What is market monetarism?

People have asked me for a summary of market monetarist ideas.  Or a “model” of some sort.  Not every market monetarist agrees with all these ideas, but most agree with most.  I’ll start with policy, then cover the more difficult theory aspects:

1.  We favor NGDP targeting.

2.  Most of us favor level targeting.

3.  Most favor targeting the forecast.  Either the Fed’s internal forecast (Lars Svensson) or a market forecast of NGDP (myself and several others.)

Update:  Andy Harless and Lars Christensen pointed out that there’s no logical reason why a market monetarist would have to favor NGDP targeting.  I agree.  Bill Woolsey thinks level targeting is more important, and I’m inclined to agree.  There are lots of proposals that seem in the spirit of NGDP level targeting, but differ slightly: Bennett McCallum’s NGDP growth rate targeting, George Selgin’s productivity norm, Earl Thompson’s wage index target.  I would never suggest that market monetarism is some sort of fixed category, rather it’s a constantly evolving set of ideas that individual economists are sympathetic to in varying degrees.

Now for the theory part:

4.  Money matters, beyond the impact on interest rates.  But we don’t make any assumption about the stability of V (unlike traditional monetarists.)  Money matters because of the “hot potato effect.”  That is, the Fed determines the supply of base money and the public determines the real quantity of base money and the “Cambridge k,” which is the ratio of the base to NGDP.  In the long run “k” moves independently of once-and-for-all changes in the base.  That’s because once-and-for-all changes in the base have little or no effect on interest rates in the very long run.   Hence once-and-for-all changes in the base have a roughly proportional effect on long run NGDP.  We believe that unless you explicitly model money, you can’t explain why NGDP is not 1000 times higher or lower.

Put simply, we assume that a big crop of new currency lowers the value of money (i.e. its purchasing power) for the same reason that a big crop of apples lowers the value of an apple.

5.  Like monetarists, we assume many different transmission channels, not just interest rates.  Money affects all sorts of asset prices.  One slight difference from traditional monetarism is that we put more weight on the expected future level of NGDP, and hence the expected future hot potato effect.  Higher expected future NGDP tends to increase current AD, and current NGDP.

6.  Like monetarists (and like NKs such as Bernanke and Mishkin) we find interest rates to be a highly unreliable indicator of the stance of monetary policy.  We agree with Mishkin that it’s better to use a wide range of asset prices, but also agree with Bernanke that NGDP growth is the best indicator of the stance of monetary policy.  We disagree with the traditional monetarist view that the money supply (however defined) is a reliable indicator.  Speaking for myself, I haven’t studied the Divisia index enough to have an intelligent opinion.  Some market monetarists like that indicator.

7.  Like Krugman, Woodford, and Eggertsson, we believe that temporary currency injections have little or no impact on AD.  Instead, current AD and NGDP are determined by changes in the future expected path of NGDP.  We differ from those NKs in that we think the expected future path of money is much more informative than the expected future path of interest rates, except at the zero bound.  We believe that at the zero bound the important variable is the expected level of base money when the economy has exited the zero bound.  My own view is that if the central bank pays interest on reserves, then the long run path of the non-interest-bearing currency stock may be more informative than the monetary base.

8.  Because of point 7, there can be an “indeterminacy problem” in trying to model a fiat money regime.  In practice I don’t think this is a big problem, as there is an implied promise at some future date to exchange fiat currency for some sort of real good.  This might occur at the time we switch to all electronic money.  Or it might involve NGDP futures contracts.  I’m not an expert on indeterminacy, and would recommend reading Bennett McCallum.  If you put aside the indeterminacy issue, then NGDP could be modeled roughly as follows:

The interaction of the supply of base money and velocity (or the Cambridge k) determines NGDP.  The central bank controls the supply of money, and the demand for base money is mostly determined by nominal interest rates, but also tax rates (as currency is held for tax evasion.)  When not at the zero bound, they aren’t close substitutes.  Nominal interest rates are strongly and positively correlated with the output gap, and with expected NGDP growth.  That means expected future base growth has a strong and positive impact on current interest rates (when not at the zero bound.)  If the central bank does NGDP level targeting, then the specific NGDP growth path chosen is by far the most important determinant of nominal rates, and hence velocity.  Output gaps are determined as in other natural rate models, by unexpected changes in NGDP.  (Notice we use NGDP growth where other models use inflation.)

9.  Market monetarists believe currency and T-bills are close substitutes at the zero bound, but not perfect substitutes.  That’s because it’s costly to store huge quantities of cash (which makes legal investors prefer T-bills) and cash is anonymous (which makes tax evaders prefer cash.)  (When not at the zero bound, they are not close substitutes.)  Nonetheless, temporary currency injections will have little impact at the zero bound.  But this is also true of temporary injections when not at the zero bound.  Permanent monetary injections are effective whether at the zero bound or not.  Market monetarists think Keynesians approach the liquidity trap from the wrong direction, seeing it as a barrier to expansionary monetary policy.  Market monetarists believe it has never posed such a barrier, and instead central banks have been limited, if at all, by an unwillingness to use unconventional tools, AND EVEN MORE IMPORTANTLY, by an unwillingness to set an adequate nominal target, and/or to engage in level targeting.  We believe the liquidity “trap” is not a trap at all, but merely a reflection of excessively tight money which has opened up a large output gap and/or led to subnormal expected NGDP growth.

10.  Some of us are skeptical of fiscal stimulus, partly because we think monetary stimulus is more efficient for the usual deadweight cost of future taxes reasons, and partly because the central bank might offset the effect by targeting inflation or NGDP.  Speaking for myself, I do agree with those who say lower real interest rates increase the number of public investments that meet cost/benefit criteria, and that some types of stimulus such as employer-side payroll tax cuts can “work” when the central bank stubbornly targets inflation or NGDP at the wrong level.

To summarize, we have many similarities to monetarism, but don’t favor a stable money supply rule, nor do we assume relatively stable velocity.  I also disagree with their “long and variable lags” approach, but am not sure if other market monetarists agree with me.  I think we all agree that monetary policy affects asset prices with no lag, and that traditional monetarists sometimes went off course by predicting inflation or deflation when asset market indicators were predicting no such thing.

We also overlap with new Keynesians, particularly in the emphasis on rational expectations and the importance of future expected path of policy.  We think NKs misinterpreted real world “liquidity traps” such as Japan in the late 1990s, and hence developed a theory based on credibility problems that don’t actually occur in the real world.  If a central bank promises to inflate and do level targeting, it will be believed.  We also think NKs put too much emphasis on short term interest rates as an indicator of the stance of monetary policy, and hence miss events like December 2007, when an unexpectedly contractionary Fed announcement reduced three month T-bill yields, because the effect on near term NGDP growth expectations overwhelmed the liquidity effect.  Nick Rowe says IS curves often slope upward, and I agree.

PS.  I forget earlier to link to this excellent Christina Romer interview on the Great Depression.  People often ask me what to read, and these are good choices.


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150 Responses to “What is market monetarism?”

  1. Gravatar of Luis Enrique Luis Enrique
    5. March 2012 at 06:03

    I think the main question non-economists (or maybe just me) want answered about monetary policy in general is: “how does it affect things I care about, like unemployment?”

    Take this “how QE works” pamphlet from the BoE for example:

    http://www.bankofengland.co.uk/monetarypolicy/Documents/pdf/qe-pamphlet.pdf

    spending and incomes increase for three reasons: higher asset prices, lower costs of borrowing and more bank lending.

    it’s pretty easy to be sceptical of all three channels at the present moment in time. Corporations are net cash, the elasticity of corporate investment to changes in borrowing costs is probably low, the link between money and bank lending is weak and more QE ain’t going to start banks lending to SMEs; it’s not easy to see how making people who already own assets a bit wealthier is really going to take chunks out of unemployment.

    It’s easier to understand how the government spending and hiring can reduce unemployment, at times like these.

    afaics you deal with this in the second para of point 8?

    have you already written a post that contains you best answer to the question of how monetary policy works, that you would point me to if I am looking for reasons to believe that monetary policy is as effective as you think it is?

  2. Gravatar of Major_Freedom Major_Freedom
    5. March 2012 at 06:59

    No mention of how market monetarism exacerbates cantillon effects, how it hampers individual economic calculation, generates business cycles, as well as a more rapid growth in the state than would direct taxation and borrowing allow.

    In other words, a sugar coated poison pill.

  3. Gravatar of W. Peden W. Peden
    5. March 2012 at 07:12

    “I also disagree with their “long and variable lags” approach, but am not sure if other market monetarists agree with me.”

    It presumably depends on the nature of the monetary shock and expectations. An increase in the quantity of money that is accompanied by a big reduction in interest rates will presumably initially coincide with a fall in velocity, which ceteris paribus will imply a lag until interest rates rise. The expectations effect will either make or break this mechanism, of course. Also, because of capacity, the lags from money to inflation and money to NGDP will be different: by the mid-1970s, US NGDP growth was actually slowing down, but inflation was rising as the strong growth of 1972-1973 turned into recession. In contrast, the lag between M2 and NGDP in the US (when there has been a relationship) in the US seems to have been very very short.

    The main cases of long lags with which I’m familiar are in the UK: there was a three year lag between peak M3 growth in 1967-1968 and NGDP growth in 1970-1971; a three year lag in peak M3 growth in 1972-1973 and peak NGDP growth in 1975-1976; and a two year lag in M4 from 1985-1986 and NGDP growth in 1987-1988.

    (The 1972-1973 case is complicated by the end of the interest rate cartel at the end of 1971 and its effects on the demand for deposits vs. the demand for bonds.)

    However, there’s no ready rule with the lags: the sharp slowdown in M4x growth in 2008 preceded the contraction in NGDP by a few months-

    http://www.bankofengland.co.uk/statistics/PublishingImages/fm4/2011/sep/chart1.gif

    As you say, one has to look at aggregate prices more generally. If inflation expectations are very low, then inflation probably isn’t on the horizon even if monetary growth is strong.

  4. Gravatar of Morgan Warstler Morgan Warstler
    5. March 2012 at 07:25

    If you spent ANY frigging time talking about the other side of the coin.

    That at 4% or 4.5% level NGDP it is virtually impossible:

    1. to have booms and bubbles.
    2. a clear choice of private borrowing over public spending emerges and govt. shrinks.

    You’d calm down m_freeman quite a bit.

  5. Gravatar of Morgan Warstler Morgan Warstler
    5. March 2012 at 07:25

    you’d also let those that talk about MM understand what you are getting them into.

  6. Gravatar of Benjamin Cole Benjamin Cole
    5. March 2012 at 08:06

    Excellent wrap-up. This is the way forward for Western nations.

    I have minor quibbles, or, even less than that, would like some points highlighted.

    When an item—paper money–is coin of the realm, people react to it. We know the American West was developed more rapidly with the help of counterfeiters. The paper money exchanged hands, and bridges were built, fences erected, land farmed. The positive effects cannot be denied.

    There is even the reality that a bogus bill, traded around a small town, might create dozens and dozens of dollars of output—vastly exceeding the minute loss in purchasing power due to inflation.

    So, unlike more apples, printing more fiat money has the effect of creating more output. You can overdo it—and just as dangerously (see Japan) you can easily underdo it.

    But to not use the power of the press to increase prosperity is lunacy. It is suffering for no reason. It is pain without the gain. We know from Japan there is no reward for monetary asceticism. Or if there is, it is yet decades upon decades in the coming—sure, let’s consign several lifetimes to economic penury in order to reach the promised land. If we do.

    We Market Monetarists now must concentrate on “selling” our story to the shibboleth-worshipping economics community (hard sell) and the broader public (probably more open-minded).

    The Theo-Monetarists and Econo-Shamans have developed arguments over the years, usually laced with moral imperatives and high-sounding premises.

    Perhaps Market Monetarists need to think along the same lines.

  7. Gravatar of Becky Hargrove Becky Hargrove
    5. March 2012 at 08:23

    Major Freedom,
    Underneath it all, what is your real issue with Market Monetarism? Is it simply that you think the lower classes just need to go away? Because whenever such a ‘stealth’ approach is used (just take away their oxygen), the lower classes eventually come back. Better to transform the lower classes into citizens with honor, integrity and respect who are capable of contributing to societal wealth. (Of course – granted, there are plenty of liberals who certainly need to help with that)

  8. Gravatar of Il Gattopardo Il Gattopardo
    5. March 2012 at 08:49

    Nothing changes. The New Friedman still doesn’t know

    4. how to define money based on the criteria of stable demand and supplier’s control;
    5. what the transmission channels are;
    6. why some people still look at interest rates;
    7. anything about the timing of the effects;
    8. how the failure to define money affects everything he says;
    9. that between the extreme of zero substitution and perfect substitution there are many degrees of substitution;
    10. why some people believe that fiscal stimulus is effective when everyone knows how effective monetary policy is.

    I assume that based on this SS’s post, Tyler Cowen will write post # 1 trillion arguing for TGS (I bet, however, that he will not change his conclusion about subsidizing research).

  9. Gravatar of Lars Christensen Lars Christensen
    5. March 2012 at 08:52

    Scott, agreed, but it is also important to note that we strongly believe that markets mater. We want to use market instruments to track and implement monetary policy and we believe in rules rather than discretion.

  10. Gravatar of Lars Christensen Lars Christensen
    5. March 2012 at 09:00

    by the way I did not formulate a MM model, but I did write a post on how I believe we should teach economics

    http://marketmonetarist.com/2011/12/23/how-i-would-like-teach-econ-101/

    Fundamentally I think MM’ers start out with MV=PY rather than Y=C+I+G+X-M. That is also why we think that the fiscal multiplier is zero under any nominal target and that NGDP causes RGDP rather than the other way around.

  11. Gravatar of Andy Harless Andy Harless
    5. March 2012 at 09:07

    I don’t think the first point, “We favor NGDP targeting,” is essential to market monetarism. Most people consider Nick Rowe a market monetarist, but he has not been unwavering in his support of NGDP targeting. (He seems to lean more in that direction recently, but in the past he has seemed to suggest that there might be preferable alternatives.) I suppose I should let him speak for himself, but in any case, I think the tendency of market monetarists to support NGDP targeting is more a case of rallying around one convenient proposal rather than an essential feature of the approach.

    I would also add that market monetarists, like new Keynesians (and like the old monetarists as well as old Keynesians), believe that nominal wage and/or price rigidities have an important role in business cycles. This seems to be one thing that separates “market monetarists” from “new monetarists” like Steve Williamson.

  12. Gravatar of Lars Christensen Lars Christensen
    5. March 2012 at 09:09

    A bit more shameless self-promotion (sorry Scott). For those interested here is a link to my original paper on MM: http://thefaintofheart.files.wordpress.com/2011/09/market-monetarism-13092011.pdf

  13. Gravatar of Cthorm Cthorm
    5. March 2012 at 09:23

    I also disagree with their “long and variable lags” approach, but am not sure if other market monetarists agree with me. I think we all agree that monetary policy affects asset prices with no lag, and that traditional monetarists sometimes went off course by predicting inflation or deflation when asset market indicators were predicting no such thing.

    This is one of the things I learned in class that drives me crazy. How can “long and variable lags” exist in an economics tradition that embraces even the weak-form EMH. As long as you have a model with t + 1, you have no excuse for ignoring expectations. Traditional monetarists got off course not by ignoring asset market indicators per se (most supported EMH afaik), but by fetishistic idolation of the growth of M as a reliable indicator, leading them to favor the M-growth dogma over the market-based evidence.

    @Lars

    Speaking only for myself, I’ve always found MV=PY to be a more useful concept than Y=C+I+G+X-M. The national accounting model just screams irrelevance to me. I hated those portions of my Macro tests. If it wasn’t for the Solow model and observations about z-factor productivity I would’ve stopped taking Macro altogether. Anyway, here is my scientistic reasoning for dismissing Y=C+I+G+X-M as being anything but a distraction:

    1) Consider MV=PY versus Y=C+I+G+X-M. The latter is focused entirely on one variable in the four-term expression.

    2) To get to an equation focused on Y, you assume a constant price level. Let’s repeat that. You assume away the PRICE level, in a discipline based on the “allocation of scarce resources.” How can you study the allocation of scarce resources without the SINGLE INDICATOR that signals relative & absolute scarcity?

    3) Focusing on the components of Y is not really ‘Macro’ in function. It’s focusing on the ingredients and not on the big picture, which is what the name ‘Macro’ has always implied to me. What moves economies in the long run? Z, M*V, and population. NOT C, NOT I, NOT G, and certainly NOT X-M. In plain terms what matters in the long run is: productivity, technology & efficiency (Z); the supply/demand of the medium of exchange (M*V); and the size of the population. C+I+G+X-M can only matter if they have some effect on Z, M*V, or the population.

  14. Gravatar of Integral Integral
    5. March 2012 at 09:24

    A good summary of the MM position was sorely needed and this post fits the bill nicely.

  15. Gravatar of Lars Christensen Lars Christensen
    5. March 2012 at 09:25

    Andy, I agree…NGDP level targeting is not the only answer. It is a very neat way to express the MM policy recommendation in the present situation in the US or the euro zone, but wage level targeting might also make sense and another policy recommendation might be suiting for for example commodity exporting countries. That said, the key point is the call for rules rather than discretion. The fact the markets tell us about the monetary policy stance, that price and wages are rigid. That money matters…that monetary policy is more effective than fiscal policy etc…

  16. Gravatar of Cthorm Cthorm
    5. March 2012 at 09:38

    @Luis Enrique

    In my mind the easiest way to think of how monetary policy effects unemployment is in a simple equation. D = demand; M*V = the supply/demand of the medium of exchange; Z = technology/productivity; p = population. Where M*V is a value between 0 and 1 in the long run.

    D = (Z)(M*V)(p)

    If M*V falls below 1, in the short run you will have unemployment/demand shortfall. The original level of D can still be met by an increase in Z or p. M*V simply represents whether or not the medium of exchange (money) is sufficient to support current levels of demand. If it is insufficient, then demand tomorrow will be lower than demand today, which is a clear vicious cycle.

  17. Gravatar of bill woolsey bill woolsey
    5. March 2012 at 09:41

    I disagree with a good bit of this, but consider them to be minor details. If I had to summarize the disagreement, it would be that you are too “base money” centric.

    To some degree, this amounts to “who is in the club?”

    I think the “level targeting” is nearly as important as the target being spending on output. Maybe equally imporant. Maybe even more important. Sometimes I think my views are closer to someone who favors a price level target to someone who favors a nominal GDP growth rate target.

    I am also inclined to emphasize the role of expectations. Rather than current excess supplies or demands for money pushing future nominal GDP up or down, expectations of future excess supplies or demand for money pull nominal GDP up or down.

    I must admint that I have never had much confidence in your or anyone’s ability to gauge future monetary disequilibrium from current stock market prices. Too much else can be going on there.

    I don’t like TIPS because that is inflation, not nominal GDP.

    Old monetarism is the view that keeping a measure of the quantity of money on a slow steady growth path would come clsoe to keeping spending on output on a slow steady growth path and that was the least bad macroeconomic environment. The assumption is that velocity doesn’t change much. Market monetarism accepts that velocity can change significantly and so the quantity of money needs to adjust to offset those changes in velocity.

  18. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    5. March 2012 at 09:46

    ‘…it’s not easy to see how making people who already own assets a bit wealthier is really going to take chunks out of unemployment.’

    No? They dine out more frequently, redecorate their mansions, buy a newer Mercedes…a larger yacht, donate more to charity….

  19. Gravatar of Major_Freedom Major_Freedom
    5. March 2012 at 10:08

    Morgan Wartsler:

    If you spent ANY frigging time talking about the other side of the coin.

    That at 4% or 4.5% level NGDP it is virtually impossible:

    1. to have booms and bubbles.

    2. a clear choice of private borrowing over public spending emerges and govt. shrinks.

    Both 1. and 2. are false.

    If the Fed has to inflate the money supply into the banking system, and thus lead to temporarily lower nominal interest rates (Sumner is flat wrong to assert that interest rates are not lowered by way of Fed inflating bank reserves), in order to get people to spend more than they otherwise would have, to generate an arbitrary 4.5% NGDP in the region called “America”, then that will generate the business cycle, because market interest rates will not be a function of pure individual savings and time preferences. It will be a product of monetary manipulation.

    Public spending will not be curbed in favor of private borrowing if the standard of reference is a free market gold standard, because it will still be far easier for the state to print money for itself rather than tax (or tax in the future if borrowing).

  20. Gravatar of Major_Freedom Major_Freedom
    5. March 2012 at 10:14

    Becky Hargrove:

    Underneath it all, what is your real issue with Market Monetarism?

    That’s what I have been explaining.

    Is it simply that you think the lower classes just need to go away?

    The lower classes are HURT in a market monetarism world. They are BENEFITED when they can choose their own money, such as gold, to preserve their purchasing power, and their jobs and homes to the extent that the business cycle is reduced because of it.

    Because whenever such a ’stealth’ approach is used (just take away their oxygen), the lower classes eventually come back. Better to transform the lower classes into citizens with honor, integrity and respect who are capable of contributing to societal wealth.

    How about you treat them like human beings and give them the decency of allowing them the freedom to transform themselves with honor, integrity and respect who are capable of contributing to themselves and others the way they see fit?

    Your worldview of monetarism is totally upside down. You actually believe that monetarism benefits the poor. It is exactly the opposite. You could not be more wrong. Inflation is a system that hurts the poor the most. They are the least capable of handling the economic destruction and reduced productivity unleashed by monetarism.

    My position is not based on “rich versus poor” or “slave morality.” It is based on individual liberty, which is not only the only logically defensible ethic, but it is necessary for human welfare and prosperity.

  21. Gravatar of Major_Freedom Major_Freedom
    5. March 2012 at 10:20

    Becky, your comment truly represents the madness that can ensue by those who advocate for a destructive ideology whilst believing they are helping the vulnerable and needy. Free market capitalism, including money production, is the most humane, safe, and beneficial system for the vulnerable in society, for it is in this system that systematic violence and coercion is reduced, which then allows for maximum productivity and lowest prices. All this is maximized in a system of individual private property and unhampered economic calculation.

    This may shock you, but an ethic that doesn’t explicitly seek to use state violence to help the poor, doesn’t mean that it is uncaring for the poor. You’re just so clouded by what you are actually calling for that you don’t even see that the poor are worse off the more state violence is introduced into society. With state controlled money production, state violence is introduced into virtually every single trade.

    You think you are helping the poor when you call for more government, but the poor are better off being free and able to compete with the wealthier economic actors fairly.

  22. Gravatar of Nick Rowe Nick Rowe
    5. March 2012 at 10:21

    Scott: Good post.

    A couple of minor points:

    1. “Speaking for myself, I do agree with those who say lower real interest rates increase the number of public investments that meet cost/benefit criteria, and that some types of stimulus such as employer-side payroll tax cuts can “work” when the central bank stubbornly targets inflation or NGDP at the wrong level.”

    I think you need to clarify that last bit about “…when the central bank stubbornly targets inflation or NGDP at the wrong level.” I know what you mean, but that’s not it. If the Fed suddenly decided to target 0% NGDP, that wouldn’t make fiscal policy work. It’s if the Fed targeted something other than NGDP, like targeting interest rates, that fiscal policy could work.

    2. What about MMs believing “Recessions (or business cycles) are always and everywhere a monetary phenomenon”? I believe that, but I’m not sure how many would agree.

    Andy: yes, I have been slower and more lukewarm on the NGDPLP target than others. The recent data on P vs NGDP over time are strongly suggestive that NGDP would have been a better target variable than P. Those data have been the main thing which caused me to move away from inflation targeting to NGDPLPT. But I wish I were more confident of the theory to back that position. It’s something I’m still thinking about.

  23. Gravatar of Major_Freedom Major_Freedom
    5. March 2012 at 10:27

    Nick Rowe:

    Andy: yes, I have been slower and more lukewarm on the NGDPLP target than others. The recent data on P vs NGDP over time are strongly suggestive that NGDP would have been a better target variable than P. Those data have been the main thing which caused me to move away from inflation targeting to NGDPLPT. But I wish I were more confident of the theory to back that position. It’s something I’m still thinking about.

    If only more economists thought like that, then they wouldn’t keep lazily conflating correlation and causation.

    Sumner did not once address a single theoretical aspect of market monetarism nor did he address any causal arguments of why it allegedly “works.” Merely pointing to a positive correlation between NGDP and employment/output is not good enough. One can do the same thing with global warming and pirate attacks.

    The true test of an economist is his ability to ground his arguments on economic first principles. Any yahoo can observe historical data and tabulate correlations between variables.

  24. Gravatar of Lee Kelly Lee Kelly
    5. March 2012 at 10:58

    Fundamentally, market monetarists are concerned with the supply of and demand for money. Metrics of aggregate nominal income are singled out as vicarious indicators of monetary disequilibrium. The ultimate purpose of their proposals for a nominal GDP target would be to approximate equilibrium in the supply of and demand for money (perhaps with a nod to asymmetrical price stickiness). While no cure-all, market monetarists expect such a policy to greatly mitigate booms and busts otherwise catalysed by monetary disequilibrium. This rather narrow focus on preventing monetary disequilibrium unites market monetarists more than anything else, and it’s curious that more economists do not share this concern.

  25. Gravatar of ssumner ssumner
    5. March 2012 at 12:02

    Luis, There are two parts to that: How does M affect NGDP? And how does NGDP affect unemployment? I don’;t have much to add to the standard natural rate models of NGDP and U, what’s distinctive about market monetarism is that we see M affecting NGDP via the hot potato effect.

    Major, As usual it does exactly the opposite of everything you say.

    W. Peden, I have a slightly different view. A big increase in M isn’t a big monetary shock, what matters is the expected future path of M. I believe that a change in the expected future path of M has a very rapid impact on P and Y. I think what creates the perception of lags is that sometimes big increases in M are viewed as temporary, and this initially have little effect. If it later turns out they are permanent, then the effect may be large, but delayed. But that’s not really a “lag” it’s a misidentification of the actual monetary shock (which is the point in time when it became perceived as permanent.)

    Morgan, I’ve given up on Freeman.

    Ben, I agree that paper money has more real effects than apples, but that’s because other (sticky) prices are measured in terms of money.

    Il Gattopardo, Might I suggest a course in reading comprehension?

    Lars. I agree with those points. I tried to mention markets in point 3, but perhaps should have said more.

    Andy, You are probably right about NGDP not being essential, although I’d say there’s fairly widespread opposition to simple inflation targeting. Maybe I’ll add an update.

    I agree on sticky wages and prices, and my reference to natural rate models was meant to allude to that fact. Perhaps I should have been more specific.

    Cthorm, I agree.

    Thanks Integral.

    Bill, I mostly agree. I don’t claim MMs need to agree with everything I wrote, and agree that level targeting is more important than the specific NGDP target.

    I agree that expectations are crucial, but you also need the hot potato effect because expectastions must be about SOMETHING. There needs to be some transmission mechanism other that inflation happens because people expect inflation.

    I focus on the base because it’s the medium of account and it’s what the Fed controls. I agree they influence M2 indirectly, just as they influence NGDP indirectly. Ultimately if you want to use the base to target market forecasts on NGDP, then M2 matters only to the extent that market participants use M2 to help them forecast NGDP. My hunch is they mostly use other things.

    Nick, You’ll always be a market monetarist in my mind no matter what target you favor.

    Regarding employer-side payroll tax cuts, if the nominal wage is sticky then they shift the SRAS curve to the right. In that case RGDP rises even if the central bank is targeting NGDP. They basically improve the P/Y split–it’s pure supply side policy. Perhaps “fiscal policy” is the wrong term.

    I agree that recessions are almost always monetary, with two exceptions:

    1. Huge real shocks can cause RGDP to fall. But in that case employment often doesn’t change much (see Japan in 2011) So I’d say if recession are defined as a big rise in unemplyment, they are especially likely to be monetary in origin.

    2. A big rise in the minimum wage (or national union activity) is perhaps the most likely to cause a non-monetary recession in terms of higher unemployment. But I don’t know of any US recessions caused by less labor supply–the closest might have been the NIRA, which sharply slowed the recovery from the Depression for two years in America.

  26. Gravatar of Marcus Nunes Marcus Nunes
    5. March 2012 at 12:09

    @lee kelly
    Nicely put.

  27. Gravatar of TheMoneyIllusion » What is market monetarism? | Futures Market Updates/News TheMoneyIllusion » What is market monetarism? | Futures Market Updates/News
    5. March 2012 at 12:12

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  28. Gravatar of Lee Kelly Lee Kelly
    5. March 2012 at 12:22

    Market monetarists emphasise money’s dual role as the medium of exchange and the unit of account. Money is not just a highly liquid asset.

    Medium of Exchange –

    People accept money even if they have no desire to hold more on average, because it is a means to facilitate transactions for whatever they really do want. This is not true for near monies. For even the nearest of near monies, someone must be convinced to hold more of it (at a given price) or it simply will not come into existence in the first place. If there is too much or too little of a near money, then its quantity may rise or fall as more is issued or old issues are left to mature. This is not true of money itself. People only get rid of unwanted money balances by passing them onto others, but on aggregate the money supply must be equal to money balances.

    Unit of Account -

    If there is too much or too little of some near money, then its price can rise or fall until people are willing to hold the quantity that actually exists. This is not true of money itself. If there is too much or too little money, then every other price in the economy must rise or fall instead to achieve equilibrium–money doesn’t have a price of its own. This is a more difficult and roundabout problem for the price system to solve than a single price change. Even once inflation or deflation has run its course, the adequacy of the unit of account to coordinate long-term debt relationships is impaired.

    There are a bunch of complications I left out, but this is a comment not an essay.

  29. Gravatar of ssumner ssumner
    5. March 2012 at 12:22

    Lee, I agree. But I suppose others say they are trying to reduce disequilibrium, but with a different policy framework.

  30. Gravatar of Major_Freedom Major_Freedom
    5. March 2012 at 12:23

    Lee Kelly:

    Fundamentally, market monetarists are concerned with the supply of and demand for money.

    I’m going to start a new school of economics called Yammerism. In this school of thought, nominal yammers should rise by 5% per year. If it doesn’t rise by that much in the private market of yammering, then the state should pick up the slack in yammering, and plug the gap by increasing their yammering to the primary dealers of yammering, the mainstream media and Yammerist college professors.

    Yammering is too important to be left to the free market. If state yammering is to exist, then Yammerist economists should advise the state on when to yammer more and when to yammer less. After all, we’re not dogmatists in only wanting private sector yammering.

    If the demand for withholding yammers from the market increases too much, causing nominal gross domestic yammering to decline below target, then that will lead to a reduced real output and employment, since yammering is ubiquitous and everywhere. It is not like other things like money and shoes. Yammering takes place even when people yammer to themselves.

    Historical studies have also shown that depressions are strongly correlated with nominal shocks in yammering. Every time there is a depression, there is a fall in private sector yammering. There should be more state yammering to prevent the aggregate supply of yammers from falling. If the private sector hoards more of their yammering, then the state should yammer more. If the private sector hoards less of their yammering, then the state should yammer less. This is how the state will be constrained in their yammering.

    For diverse economies, there should be yammer independence. This follows from optimal yammering area theory. When labor and capital cannot be easily moved, if factors are immobile, then these locations should have their own yammering, to absorb sudden shocks in worldwide demands for yammering.

    We also can’t ignore the fact that the exchange ratios of yammers tend to be sticky in the real world, and so to avoid yammer disequilibrium, aggregate national yammering targeting should be explicit and predictable. Heck, we could even have a futures market in a NGDY index.

    Some key differences between Yammerism and Market Monetarism:

    1. Yammer targeting has lower transactions costs than money spending targeting.

    2. Yammers don’t need to be stored anywhere.

    3. Unlike Market Monetarists, Yammerists assume far more transmission channels, not just nominal money spending. Yammers can be found anywhere from hospital neonatal facilities, to the halls of the world’s finest educational institutions.

    4. Yammerists find NGDP targeting to be a highly unreliable predictor of future trends. We find yammering to be a better predictor of where the future economy is heading. For example, prior to the 2008 crisis, there was yammering that a future crisis would take place. NGDP analysis failed to predict it. Some market monetarists even denied there was a bubble and bust.

    5. Yammerists believe that long term money spending growth, and expectations of future NGDP, have little to no affect on yammering. Yammerists believe that yammering is much more informative than expectations of future path of aggregate money spending or interest rates.

    6. Like market monetarism, there can be an “indeterminacy problem” in modelling a state yammering regime. But in practise I don’t think this is a big problem, as there is an implied promise at some future date to exchange yammering at the state for some sort of real good in return. This might occur at the time we switch to all electronic yammering. Or it might involve NGDY futures contracts. I’m not an expert on indeterminacy, and would recommend reading Yammer McYammerstein. If you put aside the indeterminacy issue, then NGDY could be modeled roughly as follows:

    The interaction of the supply of state yammering and yammerocity (or the Chicago Y) determines NGDY. The central yammerer controls the supply of yammers, and the demand for base yammering is mostly determined by nominal yammer borrowing costs, but also yammer tax rates (as currency is held for yammer tax evasion.) When not at the zero bound, they aren’t close substitutes. Nominal yammer borrowing costs are strongly and positively correlated with the output gap of yammering, and with expected NGDY growth. That means expected future state yammer growth has a strong and positive impact on current yammer borrowing rates (when not at the zero bound.) If the central yammerer does NGDY level targeting, then the specific NGDY growth path chosen is by far the most important determinant of nominal yammer borrowing costs, and hence yammerocity. Output gaps are determined as in other natural yammer borrowing cost models, by unexpected changes in NGDY. (Notice we use NGDY growth where other models use inflation.)

    7. Yammerists believe market monetarist yammering and state yammering are close substitutes at the zero bound, but not perfect substitutes. That’s because it’s costly to store huge quantities of yammers (which makes legal investors prefer state yammering) and internet yammering is anonymous (which makes yammer tax evaders prefer internet yammering.) (When not at the zero bound, they are not close substitutes.) Nonetheless, temporary yammer injections will have little impact at the zero bound. But this is also true of temporary injections when not at the zero bound. Permanent yammer injections are effective whether at the zero bound or not. Yammerists think Market Monetarists and Keynesians approach the liquidity of yammers trap from the wrong direction, seeing it as a barrier to expansionary yammer policy. Yammerists believe it has never posed such a barrier, and instead central yammerers have been limited, if at all, by an unwillingness to use unconventional tools, AND EVEN MORE IMPORTANTLY, by an unwillingness to set an adequate nominal yammer target, and/or to engage in level targeting. We believe the liquidity of yammers “trap” is not a trap at all, but merely a reflection of excessively tight yammers which has opened up a large output gap and/or led to subnormal expected NGDY growth.

    8. Some of us are skeptical of monetary stimulus, partly because we think yammer stimulus is more efficient for the usual deadweight cost of future taxes reasons, and partly because the central yammerer might offset the effect by targeting inflation of yammers or NGDY. Speaking for myself, I do agree with those who say lower real yammer borrowing rates increase the number of public yammer investments that meet cost/benefit criteria, and that some types of stimulus such as employer-side yammer tax cuts can “work” when the central yammerer stubbornly targets inflation of yammers or NGDY at the wrong level.

  31. Gravatar of Major_Freedom Major_Freedom
    5. March 2012 at 12:25

    ssumner:

    Major, As usual it does exactly the opposite of everything you say.

    As usual, you are totally wrong. It does not do the opposite of everything I am saying. It does what I am saying. It does the exact opposite of what you are saying.

    Hey this is fun.

  32. Gravatar of Lee Kelly Lee Kelly
    5. March 2012 at 12:33

    My main concern about NGDP targeting is that it may fail to stabilise the unit of account. My main concern about price level target targeting is that is may fail to produce a sub-optimal quantity of the medium of exchange.

  33. Gravatar of Lee Kelly Lee Kelly
    5. March 2012 at 12:35

    Oops! In that last comment, ‘sub-optimal’ is supposed to be ‘optimal’, or, I suppose, you could substitute ‘fail’ for ‘not fail’. Either works, but I suggest the former.

  34. Gravatar of D R D R
    5. March 2012 at 12:35

    “But I don’t know of any US recessions caused by less labor supply–the closest might have been the NIRA, which sharply slowed the recovery from the Depression for two years in America.”

    Do you have any numbers to support this?

  35. Gravatar of Greg Ransom Greg Ransom
    5. March 2012 at 12:36

    This all seems useless unless you deal with bungie jumping “substitutes for money” connected with assets of cyclically changing value and liquidity — repo money, MBSs, commercial paper, etc. — and a systematically pathological financial sector perversely incentivized by To Big To Fail taxpayer insurance against large and systematic down side risks.

    Rather, you’re just giving us another version of systematic and massive wealth transfers to the financial class symbolized by the Greenspan put and TARP — you will never be able to sustain an attempt to keep ahead of the economic train wreck guaranteed by a financial sector encouraged to act as if there are is no real economy outside of a temporarily self-sustaining financial snowball fed by the Federal Reserve and headed toward either hyper-inflation or a brick wall.

    It simply will not do to single out a “given” trajectory for aggregate nominal income as a lone metric of monetary equilibrium.

    If you have massive disequilibrium between the value path across time of the assets which are backing “substitutes for money” and the value of those “substitutes for money”, and the institutions which depend on those “substitutes” for their solvency, then you’ve good massive and unsustainable monetary disequilibrium. And all of your “monetary monetarist” policy-focused dentistry can’t fix that, it can only be a partial band-aid. And if cluelessly pursued “monetary monetarism” can witlessly _encourage_ growing disequilibrium, and can serve as a moral hazard for _more_ and _greater_ disequilibrium.

  36. Gravatar of Greg Ransom Greg Ransom
    5. March 2012 at 12:38

    Make that — then you’ve got massive & unsustainable monetary disequilibrium

  37. Gravatar of D R D R
    5. March 2012 at 12:39

    (I mean that NIRA “sharply slowed the recovery from the Depression for two years”)

  38. Gravatar of Greg Ransom Greg Ransom
    5. March 2012 at 12:47

    Lee writes,

    “My main concern about NGDP targeting is that it may fail to stabilise the unit of account.”

    The problem here is that there are all kinds of “money” and there is not a single thing which is “the unit of account”, and all sorts of things can substitute for many of the most important function of these various kinds of money:

    http://faculty.unlv.edu/msullivan/Sweeney%20- %20Money%20supply%20and%20inflation.pdf

    The question is — can we expect NGDP targeting to effectively stabilize all of these different types of monies and shadow monies and their complex interconnections through various institutions, will all sorts of built in moral hazard, lack of transparency problems, and knowledge problems across time, among other problems.

    THAT is what NGDP targeting has to do — and Scott is a AWOL when it comes to the big issue.

  39. Gravatar of Greg Ransom Greg Ransom
    5. March 2012 at 12:47

    Lee writes,

    “My main concern about NGDP targeting is that it may fail to stabilise the unit of account.”

    The problem here is that there are all kinds of “money” and there is not a single thing which is “the unit of account”, and all sorts of things can substitute for many of the most important function of these various kinds of money:

    http://faculty.unlv.edu/msullivan/Sweeney%20- %20Money%20supply%20and%20inflation.pdf

    The question is — can we expect NGDP targeting to effectively stabilize all of these different types of monies and shadow monies and their complex interconnections through various institutions, will all sorts of built in moral hazard, lack of transparency problems, and knowledge problems across time, among other problems.

    THAT is what NGDP targeting has to do — and Scott is a AWOL when it comes to the big issue.

  40. Gravatar of Lee Kelly Lee Kelly
    5. March 2012 at 12:49

    Major Freedom,

    For all your yammering, perhaps it has eluded you that many market monetarists are also in favour of, or at least sympathetic to, proposals to abolish central banking and have a completely free market in money.

    I don’t like central banking. In an ideal world, we should no more have to discuss monetary policy rules any more than we discuss automobile policy rules. I’d love to just open it all to marketplace competition, but that just isn’t going to happen, especially not in the near future.

    Part of the appeal of an NGDP target, for me, is that it would tolerably emulate how I think the money supply would behave in a truly competitive system of money and banking. The first step to getting rid of central banking could be to show how its best monetary policy is all about trying to copy a world where central banking didn’t exist–the system would be demonstrating its own redundance.

  41. Gravatar of Greg Ransom Greg Ransom
    5. March 2012 at 12:53

    Scott has fairly well indicated that he finds the task of thinking about free banking to be too much hard work.

    Lee writes,

    “Many market monetarists are also in favour of, or at least sympathetic to, proposals to abolish central banking and have a completely free market in money.”

  42. Gravatar of Morgan Warstler Morgan Warstler
    5. March 2012 at 12:57

    Freeman,

    “If the Fed has to inflate the money supply into the banking system, and thus lead to temporarily lower nominal interest rates (Sumner is flat wrong to assert that interest rates are not lowered by way of Fed inflating bank reserves), in order to get people to spend more than they otherwise would have, to generate an arbitrary 4.5% NGDP in the region called “America”, then that will generate the business cycle, because market interest rates will not be a function of pure individual savings and time preferences. It will be a product of monetary manipulation.”

    Now look dude, before you auto-respond with me, I’m asking you to take the time to let me describe what I mean. Lord knows I agree with you often enough.

    Please forget now. I do not want to even consider now. We’ll talk about now later.

    Instead I want to start at 2001, with a 4% level target on NGDP.

    You have to go back to the Internet crash mentally. I and all my friends, save Mark Cuban, thought we were millionaires and then we weren’t.

    Dow and Nasdaq are dying, and we’re having a recession.

    the 4% level target is in place:

    http://www.usinflationcalculator.com/inflation/historical-inflation-rates/

    can’t do two links, but this is what I see:

    By Jan 2004, we’re definitely over 4% even with some make up, and the money supply is being reduced, rates aqre going up.

    BUT WAIT!!!

    Barney Franks wants to give all poor people houses.

    Immediately, the futures market BRUTALLY rips even more money out of the economy and rates on mortgages SOAR.

    Local businessmen who can no longer borrow at 3-4%, march on Washington and burn Fannie Freddie to the ground.

    Scrambling to appease the rampaging NGDP futures market vigilante that continues to predict NDGP over 4%, the Federal gvt. cuts back on state transfers and state cut back on public employee pay rolls.

    Intense bombing of Iraq, causes the price of oil to spike, driving inflation higher, and the frigging futures market just keeps sucking money out of the economy.

    People getting good rates are saving hand over fist.

    Ok,

    WHY doesn’t that happen? Please be clear as day about why.

  43. Gravatar of Lorenzo from Oz Lorenzo from Oz
    5. March 2012 at 12:59

    On the indeterminacy issue, I suggest that there is much less there than there seems. Think of it in terms of transaction horizons. If you buy a good you are going to use up, so there is no future transaction involved, then its transaction horizon finishes once you have bought it. You have no concern with its future price. If you buy a good which you are not going to use up–an asset, or something that you might possibly sell (albeit it at a depreciated value) to the second-hand market–then it has an open transaction horizon (for you). Until you sell it, when its transaction horizon closes.

    The transaction horizon of the person you sell it to matters for the expected price but, once you have sold it, they take on the risks (positive or negative). Your concern is merely their expectations at the time of sale. Future information after that point no longer matters to you. Any such information is on the other side of the (now closed) transaction horizon.

    Such transaction horizons are how assets can surge in price even though we may have reason to believe a turning point will occur (sometime). A theoretical turning point does not matter for the price until it becomes part of the information within current transaction horizons.

    The utility of fiat money as a transaction good is similarly a matter of transaction horizons. Any putative loss of utility by some fiat money as a transaction good does not matter until it becomes part of the information within current transaction horizons. Even then, there is the possibility of unloading before the game of “musical transaction chairs” stops. So, for example, as the prospect of the collapse of the Confederacy loomed, the value of the C$ dropped dramatically, but people kept transacting with it up until the bitter end.

    So, the theoretical end of a fiat money does not matter if no specific information (beyond its theoretical possibility) has entered folk’s transaction horizons. Arguing backwards from “it will end” does not work because it imports information into the sequence of transactions that does not yet exist.

  44. Gravatar of Mike Sproul Mike Sproul
    5. March 2012 at 13:00

    A big crop of apples doesn’t get entered on the farmers’ balance sheet as the farmers’ liability. A big crop of new money is used by the Fed to buy new bonds. The new money is the Fed’s liability and the new bonds are the Fed’s asset. Since the fed’s assets moved in step with its liabilities, the value of the dollar is unaffected, unlike apples.

  45. Gravatar of Negation of Ideology Negation of Ideology
    5. March 2012 at 13:12

    It seems to me we are framing market monetarism backwards. Instead of saying “We favor NGDP targeting”, we should say “We favor tying the dollar to GDP”.

    I know it’s the same thing. But I think it’s a better way of describing it. We’re just defining the dollar to be some share of the real economy.

  46. Gravatar of Lee Kelly Lee Kelly
    5. March 2012 at 13:16

    Greg,

    Most near monies are not money: they’re just highly liquid. The difference is that I can spend money and I can’t spend near monies. To “spend” near monies, I must first find someone else willing to hold it. This is not true with money. People accept media of exchange even though they do not want to hold more money, because it can be readily exchanged for something they do want in a way that near monies can’t. In other words, the “hot potato” effect is not true for near monies.

    Various assets function as media of exchange: base money, demand deposits, and, perhaps on specific markets, T-bills, repos, and the like. However, only base money is the unit of account. T-bills, repos, and other liquid assets, even demand deposits, have prices of their own; disequilibria in their respective markets instigate price and quantity changes. This is not true for base money. Base money has no price of its own, and so disequilibrium forces a change in the general level of prices unless the central bank takes deliberate action to restore equilibrium by changing the supply of base money instead.

    Anyway, all those assets that function as media of exchange piggy-back on base money. Ultimately, a shortage of base money will undermine the value of assets like the collateral used for repurchase agreements. Repos will then stop functioning as media of exchange or, at least, their supply will dry up, and all because their is a shortage of base money. (The analogous situation with demand deposits is a bank run). This does not work in reverse. That is, while a shortage in the repo market may increase the demand for base money, it does not inhibit the creation of new base money.

  47. Gravatar of Major_Doofus Major_Doofus
    5. March 2012 at 13:24

    Scott,

    The “theory part” of Market Monetarism is just hydraulic Keynesianism at its core with a few word changes. When unemployment rises increase the amount of state generated violence. When unemployment falls ease off the pedal and decrease state generated violence via raising interest rates. Any increase in the money supply will guarantee an increase in violence, any increase in “NGDP” through the use of coercive force is not a real recovery at all, and any use of non-competitive currencies feeds the vicious cycle of state generated fiat money violence. You want to INCREASE NGDP because you think state force is legitimate if used to cure unemployment, but violence is always wrong no matter what the collectivists yammering on the news station say Scott.

    When it comes down to practicality your all willing to throw away all of the most basic economic precepts in the name of a gimmicky joke of an idea and who better to implement your idea but a wise Soviet technocrat with a central plan?

  48. Gravatar of Lee Kelly Lee Kelly
    5. March 2012 at 13:29

    Scott,

    Why don’t economists ever say: ‘interest rates are too high to equilibrate the supply of an demand for money’ or ‘there is a shortage of money because there isn’t enough fiscal stimulus’? If that’s what they really mean, then why don’t they ever say it? It would clear up a whole mess of confusion using nothing but the most basic concepts and terms in economics. Presumably, none of them favour monetary disequilibrium as a policy goal, so why don’t they phrase their arguments to make that point clear?

  49. Gravatar of Major_Freedom Major_Freedom
    5. March 2012 at 13:31

    Lee Kelly:

    For all your yammering…

    Hey, if the central yammerers aren’t going to hit my desired target of yammering, then I feel no qualms in filling the yammering gap. You should thank me, because I am “stimulating” yammering and boosting real output and employment.

    …perhaps it has eluded you that many market monetarists are also in favour of, or at least sympathetic to, proposals to abolish central banking and have a completely free market in money.

    I’ll believe that when I see market monetarists stop spending their time and resources and energy devoted to advising the central bank, coming with “optimal” central bank theories, and when I see them spend their time, resources and energy devoted to criticising fiat monetarism and advocating and explaining how a free market in money would work and how it is optimal.

    Until that time, no, it’s not “eluding” me that many market monetarists CLAIM to be in favor of abolishing central banks. When their actions meet their words, then I will accept it as something other than…monetarist yammering.

    I don’t like central banking. In an ideal world, we should no more have to discuss monetary policy rules any more than we discuss automobile policy rules. I’d love to just open it all to marketplace competition, but that just isn’t going to happen, especially not in the near future.

    Then intellectually fight for it and stop capitulating morally and intellectually. You’re not making peace with me by acting like an intellectual traitor.

    Part of the appeal of an NGDP target, for me, is that it would tolerably emulate how I think the money supply would behave in a truly competitive system of money and banking.

    You know what? You’re right. I should capitulate and start spending my days advising rapists and murderers, because if they are going to exist, if a rape and murder free world is currently impossible, then I might as well start coming up with optimal rape and murder schemes, to make rape and murder as efficient as possible. Hopefully, they will one day offer me a lucrative job.

    The first step to getting rid of central banking could be to show how its best monetary policy is all about trying to copy a world where central banking didn’t exist–the system would be demonstrating its own redundance.

    That was already tried, but in reverse. It can’t be a strategy going the other way, if where you want to go was the initial starting point.

  50. Gravatar of Greg Ransom Greg Ransom
    5. March 2012 at 13:47

    Lee, is overnight money “money” or “near money” in your classification system.

    Lee writes,

    “Most near monies are not money: they’re just highly liquid. The difference is that I can spend money and I can’t spend near monies. To “spend” near monies, I must first find someone else willing to hold it.”

  51. Gravatar of Greg Ransom Greg Ransom
    5. March 2012 at 13:53

    Disequilibrium can encourage/force banks to expand cash holdings or encourage/force individuals to expand their cash holdings or can encourage/force the government to bail out insolvent large players, etc.

    Disequilibrium effects don’t go directly into the “price level” — bungie gyrations in assets effecting media of exchange causes bungie gyrations in the demand and supply and _uses_ of different kinds of “base money”.

    Lee writes,

    “Various assets function as media of exchange: base money, demand deposits, and, perhaps on specific markets, T-bills, repos, and the like. However, only base money is the unit of account. T-bills, repos, and other liquid assets, even demand deposits, have prices of their own; disequilibria in their respective markets instigate price and quantity changes. This is not true for base money. Base money has no price of its own, and so disequilibrium forces a change in the general level of prices unless the central bank takes deliberate action to restore equilibrium by changing the supply of base money instead.”

  52. Gravatar of Major_Freedom Major_Freedom
    5. March 2012 at 13:59

    Morgan Warstler:

    BUT WAIT!!!

    Barney Franks wants to give all poor people houses.

    Immediately, the futures market BRUTALLY rips even more money out of the economy and rates on mortgages SOAR.

    Local businessmen who can no longer borrow at 3-4%, march on Washington and burn Fannie Freddie to the ground.

    Scrambling to appease the rampaging NGDP futures market vigilante that continues to predict NDGP over 4%, the Federal gvt. cuts back on state transfers and state cut back on public employee pay rolls.

    Intense bombing of Iraq, causes the price of oil to spike, driving inflation higher, and the frigging futures market just keeps sucking money out of the economy.

    People getting good rates are saving hand over fist.

    Ok,

    WHY doesn’t that happen? Please be clear as day about why.

    1. The central bank secretly finances the major NGDP futures dealers who sell NGDP futures contracts short, thus creating an opportunity for the central bank to print more money than would otherwise be possible with “arm’s length” futures traders. Exactly what the central bank does now with bailing out the major banks that are not fully disclosed to the public for “financial system stability” reasons.

    2. No investors invests into and no seller sells into “NGDP”. The central bank would not be committed to NGDP just because that’s their stated mandate, just like they don’t commit themselves to full employment and price stability even though that’s their current mandate.

    3. NGDP futures speculators cannot arbitrarily “suck money out of the economy”. They can only ever hold money that is first given to them. They cannot stop money from being spent elsewhere. This holds true for every other economic agent. The individual’s demand for money for holding and for spending is not going to be determined by their NGDP expectations. It’s going to be determined by their own market expectations, in their specific circumstances and their specific time/consumption/investment preferences. NGDP can rise or fall by 10% and it won’t make a lick of difference to the investor or seller or laborer who expects a 1% rise or fall in their gross incomes.

    4. Oil prices rising is not a cause of inflation. In the absence of an increase in the quantity of money and volume of spending, a rise in the demand for oil will be matched by an equivalent fall in demand in other goods. There cannot be a general rise in prices on the basis of a rise in demand here and an equivalent fall in demand there. If oil prices rise on the basis of a decreased supply of oil, then the least valued marginal uses of oil will be the first to be jettisoned, leaving the most valued uses still intact. You might see fewer weekend car trips, etc, but the same transport of highly valued goods like food and medicine. If some prices keep rising, on the basis of oil prices rising, but there is no increase in aggregate demand, then other prices must fall because their demand falls.

    I don’t know what else to say in response to your post other than the fact that you aren’t even addressing my criticisms.

  53. Gravatar of Lee Kelly Lee Kelly
    5. March 2012 at 13:59

    Major Yammerer,

    Intellectual traitor? That’s a revealing accusation. Look, I’m not on your team. Loyalty to ideas is a mug’s game. Ideas are abstract things that don’t give a crap what how you feel about them–they will not strive to be worthy of your loyalty. If I think an idea is wrong, then what reason is loyalty to you or anything else to continue advocating it?

    Anyway, using your analogy, my goal is not to help rapists and murders commit crimes better, but to limit the damage they can do as much as possible, and while recognising that complete eradication of all rape and murder is, at the very least, impractical in the short run.

    I think something like NGDP targeting is the least bad monetary policy that a central bank can pursue. That’s not exactly high praise. In any case, it’s clear that you think central banking is a much bigger evil than I do. Frankly, I’m here mostly for intellectual curiosity, not as an advocate. Discussing monetary economics in the context of central bank policy is, whether I like it or not, where most of the interesting discussion is going on at the moment.

  54. Gravatar of Major_Freedom Major_Freedom
    5. March 2012 at 15:03

    Lee Kelly:

    Intellectual traitor? That’s a revealing accusation.

    Is that too harsh for you to handle? Yes, intellectual traitor. Those who act as allegedly disinterested dilettantes, dabbling whimsically in advising the actors whose actions they ostensibly claim to be against. I am against inflation, but I will advise the inflators.

    This is not how to abolish central banking.

    Look, I’m not on your team. Loyalty to ideas is a mug’s game. Ideas are abstract things that don’t give a crap what how you feel about them–they will not strive to be worthy of your loyalty. If I think an idea is wrong, then what reason is loyalty to you or anything else to continue advocating it?

    Well, contrary to you, I take ideas VERY seriously. In fact, I hold them as the most important thing that characterizes a person.

    That you say “Loyalty to ideas is a mug’s game” is, quite frankly, disgusting and offensive to my sensibilities, for what that is worth. Loyalty to the idea of truth is what every intellectual at the very least must have in my judgment. If not, then you have no business in intellectual affairs with me.

    Anyway, using your analogy, my goal is not to help rapists and murders commit crimes better, but to limit the damage they can do as much as possible, and while recognising that complete eradication of all rape and murder is, at the very least, impractical in the short run.

    The only position that one can take for minimizing the damage the Fed does, is to relentlessly pressure for its abolition, just like we do for rape and murder. By taking an absolute stand against it, and not advising the rapists and murderers, but advising those who want to abolish rape and murder but don’t know how.

    If you are not, then you are not minimizing the damage it does. Minimum damage would be ZERO damage, since it is possible. You say it’s “impractical”, but it’s not “impractical” at all. It’s supremely practical. Central banking has ended twice before in the US. And that was in an age of slower and less prevalent communication among the populace.

    I think something like NGDP targeting is the least bad monetary policy that a central bank can pursue.

    Well then you aren’t thinking enough about it, because an even lesser evil monetary policy would be the central bank printing money only when new gold is discovered and enters the central bank’s vaults if they should hold any. That would be even better than oppressing and destructively counter-acting any individual preference based changes in paper claim to gold (cash) holdings (hoarding), by printing more money and pretend that cash holdings aren’t vitally important to people’s lives.

    If NGDP targeting is intended to closely mimic a gold standard, then it utterly fails, because a gold standard is not prejudicially against gold “hoarding.” The Earth doesn’t spit out more gold just because people are holding more of it and spending less of it.

    That’s not exactly high praise. In any case, it’s clear that you think central banking is a much bigger evil than I do.

    When I see tens of millions unemployed, and I see wars financed by it, when I see all the destruction that is unleashed, then I am convinced that those who truly understand central banking have to be sociopaths not to consider it evil and go “meh”. The thing is that most who are not interested or think it’s beneficial, don’t truly understand it.

    Frankly, I’m here mostly for intellectual curiosity, not as an advocate. Discussing monetary economics in the context of central bank policy is, whether I like it or not, where most of the interesting discussion is going on at the moment.

    Interesting to who? Clearly you, so it is whether you like it or not, namely, you do like it.

    Anyway, I don’t see the point of your post other than what I think is a defense of yourself as not being an intellectual traitor. But if you are truly against central banking, then for Pete’s sake, act like it.

  55. Gravatar of dwb dwb
    5. March 2012 at 15:39

    major_freedom

    how long have you been unemployed?

  56. Gravatar of bill woolsey bill woolsey
    5. March 2012 at 15:41

    “different kinds of “base money”.”

    What are these different _kinds_ of “base money?”

  57. Gravatar of CA CA
    5. March 2012 at 15:47

    This place has turned into a crazy clown show.

  58. Gravatar of bill woolsey bill woolsey
    5. March 2012 at 15:49

    Scott:

    I don’t see any value in the M2 measure of the quantity of money.

    I suppose something like MZM is better.

    However, it is too easy to fall into some kind of nothing that the problem is changes in the quantity of some measure of the quantity of money. The problem is shortage or surpluses.

  59. Gravatar of CA CA
    5. March 2012 at 16:05

    I understand Professor Sumner’s desire to have this blog be a free and open exchange of ideas. But wouldn’t individuals who disagree with EVERYTHING Sumner writes be better served if they started their own blogs, instead of carpet-bombing the comments section of this one?

  60. Gravatar of bill woolsey bill woolsey
    5. March 2012 at 16:09

    major freedom

    You are wrong about oil.

    A decrease in the supply of oil doesn’t lower the demand for other goods. It decreases the supply of oil, raises the price of oil and reduces the quantity of oil. The price level is higher. Spending on oil depends on elasticity of demand. It could rise, stay the same, or fall. Other spending stays the same. Higher price level. The shift to the higher price level is inflation.

    Now, if the price level rises, and the nominal quantity of money is the same, this reduces real balances. If the demand for real money balances is constant, then a deflation in other prices must occur.

    However, the reduced supply of oil also reduces real income. If money is normal good, and it is, then the lower real income results in a reduction the real demand for money matching the decrease in the real quantity of money due to the higher price level.

  61. Gravatar of Morgan Warstler Morgan Warstler
    5. March 2012 at 16:09

    Freedom,

    Look, if you answer is always going to be the Fed secretly cheats, well, I’m stuck. Conversation on that piece ends.

    But you may find this a bit interesting, this is how the futures market would work in my head:

    1. you have to fund your trading acct. put your money down on black.

    2. If you lose and NGDP is too high, your money is destroyed in some percentage based on how much was bet and how much money has to leave the money supply.

    3. If you win, you win your share of the new money that must be printed.

    No one makes the market but the Fed, the Fed plays sole and exclusive bookie, and lets everyone put their money on table.

    Then the Fed works its ass off using the internet to get better and better at measuring GDP in a transparent way, and lets everyone and anyone have the same immediate access to the date.

    Maybe to screw HFT, so one can co-locate their servers where the data is published.

  62. Gravatar of bill woolsey bill woolsey
    5. March 2012 at 16:30

    Ransom:

    “The problem here is that there are all kinds of “money” and there is not a single thing which is “the unit of account””

    The unit of account in the U.S. is “the dollar.”

    “the institutions which depend on
    those “substitutes” for their solvency,”

    What insitutions do you have in mind that depend on money substitutes for their solvency?

    Stabilizing the growth of spending on output provides the least bad environment for microeconomic coordination.

    It doesn’t somehow micromanage the spending of money so that no one spends money on th wrong thing. Every time I read your arguments, it seems to me that because poor invesetments involve spending money, it is somehow monetary disequilibrium.

    If people are willing to hold money substitutes rather than money proper, then the quantity of money proper should fall to match the decreased demand. There is no guarantee that those holding the money substitutes aren’t lending money to people who make bad investments.

    If the insitutions fail and people lose money from lending to them, they are generally poorer. Still, if they want to rebuild their money holdings, then the quantity of money should increase.

  63. Gravatar of Mike Rulle Mike Rulle
    5. March 2012 at 17:01

    Scott,

    You hurt my feelings re: your comment:

    “I’m told that ‘falisfiability’ went out of style in epistemology several decades ago, but am certainly no expert”.

    “Out of style”? Since when? That was condescending, plus wrong. There has always been disagreement as to the nature of scientific method, at its core when speaking of the nitty gritty. Popper, who was the first to literally define a “scientific theory” in terms of “that which could be falsified and create predictions”, just died 18 years ago. So your “several decades ago” comment almost precedes the creation of the term in science. Obviously, this definition of science makes science a subset of knowledge—epistemologically speaking. (For example, we all assume we are not part of some solopsistic optical illusion)

    One of the current critiques, for example, of super string theory is that “its not even wrong” because there is no theoretical way to even test it. I am not an “its not even wrongist” or I would never read your columns.

    Falsifiable was perfectly legitimate in my context and it was clear I was not holding you to a higher standard than other economic theorists when I asked what your model was. Your ideas are interesting because you believe if they were followed, we would have better economic outcomes. I was merely honestly asking 2 questions: 1)what policies would you propose and 2)how would you know if they were working?

    You answered the first question above. It is very difficult to demonstrate the second answer except over long periods of time–that is clear.. But look where we are with “Stimulus Theory”—the arguments have been recirculating for 80 years with no end in sight. I was hoping your NGDP theory might have had a simpler answer to 2 than that. —-it was perhaps unfair to expect that.

  64. Gravatar of Lorenzo from Oz Lorenzo from Oz
    5. March 2012 at 17:13

    Major_Doofus: When unemployment rises increase the amount of state generated violence. Violence involves actual physical harm. Strangely, I am not aware of any connection between increasing expenditure more than revenue and any actual violence.

    Yes, all state action is ultimately based on the paradox that we need the state to protect ourselves from predation but the state is the most potentially dangerous predator. This is a paradox that can never be solved, only managed. But, looking at life expectancies, levels of prosperity and declining violence in Western societies in particular, we seem to be managing the paradox fairly well. (Pinker’s Better Angels of Our Nature covers long term trends in impressive detail, demolishing the-state-as-vile-perversion on the way through.)

    Either way of “solving” the paradox (abolishing the state or presuming that there is some perfectly non-predatory/exploitive state which is achievable) is a non-starter, as we have lots of historical evidence for. (I discuss why anarchy, including anarcho-capitalism, does not work at some length. As for the latter, see the histories of tolatrianism, theocracies, etc.)

    We can take it as read that Market Monetarists accept the state and state action. If you don’t fine; but non-acceptance does not provide the basis for a critique that is going to have much traction.

  65. Gravatar of Lorenzo from Oz Lorenzo from Oz
    5. March 2012 at 17:29

    Major_Freedom: No mention of how market monetarism exacerbates cantillon effects At NGDP growth about 2% higher than output growth, the cantillon effects are going to be pretty minor.

    In fact, the “money spreads out from particular points” argument is deeply unimpressive since it is an argument which applies equally to ALL production: it all spreads out from particular points. Perhaps the benefit of production might be bigger than any issue with its uneven arrival in the economy,

    how it hampers individual economic calculation This again. As above, at around 2% p.a, a pretty minor effect. But, as previously noted, having income is rather more important. You calculate in order to transact, you don’t transact in order to calculate. Having money serve its function of facilitating transactions comes first.

    generates business cycles, Not if it has not yet been implemented it doesn’t. In fact, the country which has closest to NGDP targeting, Australia, hasn’t had a recession since 1991.

    as well as a more rapid growth in the state than would direct taxation and borrowing allow. Actually, the point is that it would largely obviate any argument for fiscal stimulus and work by much less state action than the alternatives.

    I understand the appeal of self-righteous doctrinal purity, but more engagement with the facts of the case would help.

  66. Gravatar of tim tim
    5. March 2012 at 18:14

    Scott
    I see these two quotes as inconsistent;

    Like monetarists, we assume many different transmission channels, not just interest rates. Money affects all sorts of asset prices.

    and,

    The central bank controls the supply of money, and the demand for base money is mostly determined by nominal interest rates.

    I always thought of the transmission mechanism as being the adjustment in various factors which affected the amount of money people wished to hold, such as permanent income, interest rates, stock prices and the price of durable and semi-durable goods. As the money supply is fixed by the central bank, and demand must equal supply, an increase in the money supply would have the hot potato effect of the public trying to get rid of the money, and that activity would cause adjustment in these factors which would bring money demand in line with supply. So interest rates would be only one factor in determining money demand.
    (Of course, permanent income could be absorbed into the broader NGDP expectations)

  67. Gravatar of Greg Ransom Greg Ransom
    5. March 2012 at 19:39

    Sorry, I don’t buy this. I can spend money substitutes in all sorts of ways. And half half decade ago MBSs became hot potatoes, and so did lots of other stuff. Bear Stearns & Lehman became hot potatoes.

    Lee writes,

    “Most near monies are not money: they’re just highly liquid. The difference is that I can spend money and I can’t spend near monies. To “spend” near monies, I must first find someone else willing to hold it. This is not true with money. People accept media of exchange even though they do not want to hold more money, because it can be readily exchanged for something they do want in a way that near monies can’t. In other words, the “hot potato” effect is not true for near monies.”

  68. Gravatar of Greg Ransom Greg Ransom
    5. March 2012 at 19:40

    Bill asks,

    “What insitutions do you have in mind that depend on money substitutes for their solvency?”

    Financial institutions, etc.

  69. Gravatar of Greg Ransom Greg Ransom
    5. March 2012 at 19:48

    Bill asks,

    What are these different _kinds_ of “base money?”

    It’s different depending on who owns it and what they are using it for …

  70. Gravatar of Lee Kelly Lee Kelly
    5. March 2012 at 20:06

    If not, then you have no business in intellectual affairs with me. – Major Freeman

    Finally, something we can agree on! In any case, I’m not advising central bankers or, at least, they’re not going to listen. Why should they? Who am I? Nobody. I sometimes write comments on a blog. I have neither qualifications nor work experience of any relevance to these matters. Heck, I’ve hardly even met any economists (though I did manage to attend to 2010 Austrian Scholars Conference at the Ludwig von Mises Institute–that was kind of fun). To me, economics is mostly just a hobby; maybe you should get a hobby.

  71. Gravatar of Greg Ransom Greg Ransom
    5. March 2012 at 21:05

    Over the last decade the government and the Fed made sure creditors and stock holders tied to many of the biggest firms and banks were kept whole and didn’t lose a penny –and in part because of that there was a very high probability that that those wo were holding money substitutes were lending money to people making bad investments — or what would have been bad investments if the expected government / Fed bailouts & money creation didn’t appear just as creditors and stockholders had every reason to expect.

    Bill writes,

    “If people are willing to hold money substitutes rather than money proper, then the quantity of money proper should fall to match the decreased demand. There is no guarantee that those holding the money substitutes aren’t lending money to people who make bad investments.

    If the insitutions fail and people lose money from lending to them, they are generally poorer.”

  72. Gravatar of Greg Ransom Greg Ransom
    5. March 2012 at 21:08

    Charles Calomiris reports on what Wall Street bankers and investors were counting on in 2007 in a conversation with Russ Roberts:

    http://www.econtalk.org/archives/2012/03/calomiris_on_ca.html

  73. Gravatar of Greg Ransom Greg Ransom
    5. March 2012 at 21:44

    Shadow money [implies] that conventional measures of the money stock are a very poor gauge of inflationary or deflationary pressure. So we make a preliminary attempt to measure the “effective” money supply in the US, including the close substitutes for conventional money that are especially important in setting asset prices and financial system leverage. As the charts .. show, what we call private shadow money in the US fell by about $3 trillion from July to November 2008 ..

    ——

    As strong price performance turns into a boom, optimistic investors desire to buy more on margin. They leverage up, usually using the buoyant asset itself as collateral. Lenders are all too willing to benefit by funding these purchases – after all, in the worst case, they will be holding valuable collateral. Borrowing terms such as haircuts, loan-to-value ratios, or margin requirements get easier. New money flows in, and associated financial assets begin to take on money-like attributes. As buying on leverage accelerates, prices and credit conditions blow past what is warranted by fundamentals. There is a monetary expansion in the broad sense of shadow money, but when the bust comes this is quickly reversed. Lending conditions tighten, collateral prices plummet, and highly leveraged optimists are wiped out. Now cash is king; investors do not want houses, stocks, tulips or asset-backed commercial paper. To accommodate this demand for cash the government/central bank must quickly and forcefully expand the monetary base or else the increase in money demand can lead to a painful general deflation. Meanwhile, the sudden disappearance of good collateral in the financial system has created a dangerous de-leveraging that could feed on itself. The government may respond by increasing its own debt, since public collateral in the forms of treasury bills and such do still have funding liquidity, and by flooding the market with government paper the leverage collapse can be better managed. In our stylized example effective money (meaning shadow money plus the conventional money stock) falls sharply, but it would have fallen much more without aggressive policy actions.

    —-

    The growth of the shadow banking sector and especially the mortgage market in the past decade made private collateral more central to credit creation than ever before. Repo lending became the critical swing variable in shadow banks’ balance sheets; home equity extraction became the key means to smooth consumer spending during income shocks; and off balance sheet funding of various assets became a major earnings generator for commercial banks. The spiraling pro-cyclical boom in collateralized credit markets and related asset prices was the essence of the 2002-2007 economic cycle. But the process seems barely to have affected money demand and money supply in those years. Regular bank loan growth was limited, keeping the money stock from soaring, and money demand was held back by widespread beliefs in an easy availability of borrowing against collateral. Policy was complicit in allowing this boom by focusing on price level inflation only and not effective money. With regular M2 or MZM money supply and demand effected only indirectly by the credit boom, not to mention a huge output gap following the 2001 recession, it was unlikely that inflation would soar. A similar credit boom occurred with no CPI inflation in the 1920s also, another period where a huge collateralized credit pyramid was built virtually on top of a reasonably stable money stock. It was as if this pyramid was build right on top of a central bank’s headquarters but, because the traditional money numbers themselves were fairly stable, key decision-makers did not notice.

    – “Long Shadows — Collateral Money, Asset Bubbles, and Inflation” by Wilmot, Sweeney, Klein & Lantz.

    http://faculty.unlv.edu/msullivan/Sweeney%20-%20Money%20supply%20and%20inflation.pdf

  74. Gravatar of Mikko Mikko
    5. March 2012 at 23:02

    I think you forgot one (or perhaps did not express it clearly enough in 1.: market monetarists believe that instability in NGDP growth is a (or even the) major cause of recessions in our societies.

  75. Gravatar of Bill Woolsey Bill Woolsey
    6. March 2012 at 05:10

    Ransom:

    You (and the material you cite) is rife with confusion of money and credit.

    For every borrower there is a lender.

    The conditions where people lend when they don’t want to are unusual and involve imabalances beween the quantity of money and the demand to hold it.

    Market monetarists do not favor targeting either CPI inflation or any measure of the quantity of money.

    By the way, you are wrong that no stockholders took any loss on investment during the Great Moderation. It was creditors that took no loss from institutions “too big to fail,” and presumably took too little care about to whom they made loans. The stockholders did take losses and were often more or less wiped out.

    Sumner’s correct point is that control over the monetary base is adequate to control expected aggregate expenditure on output, and this keeps current spending on output close to target, which dampens any large flucuations in output or prices.

    Nothing in this guarantees that people will not make bad investments. However, using base money to keep spending on output growing at a slow steady rate never requires anyone to make a bad investment. And using the control over base money to try to keep people from making bad investments is a mistake.

    You are constantly quoting the most awful interventionists who want to central bank to undertake massive interventionist policies. The central bank is supposed to determine whenver people are lending too much on the wrong things and then respond by creating a shortage of money, causing a recession to “pop” the bubble before it gets out of hand. This view is wrong headed. Really, it is evil. The central bank uses its monopoly on base money to cause recessions because they decide that people are choosing to undertake excessive credit transactions to buy the wrong things.

    Their arguments that watching M2 or MZM is inadquate are correct. The demands for those aggregates of monetary instruments are not fixed, and a change in the demand for them, or at least, the monetary elements of them, will create an imbalance between the quantity of them and the demand to hold them if the quantity of them fails to change.

    However, increased borrowing does not imply that the demand for money has fallen or the “true” quantity of money, measured or not, has risen. It could happen, but not necessarily.

    Unfortuantely, the bankers in charge of central banks naturally focus on credit. And the central bankers want to regulate credit. We, as central bankers, are responsible for making sure that the banks that we supervise don’t borrow and lend too much. We need to make sure they only good loans.

    Well, that shouldn’t be the job of central banks or anyone. “Central banks” should have the job of managing the quanity of their own liaiblities, that they monopolize by force, so that it meets the demand to hold them.

    The banking system is related because banks demand central bank liaibliites themselves and also, the media of exchange some of them issue serve as subsittutes for the central bank liabilities.

    Microsoft builds a new factory which it funds by sale of stock. This facotory might be a bad investment. This has nothing to do with monetary disequilibrium. But, gee, Microsoft will sell the stock for money and spend the money, paying construction firms and so on. Further, base money will shift beween the accounts of the banks of those buying the stock to the accounts of the banks that are patronized by those owning the construction firms and on to the firms selling materials and workers and so on.

    Just because the factory turns out to be mistake, and all of the payments are made with money, doesn’t make this monetary disequilibirum. Yes, the base money is being held by different people and used for different purposes. But that isn’t monetary disequilibrium. That is what it means for money to serve as medium of exchange.

    Now, if the people buying the stock choose to hold less money in their checking account to fund the additional stock holdings, then this creates an excess supply of money. This reduces the derived demand for base money. The central bank should reduce the quantity of base money to offset this change.

    Even though, by assumption, the microsoft factory was a mistake, the disequilibrium isn’t that factory. It is rather that the demand for checking accounts dropped and some bank should be lending less. Those who would have borrowed from the banks should be borrowing less. And this is what frees up the resources to build the microsoft factory. Which is a waste, by assumption.

    Now, it is also true that the central bank needs to sell off bonds and lend less too. Under conventional assumptions, some one else buys the bonds, and they should hold less of some other finanical asset, and whoever would have sold those finanical assets must spend less too, which frees up a bit of the resources that microsoft will use.

    If base money doesn’t drop, then any decease in lending by the banks (which they should do) will tend to cause an excess supply of base money. And so, the banks will maintain their loans.

    This is monetary disequilibirum. The amount of money people want to hold has fallen, (they are instead holding microsoft stock,) but the quantity of money fails to fall and still funds loans. How can peopel be “forced” to hold money? No individual is. They spend it, and those receiving payments accept it. And they spend it.

    If, on the other hand, those buying the new stock sell other stock, or refrain from purchasing bonds, or any number of things, then there is no monetary disequilibirum.

    If microsoft finances this by issuing overnight commercial paper, then the chance that people will choose to hold less money in checking accounts and instead hold microsoft commercial paper is much greater. And this reduces the derived demand for base money, and so, the quantity of base money should drop.

    But the problem isn’t that people are lending too much of microsoft. And if the problem is that microsoft is making a bad investment, that isn’t the central bank’s problem.

    But again, reducing the quantity of base money, not because the demand to hold it fell, but rather because people are borrowing and lending too much to fund products that the central bank considers inappropriate, is the perfect example of the fatal conceit.

  76. Gravatar of Luis Enrique Luis Enrique
    6. March 2012 at 05:47

    Scott,

    well, thanks for the reply.

    I feel I am being obstinant and obtuse, but really that isn’t going to convince anyone who think that in the present circumstance, the central bank can do all the QE you’d like it to, and it will be pushing on a string. With all those hot potatoes piling up on reserve.

    I wish there was an easy to understand story about what would happen to make households and firms decide to spend more, that’s about tangible behaviour and does not involve manipulating algebra, that would make me go “ah, now I see how it’d work”. The BoE tries to do it – i.e. by arguing QE reduces borrowing costs so spending rises – but it’s just not convincing, imho.

    I know this is not necessary for the argument that NGDP targeting is superior to monetary policy as is, but if you want people to believe that NGDP targeting is all we need and fiscal policy is not required, then I think you need a stronger story.

  77. Gravatar of Major_Freedom Major_Freedom
    6. March 2012 at 06:01

    dwb:

    how long have you been unemployed?

    Since I retired young and wealthy.

    Bill Woolsey:

    major freedom

    A decrease in the supply of oil doesn’t lower the demand for other goods.

    I didn’t say a decrease in the supply of oil lowers the demand for other goods. I said given unchanged money and spending, an increase in the demand for oil is accompanied by a decrease in the demand for other goods, and as such, there is no pressure raising general prices, i.e. no inflation.

    The notion that oil prices rising is inflationary, is a myth.

    I also said that a rise in the price of oil that results from a decreased supply of oil, also is not inflationary.

    Morgan Warstler

    Look, if you answer is always going to be the Fed secretly cheats, well, I’m stuck. Conversation on that piece ends.

    As opposed to you saying business investors will “cheat” by burning Fannie and Freddie to the ground? I didn’t find that a conversation stopper.

    It’s naive and unwise to assume an non-cheating agency that can print its own money. I mean come on, you have to be a Pollyanna to believe in that.

    The whole reason the Fed was created was to “cheat” the private property system that limited their ability to violate it. Don’t you know the history of the Fed? It was formed for nefarious purposes, not altruistic benevolent reasons. Friedman spent a grand total of only 11 pages discussing the political and social factors that resulted in the formation of the Fed in his 1963 “A Monetary History”.

    But you may find this a bit interesting, this is how the futures market would work in my head:

    1. you have to fund your trading acct. put your money down on black.

    2. If you lose and NGDP is too high, your money is destroyed in some percentage based on how much was bet and how much money has to leave the money supply.

    Money is destroyed? What? In typical futures contracts, the loser’s money goes to the winner’s account. It is not vaporized into thin air.

    3. If you win, you win your share of the new money that must be printed.

    Why should the Fed print money for you?

    No one makes the market but the Fed, the Fed plays sole and exclusive bookie, and lets everyone put their money on table.

    And you’re saying no cheating will take place? No under the table slips? No you scratch my back and I will scratch yours? Nothing? Everyone is honest? COUNTERFEITERS are expected to be honest?

    I know that monetary theory is one thing, but please, you have to understand humans a little better. It’s why we now have moral hazard theory.

    Lorenzo from Oz:

    Major_Freedom: No mention of how market monetarism exacerbates cantillon effects At NGDP growth about 2% higher than output growth, the cantillon effects are going to be pretty minor.

    In fact, the “money spreads out from particular points” argument is deeply unimpressive since it is an argument which applies equally to ALL production: it all spreads out from particular points.

    Yes but the difference is that production can spread out from any individual, and not just one legally protected monopoly vanguard as is the case with money production.

    If there was a legal monopoly of computer making, where only one legally protected monopoly can produce computers, then I would make the same argument as I am now against the Fed.

    What is unimpressive is your defense of monopoly money production.

    “how it hampers individual economic calculation.”

    This again. As above, at around 2% p.a, a pretty minor effect.

    I’m talking more about interest rates, which will be non-market if the Fed inflates into the banking system. That affects the entire economy. It’s not minor.

    But, as previously noted, having income is rather more important. You calculate in order to transact, you don’t transact in order to calculate. Having money serve its function of facilitating transactions comes first.

    No, economic calculation is not just about calculating in order to transact. The transactions themselves play a role in calculation itself. Calculation is based on prices, and prices result from transactions. It goes both ways.

    “generates business cycles”

    Not if it has not yet been implemented it doesn’t.

    I am talking about the cycles generated when it is implemented. I don’t need to actually observe it to know what will happen, any more than I don’t need to actually observe worldwide communism before I can know that there isn’t a price system for the means of production and hence no cost accounting in communism. Economic propositions are not hypothetical or empirical. They are logico-deductive.

    In fact, the country which has closest to NGDP targeting, Australia, hasn’t had a recession since 1991.

    Cool. Countries that were on a 100% reserve gold standard didn’t have a recession ever. Gold wins.

    Example is 17th century Holland and the Bank of Amsterdam’s virtual 100% reserve policy that made it the investment center of the world.

    “as well as a more rapid growth in the state than would direct taxation and borrowing allow.”

    Actually, the point is that it would largely obviate any argument for fiscal stimulus and work by much less state action than the alternatives.

    You misunderstand. I am talking about the state retaining a central bank that can print its own money. That alone, in comparison to a gold standard, facilitates growth in government. It is not minor.

    I understand the appeal of self-righteous doctrinal purity, but more engagement with the facts of the case would help.

    You say that like I am not engaged with the facts, except you haven’t shown how that is the case. Empty accusations are useless.

  78. Gravatar of Bill Woolsey Bill Woolsey
    6. March 2012 at 06:11

    If the decrease in the supply of oil leaves aggregate spending unchanged, it increases the price level because it reduces real output.

    If the money supply remains unchanged, it raises the price level by reducing real income an the real demand to hold money.

    Believe it or not, Rothbard was aware of basic monetary economics. And that is all that is.

  79. Gravatar of Bill woolsey Bill woolsey
    6. March 2012 at 06:44

    Morgan:

    Index futures convertibility doesn’t work like that.

    It isn’t the payoffs on the contract that change the quantity of money.

    The payoffs on the contract impose costs on the central bank when it makes errors that speculators predict.

  80. Gravatar of George Selgin George Selgin
    6. March 2012 at 06:47

    Major_Freedom is living proof that a little knowledge (in this case, a teeny-weeny amount of knowledge concerning “Cantillon” effects and the Austrian theory of the business cycle) is a dangerous thing.

    For the record and for whatever it may be worth, there is no inherent inconsistency between stability of spending (MV), which may be at least approximately achieved by targeting NGDP,and the avoidance of both Cantillon effects and Austrian-type boom-bust cycles. Anyone who suggests otherwise merely demonstrates ignorance of the Austrian theory, and (since he was perfectly explicit on this) of Hayek’s business cycle writings especially.

    To be a hedgehog rather than a fox is one thing; but to be an ignorant hedgehog is quite another. Major_Freedom is an ignorant hedgehog: he knows but one thing, and he knows it badly.

  81. Gravatar of dwb dwb
    6. March 2012 at 06:53

    if i were retired there would be a lot of things i would be doing, making long clever posts defending yammering would not be one of them.

  82. Gravatar of dwb dwb
    6. March 2012 at 07:15

    incidentally, i guess then i should assume then you are talking your book.

  83. Gravatar of Morgan Warstler Morgan Warstler
    6. March 2012 at 07:24

    “It isn’t the payoffs on the contract that change the quantity of money.

    The payoffs on the contract impose costs on the central bank when it makes errors that speculators predict.”

    Woolsey, why not?

    The Fed hands you newly printed money.

    The Fed deletes money from your acct.

    money supply up, money supply down.

  84. Gravatar of Bill woolsey Bill woolsey
    6. March 2012 at 07:43

    According to Sumner, when the Fed is long on the contract, it purchases government bonds. Those selling the government bonds to the Fed have additional money balances.

    If the Fed is short on the contract, it sells government bonds. Those buying government bonds to the Fed have lower money balances.

    When the contract is actually settled 15 months later any payments to speculators would, ceteris paribus increase the quantity of money if the speculators were right, regardless of whether nominal GDP was too low (when increases in the quantity of money would be appropriate) or too higher (when increases in the quantity of money would be inappropriate.) If the central bank actually does create or destroy money with payoffs, this is at the expensive of its net worth. My view is that these should be sterilized.

    Assuming some kind of margin account with trades, then funds are tied up when purchases by speculators signal a needed increase in the quantity of money as well as when their sales signal a needed decease.

    Neither the margin accounts nor the payoffs are relavent.

    It is the open market operations in government bonds that create changes in the quantity of base money. For Sumnner, these occur in parellel to the trades on the future contract.

    In my view, the central bank should be free to do what it likes subject to the contraint that it trade the futures contract. For me, I am looking towards complete privatization, and this constrained freedom approach is more consistent than a mechanical rule.

  85. Gravatar of Morgan Warstler Morgan Warstler
    6. March 2012 at 07:54

    ah see, I’m saying mine is better.

    No reason to sell and buy government bonds.

    Just directly hoover money out of or shovel it into the hands of retail investors.

  86. Gravatar of Greg Ransom Greg Ransom
    6. March 2012 at 08:07

    Bill, why exaggerate and falsely assert that I made a claim that I in fact never made?

    The fact is there were stockholders who were bailed. Listen to the Russ Roberts interview I link above for a few details.

    The fact that many were bailed doesn’t imply that no one took a loss. Simple fallacy of basic logic to suggest otherwise.

    “you are wrong that no stockholders took any loss on investment during the Great Moderation. It was creditors that took no loss from institutions “too big to fail,”

  87. Gravatar of Major_Freedom Major_Freedom
    6. March 2012 at 08:20

    Ah, Prof. Selgin, we meet again, at last. Still promoting the monetary system of replacing unconditional property rights to money with lottery ticket casino gambling?

    Major_Freedom is living proof that a little knowledge (in this case, a teeny-weeny amount of knowledge concerning “Cantillon” effects and the Austrian theory of the business cycle) is a dangerous thing.

    teeny weeny?

    I know more about ABCT that you and White combined, if you want to go down that route.

    For the record and for whatever it may be worth, there is no inherent inconsistency between stability of spending (MV), which may be at least approximately achieved by targeting NGDP, and the avoidance of both Cantillon effects and Austrian-type boom-bust cycles. Anyone who suggests otherwise merely demonstrates ignorance of the Austrian theory, and (since he was perfectly explicit on this) of Hayek’s business cycle writings especially.

    What powerful logic. What incredibly profound economic reasoning and display of factual knowledge. “There is no inherent inconsistency, and anyone who suggests otherwise is an idiot.”

    Too bad for you that there is in fact an inconsistency. Your error is that you fell hip deep into the fundamental Keynesian error of conflating the
    demand for money (which is set according to the marginal utility of money) and savings (which is set according to time preference). In reality it is not true that holding money is equivalent to saving. Saving is not “not spending.” Saving is not consuming. The demand for money has nothing to do with saving or not saving. The demand for money can decrease, and savings can still decrease if the decrease in the demand for money results in more consumption and unchanged investment.

    Your misunderstanding of ABCT and of Hayek’s work centers on this fundamental point.

    One likely reason why you find affinity with Sumner’s NGDP framework is because he too thinks like a Keynesian and conflates saving with cash holding.

    At any rate, a central bank policy of “stabilizing” aggregate spending, which of course really means growing aggregate spending, is in fact inconsistent with avoiding the business cycle. Anyone who denies THAT is totally ignorant of ABCT.

    If economic actors prefer to hold more cash and decrease their nominal spending, but the central bank is inflating into the banking system, in an attempt to stimulate the banking system into lending more and boosting aggregate spending back up, if the banking system were to follow the dictum that an increased demand must be accommodated by issuing fiduciary credit, then the social rate of time preference would be falsified. The result will be excessive investment, and a business cycle will result.

    You can’t avoid the business cycle as long as the central bank affects nominal interest rates and affects the supply of loans beyond what is justified by time preferences.

    To be a hedgehog rather than a fox is one thing; but to be an ignorant hedgehog is quite another. Major_Freedom is an ignorant hedgehog: he knows but one thing, and he knows it badly.

    Could it be that you just have sour grapes because I made you look rather foolish after your vicious and uninformed attack on Murray Rothbard’s work?

    Or could it be our run ins on the Mises.org blog? Swooping in here with insults is how I would expect a 12 year old to act, not a professor of economics.

    I’m sorry that you still feel stung, but you have to understand my motivation. My motivation is that I find you monetarists, who should understand money and banking, to be, along with your kin the Keynesians, destructive, dangerous, wrong, and the bane of a prosperous society. I find you to be opportunistic intellectual traitors, who sold your souls because you couldn’t hack it being independent and being targeted by political hacks into ALLEGEDLY being minimized. Don’t worry, I get enough attention from hacks to last all of you multiple lifetimes. I accept it. I am not scared. My income doesn’t depend on me remaining ignorant about it.

  88. Gravatar of Becky Hargrove Becky Hargrove
    6. March 2012 at 08:59

    Major Freedom,
    You say that you are about economic freedom but nothing could be further from the truth. You and your ilk are about strangling monetary systems to force the middle classes to ‘get in line’ and you could have been using your excess energies in far more productive ways. There are better ways of transforming knowledge wealth than simply forcing the present version of it out of existence.

    As for the lower classes? Don’t even bother pretending your method might work for them. The lower classes are already well beyond the zero bound and thus now have to think beyond monetary terms to create their own survival. Eventually they will be able to recreate wealth on their own terms and when they do the other classes will ultimately benefit: it will allow the set point of the basket of middle class consumer goods to finally adjust downward to a medium price range.

    Destroying the primary monetary edifice of our time is no way to move society ahead and you know it. Those of us among the lower classes need that edifice to lean on, to make our own survival more likely. So I suggest you find a better way to conduct your time.

  89. Gravatar of dwb dwb
    6. March 2012 at 09:41

    you could have been using your excess energies in far more productive ways.

    well, most people I know who are “wealthy and retired” (and i know a few) spend their days with their grandkids (or if you’re young, making grandkids), traveling, hunting, fishing, going to shows, or otherwise enjoying life not carpet bombing a blog with nonsense. Its a free country, the blessing of which is one gets to spend ones time however one likes. I am lucky enough to work from home so although some days it feels like i might be retired, i have a long list of projects and deadlines that argue otherwise. I would personally think if i was wealthy, had an agenda, i would either run for office or run seminars around the country spreading my nonsense, not carpet bombing a blog. I am not criticizing, just observing.

  90. Gravatar of Major_Freedom Major_Freedom
    6. March 2012 at 10:03

    Becky Hargrove:

    You say that you are about economic freedom but nothing could be further from the truth.

    Oh this ought to be fun.

    You and your ilk are about strangling monetary systems to force the middle classes to ‘get in line’ and you could have been using your excess energies in far more productive ways.

    What does all this even mean? “Strangling monetary system”? “Force middle classes to ‘get in line’”?

    Cheap money doesn’t benefit the middle classes, Becky. They HARM the middle classes, because contrary to being “strangled”, a free market gold standard would allow the middle class’ incomes and purchasing power to be BETTER PROTECTED against arbitrary redistributions of wealth.

    Having access to more and cheaper loans does the middle class no good if prices are rising and their purchasing power is decreased as a result. It is a myth to believe that the middle class will get “squeezed out” in a free market gold standard.

    Your view of fiat money is waaaay off base. You view it is a benevolent caretaker of the poor and vulnerable, when in reality it is the poor and vulnerable who are most harmed by it, since they are least able to withstand the ravages of the business cycle, and inflation.

    Gold is the poor man’s money. Fiat is the wealthy elite’s money. It’s why the poor didn’t willingly give their gold to FDR and why he had to pass a law making it illegal for poor people to own gold.

    Your worldview – and I cannot emphasize this enough because you’re so utterly lost – is totally and completely 100% upside down. I don’t know where or how you were brainwashed into believing that central banks “help the poor”, but it is exactly 100% the opposite. Stop conflating what you are fallaciously perceiving to be good intentions, with results.

    The poor and middle class are LIBERATED and FREED UP when their incomes are secure from being taxed through inflation. They can still get loans as well, because while the nominal amounts of loans are smaller, the individual loan sizes will be smaller too. So instead of the middle class borrowing $450,000 to buy a $500,000 house, they will borrow only $45,000 to buy a $50,000 house.

    A more stable monetary system, what you call “strangled”, will lead to lower PRICES across the board. Just because there would be less nominal lending, that doesn’t mean the middle class will get “squeezed out.” They didn’t get “squeezed out” in the classical gold standard, and they won’t in a reintroduced gold standard.

    You are viewing me and “my ilk” as evil greedy anti-middle class fascist business heartless bastards, when in reality we just have the KNOWLEDGE that you don’t understand, which is the best at safeguarding middle class families.

    Just look at what fiat money has done to the millions of middle class families. All that “benevolent” cheap money policy to get middle class and poor people into homes, totally backfired. It backfired not because there wasn’t enough cheap money, but because there was too much cheap money. Many lost their jobs and their homes.

    Contrary to your beliefs, the middle class is gradually wiped out in a fiat money regime. You see this more and more. Prior to 1971, the middle class was strong. After 1971, the year the monetary system left the last vestiges of the gold standard, the middle class declined, and since then, real wages have stagnated.

    Inflation, again, DOES NOT HELP THE MIDDLE CLASS. It harms them. It destroys their lives.

    The best safety the middle class can have is being taken care of by their fellow mankind who operate WITHIN the division of labor, and that includes money production.

    There are better ways of transforming knowledge wealth than simply forcing the present version of it out of existence.

    Is that how you also approach rape, murder, and theft? Not by eradicating it, but to utilize it for good?

    As for the lower classes? Don’t even bother pretending your method might work for them. The lower classes are already well beyond the zero bound and thus now have to think beyond monetary terms to create their own survival.

    You’re right, I don’t have to “pretend” it might work for them. I know it WILL work for them.

    The lower classes are already well beyond the lower bound, in what kind of a monetary system? A fiat one, pay attention!

    Eventually they will be able to recreate wealth on their own terms and when they do the other classes will ultimately benefit: it will allow the set point of the basket of middle class consumer goods to finally adjust downward to a medium price range.

    They can’t recreate wealth on their own when their purchasing power is continually sapped, keeping them poor and unable to accumulate profits.

    Destroying the primary monetary edifice of our time is no way to move society ahead and you know it.

    Don’t presume to tell me what I know and don’t know. What I know is that the present monetary “edifice” is what is destroying society. I don’t care if you don’t know it.

    Those of us among the lower classes need that edifice to lean on, to make our own survival more likely. So I suggest you find a better way to conduct your time.

    Credit expansion and inflation doesn’t make their survival more likely. It makes it less likely because it increases prices and prices poor people out of the market.

    If I have a suggestion for you, you should stop trying to help people by destroying their lives with quick fix, yet destructive programs that end up making things worse. You should stop pretending that you have any clue how to make people’s lives better off by reforming the monetary system. You should start being more productive and advancing ideas and programs that actually protect the poor and middle class from legalized counterfeiters. You should start educating yourself on the history of banking and the nature of money and banking. You should realize that I have the moral high ground relative to you. I am promoting beneficial ideas that will help the poor and middle class, while you continue to destroy them.

  91. Gravatar of Long and variable leads and lags « The Market Monetarist Long and variable leads and lags « The Market Monetarist
    6. March 2012 at 10:16

    [...] Sumner yesterday posted a excellent overview of some key Market Monetarist positions. I initially thought I would also write a comment on what I [...]

  92. Gravatar of Becky Hargrove Becky Hargrove
    6. March 2012 at 10:21

    Major….
    touched a nerve, did’nt I. (hehe) Nuff said.

  93. Gravatar of Economists And Building Theory Around Policy…. | Modern Monetary Realism Economists And Building Theory Around Policy…. | Modern Monetary Realism
    6. March 2012 at 10:33

    [...] potential policy solutions and then build an understanding of the world around this.  In a recent story Scott Sumner explained what Market Monetarism is and how it’s essentially a set of policy [...]

  94. Gravatar of dwb dwb
    6. March 2012 at 10:40

    @Becky:

    excellent effort but you are wasting your time. major_dumba$$ rants have been endlessly rebutted to no avail. facts are no barrier to an opinion.

  95. Gravatar of Greg Ransom Greg Ransom
    6. March 2012 at 11:02

    Bill, what are the grounds for saying this, what is the confusion and what in the non-confused way of understanding the phenomena identified:

    “You (and the material you cite) is rife with confusion of money and credit.”

    It might help if you directly identified the mistakes made by Sweeney, Hayek, et al.

    So far you haven’t.

  96. Gravatar of Major_Freedom Major_Freedom
    6. March 2012 at 11:07

    Becky Hargrove:

    Major….touched a nerve, did’nt I. (hehe) Nuff said.

    Wait, I thought you invited me to your own nerves? Now you’re saying you just said it to get a rise out of me? That’s the definition of trolling you know. Why are you trolling? Did I touch a nerve with you?

    dwb:

    @Becky:

    excellent effort but you are wasting your time. major_dumba$$ rants have been endlessly rebutted to no avail. facts are no barrier to an opinion.

    First, my “rants” have not been “endlessly rebutted.” I have been endlessly rebutting market monetarists here. Second, from what you have written, I think you need to consider your opinions.

    But that’s good that you feel compelled to isolate me by teaming up with Becky. It means you feel threatened, and when people feel threatened, their tribal instincts typically kick in. That you feel threatened, is inconsistent with your claims that I am not presenting facts.

  97. Gravatar of Greg Ransom Greg Ransom
    6. March 2012 at 11:15

    Bill, with a Greenspan Put in place, and with the background of To Big to Fail, with interest rates set below the natural rate, with enforcement of mortgage origination fraud halted, with the Fed Gov exchanging the right to acquire and expand (Countrywide, BofA, WaMu) for pathologically lowering lending standards, with asymmetry of knowledge of the content & quality of of MBSs, etc, please tell me what you believe will take place in terms of the equilibrium relations across time between shadow money, inside money, credit, financial firm bonus & equity returns, and the time structure of production.

    Will financial institutions put themselves in a sustainable position, re borrowing and lending? Will the structure of production be in a sustainable position across time? Will the relations between shadow money, inside money, repo money, outside money, Treasuries, etc. be in a sustainable equilibrium relation across time.

    Please explain, given these remarks:

    “We, as central bankers, are responsible for making sure that the banks that we supervise don’t borrow and lend too much. We need to make sure they only [make] good loans.

    Well, that shouldn’t be the job of central banks or anyone.”

  98. Gravatar of Lee Kelly Lee Kelly
    6. March 2012 at 11:22

    The notion that an increase in money demand, centaris paribus, is not an increase in desired saving is just a frail effort to rescue Rothbard’s nonsense. It contradicts a fundamental proposition of economics: the purpose of production is consumption. That is, we produce either consumer or capital goods, and the purpose of capital goods is to produce consumer goods in the future. In the interminable long-run, production and consumption are equal.

    The idea that holding money balances falls into some nebulous domain between consumption and saving is preposterous. It implies that the purpose of some production, that is, whatever someone produces to acquire larger cash balances, is neither to achieve present nor future consumption. Therefore, production does not equal consumption, even in the interminable long-run, because that portion of income held as money balances represents production for no reason. So much for purposeful human action.

    It’s an especially silly notion when all money is a liability of some financial institution. You might oppose with our current monetary system, as do I, but when money is a financial asset of a bank (or central bank), holding larger cash balances is de facto lending to the bank. It doesn’t matter for economic coordination whether individuals are aware they are lending to the bank any more than they understand what it means to be a bond holder. All that matters is that by holding larger cash balances (or purchasing bonds), they are relinquishing control over present resources for a larger claim on future goods and services.

    If we actually had a monetary system based on gold coins and 100 percent gold-backed banknotes, then holding larger money balances would be more like purchasing commodities. To the extent that such a use of gold gold money disrupted its value (and so cause inflation or deflation), that would be just one reason why gold would be a sub-optimal money.

    An increase in money demand does not represent a general desire for a lower aggregate nominal spending, nor deflation, and especially not the interim period before deflation has run its course. That is not why people try to increase their cash balances–it’s just the an unintended consequence.

    Finally, Cantillon effects aren’t always bad. Suppose that George was going to lend Scott $100,000, but instead of just giving him the money, George promises to bury $100,000 in his backyard and not touch it until the loan is ready to be repaid. Scott, then, uses a printing press to make the $100,000 in crisp new bills. When it comes time to pay off the debt, Scott will burn $100,000 and give the interest to George, while George digs up his $100,000 from the backyard and starts spending again.

    There is no doubt that Scott’s spending of the new money–made from “thin air”, no less–will change relative prices. The injection effects will tend to drive up prices of goods that Scott wishes to buy, diverting resources into the production of those goods. However, this is exactly what is supposed to happen! George is lending Scott the money. Scott borrowing is just the vessel through which George is expressing his demand for future goods. If George had decided to spend the money directly on future goods himself, then it might have had a similar effect on relative prices.

    Cantillon effects are only pernicious when there is an excess supply or demand for money; otherwise they are just another name for relative price changes.

  99. Gravatar of Greg Ransom Greg Ransom
    6. March 2012 at 11:23

    Bill writes,

    “If microsoft finances this by issuing overnight commercial paper, then the chance that people will choose to hold less money in checking accounts and instead hold microsoft commercial paper is much greater. And this reduces the derived demand for base money, and so, the quantity of base money should drop.”

    This is MY argument. And for making it you insisted that I’m rife with confusion of credit and money.

    Please explain your inconsistency on this.

  100. Gravatar of Gabe Gabe
    6. March 2012 at 11:41

    Major made some good points.

    How can you believe that system that is set up to bail out billionaires and pile debts on current wage earners and their children and their grandchildren is actually set up to help the poor.

    Really you think making house prices stretch out to 7 times the median income from the old norm of 3 times the median annual income is a good thing?

    Really you think making college costs increase 400% while the median income stays fixed is good for the poor?

    Really you think that when the shit hits the fan than Goldman Sachs and JP Morgan board members are not getting helped as much as the working poor?

    Just not seeing how central panning of the money supply helps anyone but hte central planners/their bosses and their friends.

  101. Gravatar of Greg Ransom Greg Ransom
    6. March 2012 at 11:41

    Bill, the first place I’ve found Hayek discussing The Knowledge Problem is in a 1928 discussion of relations between different kinds of money and different kinds of credit instruments, and substituting uses among these. It is simple impossible to know enough to know all of the relations between all of these — or how any of these are all tied into real production and consumption plans across time. (See Hayek’s “Intertemporal Price Equilibrium and Movement in the Value of Money”)

    So the knowledge problem in the financial / money / credit sector creates the space necessary for a “loose joint” in the system.

    Now, with To Big To Fail, with the Central Planning of credit terms and the supply of money and credit by a central bank, with pathological regulations of various kinds, with bonus compensation, with asymmetry of knowledge, etc. it certainly is the case that the relation of equity & cash reserves to liabilities, and the relation of the riskiness of equities and liabilities are things that can set up systematic over-risk or unsustainable risk, or short term gains with increasing long term changes of insolvency — and the regulatory regime of bank regulators and the Fed IS responsible for centrally planning the coordination of these relations so the system doesn’t BRICK.

    It may be a fatal conceit to think that central banking and bank regulation can do all of this — but the system we have says — demands — “bring it on”.

    There is no choice to do otherwise.

    Once you begin put the Fed in charge of the central planning of money and credit and the trade cycle, and you task them with To Big To Fail responsibilities, and you set up a pathological regulatory system, you’ve already bought the farm. The knowledge problems here are non-optional. They were already bought when game began.

    Bill writes,

    “The problem is that microsoft is making a bad investment, that isn’t the central bank’s problem.

    But again, reducing the quantity of base money, not because the demand to hold it fell, but rather because people are borrowing and lending too much to fund products that the central bank considers inappropriate.”

  102. Gravatar of Dan Kervick Dan Kervick
    6. March 2012 at 11:45

    Put simply, we assume that a big crop of new currency lowers the value of money (i.e. its purchasing power) for the same reason that a big crop of apples lowers the value of an apple.

    The big crop of new apples will have no effect on the price of apples if the harvesting of the new apples has no bearing on the quantity of apples that are actually brought into markets where prices are determined by trade. And that’s the way it is with bank reserves. CB purchases of dollar denominated securities with dollars, swapping in immediate reserves for the deferred reserves that would have been received later as interest payments on the securities, has little bearing on the commercial trade in money absent some kind of liquidity crisis.

    The supply of dollars is effectively unlimited. If an apple retailer wants to sell more apples, he is limited not just by his wholesaler’s prices, but by the finite bounds on his wholesalers’ production supply. Dollars aren’t like that. If a banker wants to sell a demand deposit, he can create the demand deposit and then acquire the additional reserves the law requires after the fact at the price set by the central bank. And guess what? The supplier never runs out! As long as the banker is willing to pay the CB-determined interest rate, the supply of reserves is forthcoming. So it’s all about the target interest rate.

    I really can’t believe there is any such thing as a “hot potato effect” for dollars. The whole idea makes no sense at all. Getting more dollars always dominates in a decision matrix over getting fewer dollars, so there is no ceiling on the demand for dollars or on the willingness to “hold” dollars. For an ordinary commodity or finished good, there is always some point beyond which the marginal cost of storing additional inventory exceeds the expected marginal revenue from that additional inventory. But where is that ceiling for dollars? Nowhere! It costs almost nothing to store a dollar. In fact, you are usually paid by dollar storage facilities – banks – for the privilege of storing your dollars. A furniture dealer might have to say some day, “What the hell am I going to do with all of these bedroom sets? This excess inventory is killing my margin. I have to move them!” And the price of the sets might go down as a result. But no holder of dollars ever says, “What the hell am I going to do with all of these dollars? It’s costing me an arm and a leg to hold them.” So the “hot potato” model for dollars is completely daft.

  103. Gravatar of Greg Ransom Greg Ransom
    6. March 2012 at 11:58

    Rewrite:

    .. changing relations of the size and/or riskiness of assets to liabilities can set up systematic over-risk or unsustainable risk, or short term gains with increasing long term changes of insolvency, or plain systematic miscalculation ..

  104. Gravatar of Greg Ransom Greg Ransom
    6. March 2012 at 12:02

    Bill, note well also that financial firms were using systematically faulty risk models, and that rules encouraged banks to invest in mortgage-backed securities and encouraged them to falsely characterize the risk and quality and value of the securities they identified as capital.

    More _systematic_ pathology / disequilibrium / asymmetry of knowledge / etc. in the system.

  105. Gravatar of Greg Ransom Greg Ransom
    6. March 2012 at 12:43

    I said stockholders were bailed. E.g. Bear Stearns stockholders were bailed at $10 a share.

    TARP and the Fed bailed out all sorts of others, it is simply impossible to identify exactly all or how many.

    Bill writes,

    “you are wrong that no stockholders took any loss on investment during the Great Moderation. It was creditors that took no loss from institutions “too big to fail”

  106. Gravatar of 123 123
    6. March 2012 at 13:29

    Ngdp level targeting distributes risk between debtors and creditors optimally, thus enhancing the financial stability for any given debt to gdp ratio. Lars has blogged this a couple of times.
    Highly levered firms should start adding ngdp indexing clauses to their debt contracts.
    Today, when there are mountains of debt, market monetarism is essential.

  107. Gravatar of Lars Christensen Lars Christensen
    6. March 2012 at 14:19

    123, you are surely right about that…it is however mostly a couple of my guest blogger who have done the hard work. David Eagle is the source to go on this issue.

    See for example here: http://marketmonetarist.com/2012/01/20/guest-blog-the-two-fundamental-welfare-principles-of-monetary-economics-by-david-eagle/

    http://marketmonetarist.com/2012/01/06/selgin-and-eagle-should-be-best-friends/

    http://marketmonetarist.com/2012/01/05/guest-post-why-i-support-ngdp-targeting-by-david-eagle/

    Anybody interested in the distributional “fairness” issue between debtors and creditors should read Selgin’s “Less than zero” (and yes “internet Austrians” he has lot more insight on this issue than neo-calvinist-quasi-moralists out there…)

  108. Gravatar of Greg Ransom Greg Ransom
    6. March 2012 at 14:55

    You can find George Selgin’s _Less Than Zero_ here:

    http://mises.org/books/less_than_zero_selgin.pdf

    The argument is very clearly written and presented. Excellent.

  109. Gravatar of anon anon
    6. March 2012 at 15:12

    Dan Kervick, so why aren’t you holding all your wealth in the form of currency or checking accounts? Admittedly, agents are probably willing to hold money as a substitute for short-term risk-free bonds (meaning that central-bank operations exchanging money for short-term bonds may have negligible effect). But even the demand for such bonds is not unlimited. In general, once the preferred level of money balances has been reached, it becomes optimal to acquire other assets in exchange for money. That’s enough for the hot-potato effect to occur.

  110. Gravatar of dwb dwb
    6. March 2012 at 16:01

    Highly levered firms should start adding ngdp indexing clauses to their debt contracts.

    At the firm and household level, debt should not be tied to overall ngdp but to the firm – specific idiosyncratic income path (for example, my wages might be rising faster than ngdp because i write ipad apps). “highly leveraged” is subjective. Chances are this applies to all firms regardless of leverage.

    At the corporate level we already have debt and equity (and everything in between like convertible bonds), so really its at the household level we need this. At the household level, debt would be a share of income (for example, for your mortgage, you agree to pay 35% of your income for a “while”).

    As much as I really love the idea- and i truly believe if mortgage contracts were written like this the housing market would have sorted out a long time ago – there are enormous practical hurdles. This is relatively easy to do at the firm level (there are far fewer firms, debt contracts are often a one-off transaction every couple years). There is a lot of customization in firm-level debt contracts already so to some extent, there are already a lot of ways for firms to gear their leverage to their income over the business cycle.

    At the household level, not so much, because any particular bank deals with millions of individual retail debt contracts. You can’t just index every debt contract to ngdp because there is the risk that your income path is declining relative to ngdp because you are a horse and buggy mechanic. Someday, maybe the technology will exist to analyze every income-indexed $25,000 loan but not now and not for a while.

    also, the “creditors vs debtors” debate is oversimplified because debtors can default with some probability. It’s illusory to assume, as a creditor, principal will be repaid.

    Inflation is the one thing that solves this coordination problem.

  111. Gravatar of Lorenzo from Oz Lorenzo from Oz
    7. March 2012 at 01:09

    Major_Freedom: In fact, the country which has closest to NGDP targeting, Australia, hasn’t had a recession since 1991.

    Cool. Countries that were on a 100% reserve gold standard didn’t have a recession ever. Gold wins. Australia did not adopt its version of inflation targeting until 1993; so, no recessions so far.

    Since countries on the gold standard have had not merely recessions but Great Depressions, that 100% reserve is doing a powerful lot of work in your claim. If you would care to nominate which countries in which years meet your criteria, we can see if your remarkable claim is true.

    Yes but the difference is that production can spread out from any individual, and not just one legally protected monopoly vanguard as is the case with money production. A distinction without a difference. There are, of course, arguments against monetary monopoly but the “money enters unevenly” is not much of an argument for anything really.

    I’m talking more about interest rates, which will be non-market if the Fed inflates into the banking system. That affects the entire economy. It’s not minor. Well, at the current level of differences in Australia v US interest rates, yes it is pretty minor. 5% NGDP growth is, after all, a reversion to trend, not some weird breakout.

    I am talking about the state retaining a central bank that can print its own money. That alone, in comparison to a gold standard, facilitates growth in government. It is not minor. Mismanagement of the gold standard did far more to facilitate growth in government. As has mismanagement of the money supply in more recent times. It is likely no accident that Australia nowadays has lower taxes, public debt and government expenditure than the US.

    I get that there is an argument against central banking. But, treating having a central bank as a given (which is where practical policy is at), then what is the sensible policy?

  112. Gravatar of Bill Woolsey Bill Woolsey
    7. March 2012 at 05:02

    Ransom:

    Everything you complain abould could occur in exactly the same way if the quantity of money were continuously equal to the demand to hold money–each and every type of money.

    Market monetarists don’t advocate stablizing the CPI or keeping some measure of the quantity of money constant.

    Market monetarists favor adjusting the quantity of money according to the demand to hold money. As a practical matter this involves keeping expecations of spending on output growing at a slow, steady rate.

    What market monetarists oppose is creating an excess demand for money to pop asset bubbles or try to regulate credit.

    Our key theoretical difference with sensible Austrians (as best I can tell,) has to do with whether “excessive” trend growth in spending on output creates a problem. Does a 5% growth path for nominal GDP (and 2% inflation on average) cause a problem? Or, does 3% growth for nominal GDP (and zero inflation on average) cause a problem? Is zero percent growth in nominal GDP (or else 2% or whatever trend growth in output less trend growth in total factor productivity might be) necessary?

    Empirically, some of us look at 2000 and see nominal GDP below trend. While a regime of explicitly stabilizing nominal GDP might have helped, it is difficult to describe this situation as an excess supply of money or market interest rates below the natural interest rate.

    There were a variety of interventions that reallocated investment into housing. Such interverventions would have that effect even if there were no excess supply of money and the market interest rate was exactly at the natural interest rate. In fact, even if there were an excess demand for money and the market rate were above the natural interest rate, these interventions would have caused investment to be reallocated towards housing.

    In my view, taking risk in hope of a bailout isn’t the same thing as an imbalance between the supply and demand for money. It isn’t the same thing as a market rate below the natural rate. In my view, greater risk taking raises the natural interest rate. Bailouts are bad, but the role of the monetary authority should be to keep nominal expenditure growing on target–not engineer a recession.

  113. Gravatar of dwb dwb
    7. March 2012 at 06:02

    note well also that financial firms were using systematically faulty risk models

    partly true, but at one point most subprime were no-doc or low-doc loans. Banks relied on originators to do due diligence which, shock they did not do. So they assumed “average” characteristics. The “trust me” model just does not work in lending (shock?!). As one borrower put it, well they gave me the house, so why should i be upset that they took it? They called them liar loans for a reason.

    But, as has been pointed out many many times, the housing issue was well known way before Bear and Lehman collapsed. There were many complicit parties, to be sure, but the Fed and OCC (and FDIC) fell asleep on many jobs simultaneously.

  114. Gravatar of ssumner ssumner
    7. March 2012 at 06:30

    Major Freeman, Given that you’ve told me it’s “scientifically” proven that 9/11 was a “controlled demolition,” I’m not surprised that we disagree about almost everything. The shock is that we occasionally agree.

    Lee, I think NGDP targeting does produce a stable unit of account.

    DR, You asked;

    “Do you have any numbers to support this?”

    Industrial production grew 57% in the 4 months prior to FDR’s higher wage program (adopted in July 1933) This was under the influence of dollar devaluation. After July 1933 the dollar kept falling, but IP fell, not to regain July 1933 levels for 2 more years. Then the NIRA was declared unconstitutional, and IP started rising fast. There were a total of 5 FDR wage shocks, all five sharply slowed what had bee a very fast recovery.

    Greg, I have no idea why I should pay attention to all those other assets, I’m interest in NGDP determination.

    Lorenzo, You may well be right, but I’ve never been entirely comfortable with the indeterminacy issue. I suppose there are several arguments against it, as Somali money kept circulating even with no government.

    Greg Sproul, I look at cash as a good that is more like wallets than bonds. Producing more wallets makes each wallet worth less. Wallets are useful in making tranactions. People don’t go shopping at Target with purses full of T-bills. Cash is a very distinct asset, except when rates are near zero. Then the price level is determined by the expected supply of cash once we’ve exited the “liquidity trap.”

    Negation, I’ve made that claim before, that it’s sort of like the gold standard, with NGDP future replacing gold.

    Everyone, I’m running way behind with grading, but promise to finish the rest of the comments by tomorrow.

  115. Gravatar of Greg Greg
    7. March 2012 at 06:34

    Mr Woolsey

    “Sensible Austrians”???

    Ive only seen one. William Harrison of Credit Writedowns………….. who is now much closer to an MMTist……. hmmmmmm.

  116. Gravatar of dwb dwb
    7. March 2012 at 07:20

    @Lorenzo

    If you would care to nominate which countries in which years meet your criteria, we can see if your remarkable claim is true.

    hope you are not actually expecting facts. major_duma$$ claims have been endlessly rebutted to no avail.

  117. Gravatar of George Selgin George Selgin
    7. March 2012 at 09:11

    Greg, there are to be sure some nutty self-styled Austrians; but smug out-of-hand dismissals like yours of the whole school prove only one thing: that those who make them have missed an opportunity to be better monetary-macro economists. You might better follow the examples of Yeager, Laidler, Leijonhufvud (and, for that matter, Woolsey and Sumner), among many others.

    Or perhaps you don’t consider any of these persons “sensible” either.

  118. Gravatar of Greg Ransom Greg Ransom
    7. March 2012 at 09:14

    Scott, it’s pretty simple. If there are reasons why targeting a particular target unstoppably won’t produce stability, you’d better pay attention.

    Should I give examples from the 1940s literature on control systems to illustrate the underlying principle?

    Or examples from the history of macroeconomic policy making?

    But is this is simply a matter of your personal preferences and tastes regardless of scientific merit or significance, well, there is no accounting for such things and no one can use words to get someone else to change their interests and tastes.

    Scott writes,

    “Greg, I have no idea why I should pay attention to all those other assets, I’m interest in NGDP determination.”

  119. Gravatar of Greg Ransom Greg Ransom
    7. March 2012 at 09:21

    This is just the matter at issue, isn’t it. Whether that is all there is to it or whether these two will necessarily and reliably have the stable causal directional relation inferred.

    Bill writes,

    “Market monetarists favor adjusting the quantity of money according to the demand to hold money. As a practical matter this involves keeping expecations of spending on output growing at a slow, steady rate.”

  120. Gravatar of Greg Ransom Greg Ransom
    7. March 2012 at 09:37

    Scott, the instability, bungie yo-yo change in value and liquidity and quantity of MBSs, CDSs, and houses, etc. is the thing that makes a bungie yo-yo of NGDP determination, and the question is how any specific NGDP forecast target can eliminate or mitigate or reduce that core source of bungie bouncing.

    Care to address the issue, or is there another topic we should bounce to instead?

    Scott,

    “Greg, I have no idea why I should pay attention to all those other assets, I’m interest in NGDP determination.”

  121. Gravatar of Greg Ransom Greg Ransom
    7. March 2012 at 11:40

    Bill, this is “heads I win, tails you lose” slight of hand, built using language spin.

    What happens when the Fed over shoots the NGDP target, and acts to yo-yo it back?

    They “engineer a recession”, right?

    Can we have an honest discussion, and not stack the deck with loaded, contested, easily disputed language and claims?

    Bill writes,

    “but the role of the monetary authority should be to keep nominal expenditure growing on target–not engineer a recession.”

    If you beg the question, you haven’t engaged it or addressed it or answered it.

    If you use language and characterizations which purposely mischaracterize the position you are engaging, you really aren’t engaging the position. You are simply misrepresenting it.

  122. Gravatar of Global Economy Crisis | Pearltrees Global Economy Crisis | Pearltrees
    7. March 2012 at 12:07

    [...] What is market monetarism? 7. Like Krugman, Woodford, and Eggertsson, we believe that temporary currency injections have little or no impact on AD. Instead, current AD and NGDP are determined by changes in the future expected path of NGDP. We differ from those NKs in that we think the expected future path of money is much more informative than the expected future path of interest rates, except at the zero bound. We believe that at the zero bound the important variable is the expected level of base money when the economy has exited the zero bound. My own view is that if the central bank pays interest on reserves, then the long run path of the non-interest-bearing currency stock may be more informative than the monetary base. [...]

  123. Gravatar of ssumner ssumner
    7. March 2012 at 12:22

    Major Doofus; You said;

    “The “theory part” of Market Monetarism is just hydraulic Keynesianism at its core with a few word changes.”

    My response: ????????????

    Lee, Money supply and demand can be equilibrated in many ways, so I don’t find that language useful. In the short run interest rates adjust to provide equilibrium. In the long run prices adjust.

    Bill, I don’t see the problem as shortages or surpluses, but as changes in the base that lead to changes in NGDP. See my answer to Lee.

    CA, They stay here because they respect me.

    Mike Rulle; You said;

    ““Out of style”? Since when? That was condescending, plus wrong. There has always been disagreement as to the nature of scientific method, at its core when speaking of the nitty gritty. Popper, who was the first to literally define a “scientific theory” in terms of “that which could be falsified and create predictions”, just died 18 years ago. So your “several decades ago” comment almost precedes the creation of the term in science. Obviously, this definition of science makes science a subset of knowledge—epistemologically speaking. (For example, we all assume we are not part of some solopsistic optical illusion)”

    I’m not sure what was condescending, I’m just reporting what philosophers tell me, and write about the subject. I don’t see why it matters when he died, his influence was in decline even before he died.

    As far as your second question, it’s pretty clear the stock market favors market monetarist solutions, as stocks rise on higher inflation indicators, whereas in the 1970s they fell on indicators of higher inflation. That set of data points is not consistent with various conservative models that oppose monetary stimulus right now.

    tim, I should have said the “Cambridge k” not the “demand for money.” I use the term ‘money demand’ since it is so familiar, but I actually mean the demand as a fraction of NGDP.

    It’s not clear to me that every variable affected by monetary policy is a factor in the demand for money, but perhaps I should give that more thought.

    Just thinking out loud, suppose another currency is pegged to the dollar. Easy money might create inflation in that country, but inflation in that country wouldn’t be a factor in the demand for dollars.

    Mikko, That’s a good point.

    Luis, I have 15 page articles defending NGDP targeting, I can’t do that in response to a blog comment. The Fed has plenty of tools according to Bernanke, if you ever find a case of a fiat money central bank that tries to inflate and fails, please come back and tell me about it. Until then I can’t be responsible if people want to believe in the tooth fairy and Santa Claus and liquidity traps and other mythological entities that have never existed and never will exist.

    Dan Kervick, You said:

    “The big crop of new apples will have no effect on the price of apples if the harvesting of the new apples has no bearing on the quantity of apples that are actually brought into markets where prices are determined by trade. And that’s the way it is with bank reserves. CB purchases of dollar denominated securities with dollars, swapping in immediate reserves for the deferred reserves that would have been received later as interest payments on the securities, has little bearing on the commercial trade in money absent some kind of liquidity crisis.”

    Banks only hold a substantial quantity of non-interest bearing reserves at the zero bound. So your comment has no bearing on my argument, which was restricted to positive interest rate cases, or cases where interest rates will be positive at some future date. If interest rates will always be zero, then an OMP obviously doesn’t increase the base, because T-bonds are essentially cash.

    You said;

    “I really can’t believe there is any such thing as a “hot potato effect” for dollars. The whole idea makes no sense at all. Getting more dollars always dominates in a decision matrix over getting fewer dollars, so there is no ceiling on the demand for dollars or on the willingness to “hold” dollars.”

    I’m speechless, the entire vast literature on money demand says you are wrong. Even the most extreme Keynesians surely believe there is a demand for money. I know very few people who like to hold large cash balances. When they get extra cash for some reason, they get rid of it. Just consider an economy lacking any sort of financial markets, where there are no interest rates. More money leads to inflation, and yet there’s no interest rate mechanism.

    You said;

    “But no holder of dollars ever says, “What the hell am I going to do with all of these dollars? It’s costing me an arm and a leg to hold them.” So the “hot potato” model for dollars is completely daft.”

    Back when interest rates were positive, every profit maximizing bank said to itself, “I don’t want to hold all these non-interest-bearing ERs, let’s get rid of them and replace them with T-bills.”

    Greg Ransom, Where has NGDP targeting failed? If nowhere, then what is the theoretical reason it will fail? Will we fail to achieve a steady NGDP, or would successful stabilization of NGDP fail to reduce RGDP instability.

  124. Gravatar of Cthorm Cthorm
    7. March 2012 at 13:44

    Greg Ransom, Where has NGDP targeting failed? If nowhere, then what is the theoretical reason it will fail? Will we fail to achieve a steady NGDP, or would successful stabilization of NGDP fail to reduce RGDP instability.

    My hunch is that under a switch to a NGDP targeting policy, every holder of Non-Call Fixed Rate CMOs and Muni Bonds would make an absolute killing on capital gains. The first part of that hunch is that under NGDP targeting, it’s actually conceivable that inflation and NGDP would increase. The second part (that I’m guessing on) is that there would be considerably more interest rate volatility under such a regime. Nice high coupon fixed-rate bonds would be a great source of yield and have much less default risk if NGDP was, you know, growing.

  125. Gravatar of Major_Freedom Major_Freedom
    7. March 2012 at 15:29

    ssumner:

    Major Freeman, Given that you’ve told me it’s “scientifically” proven that 9/11 was a “controlled demolition,” I’m not surprised that we disagree about almost everything. The shock is that we occasionally agree.

    I don’t think it’s that much of a shock. You have pretty much the exact same views the ethics and economics of producing potatoes, shoes, shirts, computers and cars, but I just go one step further and refuse to abandon economic principles in the area of production of money. Money is scarce just like all other economic goods, and every single principle you apply to non-money goods, I just apply to money as well. The reason why we disagree so much is because you devote this blog almost entirely to monetary affairs, and only occasionally delve into other problems like Keynesian theory, where your lightbulb finally turns on and your ability to use economic principles is not clouded by that which prevents you from doing the same in the area of money.

    To get a sense of what I mean, imagine me as a free marketeer talking to someone who insists that the second most marketable good in the world after federal reserve notes, say gold or some other jewelry like good, is better off being monopolized by the state, and then listen them chirp on about the state being responsible for aggregate jewelry trading and the horrors of people hoarding jewelry and not trading enough of it in the market.

    The way you would talk to them is very much like how I am talking to you, in terms of economic arguments.

    Lee Kelly:

    The notion that an increase in money demand, centaris paribus, is not an increase in desired saving is just a frail effort to rescue Rothbard’s nonsense. It contradicts a fundamental proposition of economics: the purpose of production is consumption. That is, we produce either consumer or capital goods, and the purpose of capital goods is to produce consumer goods in the future. In the interminable long-run, production and consumption are equal.

    No Kelly, that’s wrong. That an increased demand for money holding is not necessarily an increase in saving is absolutely not contradicted by the fact that the purpose of production is consumption.

    Rothbard correctly pointed out that there are THREE decisions that one can do with one’s money, adding to cash balances, investing it, and consuming with it. When someone earns gross income, there is a three-fold allocation that takes place. They allocate money to holding, investing and consumption. The problem with almost all economists, especially Keynesians (and even many monetarists) is that they only
    focus on two things at any one time. They only think in terms of “not consuming and hoarding cash” or “reducing cash and investing more”, etc. They don’t consider decisions that contain three dimensions. They don’t consider a decision like “Earn $100, and allocate $20 to cash, $40 to investment, and $40 to consumption”, or whatever. They can’t, for some reason, hold three variables at once in their minds. Maybe it’s a consequence of age old dialectic philosophy corrupting economics, I don’t know.

    At any rate, holding cash is NOT the same thing as saving. Abstaining from consuming is saving. Knowing that someone abstained from consuming can only be observed through their investments. For if you don’t, then you’d have to call someone who receives a paycheck, then cashes it at his bank, then goes to the grocery store to buy food, was a “saver” in between the time he receives the money and the time he spends it on food. In fact, everyone in the world who earns money would have to be considered savers, even if they take their earnings and as fast as they possibly can spend it on consumption. Since they are “hoarding” cash, they must be considered “savers”, despite the fact that their intentions are to consume every last penny!

    In other words, the meaning of saving as abstaining from consuming would lose all praxeological meaning. We’d no longer be considering people who save as intentionally saving, but we’d have to call people who are compelled to live in a temporal world where all action takes time, where people who earn money will always hold their money for some positive period of time, to be what “saving” really means. Saving would leave the world of economics and it would enter the world of physics.

    Saving in the economic sense must therefore be something an individual has control over in terms of their intentions. Thus, a person who intentionally saves cannot be someone who just holds cash and hasn’t used it yet. It has to be when they actually use it in some way in transactions that the concept of saving arises. Saving is therefore what we call exchanging money not for the purposes of consuming. In other words, saving is what occurs when people abstain from consuming, and invest it instead. They aren’t saving by merely holding onto their money before they consume or invest. They only save once they abstain from consuming in their transactions.

    There is no difference for the concept of saving that turns not saving into saving if someone holds $100 for one second and then buys a consumer good, versus holding that $100 for one year and then buying a consumer good. Most economists would consider the latter a “saving.” After all, didn’t he abstain from consuming for one year, then bought something? Well, if we call the one year holding an act of saving, then we must consider the one second, even one picosecond, of holding as saving too. But then we’d have to conclude that EVERYTHING we buy with money is financed with “savings.” We’d all be savers all the time! But then how in this conception of saving can anyone buy anything not financed by savings? How can anyone not be savers? The answer is they can’t, which of course means that reductio ad absurdum can tell us that this conception of saving, of holding cash, is all wrong.

    The idea that holding money balances falls into some nebulous domain between consumption and saving is preposterous.

    It’s not preposterous. That earning money and holding any money at all for any length of time, no matter how small the time frame, to be an act of saving, is what is preposterous.

    It implies that the purpose of some production, that is, whatever someone produces to acquire larger cash balances, is neither to achieve present nor future consumption.

    No, that’s not true. Someone producing to acquire larger cash balances is to achieve an ability to consume AND/OR invest a larger amount in the future than they otherwise would have been able to do if they instead invested and consumed with it in the present.

    Therefore, production does not equal consumption, even in the interminable long-run, because that portion of income held as money balances represents production for no reason. So much for purposeful human action.

    No, you’re ignoring the events that transpire on account of someone increasing their cash balances by allocating less money to either investment or consumption or a combination of both.

    If someone typically earns and then spends $100 on consumption, every day say, but then one day they reduce their consumption spending by $50 and start accumulating $50 cash every day, then the economist has to ask what effects this will have on the structure of production. Well, since they are only reducing their consumption spending by $50 each day, and everything else is the same, then what will happen is that consumer goods companies will see a reduction of $50 in revenues, and hence, say, $5 in profits on the lost $50 in sales.

    This will send signals to investors. They will observe (hopefully anticipate) that profits in consumer goods are falling RELATIVE to profits in capital goods. If investors chase profits, then their investment decisions will lead them to investing more in the capital goods relative to consumer goods. This will have the result of reducing the production of consumer goods, and increasing the production of capital goods (which are for producing future consumer goods).

    This is EXACTLY what the consumers want! By holding more cash and consuming less, they are clearly desiring for there to be less current production, and, because they are not burning their money, they desire more consumption in the future than they otherwise could have had if they just kept consuming the $50 each month.

    Should this person who accumulates cash be called a “saver”? I will argue no, for the above reasons. If you say yes, then you must also call the comic book character “The Flash” a “saver”, if we were to take his cash earnings and within a microsecond rush into Wal-Mart to buy Season 2 of his television series on Blue Ray. According to his INTENTIONS however, he didn’t mean to abstain from consuming at all. But just because he isn’t God who can spend INSTANTLY, with zero time in between earning of money and spending of money, he must be considered a saver. Clearly that’s a bunch of nonsense. Only a God can avoid being a saver in a world where the mere holding of cash is considered saving. But since economists call “saving” an abstaining from consuming, it clearly implies that saving has to be tied up with intentions, with action. The only way to know if someone is purposefully abstaining from consuming is if they use their money for investment purposes.

    THIS is why saving and invest are two sides of the same coin. It is not because of some silly derivative excuse of consumer goods inventory building up when people reduce their consumption spending and accumulate cash, where inventory accumulating in the physical sense is conflated with INVESTING in inventory in the money expenditures sense.

    It’s an especially silly notion when all money is a liability of some financial institution. You might oppose with our current monetary system, as do I, but when money is a financial asset of a bank (or central bank), holding larger cash balances is de facto lending to the bank. It doesn’t matter for economic coordination whether individuals are aware they are lending to the bank any more than they understand what it means to be a bond holder. All that matters is that by holding larger cash balances (or purchasing bonds), they are relinquishing control over present resources for a larger claim on future goods and services.

    You can’t ignore the rate of production of goods over time. It’s not just about the same quantity of goods being controlled sooner or later. The decision to allocate earnings to cash balances, investment and consumption, have repercussions all throughout the structure of production.

    If we actually had a monetary system based on gold coins and 100 percent gold-backed banknotes, then holding larger money balances would be more like purchasing commodities.

    Sure, but we do that with paper money too. Paper money is a commodity. Earning money is in fact a purchase of a commodity. You sell your labor, your stocks, your bonds, your house, your anything, for paper money, and that is you purchasing the money commodity. Every exchange between two parties has two buyers and two sellers. Each party is both a buyer and seller. When you earn a wage, you are a buyer of money commodity and a seller of labor. When you pay a wage, you are a buyer of labor and a seller of money commodity.

    The fascination with money and the fact that almost everyone would accept it in trades, has, unfortunately, numbed people down to its significance. It’s made people unaware that money is simply another economic commodity. But for monetarists, they have a conniption and believe it has to be centrally controlled, lest the whole world fall apart. Well, if the importance of money means it has to be centrally controlled, then why not labor as well? That’s even more important than money. Without labor, NOTHING will get produced and the human race would go extinct. Shouldn’t labor be centrally controlled too then? We can have a central labor planning bureau that forces people to provide more labor when the supply of labor falls below X% nominal gross domestic labor growth per year. Heck, we can even have a national gross domestic labor (NGDL) futures market.

    I’ll even start a blog that shows 100% correlation between the quantity of labor supplied versus and output and employment.

    To the extent that such a use of gold gold money disrupted its value (and so cause inflation or deflation), that would be just one reason why gold would be a sub-optimal money.

    What you call “disruption”, is a constructive reflection of people’s new preferences that send powerful signals throughout the market, telling investors the new conditions and new profit opportunities.

    You’re just calling it a “disruption” because you are starting with the arbitrary and groundless belief that “spending” must be nominally stabilized by central planning bureaus. You don’t seem to realize that fiat money central planners make the economy WORSE off, because their actions affect the real structure of production, which leads to recessions and unemployment.

    An increase in money demand does not represent a general desire for a lower aggregate nominal spending, nor deflation, and especially not the interim period before deflation has run its course.

    That’s because aggregate nominal spending, and deflation, are not the concern of the individual! They are central planning tools of the state, not economic actors in general. Individuals shouldn’t have to worry about aggregate spending or deflation because what matters to the individual is their own demand and their own money conditions. Yes, it’s surprising that people will have interests that are different than yours, isn’t it?

    Second, if large numbers of people do increase their cash balances, then that is in fact a collective desire to reduce nominal spending. They are searching for higher purchasing power, and with a smaller aggregate spending, prices will tend to fall, and people will succeed in getting higher purchasing power.

    That is not why people try to increase their cash balances–it’s just the an unintended consequence.

    No, it’s intended. If there are 100 million people, and they each increase their cash by a collective $10 billion such that spending falls by $10 billion, it was all completely intended. The single abstract concept of $10 billion was not planned by any single consciousness, but it doesn’t matter. It would be like worrying over the aggregate quantity of times the word “Yes!” is said.

    Finally, Cantillon effects aren’t always bad. Suppose that George was going to lend Scott $100,000, but instead of just giving him the money, George promises to bury $100,000 in his backyard and not touch it until the loan is ready to be repaid. Scott, then, uses a printing press to make the $100,000 in crisp new bills. When it comes time to pay off the debt, Scott will burn $100,000 and give the interest to George, while George digs up his $100,000 from the backyard and starts spending again.

    Cantillon effects are bad when they result from a violence backed monopoly that prevents open competition and then prints money for itself and its friends, thus generating Cantillon effects of the wealth transfer type.

    Then there is the Cantillon effect of inflation and non-market interest rates affecting relative prices and the business cycle.

    There is no doubt that Scott’s spending of the new money–made from “thin air”, no less–will change relative prices. The injection effects will tend to drive up prices of goods that Scott wishes to buy, diverting resources into the production of those goods. However, this is exactly what is supposed to happen! George is lending Scott the money. Scott borrowing is just the vessel through which George is expressing his demand for future goods. If George had decided to spend the money directly on future goods himself, then it might have had a similar effect on relative prices.

    George didn’t abstain from his own consumption to give Sumner that money. It’s not actual saving and it’s not actual abstaining from consumption.

    Cantillon effects are only pernicious when there is an excess supply or demand for money; otherwise they are just another name for relative price changes.

    There is no such thing as an “excess” demand or supply of money.

  126. Gravatar of david stinson david stinson
    7. March 2012 at 15:49

    Hi Scott.

    Very helpful post.

    I have a question though. When you talk about demand for base money, I am assuming that, analogous to way that the demand for non-base money is really a demand for real balances, not nominal quantities, the demand for base money is also a real or relative demand – although in this case, relative to the money supply? In other words, would the “real” demand for base money (for a given level of nominal base money) be expressed by the actual reserve ratio?

  127. Gravatar of Mike Sproul Mike Sproul
    7. March 2012 at 16:08

    Scott:

    Nobody denies that a new crop of wallets makes the price of a wallet fall, and nobody denies that wallets are useful for trading. The point of dispute is that new wallets are not the liability of the wallet-maker, while new money is the liability of the money-issuer. So money is like stock (see John Cochrane). As a firm issues more shares, it normally gets new assets as well, and the share price is unaffected. As a bank (private or public) issues new money, it gets new assets in exchange, and the value of each currency unit is unaffected. By extension, there is no hot potato effect for money for the same reason there is no hot potato effect for stock. And by the way, people sometimes carry around purses full of T-bonds when they are shopping for houses and cars.

  128. Gravatar of Lee Kelly Lee Kelly
    7. March 2012 at 17:03

    Major Freedom,

    Too long; didn’t read.

  129. Gravatar of iya iya
    7. March 2012 at 18:49

    I’m open minded, but in no way convinced.
    Just like the Keynesians and in contrast to the Austrians, all the important details that make capitalism efficient seem to be lost in the focus on aggregates.

    Setting the NGDP target seems as hopeless as trying to set interest rates. Why 5% and not 15%, 0% or -5%? It would be pure luck to get the correct “natural” number, and can one size really fit all, when growth is very different over space and time? The idea seems to be to smooth falls “below trend” out, but what if it’s signal you’re trying to smooth out?

    “Output gaps are determined as in other natural rate models, by unexpected changes in NGDP.”
    What is unexpected is not obvious at all. Was the housing bust unexpected, and does it matter?

    It’s not possible to smooth out the stock market and other prices, in any case, and there will always be drops of 50% and more, otherwise you could double the returns with 2x leverage, etc.

    China is growing much stronger than 5%. Is the idea that they should try to sabotage that growth, or go around and confiscate and burn money? If the target should be higher, then how to determine whether an eventual slowdown is “real” and would justify a lowering of the target or if it’s an “unjustified” recession?
    Similarly, technological advances can lead to bursts of above average growth, while sometimes even negative growth is inevitable e.g., after natural disasters, during war or during the liquidation of malinvestments and restructuring of the economy. When the baby-boomers retire, we’ll need high productivity growth just for stagnation. How will 5% inflation be helpful if there is 0% real growth?

    Is it accepted that the actual problem is credit expansion beyond the natural level causing an artificial boom and then either credit contraction leading to bust or continuing bail-outs leading to hyperinflation?
    Probably not, because NGDP targeting does not seem to address it.

  130. Gravatar of Major_Freedom Major_Freedom
    7. March 2012 at 22:19

    Lee Kelly:

    Too long; didn’t read.

    Well that explains why your knowledge is lacking.

  131. Gravatar of Lee Kelly Lee Kelly
    8. March 2012 at 08:30

    Major,

    Look, I read some of your argument, but it’s horribly confused. I should have replied ‘Too stupid; didn’t read’, but I went for the polite option instead. So much for that! I’m probably trolling you now.

    Anyway, your confusion has to with equating income with monetary income. Of course, when someone receives money, they can decide to do three things with it: spend it on consumer goods, spend it on capital goods, or just hold onto the money.

    I’m not talking about ‘income’ as money received. Lots of income is never exchanged for money, such as the product of household chores or DIY. Income may be measured in money, because that is the unit of account, but it needn’t actually involve exchanging money.

    Income and production are really the same thing. When I chop firewood, that fuel is both part of my product and my income. We could put a dollar value on that income, but that doesn’t mean I can use it to build cash balances, because no monetary exchange actually takes place. Monetary exchange just obscures this identity, because it means we rarely consume the same stuff that we produce, but for the economy as a whole it remains obviously true: income and production must be equal.

    It’s weird to say, but to increase your cash balances by $100, you have to spend $100 of your income on cash. That is, you need to produce $100 of goods and services (and exchange them for money) to increase your cash balances. It’s really the production of goods and services that constitutes income, not the amount of money you happen to receive. (This is more obviously true in a non-monetary economy.)

    This is why there is no third option: all income is either spent on consumption or saving/investment. The goods and services you produce are either consumer or capital goods: there is no third option. You’re being misled by thinking about money too much and the real production of goods and services too little.

    When people hold larger cash balances, holding the money supply and price level constant, the immediate effect is not to produce less themselves. The loss of production is felt by others who see opportunities for mutual gain, but are unable to find the money to facilitate those transactions. Moreover, if this were a good thing, then we’d have to conclude that deflation is evil, since it allows for increased production at lower prices against the wishes of money holders.

  132. Gravatar of david stinson david stinson
    8. March 2012 at 13:42

    Sorry Scott, another couple of questions.

    1) With respect to temporary or permanent money injections, to which aggregate does this apply – monetary base or money stock?

    2) As long as the market is convinced that Fed Chairman Scott Sumner will maintain monetary equilibrium (via NGDP targeting) in the future, why is it also necessary that the market believe that money injections are permanent, particularly if, for example, Chairman Scott took the helm when the demand for money had been elevated for some time and there had been attempts (albeit perhaps inadequate ones) to meet that elevated demand? Presumably, as the Sumnerian Golden Age unfolds, and the economy recovers, the demand for money will fall, perhaps significantly. Couldn’t it be the case that a commitment to permanent money injections would be inconsistent with a commitment to monetary equilibrium?

  133. Gravatar of ssumner ssumner
    9. March 2012 at 07:24

    Cthorm, I’d expect less interest rate volatility with NGDP targeting. Interest rates are correlated with NGDP growth.

    David, I don’t follow. The real demand for base money is Base/P. I prefer Base/NGDP, as a better way of thinking about base demand.

    Mike, I don’t see money as being at all like a stock. people don’t hold cash as an investment to make a profit (usually) they hold it for transactions, to produce a service. Thus the price of cash falls with more cash for the same reason the price of other useful real goods falls when more are supplied.

    Stocks are held as investments, they have usefulness only in terms of their rate of return.

    If stocks were like cash then open market operations wouldn’t be inflationary, but we know from the TIPS markets than unanticipated monetary policy changes have big effects on inflation expectations and other macro variables.

    iya, I’m afraid you’ve confused real and nominal variables. You need to do some homework before getting deeply into monetary policy discussions. There is no natural rate of NGDP growth, and China’s 10% growth is real, not nominal.

    You said;

    “How will 5% inflation be helpful if there is 0% real growth?”‘

    I would think that’s pretty obvious. It helps stabilize unemployment. That’s the standard argument in macro, not something I dreamed up. If you don’t agree that it’s helpful then tell my why, and what monetary policy you prefer. That would make it easier for me to respond.

    David, The Base.

    Your second comment is exactly right. I think you misunderstood my argument. I never called for a money supply growth target.

  134. Gravatar of iya iya
    9. March 2012 at 09:23

    Of course China’s nominal growth is even higher, 30% between 2007 and 08. I’m asking if you suggest to force this number down to 5%? It’ll probably cause a recession and stun real growth, but assuming an economy can and does have 10% real growth, is it actually possible to hit 5% nominal growth, once the balance sheet of the central bank hits zero and you can no longer shrink the money supply?
    Or is the 5% target not supposed to be fixed, but instead discretionary?

    “…what monetary policy you prefer”
    The goal to stabilize monetary equilibrium, i.e. maximize the utility as a medium of exchange sounds good, but in the end monetary policy can only do so much and the qualitative policies are more important. If the savings rate increases as it did in the US, it means the people want to secure consumption in the future. If this money is spend on government bonds because they are guaranteed by the central bank, and the government uses the money to boost consumption, then you’ve got a future problem. It’s not even malinvestment, it’s not investment at all.

  135. Gravatar of Mike Sproul Mike Sproul
    11. March 2012 at 08:56

    Scott:

    I presume you agree that money is like stock at least in the accounting sense that new stock (and new money) both add to the issuer’s liabilities, while the bonds, goods, etc. obtained with that new stock (or money) add to the issuer’s assets.

    But when you say that money’s usefulness for trade means that the price of cash falls with more cash, you imply that the cash can be worth either more or less than the value of the assets backing it. So start with a government that has issued 100 paper dollars, and holds miscellaneous assets worth 100 oz. of silver. Then the government issues another $200 for miscellaneous assets worth 200 oz. I say you now have $300 laying claim to stuff worth 300 oz., so each dollar is still worth 1 oz. You seem to think that each dollar will now be worth something like 1/3 oz. (Arbitrage opportunities galore!)

    That TIPS data you mentioned is consistent with both your view and mine, but that’s a long story that can wait until we at least settle some more basic points.

  136. Gravatar of Major_Freedom Major_Freedom
    12. March 2012 at 10:54

    Lee Kelly:

    Look, I read some of your argument, but it’s horribly confused.

    Easy to say “confused”, harder to prove it, isn’t it? Sure, let’s just take your word for it.

    I should have replied ‘Too stupid; didn’t read’, but I went for the polite option instead. So much for that! I’m probably trolling you now.

    Easy to say “stupid”, harder to prove it.

    Anyway, your confusion has to with equating income with monetary income. Of course, when someone receives money, they can decide to do three things with it: spend it on consumer goods, spend it on capital goods, or just hold onto the money.

    First, I wasn’t conflating income with monetary income. I was only specifically talking about money income. If you want to talk about real income, we can. Second, what you just described that people can do with their (money) income, is what I just said.

    I’m not talking about ‘income’ as money received. Lots of income is never exchanged for money, such as the product of household chores or DIY.

    In a division of labor, monetary economy, I don’t treat income as including household “chores.” I don’t consider someone cooking a roast beef from a raw piece of beef an act of increasing “income.” I view that as a physical consumption of raw materials. In the same way, I don’t consider someone buying a pile of lumber, and building their own picket fence around their house to be an act of increasing “income.” I consider the money they spent for the lumber to be an income to the seller, and the physical act of building a picket fence is an act of consumption; a construction of a durable consumer good that is not meant to bring in subsequent sales revenues (to the extent that the home and the picket fence was for the purposes of residency), and an investment (to the extent the builder is intending to sell the home at a profit later on).

    Income may be measured in money, because that is the unit of account, but it needn’t actually involve exchanging money.

    Money being the unit of account is a subsidiary role that is determined by its medium of exchange attribute.

    Yes, income can be derived in barter exchanges, but in a monetary economy, I measure productivity as it relates to the earning of money.

    Income and production are really the same thing. When I chop firewood, that fuel is both part of my product and my income.

    You’re just defining income differently than I do. By your treatment, we’d have to consider all acts of consumption to be income generating. I follow Adam Smith and separating productive consumption from unproductive consumption. In a monetary economy, chopping wood into firewood is an act of unproductive consumption, since your action is not intended to bring in future sales revenues. If instead you owned a firewood selling business, then your act of chopping wood into firewood would be an act of productive consumption, since it is intended to bring in subsequent sales.

    We could put a dollar value on that income, but that doesn’t mean I can use it to build cash balances, because no monetary exchange actually takes place.

    In my treatment, if an act doesn’t earn money, then it’s not productive. This is not at all a denigration of non-monetary activity, it’s purely analytical. It’s purely to identify the sphere of productivity that exists in a division of labor society the people of which use a commodity as a universal medium of exchange.

    Monetary exchange just obscures this identity, because it means we rarely consume the same stuff that we produce, but for the economy as a whole it remains obviously true: income and production must be equal.

    Why is it attractive that income and production must equalize? Why is this identity important?

    That in a monetary economy we rarely consume the same stuff we produce is actually an incredibly profound concept that you ought not let your obvious Marxist tendencies cloud or obscure as being unjust in any sense, on the basis that workers aren’t receiving “the full product” of their labor, but rather money instead, and that the “important” concept we have to focus on is the fact that labor produces output equal to income. Well sure, if you label output as “income” (I call it “real income”), then sure, income and output/production are always equal.

    But don’t let the fact that most people don’t consume what they physically produce lead you to minimizing the importance of the implications of it. I personally find it an incredibly benevolent outcome of a monetary economy that shoemakers who want shirts or potatoes or computers don’t have to convince shirt makers, potato farmers, or computer sellers to accept more shoes. The shoe maker can simply sell shoes to anyone who is willing to buy them for money, and then he can use the money to buy shirts, potatoes and computers.

    People just need to produce anything that earns money, and they can then buy pretty much anything they want (subject to their own productivity and income making ability of course).

    You can say this “obscures” the Marxist conception of labor producing output and allegedly earning that output, but you would only be going down the path of confusion and ignorance of market activity in a division of labor economy. Division of labor cannot expand very much without money, and I hold division of labor to be a backbone of a prosperous society.

    It’s weird to say, but to increase your cash balances by $100, you have to spend $100 of your income on cash. That is, you need to produce $100 of goods and services (and exchange them for money) to increase your cash balances. It’s really the production of goods and services that constitutes income, not the amount of money you happen to receive.

    Now you’re just playing semantics. Now you’re just trying to get me to define income as output only. Sorry, I won’t do that. You can define output as “income” if you want. I will define it as “real income” instead. We’re talking about the same thing. I define “income” without qualification as “money earned”, and you can define what I call “income” to be “only money income that obscures the issue” if you want. We’d again be referring to the same thing, namely, the money that people earn in trades.

    (This is more obviously true in a non-monetary economy.)

    It’s not about “true” or “false.” You’re arguing over definitions, not substantive concepts and meanings.

    This is why there is no third option: all income is either spent on consumption or saving/investment.

    But spending money isn’t the only benefit that money brings. Money also enables people to store purchasing power for future spending. This is why I say it is important to realize that earning money income can be put to three uses, investment / consumption / cash balance. Holding money as cash is useful, or else people would not do it of course. Yes, holding money as cash makes you mad, it makes you angry, it makes you rage because they’re not giving the money to others who want more money, but money holding is a paramount aspect of a prosperous economy. Using coercion like what the monetarists want, to prevent people from holding more cash, can only be disruptive to what benefits people’s lives.

    The goods and services you produce are either consumer or capital goods: there is no third option. You’re being misled by thinking about money too much and the real production of goods and services too little.

    You are setting up a straw man by saying I am focusing “too much” on money and “not enough” on real production. I hold them both as important, thank you very much. But I nevertheless do realize that in a division of labor, monetary economy, the concept of calculation, of gains and losses, of productivity, is insuperably guided by money matters, such as prices, profits, losses, demands, earnings, etc.

    You want me to minimize the importance of money making, because you obviously don’t much like money making. You think it’s tainted with something uncouth, something nasty, something that must be doubted.

    Sorry, I won’t go down your path of ignorance. Money making is far more important to production in a division of labor economy, than you are giving it credence for.

    You are being misled, not me.

    When people hold larger cash balances, holding the money supply and price level constant, the immediate effect is not to produce less themselves. The loss of production is felt by others who see opportunities for mutual gain, but are unable to find the money to facilitate those transactions.

    No, sellers don’t unilaterally determine what is “mutually gainful.” It takes two parties to do that. If one person wants to trade, but the other does not, then there is no mutually gainful trade there. Sometimes those who have money and are willing to spend it, find sellers who don’t want to sell, because the offer is too low. You make it seem like absences of trades is due solely to money hoarding misers, when in reality it goes both ways, money hoarding misers and goods hoarding misers.

    More importantly, when people hold larger cash balances, it’s not true that the price level remains constant. It will almost certainly fall, as sellers (producers, laborers, etc) have to lower their asking prices so that buyers (consumers, employers, etc) are willing to pay it.

    If people are increasing their cash balances, it is because they obviously find prevailing prices as too high for their tastes, and they want to increase their purchasing power. In the absence of counterfeiters exploiting the masses, this would have resulted in lower prices, that cash hoarders are willing to pay, and your arbitrary defense of sellers only will get money incomes.

    Moreover, if this were a good thing, then we’d have to conclude that deflation is evil, since it allows for increased production at lower prices against the wishes of money holders.

    This follows from your prior confusion of holding prices constant.

    If holding cash is a good thing, then falling prices that result is a good thing. Since holding cash is a good thing, since it is not a violation of anyone’s property rights, then falling prices on the basis of holding more cash is also a good thing. Yes, there is “pain” involved, but there is also pain experienced by sellers of shoddy and inferior products, and their bankruptcies are a good thing.

    The pain experienced by people as they are compelled to adapt to other people’s voluntary, peaceful desires, is also a good thing. It’s only a bad thing to dictatorial minded people who want to overrule some people’s decisions and causing them pain, in order to protect other people from feeling pain.

    Bad sellers and bad laborers SHOULD feel the “pain” of a reduced money income if their buyers don’t want to spend as much money on them. Let people spend their own money and determine how much money is in circulation according to voluntary exchanges on the basis of private property rights. Trying to transcend this only brings MORE pain to the people. Instead of occasional bankruptcies and unemployment in the free market, we instead get widespread bankruptcies and unemployment in the tens of millions in a hampered market.

    You ignorantly believe you are helping by calling for more authority in society, more paternal caretaking, but you’re just making things worse. You have to accept the small pain that accompanies people changing their preferences, and stop viewing it as so evil. I mean, it hurts to go to the gym and work out hard, doesn’t it? Does that mean people should not work out at all, that it is evil and should be avoided? Or how about drug addicts who quit cold turkey? They feel pain too. Does that mean quitting heroin is an evil and should be avoided? Or what about the headaches one can get from studying really hard? Are you a wuss or are you an adult?

    Not all pain is bad pain you know. Some pain is good pain. If you’re afraid of pain, then you might want to consider inducing yourself into a voluntary coma.

  137. Gravatar of Lee Kelly Lee Kelly
    12. March 2012 at 11:49

    My obvious Marxist tendencies? Ha!

    Income = production and, in the long run, income = consumption, i.e. we produce to consume, either now or later. Though income is often measured in units of money, money is not income. Income = consumption and money cannot be consumed. Sure, the physical stuff we use for money might be consumable, but the moment we begin consuming it is the moment it stops being money. Money is a medium of exchange; it the proximate rather than ultimate goal.

    The notion that increasing money balances can be something other than saving or consuming flies in the face of this fundamental principle. To the extent that a physical commodity serves purposes other than a media of exchange is just the extent to which it makes for bad money.

    Money is very important for understanding the economy, and why it can sometimes go horribly wrong–I’m an Austrian economist at heart. Inter-temporal disequilibria caused by central banks shifting the market rate of interest above or below the natural rate is a concern. Nothing I’ve said contradicts any of that. You seriously misunderstand what your intellectual opponents actually think. This is not surprising: Rothbard sets up one strawman after another, and Mises spends a lot of time criticising nonsense propogated by social scientists of a bygone era.

  138. Gravatar of ssumner ssumner
    12. March 2012 at 18:31

    iya, That’s no answer at all, you haven’t said anything about the monetary policy you favor.

    You would generally not have to reduce the money supply to achieve 5% NGDP growth, you’d have to gradually increase it over time. If it had to be reduced once and a while the central bank could sell assets. If they ran out of assets, the treasury could give them some more to sell.

    Mike, Let’s say you are a wallet manufacturer. As you sell wallets, you accumulate assets, say bonds. You hold those bonds on your balance sheet. Does that prevent an increase in the supply of wallets from depressing their price? No, the buyers of wallets care not at all about the wallet manufacturer’s balance sheet. And I believe the same is true of cash, (unless a government is so broke they are likely to need to print money to pay bills.) Short of that, it’s the quantity of currency that matters, not balance sheets. Australia has a far better balance sheet that the US, they have a tiny net debt. But their price level is roughly the same.

    I’m shocked that you think the TIPS data is also consistent with your view. Are you agreeing with me that OMPs are inflationary? I thought you denied that? If you agree, then we have nothing substantive to debate.

    Everyone, I have a new policy of only answering comments on recent posts, so I’ll give you guys the last word.

  139. Gravatar of Major_Freedom Major_Freedom
    13. March 2012 at 04:16

    Lee Kelly:

    My obvious Marxist tendencies? Ha!

    You do realize that many of the things that people take for granted in economics, often comes from Marx, don’t you? I am not saying you’re a Marxist, I am saying you have Marxist tendencies. So do many other supposed free market advocates. It’s not really that stand offish to make explicit. If you believe in progressive taxation, if you believe in or are apologetic to central banking, if you believe in “free” state education to children, if you believe that wage earners earn not money income but real products that unjustly become the property of the employers, if you believe inheritances should be taxed, if you believe the state should control and regulate the airwaves, if you believe in any of these things, you have Marxist tendencies. Most of the above are among the ten planks of communism.

    Income = production, and, in the long run, income = consumption, i.e. we produce to consume, either now or later.

    Only if you define “income” as “the goods that are produced and sold.” I call that “real income”. I define “income” as “money earned.”

    You can’t say I’m wrong to define things this way, and I can’t you’re wrong to define things this way. We just define the same word differently. Neither of us are “right” or “wrong”, because definitions are verbal stipulations, not declarative arguments about something objective the support of which requires more than just definitions.

    Though income is often measured in units of money, money is not income.

    Of course.

    Income = consumption and money cannot be consumed.

    Only if you define income as that which is produced and consumed.

    I define “income” as “money earned in exchange.” What you are calling “income” I call “real income.”

    Sure, the physical stuff we use for money might be consumable, but the moment we begin consuming it is the moment it stops being money. Money is a medium of exchange; it the proximate rather than ultimate goal.

    Yes.

    The notion that increasing money balances can be something other than saving or consuming flies in the face of this fundamental principle.

    Not at all. I define income as money earned, and I define saving as abstaining from consuming out of gross income earned. Increasing cash balances brought about by inflation of the money supply can occur without anyone abstaining from consuming out of gross income earned.

    If someone prints themselves a $100 bill, and their cash balance increases by $100, then they didn’t “save”. They didn’t save out of gross income they EARNED. You don’t EARN income when you print it. You earn money when you trade for it, or, in a free market money standard, such as a gold standard, when the individual is free to produce it for themselves.

    In the monopoly fiat money system that is foisted on us by state coercion, the individual is not free to choose their own money. Thus the money the Federal Reserve System creates out of thin air is not money that they saved out of their earnings, and the receivers of that money is not saved out of their earnings either.

    To the extent that a physical commodity serves purposes other than a media of exchange is just the extent to which it makes for bad money.

    False. What constitutes a bad money is, all else equal, a relatively low market value per unit. Federal Reserve notes have a far lower market value than precious metals. They just appear to have a high market value because of state imposed taxation and legal tender laws. In the absence of taxation and legal tender laws, the market value of paper money will be exposed, and Fed notes will collapse to whatever the market value of defaced cotton and linen material happens to be at that time.

    Money is very important for understanding the economy, and why it can sometimes go horribly wrong–I’m an Austrian economist at heart. Inter-temporal disequilibria caused by central banks shifting the market rate of interest above or below the natural rate is a concern. Nothing I’ve said contradicts any of that. You seriously misunderstand what your intellectual opponents actually think. This is not surprising: Rothbard sets up one strawman after another, and Mises spends a lot of time criticising nonsense propogated by social scientists of a bygone era.

    Which Rothbardian straw men are you talking about? And what Mises criticized is still very much relevant today, because the economic calculation argument not only shows the flaws of soviet style communism, it also shows the flaws of monetary policy intervention, as you seem to understand.

  140. Gravatar of Mike Sproul Mike Sproul
    14. March 2012 at 08:09

    Scott:

    1) If a wallet manufacturer has a history of using its assets to buy back its wallets whenever the price of wallets declines by more than 2%/year, then wallet holders will care about the manufacturer’s balance sheet. The manufacturer will also get a quick lesson in the Law of Reflux.

    2) Open market purchases are inflationary if they leave the bank with less assets per unit of currency. I’m pretty sure that still leaves us with plenty to argue about.

  141. Gravatar of ssumner ssumner
    15. March 2012 at 09:00

    Mike, I thought you were arguing OMPs are not inflationary? If not, then what are we debating? If so, then it makes no sense to talk about 2% inflation targets, as I’m arguing an OMP can change inflation. You don’t think wallet makers can influence the price of wallets by flooding the market, assuming there is no “2% commitment?”

  142. Gravatar of Mike Sproul Mike Sproul
    15. March 2012 at 09:36

    Scott:

    My mind is reeling at the gulf between what you think I said and what I think I said. If you ever come to UCLA, try to look me up and I’ll see if things are clearer face-to-face. I’ll offer suitable bribes of beer and food.

    Until then:

    1) Start with a bank that has issued $100 of paper bank notes, against which it holds assets worth 100 oz. of silver. Thus each dollar is worth 100 oz/$100=1 oz./$. If that bank then conducts an OMP where it pays $200 for bonds worth 200 oz., then each dollar would be worth 300 oz./$300=1 oz./$. No inflation. But if the OMP was conducted so that the bank paid $200 for bonds worth only 197 oz., (or maybe the bond was worth 200 oz. but then fell in value to 197 oz.) then each dollar would be worth 297 oz/$300=.99 oz/$, for 1% inflation.

    2) Of course they can influence the price of wallets if there is no 2% commitment, but the nature of banking is to make some such commitment. Assuming away the commitment is assuming away the whole problem.

  143. Gravatar of ssumner ssumner
    16. March 2012 at 11:57

    Mike, Yes, I did misunderstand your position. I certainly agree that if there is a 2% inflation commitment, then OMPs will have almost no impact on the price level, as the Fed would have to quickly reverse them to prevent inflation from rising above 2%. I think everyone agrees with that–it is the long run expected path of monetary policy that determines the current value of the dollar.

    I had thought you were claiming that the Fed couldn’t arbitrarily decide to raise the inflation rate from 2% a year to 8% a year by doing OMPs, without the assistence of fiscal policymakers.

    I hope to retire near UCLA in about 5 years, so maybe we can have lots of lunches.

  144. Gravatar of David Eagle David Eagle
    19. March 2012 at 14:06

    This comment is for 123.

    I agree with you about the need for NPGD indexing in debt contracts. Another name for NGDP indexing is “Quasi-real indexing,” a type of inflation-indexing Dale Domian and I designed. Google “Quasi-real indexing.” While Dale and I published a paper on quasi-real government bonds in 1995, it turns out we were not the first. Robert Shiller made the same proposal in 1993 in his book “Macro Markets.” However, I do not know the extent to which Shiller realizes that his NGDP bonds are being adjusted for aggregate-demand-caused inflation and not for aggregate-supply-caused inflation. By the way, Stanley Fisher in 1984 before he became the Chair of the Bank of Israel, basically said that the ideal for indexing is to only adjust for aggregate-demand-caused inflation and not for aggregate-supply-caused inflation. That is what quasi-real indexing does.

  145. Gravatar of Mike Sproul Mike Sproul
    19. March 2012 at 17:19

    Scott:

    Excellent idea!

  146. Gravatar of Chuck Norris in Threadneedle Street « uneconomical Chuck Norris in Threadneedle Street « uneconomical
    22. March 2012 at 14:19

    [...] just a tragic shame the CPI rate was the wrong target. Share this:TwitterFacebookLike this:LikeBe the first to like this post. Categories: History, [...]

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    26. April 2012 at 12:25

    [...] really want faster nominal demand growth, then why do we not simply ask the Bank of England to target the level of nominal demand?  And empower them to use whatever tools they see fit to hit that the level: interest rates, QE, [...]

  148. Gravatar of TheMoneyIllusion » Dude, where’s your model? TheMoneyIllusion » Dude, where’s your model?
    29. May 2012 at 05:41

    [...] Wise readers will notice that I do have a model, indeed lots of them.  They’re just not mathematical [...]

  149. Gravatar of GIASTAR – Storie di ordinaria tecnologia » Blog Archive » The Federal Reserve’s Ongoing Dereliction Of Duty GIASTAR – Storie di ordinaria tecnologia » Blog Archive » The Federal Reserve’s Ongoing Dereliction Of Duty
    24. April 2013 at 01:33

    [...] have long made the case that a nominal GDP (NGDP) level target would firmly anchor the expected growth path of nominal [...]

  150. Gravatar of The Federal Reserve’s Ongoing Dereliction Of Duty The Federal Reserve’s Ongoing Dereliction Of Duty
    24. April 2013 at 08:26

    [...] have long made the case that a nominal GDP (NGDP) level target would firmly anchor the expected growth path of nominal [...]

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