is also a more fundamental explanation. The money multiplier serves the purpose of teaching the principle that central banks control, albeit indirectly, the money supply via the monetary base. Remove the money multiplier, and you must re-write the whole book with a fundamentally different theoretical approach. So, I believe in the end it is not a question of how money is taught. It is a question of how we model money in the first place. The money multiplier is a consequence of making a currency convertible into gold, and the root of the problem, in my view, is models’ lack of attention to how differently non-convertible currencies work.
Do you see other issues with the way textbooks teach money and banking?
Well, most textbooks neglect to explain how the payment system works, how payments take place between bank depositors, between banks, and between banks and the central bank and the Treasury. This causes serious misunderstandings of how monetary and fiscal policy work.
I also find it confusing (and incorrect) the graphical representation of the demand and supply of bonds that most textbooks use to explain changes in bond prices (and yields). First, because viewing the supply curve of bonds as positively sloped is misleading. Second, because that curve is said to shift when people save more, which is utterly misleading, and is said to shift when expected inflation increases without explaining that this is dependent on how investors read the central bank’s reaction function.
Do you plan to write your own textbook?
I wrote some handbooks in Italian, covering a few of these issues. I may find some time to work on an English version next year.