It really, really, really doesn’t matter who gets the money first—part 2

This post triggered a horror-show of ignorance and insults in the comment section.  So against my better judgment I’m going to push back one more time at a set of arguments that don’t stand up to close scrutiny.  Here’s a typical comment (by Suvy):

This is complete garbage. For every dollar that’s printed, it takes away from my purchasing power. By printing money and stashing them in bank reserves, the banks gain spending power at my expense. Inflation is a tax; printing money is a tax. The first people to get the new money benefit the most. If the banks get the money first; they benefit the most at my expense. It makes a huge difference on how the new money is introduced.

Here’s how things actually work.  The government prints up a million $100 bills at virtually zero cost.  The bills are used to buy $100 million worth of Treasury securities.  The existing stock of currency sees its purchasing power fall by $100 million in the long run.  So the government gains a profit of $100 million, which economists call “seignorage.”  Existing money holders see a loss of $100 million in purchasing power (in the long run.)  That’s because someone has to pay any tax.  And it’s a wash for the person or bank selling bonds to the government; they get $100 million in one asset, and give up $100 million in another.  Now let’s start going over the myths:

1.  ”It helps the bond seller because they earn commission on the sale.”  That’s actually true, but a trivial gain relative to the size of the monetary injection.  Not important in a macro sense, as I think even my opponents would agree.

2.  ”It helps bond holders because it drives up the price of bonds.”  That might be true or it might be false.  But even if it is true, the price of bonds rises due to what’s called the “liquidity effect,” which will occur regardless of who gets the new money.  That’s because interest rates are the opportunity cost of holding money, and thus if prices are sticky then interest rates may fall in the short run, as a way of inducing people to hold the extra money until prices adjust.  But that’s equally true if the money is injected by paying the salary of government workers, rather than OMOs.  Or buying gold instead of securities.

3.  ”It helps the bond holders because the government is buying bonds, rather than something else.”  Holding fiscal policy constant that is false, as the amount of debt held by the public would be exactly the same even if the government were paying the salaries of government employees with the new cash, rather than injecting the money via OMOs. The only difference would be that with the cash paid to government workers, the Treasury would issue $100 million in fewer bonds.  In contrast, the OMO leaves the gross debt unchanged, but the net debt gets reduced by $100 million as the Fed buys up that much in Treasury debt and takes it out of the public’s hands.

4.  ”It helps the people or banks that get the new cash because they get the first chance to buy up assets that are about to appreciate in price.”  Where does one even start with the series of mistakes in this claim?  Obviously for auction style asset markets there’s no advantage in getting the money first, as prices respond instantly to the news.  But let’s say I was wrong; let’s say the price of gold rises slowly in response to an injection of new currency.  The claim would still be wrong, as holding newly injected money doesn’t give anyone any sort of unfair advantage. If I heard about the Fed’s new OMO, and thought gold prices would rise gradually in response, I’d simply call up my broker and buy some gold.  What if I don’t have any currency?  I’d charge the purchase on my credit card.  What if it was some product you could only buy with cash?  Then I’d simply get money from an ATM machine, or a bank, and make the purchase.

This is a good example of the fallacy of composition.  In aggregate, the total level of nominal purchases is constrained by the amount of currency in circulation.  But not at the individual level.  Hence being the first to get the new money doesn’t confer any advantage at all–as the new money has no more purchasing power than the existing money.  A dollar is a dollar—and a $100 bill is a $100 bill.

Indeed if you really thought that asset prices would rise with a lag, then holders of the new money would actually see a loss of purchasing power due to inflation.  The banks Suvy thinks are making out like bandits see the purchasing power of their massive ERs fall by 1.5% per year via inflation, and only get a measly 1/4% in IOR.  I oppose any IOR, but they are hardly making out like bandits.  To avoid the loss of purchasing power banks might want to spend the new money right away.  But Goldman Sachs isn’t even paid cash for the T-bonds the Fed buys in OMOs.  I don’t know how they are paid, but whether it is a paper check or some sort of electronic transfer to a bank account, the point is that G-S would have to actually convert that monetary injection into cash before spending it on the goods that are going to go up in price–if cash was “purchasing power.”  But I could do the same, even if I never participated in OMOs!  Getting the money first gives G-S absolutely no advantage over me in terms of being able to speculate in assets that might rise in value.  And of course if it was goods that one could buy without cash (i.e. most goods) then there would be no basis at all for the view the receivers of new base money have an unfair advantage.

OK, so simple logic tells us that it can’t possible matter who “gets the money first.”  But might it matter what the money is spent on?  This question is more complex.  If the new money is not used to purchase T-bonds, then some other asset holders might benefit—as you’d be combining fiscal and monetary policy.  Indeed even a purchase of gold would now be equivalent to fiscal stimulus, as gold is basically just a commodity.  However I’d make the following observations:

a.  During normal times when interest rates are positive then the size of monetary injections is typically quite small as a share of GDP, so the macroeconomic impact of some unconventional purchase–say equity mutual funds–would be utterly trivial compared to the macro impact of a larger monetary base.  On the other hand if they purchased some thinly traded good, say rare stamps or coins, then obviously although the macro impact would be small the impact would be significant in those very small markets.  But central banks don’t do that.

b.  During periods where the interest rate is zero it is possible that the monetary injections would be quite large.    In that case it might matter whether the Fed bought T-bonds or MBSs or foreign exchange.  However since MBSs created by the GSEs have been backed by the Treasury, they are now very close substitutes, so even here the effect would be quite small.  And if the Fed bought more foreign debt, that would be mostly offset by foreigners buying more US debt.  And most importantly, any unconventional purchases by the Fed would matter, if they mattered at all, due to the asset being purchased, not who gets the money first.

To summarize, it makes my brain hurt to try to understand how anyone could think it matters who gets the Fed injections first, assuming the new money is sold at fair market prices.  Needless to say I can’t rule out the theoretical possibility that G-S gets some sort of sweetheart deal and earns above fair market commissions on OMOs in Treasury bonds.  If so then that’s a scandal that needs to be investigated.  But it would hardly be the basis for a serious theory of the macroeconomic effects of monetary policy.  It would be like claiming the Federal government doesn’t really control the monetary base because the North Koreans produce some $100 bills as well.  True, but nearly irrelevant.

PS.  I hope people realize my $100 bill example was a simplification of reality.  The modern Fed usually injects money first as reserves, then they get converted to $100 bills when the public’s demand for currency rises.  Nothing in my post hinges on that complication.  Before 1913 the entire base was cash.

PPS.  If people who disagree with me want to be taken seriously they might start by being a bit more polite.  I find that’s usually correlated with intelligence.  For those who were polite in the previous comment section my apologies for this tirade.

PPPS.  I was asked to comment on Noah Smith’s recent critique of David Beckworth’s post on the fiscal multiplier.  I basically agree with Noah, and would simply add that his arguments also suggests that the standard arguments in favor of the effectiveness of fiscal stimulus are also mostly flawed, in basically the same way that he claims Beckworth’s arguments are flawed (ignoring expectations channels, etc.)  When it comes to fiscal stimulus it’s all about faith—the data tell us almost nothing.

PPPPS.  Some of the smarter commenters tried to convince me that money is non-neutral.  My entire blog is devoted to the proposition that money is non-neutral–I don’t need convincing.  But that has no bearing on the claim that the effect of money policy depends on who “gets” the money first.  Non-neutrality in the labor and goods markets comes from sticky wages and prices, and non-neutrality in debt defaults comes from sticky nominal debt.


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109 Responses to “It really, really, really doesn’t matter who gets the money first—part 2”

  1. Gravatar of Arthur Arthur
    4. December 2012 at 05:42

    Thank’s Scott.

    I should have read you first post more carefully, as it did already address my doubts about the distributive effects of buying t-bonds with newly printed money. But now I see.

  2. Gravatar of Squarely Rooted Squarely Rooted
    4. December 2012 at 05:43

    Feel free to correct the living daylights out of me if this is economically illiterate, but isn’t this just Coase theorem 101? Obviously transactions costs != 0, information is imperfect, rationality is bounded, loss aversion, money illusion, etc, but there must be some sense in which the Coase theorem holds here, right?

  3. Gravatar of Morgan Warstler Morgan Warstler
    4. December 2012 at 05:50

    Buying T-Bills monetizes the debt. At minimum it drives down cost of Govt. Borrowing. The fed is buying 60%+ of new issues.

    This is true because if the Fed stopped buying T-Bills, the market would read it as a lack of confidence in US Debt.

    Confidence in US Debt is not something Scott can presume.

    So, we’d not be incorrect in saying that ALL of the current T-Bill traders would be getting screwed with their pants on… if the Fed stopped buyingT-Bills.

    They would not be eating out, they would be getting fired, they would be selling their homes, etc. But everyone expects that tomorrow and again the next day, the Fed will buy T-Bills.

    Surely, IF we can construct a mental model where fed policy is run for the benefit of a certain group (say SMB owners)

    THEN it is 100% true that current Fed policy is run at someones benefit.

    Since, as Scott has admitted here on multiple times, any Fed action, even no action is some kind of action.

    Scott has to admit the current system favors certain people.

    I think Scott is unable to model around a Fed that is outright hostile to US Debt.

    So much so, that even when he considers that the Fed might buy other things, he doesn’t assume a nosedive in the US bond market.

    Whereas, many folks RELISH the day that the US cost of borrowing shoots up and merely servicing the debt takes 33% of tax revenues…. for precisely the reason that Bill Clinton warned about it at the 2012 convention.

  4. Gravatar of Simon Simon
    4. December 2012 at 05:51

    Dear Mr. Sumner,

    I read with great interest your thoughtfully argued study concerning the effects of central bank purchases of financial assets. There can be but little doubt that you are an economist of sound mind and great wisdom, which Foreign Policy magazine can (belatedly, it must be said) attest to.

    What brought the greatest pleasure to my eyes, however, was your desire to see more politeness expressed in the comment section of this blog and in the world at large. I have long felt that the surest sign of intelligence is a polite, courteous and respectful demeanour.

    I myself have been bred with the finest manners one could ever desire and I am certain that as a result of these manners I have been blessed with intelligence, knowledge and wisdom that is surpassed by few in this great world of ours.

    I look forward to reading more of your polite discussions on the subjects of monetary policy and civility.

    Yours sincerely,

    Her Most Royal Highness Queen Elizabeth II

  5. Gravatar of ssumner ssumner
    4. December 2012 at 06:01

    Squarely rooted. I see why you say that. But I’d put it slightly differently. There are transactions costs from monetary injections, but they are utterly trivial in a macro sense. Perhaps someone could tell us the commissions earned by bond traders on OMOs. I predict it’s a trivial share of GDP.

    Thanks Queenie.

  6. Gravatar of Felipe Felipe
    4. December 2012 at 06:15

    Hi Scott, nice post.

    This goes a long way in explaining this issue, but I think the question of using other assets/channels needs further exploring. When I speak to people (non-economists like myself) that claim the Fed (or other CB) is helping the banks, it is mostly the issue that the Fed is printing bills to buy T-bonds that irritates them. Why? Not because a certain bank gets to sell its bonds, but rather because bonds are held by banks, other financial institutions and rich people, but not by the average Joe.

    The real question to be answered (for the layman) is: why does (unconventional) monetary policy have to be conducted through financial markets instead of (say) depositing the new money in regular people’s bank account?

    You have said multiple times that if the Fed decided to buy your home, then you’d benefit, but that this doesn’t happen in the t-bill market. I presume a key difference is that t-bills are fungible, and have a deeper and more liquid market than homes. What other characteristics does a monetary policy instrument need to have?

  7. Gravatar of RPLong RPLong
    4. December 2012 at 06:25

    Prof. Sumner, if I understand what you’re saying, then this would seem to imply that there is no benefit to counterfeiting dollar bills, since the counterfeiter loses in purchasing power whatever he gains in additional dollar bills.

    Again, if I understand you correctly, then it seems to me that the key issue is whether or not inflation happens economy-wide and instantaneously, as soon as the monetary injection takes place.

    But is that how inflation works? Does it magically spread across the entire economy in an instant?

    And if so, one final question: Why do the recipients of the monetary injections take the deal? What’s in it for them? If there is no gain to doing what they do, then why would they do it at all? One of your comments in the previous post acknowledged that they do in fact gain from the monetary injection, but those gains are small compared to the macroeconomic effect of the monetary injection. That may be true, but then why doesn’t the Fed inject money through me? I would be happy to reap whatever small gains are conferred upon recipients of new money. I would promise to spend those gains instantly and help the new money circulate. Why doesn’t the Fed ever offer me this deal?

    Perhaps it is because of what you say: perhaps I would just lose in purchasing power whatever I gained in money holdings.

    It’s unfortunate that the conversation took a sour turn. This stuff is really interesting to me, and I have benefited greatly from the civil side of the exchange.

  8. Gravatar of Bryan Caplan Bryan Caplan
    4. December 2012 at 06:37

    Scott, I think the people you’re criticizing are implicitly assuming *adaptive expectations*. Picture the effect of covert mass counterfeiting. In this situation, the first store where the counterfeiters spend their new money really does gain (they get extra income before the overall price level adjusts). No?

  9. Gravatar of RPLong RPLong
    4. December 2012 at 06:40

    I want to amend my previous comment a bit. Bill Woolsey also posted on the counterfeiting issue this morning and I posted my comment before reading his post. I feel he adequately explains the counterfeiting issue, so I no longer need clarification there.

    At this point, the only lingering questions are: (1) If there are no special benefits to receiving the money, then why do banks take the deal? and (2) As per Felipe’s comment, why not conduct monetary injections through ordinary people’s bank accounts?

  10. Gravatar of Greg Ransom Greg Ransom
    4. December 2012 at 06:48

    Classic Scott Sumner.

    Your Suvy comment absolutely is NOT representative of the Austrian push back.

    Thisnagain illustrates your massive ignorance of the natural of the explanatory alternative you presented to engage in your original comment on Richman.

    You’ve got Ph.D.’s and Ph.D. candidates that are telling you that you have the economics you are pretending to engage ALL WRONG.

    But you blather on, NOT GETTING IT.

    And not engaging what Richman was talking about.

    Pathetic, and an ethical and scholarly disgrace.

  11. Gravatar of Britonomist Britonomist
    4. December 2012 at 06:48

    None of this matters, what you need to show is how increasing bank reserves, (slightly) lowering longer term bond interest rates, is even close to being tantamount to “controlling AD”, and not an extremely blunt instrument, in terms of actual behavior. There is no point in trying to convince Austrians, they are not a significant obstacle, you need to convince endogenous money theorists.

  12. Gravatar of Greg Ransom Greg Ransom
    4. December 2012 at 06:49

    Pretended, not ‘presented’. Damn the iPad software.

  13. Gravatar of Squarely Rooted Squarely Rooted
    4. December 2012 at 07:06

    Scott,

    I think that sounds about right.

    Bryan,

    I think there is a sense where that is correct; if on Earth’ mass counterfeiters all buy iPads and on Earth” they all buy Kindle Fires I’d rather own AAPL on Earth’ and AMZN on Earth”. But that example doesn’t really apply because the scale of the thing matters; I don’t really think mass counterfeiting to the tune of $500b or so is really super-feasible. I am vaguely reminded of Peter Griffin attempting to bargain for all the tea in China, or Ron Swanson demanding all the meat and eggs in the diner.

    I think the key here is that if the Federal Reseve went a little crazy and decided to buy $500b worth of commodities instead of $500b of bonds we would still expect the price of existing bonds to rise, just like when the Fed buys $500b of bonds we see the prices of commodities rise.

  14. Gravatar of ssumner ssumner
    4. December 2012 at 07:35

    Felipe, Here’s how to eliminate the perception that banks and bondholders gain. Inject new money via salaries to government employees. The salary would be exactly the same, so no one would think the government employees are gaining. Then when the Fed checks get cashed in the bank, the base goes up. Or if the employees ask for currency for the paychecks, the base also goes up. The Fed is not buying bonds, but the economic effect is identical. The only difference is that bond dealers do not earn any commission selling bonds to the Fed. But the stock of T-bonds held by the public is identical.

    My house would be different as I’d charge the Fed a price above the market clearing price.

    RPLong, You said;

    “Prof. Sumner, if I understand what you’re saying, then this would seem to imply that there is no benefit to counterfeiting dollar bills, since the counterfeiter loses in purchasing power whatever he gains in additional dollar bills.”

    No, I said just the opposite. The counterfeiter is like the Fed. The Fed gains seignorage, the counterfeiter gains the difference between production costs of cash and its purchasing power.

    OK, I see you get that. Regarding your other question, during normal times when interest rates are positive banks do not want to hold ERs. As soon as they get the money they try to get rid of it. They most certainly don’t want to hold ERs. Now with rates zero and a 1/4% IOR, things are different. I have no problem with Austrians criticizing IOR as a giveaway to banks.

    Bryan, Even if there are adaptive expectations, the claim is still completely false. In that case it would be the businesses that are cyclical that gain. I certainly agree with that, but it has nothing to do with the person or bank that receives the cash from the Fed. Let’s say the steel industry is more cyclical than health care. Then newly injected money goes disproportionately into purchases of steel, rather than health care. I’m fine with that. But it has nothing to do with who gets the money directly the the Fed. The gain to the steel industry occurs because steel is cyclical, not because the Fed distributes the new money to the steel industry. Steel would still gain disproportionately if the new cash was paid out as salaries to employees at government hospitals. They’d put it in the bank. NGDP would rise, and because wages are sticky RGDP would also rise. And steel intensive industries are highly cyclical so steel production would rise more than health care output.

    Remember that the person that gets the cash directly from the Fed is not one iota richer, so they don’t “spend” more on account of being richer. The person or bank getting the $100 million allocates this liquidity according to their preferences. They don’t say “I got a $100 million in cash burning a hole in my pocket, so I better spend it at the local auto dealer and/or buy some mansions, not deposit it in the bank.” That would be insane. I can believe adaptive expectations are possible, but not insanity.

    Britonomist, I don’t need to convince either MMTers or internet Austrians. Both groups are tiny fringe groups (as are we MMs). I need to convince elite macroeconomists of market monetarism. They have the power.

    Greg, Still behaving like a petulant kindegartener eh?

  15. Gravatar of Saturos Saturos
    4. December 2012 at 07:35

    Bryan, the equivalent of your counterfeiters is the government, which conjures new financial wealth (in the form of currency) at zero cost. Counterfeiters earn seignorage. Not the members of the public who sell bonds to the Fed, who are no richer as a result.

    How does the store in your example gain? If they are selling at sub-equilibrium prices once the counterfeit money is brought into existence, they are losing, not gaining, no?

    Scott, have you ever thought about using some of these posts in class? I would go so far as to say that TheMoneyIllusion.com ought to be required reading for Bentley monetary economics students…

  16. Gravatar of ssumner ssumner
    4. December 2012 at 07:38

    Bryan, I just realized that I missed a part of your question. A counterfeiter that spends more is engaging in fiscal policy. I completely agree that if the Fed takes their profits and goes out and buys billions of dollars in cars, it will help the auto industry. But they don’t do that, they given their profits to the Treasury.

  17. Gravatar of ssumner ssumner
    4. December 2012 at 07:40

    Saturos, We think alike, I just posted something similar in response to Bryan. I don’t want to abuse my students by teaching them MM, which is still regarded by the mainstream as crackpot economics. Plus we don’t have time to get into lots of these esoteric issues.

  18. Gravatar of Suvy Suvy
    4. December 2012 at 07:43

    That idea comes straight from none other than Milton Friedman, ironically enough. When you first start to print money, prices don’t increase and the people that get the money first actually have more spending power. However, as people start to realize that more money was just being printed; prices start to go up and as the money trickles into the rest of the economy, the people at the bottom basically get wiped out.

    In Milton Friedman’s own words, “inflation is like alcoholism, in both cases, when you start drinking or when you start printing too much money the good effects come first, the bad effects only come later.”

    When you print money, it doesn’t affect prices immediately and it certainly doesn’t have the same effect on all kinds of good. For example, asset prices will be affected differently than commodities which will behave differently than regular consumer prices. The non-neutrality of money doesn’t just exist in the short run, I think it also exists in the medium term and possibly in the long run as well.

    There is a time lag between whenever the money printing starts and when prices start to increase. Those that get the money first get the largest benefit. It’s called the Cantillon Effect.

    “So the government gains a profit of $100 million, which economists call “seignorage.” Existing money holders see a loss of $100 million in purchasing power (in the long run.) That’s because someone has to pay any tax. And it’s a wash for the person or bank selling bonds to the government; they get $100 million in one asset, and give up $100 million in another.”

    It’s not a wash at all because different goods go up differently. If I hold assets and asset prices go up, I benefit disproportionately. Increasing asset prices disproportionately benefits the wealthy at the cost of the middle class and the poor. For example, the bottom 80% own 5% of the financial wealth while the top 1% own over 40% of the financial wealth. Not only that, but when you print money and asset prices start to rise, other prices rise too, but not all at the same time and the same rate. So you do devalue the money in my pocket and give it to those that own assets. You’re stealing from the bottom 80% and giving it to the top 1%. After all, printing money does not increase production.

    Fiscal policy, on the other hand, can actually be used to produce more. For example, we have something like 12 million people unemployed. This a resource that isn’t being used to produce anything. If we can use fiscal policy on infrastructure projects and things of that nature and put some of these people to work; we can produce more.

  19. Gravatar of Cthorm Cthorm
    4. December 2012 at 07:54

    I almost wrote an example of an injection policy that would be non-neutral in the last post. After thinking about what I wrote I realized even that would be neutral (the example hinged on an asset that has no sizable market or a monopsony).

  20. Gravatar of Tyler Joyner Tyler Joyner
    4. December 2012 at 08:02

    Scott,

    First of all, I’ve been devouring your blog recently and it’s very much a pleasure to read. You have some very interesting ideas. Also, congrats on the FT 100.

    You said, “During periods where the interest rate is zero it is possible that the monetary injections would be quite large. In that case it might matter whether the Fed bought T-bonds or MBSs or foreign exchange. However since MBSs created by the GSEs have been backed by the Treasury, they are now very close substitutes, so even here the effect would be quite small. And if the Fed bought more foreign debt, that would be mostly offset by foreigners buying more US debt. And most importantly, any unconventional purchases by the Fed would matter, if they mattered at all, due to the asset being purchased, not who gets the money first.”

    I’m not so sure about that one. When considering purchases of MBSs, it seems to follow that the effect would help certain portions of the economy (and therefore certain actors) more than others. MBSs were created as a way to access new pools of credit to help meet demand for loans by potential homebuyers, right? So instead of banks providing all the credit for the mortgage industry, they could sell loans to private investors and free up their balance sheet.

    Eventually this new market gets saturated and the pension funds, etc. no longer want to invest any more money in the mortgage markets. Government purchases of MBSs will indeed have far-reaching effects on the economy, as you suggest, but it seems clear that the initial effect will be to get loans off banks’ balance sheets so that they can make more loans – which is the point, of course, but it also makes them a lot of money.

    The same argument can be made for any asset, financial or otherwise. What I’m suggesting is that, in the sense that you consider buying gold to be fiscal because gold is a commodity, buying any asset at all (including Treasuries) is similar because there will be people who are effectively long and some who are short that asset.

    Also, you said: “And if the Fed bought more foreign debt, that would be mostly offset by foreigners buying more US debt.” Not sure why you think that. China has been buying a whole heap of foreign debt for a very long time, and the rest of the world isn’t holding trillions in Chinese government debt in return.

  21. Gravatar of Tyler Joyner Tyler Joyner
    4. December 2012 at 08:04

    Sorry, what I meant to say in the first half of my post is that it definitely matters what asset they buy. I realize you didn’t claim otherwise, but it seems worthwhile to highlight that there will be specific winners and losers even in monetary stimulus.

  22. Gravatar of Greg Ransom Greg Ransom
    4. December 2012 at 08:24

    Scott,

    Imagine a man who’s never read nor learned a wit of Darwin ‘refuting’ Darwin with arguments against Haeckelian vitalism.

    Now, is it polite for that man to repeatedly ignore, grossly mischaracterize, and verbally abuse those who do actually know Darwinian biology who are telling that man that he is barking up the wrong tree?

    What sort of politeness is this?

  23. Gravatar of Greg Ransom Greg Ransom
    4. December 2012 at 08:32

    Essentially, Scott, you are saying that Cantillon & Hayek non-neutrality *cannot exit*, but other kinds of non-neutrality can exist.

    You just aren’t up front in saying it.

    Scott,

    “Non-neutrality in the labor and goods markets comes from sticky wages and prices, and non-neutrality in debt defaults comes from sticky nominal debt.”

  24. Gravatar of Saturos Saturos
    4. December 2012 at 08:37

    Greg, I think Hayek also believed in non-neutrality due to nominal rigidities, did he not? Did he not regard that as the dominant form of non-neutrality?

  25. Gravatar of Greg Ransom Greg Ransom
    4. December 2012 at 08:42

    “Greg, I think Hayek also believed in non-neutrality due to nominal rigidities”

    Yes.

    “Did he not regard that as the dominant form of non-neutrality?”

    These aren’t the ones that the ‘loose joint’ of money, credit and alternative production processes tend to yo-yo on their own, and can get long out of whack before anyone notices.

    The loose joint of money, credit, and alternative production processes is typically an ultimate cause, nominal rigidities in labor, goods, and debt markets are typically proximate causes.

  26. Gravatar of Greg Ransom Greg Ransom
    4. December 2012 at 08:48

    On politeness.

    Scott repeatedly calls people names & insults people with name calling.

    Who else on his site does this but Scott.

    Scott condemns me for saying things bluntly which are true.

    Scott doesn’t read Richman and others using a principle of charity.

    He fails to use a principle of charity, and then suggests people must be stupid for holding beliefs Scott has put in their mouths which they don’t hold.

    That is very impolite.

    Scott is constantly presenting false and bogus explications of central ideas in economics and in the history of thought — and then he asserts that it is not ‘polite’ to say so, to point out that these explications are erroneous.

    So terribly impolite.

    Scott ignores folks with Ph.D training from very good schools who tell him he barking up the wrong tree and is getting the point all wrong, and then Scott insults them and calls them names — so very, very polite of Scott.

    Give me a break on the politeness red herring.

  27. Gravatar of Andrew Andrew
    4. December 2012 at 08:53

    Scott- (or really anyone else)

    Following monetary expansion does the same amount of labor allow me to consume less, the same or more?

    This is really the only question I have.

  28. Gravatar of dtoh dtoh
    4. December 2012 at 09:01

    Scott,
    Technically speaking bond traders don’t earn a commission on OMO, as they are acting as a principal. They do try to earn a spread though by buying the bonds at a lower price than the price at which they sell to the Fed. Typically, it’s tiny on average….a fraction of a basis point. An individual trader might do a lot better or a lot worse especially if they bought the bonds in advance in anticipation of OMP or if they carried a short position after selling to the Fed.

    The money made by the primary dealers on OMO is negligible, and those commenters who suggest otherwise simply don’t understand how the markets work.

  29. Gravatar of Floccina Floccina
    4. December 2012 at 09:02

    Scott thank you for this great educational post.

  30. Gravatar of Becky Hargrove Becky Hargrove
    4. December 2012 at 09:03

    Greg,
    Yes but you just drove poor, polite David Glasner nuts a few days ago.

  31. Gravatar of Greg Ransom Greg Ransom
    4. December 2012 at 09:14

    Earth to Scott, this is not what folks who thinking of ideas introduced by Cantillon, Hume, Wicksell, Mises, Hayek and many others are talking about when they are talking about the non-neutrality introduced into economic processes by the introduction of money and credit.

    The principle of politeness would demand that you actually address what those you are pretending to engage are actually talking about.

    It would be impolite to continue to ignore what they are saying, to continue to pretend the the real issue isn’t something else than what you are distracting people with.

    That would be polite.

    Can we get some politeness around here?

    Scott,

    “Some of the smarter commenters tried to convince me that money is non-neutral. My entire blog is devoted to the proposition that money is non-neutral–I don’t need convincing. But that has no bearing on the claim that the effect of money policy depends on who “gets” the money first. Non-neutrality in the labor and goods markets comes from sticky wages and prices, and non-neutrality in debt defaults comes from sticky nominal debt.”

  32. Gravatar of dtoh dtoh
    4. December 2012 at 09:18

    Scott,
    You said,

    Remember that the person that gets the cash directly from the Fed is not one iota richer, so they don’t “spend” more on account of being richer. The person or bank getting the $100 million allocates this liquidity according to their preferences. They don’t say “I got a $100 million in cash burning a hole in my pocket, so I better spend it at the local auto dealer and/or buy some mansions, not deposit it in the bank.” That would be insane.

    Thank you. This is exactly the point I’ve been trying to make.

    What does cause them to spend more money at the auto dealer (or on new factories) is the fact that there is a change in the way they allocate this liquidity between financial assets and between real goods and services either because a) the real price of financial assets has risen (nominal yield less expected inflation has gone down) relative to real goods/services or b) because their expectations (e.g. future income, return on real assets, etc.) have changed.

    I.e. it is not the HPE which causes the change, it is a movement along or a shift in the preference curve between holding financial assets (long or short) versus spending on real goods and services.

  33. Gravatar of Becky Hargrove Becky Hargrove
    4. December 2012 at 09:21

    Greg,
    Free markets in physical products imply many reorganizations of actual physical components. Free markets in knowledge, thought and ideas imply many reorganizations of actual knowledge, thoughts and ideas.

  34. Gravatar of Gabe Gabe
    4. December 2012 at 09:45

    Today I Learned that commissions to bond dealers at Goldman Sachs/JP Morgan and the rest of the primary dealers are paltry. Thanks Prof Sumner!

  35. Gravatar of Gabe Gabe
    4. December 2012 at 09:48

    I guess those primary dealers really are doing god’s work…it should be re-classified as charity work, maybe we should take up collections to send their families some canned food this christmas?

  36. Gravatar of Luis Pedro Coelho Luis Pedro Coelho
    4. December 2012 at 09:49

    “On the other hand if they purchased some thinly traded good, say rare stamps or coins, then obviously although the macro impact would be small the impact would be significant in those very small markets. But central banks don’t do that”

    Do Greek bonds count? Or of any of the PIIGS?

    *

    There is an even stronger point: at moderate NGDP growth rates, if money is tight, it doesn’t even matter that much who controls the seignorage gain. If we need to find an actor to benefit, the central government will do just fine. However, what if there is no single central government? Like the eurozone.

    I think, that there, it wouldn’t even matter that much who gets the money, the PIIGS would greatly benefit from the ECB printing money to buy up German Bunds. However, because everyone is vying for the seignorage benefits, nobody even proposes this, and we leave money on the table.

  37. Gravatar of Greg Ransom Greg Ransom
    4. December 2012 at 09:56

    Here’s Arnold Kling’s helpful suggestion, Scott:

    “take the most charitable view of those who disagree”

    You, Scott, ask to understand what Sheldon Richman is talking about, when he talks about the general ‘Austrian’ idea that money creates non-neutral discoordination across the the full network of structure of prices and production across time, systematically shifting margins and margins of relative gain and loss. Ie expansions of money and credit represent channels of expanding and contracting flow across myriad alternative pathways in time.

    The polite approach would be to engage that picture of things, do attempt to capture whatever causal image it has of the economic process, show some competence in the vast scientific literature on this topic, and they talk about some of the conceptual problems or causal limitations of this account of the causal mechanisms of the market process.

    Or, alternatively, you can do what you have done.

  38. Gravatar of Rademaker Rademaker
    4. December 2012 at 10:02

    The problem with their reasoning is that they don’t realize that in as far as the “money printing” is anticipated, any decrease in purchasing power it engenders is already priced in through expectations. So the act itself changes nothing other than to confirm those expectations such that the pricing relations are kept the same. The government’s monetary expansion strategy is part of the contract that the money represents. It is baked into it.

  39. Gravatar of Morgan Warstler Morgan Warstler
    4. December 2012 at 10:03

    “But they don’t do that, they given their profits to the Treasury.”

    Once again, Scott admits all that need be admitted.

    By creating an artificial market for T-Bills, the cost of govt. is not properly felt…

    And that creates many unfair winners and losers.

    The winners are everyone from Goldman & PIMCO to defense companies to public employees.

    —–

    The question is not does someone benefit, it is WHO should benefit if we want America to be structurally small and more impervious to big business and big government.

  40. Gravatar of Greg Ransom Greg Ransom
    4. December 2012 at 10:14

    Scott, Robert Murphy has not been addressed.

    Let’s be polite, and again what people are actually saying.

    What Murphy is asking you to imagine is two different flows of expansions of money and credit, money and credit streaming into the hands of huge financial institutions and the investor class or money and credit streaming into the hand of the poor who use their money and credit to buy a plethora of sundry immediate consumption goods requiring very little capital to produce.

    These alternative streams will stretch or contract the whole network and structure of production flows across time in very different ways.

    Now consider that world of alternative causal streams as what people are gesturing to when they talk about “who gets the money first”.

    Now, attempt to be polite, and use Arnold Kling’s rule.

    Good luck.

    Scott writes,

    “It makes my brain hurt to try to understand how anyone could think it matters who gets the Fed injections first.”

  41. Gravatar of Greg Ransom Greg Ransom
    4. December 2012 at 10:15

    Let’s be polite, and *address* what people are actually saying.

  42. Gravatar of higgins higgins
    4. December 2012 at 10:18

    “And it’s a wash for the person or bank selling bonds to the government; they get $100 million in one asset, and give up $100 million in another.” -sumner

    I don’t believe this is correct. The fed purchase of the bonds pushes the price of the bonds higher than it would otherwise have been. They are selling what would have been a $99M million asset for what is now $100M dollars.

    “2. ”It helps bond holders because it drives up the price of bonds.” That might be true or it might be false.” -sumner

    I believe this is true – bond prices are affected. The fed has introduced with its OMO a demand for bonds to be purchased by newly printed money. Without this additional demand, and with an unchanged bond supply, the price would have been lower. This is supply/demand model, not liquidity effect. The marginal bond purchaser is priced out of the market by the fed’s purchase. Even if you decide to vary the supply of bonds, there is always a marginal purchaser priced out by the fed, pushing the price higher than it otherwise would have been. To me, this clearly helps existing bond owners.

  43. Gravatar of Greg Ransom Greg Ransom
    4. December 2012 at 10:20

    Becky writes,

    >>Greg,
    Free markets in physical products imply many reorganizations of actual physical components. Free markets in knowledge, thought and ideas imply many reorganizations of actual knowledge, thoughts and ideas.<<

    Unsustainable flows of money and credit can give an economic status to goods which turn out after recoordination to be non-economic goods, malinvestments.

    See the houses bulldozed in north Los Angeles county, etc in the late 2000s.

    Similarly, malinvestments in ideas which turn out on examination to have little cognitive content or value happens — especially when subsidized by institutions or when enforce and replicated by guilds with monopoly control over institutions.

  44. Gravatar of Phil Phil
    4. December 2012 at 10:23

    It is always nice to see bloggers who pay attention to their commentators.

    (1) (@ Morgan Westler)
    Of course Fed policy helps some more than others, but that is a double edged sword. If Fed policy supports equities, it does so by altering the future growth expectations. An equity is basically priced so that the the forecast of its future discounted cash flow is equal to the “risk free rate” plus a risk premium. Looser monetary policy does not help asset markets in a one to ton ratio – during stagflation in the seventies moves to loosen monetary policy and alleviate unemployment crushed asset markets. If equities respond positively to fed policy all that means is that future growth prospects have improved. Monetary policy improves future growth exactly the same as any measure that will improve our future growth trajectory, and that is all that is happening. Similarly, policy moves that improve the future growth trajectory will lower the price of gold, because people buy gold only when they are worried about everything else…

    Its a fact that the poor suffer most during recessions, as they tend to become unemployed more easily and have less savings, using OMO to exit this slump faster is the single best thing for poor people.

    (2) @ssumner: I think the best way to convince people that you are right is to focus on the price of money as 1/NGDP*. That makes it evident that we are living through a deflationary shock, and the correct policy prescription is identical to every other deflationary shock. There is a lower bound on wage falls, and that means that prices to not fall during a deflationary shock, but the economy will not function properly until prices have adjusted. The single best way to adjust prices is to expand the monetary base through unsterilised transactions, with the promise to continue until NGDP is back on target.

    The nice thing about this is that you can construct pretty strong empirical evidence that we are in a deflationary shock. Look for example, at GDP per capita at price purchasing power – pretty much every western country has GDP per capita higher than its pre crisis peaks in PPP terms. How can that be when GDP per capita is still so far below its pre crisis peaks in all these same countries. Answer = deflation.

    *It certainly convinced me…I was amazed by the power of this insight.

    (3)@ssumner – finally a genuine question:

    I have been thinking about the effects of demographics on interest rates. In particular, about the baby boom generation and the thirty year bull market in bonds. My intuition was that an expanding labour force, would require the building of more capital, and that this should drive interest rates up. As they age and enter the most productive phase of their life interest rates fall below their original state, and finally when they retire, interest rates shoot up rapidly because of the excessive dis-saving of a larger than normal retirement. Is this your intuition also? I built a moderately sophisticated model that seems to indicate that only the second and third of these effects are real. Which puzzles me. Is it my thinking, or my modelling, that is wrong? :)

  45. Gravatar of higgins higgins
    4. December 2012 at 10:26

    “4. ”It helps the people or banks that get the new cash because they get the first chance to buy up assets that are about to appreciate in price.” Where does one even start with the series of mistakes in this claim? Obviously for auction style asset markets there’s no advantage in getting the money first, as prices respond instantly to the news.” -sumner

    The actor with the new money has new purchasing power that the others don’t. Prices will rise due to the inflation of the money supply because the new-money-holders will outbid the marginal buyers in acquiring existing goods/services. The sellers get higher prices for those goods/services, and the buyer gets goods/services that would have otherwise gone to the marginal buyer who was priced out of the market.

  46. Gravatar of dtoh dtoh
    4. December 2012 at 10:32

    Greg,
    Scott does explicitly recognize that injections of money and credit do disproportionately benefit some economic players, e.g. the steel and other cyclical industries. The point he is making is that it makes little difference where the money is injected. There is a big distinction between the two.

    And BTW, monetary policy is not conducted through helicopter drops so it has to flow into the hands of the investor class or those with borrowing capability. If you advocate tax rebates or handouts to the poor, that’s fine; but that’s fiscal/tax policy and it’s got nothing to do with monetary policy.

  47. Gravatar of Alex Godofsky Alex Godofsky
    4. December 2012 at 10:36

    Greg, the liquidity-constrained poor you are talking about won’t generally have ANY financial assets the Fed can purchase for money (otherwise they wouldn’t be liquidity-constrained!), let alone T-Bills specifically.

  48. Gravatar of Tyler Joyner Tyler Joyner
    4. December 2012 at 10:38

    Phil, you said :”As they age and enter the most productive phase of their life interest rates fall below their original state, and finally when they retire, interest rates shoot up rapidly because of the excessive dis-saving of a larger than normal retirement”.

    Why would interest rates shoot up? Retirees are much more likely to shift their investments from stocks into bonds, which, all else held equal, would tend to increase bond prices and depress interest rates.

  49. Gravatar of johnleemk johnleemk
    4. December 2012 at 10:44

    Scott,

    Just want to make sure I understand the heart of your argument. It sounds like your contention is:

    1. Modern central banks create new money, boosting the money supply (and eventually NGDP by extension)
    2. New money has to first be converted into cash in order to actually buy things people want
    3. New money is distributed like a financial asset, placed on the auction block
    4. Non-central banks who buy new money must offer another financial asset of equal value in return
    5. Private actors thus gain little or nothing because they’re exchanging one financial asset for another
    6. After this exchange, the only thing private actors can do with their new money is convert it into cash and buy stuff with it, which boosts NGDP, or leave it locked up in their bank accounts, which does nothing

    Did I get that right? For some reason this sounds close to MMT to me, but that can’t be right…I guess I need to insert Nick Rowe’s exposition on the people of the concrete steppes after my point #6 to fully close the loop on how money creation boosts NGDP.

  50. Gravatar of Mike Sproul Mike Sproul
    4. December 2012 at 10:46

    “The bills are used to buy $100 million worth of Treasury securities. The existing stock of currency sees its purchasing power fall by $100 million in the long run.”

    Unless, of course, the extra $100 mil of Fed assets is adequate backing for the extra $100 mil of dollars, in which case the existing dollars hold their value, and $100 mil worth of some other kind of dollars (checking account dollars, credit card dollars, etc.) reflux to their issuers.

  51. Gravatar of Greg Ransom Greg Ransom
    4. December 2012 at 10:50

    I’ve pointed out to Scott, using NGRAM to establish the self-evident fact, that the language of ‘neutral money’ was essentially introduced into the English language literature by Friedrich Hayek:

    http://books.google.com/ngrams/graph?content=neutral+money%2Cneutrality+of+money&year_start=1800&year_end=2000&corpus=15&smoothing=1&share=

    Hayek’s conception on non-neutrality is not a “private language”, its part of the core of the heritage of economic science.

    It’s to Scott Sumner’s shame — and to the shame of Grad School economics more generally — that it’s all completely unknown to him.

    Now, Scott’s original insult laced request was to provide an alternative definition of the non-neutral significance of money and credit.

    I did that. I did it several times. I did it again and again.

    Scott ignored it.

    And then went on to repeatedly call me names and insult me.

    Here’s Scott’s original demand:

    “If you and your fellow Austrians want to go through life with your own private language that no one else understands, you’ll have about as much success as language purists who insist on calling happy people “gay.” Good luck.

    I notice you don’t provide an alternative definition of money non-neutrality that would make his statement correct, and I’m quite sure that’s because you are unable to do so. It’s all bluster on your part. Now I’m calling your bluff and the readers are about to see how empty your claims actually are.”

  52. Gravatar of Greg Ransom Greg Ransom
    4. December 2012 at 10:54

    dtoh, this was helpful, thanks:

    “Scott does explicitly recognize that injections of money and credit do disproportionately benefit some economic players, e.g. the steel and other cyclical industries. The point he is making is that it makes little difference where the money is injected. There is a big distinction between the two.”

    Note well that many using the language of “who gets the money first” would in this scenario identify the steel industry as among one of those ‘getting the money first”.

  53. Gravatar of StatsGuy StatsGuy
    4. December 2012 at 10:58

    ssumner:

    I think what you say here is mostly consistent with my summary on the previous thread. I would add a few things:

    1) “any unconventional purchases by the Fed would matter, if they mattered at all, due to the asset being purchased”

    I would add “would matter due to the asset being purchased, OR THE PROMISE to purchase that asset until a certain objective is achieved”. Remember, all the action is at the margin. If the Fed said “we’re going to buy gold until expected NGDP hits 5%” would that yield the same relative asset prices as if the Fed said “we’re going to buy long term treasuries until expected NGDP hits 5%”, EVEN IF the Fed’s reputation was good enough that it didn’t have to spend a penny? Tough question – there is an argument yes, but the real world is messy.

    2) You write: “During normal times when interest rates are positive then the size of monetary injections is typically quite small as a share of GDP, so the macroeconomic impact of some unconventional purchase–say equity mutual funds–would be utterly trivial compared to the macro impact of a larger monetary base.”

    During normal times, with small amounts, I think you are right… depending on how the Fed phrased expectations. If NGDP was running at 3%, and the Fed said “we’re going to buy the S&P, nasdaq, and DJ until NGDP hits 5%”, it may be the Fed spends very little, but there’s a massive impact on stock prices. In a “normal” state, is this bigger than the stock price boost if the Fed said “we’ll buy Treas until NGDP hits 5%”? Again, hard real world question, but you are possibly right.

    In the case of zero bound (not normal times), it’s clear that ACTUALLY spending large amounts of money may be required (to generate credibility, if nothing else). The Fed is widely expected to renew standard QE (in addition to $40 billion in MBS buys monthly) in December as it runs out of short term assets to sell to buy long term (Operation Twist closes), possibly running at $85 billion a month – or, a trillion a year. It’s estimated that a 20% gain/drop in stocks requires about a 300 bil inflow/outflow (I recall), even though the actual value shift is much greater than the flow. A 1 trillion dollar flow? Wow. If that kind of money were dumped into stocks instead of bonds, the effect would be HUGE (as would be NGDP impact). But these are not normal times…

    3) On the issue of the Fed paying salaries instead of buying (short term) bonds, I agreed with you in the last post. I would ask that you add one more thing, which you are implicitly assuming – that is permanence. When talking about increasing the monetary base, you always mean this, but it’s not always clear. At a practical level, the Fed paying salaries might be perceived as more permanent, possibly because people might think it’s harder to undo (than selling short term treas back into the market).

    4) If there are REAL hard liquidity constraints, then getting the money first could matter. This is VERY rare, and I don’t know whether I’d call this monetary policy because it’s really a form of targeted subsidized credit. This MIGHT have occurred in early 2009, where some banks were illiquid (subject to runs), and the Fed provided credit to buy cheap assets that they MAYBE would not have been otherwise able to buy (even if they KNEW that asset prices would rise due to upcoming QE). And even then, I’d question whether it was because banks couldn’t get credit, or they were too scared to buy without a clear signal of monetary policy.

    Anyway, this couple of posts shifted my thinking a little bit, so I’m grateful.

    Please make sure you take some time off so you don’t burn out!

  54. Gravatar of Greg Ransom Greg Ransom
    4. December 2012 at 11:03

    We are doing thought experiments.

    The Fed literally could crack the printing presses and dump trillions in cash into the hands of whoever they wanted.

    The idea of a clean difference between monetary & fiscal policy is illusory. What is the Fed doing when it buys up all sorts of equities and assets, eg mortgage backed securites?

    Is that fiscal policy or monetary policy? Who cares.

    “BTW, monetary policy is not conducted through helicopter drops so it has to flow into the hands of the investor class or those with borrowing capability. If you advocate tax rebates or handouts to the poor, that’s fine; but that’s fiscal/tax policy and it’s got nothing to do with monetary policy.”

  55. Gravatar of Major_Freedom Major_Freedom
    4. December 2012 at 11:10

    ssumner:

    Here’s how things actually work. The government prints up a million $100 bills at virtually zero cost. The bills are used to buy $100 million worth of Treasury securities. The existing stock of currency sees its purchasing power fall by $100 million in the long run. So the government gains a profit of $100 million, which economists call “seignorage.” Existing money holders see a loss of $100 million in purchasing power (in the long run.) That’s because someone has to pay any tax. And it’s a wash for the person or bank selling bonds to the government; they get $100 million in one asset, and give up $100 million in another.

    You are still fallaciously assuming that bond prices are unaffected by Fed policy. When you say “$100 million worth of treasuries”, you cannot abstract that price away from the Fed adding a nominal demand component to the pricing. A t-bond with and without the Fed purchasing it will result in different prices, not equal prices. If you accept the fact that Fed policy affects bond prices, then you should be able to understand that the more t-bonds an individual owns, the more their asset prices are affected, and hence the more their income is affected. Since not everyone owns treasury bonds, and for those who do, since not every owner owns an equal amount of t-bonds, it means you are wrong to say it doesn’t matter who the Fed sends its checks to.

    1. ”It helps the bond seller because they earn commission on the sale.” That’s actually true, but a trivial gain relative to the size of the monetary injection. Not important in a macro sense, as I think even my opponents would agree.

    What does it matter if the relative effects the “lunatics” are talking about, are insignificant or significant, trival or non-trivial, or small or large? Did anyone ask you for your opinion on the adjective to describe it? It’s non-zero. That should be sufficient.

    2. ”It helps bond holders because it drives up the price of bonds.” That might be true or it might be false. But even if it is true, the price of bonds rises due to what’s called the “liquidity effect,” which will occur regardless of who gets the new money. That’s because interest rates are the opportunity cost of holding money, and thus if prices are sticky then interest rates may fall in the short run, as a way of inducing people to hold the extra money until prices adjust. But that’s equally true if the money is injected by paying the salary of government workers, rather than OMOs. Or buying gold instead of securities.

    No wonder you are making so many egregious errors. The mistakes run deeper than at first blush. No, interest rates are not “the opportunity cost of holding money.” This can easily be understood by simply considering conditions of very high inflation. During these periods, the desire to hold money plummets, and yet contrary to the liquidity preference theory, interest rates rise, not fall. Similarly, should inflation come back down, the desire to hold money rises back up, and yet again contrary to the liquidity preference theory, interest rates fall, not rise.

    Moreoever, the claim that prices are “sticky”, contradicts your other, tacit, claim, that monetary inflation instantly increases the prices of all goods equally. You denied the Cantillon Effect is true, which is equivalent to saying that all prices instantly adjust upwards when there is inflation of the money supply into the banking system, or someplace else (such as Caterpillar, or GE). The very claim of price stickiness is the Cantillon Effect in action. Inflation to buy bonds increases bonds prices, but that inflation at that time cannot increase all other prices, until they money is actually spent and respent throughout the economy from person to person. I know my wage didn’t instantly adjust on the news Bernanke is going to buy $40 billion additional MBS a month. Why? Because my employer hasn’t gotten any of that money yet since it hasn’t been received and then spent by HIS customers!

    The prices of bonds won’t rise unless there is a rise in the nominal demand for bonds. Supply and demand? Hello? If the Fed prints $100 million and buys tacos, or gold, then there is no additional demand for bonds, and you have no basis for arguing that bond prices will rise anyway. Why would bond buyers raise their nominal demand for bonds after a taco seller receives money from the Fed? Your theory makes no sense.

    3. ”It helps the bond holders because the government is buying bonds, rather than something else.” Holding fiscal policy constant that is false, as the amount of debt held by the public would be exactly the same even if the government were paying the salaries of government employees with the new cash, rather than injecting the money via OMOs. The only difference would be that with the cash paid to government workers, the Treasury would issue $100 million in fewer bonds. In contrast, the OMO leaves the gross debt unchanged, but the net debt gets reduced by $100 million as the Fed buys up that much in Treasury debt and takes it out of the public’s hands.

    This is incorrect. Your 4th example does not have the same debt as the first three. In the first three, debt is reduced from X to x. In your 4th example, the debt started at x and ended up at x. In the first three examples, the difference X-x is the effect the “lunatics” are referring to. The “gift” of a bond from treasury to the Fed doesn’t entail any X-x.

    More importantly, constant fiscal policy does not even occur when the Fed buys bonds. When the Fed buys bonds, debt held by bondholders decreases, and cash to bond holders increases. The bond holder’s purchasing power has gone up. Individuals use money to buy goods, not treasury bonds. If the bondholders instead sold the bonds to non-Fed actors, then those non-Fed actors would be voluntarily relinquishing purchasing power in order to receive income earning bonds. That is not the same as compared to the Fed buying the bonds from bondholders, and imposing reduced purchasing power on those who were assumed to have bought the bonds as in the prior scenario.

    4. ”It helps the people or banks that get the new cash because they get the first chance to buy up assets that are about to appreciate in price.” Where does one even start with the series of mistakes in this claim? Obviously for auction style asset markets there’s no advantage in getting the money first, as prices respond instantly to the news.

    First, it isn’t a “mistake”. Second, even if prices responded “quickly”, or “instantly”, then you have to dig deeper and take into account the fact that those who are paying higher prices for the bonds, would be spending less on other items NOT bonds. They get the same bonds but at higher prices, which means they have less left over to pay for other things. The bond sellers make the gain that the non-bond sellers lost.

    It would be like the Fed printing and spending money to buy naive economist’s labor, which, assuming it increases the wage rates, means that if a given economist’s employer wants to keep them on, they will have to pay them more, and thus have less left over for other things. They receive the same labor from the same economists, but at higher prices. The gain to the economists comes at the expense of the losses to those who have less money left over to buy other things.

    The same principle holds true for bond purchases. If bond prices rise, then bond investors have to pay more for bond prices and thus have less money left over to buy other things. The gain to the bondholders who receive a free income boost, comes at the expense of those who have less money for other things.

    To think like an economist you must must must be able to hold more than one or two factors in your mind in the course of a thought. You are remaining completely superficial and not taking into account the subsidiary effects on other parties, over longer than “instantly”.

    But let’s say I was wrong; let’s say the price of gold rises slowly in response to an injection of new currency. The claim would still be wrong, as holding newly injected money doesn’t give anyone any sort of unfair advantage. If I heard about the Fed’s new OMO, and thought gold prices would rise gradually in response, I’d simply call up my broker and buy some gold.

    Injection of new money going to whom? Gold sellers? Bond sellers? Whatever gain can be made by buying gold as an inflation hedge, does not eliminate the gain that already went to the parties who received the new money first! Why did not take into account the specific parties who received the new money first in your gold hedge example? It’s a core component of the very argument you are attempting, and failing, to refute.

    What if I don’t have any currency? I’d charge the purchase on my credit card. What if it was some product you could only buy with cash? Then I’d simply get money from an ATM machine, or a bank, and make the purchase.

    Are you joking? You are suggesting it makes sense to pay credit card level financing rates, to buy gold that you expected to appreciate at a “gradual” rate that would likely be lower than the credit card rate?

    But let’s suppose by some fluke that it was possible. You’d still be wrong, because one can only buy more gold if one HAS THE MONEY available. One cannot buy more gold than the income one receives. If one is last in line to the printing press, then those who receive the new money first will see their incomes rise BEFORE those last in line.

    This is a good example of the fallacy of composition. In aggregate, the total level of nominal purchases is constrained by the amount of currency in circulation. But not at the individual level. Hence being the first to get the new money doesn’t confer any advantage at all–as the new money has no more purchasing power than the existing money. A dollar is a dollar—and a $100 bill is a $100 bill.

    Absolutely false. If the initial receiver’s cash balance goes up before everyone else’s cash balance goes up, due to inflation, then that does indeed confer a benefit to them. They don’t own money of less purchasing power until that money is used to make purchases. But by then they will have already received what money can buy. Once that new money circulates, and is added to the nominal demand component of purchases, then the “purchasing power of money” falls.

    Maybe if the context was a gold standard you’d get it. Suppose a gold miner found underneath his house 1,000 ounces of gold. At the time he holds that gold, the “purchasing power” of gold has not decreased, because it hasn’t been spent yet. So whatever spending he engages in, he receives a gain in purchasing power because aggregate prices cannot increase unless money is actually spent. So he buys at the lower prices. Once the money is spent and respent, then more and more goods will increase in price. But by then, he already gained in real terms.

    Or, if that is still too complicated, imagine I told you that there is a planet in outer space that is made of pure diamond. Suppose I tell you I own it. Would this make the purchasing power of diamonds on Earth fall? No, it wouldn’t, not unless the diamond on that planet was harvested, brought back to Earth, and put into circulation. Imagine the windfall the astronaut would get once he brought back the diamonds. He would probably have to spend a lot of diamonds to get wealth, but he will be able to outbid everyone for anything he wants.

    The same principle of “outbidding” exists with less than planet sized diamonds, to fiat money, to merely buying t-bonds. The same principle is there, it’s just what you would probably call “trivial” if you ever finally grasped what’s going on.

    Indeed if you really thought that asset prices would rise with a lag, then holders of the new money would actually see a loss of purchasing power due to inflation. The banks Suvy thinks are making out like bandits see the purchasing power of their massive ERs fall by 1.5% per year via inflation, and only get a measly 1/4% in IOR.

    THINK RELATIVELY.

    The banks are receiving the very money that is causing the drop in purchasing power. But those who are not receiving the new money, they are still experiencing the drop in purchasing power! So that RELATIVE difference is what the “lunatics” are referring to when they say “initial receivers gain at the expense of later receivers.”

    Would it make any sense for me to say that the astronaut is not better off having brought back the planet of diamonds to spend, because heck, the purchasing power of diamonds went way down? Please tell me that you can add “X% more cash” to “X% loss of purchasing power” for the initial receivers, and compare it to “X% loss of purchasing power” for the later receivers, and see that one group is benefited while the other is not.

    I oppose any IOR, but they are hardly making out like bandits.

    Awww, how nice. You “oppose” IOR. But you are in favor of trillions of new dollars going to the banks. How virtuous.

    To avoid the loss of purchasing power banks might want to spend the new money right away.

    It’s comments like these that really show profound ignorance of money. No Sumner, I don’t have to quickly spend the diamonds before they lose purchasing power. The purchasing power is contingent on my spending the diamonds. If I don’t spend the diamonds, then the diamonds won’t lose purchasing power.

    You yourself should understand this point, since you have repeatedly called for no more IOR, which would, supposedly, result in more spending, higher prices, and higher NGDP. Now why would those reserves have to actually be spent before prices and NGDP rises, if you weren’t already assuming that purchasing power declines don’t occur until AFTER the banks spend the idle reserves?

    You keep conceding the “lunatics” argument, and yet you are talking like you’re disproving it.

    But Goldman Sachs isn’t even paid cash for the T-bonds the Fed buys in OMOs. I don’t know how they are paid, but whether it is a paper check or some sort of electronic transfer to a bank account, the point is that G-S would have to actually convert that monetary injection into cash before spending it on the goods that are going to go up in price–if cash was “purchasing power.”

    That’s funny: “If cash was purchasing power.” MONEY is purchasing power, not cash per se.

    There is no “converting” necessary once the Fed increases bank reserves. Those reserves are money, and the banks can buy goods, services, financial assets, etc, with it.

    But I could do the same, even if I never participated in OMOs! Getting the money first gives G-S absolutely no advantage over me in terms of being able to speculate in assets that might rise in value.

    They can speculate with more money than you because they receive the new money first before you do. Any price increases you observe around you is a function of those same initial and subsequent receivers spending that money. If you speculate on those assets, and you are able to sell them at higher prices, then the BUYERS (you know, the whole “keep in mind more than one thing at once” thing?) will have to pay higher prices for those same assets, and you will gain at THEIR expense. You can’t make a money gain unless you find a money buyer. Not everyone can be ONLY buyers of assets to speculate on, in order to avoid the “lunatic” effect. If everyone bought gold and only held onto it, then the price of gold would collapse to zero, because there would be no price of gold as there would be no exchanges in gold to subsequent buyers.

    The lunatic argument is that SOME PEOPLE are going to get screwed by inflation. If you try to avoid it by buying gold, and you expect to SELL it later on, then you are not refuting the “lunatic” argument. You are just saying “I personally can mitigate the “lunatic” effect if there is someone out there who will buy gold from me at a higher price to themselves.”

    In other words, if everyone tried to do what you suggest, then everyone would suffer losses equivalent to the money they thought they would be able to get through selling the gold.

    In the real world, not everyone is able or willing to speculate on inflation hedges. Not everyone even understands inflation! Sucks to be them you say? Thanks for admitting inflation is an insidious form of exploiting poor and uninformed people.

    And of course if it was goods that one could buy without cash (i.e. most goods) then there would be no basis at all for the view the receivers of new base money have an unfair advantage.

    That is incorrect. Money is money. If one receives base money, that is money that nobody else received.

    OK, so simple logic tells us that it can’t possible matter who “gets the money first.”

    But might it matter what the money is spent on? This question is more complex. If the new money is not used to purchase T-bonds, then some other asset holders might benefit—as you’d be combining fiscal and monetary policy.

    Call it what you want (fiscal or monetary), but you again just contradicted yourself. If you say it doesn’t matter who gets the money first, then you can’t possibly also believe that “if the new money is not used to buy t-bonds, then some other asset holders might benefit“.

    It is astonishing (actually, again, at this point I am no longer astonished at the blatant contradictions here), that you can say it doesn’t matter who gets the new money first, and then, in the very next sentence no less, you say it would benefit non-bond asset holders if the Fed bought their assets instead of t-bonds.

    I think Greg went far too easy on you. He should have used the same language you use against others after which you cry foul when that same language is used against you.

    Indeed even a purchase of gold would now be equivalent to fiscal stimulus, as gold is basically just a commodity.

    Call it what you want, it’s still caused by inflation. It’s still caused by the Fed. No critic of the Fed is criticizing it on the basis of the name “monetary policy”. They are looking at the actions taken.

    It’s funny that you define monetary policy as only “Fed buying government debt”. It’s funny because it looks exactly like trying to avoid getting dirty should the Fed start buying the S&P 500 to raise AD. “Oh no! That’s not monetary policy! That’s fiscal policy! Blame the Congress!”

    However I’d make the following observations:

    a. During normal times when interest rates are positive then the size of monetary injections is typically quite small as a share of GDP, so the macroeconomic impact of some unconventional purchase–say equity mutual funds–would be utterly trivial compared to the macro impact of a larger monetary base.

    Again, who asked you about your opinion for the adjective to describe the “size” of the “lunatic” effect? What is “utterly trivial” to you is positive and non-zero and thus consistent with the “lunatic” effect.

    b. During periods where the interest rate is zero it is possible that the monetary injections would be quite large. In that case it might matter whether the Fed bought T-bonds or MBSs or foreign exchange. However since MBSs created by the GSEs have been backed by the Treasury, they are now very close substitutes, so even here the effect would be quite small. And if the Fed bought more foreign debt, that would be mostly offset by foreigners buying more US debt. And most importantly, any unconventional purchases by the Fed would matter, if they mattered at all, due to the asset being purchased, not who gets the money first.

    I said on another blog that your last post should win gold at the mental gymnastics championships, but I think there should be a recount. This one wins.

    That last comment: “any unconventional purchases by the Fed would matter, if they mattered at all, due to the asset being purchased, not who gets the money first”, shows that you didn’t learn from my comments in the previous blog post, where I showed you that you are fallaciously abstracting assets away from their owners and from individuals in general, when the importance is precisely the other way around. It matters who gets the new money because it is individuals who are the basis for which assets are affected. If you say t-bonds are affected, then what you are really saying is that changing inflation is being valued differently by the individuals who own (and buy) t-bonds. If you say MBS are affected, then what you are really saying is that changing inflation is being valued differently by the individuals who own (and buy) MBS.

    If individuals are not present, then neither are t-bonds nor MBS nor inflation. But if t-bonds, MBS and inflation are not present, individuals can still be present. You have the center of understanding reversed. You’re looking at the economy like a mechanical robot, where assets are affected, but the individual owners are not.

    To summarize, it makes my brain hurt to try to understand how anyone could think it matters who gets the Fed injections first, assuming the new money is sold at fair market prices.

    That assumption is wrong.

    Needless to say I can’t rule out the theoretical possibility that G-S gets some sort of sweetheart deal and earns above fair market commissions on OMOs in Treasury bonds. If so then that’s a scandal that needs to be investigated. But it would hardly be the basis for a serious theory of the macroeconomic effects of monetary policy. It would be like claiming the Federal government doesn’t really control the monetary base because the North Koreans produce some $100 bills as well. True, but nearly irrelevant.

    Needs to be investigated? You are either a liar or you are just so incredibly sloppy that you can’t even see you contradict yourself. You Chicago types insist on Fed “independence”, which means Fed secrecy, and yet here you are claiming that the Fed has to be audited top to bottom, which is the only way to know of these “sweetheart deals”, and which Bernanke said would be an effective Congressional take over of the Fed?

    Speaking of brains hurting. “Should be investigated” is a euphemism for “I know they never will be investigated if I demanded it, and I don’t care, because it’s more important the Fed continues to be run by philosopher kings, rather than the idiot populace who are too stupid to set their own prices and interest rates on their own, or worse, run by nobody and (gasp!) move towards a free market in money.”

    PS. I hope people realize my $100 bill example was a simplification of reality. The modern Fed usually injects money first as reserves, then they get converted to $100 bills when the public’s demand for currency rises. Nothing in my post hinges on that complication. Before 1913 the entire base was cash.

    I hope people realize you were so incredibly wrong with that example that “simplification of reality” is another way of saying “I made a mistake but I can’t admit it because I know I have been vitriolic and it would only invite more refutations and loss of credibility.”

    PPS. If people who disagree with me want to be taken seriously they might start by being a bit more polite. I find that’s usually correlated with intelligence. For those who were polite in the previous comment section my apologies for this tirade.

    I only take non-hypocrites at their word. Anyone who demands politeness, yet engages in very impolite rhetoric himself, is someone not to be taken on their word.

    PPPPS. Some of the smarter commenters tried to convince me that money is non-neutral. My entire blog is devoted to the proposition that money is non-neutral–I don’t need convincing. But that has no bearing on the claim that the effect of money policy depends on who “gets” the money first. Non-neutrality in the labor and goods markets comes from sticky wages and prices, and non-neutrality in debt defaults comes from sticky nominal debt.

    How about non-neutrality in the money market? You know, the topic of the non-neutrality discussion?

    Money is non-neutral not because labor, goods, and bond prices are “sticky.” Prices are “sticky” because of the non-neutrality of money. Money enters the market at distinct points, and only after is it spent and respent, bidding up nominal demands and prices along the way. Thus, at any given time, prices for things further down the line are not increasing because of the inflation taking place at that very moment, but is rather increasing in price because of inflation some time prior.

    **INFLATION OF THE MONEY SUPPLY DOES NOT AFFECT ALL PRICES AND SPENDING EQUALLY AT THE SAME TIME**

  56. Gravatar of Scot Sumner and Cantillon Effects–Part 2 « Punto de Vista Economico Scot Sumner and Cantillon Effects–Part 2 « Punto de Vista Economico
    4. December 2012 at 11:21

    [...] intense (heated?) debate around the Cantillon Effects after an injection of money has produced a new post by Scott Sumner. Scott Sumner argues that it doesn’t matter where money in injected first [...]

  57. Gravatar of dtoh dtoh
    4. December 2012 at 11:26

    Greg,

    You said,

    Note well that many using the language of “who gets the money first” would in this scenario identify the steel industry as among one of those ‘getting the money first”.

    I think the way to think about this is who gets the money first versus who uses the money first.

    It really doesn’t matter who gets the money first. At the risk of over-simplification, who uses the money first will always be those economic players whose indifference curves between holding financial assets and spending on real goods and services are flattest. I.e. those where a small change in the real price of financial assets will cause them to exchange financial assets for real goods and services by either selling financial assets they already hold or by issuing (including borrowing from banks) new financial assets.

    As Scott notes, this might typically be businesses in cyclical industries.

    (In reality, it’s not just the shape of the indifference curve, but it also depends on whose indifference curves are mostly like to shift in expectation of increased AD.)

  58. Gravatar of Bob Murphy Bob Murphy
    4. December 2012 at 11:28

    Scott, I said “I’ll leave you alone” but that was on the *other* thread, so let me take one more shot at this:

    Suppose the government abolishes the FOMC, and instead hands over a literal printing press (cranking out $100 bills) to a college in the US. The college administration can print as much money as it wants, the only constraint is, Congress says they have to use the newly printed money to pay college expenses, like building a new cafeteria and paying salaries to faculty and staff.

    Are you saying your lifestyle wouldn’t be affected, if Bentley got awarded the printing press versus UC Berkeley?

  59. Gravatar of dtoh dtoh
    4. December 2012 at 11:50

    MF,
    Why don’t you try shorter more concise posts limited to a single point. You might get more detailed and specific responses. (Constructive suggestion).

  60. Gravatar of Laurent Laurent
    4. December 2012 at 11:51

    Bob Murphy,
    The college printing press analogy is misleading. With the FOMC procedures, the government has seignorage. Of course, if it transfers seignorage to a college, that college will benefit at the expense of every other agent holding money.

    However, this raises an interesting point. If China decides to peg its currency, ignoring a massive OMO where the US government holds seignorage, it will be at a net loss.

  61. Gravatar of Bob Murphy Bob Murphy
    4. December 2012 at 11:52

    (BTW Scott if you can please answer my question here about Bentley vs. UC Berkeley, I promise I won’t post again on this thread. But I can’t control Greg Ransom!)

    For curious onlookers, I *think* I figured out what is going on: What Austrian guys have in mind, in terms of “of course it matters who gets the money first!!”, is classified in Scott’s mental model as “fiscal policy.” See his comment above, where he said something like if the Fed just printed money and bought cars with it, that would help the auto industry, but it would be fiscal policy, not monetary policy.

    In contrast, I think most Austrians think of “monetary policy” as something that the monetary authority does, like print money and buy stuff with it.

  62. Gravatar of Iván Carrino Iván Carrino
    4. December 2012 at 11:57

    I think point #4 is the key to the argument. However, I think it has really unreal assumptions:

    1st “prices respond instantly to the news”
    2nd “If I heard about the Fed’s new OMO, and thought gold prices would rise gradually in response, I’d simply call up my broker and buy some gold.”

    So you are assuming and immediate transmission of information, a perfect information, and you are also assuming that everyone will buy the same asset whenever they hear about the news (something like assuming: “everyone is Peter Schiff).

    The thing is that the Cantillon effect takes place in the real market economy, where none of this happens.

    Finally, you claim: “being the first to get the new money doesn’t confer any advantage at all–as the new money has no more purchasing power than the existing money. A dollar is a dollar—and a $100 bill is a $100 bill.”

    Really? Is a dollar of, say 1970, a dollar of 2012? Well, that’s precisely the issue at stake here.

  63. Gravatar of George George
    4. December 2012 at 11:58

    Bob Murphy, in your example the college would benefit from seignorage from printing money as prof sumners has duly noted. However suppose a consultant comes for a mission, would it really for him if he’s paid through the printing press or through “regular” money? Prof Sumners is arguing that no(which sounds like a very reasonable argument don’t you think?)

  64. Gravatar of Bob Murphy Bob Murphy
    4. December 2012 at 11:58

    Laurent wrote:

    “Bob Murphy,
    The college printing press analogy is misleading. With the FOMC procedures, the government has seignorage. Of course, if it transfers seignorage to a college, that college will benefit at the expense of every other agent holding money.”

    No, you just demonstrated why my analogy is perfect. I didn’t ask Scott if the *administration* of Bentley would be indifferent, I asked if *Scott* would be indifferent. He is one of the people on whom the owner of the new printing press would be spending its money.

    So, if Scott agrees he would be better off if Bentley got the printing press, then he agrees with Sheldon Richman that the people on whom the Fed spends its money benefit. Or at least, he needs to explain why the principle works for Scott but not for Wall Street guys.

  65. Gravatar of Doug M Doug M
    4. December 2012 at 12:10

    I think the mis-conception that our dear Professor is trying to clear up, is that when the fed buy $100,000,000 in securites, that money is not soaked up by the financial markets. The guy who held T-bills sells his t-bills to the fed as a half a basis point higher than he had them marked a few minutes ago. He has 100,000,000 million few t-bills and 100,000,000 more cash and is a thousand dollars richer. And he takes his 100 million and buys GE commercial paper, and someoen else has 100M fewer assets and 100M more cash and is a few hundred dollars richer, etc. So, asset prices will rise some amount, but at the end of the day there is still group of people who have $100M more cash than they did in the morning, and have about the same quantity of fewer assets.

    Ssumner, something that I have tried to bring attention to in this space, is tha you are underapreciating is the role that private banks have in money creation. The Fed only creates a small fraction of the money supply. Private banks create the bulk of it. When we talk about what the Fed is doing, or could be doing to expand the money supply, people are ignoring that private banks are currenly not doing a very good job of turning newly created reserves into new loans and money.

    Suvy,

    “When you first start to print money, prices don’t increase and the people that get the money first actually have more spending power.”

    The Fed merely needs to suggest that it will be printing more money to push prices higher. Expectations of inflation drive inflation.

    Gabe, A T-bill trader makes about $10 for every million he trades. You trade a billion a day, then you are going to do okay. As a percentage of face, it is pretty darn small. When the Fed comes in to do OMO, it is a decent payday for a handful of traders.

  66. Gravatar of Laurent Laurent
    4. December 2012 at 12:14

    Bob Murphy,

    The net beneficiary of OMP by the fed is the Treasury. Not Wall Street guys. Indeed, during the time the Fed holds the T-Bonds, the coupon payments go right back to the Treasury. Thus the government has lower interest costs. And can spend more (or decrease taxes, or pay back debt, whatever).

    You could argue that government cronies will profit from the OMP, depending on the administrations’ choices, at the expense of money-holders. But as Prof Sumner said quite clearly, that is a fiscal issue.

  67. Gravatar of StatsGuy StatsGuy
    4. December 2012 at 12:32

    Just a note on seignorage – there are two aspects:

    1) The direct payments by Fed to Treasury (and discounted future payments). This was running over $80 billion last year, and has probably increased this year. Given Fed is likely to hold assets till end of 2015, and substantial assets thereafter, I think we can expect this is a non-trivial amount over the 2009-2015+ period.

    2) The savings from lower marginal rates on future borrowing/rollovers, which is not technically seignorage, but is a lot of money.

    BTW, I’m not disagreeing with seignorage – I’m all for it when the economy is like it is now. QE _increases_ NGDP, and taxes _lower_ NGDP, so ‘seignor’ away until NGDP hits target! Besides, it’s a natural brake on wealth concentration. (I wonder if we have enough data since 2009 to redo the Romer analysis on whether inflation hurts the poor?)

  68. Gravatar of Major_Freedom Major_Freedom
    4. December 2012 at 12:41

    dtoh:

    Why don’t you try shorter more concise posts limited to a single point. You might get more detailed and specific responses. (Constructive suggestion).

    Thanks dtoh, but I am more serious about this than one liners and quips. It’s for serious readers willing to delve into the details that are getting glossed over.

  69. Gravatar of Major_Freedom Major_Freedom
    4. December 2012 at 12:53

    Bob Murphy:

    For curious onlookers, I *think* I figured out what is going on: What Austrian guys have in mind, in terms of “of course it matters who gets the money first!!”, is classified in Scott’s mental model as “fiscal policy.” See his comment above, where he said something like if the Fed just printed money and bought cars with it, that would help the auto industry, but it would be fiscal policy, not monetary policy.

    In contrast, I think most Austrians think of “monetary policy” as something that the monetary authority does, like print money and buy stuff with it.

    Yes, I picked up on that labeling and nomenclature sideshow as well. But the Austrian “lunatic” argument never was what we should call it. It was never about whether we should call bond buying or car buying fiscal or monetary policy. It’s a total red herring!

    ———————

    George:

    the college would benefit from seignorage from printing money as prof sumners has duly noted. However suppose a consultant comes for a mission, would it really for him if he’s paid through the printing press or through “regular” money? Prof Sumners is arguing that no(which sounds like a very reasonable argument don’t you think?)

    It isn’t an on-off switch thing. All money is printing press money at the end of the day. No, the argument is more of a declining series of purchasing power gains, which equivalent declining series of purchasing power losses.

    If you can see that the university will benefit through seignorage, then you have to first understand why that gain is even there. Once you do, then it becomes easier to see how those the university spends money on, would benefit as well, but less so than the university. All throughout this time those at the very end of the line would experience this inflation path as rising prices, rather than rising incomes. Once the new money finally does raise their income, then they will “gain”, but by that time, prices are all higher anyway, and not only that, but the university is probably still engaged in perpetual money printing, constantly keeping the wave above the heads of those at the end of the line. Make sense?

    ————————-

    Laurent:

    The net beneficiary of OMP by the fed is the Treasury. Not Wall Street guys. Indeed, during the time the Fed holds the T-Bonds, the coupon payments go right back to the Treasury. Thus the government has lower interest costs. And can spend more (or decrease taxes, or pay back debt, whatever).

    The Wall Street guys make a cut of the benefit as well. If they are among the initial receiver group (and we can suppose the first 3 or 4 receivers as part of that initial group), then that group benefits at the expense of everyone else NOT in that group, i.e. (the 5th, 6th, 7th, etc receivers).

    Wall Street benefits when the Fed buys bonds from them, the same way (which Sumner admitted), car sellers would benefit if the Fed buys their cars.

  70. Gravatar of Major_Freedom Major_Freedom
    4. December 2012 at 12:56

    Laurent:

    You could argue that government cronies will profit from the OMP, depending on the administrations’ choices, at the expense of money-holders. But as Prof Sumner said quite clearly, that is a fiscal issue.

    The inflation money itself is the issue. Call it fiscal or monetary or whatever.

  71. Gravatar of Major_Freedom Major_Freedom
    4. December 2012 at 13:07

    Iván Carrino:

    So you are assuming and immediate transmission of information, a perfect information, and you are also assuming that everyone will buy the same asset whenever they hear about the news (something like assuming: “everyone is Peter Schiff).

    The thing is that the Cantillon effect takes place in the real market economy, where none of this happens.

    It is not even necessary for immediate transmission of information to perfect information to NOT exist, if the Cantillon Effect is to exist.

    It’s easy to see how. Suppose the Fed announced that it is going to print $500 trillion this Friday. Suppose everyone had perfect information about what will happen to prices at that time. What would happen today? Well, prices would almost certainly rise…but, they can’t rise to levels that presume the $500 trillion to actually be in circulation today. It will be impossible to raise current prices today to levels such that when the $500 trillion actually enters the market this friday, prices somehow will not rise at all. Prices today will still be capped to what people can actually physically pay today, with the existing, lower quantity of money.

    Once friday does occur, those who spend that money will have a relative advantage as compared to everyone else. Everyone else raised their prices, but they could only raise them to what people were actually able to pay at the time.

    So adding in uncertainty and imperfect information and prices that don’t adjust sufficiently upwards in the present, add all these real world factors in, and the Cantillon Effect, contrary to suddenly coming into existence, would actually be even more exacerbated.

  72. Gravatar of Squarely Rooted Squarely Rooted
    4. December 2012 at 13:15

    Nothing further on the substance; just noting that I wish I had the time, drive, and energy to write actual posts on my blog as long, detailed, and comprehensive as the folks who are writing thousands of words in the comments section here. I wonder why they don’t, you know, do that.

  73. Gravatar of Major_Freedom Major_Freedom
    4. December 2012 at 13:17

    Squarely Rooted:

    My secret is above average speed typing.

  74. Gravatar of George George
    4. December 2012 at 13:19

    Major freedom I think this is a different discussion here. The added money will create inflation in the long run from where the seigniorage comes from (Wikipedia does a wonderful job explaining it btw). Note that I specifically mentioned an external consultant so that he is independent of the university (otherwise you would argue that being a professor in the college you profit from the increased funding if the university). So from this consultants point of view he is not profiting at all from the money.

    The consultant just did his job which is worth let us say 100$ whether he receives this from already existing money or newly printed money does not matter, money is indistinguishable.

    In the case of a wage it’s a different story, but if it’s let us say the consultant sold a piece of land to the university, then if he keeps the money received if anything he would lose due to inflation in the long run. But even that argument is wrong, the consultant sod the land because he wanted to sell it, and he would have done so if he is receiving newly printed money or existing money so the inflation would have eaten his savings any way.

    If I understand you correctly though what you are saying is if the college is purchasing a lot of land then naturally the land value goes up and therefore th consultant is benefiting from this but this is clearly fiscal policy it’s not the fact that the monetary base went up that made land prices goes up but the increased demand for land.

    Going back to QE I guess there real question here is: are the t-bills increasing in value due to the increased demand for t-bills by the fed or because of “liquidity effect” as prof summer points out. Furthermore with interest rate at 0 (or almost) don’t you think that money is a perfect substitute for the bonds?

  75. Gravatar of dtoh dtoh
    4. December 2012 at 13:27

    MF
    Thanks dtoh, but I am more serious about this than one liners and quips. It’s for serious readers willing to delve into the details that are getting glossed over.

    As Cicero once said, “If I had had more time, I would have written a shorter comment.”

    And seriously, you don’t have to cover all your points in a single comment. Give it time. There’s no way you can convince people in a single post. You need to sell them over time. (Not that I agree with your views.) :)

  76. Gravatar of George George
    4. December 2012 at 13:39

    On the t-bill argument if you read the PS of the latest blog, prof sumners makes a great point. Holding fiscal policy constant and assuming that the decision to increase the monetary base is decided, then you will either buy t-bills or use this money to spend on government projects both have the same impact on t-bill demand. If you decide to buy cars you can view that as just fed buys t-bill treasury having less debt would go and borrow and then buy the car. This would have an impact on the car but due to the fiscal policy but of the treasury buying a car and not the monetary policy bit.

  77. Gravatar of Chuck E Chuck E
    4. December 2012 at 13:47

    @ Doug M

    You are suggesting that the private banks “create the bulk of it” by lending against their reserves. Correct?

  78. Gravatar of Major_Freedom Major_Freedom
    4. December 2012 at 14:32

    George:

    The added money will create inflation in the long run from where the seigniorage comes from (Wikipedia does a wonderful job explaining it btw).

    No, that’s a different discussion. I am not talking about CPIs. I am talking about the relative price changes that occur with initial doses of inflation, before that money spreads throughout the greater economy and having a noticeable effect on CPI.

    Note that I specifically mentioned an external consultant so that he is independent of the university (otherwise you would argue that being a professor in the college you profit from the increased funding if the university). So from this consultants point of view he is not profiting at all from the money.

    But he is, relative to those who receive the new money after he does.

    Again, it’s not an on-off switch. It’s not just the first party that gains or not, and then that’s it. I hate saying the following because it’s usually a cop out, bu “it’s more complicated.”

    The consultant just did his job which is worth let us say 100$ whether he receives this from already existing money or newly printed money does not matter, money is indistinguishable.

    That $100 is CONTINGENT upon the university printing money! You can’t abstract away one from the other. You can’t say that if he gets $100 from an inflation financed university, that he would have gotten $100 from that same university if it didn’t have a printing press.

    In the case of a wage it’s a different story, but if it’s let us say the consultant sold a piece of land to the university, then if he keeps the money received if anything he would lose due to inflation in the long run. But even that argument is wrong, the consultant sod the land because he wanted to sell it, and he would have done so if he is receiving newly printed money or existing money so the inflation would have eaten his savings any way.

    Yes, he might still have otherwise sold it, but you can’t assume he would have gotten the same price.

    If I understand you correctly though what you are saying is if the college is purchasing a lot of land then naturally the land value goes up and therefore th consultant is benefiting from this but this is clearly fiscal policy it’s not the fact that the monetary base went up that made land prices goes up but the increased demand for land.

    Call it what you want. Fiscal policy, monetary policy, flibbertygibberty policy, it doesn’t matter. Merely NAMING something differently doesn’t mean you changed the actual mechanics.

    Going back to QE I guess there real question here is: are the t-bills increasing in value due to the increased demand for t-bills by the fed or because of “liquidity effect” as prof summer points out.

    It can’t be the liquidity effect because if the Fed buys cars, or tacos, then there is no necessary connection to borrowers in Wall Street suddenly raising their nominal demand for bonds. If anything, it would raise the prices of cars and tacos, and thus bring about the Cantillon Effect that way.

    Furthermore with interest rate at 0 (or almost) don’t you think that money is a perfect substitute for the bonds?

    No, because (if you’re a bond holder) you still have to sell your bond to acquire money to invest and consume and hold. You still are incurring a risk that doesn’t come with owning money. The coupon or stated interest rate is not the only factor investors take into account. They also take into account return, which contains counter-party risk, and purchasing power considerations, time horizons, among other things.

  79. Gravatar of Major_Freedom Major_Freedom
    4. December 2012 at 14:34

    dtoh:

    And seriously, you don’t have to cover all your points in a single comment. Give it time. There’s no way you can convince people in a single post. You need to sell them over time.

    I don’t expect to convince Sumner, since he has proven himself unwilling, or unable, to take ideas really seriously.

  80. Gravatar of Major_Freedom Major_Freedom
    4. December 2012 at 14:39

    George:

    Holding fiscal policy constant and assuming that the decision to increase the monetary base is decided, then you will either buy t-bills or use this money to spend on government projects both have the same impact on t-bill demand.

    It’s not just about t-bill demand. It’s the demand for whatever the Fed is buying. If the Fed prints money and the government spends it on cars rather than bonds, then that will affect car prices and thus change the relative price structure that otherwise would have prevailed for cars vis a vis non-cars.

    Holding government spending constant, and showing examples where t-bond demand doesn’t change, doesn’t refute the Cantillon Effect.

    If you decide to buy cars you can view that as just fed buys t-bill treasury having less debt would go and borrow and then buy the car. This would have an impact on the car but due to the fiscal policy but of the treasury buying a car and not the monetary policy bit.

    But the Treasury got the money from the Fed, so it’s not independent of the Fed. Call it fiscal policy if you want, it won’t change what is going on.

  81. Gravatar of Pedro Romero Pedro Romero
    4. December 2012 at 14:40

    It does matter when fiscal policy is not held constant. When Richard Cantillon talked about this, in early eighteen century, he was describing how the process of new gold money extracted from the mines was altering the spending patterns of economic agents.

  82. Gravatar of George George
    4. December 2012 at 14:59

    MF, you are right about saying that the 100$ are contingent on the university printing the money but isn’t that the whole purpose of QE? :) this applies not only to the mentioned consultant but to all agents in the economy. Agents want money so there is a certain demand for money if there is not enough offer we have a problem (kind of), printing more money will solve it. But printing more money is not solving the contractor’s specific problem it’s solving the general lack of money offer, so you cannot say that the contractor is profiting from this printing.
    What you could say though is that if he’s selling land he would be profiting because the university is specifically targeting land purchase. Which for me is a fiscal policy.

    As for the equivalence of bonds and money at 0 rates, indeed but what you described is exactly the liquidity effect so if the fed is openly buying bonds, this liquidity effect goes down and bond prices converge to money “price” so the move in price is indeed a liquidity effect.

  83. Gravatar of Iván Carrino Iván Carrino
    4. December 2012 at 16:12

    I see your point Major_Freedom but I think Scott has a point when he says that, if you can’t pay right away, you can borrow money, pay with your credit card, etc… So I think Cantillon Effects happen in the “real world”, in the market *process*, and no in equilibrium… Still, I’m just learning here :)

  84. Gravatar of Iván Carrino Iván Carrino
    4. December 2012 at 16:44

    ssumner

    “Here’s how to eliminate the perception that banks and bondholders gain. Inject new money via salaries to government employees. The salary would be exactly the same, so no one would think the government employees are gaining”

    But then you are eliminating the need for gvt to issue a bond, and, thus, liberating money of some guy who would have invested in the bond but now has the money available for another purpose. Now this guy uses the money to buy goods and that’s how you trigger a Cantillon Effect and inflation…

  85. Gravatar of Britonomist Britonomist
    4. December 2012 at 16:59

    ” I need to convince elite macroeconomists of market monetarism.”

    Not just them, you need to convince the new generation of grad students, and I can tell you many of them, from personal experience, are leaning closer to endogenous money.

  86. Gravatar of Sarkis Sarkis
    4. December 2012 at 17:45

    Britonomist
    “Not just them, you need to convince the new generation of grad students, and I can tell you many of them, from personal experience, are leaning closer to endogenous money.”

    If that is the case (leaning closer to e.m.) then its only because British universities are dismal at monetary economics. There is no good quality grad teaching going on at the moment in this field so people (research students) tend to focus on irrelevant theories and models. If you go to any British university and ask economists about macroeconomics they will only be able to think in terms of general equilibrium models or some keynesian spin off and some textbook stuff. Mention market monetarism and they will probably think you are crazy. I’m talking about top 5 universities here. Don’t think scott sumner needs to convince these people but that these people should at the very least familiarise themselves with new ideas like NGDPLT. Thats my personal experience.

  87. Gravatar of ssumner ssumner
    4. December 2012 at 17:58

    I just have time for a couple comments now:

    Bob Murphy, In my original post I didn’t even mention Cantillon, I focused on Richman’s claim, which had no fiscal aspects at all. If Cantillon was thinking in terms of combined fiscal/monetary operations that’s fine. But that wasn’t my post, and it’s also not relevant to the US, with the possible exception of the 2008 bailouts. But even those were mostly handled by the Treasury when they had important fiscal components, if I’m not mistaken. Wasn’t the GM bailout, etc, a Treasury operation? The Fed hasn’t lost any money on these, they’ve racked up huge profits. But yes, in theory a central bank could do fiscal policy, and then Cantillon would be correct.

    Even the Fed’s MBSs are now essentially backed by the Treasury, hence they are de facto Treasury debt.

    Britonomist. The term “endogenous money” is hopelessly vague. With any targeting regime (inflation, exchange rates, interest rates, etc) the money supply is endogenous, at least in the short run (with interest rates) or long run (inflation). If you mean MMT, it will never catch on with elite macroeconomists.

    Not while Nick Rowe is alive.

  88. Gravatar of Britonomist Britonomist
    4. December 2012 at 18:54

    “If that is the case (leaning closer to e.m.) then its only because British universities are dismal at monetary economics.”

    I’d disagree, but then I may be biased. On the other hand, this is not just British students at British universities, I get to talk to many American grad students on the internet.

    “Britonomist. The term “endogenous money” is hopelessly vague. With any targeting regime (inflation, exchange rates, interest rates, etc) the money supply is endogenous, at least in the short run (with interest rates) or long run (inflation). If you mean MMT, it will never catch on with elite macroeconomists.”

    Okay true, I should clarify, I do NOT mean MMT, that is an extreme version of the people I place in this group. Basically, what I mean is anyone who is largely critical of the money multiplier, critical of the idea that more bank reserves must lead to more lending and hence more spending, OR critical of the idea that lowering interest rates even further will have any significant effects (e.g. balance sheet recession analysis of people like Koo).

  89. Gravatar of Britonomist Britonomist
    4. December 2012 at 19:02

    Basically, traditional Keynesians with some updated criticisms of monetary policy. Monetarists vs Keynesians is a more fruitful debate than Monetarists vs Austrians IMO

  90. Gravatar of Greg Ransom Greg Ransom
    4. December 2012 at 19:27

    For crying out loud!

    We’ve all been PUNKED!!

    Scott writes,

    “Bob Murphy, In my original post I didn’t even mention Cantillon, I focused on Richman’s claim, which had no fiscal aspects at all. If Cantillon was thinking in terms of combined fiscal/monetary operations that’s fine. But that wasn’t my post, and it’s also not relevant to the US, with the possible exception of the 2008 bailouts. But even those were mostly handled by the Treasury when they had important fiscal components, if I’m not mistaken. Wasn’t the GM bailout, etc, a Treasury operation? The Fed hasn’t lost any money on these, they’ve racked up huge profits. But yes, in theory a central bank could do fiscal policy, and then Cantillon would be correct.”

  91. Gravatar of ssumner ssumner
    4. December 2012 at 19:51

    Statsguy, You said;

    “In the case of zero bound (not normal times), it’s clear that ACTUALLY spending large amounts of money may be required (to generate credibility, if nothing else).”

    Generally a very good comment you made, but I take strong exception to this statement. Not only is it not clear, I have yet to see even a shred of evidence. I think a NGDPLT would be 100 times more powerful than “large amounts of money.”

  92. Gravatar of Major_Freedom Major_Freedom
    4. December 2012 at 19:56

    Greg:

    For crying out loud!

    We’ve all been PUNKED!!

    Well, on the bright side, at least there has been some improvement/progression.

  93. Gravatar of Major_Freedom Major_Freedom
    4. December 2012 at 19:59

    The only thing that is left is to

    1. Emphasize it doesn’t matter whether or not Fed purchases are called “fiscal policy” or “monetary policy”; and

    2. The Cantillon Effect that arises from Fed purchases of cars, tacos, gold, and everything else that has a price, also arises from Fed purchases of government bonds, MBS, and every other financial security.

    After that we can all go home.

  94. Gravatar of Greg Ransom Greg Ransom
    4. December 2012 at 20:06

    Robert Murphy thinks Scott Sumner doesn’t really dispute what Austrian have in mind:

    http://consultingbyrpm.com/blog/2012/12/resolution-of-the-sumnerrichman-showdown.html

    But I think Scott Sumner really does dispute what Austrians have in mind, he just doesn’t know what it is that Austrians have in mind. That is just thing that *allows* him to dispute it, he doesn’t have any idea what the alternative to his own view actually is.

    Here is why Sumner unwittingly and unintentionally but in effect disputes what Austrians have in mind.

    Scott believes that the EMH makes money and credit markets and asset markets essentially perfect and instantaneous — its impossible to be fooled by money and credit and asset prices. So there cannot be a “loose joint’ in the domain of money, credit and production — there can’t be erroneous malinvestment, stretching and contracting in a boom and bust cycle. EMH means perfect and instantaneous expectations, perfectly coordinated across the future, don’t you know.

    And, likewise, because of the EMH, no one can really benefit via a transaction with the Fed, you can’t beat the market, and so there are no gains to be made, and certainly no increased marginal gains to be made in the expansion of an artificial boom. Artificial booms can’t exist.

    When we drill down, that is what we are drilling down into.

    Scott doesn’t think in the categories of heterogeneous production goods with varying production times and output — he doesn’t think he needs to imagine such stuff. It’s all perfectly and instantaneously coordinated thru time via EMH and EMH expectations.

  95. Gravatar of Greg Ransom Greg Ransom
    4. December 2012 at 20:12

    What we have run into again is Lerner and Lange socialist economics thinking, the ‘given’s in economists model and the perfect and instantaneous coordination promises by the EMH model, these instantaneously and perfectly expectations across time:

    “Scott doesn’t think in the categories of heterogeneous production goods with varying production times and output — he doesn’t think he needs to imagine such stuff. It’s all perfectly and instantaneously coordinated thru time via EMH and EMH expectations.”

  96. Gravatar of Britonomist Britonomist
    4. December 2012 at 20:54

    Did you just refer to the EMH as socialist? ahahaha

  97. Gravatar of Resolution of the Sumner/Richman Showdown Resolution of the Sumner/Richman Showdown
    4. December 2012 at 21:38

    [...] Richman article talking about Cantillon effects. If you care, I now have the resolution, because of Scott’s follow-up post. Scott actually doesn’t dispute anything in what the Austrians have in mind when they say [...]

  98. Gravatar of Resolution of the Sumner/Richman Showdown – Unofficial Network Resolution of the Sumner/Richman Showdown - Unofficial Network
    4. December 2012 at 23:18

    [...] Richman article talking about Cantillon effects. If you care, I now have the resolution, because of Scott’s follow-up post. Scott actually doesn’t dispute anything in what the Austrians have in mind when they say [...]

  99. Gravatar of Prakash Prakash
    5. December 2012 at 01:20

    Scott, I’ve been trying to follow this debate, since both sides seem to be presenting logical arguments.

    Is Bob Murphy’s argument correct? Is purchase of anything other than government securities considered as “fiscal policy” in your mind?

    My thoughts go to a situation where a government is debt free.

    If such a country went into a recession, and the central bank reduces the interest rate till zero. The economy does not recover. After that, the central bank literally cannot do monetary policy, right? Since any assets that it will buy will be “fiscal policy”. Is my understanding correct?

  100. Gravatar of StatsGuy StatsGuy
    5. December 2012 at 07:47

    ssumner:

    “Not only is it not clear, I have yet to see even a shred of evidence. I think a NGDPLT would be 100 times more powerful than “large amounts of money.””

    If the Fed would just test that hypothesis, we wouldn’t have to argue about it! Right or wrong, I’d be happy with the result. In fact, I’d rather be wrong.

  101. Gravatar of Doug M Doug M
    5. December 2012 at 08:29

    Chuck E,

    Yes, banks create money when they lend.

  102. Gravatar of KevinH KevinH
    5. December 2012 at 11:34

    I’m with you on everything but #2.

    If the government were to buy $100million worth of beanie-babies or JCPenny stock, wouldn’t that raise the prices of those assets? You just need simple supply and demand, not “liquidity effect.” Would you still argue the same thing if they were buying Nigerian Bonds? I think you are conflating the concentration of the effect, which is very small and distributed throughout many segments of the economy, with the presence of an effect.

  103. Gravatar of Ray Lopez Ray Lopez
    5. December 2012 at 11:56

    I went through each of these posts and as an independent observer have these comments:

    1) Scott Sumner is rebutting an argument that might be a strawman, but he does a good job rebutting it. Having been kicked out of the forum at the Austrian camp for raising an innocent question about the helicopter drop thought experiment, I sympathize with Prof. Sumner.

    2) His opponents, in particular a certain Greg Ransom, are trying to make another point and it’s not central to Sumner’s thread in this post. Scott’s thread goes to the strawman raised in his OP, viz., that it matters who gets the new money first.

    3) Ultimately, it’s the proverbial three blind men and the elephant as to who is ‘right’ on each of the respective camp’s points. The economy is non-linear and probably “all of the above” is true and not true, depending on the phase state of the system at any given time.

  104. Gravatar of Mike Sandifer Mike Sandifer
    5. December 2012 at 13:07

    Statsguy,

    You are very naive if you think any amount of evidence will ever convince many hard money people to think they’re wrong.

  105. Gravatar of Eddie Eddie
    5. December 2012 at 18:24

    Wow. I’m really shocked that sumner wastes his time reading clowns like ransom or responding to idiot austrian fanboys like ransom.

  106. Gravatar of Mike Sax Mike Sax
    6. December 2012 at 10:24

    “My entire blog is devoted to the proposition that money is non-neutral–I don’t need convincing.”

    Only in the short-term, though, correct? In the long term you believe it’s neutral, don’t you?

  107. Gravatar of ssumner ssumner
    7. December 2012 at 07:44

    prakesh, No, I’d consider purchases of stock or corporate bond funds to be monetary policy.

  108. Gravatar of Those Dreaded Cantillon Effects « Uneasy Money Those Dreaded Cantillon Effects « Uneasy Money
    8. December 2012 at 15:41

    [...] again, I find myself slightly behind the curve, with Scott Sumner (and again, and again, and again, and again), Nick Rowe and Bill Woolsey out there trying to face down an [...]

  109. Gravatar of Cantillon-effekter och Fed | Statans Dagblad Cantillon-effekter och Fed | Statans Dagblad
    25. January 2013 at 10:07

    [...] är Scotts första svar och hans andra inlägg Han skrev sedan två inlägg till på sin blogg om saken. Murphy kommentarar på Scotts blogg och [...]

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