Adding prose to Nick’s poetry

In recent years Nick Rowe has come up with a clever set of metaphors to describe a central puzzle of monetary economics—the fact that easy money both lowers and raises interest rates.  Here’s the punchline of his latest:

According to that theory: if the central bank wants to lower the real interest rate on paper money (because it thinks there’s a danger the real interest rate on paper money will rise above target unless it does something) it needs to lower the nominal interest rate on electronic money. The central bank calls this the “short run” part of its theory.

But, according to that same theory: if the central bank’s target for the real interest rate on paper money were lower, the nominal interest rate on electronic money would need to be higher. The central bank calls this the “long run” part of its theory.

Very few people understand the central bank’s theory. Even some very good monetary economists don’t get the short run part, and think that if the central bank wants to lower the real interest rate on paper money, all it needs to do is raise the nominal interest rate on electronic money.

Just in case you haven’t figured it out yet: this is not an imaginary world. It’s the real world. But it definitely is weird. Only a finance theorist could have dreamed up a world this weird.

This is a bit unfair to Nick, like quoting just the last stanza of a poem.  Please read the whole thing. Here I’d like to talk a bit more about the money/interest rate puzzle—what drives it, and why it’s so important.

Let’s start with a simple flexible price world, where the central bank decides to increase the trend growth rate of zero interest fiat money.  Most monetary models would predict superneutrality, which means that the inflation rate and the NGDP growth rate and the nominal interest rate would rise in proportion to the rise in the money supply growth rate.  We will call this assumption A.  I’m going to try to amend this example with two other assumptions, to see if they can cause this result to “flip,” so that easy money makes nominal rates fall.  Neither will work.

B.  Now assume that prices are sticky.  What happens if the money supply growth rate increases? Most likely rates will still rise over time.  They might even rise immediately.  This is something like what occurred during the “Great Inflation.” And nominal rates rose during that episode.  Trend rates by definition involve long periods of time, and prices are flexible over long periods of time.

C.  Now go back to the flexible price assumption, but change the example from an increase in the growth rate of M to a one time increase in the money supply.  With flexible prices money should be neutral even in the short run (technically you also need flexible debt payments, i.e. indexed mortgages.)  If money is neutral then P and NGDP immediately rise in proportion to the rise in money, and nominal interest rates are unchanged.  This is what happens during a “currency reform.”

So we still have not reversed the results.  We still don’t have a clear and unambiguous example of easy money lowering nominal rates.  Sticky prices didn’t do the job, nor did switching to a one-time change in M.  But now let’s see what happens if we try both assumption B and assumption C at the same time:

D.  Assume a sticky price world and a one-time rise in M.  Now we have short run disequilibrium in the sense that the supply of money exceeds the demand for money, and since prices are sticky the price level has not risen enough to restore equilibrium.  But nominal interest rates can immediately fall, and this lowers the opportunity cost of holding cash and electronic reserves.  So we do reach an equilibrium in one sense, nominal rates adjust to equilibrate the supply and demand for money. Then in the long run prices adjust and nominal rates return to their original level.  Money is neutral in the long run.  We have a more comprehensive macroeconomic equilibrium in the long run, whereas we only reach a monetary equilibrium with the adjustments in nominal rates.

Thus to reverse the Kocherlakota/Williamson result that inflation and nominal rates move in the same direction, we need not one but two assumptions—a onetime rise in M and sticky prices. That’s why it seems like such a perplexing puzzle, the resolution is not simple.  And I think the reason Nick and the rest of us MMs keep harping on this issue is that it seems really important.  Consider a few facts:

1.  The declines in NGDP during 1929-33 and 2008-09 seemed to be lose-lose events.  Almost everyone lost money, from the poor to the banksters.  Hard to believe that special interest politics would have led Fed officials to intentionally engineer such catastrophes.

2.  Easier money would have prevented or at least greatly moderated these two disasters.

3.  One reason that money wasn’t made easier is that almost everyone (wrongly) assumed money was already incredibly easy.  If nominal rates had been 8% during 1930 or 2008, the Fed would have cut them sharply.

4.  Their assumption was wrong because very few people understand Nick’s nice little parable.

As so we must suffer.

PS.  Nick needs to collect all his little stories into a book.  I’m imagining the monetary equivalent of Italo Calvino’s Invisible Cities.  Something like “Imaginary Economies.”


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100 Responses to “Adding prose to Nick’s poetry”

  1. Gravatar of flow5 flow5
    23. January 2014 at 08:54

    Whether interest rates rise or fall (given any injection of liquidity by the Fed), principally depends upon whether at that time, the rate-of-change in the proxy for inflation is rising or falling. I.e., the level of interest rates principally depends upon inflation expectations.

  2. Gravatar of benjamin cole benjamin cole
    23. January 2014 at 10:32

    Excellent blogging.
    Sadly, the media is constantly referring to the “ultra-accommodative” Fed, blah, blah, blah.
    So why record-low inflation?
    The real risk: sluggish growth and we hit next recession while still near ZLB.
    At that point the Krugmans will call for huge deficit spending and the Cochranes will say QE didn’t work…the United States of Japan, here we come?
    Sometimes it seems inevitable…

  3. Gravatar of Doug M Doug M
    23. January 2014 at 11:59

    “Most monetary models would predict superneutrality, which means that the inflation rate and the NGDP growth rate and the nominal interest rate would rise in proportion to the rise in the money supply growth rate. We will call this assumption A.”

    No… the nominal rate falls… when the Fed increases the supply of money money becomes cheap and no one needs to pay a dear price to get their hands on some… Inflation and NGDP rise proportionally, I am with you there.

    “Money is neutral in the long run.”

    Money is not neutral. There is a reason why economists and bankers like small positive rates of inflation and don’t like small rates of deflation. Your debt level in insensitive to the price level.

    Looking for an analogy…

    Did you know that as you slow down an airplane, it takes more power to maintain level flight the slower you go? As the airspeed comes down the plane must take on a nose-up attitude to maintain lift. But flying nose-up increases drag. And increased drag requires more power to overcome. Pilots refer to this as the region of reverse command.

    If you want to slow down and maintain level flight, first the pilot cuts power, and when the plane hits the desired airspeed, add power and add more power than before he started cutting. If you don’t do it right, you will either fly erratically, usually losing altitude, and risk stalling the plane.

    I think that this is a fitting metaphor for central bank theory.

    When the Fed wants to perform a “soft landing”, first the cut powers — raising the nominal and real interest rates, and as the economy starts to slow add power back, ultimate settling at a lower real rate than before they began their attempt to land.

    And, near the ZLB, there is a lot of drag to overcome. The Fed has to apply a whole lot of power (base money creation) just to maintain level flight. What seems like a flood of money just doesn’t do as much to GDP (or inflation) as it would in more normal times.

  4. Gravatar of ssumner ssumner
    23. January 2014 at 12:34

    Doug, I think you misunderstood me. I didn’t say the money supply increased, I said the money supply growth rate increased, which is a very different phenomenon. Take a look at nominal interest rates during the Great Inflation.

  5. Gravatar of Doug M Doug M
    23. January 2014 at 12:49

    When the money supply growth rate increases (second derivative)

    I would expect:
    nominal rates to fall (imediatiatly).
    Real rates to fall (immediately).
    Inflation to rise (soon, but not immediately)
    Nominal rates to increase (following the rise in inflation, soon enough but not immediately)

  6. Gravatar of Don Geddis Don Geddis
    23. January 2014 at 14:15

    Doug M: so, you have an expectation that nominal rates would fall immediately, but then soon rise above where they started? This sounds like an arbitrage opportunity. Borrow huge sums of money right away, only to lend them out again once rates rise (“soon”). Let me guess: you don’t believe in the EMH either.

    Do you find historical evidence for your expectations, in the US in the 1970′s, or the hyperinflations of Germany or Zimbabwe?

    One thought for your model of incentives: you say “money becomes cheap”, and that’s why you think rates drop … but you need to also keep in mind that when the loan gets paid back in the future, it will be with dollars that are less valuable (due to the extra inflation between now and then). Surely lenders need to be compensated for the reduction in future purchasing power. Doesn’t that provide immediate pressure on rates rising, the opposite direction than you are thinking?

  7. Gravatar of Doug M Doug M
    23. January 2014 at 14:36

    “Borrow huge sums of money right away, only to lend them out again once rates rise (“soon”). Let me guess: you don’t believe in the EMH either.”

    I borrow money today for a 2 year term, hold it for a year. Paying interest while I am carrying it. Lend it out a year from now for a one year term. It can still be a money loser.

    Even with perfect knowledge that rate will rise, doesn’t mean that there is an arbitrage-free way to capitalize upon it.

    The EMH has nothing to do with it.

  8. Gravatar of Doug M Doug M
    23. January 2014 at 16:23

    US in the 70s.
    NGDP started moved to a a sustainded higher plateau in Q4 70.
    Rates initially moved lower, and didn’t begin to rise until 1973.

    When NDGP growth moved onto a lower plateau in 1978, Rates continued to rise until 1982.

  9. Gravatar of Major_Freedom Major_Freedom
    23. January 2014 at 16:39

    The “puzzle” can be rather easily solved by splitting “inflation”, “spending”, and other nominal activities into two distinct categories. Inflation of the money supply that enters the loan market first, or is expected to enter the loan market first, and inflation of the money supply that enters other markets first.

    If inflation enters the loan market first, or is expected to enter the loan market first, and price inflation is or is expected to be stable, then interest rates will be lower than they otherwise would have been.

    If inflation enters other markets first, or is expected to enter other markets first, and price inflation is not or is not expected to be stable, that is, it is expected to rise, then interest rates will be higher than they otherwise would have been.

    The reason “expansionary monetary policy” has no one specific effect on interest rates, is because the Fed, once it prints money, has little to no control over how that money is subsequently exchanged. Lent, spend, invested, these are all based on human knowledge and preferences, which are a priori unpredictable.

  10. Gravatar of Major_Freedom Major_Freedom
    23. January 2014 at 16:54

    The more accommodative the Fed becomes, the less the effects suggest the Fed is accommodative.

    ———————–

    In other news, Mark Carney has thankfully experienced a small twitch of rationality:

    http://www.zerohedge.com/news/2014-01-23/bank-england-folds-forward-guidance

  11. Gravatar of John Becker John Becker
    23. January 2014 at 18:37

    Stop trying to stabilize the economy. It’s a living system and living systems need stress. What we try to do now is like how the park service used to put out every fire that started only to create the conditions for a massive fire down the road. We are trading the discomfort of exercising and eating right for the excruciating pain of a heart attack. The more the Fed tries to avoid the pain of a recession, the greater upheaval WE ALL have to endure down the road.

    For some reason, economists think of the economy as a machine that you can fine tune and fix rather than a natural system that is robust unless manipulated. Machines need constant intervention to keep running, natural systems need to be left alone. The economy as a machine metaphor is one that is both very common and very harmful.

  12. Gravatar of John Becker John Becker
    23. January 2014 at 19:00

    Major Freedom,

    With the way the Fed operates, doesn’t money have to enter into the loan market first? The Fed purchases a financial asset from a bank, thus the bank has greater liquidity with which to make loans. Ceteris paribus, Fed asset purchases will always tend to lower interest rates relative to what they would have been otherwise.

    In the real world, whether asset purchases raise or lower rates depends on expectations of (price) inflation. If people expect the banks to simply hold the money in excess reserves, purchases will result in lower rates as there is now more liquid capital to borrow from. However, if they expect (price) inflation, news of planned asset purchases will immediately result in higher interest rates before the Fed has spent a single dollar on asset purchases from banks.

    Obviously, banks needed to use the Fed’s newly created money to make loans in order for that money to have an impact on prices BESIDES THE PRICE OF BONDS which varies inversely with the interest rate. Inflation defined as newly created money (i.e. correctly) will always boost prices even if the prices are just the prices of bonds.

    Where this gets interesting is it reveals that the Fed cannot truly set interest rates. The market sets a band of rates and Fed purchases or sales of financial assets can only move the Fed Funds rate within this band. Right now, there is no way the Fed could sell enough assets to make the Fed Funds Rate 20% and in the early 1980s, there was no way that they could buy enough assets to get banks to hold enough money to bring rates down to 0.25%

    The Fed controlling rates is an illusion as Eugene Fama and Milton Friedman have correctly pointed out before. This is not a full-on endorsement of their views.

  13. Gravatar of Tom Brown Tom Brown
    23. January 2014 at 19:04

    John, I see no difference between natural systems and machines. All the evidence points to it being a purely mechanical universe, obeying mechanical laws. The God of the Gaps has been doing nothing but retreating for centuries now. Plus it’s very much in the nature of all living things to do what they can to control their natural environment. Nobody wants to be left out in the rain to endure the ravages of “nature.” Maybe a few wack-a-doodle hippies, but not the rest of us. :D

  14. Gravatar of John Becker John Becker
    23. January 2014 at 19:05

    I’ll amend what I said at the end. Over a long period of time, the Fed could conceivable hit any rate they wanted. If they wanted to hit 20%, they would have express an intent to do so and back it up with some purchases. If the FFR was currently 20%, they would have to express their intent to bring rates down to 0.25% and back it up with asset sales. However, at any given moment, the range of interest rates which the Fed could conceivably target is limited by the Wicksellian equilibrium rate.

  15. Gravatar of John Becker John Becker
    23. January 2014 at 19:09

    Tom Brown,

    There is a reason the Forest Service stopped putting out every forest fire immediately. You cannot deny that living things need stress. Machines do too to some extent. My car would go bad very fast if I never drove it. Bike tires lose air if you don’t ride on them etc…

    I guess I could make my point better by saying that by trying to stabilize (prevent stress) on the economy, they are actually making it more unstable. This is some kind of natural law that applies to some machines and natural systems. Taleb calls it antifragility but I’m not a huge Taleb fan or fan of that term.

  16. Gravatar of Saturos Saturos
    23. January 2014 at 19:22

    Don’t short term nominal rates generally fall whenever the Fed eases, even if they’re signalling an ongoing increase in the growth rate of M?

  17. Gravatar of Peter N Peter N
    23. January 2014 at 20:20

    1) If extra money is held by those who want to invest, interest rates go down – supply and demand.

    2) If extra money is held by those who want to spend, the CPI goes up – supply and demand.

    3) If the expected growth rate of the CPI increases, investors will require increased nominal returns to get the same real return. Either rates will go up or investment will go down.

    It’s how these link up and which way 3 goes that are the problems. These may not be easily predictable, particularly as to timing.

    It’s a commonplace that timing the market is harder than predicting its direction.

  18. Gravatar of Benjamin Cole Benjamin Cole
    23. January 2014 at 20:26

    Okay stick with me here, I had a profound epiphany.

    Okay, so we get to zero inflation, or very close. Or minor deflation.

    Then, let’s say, we have a glut of savings.

    The price signal should result in a loss to savers. People think they are entitled to a return on their savings. But in fact, by free markets, they are also entitled to losses. If there is a glut of savings, you should get losses on your savings until the pool dries up.

    Okay, but in deflation or zero inflation, the price signal for excess savings does not work. People still have an incentive to save, even if just in cash.

    Without a price signal hurting savers, demand remains repressed, people are not spending enough. It is financial repression! The repression is on consumption!!

    We have the FDIC guaranteeing no losses on savings! This is mimicked around the world by governments.

    This is is one more reason why a modern economy cannot operate in a low inflation or deflationary environment. The price signal to discourage savings in flummoxed by government. (This also happens in a gold standard, btw.)

    Dudes, print more money, and run inflation at a 2 percent floor, not a target. A floor.

    And maybe a 3 percent floor would be better.

  19. Gravatar of John Becker John Becker
    23. January 2014 at 22:29

    Ben Cole,

    Other things being equal in this scenario, the “punishment” on savers you seek comes from lower than normal rates of return on investment in real terms. It is also an excellent time for entrepreneurs to borrow lots of money and expand operations so long as returns on investment are higher than the very low interest rate. The differential matters rather than the magnitude. Furthermore, if prices are falling, that allows people to buy more with the same amount of money which encourages consumption to a similar degree that it encourages saving. I believe that you are incorrect that in this scenario the market is sending incorrect signals or signals that would necessarily lead to long-term stagnation.

    In this situation, what matters is returns on investment relative to interest rates and inflation doesn’t do anything to help that. As long as there are profitable outlets for investment, and there generally are in an UNHAMPERED market, the savings glut scenario you propose is an unstable equilibrium. This situation would actually push people to invest very aggressively and investment spending is at least as good for the labor market as consumption spending.

  20. Gravatar of Daniel Daniel
    24. January 2014 at 03:35

    So, according to the gospel of austro-sadists, it is desirable for deflationary death spirals and massive inflations to occur every once in a while because it would make the world a more “anti-fragile” place.

    And then they wonder why they’re not sitting at the grown-ups table.

  21. Gravatar of Brian Donohue Brian Donohue
    24. January 2014 at 05:25

    Benjamin Cole,

    You wrote:

    “The price signal should result in a loss to savers. People think they are entitled to a return on their savings. But in fact, by free markets, they are also entitled to losses. If there is a glut of savings, you should get losses on your savings until the pool dries up.”

    We’re already there. If you put money in 1-year Treasuries at the end of 2008, you have enjoyed a negative 10% real return since then.

    I’m not saying this is necessarily a bad thing, but I’m a bit leery of your moar moar moar schtick.

  22. Gravatar of Morgan Warstler Morgan Warstler
    24. January 2014 at 05:35

    Benji,

    That’s simply not true.

    The 50% of free markets is that during bad times, there is a LIQUIDATION.

    People have to go the PAWN SHOP.

    (Remember, all banks that “issue their own currency” are actually pawn shops (collateral)).

    This is what BEARS are for, they are BETTING that things will slow down, and they will swoop in and have MORE of the money / economy / stuff / status / power in their control after – this is their motivation.

    When savings dry up, the idiots who flew too close to the sun, get gutted like fish.

    The gutting is what tampers the next overinvestment. Not just to make us anti-fragile, but to make sure we have the LINE set right, so the house (all of us) doesn’t go out

    BUY LOW, SELL HIGH

    50% of free markets is based on liquidations.

    The one thing about gold was that we never got to a point where there was no more to be mined ANYWHERE, there was always a presumption, the idiotic waste of turning of the earth – of rushing to California etc and spending all day looking for it.

    And with BTC, that stops.

    Anyhoo, the more interesting turn of economics is:

    1. is the end of scarcity
    2. there can be no digital property

    I’ve come to think NGDPLT is an unstoppable outcome.

    Carney is going to have to use it now, no?

    But NGDPLT is going to make it’s bones bc it is best at dealing with 1 and 2.

    Remember in the end we will all be brains in a pan (see the new OCULUS RIFT), living thru electronic signals (like the Matrix, except not with each other), until the singularity when your consciousness goes pure software independent of hardware.

    That’s the trend line. We march towards it.

    And the next stop in that future is the continued diminished “value” of atomic which can be owned, and the digital which cannot be.

    Peeps chose cell phones over toilets, dontcha know.

    So as there is too much nominal money, and not investments that can return ROI, unless they are one that destroys the atomic structure replacing it with a digital one on the march towards you never leaving your chair….

    A nice low NGDPLT will allow us to unwind on our way to BTC / Singularity nirvana.

  23. Gravatar of Benny Lava Benny Lava
    24. January 2014 at 05:40

    I’ll never understand the moralists like John Becker who say that recessions can’t be avoided (paging Australia). People need to suffer because the economy was going well and people were working? For that sin they need to be punished with unemployment? Nature needs stress? Someone has obviously never grown a rose garden. You religious fanatics seek to immiserate the human condition because you are petty sadists, nothing more. Away with these superstitions.

  24. Gravatar of Benjamin Cole Benjamin Cole
    24. January 2014 at 05:43

    John Becker:

    Thanks for your reply.

    You did not address my primary concern.

    That is, we have government guaranteed savings. The FDIC insurance, and I suppose Treasury bills. Obviously, this situation applies to all major nations.

    Thus, it is possible to save money and be sure not to lose your money (in a zero inflation, or deflationary environment).

    Now, in a pure free market, there is no guarantee of return. You are entitled to losses or gains, depending on the quality of your investment or intermediary.

    In a free market, there would be times when returns on savings accounts ran negative. The intermediary would not generate enough income to honor all deposits. Oh sure, they would re-insure and all that, but we saw what happened to AIG.

    Sooner or later savers would lose money, in a pure free market. That would discourage savings. Or, if there were a glut, the banks would say they will take your money, but only for a fee.

    In our world, a saver can never lose money. The feds guarantee that you will not, and they can print money, so that is a pretty good guarantee. That encourages over-saving.

    And that is where we are now–too much savings.

    I agree with you in one regard, and that is that investors are hunting yield today, and that will increase in years ahead. A glut of savings is continually pushing down yield, and so finding returns is getting harder and harder.

    It make be that all central banks need to conduct major QE operations in unison, and heavily for many years—or we get rid of government insured savings deposits.

    Moar! (Is that more?)

  25. Gravatar of Vivian Darkbloom Vivian Darkbloom
    24. January 2014 at 05:54

    “Thus, it is possible to save money and be sure not to lose your money (in a zero inflation, or deflationary environment).”

    Umm, is this post tax? That is, tax imposed by the very same entity that issued those bonds that make it “sure not to lose your money”?

  26. Gravatar of libertaer libertaer
    24. January 2014 at 06:27

    Scott,

    “Their assumption was wrong because very few people understand Nick’s nice little parable. As so we must suffer.”

    Do you really think this is all just a mistake?

    Monetary policy is not easy, but neither is quantum physics or relativity. Why don’t we see big messups in technology caused by the trickiness of the underlying theory?

    Is there any other example where positive knowledge is not mastered (even by the elite) although everybody would profit from it?

  27. Gravatar of ssumner ssumner
    24. January 2014 at 06:33

    Doug, Why wouldn’t nominal rates rise when expected inflation rose, not actual?

    Inflation also moved lower in the early 1970s.

    MF, Not sure what it means to say inflation goes into various markets.

    John Becker, Yes, and stop trying to drive the car, just let the car go where it wishes.

    Saturos, I can’t answer that, as it would be very difficult to do an experiment. The data we do have is quite crude, but suggests that a higher money supply growth rate raises interest rates. But we don’t know how quickly.

    Benny, Yes, what they don’t realize is that even if there are no recessions, individual people suffer recession-like stress all the time.

  28. Gravatar of ssumner ssumner
    24. January 2014 at 06:36

    libertaer. If all the government experts are saying silly things, and all the academic economists who comment on policy are saying similar silly things (both hawks and doves) even if they are economists that are otherwise highly critical of the Fed, then I’m inclined to believe they actually believe those silly things. What other explanation is there?

  29. Gravatar of Morgan Warstler Morgan Warstler
    24. January 2014 at 06:51

    Benny, t’s not about “suffering” being good.

    It’s about cost of capital growing so high that that “over-production” ceases.

    NGDPLT succeeds not bc of what it does in 2008, but bc it is a HARD CAP on growth, which makes 2008 nearly impossible to get to.

    NGDPLT essentially puts out the exact same amount of punch every single month… if too much gets drunk, next month, we know we’ll be missing that much punch.

    Which is WHY I keep saying, the real effect of NGDPLT is that everybody watches everybody else to see WHO is drinking the punch.

  30. Gravatar of Morgan Warstler Morgan Warstler
    24. January 2014 at 06:59

    Imagine that Scott’s blog only could have 500 comments left per month (yes I know this isn’t a perfect example of economy).

    BUT, we’d all start to pay lots of attention to WHO used those posts.

    Nothing focuses the mind on WHO in the economy is unproductive, than when they are using up the hard cap.

    Outside population gain, Real growth will be deflationary, but hiring people to dig and fill ditches is pure inflation adding to our NGDP even though it does nothing.

  31. Gravatar of John Becker John Becker
    24. January 2014 at 09:15

    Ben Cole,

    I’m not sure what you’re getting at because people always have the option of just sticking money under their mattress and burying it in the ground. Everyone is allowed to earn nothing on their money with or without the FDIC. The reason people have money in banks or invested in T-Bills is to earn some kind of interest. If I’m understanding you correctly, your argument then boils down to many similar ones about needing negative rates interest rates.

    My basic argument is still that all you need to make this an unstable equilibrium is for entrepreneurs to be able to come up with projects that have a higher return on investment than their very low cost of capital.

    Pumping money into a system that’s already flooded with money clearly isn’t addressing the problem. In any case, higher inflation does not make business investment more profitable in the long run as it tends to drive up interest rates and discourage long-term borrowing.

    The situation in the United States, I’ll avoid generalizing to other countries although this may apply there as well, is one in which the government made and kept many financial firms alive that wouldn’t have survived otherwise. Then while those companies were licking their wounds and trying to rebuild, they got slapped with higher capital requirements and a wave of new regulation. Do you think they’re gonna be eager to lend?

    Banks have done the more prudent thing and sat on T-Bills and their safest investments while the interest returns rebuilt their balance sheets. I see the weak state of the banking system due to repeated government interventions as the cause of a low amount of lending relative to the supply of loanable funds rather than a need for negative interest rates.

  32. Gravatar of John Becker John Becker
    24. January 2014 at 09:20

    Scott,

    “Yes, and stop trying to drive the car, just let the car go where it wishes.”

    This is a perfect example of how you see the economy in a simplistic way when it comes to money but would never make a statement like this when talking about something like income distribution. If the economy is just a car people need to steer around, why not just make incomes more equal. You know that there would be unintended consequences to a government planner trying to flatten the income distribution but can’t see any bad consequences at all with the government trying to achieve similar goals with money.

  33. Gravatar of Brian Brian
    24. January 2014 at 12:45

    I don’t mind the analogy Morgan, but its not a cap. Its targeting. So if there a 600 comments this month we adjust so we’ll only get 500 next month.

    But in this analogy, how do you stop the government from posting too much so everybody else gets a shot?

  34. Gravatar of Jason Jason
    24. January 2014 at 13:09

    Did you read the Paul krugman column today Scott?

    You must be very frustrated that he is talking about something you consider to be “meaningless”! :-)

    I read your earlier posts on it. And while I sort of understand where you are coming from, I think it’s a stretch and an exaggeration to call income inequality data “meaningless!” I define income as saving (the total LEVEL of saving, ones assets minus liabilities,) minus consumption. I think it’s a useful definition, it’s the reverse of a common identity, saving equals income minus consumption.

    Income(both wage and rentier income) is what you use in order to engage in consumption without diminishing your equity , or even increasing it. Are asset and liability data meaningless too, Scott?

    Even with all the problems of income data, (such as life cycle effects transfers etc,) a snapshot in time of income data still tells us something. (Maybe not as much as Paul krugman and the left days it does, but something)

    Since the left is big on income inequality now and the pres is talking about it next week, could you provide a summary of you earlier posts or making a new one showing once and for all why income inequality data doesn’t matter

    Thanks,
    Jase

  35. Gravatar of John Becker John Becker
    24. January 2014 at 13:43

    Daniel,

    I don’t doubt that we all want the same things here. Prosperity, opportunity for anyone willing to work hard, and good living standards for everyone including the least fortunate in society. What we have is a debate over the means. I believe that a system based entirely on private property is the best way to achieve this end. The introduction of more capitalism to place like India and China has given more people high living standards in the past 15 years alone then in all of human history prior to that.

    Compare the successes of even allowing some private property in China over the last 35 years with the horrors of a system based on government ownership (the previous “Communist” government) where people starved to death by the millions.

    On the monetary side, I favor either a classical (pre-WWI) gold standard or a free market in money production where banks produce their own money. If you look at history, the gold standard during the 100 years from 1814-1914 produced much more stable prices than the current fiat money system. I believe that a free market in money production would become even more stable. I am certainly not in favor of either inflation or deflation although I am certain that the solution is not for the government to try and stabilize the price level.

  36. Gravatar of Daniel Daniel
    24. January 2014 at 13:59

    I believe that a system based entirely on private property is the best way to achieve this end.

    I don’t remember anyone here arguing otherwise.

    the gold standard during the 100 years from 1814-1914 produced much more stable prices than the current fiat money system.

    http://66.147.242.158/~papolicy/wp-content/uploads/2009/06/Figure1_Recessions_1857to2009.gif

    http://static6.businessinsider.com/image/4c99d2da7f8b9a7973ed0a00/hate-recessions-and-deflation-then-be-glad-were-not-on-the-gold-standard.jpg

    Like I said before – if you arrive at policy conclusion solely through thought experiments in which people are assumed to be frictionless and spherical, you’re in for a very rude contact with reality.

    the solution is not for the government to try and stabilize the price level.

    I do believe that is pretty much the reason for this blog’s existence – the massive failure of inflation targeting.

  37. Gravatar of Tom M. Tom M.
    24. January 2014 at 14:06

    John Becker,

    Honduras is an example of capitalism. China is an example of mercantilism.

  38. Gravatar of ssumner ssumner
    24. January 2014 at 15:37

    John Becker, You misunderstand what I am proposing. Your arguments apply to the real economy. You are right that free markets, not government bureaucrats should allocate resources in the real economy. The nominal economy has nothing at all do do with the real economy, even though they are “correlated.”

    I favor targeting NGDP, which is just another way of saying that if the government plans to have a monopoly on the production of currency, they should not creates massive nominal shocks that cause problems for the economy. I don’t even no what it means for the government not to control the money supply, when it produces currency. Does it mean legalizing counterfeiting? Or spinning a roulette wheel to determine the money supply? Of keeping it fixed? I have no idea as to what the alternative to a sensible monetary policy would be. My opponents just wave their hands and say that the right amount of money will magically appear if the government is not involved, and the arguments they use are typically completely unpersuasive, Just handwaving.

    Jason, I don’t know what article you are talking about, you should provide a link. The difference between assets and liabilities is wealth, not saving. Economists who have studied public finance (both liberals and conservatives) know that “income” inappropriately adds wage and investment income, as if they are the same thing. That’s why smart liberal economists favor consumption taxes.

    I have a post over at Econlog (a few days back) explaining what’s wrong with income.

  39. Gravatar of Tom Brown Tom Brown
    24. January 2014 at 17:02

    Scott, do you think it would be possible to test a number of economic policy ideas against one other by means of an online video game? Suppose that such a game was constructed (where players role play a character, and try to improve their character’s simulated economic well being) such that a number of nearly identical simulated worlds were constructed, and players were attracted with real cash prizes offered for the best scores in each world (to incentivize people to do their best). Players signing up would be randomly assigned to each world. The only difference between each world would be in the simulated monetary system and who controls it. One could be controlled by MMists, another by Krugmanites, another by Austrians, another by PKEers, etc. The game would continue for a long period of time (months perhaps… or maybe longer) and at the end a score would be calculated for each world based on pre-determined measures of each world’s overall economic health. Is this idea too outlandish? I realize that such a test would be far from perfect.

  40. Gravatar of benjamin cole benjamin cole
    24. January 2014 at 17:39

    John Becker-
    Thanks for your reply.
    I had thought of that, in deflations people can just put cash into tree trunks, safety deposit boxes…resulting in more deflation, if the money supply is fixed.
    Seems like a deflationary recession is easy to set off once you get close to ZLB…

  41. Gravatar of Jason Jason
    24. January 2014 at 18:11

    http://www.nytimes.com/2014/01/24/opinion/krugman-the-populist-imperative.html?ref=paulkrugman&_r=0

    Is this helpful, Scott?

  42. Gravatar of Geoff Geoff
    24. January 2014 at 18:25

    Benjamin:

    If people decide to hoard cash instead of spending it on anything, that means they want to consume more in the future than they otherwise would have consumed. That’s what holding more money for a longer period of time entails. If the central bank does not try to “rescue” the people, then material resources and labor would indeed be redirected towards the production of future goods, and away from the production of present goods.

    “Recession” or not, this would change the capital structure to be more in line with actual consumer saving/consumption behaviors.

  43. Gravatar of Major_Freedom Major_Freedom
    24. January 2014 at 18:40

    John Becker:

    With the way the Fed operates, doesn’t money have to enter into the loan market first? The Fed purchases a financial asset from a bank, thus the bank has greater liquidity with which to make loans. Ceteris paribus, Fed asset purchases will always tend to lower interest rates relative to what they would have been otherwise.

    Banks do more than lend. Banks can buy stocks, land, pay dividends, and so on.

    Also, even if the banks do lend the money first, depending on expectations of where and how the money will be spent, affects what happens to interest rates. Then there are other, non-monetary factors affecting interest rates as well.

    “In the real world, whether asset purchases raise or lower rates depends on expectations of (price) inflation. If people expect the banks to simply hold the money in excess reserves, purchases will result in lower rates as there is now more liquid capital to borrow from. However, if they expect (price) inflation, news of planned asset purchases will immediately result in higher interest rates before the Fed has spent a single dollar on asset purchases from banks.”

    Right

    “Obviously, banks needed to use the Fed’s newly created money to make loans in order for that money to have an impact on prices BESIDES THE PRICE OF BONDS which varies inversely with the interest rate. Inflation defined as newly created money (i.e. correctly) will always boost prices even if the prices are just the prices of bonds.”

    Yes.

    “Where this gets interesting is it reveals that the Fed cannot truly set interest rates. The market sets a band of rates and Fed purchases or sales of financial assets can only move the Fed Funds rate within this band. Right now, there is no way the Fed could sell enough assets to make the Fed Funds Rate 20% and in the early 1980s, there was no way that they could buy enough assets to get banks to hold enough money to bring rates down to 0.25%”

    Strongly affect interest rates. “Set” or “determine” would perhaps be too strong a word. Other than the fed funds rate that is.

    “The Fed controlling rates is an illusion as Eugene Fama and Milton Friedman have correctly pointed out before. This is not a full-on endorsement of their views.”

    Perfect determination is an illusion, yes, but that doesn’t mean we have to reject any affect at all.

  44. Gravatar of John Becker John Becker
    24. January 2014 at 18:43

    Daniel,

    I don’t like the gold standard based on a thought experiment. I like it for 3 reasons.

    1. It produces LONG TERM price stability which aides economic calculation. Prices came down slightly from 1814-1914 as the production of goods slightly outpaced new gold discoveries. In comparison, $100 today is equal to $4.25 in 1914.

    2. It protects private property. When the government creates money, they are essentially stealing real resources through the monetary system. That’s why counterfeiting is illegal. Inflation is a tax and a horribly regressive one at that.

    3. It facilitates international trade. Under the gold standard, all countries use the same money which makes it much easier for businesses to operate and trade. Right now a company like Apple has to hedge in currency futures. Plus if you travel, you don’t have to change currencies. If this doesn’t seem like a big deal, imagine a world where every city or every household had their own currency and how this would defeat the point of even using money.

    Inflation targeting failed for the same reason that NGDP targeting will fail. When you stabilize one thing, the other things that it used to correlate to will become more unstable.

    Tom M,

    I don’t know what definition of capitalism you are using. The most common definition I have heard is private ownership of property. According indices of economic freedom, Honduras and China are both repressed but at least China is consistently moving in the right direction. What stood out about Honduras as an example of capitalism or secure property rights?

    http://www.heritage.org/index/ranking

    If you’re gonna say things that don’t make sense, at least elaborate.

    Scott,

    You seem to believe that whoever is in the Fed is a technocratic angel without political or economic incentives. However, basic economic reasoning would say that anyone with a monopoly on money production is going to try to maximize the net present value of that asset if it is privately owned or print money like crazy in response to political pressure. Either way, the system will produce far more inflation than is economically desirable and that’s exactly what we’ve gotten since leaving the gold standard. The only reason inflation is 2% instead of 10% is that people wouldn’t stand for 10% year after year. Listen to public choice theory. The Fed has incentives that have nothing to do with our economic well-being.

    How is it just hand waving to point specifically to the classical gold standard or a privately issued currency system? If you really believe that the market produces cars better, why are you completely shut off to the idea that the market might produce money better as well?

    Ludwig von Mises in The Theory of Money and Credit lays out how to get back to the classical gold standard and it’s very simple. Friedrich Hayek and David Friedman have laid out extensive descriptions of how a privately issued currency system would work.

    How are you not imaginative enough to picture a system besides the one we have now? Come on. All you would need is to say each bank can issue their own money and rapidly people would coalesce around a few options.

    I’ve read your blog for four years now and you still haven’t explained how on earth it would even be possible for the nominal economy to have nothing to do with the real economy. If a bunch of big businesses made bad investments and couldn’t pay their banks back on loans, then banks failed, would that not be a real factor impacting the nominal economy?

    Ben Cole,

    In a real deflation, you do get a positive return for just sitting on money. However, lower prices also mean that you can buy more or better stuff with the same amount of money. In my opinion, these effects more or less cancel out and the prices of many goods like computers and TVs have come down greatly without seeing people postpone purchases indefinitely.

    A deflationary recession at the zero lower bound is easy to set off if you ruin the banking system so that no one wants to risk making a loan then buy all of the bank’s treasury bills to bring interest rates down to zero.

  45. Gravatar of Edward Edward
    24. January 2014 at 18:45

    “If people decide to hoard cash instead of spending it on anything, that means they want to consume more in the future than they otherwise would have consumed. That’s what holding more money for a longer period of time entails. If the central bank does not try to “rescue” the people, then material resources and labor would indeed be redirected towards the production of future goods, and away from the production of present goods.

    “Recession” or not, this would change the capital structure to be more in line with actual consumer saving/consumption behaviors.”

    Wow, same old Austrian fallacies eh?

    FIrst it does NOT follow that hoarding cash means people want to consume more in the future than they do in the past. They could be hoarding cash as a precautionary measure, out of sheer terror of losing their jobs, and not as part of some “plan.” In that case, you get lower prices on both consumption and investment goods. But since some prices are sticky, like wages and debt contracts, you get massive unemployment instead.

    “If the central bank does not try to “rescue” the people, then material resources and labor would indeed be redirected towards the production of future goods,”

    Not so, there would be less production in general, both of present and future goods

    ““Recession” or not, this would change the capital structure to be more in line with actual consumer saving/consumption behaviors.”

    Actual consumer/saving patterns are highly situational and path dependent. People’s time preferences are not at all stable, but swing wildly depending on their expectations, and perceived economic situation

  46. Gravatar of Major_Freedom Major_Freedom
    24. January 2014 at 18:46

    Daniel:

    So, according to the gospel of austro-sadists, it is desirable for deflationary death spirals and massive inflations to occur every once in a while because it would make the world a more “anti-fragile” place.

    Other than “gospel”, “sadists”, “deflationary death spiral”, and “massive inflations”…yes?

    There is too much accusatory and inaccurate rhetoric in what you said to give a proper response.

    And then they wonder why they’re not sitting at the grown-ups table.

    Were you abused as a child? You sound like an abusive parent.

    By the way, “sadism” is revelling in inflicting violence against innocent people. Your own worldview CALLS for violence against innocent people. Perhaps you are confused about the reality of intervention. Maybe you are unable to distinguish between intervention and non-intervention. Maybe to you if 51 people vote to harm 49 people, then it’s not violence because the 51 outnumber the 49.

    In my ethics, the individual is the center of focus. Inflicting harm on innocent individuals, in the name of social democracy, or stable economies, or what have you, is sadism. I am advocating for a removal of such violence. A removal of sadism.

    You’re not a very sophisticated writer or thinker.

  47. Gravatar of John Becker John Becker
    24. January 2014 at 18:54

    MF,

    The market or Wicksellian equilibrium interest rate strongly limits the range of rates that the Fed could target for the Fed Funds Rate. I do not think that the Fed can hit any Fed Funds rate it wants right now. Never mind the other interest rates which it has less power over. The Fed could not announce that they are targeting a 20% Fed Funds Rate at the next meeting and have it done within the next day when the Fed Funds Rate is currently 0.25%.

    The printing press gives the Fed a great deal of power to manipulate the market but the market always gets the final say. That’s the central lesson of the Austrian Theory of the Business cycle and it’s a similar point I’m trying to make here.

    For instance, I don’t think the Fed could target the Fed funds rate higher than 3% and immediately hit it right now.

  48. Gravatar of Geoff Geoff
    24. January 2014 at 18:55

    Edward:

    “Wow, same old Austrian fallacies eh?”

    It isn’t a fallacy. People do not hold money for the purposes of eating it, or sitting on it forever. They hold money for the purposes of spending it in the future, be it the near future or the long term future.

    “FIrst it does NOT follow that hoarding cash means people want to consume more in the future than they do in the past.”

    Sure it does. Holding money now instead of spending it now, is done in order to either invest or consume more in the future. Investing or consuming more in the future is, for both investing and consuming, a plan to consume more in the future. If they hold onto their money in order to invest more in the future, then that is to consume more in the future. If they plan to hold onto their money in order to consume more in the future, then that is also to consume more in the future.

    “They could be hoarding cash as a precautionary measure, out of sheer terror of losing their jobs, and not as part of some “plan.””

    Why would they hold money as a precautionary measure though? What is the purpose of holding onto money, when it comes to what money can DO for a person?

    Holding onto money out of “sheer terror” is a plan to spend more in the future than they otherwise would have spent. It is irrelevant what exactly they will spend their money on in the future, because in all cases it is associated with more consumption in the future.

    “In that case, you get lower prices on both consumption and investment goods. But since some prices are sticky, like wages and debt contracts, you get massive unemployment instead.”

    People don’t just hold onto money for no goods related reason. Sheer terror, precaution, etc, these are all acts of holding onto money for the purposes of consumption in the later future versus consumption in the near future.

    “If the central bank does not try to “rescue” the people, then material resources and labor would indeed be redirected towards the production of future goods,”

    “Not so, there would be less production in general, both of present and future goods”

    Not in the long run. Yes, there would likely be a reduction in both consumer goods and capital goods in the short run, but because of the higher cash holding, and the fact that people are producing goods without consuming them now, compels producers via relative profit and loss to devote more resources and labor to longer term projects.

    ““Recession” or not, this would change the capital structure to be more in line with actual consumer saving/consumption behaviors.”

    “Actual consumer/saving patterns are highly situational and path dependent. People’s time preferences are not at all stable, but swing wildly depending on their expectations, and perceived economic situation”

    Congrats on throwing MM under the bus.

    Then there is no reason for monetary policy designed around unpredictable expectations of the fickle consumer. Any “rule” would necessarily be contrary to the interests of consumers, because the rule is fixed, but consumer preferences are not.

  49. Gravatar of Major_Freedom Major_Freedom
    24. January 2014 at 19:01

    John Becker:

    The market or Wicksellian equilibrium interest rate strongly limits the range of rates that the Fed could target for the Fed Funds Rate. I do not think that the Fed can hit any Fed Funds rate it wants right now. Never mind the other interest rates which it has less power over. The Fed could not announce that they are targeting a 20% Fed Funds Rate at the next meeting and have it done within the next day when the Fed Funds Rate is currently 0.25%.

    Sure, there are practical limits, but this doesn’t mean the Fed doesn’t affect interest rates. That’s the point here. The Fed could raise the fed funds rate within a reasonable range tomorrow, if it wanted to. You do accept that the Fed can and does “target” the overnight rate, right? That they are targeting 0-0.25% by choice?

    The printing press gives the Fed a great deal of power to manipulate the market but the market always gets the final say. That’s the central lesson of the Austrian Theory of the Business cycle and it’s a similar point I’m trying to make here.

    I agree that the market eventually overwhelms, which is precisely why we have the business cycle instead of millions of obedient little serfs all doing what they are supposed to be doing in response to the overlords at the Fed and perpetual “stability” in the face of price dislocutions.

    For instance, I don’t think the Fed could target the Fed funds rate higher than 3% and immediately hit it right now.

    Well, the overnight rate is the average rate that banks lend to each other, given their knowledge of the circumstances and expectations of the future. This takes time from the moment the Fed initially inflates. So yes, tomorrow might be too soon. But 3% say by next month I would say is feasible.

  50. Gravatar of Tom Brown Tom Brown
    24. January 2014 at 19:21

    “For instance, I don’t think the Fed could target the Fed funds rate higher than 3% and immediately hit it right now.”

    Excess reserves (ER) > 0 implies the overnight rate is driven down to the IOR rate. So all that’s required currently is to raise the IOR rate to the desired level (in this case something > 3%). A different strategy (OMOs) is required if ER = 0.

  51. Gravatar of John Becker John Becker
    24. January 2014 at 19:23

    Jason,

    Scott has made interesting points that there may not really be much the government can do to change income inequality. Income inequality seems to exist independent of the political systems. Countries that are considered more socialist (where property rights are less secure in my definition) do not have more equal income distributions than places which are more capitalist.

    Cultural and ethnic differences within a country correlate most strongly to income inequality. Places that are ethnically homogeneous tend to have low GINI coefficients while places that are very diverse have much more unequal distributions. For examples outside of the U.S., look at African countries. The elite are usually Asians or Europeans. Then there are tribal groups like the Igbos who tend to do better economically. Jewish people also tend to be in the upper class wherever they live. Native peoples tend to do very poorly relative to the dominant ethnic group in the United States, Canada, Australia, and Russia. Countries with very different economic systems.

    To paraphrase, someone once told Milton Friedman that Sweden was very economically equal. Friedman replied that it wasn’t interesting because Swedish people had very equal incomes in the United States as well! Great point.

    I have a question for people making the type of argument Paul Krugman makes in his Op-Ed you linked to; would you rather live in a place with full employment and income inequality but a low overall standard of living or a place with higher unemployment and more income inequality but a higher standard of living?

  52. Gravatar of Tom Brown Tom Brown
    24. January 2014 at 19:27

    Anybody, if you were to put a gun to an Austrian’s head and tell him that he had to write an algorithm to replace the Fed’s decision makers, what would that algorithm look like? Would it include eliminating all OMOs and ceasing the payment of IOR immediately? Would it first attempt to unwind the Fed’s BS? I think I have an idea what the algorithm would look like if the victim were an MMist, an NKer, an MMTer, or a traditional monetarist, but I don’t know what the Austrian would do.

  53. Gravatar of John Becker John Becker
    24. January 2014 at 19:41

    Tom Brown,

    I would do what Ludwig von Mises recommended in The Theory of Money and Credit. You announce that the United States is returning to a gold standard where the dollar represents an amount of gold, this is another way of saying that the value of gold will be fixed in terms of dollars. Announce that there will be no further OMOs until the price has been pegged. The price of gold is likely to go up temporarily due to higher gold demand in the future. Once the markets have time to react to this announcement, you peg the dollar to gold when you think the price of gold has hit its highest point in order to prevent a destabilizing deflation.

    Say you make that announcement and the price of gold goes from $1268 today to $1400 tomorrow and levels off. Then you woud peg the dollar to gold at $1400 per ounce. It’s a pretty simple plan.

    The other option is a privately produced money system like competing fiat and/or commodity based currencies. Here is what David Friedman, not technically an Austrian but still a very free market economist, says about switching to a private money system. Specifically read the section called “The Private Alternative.”

    http://www.cato.org/pubs/pas/pa017.html

  54. Gravatar of Tom Brown Tom Brown
    24. January 2014 at 19:49

    John, thanks for your response. Why gold? Why not some other commodity? Are there a set of acceptable alternative commodities?

  55. Gravatar of Tom Brown Tom Brown
    24. January 2014 at 20:33

    … could you frame the algorithm in more general terms as “select a commodity or basket of commodities with x, y, and z properties, with their proportion determined by a, b, and c, and then target this basket of commodities?”

    What would those properties be? If more than one commodity, how would you select the proportion of each in a basket to target? Is there some additional risk in choosing just a single commodity?

  56. Gravatar of John Becker John Becker
    24. January 2014 at 21:08

    Tom Brown,

    The reason for gold over other commodities is that gold has been generally accepted as money throughout history because it has a high price to weight value, malleability, and are easy to weigh and measure. These are less important today than in the past but are still factors. Silver or platinum could perform the same functions and with modern technology it would be very easy to transfer and account for ownership of gold or any other commodity money with similar characteristics.

    I favor gold over other commodities or a commodity standard because the biggest benefit of a gold standard would be getting everybody on the same page. If the United States went back on gold, hopefully other countries would do so as well. This would greatly facilitate international trade, travel, and job creation. A multinational company like Coca-Cola would no longer need to incur the transactions costs of hedging on against currency fluctuations in financial markets. Travelers would no longer have to incur the transactions costs of changing currencies. Businesses operating facilities in different countries would be easily able to compare costs and revenues to determine profitability over time for facilities in different countries.

    The convenience of a simple, single commodity currency system explain why I would favor gold relative to a commodity basket or some other commodity. If you could convince everyone to use silver, I’d change my mind. To see the benefit of a single, worldwide currency, imagine if every person city produced and used their own money like nations do now. You’d probably have to carry a bunch of money in a bunch of different currencies around with you all the time.

    I dislike choosing a proportion of commodities in a basket to track something like the CPI for the same reasons I don’t particularly care for the CPI. Everyone’s experience of prices is different because everyone buys different things. Everyone essentially has their own CPI.

    I know this sounds outlandish but keep in mind the incentives of people in the present system. The chairperson of the Fed enjoys a big political gain if he can give the economy a jolt of money which temporarily boosts business. Much like a government running a deficit. In both cases, their is never an incentive to make the hard choice even if it’s the right choice. Politicians never balance the budget and central bankers almost never allow deflation.

    In addition, Friedman has a good quote in the piece I just referred you too.

    “Before leaving the subject of fractional reserve systems, I should mention one particularly bizarre variant — a fractional reserve system based on fiat money…The resource cost of producing fiat money is zero; more precisely, it costs no more to print a five-dollar bill than a one-dollar bill, so the cost of having a larger number of dollars in circulation is zero. The cost of having more bills in circulation is not zero but small. A fractional reserve system based on fiat money thus economizes on the cost of producing something that costs nothing to produce; it adds the disadvantages of a fractional reserve system to the disadvantages of a fiat system without adding any corresponding advantages. It makes sense only as a discreet way of transferring some of the income that the government receives from producing money to the banking system, and is worth mentioning at all only because it is the system presently in use in this country.”

  57. Gravatar of John Becker John Becker
    24. January 2014 at 21:16

    Anyone who is interested, here is Hayek’s proposal for competing fiat currencies.

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

  58. Gravatar of Tom Brown Tom Brown
    24. January 2014 at 21:57

    John, thanks again for the detailed reply. Here’s the kind of risk I had in mind with a single commodity: what if a large nation, like China, were to suddenly experience a huge increase in their demand for physical gold … perhaps they enter a new political phase adopting another Mao like cult of personality who convinces them they need to all collect as much gold as possible… I don’t know, I’m just trying to imagine a reason why a single commodity might experience a sudden “irrational” uptick in demand. Won’t that tend to screw over the rest of the world if we all use gold for an MOA?

  59. Gravatar of Tom Brown Tom Brown
    24. January 2014 at 22:20

    … and regarding fraction reserve banking with fiat money, I don’t think the fraction matters much provided the CB is setting a series of fixed overnight rate targets (perhaps changing them every six weeks or so, like they have historically done). Obviously some countries do just fine with a 0% requirement (e.g. Canada). But a 100% requirement on a subset of deposits (checkable) wouldn’t be much different: it’d make it a bit harder for a bank to retain a profitable spread on its BS (if it couldn’t convince depositors to transfer out of checkable deposits), but it wouldn’t fundamentally limit credit growth, since in the short run (in defending the overnight rate) the CB would produce whatever amount of CB deposits were needed.

    Throw out the fixed overnight rate target though, and that may no longer be true! (depending on what you replaced it with, e.g. if the CB instead targeted the quantity of base money).

    BTW, check out JP Koning’s latest article on “Banknotes: IOUs or not” to get a little push back on the whole concept of supposedly “fiat” money: especially the comments by Mike Sproul (Mike is a backing theory (& Real Bills) advocate and thinks that there really is no such thing as fiat money). I’d provide a link, but when I do for JP’s site, my comments typically go to spam.

    But I’ll try one here for Mike:

    http://www.econ.ucla.edu/workingpapers/wp830.pdf

    http://www.csun.edu/~hceco008/realbills.htm

  60. Gravatar of Tom Brown Tom Brown
    24. January 2014 at 23:52

    … I guess because I’m not a gold “user” I’m extra suspicious of making that the sole item in the basket of goods we define UOA with. Especially when I look at the volatility of gold’s price in relation to things I actually am a user of. Why should I want the value of our UOA to fluctuate with wedding gift fashion trends in India?

  61. Gravatar of Daniel Daniel
    25. January 2014 at 01:28

    John Becker

    It produces LONG TERM price stability which aides economic calculation.

    So, by your logic, if you’re sitting with one leg on a solid block of ice and with the other one on a hot stove – you’re doing just fine, thank you very much ?

    Oh, and that fact that half the time was spent in recessions ? It was just making the world a more “anti-fragile” place.

    When the government creates money, they are essentially stealing real resources through the monetary system.

    Do you sprint to the ATM in order to be the first who gets the money ? If not, why ? By your logic, you should.

    It facilitates international trade

    I take it that mental contortions are your favourite sport.

    I favor gold over other commodities or a commodity standard because you’ve got your ideological blinders strapped on so tight you’re lost contact with reality.

    In the real world, the US government forced China off their silver standard back in the 1930s. How ? By hoarding silver – thus throwing them into a recession.

    And your proposal for a better tomorrow is to revisit past failures ? There’s something seriously wrong with your brain, bro.

    Major_Freedom,

    You’re an idiot.

  62. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    25. January 2014 at 06:23

    ‘Scott, do you think it would be possible to test a number of economic policy ideas against one other by means of an online video game?’

    You should be asking Vernon Smith;

    http://www.econtalk.org/archives/2007/05/vernon_smith_on.html

  63. Gravatar of John Becker John Becker
    25. January 2014 at 07:30

    Tom Brown,

    Because the only other alternative is having the Unit of Account’s value vary with the whims of political pressure and the economics profession. If the Fed was run by technocratic angels like many people presume it is, then I would agree with the system that you and Scott support. Since the Fed is run by real people with their own incentives, I’m not comfortable with them having the amount of power that they do.

    I don’t invest in gold either.

    Daniel,

    There wasn’t one argument with any substance in there. Aren’t there youtube videos for you to troll? Stick to the issues like most people do and I’l talk to you.

  64. Gravatar of Daniel Daniel
    25. January 2014 at 07:43

    Now isn’t that cute. The austrian cultist is upset people don’t agree with him.

    Get this in your thick head – commodity standards were tried, and they were a resounding failure. Your fixation with their imaginary virtues speaks only of your ignorance.

    Also, it appears you’re too stupid to even consider the political dimension of things. Back then, the franchise was limited – so those who were the hardest hit by the recessions (the recessions you handwave away) had no feed-back on the matter.

    FDR’s statist experiments were a direct consequence of the gold standard.

    And you want to go back to THAT ?

    PS In fairness, you’re better than Geoff/Major_Freedom – in that you don’t write walls of text. But your contempt for reality is the same.

  65. Gravatar of Daniel Daniel
    25. January 2014 at 07:49

    Correction – the above should be

    But witness what happens under universal suffrage – FDR’s experiments …

  66. Gravatar of Major_Freedom Major_Freedom
    25. January 2014 at 09:42

    Daniel

    “It produces LONG TERM price stability which aides economic calculation.”

    So, by your logic, if you’re sitting with one leg on a solid block of ice and with the other one on a hot stove – you’re doing just fine, thank you very much ?

    Doesn’t follow.

    Oh, and that fact that half the time was spent in recessions ? It was just making the world a more “anti-fragile” place.

    Not a valid response that addresses the issue at hand.

    “When the government creates money, they are essentially stealing real resources through the monetary system.”

    Do you sprint to the ATM in order to be the first who gets the money ? If not, why ? By your logic, you should.

    One is not creating NEW money by withdrawing money from their checking accounts. John is talking about creating new money, which takes place prior to you withdrawing the money you have already earned.

    “It facilitates international trade”

    I take it that mental contortions are your favourite sport.

    Not a valid response that addresses the issue.

    “I favor gold over other commodities or a commodity standard because you’ve got your ideological blinders strapped on so tight you’re lost contact with reality.”

    In the real world, the US government forced China off their silver standard back in the 1930s. How ? By hoarding silver – thus throwing them into a recession.

    If China buys American goods using silver now, but Americans do not buy Chinese goods using that same silver soon after, such that Chinese exporters to the US mistake what American importers want, it’s not ipso facto justification for imposing a central bank in China such that existing Chinese silver money owners are sapped of their purchasing power, for the sake of those Chinese exporters who make mistakes.

    You seem to be incapable of identifying market processes in international trade, and instead just use the same old “recession”, “hoarding”, and other aggregated concepts that mask what’s really going on.

    And your proposal for a better tomorrow is to revisit past failures ? There’s something seriously wrong with your brain, bro.

    Free markets are not a failure. Intervention is a failure.

    Major_Freedom,

    You’re an idiot.

    I am more intelligent than you.

    ———————

    Now isn’t that cute. The austrian cultist is upset people don’t agree with him.

    It’s not just that you disagree. Disagreement with some substantive argument is better than what you are doing, which is disagreement plus insults and clearly shallow intellect.

    Get this in your thick head – commodity standards were tried, and they were a resounding failure. Your fixation with their imaginary virtues speaks only of your ignorance.

    Commodity standards do not fail. What you are calling commodity standards that failed are hampered commodity standards. Hampered by the state. State imposed or sanctioned inflation combined with a commodity base is not a commodity standard.

    Your inability to parse intervention versus non-intervention is the reason you are making false conclusions.

    Also, it appears you’re too stupid to even consider the political dimension of things. Back then, the franchise was limited – so those who were the hardest hit by the recessions (the recessions you handwave away) had no feed-back on the matter.

    Which recessions? The ones with or without state intervention?

    FDR’s statist experiments were a direct consequence of the gold standard.

    No, it was a direct consequence of central banking. The Fed was established in 1913, well before the great depression took place.

    And you want to go back to THAT ?

    No, we want to move forward to a free market in money. Not a gold standard imposed by the state. Not a gold plus inflation standard that took place during the war of 1812, civil war, and great depression.

    PS In fairness, you’re better than Geoff/Major_Freedom – in that you don’t write walls of text. But your contempt for reality is the same.

    Your conception of reality is false. You are making mistakes in your claims of history and economics.

  67. Gravatar of Major_Freedom Major_Freedom
    25. January 2014 at 10:13

    Daniel:

    You’re the sadist, because you want, encourage, and try to thwart protections against, initiations of force against innocent people.

    You’re calling me a sadist despite the fact that my ethics call for a prohibition on sadism, whereas your ethics calls for sadism.

    Also, I am more intelligent than you, so for you to call me retarded, implies that you are worse than retarded.

    You have no substantive knowledge on the subject at hand.

  68. Gravatar of ssumner ssumner
    25. January 2014 at 10:28

    Tom, It seems like that would work better for micro issues, but I’m no expert on video games. All I play is doodle jump.

    Jason, I don’t agree that inequality is one of the two big problems we face, I’d put unemployment, poverty and the war on drugs much higher.

    John, You said;

    “You seem to believe that whoever is in the Fed is a technocratic angel without political or economic incentives.”

    When comments start out like this I immediately stop reading. I have no time for nonsense, too many good questions.

  69. Gravatar of Tom Brown Tom Brown
    25. January 2014 at 10:55

    Scott, re: macro policy video game experiment: I was hoping you’d be more intrigued with the idea. Are you aware of anybody in the academic econ world that’s tried such a thing, even for micro?

    I’ll look into this doodle jump thing… maybe it can be modified to do the job. :D

  70. Gravatar of Daniel Daniel
    25. January 2014 at 11:01

    Apparently, to buy into austro-sadism one has to be both autistic and retarded.

  71. Gravatar of Jeff Jeff
    25. January 2014 at 11:03

    John,

    Please go read up on Irving Fisher’s Compensated Dollar proposal. It’s a variant of the gold standard which varies the official price of gold inversely with the general price level. If the demand for gold suddenly increases, as it did at the beginning of the Depression, prices start falling and the price of gold is increased. That increases the money supply and the price level moves back up.

    There is no question in my mind that a compensated gold dollar scheme is far superior to the fixed-gold-price standard that prevailed 100 years ago. But I’m guessing that you would disagree. Do you?

  72. Gravatar of Tom Brown Tom Brown
    25. January 2014 at 11:03

    John Becker, you write:

    “Because the only other alternative is having the Unit of Account’s value vary with the whims of political pressure and the economics profession.”

    Would it make a difference if we eliminated human judgement from the mix and instead used an algorithm? You’ll probably say “but algorithms are designed by humans, etc.”… yes, I know, but perhaps there are ways to mitigate that problem.

    Personally I think we should codify into law algorithms for lots of things… drawing voter districts would be a good one for example.

  73. Gravatar of Daniel Daniel
    25. January 2014 at 11:27

    I think it’s more than fair to say that the austrians live in a parallel universe – one where wages aren’t sticky – or if they are, it’s not a problem a recession can’t cure , where recessions didn’t happen – or if they did, it was a good thing, it made the world more anti-fragile, where Hitler had nothing to do with the Great Depression – and the Great Depression was definitely not caused by the gold standard, etc.

    In all seriousness, how can one argue against such a mindset ?

  74. Gravatar of Major_Freedom Major_Freedom
    25. January 2014 at 13:02

    Daniel:

    Still no substantive comments I see. In all seriousness, your ignorance is preventing you from knowing that your beliefs are flawed.

  75. Gravatar of Daniel Daniel
    25. January 2014 at 14:18

    In all seriousness, you are an autistic moron.

  76. Gravatar of Major_Freedom Major_Freedom
    25. January 2014 at 14:35

    I understand you’re seriously devoid of the minimum requisite knowledge of these topics to enable you to respond with substantive comments, instead of childish insults.

    I would understand if you were abused as a child.

  77. Gravatar of Daniel Daniel
    25. January 2014 at 14:55

    Yup, still a moron.

  78. Gravatar of benjamin cole benjamin cole
    25. January 2014 at 16:58

    John Becker—
    Thanks for your reply.
    I am not sure perfect free markets are immune to long-term and sustained busts, or deflationary recessions.
    Man is given to emotions and ambition, desire, greed and fear. Even free markets can have booms and busts.
    There is a free market in art and a set of three paintings just sold for $127 million. Gold has vacillated wildly in the last 30 years including in relation to silver.
    The stock market?
    Sadly man will even make war avainst their own economic interests.
    I see no guarantee everything always stabilizes and improves quickly in pure free markets and free banking.

  79. Gravatar of Major_Freedom Major_Freedom
    25. January 2014 at 19:30

    Still smarter than you.

  80. Gravatar of Saturos Saturos
    25. January 2014 at 20:37

    Krugman actually sounds a bit like you here Scott: http://krugman.blogs.nytimes.com/2014/01/25/none-so-blind-macroeconomics-division/

    MF, welcome back!

  81. Gravatar of Saturos Saturos
    25. January 2014 at 20:56

    Excellent new post on EconLog Scott btw, you finally figured out what needed to be said.

  82. Gravatar of Major_Freedom Major_Freedom
    25. January 2014 at 21:02

    Saturos:

    I originally agreed to no longer post here as an incentive for Sumner to debate Murphy.

    (Long story short, I was loathed so much here, that the thought was that with me agreeing to not post anything for a few months, Sumner would agree to debate Murphy).

    But since he hasn’t debated Murphy for an entire year despite being on sabbatical, I believe he isn’t going to debate him any time soon. Couple that with many of the posters here who have contacted me on other blogs effectively saying they miss me, I can’t find a good reason to remain absent.

    So what did I miss?

  83. Gravatar of CA CA
    25. January 2014 at 21:31

    It’s my understanding that Sumner agreed to the debate but Murphy cancelled on two different occasions.

  84. Gravatar of Major_Freedom Major_Freedom
    25. January 2014 at 21:50

    CA:

    I heard that too. It’s too bad.

  85. Gravatar of Daniel Daniel
    26. January 2014 at 01:09

    Wait, so now we’re gonna have TWO austro-sadist morons writing walls of text ?

  86. Gravatar of Major_Freedom Major_Freedom
    26. January 2014 at 02:22

    Daniel, you are a sadist because you call for, and seek to prevent protections against, initiations of force.

    Sadism is taking pleasure in other people suffering. Initiating force makes people suffer. Since you take pleasure in your political philosophy of initiating force being put into action, you are by the definition of sadism, a sadist.

    I believe you are accusing Austrians as being sadists because you can’t be a sadist if they get their way. So they must be sadists.

    I am also more intelligent than you. So if I am a moron, then you are worse than a moron.

    Still no substantive responses to the challenges I see.

    You know, you can insult all day long, but it is only going to make you a worse person. You are hurting yourself. Just like when you were a child, right? Try to break out of the cycle.

  87. Gravatar of Daniel Daniel
    26. January 2014 at 02:31

    Scratch that, ONE austro-sadist moron with a personality disorder.

  88. Gravatar of ssumner ssumner
    26. January 2014 at 07:29

    Saturos, Thanks, and the Krugman posts links to a Barro article that clearly shows he was highly skeptical of models where AD (or nominal) shocks have important real effects.

  89. Gravatar of ssumner ssumner
    26. January 2014 at 07:30

    CA, As I recall there was talk of a debate, but nothing was ever set up.

  90. Gravatar of Major_Freedom Major_Freedom
    26. January 2014 at 09:50

    Daniel:

    Daniel, you are a sadist because you call for, and seek to prevent protections against, initiations of force.

  91. Gravatar of Tom M. Tom M.
    26. January 2014 at 10:52

    Umm, are there actually people out there who don’t think Major_Freedom and Geoff are the same person?

  92. Gravatar of Tom Brown Tom Brown
    26. January 2014 at 13:04

    Tom M.

    Somebody mentioned once that MF = Geoff. Sadowski maybe? I’ve been assuming that’s been the case for a while now.

  93. Gravatar of Major_Freedom Major_Freedom
    26. January 2014 at 13:09

    That’s hilarious.

  94. Gravatar of Negation of Ideology Negation of Ideology
    26. January 2014 at 14:37

    John Becker,

    You’re asking the right questions, but you need to think this through further. There is no such think as a neutral monetary policy. There is no such thing as a free market monetary policy.

    Except in one sense, we already have a free market monetary policy because people can legally trade and enter into contracts with whatever they want. You like the gold standard? It already exists – it’s called gold.

    The question then is, what should the government use for taxation, royalties, etc. Unless you are an anarchist, you can’t avoid this question. The government needs to use something, even if it is just a nigh watchman state. Whatever the government usually becomes the common currency, but there is nothing stopping individuals from using whatever they want.

    If the government picks something, such as gold or tobacco, then it will invariably affect the market for that good, even if it tries not to do so. On top of that, an automatic incentive is built in for the government to meddle in that good. That’s why the people who like gold should be the ones most opposed to the gold standard. Separation of gold and state, if you will.

    The gold standard is simply another government program. There’s nothing preventing it from arbitrarily changing the gold price, or botching it like any other program. On top of that, there is no guarantee that the supply and demand for gold will match the real economy.

    So you’re left with the question of what the government should use for money. I suggest it should use something that will have no impact on relative prices, be based on the entire economy, and preference no individual or group. I suggest that NGDP fits the bill.

  95. Gravatar of Tom Brown Tom Brown
    26. January 2014 at 15:22

    Negation, nice summary. I’m always on the look out for this kind of thing.

    You’re line of reasoning here was why I asked John earlier: if someone put a gun to his head and forced him to run the Fed, what would he do? I think I said “write an algorithm to run the Fed” actually to take the day to day human judgement factor out of it. (MF had already suggested that to take the reigns of the Fed automatically makes you a psychopath, which is why I added an element of coercion). John was willing to give a reasonable answer, rather than dodging the question. But I agree, no matter what you do, you are DOING something.

  96. Gravatar of TravisV TravisV
    26. January 2014 at 19:49

    Yglesias joins Ezra Klein!!!!!!!

    http://marginalrevolution.com/marginalrevolution/2014/01/the-new-ezra-klein-venture-at-vox.html

    http://www.theverge.com/2014/1/26/5348212/ezra-klein-vox-is-our-next

  97. Gravatar of Willy2 Willy2
    26. January 2014 at 23:33

    Interest rates are NOT set by any Central Bank. They are set by a force called “Mr. Market”. And the FED ALWAYS FOLLOWS the market.

    But the FED always uses language to obfuscate they’re not in control of interest rates.

  98. Gravatar of Tom Brown Tom Brown
    27. January 2014 at 11:51

    Willy2, the CB has the power to put an upper bound on any nominal interest rate or any maturity it wants: it has a bottomless pocket w/ which to buy up debt at that maturity.

    Typically it only targets the overnight rate, and there’s plenty of evidence that it’s been very successful in hitting that nominal rate over the past few decades (It typically has enough inventory to set a lower bound as well).

    Even now, with excess reserves > 0, it can simply set the overnight rate to whatever it wants to by setting the IOR rate to that value.

  99. Gravatar of ssumner ssumner
    27. January 2014 at 18:19

    Tom, I assume they are Siamese twins who take turns posting here.

    Travis, That’s putting about half the brain power of Generation X (or Y or whatever) into the same company. Dangerous. They should be forced to fly on separate planes.

    Willy2, I’m working on a post on that–either here or Econlog.

  100. Gravatar of Negation of Ideology Negation of Ideology
    28. January 2014 at 02:01

    Tom Brown -

    Thanks. I think John is asking his questions in good faith. And I’ve always liked the idea of using an algorithm to run the Fed. I believe Milton Friedman proposed that at one time. Of course, I prefer an algorithm to target NGDPLT to a money supply targeting rule that he proposed. Although I think Scott has said Friedman moved closer to his position later in life.

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