Nick Rowe has a new post that discusses the concept of an “excess demand for money.” I’m not sure what that concept means, so I’ll address his post obliquely, by describing what I think is actually going on. I’ll let readers decide how my monetary transmission process should be described. Let’s look at a (permanent) 10% increase in the base, in 6 easy steps. For those that don’t think the Fed controls the base, just assume an interest rate targeting change that forces the Fed to increase the base by 10% in order to hit their new interest rate target.
1. Immediately after the money is injected there is an excess supply of money if we were to assume that there was no change in NGDP or any asset price.
2. However asset prices and expected NGDP growth change immediately, so that Ms is again equal to Md. There would be no excess supply or demand for money in that sense. But the goods and labor markets don’t clear, so there may be an excess supply in some other sense.
3. Time passes by . . .
4. Output and semi-sticky prices adjust. Semi-sticky prices include things like gasoline, food and real estate.
5. More time passes by . . .
6. Wages and sticky prices adjust. Output and employment return to the natural rate, and NGDP rises by 10% relative to the level that would have occurred if there were no increase in the base. Real asset prices are unchanged. Nominal interest rates are unchanged.
That’s how I see things. I prefer to call step two “monetary equilibrium,” but I don’t really have any substantive disagreement with those insist it should be called “monetary disequilibrium” because goods markets are not clearing. That’s just semantics. To me, disequilibrium is a psychological concept—frustration. I want to buy tickets to see the Stones, but the concert is sold out. I’m frustrated. When the Fed increases or decreases the base I do not walk around weeks later frustrated that my wallet contains $260 in cash, rather than $240 or $280. I’m holding exactly as much cash as I prefer to hold, given current asset prices. Any increased frustration occurs in the goods and labor markets, where people can’t sell as much as they’d like, where they are forced to work overtime against their will.
Again, I’m not saying people who disagree with me on excess money demand are wrong, just that our disagreement is mere semantics, nothing more.
PS. What causes the changes in step 4? The increase in the money supply? Yes. Or the increases in asset prices and expected NGDP growth? Yes. Either/or questions are not supposed to be answered “yes” in both cases, but this is an exception.
PPS. Those in the underground economy may feel frustration after a change in monetary policy, as it is costly to rapidly adjust cash balances via consumption, and they can’t adjust via asset purchases or sales without the IRS noticing.