Never reason from a price change, example #397

Here’s John Cochrane:

An audience member asked a very sharp question: Suppose the Fed raises interest rates but does not raise the rate on reserves? Now, banks do have an incentive to lend them out instead of sitting on them. Wouldn’t velocity pick up, MV=PY start to work again, and the Fed get all the “stimulus” it wants and then some?

It’s a particularly sharp question, because it gives sensible-sounding mechanism why the conventional sign might be wrong: why raising rates now might give monetary “stimulus” that is otherwise so conspicuously lacking. There are a few other of these stories wandering around. One: Low rates are said to discourage retirees and other savers, who now “can’t afford to spend.”  (Quotes around things that don’t make much economic sense.)   John Taylor, wrote a very provocative WSJ oped, (too subtle to summarize in one sentence here) and also came close to saying the sign is wrong and higher rates would be more stimulative.

But is the suggestion right? I sort of stammered, and needed the weekend to think it through. (Giving talks like this is a great way to clarify one’s ideas. Or maybe this just reveals my shocking ignorance. In any case, it makes a good exam question.) Think about it, and then click the “read more.”

Become a market monetarist and free up your weekends!  In fairness, the Cochrane “read more” gets it right–no need to check.

On a serious note, it’s discouraging to see Cochrane continue to insist that QE does nothing, while the markets continue to scream that the Fed’s decisions on QE are the most important thing in the universe right now.  Either reserves and T-securities are not perfect substitute, or else the Fed is sending signals about future Fed policy, when reserves and T-securities will no longer be prefect substitutes.   More likely both.

HT:  Tyler Cowen


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41 Responses to “Never reason from a price change, example #397”

  1. Gravatar of jknarr jknarr
    5. June 2013 at 10:57

    Too bad then that the Fed no longer has any short-term Treasury assets. Equivalency a bit of a moot point. The ongoing focus on the asset side is however baffling — what do we care what they buy at market prices? Fed liabilities are long-lived and important — where they are created and in what form. This is why QE has “failed” — excess reserves are meaningless in a near-zero rate environment, as NGDP is too low (and debt too high) to justify lending.

    Raising FF and lowering IOR could work, but exactly how is the Fed going to boost FF? By selling long-term notes and taking back the huge volume of outstanding excess reserves. This gives less of a lending base, not more.

  2. Gravatar of Geoff Geoff
    5. June 2013 at 11:30

    “while the markets continue to scream that the Fed’s decisions on QE are the most important thing in the universe right now.”

    How exactly are the markets “screaming” this particular argument? The fact that stocks go up with QE? Please say it’s more than that.

  3. Gravatar of OhMy OhMy
    5. June 2013 at 12:32

    2 comments:

    1. Market Monetarists always reason from the price change, but only when it suits them: rates up on QE announcement – celebration, rates down: [crickets]. Markets don’t “scream” at all, they are silent, why make stuff up? Out of the 4 QE announcements TIPS spreads didn’t even flinch 3 times, and one time they barely moved, then went back to where they were in a week or so.

    2. Someone has to inform Cochrane that banks do not lend out reserves, indeed they can’t, technically impossible. Reserves only exist as numbers in a Fed spreadsheet, impossible to lend them to anybody but another bank.

  4. Gravatar of Saturos Saturos
    5. June 2013 at 12:33

    Unrelated: has everyone seen this? I thought it was good: http://www.marketwatch.com/story/madoff-dont-let-wall-street-scam-you-like-i-did-2013-06-05?pagenumber=2

  5. Gravatar of Bababooey Bababooey
    5. June 2013 at 13:00

    Never reason from a price change, example #397

    I’m a bit obtuse, but how comes price changes in the market “scream” something, but price changes elsewhere are mute?

    Also, prices have doubled between tomorrow’s LA Kings game-tickets and the last time I went. From this, I reason something more important is happening.

  6. Gravatar of J J
    5. June 2013 at 13:57

    OhMy and Bababooey,

    Maybe Professor Sumner will disagree, but I think you two are missing the point of the ‘never reason from a price change’ mantra. Of course, price changes matter and are important data. The point is that, when reasoning from a price change, you must understand the mechanism behind the price change. If the price of apples goes up, does this mean sales of apples will fall? Or did the price go up because apple sales were going up due to an increased taste for apples? We cannot simply reason from the price change in isolation.

    Arguing that there is a correlation between stock price increases or TIPS spread increases and QE and that it is likely that causation flows from QE to stock price increases or TIPS spread increases does not violate the mantra.

  7. Gravatar of ssumner ssumner
    5. June 2013 at 14:47

    jknarr, I’m afraid I don’t follow.

    OhMy, You said;

    “Market Monetarists always reason from the price change, but only when it suits them: rates up on QE announcement”

    That’s not what “reasoning from a price change” means. Reasoning from a price change would be “I see interest rates rising, I can infer there must be some QE going on.”

    And banks most certainly can lend out reserves, they do it every day. Of course the second they are lent out they switch from being reserves to being cash. That’s obviously what Cochrane meant, and it’s what any sensible person means when they talk about lending out reserves. Many people wrongly think that most loans involve lending out reserves. That of course is false, in most cases loans are made by setting up demand deposits. But it’s not all that uncommon for reserves to actually be lent out. All you need is for someone to borrow some money, then tell the banker they want it in cash.

    bababooey, That’s not reasoning from a price change because I’m linking the price movement to the shock that caused the price movement. Reasoning from a price change would be to assume there must have been a certain change in monetary policy, merely on the basis of the interest rate change. But in this case we can see prices move in real time in response to announced changes in the money supply. When you have both P and Q data you are not reasoning from a price change.

    That’s not to say I’m never guilty of reasoning from a price change, I’ve done it plenty of times.

  8. Gravatar of Tom Brown Tom Brown
    5. June 2013 at 18:04

    @Oh My,

    I prefer to say that reserves can only go three places (and sometimes they stop being reserves when they do):

    1. To another entity with a Fed deposit (banks, GSEs, Tsy, foreign central banks, IMF, etc).

    2. Withdrawn as cash.

    3. Back to the Fed (where they’re destroyed)

    Actually the only case in which they are still reserves is 1. And then only when they go to other banks. In all other cases they cease to be reserves.

  9. Gravatar of OhMy OhMy
    5. June 2013 at 18:18

    SSumner,

    Thank you for the explanation of what “lending reserves” means. But I still disagree: banks don’t lend cash either. Nobody withdraws cash and if they do, it gets redeposited and goes back to the Fed. So we need much more than someone wanting cash, we need someone wanting cash and NOT SPENDING IT, which basically never happens, because why take the loan out in the first place? And in any case this is a decision of the borrower not the bank, so incentivizing the bank to “lend out reserves” is for naught if people don’t want to withdraw cash.

  10. Gravatar of 123 123
    5. June 2013 at 20:00

    No wonder Cochrane needed a weekend. Because the excerpt is compatible with two opposite scenarios:

    1. Charlie Plosser becomes the Fed chair, decides money is too easy, raises FFR and shrinks the balance sheet. 1937 again.
    2. Some market monetarist becomes the Fed chair, decides money is too tight, implements NGDPLT, and is forced to raise the FFR and shrink the Fed’s balance sheet.

  11. Gravatar of Benjamin Cole Benjamin Cole
    5. June 2013 at 20:51

    We need “econo-psychiatrists” to figure out this fixation, this irrepressible urge that only Phd economists get to raise interest rates and fight inflation…when inflation is at 0.7 percent, and falling, the economy is slack, and higher rates will probably slow growth.

    But can the Fed raise rates? I wonder. What happens when savers globally “save too much” despite lower rates? What happens large huge populations around the globe save, regardless of interest rates?

    Cochrane links arms with the Theomonetarists. It is not what makes sense: It is a faith-basd commitment to tight money, at least when there is a D-party president.

  12. Gravatar of Geoff Geoff
    5. June 2013 at 21:07

    “We need “econo-psychiatrists” to figure out this fixation, this irrepressible urge…

    …to believe that more green pieces of paper will make us wealthier.

  13. Gravatar of Max Max
    5. June 2013 at 23:02

    OhMy, it would be possible to force reserves to be “lent out” by penalizing (negative IOR) reserves. Banks would lend out reserves to Goldman Sachs, and GS would place the reserves (now currency) in a vault and pay someone to guard it. This would be a very “banana republic” move, though. There is no sense in a negative IOR without a plan to get rid of the zero bound.

  14. Gravatar of W. Peden W. Peden
    6. June 2013 at 04:23

    OhMy,

    “Nobody withdraws cash”

    Ladies and gentlemen: the world of MMT. Not the real world, but an interesting world, in a sense.

  15. Gravatar of OhMy OhMy
    6. June 2013 at 05:10

    W Peden,

    That’s it?

    Yes, nobody withdraws cash in quantities that would matter and sits on it, nobody takes out loans to take out cash and not spend it. If you claim that borrowing and paying interest to sit on the cash is what market monetarism describes then it is very funny. The world of MM. Not the real world, but an interesting world, in a sense.

  16. Gravatar of ssumner ssumner
    6. June 2013 at 06:44

    OhMy, You said;

    “Thank you for the explanation of what “lending reserves” means. But I still disagree: banks don’t lend cash either. Nobody withdraws cash and if they do, it gets redeposited and goes back to the Fed.”

    This is simply false, and the data shows that unambiguously. Up until 2008 over 95% of new money injected into the banking system by the Fed spilled out into cash held by the public. The public has a large and ever growing demand for cash. You should check the data.

    123, Good excuse, but I doubt it.

    Max, Good point.

  17. Gravatar of W. Peden W. Peden
    6. June 2013 at 07:02

    OhMy,

    My comment works better than yours, because I was actually referring to something you wrote.

    Deposits are liabilities to pay cash, right? Deposits expand with loans when banks expand their asset sheets by extending credit; there is no way that a bank can lend money without deposits.

    So we have banks (i) lending, (ii) creating deposits as a necessary counterpart of such lending, (iii) these deposits are liabilities to pay cash on demand (within or without the financial system i.e. even if you can’t use a deposit at an ATM/branch you can transfer funds from it to an account from which cash can be withdrawn at a branch/ATM) and (iv) the banking system requiring reserves in order to meet liabilities to pay cash on demand.

    You can refuse to CALL all that “banks lending out reserves” if you want, but an actual disagreement has to involve one of the above propositions.

    You were on a better track with your (contradictory) claim that “if they do [withdraw cash] it gets redeposited and goes back to the Fed”, which is also false and misses out most of the important details of how money works (cash also gets spent and held, and as Scott Sumner points out there is a demand for cash) but at least it’s not false not as a matter of accounting identities or the claim that “nobody withdraws cash”.

  18. Gravatar of OhMy OhMy
    6. June 2013 at 07:39

    W Peden,

    I sohouldn’t have made any comment, because actually my first post explained everything and you took it out of context.

    SSumner,

    I checked the data: monetary base up 100%, cash up 10%, but NOT through the mechanism you and Cochrane posit, loans and consumer credit went DOWN in the same period. Please produce data where more monetary base causes loans withdrawn as cash.

    http://research.stlouisfed.org/fred2/graph/fredgraph.png?&id=BASE,CURRENCY,LOANS,TOTALSL&scale=Left,Left,Left,Left&range=Custom,Custom,Custom,Custom&cosd=2008-02-15,2008-01-06,2008-01-01,2008-01-01&coed=2013-05-29,2013-05-20,2013-04-01,2013-03-01&line_color=%230000ff,%23ff0000,%23006600,%23ff6600&link_values=false,false,false,false&line_style=Solid,Solid,Solid,Solid&mark_type=NONE,NONE,NONE,NONE&mw=4,4,4,4&lw=1,1,1,1&ost=-99999,-99999,-99999,-99999&oet=99999,99999,99999,99999&mma=0,0,0,0&fml=a,a,a,a&fq=Bi-Weekly%2C+Ending+Wednesday,Weekly%2C+Ending+Monday,Monthly,Monthly%2C+End+of+Period&fam=avg,avg,avg,avg&fgst=lin,lin,lin,lin&transformation=pc1,pc1,pc1,pc1&vintage_date=2013-06-06,2013-06-06,2013-06-06,2013-06-06&revision_date=2013-06-06,2013-06-06,2013-06-06,2013-06-06

  19. Gravatar of OhMy OhMy
    6. June 2013 at 09:10

    SSumner,

    “Up until 2008 over 95% of new money injected into the banking system by the Fed spilled out into cash held by the public.”

    Up until 2008 the change in the monetary base was a RESPONSE to larger demand for cash by the public. You always get the causality wrong. Monetary base is demand driven.

    That is when you try to play the trick in the other direction, hoping the base will leak out as cash you get this:

    http://research.stlouisfed.org/fred2/graph/fredgraph.png?&id=CURRENCY,BASE&scale=Left,Left&range=Custom,Custom&cosd=2008-01-06,2008-02-15&coed=2013-05-20,2013-05-29&line_color=%230000ff,%23ff0000&link_values=false,false&line_style=Solid,Solid&mark_type=NONE,NONE&mw=4,4&lw=1,1&ost=-99999,-99999&oet=99999,99999&mma=0,0&fml=a,a&fq=Weekly%2C+Ending+Monday,Bi-Weekly%2C+Ending+Wednesday&fam=avg,avg&fgst=lin,lin&transformation=lin,lin&vintage_date=2013-06-06,2013-06-06&revision_date=2013-06-06,2013-06-06

  20. Gravatar of jknarr jknarr
    6. June 2013 at 09:23

    OhMy, you might look at the 1930s-1940s example (currency in circulation versus reserves — both are on FRED). The Fed created huge reserves in the 1930s, and then currency was hugely demanded into existence in the 1940s. This may or may not help.

    The monetary base is mostly demand driven on reserve- and currency- sides — but mostly in relation to target Fed Funds under normal conditions. At the zero bound this changes.

    Note that the Fed could force the creation of demand deposits or currency at any time by buying assets from the public — not Treasurys from the banks (for reserves).

    Most of the time, a bank uses excess reserves to make a loan, shifts reserves to required, creates a demand deposit and corresponding loan asset, and then produces cash on demand.

    The fact that the base is typically a demand function does not rule out the forced creation of the base, however. Say the Treasury wants a special loan, then the Fed creates the reserves, sets up a Treasury account, and the banks have more monetary base. Alternatively, the Fed could buy gold from the public for cash and force base creation. It’s just that we’ve not seen this for a very long while, but it is certainly a potential policy tool.

  21. Gravatar of Barry@Keyna.org Barry@Keyna.org
    6. June 2013 at 09:40

    “Cochrane continue to insist that QE does nothing, while the markets continue to scream that the Fed’s decisions on QE are the most important thing in the universe right now.”

    QE is doing great for the top 20% who own 80% of the financial assets, but the bottom 80% who are wager earners, not so much.

  22. Gravatar of Tom Brown Tom Brown
    6. June 2013 at 09:41

    I have absolutely no data to back up this assertion, but isn’t holding cash purely a matter of convenience? I choose to keep my funds in the most convenient form in any given situation, and for me that’s a bank deposit 99% of the time. I have renters who are the opposite. I don’t think they have a bank deposit. I realize that’s not “macro” thinking, but I’m struggling to see any other driver. The amount of excess reserves my bank holds has no bearing on my convenience decision (that I’m aware of!). Certainly businesses and retirement funds aren’t choosing to hold more cash than they have to are they? I’ve never taken a loan out in cash. I suppose people do (cash advances).

  23. Gravatar of Tom Brown Tom Brown
    6. June 2013 at 09:46

    And BTW, if it were up to me we’d go cashless tomorrow! Would that break something in the “transmission mechanism” if we did? I don’t like managing bits of paper or metal, so I’m looking forward to the day when we get rid of all that trash. It’s as obsolete as the post office: stuffing a box on my property with trash every day at noon like clockwork.

  24. Gravatar of jknarr jknarr
    6. June 2013 at 09:51

    TomB — you are right about convenience. Keep in mind, though, that convenient funds via the bank have tons of deadweight loss to them — fees upon fees. Currency is base money — no counterparties, no fees.

    Cash is a much better alternative for most people, frankly, and had been until the 1980s or so — no counterparty risk, no fees, no overdrafts, no debt. Credit cards are convenient, too, but again there are huge fees involved — you often can get a better price in cash.

    Banks are traditionally mostly for people with too much liquid funds to handle in cash — most people have no business paying so much in fees. The convenience is not worth it.

    Convenience is one way of looking at it, but consider also that banks and governments hate cash — it’s more difficult to extract fees and taxes from cash transactions than permanently-recorded-and-monitored electronic deposits.

  25. Gravatar of Tom Brown Tom Brown
    6. June 2013 at 09:58

    @jknarr,

    you write “Note that the Fed could force the creation of demand deposits or currency at any time by buying assets from the public “” not Treasurys from the banks (for reserves).”

    That’s primarily what happens with QE isn’t it? Isn’t it mostly non-banks that sell their Tsy debt on the open market which the Fed buys (using PDs as intermediaries)? Thus the effect is an asset swap for non-banks (with no expansion o their balance sheets), and growing balance sheets for both the Fed and the banks (and no equity change — to 0th order anyway — for anybody).

    I’ve sketched out what I think is the typical situation on super simplified balance sheets here:

    http://brown-blog-5.blogspot.com/2013/03/banking-example-4-quantitative-easing.html

    (I skip the bit about PDs doing the actual buying for Tsy, and go right to the result)

    I link to a chart at ZH that caused a lot of hyperventilating showing deposits growing faster than loans at banks after 2008, but I think QE purchases from non-banks explains this nicely.

  26. Gravatar of jknarr jknarr
    6. June 2013 at 10:05

    Tom — the problem is on the liability side. When they buy from PDs, they create excess reserves, not demand deposits. When the PD buys Treasurys from nonbanks, they need to obtain funding — and cannot use reserves.

    I’ve looked closely at the demand deposit formation of recent years — it’s absolutely remarkable. It seems to have more of a unique connection to Treasury deficits however. That is, demand deposits are the asset side to Treasury liabilities, and Treasury liabilities are tied to excess reserve assets.

    The UST remains the vector for monetary policy, not nonbank purchases.

  27. Gravatar of Tom Brown Tom Brown
    6. June 2013 at 10:15

    jknarr, I agree with you. Did you look at my example? The bank ends up with excess reserves when the Fed essentially buys from non-banks. If there were instead primarily a net sale of only bank held Tsy debt to the Fed, then it’d be an asset swap for the banks. Still resulting in excess reserves, but w/o a growth in bank balance sheets. Do you disagree?

    Regarding Tsy deficit spending, I see it this way… well actually, I have an example of that:

    http://brown-blog-5.blogspot.com/2013/05/banking-example-8-treasury-deficit.html

    In other words, it’s taking deposits from Peter to pay Paul, and issuing Peter Tsy debt in the process. Now if the Fed is buying Peter’s Tsy debt (in addition to Tsy deficit spending), then yes, I can see it directly contributing to more demand deposits as in my example #4 in my previous post.

  28. Gravatar of jknarr jknarr
    6. June 2013 at 10:34

    TBrown, I agree — we get into the weeds on demand deposits however — the repo funding is derived from deposits somewhere, and we are talking net effects. It’s more of a money market-demand deposit swap potentially.

    IMHO, PD based QE can produce DDs, but its comparatively trivial vs 1:1 direct purchases, mostly because slow NGDP and low rates. Otherwise, PDs would take the reserves and lend — the traditional DD formation route. Consider the currency case — the Fed buys gold from the public and funds it with $100 bills — that would be expansionary.

  29. Gravatar of TheMoneyIllusion » AS/AD, now more than ever TheMoneyIllusion » AS/AD, now more than ever
    6. June 2013 at 10:36

    […] Bernanke is engaged in.  BTW, American NGDP is up 12.1% in 5 years, which is still too little.  Commenter Barry […]

  30. Gravatar of ssumner ssumner
    6. June 2013 at 15:51

    OhMy, So after 1964 the public’s demand for cash started mysteriously soaring at a much higher rate, perhaps so they’d have enough cash to buy things during the Great Inflation. Is that your claim?

    Tom, I’m just the opposite. I’d keep cash and get rid of bank deposits at the Fed. I’d make the base 100% cash, as it used to be.

  31. Gravatar of Tim Condon Tim Condon
    6. June 2013 at 16:19

    Does Cochrane’s difficulty arise because he’s effectively thinking of a non-monetary economy with no currency providing transactions services? He’s in a general equilibrium world where the fed is another actor in the Treasury market and reserves are a perfect substitute for s-t treasury bills. The fed may want a different rate on t-bills than the market produces but any attempt to do anything to get it will be undone by the market.

  32. Gravatar of OhMy OhMy
    6. June 2013 at 16:21

    Ssumner,
    My claim is that movements in deposits and loans Granger cause movements in the base, as documented by econometric studies. Do you claim the causality runs the other way? Which studies back this up?

  33. Gravatar of jknarr jknarr
    6. June 2013 at 17:09

    OhMy — would you say that the Fed could, at least in theory, create a larger monetary base without the participation of loans?

    I am absolutely certain that the causality runs lending -> base for much of the historical data. Banks make loans and then need to obtain reserves over the (lagged) maintenance window. I don’t need Granger for that.

    The point is that it’s not necessarily one-way. Could you consider different circumstances where the Fed creates base money in the absence of vigorous lending? What did Zimbabwe’s central bank do?

  34. Gravatar of OhMy OhMy
    6. June 2013 at 17:41

    jknarr,
    Yes the Fed creates the base. And? Nothing more happens. The base causes nothing. That is all I say. Yes, many CBs showed: they can push the base wherever, it just doesn’t do anything else than push the rates down (that is why they pay IOR if they have a non zero policy)

  35. Gravatar of jknarr jknarr
    6. June 2013 at 17:47

    OhMy — we’re including currency in the base, right? I understand your argument from the reserves point of view — it’s all around us at present — but consider the extreme case of printing currency to fund large-scale government operations: the central bank gets a special IOU, the government gets currency and spends it, and increases the base. It seems to me that this would do something to prices (that would not necessarily occur with reserve formation).

  36. Gravatar of OhMy OhMy
    6. June 2013 at 18:13

    jknarr,
    Base does include currency but that component is demand-determined. The CB cannot make us convert our deposits into cash, how would it do it? Do you know anybody who senses the CB made some large securities purchase and runs to withdraw cash?

  37. Gravatar of jknarr jknarr
    6. June 2013 at 18:44

    OhMy — I understand and agree with the point, but you (understandably) put demand deposits in front of currency.

    Just to be clear, demand deposits are derivatives of base money — they are promises to deliver currency on demand, and nothing more. The ultimate value of the USD is due to the scarcity of base money. And the CB does help the conversion — near-zero Fed Funds does “make us convert” deposits into cash — zero rates plus fees plus bank run counterparty risk makes DD a welfare-destroying means of storage vs currency. DD typically gets yield for a reason, and cash pays zero — which is the inferior asset?

    Historically, this demand for base money currency in Zimbabwe and Weimar came from the government — they will spend currency if push comes to shove. Yes, you could hang on to your demand deposits as long as you like — you are right in that you cannot be forced — but you’d get pennies on the dollar in real terms. Hence, you’d be “made to convert” pretty quickly.

  38. Gravatar of Tom Brown Tom Brown
    6. June 2013 at 19:04

    @Scott,

    “Tom, I’m just the opposite. I’d keep cash and get rid of bank deposits at the Fed. I’d make the base 100% cash, as it used to be.”

    That’s so 20th century!… or should I say, 1st and 2nd millennium! 😉

    But seriously, do you know anyone that really uses paper much anymore? How about at your work? Anybody that reads paper books, newspapers or magazine? Mails paper letters? Ha! … paper’s OK for sopping up spills and for in the bathroom, but I find less and less of a use for it other than that. It had a good run. Time to move on. Good riddance!

  39. Gravatar of OhMy OhMy
    6. June 2013 at 19:04

    jknarr,

    “Just to be clear, demand deposits are derivatives of base money “” they are promises to deliver currency on demand, and nothing more. The ultimate value of the USD is due to the scarcity of base money. ”

    Most dollar-denominated debts are not cancelled with actuall dollars but with… other debt. You borrow 100k, the bank types a number into an execel spreadsheet, 1 and 5 zeros. That is it. Yes it is a promise to pay 100k USD if you say so, but most of the time none of these 100k IOUS will get settled in USD. In the end you will amass a 100k deposit, bank’s debt towards you and you will pay off the loan not by paying 100k USD but by telling the bank to cancel the deposit – the debts are cancelled against one another.

    “The ultimate value of the USD is due to the scarcity of base money. ”

    I disagree. There is never a scarcity of base money, that is the role of the Fed, it guards the stability of the payment system. When you want to convert your other assets to base (like treasuries) the Fed will always do it, in fact it will do it without thinking about it: by selling your treasuries you put an upward pressure on the rate and some intern at the Fed will do an OMO to get the short rate inside the targeted bank. That is it.

    The value of dollars (and treasuries) comes from the fact that they are units the state accepts in payment of our tax obligation, they are tax credits. This is how state money was introduced each time in history: the state (king) would introduce a tax payable in stuff only he possessed: like his own coins. He didn’t need the coins, he minted as many as he wanted. The public didn’t have them. Therefore when he spent them, although they always were stamped with value HIGHER than the metallic content they were accepted. So a $1 dollar gold content coin stamped “$10” would extinguish a tax obligation of $10 to the state. Nobody will sell if for goods worth $1, so it circulates at $10. Gold is just a medium, like watermarked paper today, something hard to counterfeit. If the kind did it the other way: mark a coin with $10 gold content “$1” he would never see his gold again – it would be melted and sold for $10.

    points 7 and 8 here:
    http://neweconomicperspectives.org/p/modern-monetary-theory-primer.html

  40. Gravatar of jknarr jknarr
    6. June 2013 at 19:38

    A Chartalist! The point is that base money extinguishes a demand deposit/loan — there may be a treasury asset on the other side of the Fed, but fiat central bank balance sheets are effectively unbacked. I know MMT well, so its nice to have met one “in the flesh”.

    Again, what is stopping a government from over-providing base currency? It defines the currency and creates supply-demand conditions, but this is an open system, not closed. Gold’s not a good example (note too that gold has more unique properties than counterfeiting — it is dense, has a high stock-to-new-flow and does not corrode away.)

  41. Gravatar of ssumner ssumner
    7. June 2013 at 06:29

    Tim, I’m not sure.

    OhMy, Granger causation tells us little or nothing about actual causation in a world of ratex.

    Suppose you had an economy with currency but no banking system. Would currency then cause inflation?

    Tom, Currency is becoming a more important component of the money supply, not less important. The demand for currency has been soaring.

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