When there is a big crop of apples, the value of apples tends to fall. There is no need to discuss obscure “channels” such as bank lending. Apples are worth less for “supply and demand” reasons. When there is a big crop of money, the value of money tends to fall. Again, no need to talk about “channels.” This post was motivated by a recent comment, which is something I see pretty often:
The CB [central bank] interacts with counterparties that have little or no propensity to spend and the lending channel is blocked.
That’s a fairly common view, and yet it contains no less than three serious fallacies. This is what the commenter overlooked:
1. Counterparties don’t matter. The Fed buys assets from counterparty X, who almost always immediately cashes the check and the new base money disperses through the economy almost precisely as it would if the Fed had bought assets from counterparty Y, or counterparty Z.
2. The propensity to spend doesn’t matter for the same reason. Once counterparties get rid of the new base money, the impact on NGDP depends on the public’s propensity to hoard money, and any change in the incentive to hoard. In the long run money is neutral and NGDP changes in proportion to the change in M, regardless of whether the person receiving the money has a marginal propensity to consume of 90% or 10%. Either way they’ll almost always “get rid of” the new money, either by spending it or saving it. Saving is not hoarding, it’s spending on financial assets.
3. The lending channel doesn’t matter. In the long run all nominal prices rise in proportion to the change in M. In the short run sticky wages and prices cause the new money to have non-neutral effects. Those non-neutral effects reflect wage and price stickiness, not “channels” of spending.
Here’s where the confusion comes from. As soon as we move from a world of flexible prices and money neutrality (as with a currency reform) to a sticky-price world, real effects become the most noticeable short run effect of monetary shocks. This causes many observers to reverse causality. They assume that easy money boosts real GDP, and if output rises enough it eventually triggers inflation. Thus they see real shocks triggering nominal changes. If that’s your view of the world then channels of causation would seem to make lots of sense. Why does RGDP change? And which types of output change first? Does more real lending cause more RGDP? Do changes in interest rates cause more RGDP? These are the questions you would ask.
If instead you think in terms of nominal shocks having real effects then the “channels” approach is totally superfluous. A change in M causes a change in NGDP for supply and demand reasons, and if wages and prices are sticky then the change in NGDP triggers a change in RGDP. Because NGDP affects RGDP, it will also affect all sorts of other real variables like real lending quantities and real interest rates. But those are the effects of monetary shocks, they aren’t monetary shocks themselves.
Because money is a durable asset, expectations of the future value of money play an important role in its current value. I suppose that is a channel of sorts, but it’s merely a channel connecting future expected NGDP to current NGDP. To go from there to real variables such as output and employment, you simply need sticky wages and prices; channels like lending and interest rates add no explanatory power.
PS. Ramesh Ponnuru has an excellent new post on monetary offset.
PPS. Totally off topic, have other bloggers picked up this story:
The latest attempt by academia to wall itself off from the world came when the executive council of the prestigious International Studies Association proposed that its publication editors be barred from having personal blogs. The association might as well scream: We want our scholars to be less influential!