Short intro course on money

I tried to put together a short intro course on money for students who have already studied basic macroeconomics.  It consists of nine posts:

1.  Money matters a lot. (and non-monetary shocks don’t matter as much as you’d think.)

2.  Why does money matter?

3.  Money and inflation, pt. 1:  The long twilight of gold.

4.  Money and inflation, pt. 2:  Why does fiat money have value?

5.  Money and inflation, pt. 3:  The “hot potato” model (The QTM and the Great Inflation)

6.  Money and inflation, pt. 4:  The role of expectations

7.  Money and inflation, pt 5:  It’s (almost) all about expectations

8.  Money and output (the musical chairs model)

9.  Money and asset prices (the liquidity effect as an epiphenomenon)

I will maintain a link under “Quick intro to my views” in the right column.  I may update occasionally.

 


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53 Responses to “Short intro course on money”

  1. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    7. April 2013 at 09:21

    As I read this I’m sort of watching C-Span, and hearing the most incomprehensible gibberish this side of Prof. Irwin Corey from David Stockman.

    If anyone knows Stockman or his family, advise that he gets a medical exam, immediately. I’m not kidding that he appears to be on the verge of Alzheimer’s. Krugman was being kind in merely calling a cranky old man.

  2. Gravatar of Mike Sax Mike Sax
    7. April 2013 at 10:34

    Thanks Scott I find this compilation very helpful. Regarding the idea that real shocks don’t cause recessions you have allowed in the past that the 70s oil shocks might qualify for this. So how to account for this: the exception that proves the rule?

  3. Gravatar of Don Geddis Don Geddis
    7. April 2013 at 11:31

    “for students who have already studied basic macroeconomics” I think you’re aiming too narrowly. Even your very first post in the series starts off with: “they need to unlearn things they believe, that just ain’t so”. Do you honestly think it would be more helpful for a student to have studied (wrong) “basic macro” — vs. perhaps just being familiar with only micro econ — before trying to tackle your series?

  4. Gravatar of Ben J Ben J
    7. April 2013 at 15:30

    Don Geddis,

    Some into to macro courses I’m aware of don’t even include money.

  5. Gravatar of Ben J Ben J
    7. April 2013 at 15:34

    Intro*, sorry.

  6. Gravatar of ssumner ssumner
    7. April 2013 at 16:55

    Mike, Oil might have played some role in the 1974 recession, but so did monetary policy, price controls, the end of the Vietnam war, etc.

    Don, Maybe, I just meant I didn’t want to have to explain what NGDP is, or the Fed, or open market operations, etc., etc.

  7. Gravatar of ChargerCarl ChargerCarl
    7. April 2013 at 18:46

    This is much appreciated, thanks.

  8. Gravatar of Joe Eagar Joe Eagar
    8. April 2013 at 02:53

    I found these posts very insightful; clear, easy to understand, very accessible. I do wish Dr. Sumner had addressed the problem of monetary/fiscal policy conflict, which seems to be one of the great unsolved policy dilemmas of our time. No one really knows what central banks should do if fiscal policy is appreciating the real exchange rate and overheating the economy; the typical answer is “make the fiscal authorities stop appreciating the real exchange rate.”

  9. Gravatar of Paul Andrews Paul Andrews
    8. April 2013 at 04:05

    Patrick,
    What specifically do you disagree with that Stockman has said?

  10. Gravatar of Paul Andrews Paul Andrews
    8. April 2013 at 04:21

    Seems about as far from Alzheimer’s as nearly everyone else:
    http://www.marketwatch.com/Story/story/print?guid=FE3CE546-9C9A-11E2-A906-002128040CF6&buffer_share=5c6b8&utm_source=buffer

  11. Gravatar of Daniel Daniel
    8. April 2013 at 05:09

    Well, yeah – if the Fed (and the rest of the central banks) had done its (their) job correctly in 2008, we wouldn’t be at the “zero lower bound”. Nor would they have to expand their balance sheets.

    But two wrongs don’t make a right.

    Stockman IS a cranky semi-senile old coot. The gold standard ? “Less debt, more work” ? “ZOMG zero interest rates” ? He’s got nothing constructive to say – just your average garden-variety Fed basher. And he isn’t even bashing them on their real failures.

  12. Gravatar of Mike Sax Mike Sax
    8. April 2013 at 05:41

    Paul while you didn’t poise the question directly to me, how about saying that we should raise interest rates with such high unemployment and slow growth?

  13. Gravatar of Daniel Daniel
    8. April 2013 at 06:17

    I doubt this will make any austro-nut change his/her mind, but I look forward to their mental gymnastics

    http://marketmonetarist.com/2013/04/07/the-austrian-bust-higher-inflation-and-relative-deflation/

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  17. Gravatar of Paul Andrews Paul Andrews
    8. April 2013 at 12:57

    Mike,

    (re Stockman).

    “Paul while you didn’t poise the question directly to me, how about saying that we should raise interest rates with such high unemployment and slow growth?”

    Artificially low interest rates induced by monetary stimulus encourage malinvestment. We have persistent high unemployment and slow growth because of the inflationary policies, and therefore malinvestment, of the last 30+ years. Higher interest rates would cause malinvestments to be cleaned out, allowing resources to be put to more productive use. Yes there would be a period of pain as a result, but in the medium to long term the economy would be much healthier.

    Even though people may reasonably disagree with that, there are very persuasive arguments in its favor, and a proponent of these views doesn’t deserve character assassination (although I can understand why that occurs – it has happened to many inconvenient truthsayers over history, including during the many episodes of escalating money-printing).

    Let’s find some common ground – let me know the first part you disagree with and we can discuss to see where we agree and where we part company.

  18. Gravatar of Daniel Daniel
    8. April 2013 at 14:13

    Lemme have a go at this

    Artificially low interest rates

    As opposed to what exactly ?

    induced by monetary stimulus

    Define “monetary stimulus”.

    malinvestment

    Define “malinvestement” in a non-circular way.

    persistent high unemployment and slow growth because of the inflationary policies of the last 30+ years

    That doesn’t even make sense.

    Inflation has been 2-3% for the past 25+ years. Unemployment soared after the NGDP plunge of 2008. Growth was steady during the “Great Moderation”.

    What planet are you living on ?

    Higher interest rates would cause malinvestments to be cleaned out

    More circular logic.

    there would be a period of pain, but in the medium to long term the economy would be much healthier

    Bloodletting is good for ya, I tell ya !
    What, the patient is getting pale ?
    It’s just the toxins leaving the body.

    In short – everything is a bubble, easy money is a sin, we must repent.

  19. Gravatar of Daniel Daniel
    8. April 2013 at 14:35

    But anyway, check out 3.4

    http://econfaculty.gmu.edu/bcaplan/whyaust.htm

    The Austrian Business Cycle has been debunked many times over. The fact that some people still cling to that piece of nonsense only proves their limitations.

  20. Gravatar of Paul Andrews Paul Andrews
    8. April 2013 at 19:17

    Daniel,

    You seem to be of the opinion that the summary I put forward is entirely irrational.

    However there are many completely reasonable people making exactly these points.

    I’m sure we can all gain a better understanding if we engage rather than besmirch our opponents.

    I’m happy to give answers to the specific points you have made, and to discuss them politely and rationally in the spirit of finding common ground, if you are willing to do the same.

    In a previous conversation I asked for your opinion on a series of questions, in an attempt to find common ground. If you’d like to provide your answers I’m happy to continue with a discussion that is calm and respectful.

    The questions were:

    “Do you agree that sometimes people buy assets purely because they are increasing in price?

    If you agree with that, do you agree that a positive feedback loop is sometimes created: people buy because price is going up -> causes price to increase further -> more people buy because price is still going up -> etc. ?

    If you agree with that, do you agree that eventually the stock of such people who are liable to the described behavior with respect to the particular asset will run out?”

  21. Gravatar of Mike Sax Mike Sax
    8. April 2013 at 19:47

    Paul where do I start to disagree? Well let’s look at what you actually said:

    “Artificially low interest rates induced by monetary stimulus encourage malinvestment. We have persistent high unemployment and slow growth because of the inflationary policies, and therefore malinvestment, of the last 30+ years. Higher interest rates would cause malinvestments to be cleaned out, allowing resources to be put to more productive use. Yes there would be a period of pain as a result, but in the medium to long term the economy would be much healthier.”

    I’m not sure what I think about the first two sentences but it’s not a slam dunk that it’s right. However at the third sentence that higher interest rates would clear out malinvestments you have defintely lost me.

    I agree with the first half of your prediction: it would lead to a lot of short term pain. HOwever, I think the long term would have pain as well.

    Actually Lars Christensen has an interesting piece about Austrianism today that touched on your point-to be sure I’m not sure whether your an Austrian though your views expressed here sound like it.

    I will quote a few paragraphs that I think are especially relevant:

    “An increase inflation should be welcomed if it reflects a rational and undistorted reaction to investors realising that they have made a mistake. That is exactly what happens in an Austrian style bust. We might get relative deflation/disinflation, but the aggregate price level increases due to the negative supply shock.”

    “Therefore, when Austrians often argue that the bust should be allowed to play out without any interference from the government or the central bank then that logically mean that they should welcome an increase in inflation in the bust phase of the business cycle. That obvious is not that same saying that monetary policy should be eased in the bust phase, but inflation should nonetheless be allowed to increase as we get “benign” inflation.”

    “However, in my view that would mean that it would be wrong from an Austrian perspective for the central bank to tighten monetary policy in response to rise in (supply) inflation during the bust. Those Austrian economists who favour NGDP level targeting – like Anthony Evans and Steve Horwitz – would likely agree, but what about the “internet Austrian”? And what about Bob Murphy or Joe Salerno?”

    “Obviously the story I have told above is a caricature of the Austrian Business Cycle theory, but I think there is a relevant discussion here that need to be addressed. Is the aggregate price level likely to rise in the bust phase as natural consequence of market forces being allowed to run it cause?”

    “The reason that I think this debate is important is that some Austrians spend a lot of time arguing that the deflationary tendencies that we see for example in Europe at the moment are a natural and necessary bursting and deflating of a bubble. However, IF we indeed were in the bust phase of a Austrian style business cycle then we would not be seeing deflationary tendencies. We would in fact be seeing the opposite – we would see HIGHER inflation, but at the same time relative deflation.”

    “Obviously this is not what we are seeing in the US and Europe today – inflation in both the US and the euro zone is well-below what it was during the “boom years”. That mean that we are not in the bust phase of an Austrian style boom-bust. There might very well have been a boom-bust initially (I believe that was the case in some European countries for example), but we have long ago moved to another phase – and that is what Hayek termed secondary deflation – a downturn in the economy caused by an monetary contraction.”

    I nmy view, higher interst rates right now might please some high savers but would lead us on the macro level to Euroepean conditions from relatively more healthy U.S. conditions.

  22. Gravatar of Mike Sax Mike Sax
    8. April 2013 at 21:19

    About the only thing I can say nice about Stockman is that he at least seems to be sincere. Now that sincereity is in the service of ideas I think are wrong-obssessiive preoccupations with debt and austerity but he left the Reagan White House in protest to it’s deficits.

    So unlike most Republicans who are only deficit hawks during Democratic Administrations, he’s a true blue deficit hawk.

    Unfortunately his cause is wrong but he’s honestly devoted to it.

  23. Gravatar of Mike Sax Mike Sax
    8. April 2013 at 21:20

    Here is my two cents on the Stockman-Krugman debate.

    http://diaryofarepublicanhater.blogspot.com/2013/04/some-thoughts-on-krugman-vs-stockman.html

  24. Gravatar of Paul Andrews Paul Andrews
    8. April 2013 at 22:42

    Mike,

    I said:

    “Artificially low interest rates induced by monetary stimulus encourage malinvestment. We have persistent high unemployment and slow growth because of the inflationary policies, and therefore malinvestment, of the last 30+ years. Higher interest rates would cause malinvestments to be cleaned out, allowing resources to be put to more productive use. Yes there would be a period of pain as a result, but in the medium to long term the economy would be much healthier.”

    You said:

    “I’m not sure what I think about the first two sentences but it’s not a slam dunk that it’s right. However at the third sentence that higher interest rates would clear out malinvestments you have defintely lost me.”

    So you think that it’s at least possible that artificially low interest rates induced by monetary stimulus encourage malinvestment, and that we have persistent high unemployment and slow growth because of the inflationary policies, and therefore malinvestment, of the last 30+ years.

    If it’s possible that persistent low interest rates have caused the current high unemployment and slow growth, isn’t it also possible that to rectify that we need higher interest rates?

    Re: Austrianism. I don’t count myself as an “Austrian”, but my views do overlap a fair bit with Austrian economics. I don’t agree that we need a gold standard. I agree that private corporations should not be propped up by government. This should preclude the purchase of private securities such as RMBS by the central bank. I think a 0% inflation target would be a vast improvement over continual inflation (however low). I think the central banking system is vastly better than pure fiat systems in which the government issues currency directly, but is susceptible to acting in the interests of powerful financial interests, rather than from sound economic principles. Therefore I would prefer to see rule-based central banking, which maintains a fixed per-capita base money level, or a 0% inflation target. Perhaps better would be a relaxation of legal tender laws, allowing various currencies to compete, but I am not totally convinced of this.

    Regarding the passage you quoted from Lars Christensen, I think he misses one of the fundamental Austrian points – that you can’t just look at aggregates. The economy is highly complex and organic – if there’s a supply shock, some goods may increase in price. Others will decrease. In the bust, the economy changes qualitatively. New things get produced. Other things stop getting produced. To look at it purely quantitatively, especially in highly aggregated national statistics, leads to fundamental misunderstandings. The qualitative change – the restructuring – is fundamentally an organic process and is not amenable to central control. Tinkering with aggregates, especially if intended to maintain an old status quo, gets in the way. To me this is a key insight of the Austrians and one aspect that I think they have exactly right. Lars talks only about aggregates in the passage you quoted.

    You said:

    “In my view, higher interest rates right now might please some high savers but would lead us on the macro level to European conditions from relatively more healthy U.S. conditions.”

    I can understand why it looks that way to a lot of people. I think where we would part company would be on the importance of the organic structural nature of economies, and on the power of natural emergent forces in complex systems that are left alone rather than tinkered with. I believe that power is very strong, and this leads me to think that in the long term allowing complex economies to operate freely results in them being much healthier.

  25. Gravatar of Daniel Daniel
    9. April 2013 at 03:59

    Paul Andrews,

    YOU are the person saying – “we need to inflict MORE PAIN in order to purge the rottenness out of the system”.

    That, to me, sounds more like the stuff a sadistic inquisitor would say. And I’m not really interested in finding “common ground” with such people.

    I also find it very ironic and amusing when people who profess faith in the free market speak of “malinvestment”.

    Well, which one is it, dude ? Sounds to me like you think the free market is a dim-witted animal easily led astray.

    And last, but not least, I keep asking you to operate with non-vague and falsifiable statements – and the need to do so goes right over your head.

    That, to me, is conclusive evidence that this is not about economics – but about a moralistic world-view – one in which the sin of “easy money” must not go unpunished.

  26. Gravatar of Paul Andrews Paul Andrews
    9. April 2013 at 06:14

    Daniel,

    There is far more pain in an unhealthy economy than a healthy one. The goal is to reduce total pain over the long term, not to minimize short term pain. To prolong long term pain in order to achieve short term temporary pain relief is more sadistic than the alternative.

    Fully free markets punish those who make poor investments. Propped-up markets allow poor investments to continue.

  27. Gravatar of Daniel Daniel
    9. April 2013 at 06:37

    Let’s take the existence of central banks as a starting point. In a perfect world, such a thing would not exist – but we don’t live in a perfect world.

    So we cannot be “fully free” (whatever that means).

    The question is – what now ? What do we instruct these central banks to do ?

    Interestingly enough, Hayek thought that keeping NGDP steady was the best one could do in such circumstances.

    People like you seem to think that monetary contraction is the answer – since anything else is “propping up sinners”.
    And when somebody points out that “sticky wages” are a very real thing – he/she gets branded “a central planner”.

    Dude, just face it – your world-view is guided by your moral intuitions. And it’s leading you astray.

  28. Gravatar of Mike Sax Mike Sax
    9. April 2013 at 06:54

    Paul I get that Austrians say aggregates don’t matter or aren’t the vital thing. I just happen to disagree with this. IN truth they are holding out for the return of 19th century economics, when there was no Macro only Micro-ie, pre Keynes.

    I don’t buy it. ONe crucial issue is whether you argree with methodological individualism-which believes that the whole is merely the sum of its parts-ie, the whole or aggregate is merely additive.

    Of course in questioning methodological individualism I’m not only questioning Austrians but a lot of the mainstream Neoclassical establishment, although more mainstream economists are not so extreme in their application of it.

    Major Freedom always struck me as particularly Rothbardian and extreme in his MI where you could never say “Unemployment is high” only that “some people are unemployed other people aren’t” yet, why should we constrain ourselves in this way?

    If it’s possible for us to ascertain that some people are unemployed why can’t we also see if a lot of people are unemployed at one particular time or a smaller number at another time.

    That’s also an incredibly insensitive claim to make when unemployment is actually quite elevated as it has been since 2008.

    I know this is what MF said not you but my point is that this is where the refusal to use aggregates gets us if taken to its logical conclusion.

  29. Gravatar of Paul Andrews Paul Andrews
    9. April 2013 at 07:10

    Daniel,

    As mentioned above I favor rule-based central banking, which maintains a fixed per-capita base money level, or a 0% inflation target – i.e. as close to true price stability as possible. An arbitrary 2% inflation target does not produce stable prices, it produces stable price growth.

    The central bank should be responsible for one thing only – the stability of the currency. It should not attempt to “manage” the economy.

    I haven’t mentioned anything about “sinners” in any of my comments.

    Sticky wages are certainly real – I’ve never said that anyone who thinks that is a “central planner”, but trying to “solve” sticky wages via monetary easing encourages them to stay sticky.

    Hayek, once to my knowledge, in 1974 said that he favoured stabilization of NGDP at a particular level (not at a particular growth rate) *in extreme cases*, NOT a permanent stabilization. You can find an in-depth discussion here: http://www.themoneyillusion.com/?p=14468 If you have evidence otherwise please provide a reference.

  30. Gravatar of Paul Andrews Paul Andrews
    9. April 2013 at 07:25

    Mike,

    I don’t have an absolute aversion to aggregates.

    However they don’t tell the full story – I guess you would agree with that.

    I would go further and say that they tell a tiny fraction of the full story. They certainly aren’t the “vital thing” in my opinion, so perhaps that is where we part company.

    In other words, yes, we should monitor the unemployment rate. But we can’t fix it when it goes up simply by employing more people as part of a central plan. (Well, we can for a time, but it cannot be sustained in the long term). When the focus is entirely on aggregates, there is always a temptation to treat the symptoms. (e.g. printing more money to try to achieve an arbitrary 5% NGDP growth rate).

    To me it is beyond doubt that complex systems can be self-organizing and have produced absolutely incredible, astounding results. Look at evolution for example. (If you are a creationist then you may not agree here of course).

    I think there is little doubt that America became a great economy as an emergent phenomenon grounded in the free actions of many self-interested individuals.

  31. Gravatar of Daniel Daniel
    9. April 2013 at 07:26

    Ahem, so it seems that stabilizing NGDP per capita (aka people’s nominal incomes) is indeed a desirable thing.

    Then why should the Fed raise rates now ? Inquiring minds need to know.

    Also, it should be kept in mind that during the “Great Moderation”, a 5% percent yearly nominal increase was imbedded in debts and wages – I take it that the cost of adjusting to a 0% nominal growth is worth it ?

    Because, after all, what’s a “lost decade” of economic hardship compared to redeeming our sins.

  32. Gravatar of Paul Andrews Paul Andrews
    9. April 2013 at 07:31

    Mike,

    “whole is merely the sum of its parts-ie, the whole or aggregate is merely additive”

    The whole is certainly much, much more than the sum of its parts. What is a pile of atoms compared to the same pile reconfigured to form a living human?

    The whole concept of emergence epitomises the belief that the whole is much more than the sum of its parts. Emergence is core to Austrian economics, and is core to my beliefs also. I don’t understand the tendency of some Austrians to deny the existence of certain emergent phenomena – e.g. “society”. I think they are on the wrong track.

  33. Gravatar of Paul Andrews Paul Andrews
    9. April 2013 at 07:36

    Daniel,

    “Ahem, so it seems that stabilizing NGDP per capita (aka people’s nominal incomes) is indeed a desirable thing.”

    How so?

  34. Gravatar of Mike Sax Mike Sax
    9. April 2013 at 07:38

    I’m glad to hear Paul that you agree that the whole is more than its parts. I can see that whether or not I agree with you on everything-who does agree on everything-there’s more sophistication in the way you look at things than what many of us have stereotyped as the classic “Internet Austrian”

  35. Gravatar of Mike Sax Mike Sax
    9. April 2013 at 07:40

    On the other hand I still disagree with you on the big question of demand stabliziation of course.

  36. Gravatar of Daniel Daniel
    9. April 2013 at 07:40

    Ya know, that whole “stability of currency thing”.

    I have better things to do than play mind games.

  37. Gravatar of Mike Sax Mike Sax
    9. April 2013 at 07:42

    But I have read some Austrian stuff-Steve Horowitz for instance-that make you think at least. I mean some of what ABCT models does explain aspects of the business school neither the Market MOnetarists nor even New Keynesians like Krugman seem to have any interest in explaining.

    Like for instance the spike in oil prices in 2008 could be seen as predicted by ABCT if the prediction for inlfation is applied not to the bust itself but just prior to it.

  38. Gravatar of Paul Andrews Paul Andrews
    9. April 2013 at 08:02

    Mike,

    I haven’t read Horowitz – I will take a look, thanks.

  39. Gravatar of Paul Andrews Paul Andrews
    9. April 2013 at 08:03

    Daniel,

    A stable currency does not imply stable NGDP.

  40. Gravatar of Daniel Daniel
    9. April 2013 at 08:05

    How does one measure a currency’s “stability” ?

  41. Gravatar of Paul Andrews Paul Andrews
    9. April 2013 at 08:33

    Daniel,

    The same types of measures we use now – CPI, price deflators, exchange rates. I’m not saying we change the control panels, just that we stop manipulating the base money level to achieve ends other than currency stability.

    Now, I’ve paid you the courtesy of answering some of your questions – perhaps you could pay me the same courtesy?

  42. Gravatar of Daniel Daniel
    9. April 2013 at 08:39

    Ahem, so the CPI is a gauge of “stability” ?

    So … hmmm … when faced with a supply shock (say, a civil war breaks out in Nigeria and the price of oil goes up) the proper thing to do, according to your logic, is a monetary contraction. Otherwise we would have (supply-side) inflation.

    Jeez man, you really are dense.

    Anwers ? OK.

    The concept of “bubbles” is so vague and unfalsifiable as to be completely useless. The fact that some people invoke such a concept in order to justify their sadistic macro policies speaks only of their mindset.

    Satisfied ?

  43. Gravatar of Paul Andrews Paul Andrews
    9. April 2013 at 16:21

    Daniel,

    You don’t seem to want to answer this simple question:

    Do you agree that sometimes people buy assets purely because they are increasing in price?

    Yes or no?

  44. Gravatar of Geoff Geoff
    12. April 2013 at 05:57

    Paul Andrews:

    “Do you agree that sometimes people buy assets purely because they are increasing in price?”

    You should be clearer on this one, Paul. What you’re really asking is

    “Do you agree that sometimes people buy assets purely because they have increased in price.”

    In other words, do people buy assets purely because the history of the asset’s price is one of increase?

    I for one agree that people do that.

  45. Gravatar of Geoff Geoff
    12. April 2013 at 05:58

    I’ve personally witnessed many investors agreeing to buy certain mutual funds for example on the basis that those funds have increased in price in the recent past.

  46. Gravatar of Paul Andrews Paul Andrews
    12. April 2013 at 07:08

    I’m comfortable with either wording Geoff and yes I think most people would have either done this or have direct knowledge of people who have done it.

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