There’s no going back
When I was young I thought I was experiencing a series of events. Now I understand that I was experiencing the feeling of being young. Sure you can go back and revisited a bunch of European countries, but it won’t seen the same as when you first tramped around Europe with a backpack, and the world seemed charged with mystery and meaning.
I think of public policy in similar terms. Obviously there are cases where we can literally go back—the 21st Amendment restored the status quo ante of before the 18th Amendment. But it’s never quite the same. Indeed in just the last 10 years we’ve lost the ability to drink alcohol at our Bentley holiday party (I suppose due to fear of lawsuits.)
How I think about the past often depends on whether my mood is that of an ornery reactionary or a hopeful progressive. Whether listening to talk radio or NPR. Sometimes I think both the left and right miss something important when they visualize the past. The right tends to romanticize a golden age that was ruined by statism, whereas the left sees a period of misery, which progressive legislation has lifted us above. I believe the right has lots of blind spots, and the left often attributes change to legislation that actually reflects the fact that we are vastly richer than 100 years ago.
As a macroeconomist I often think of the spring of 1929 as a sort of golden age of policy, when there didn’t seem to be any significant macro problems and we had a pretty efficient policy regime. But how should a pragmatic libertarian like me think about 1929 vs. today? It’s not quite as obvious as you might think. In some ways things have certainly got worse; Federal spending has grown from 3% to over 20% of GDP. We have an alphabet soup of regulatory agencies that do more harm than good. But there are also many changes for the better. The rights of blacks, women, and gays are much better protected than in 1929. And even many of the changes that would be vigorously opposed by more dogmatic libertarians, are somewhat ambiguous to a pragmatist like me:
1. Social Security and Medicare really do help older people, but the systems were set up in a way that discourages saving.
2. Some environmental regulations really do improve our lives, but they are often implemented in an inefficient way.
3. We have lower tariffs, but many more non-tariff barriers.
4. We’ve gained the right to drink alcohol, but also suffer from a new reign of paternalism
5. We are more willing to tolerate immigration from non-European countries, but must suffer under the abominable TSA and INS.
6. There is less regulation of transport pricing and entry, but more rent controls and minimum wages
7. We have unlimited bank branching, but much more moral hazard in the system.
8. There is more annoying paperwork today, but also less governmental corruption
I suppose for a dogmatic libertarian things are clearly worse, but for a pragmatist like me that’s not so clear. Which finally brings me to monetary policy. Are we better off today than in 1929? How about compared to 1912? I pick those dates because our monetary system has undergone two revolutionary changes in the past century; we’ve added a central bank and dropped the gold standard. There’s only one thing I am really sure of; it’s a really, really bad idea to have both a central bank and a gold standard. If you don’t believe me, check out the macro performance of the US between 1913 and 1941. Both inflation and output were extraordinarily unstable.
In my view we are better off without the gold standard. We can’t afford to leave the price level and NGDP to chance, where an increase in the demand for gold could cause severe deflation and depression. Admittedly the worst example of this occurred under a gold standard that was far from pure (1929-33) but there are two strong arguments that cut the other way:
1. The gold standard was also far from pure during the so-called classical period (up to 1914.)
2. The whole point of the gold standard is that it’s supposed to work automatically, to protect you against foolish governmental decisions—indeed to prevent governments from printing too much or too little money. If we need sensible government to make the gold standard work, then why not just attach the sensible government to a fiat regime, that will work even better (and did between 1983-2007.)
So far I’ve been emphasizing my progressive side, but now I’m going to do a 180 degree pivot. I think a very strong case can be made that we’d be better off if the Fed had never been created. Indeed a recent paper by George Selgin, William D. Lastrapes, and Lawrence H. White makes exactly that case. It’s a very long paper and it marshals an impressive array of evidence against the Fed. The focus in on two areas; whether the Fed has actually made the economy more stable (unlikely), and the effects of its regulatory actions,particularly in the recent crisis. As far as I am concerned, their new paper becomes the definitive critique of the Federal Reserve System, which any academic researching the issue will have to address.
If you are a pragmatist like me, don’t write off the paper as a hopelessly utopian attempt to re-create a mythical gold age. Their arguments are much more subtle and nuanced:
“Coming up with alternatives to the Fed today takes more imagination. Assuming that there is no political prospect of replacing the fiat dollar with a return to the gold standard or other commodity money system, for the dollar to retain its value some public institution must keep fiat base money sufficiently scarce. [..] [T]he Fed’s poor record calls for seriously contemplating a genuine change of regime. In particular it strengthens the case for pre-commitment to a policy rule that would constrain the discretionary powers that the Fed has used so ineffectively. Whether implementing such a new regime should be called “ending the Fed” is an unimportant question about labels.”
That’s exactly where I am on the issue. It’s not a question of going back or staying where we are, it’s about moving forward. Here’s an analogy. The left and right have been debating whether we need a government-run postal service for decades. Long before that debate is resolved technology will have eliminated the need for snail mail (except packages, which can be easily delivered by Fedex or UPS.) It’s likely that long before we solve the problem of whether to use interest rate or money supply control, we will go to a cashless society with all electronic money. That will make possible Robert Hall’s (1983) visionary scheme to index interest on reserves in such a way as to automatically stabilize the expected future price level (or NGDP.) No Fed discretion is required. Even Woodford once had nice things to say about the idea.
The debate over “ending the Fed” is pointless. There will always be something called “the Fed.” What we need to do is not to end it, but emasculate it. Take away its discretion and simply give it a nominal mandate, and let the market implement the mandate.
I see the human race as like that runaway train in the new Hollywood film. Technology is hurtling us rapidly toward a future that we can’t envision, and which would both horrify and dazzle us if we could. (Just as the ancient Greeks would be both horrified and dazzled by our current culture.) We don’t study the past to try to recreate the past, but rather to learn lessons that we hope will make the ride on this runaway train a bit smoother.
PS. Thanks to William for sending me the quotation. I’ll try to have more to say about other issues raised in the Selgin/Lastrapes/White paper when I have more time. David Beckworth, Tyler Cowen, Alex Tabarrok, Bryan Caplan, and Arnold Kling also make comments. I agree with some of the points made by Cowen, although I’d point out that while it’s true that if we’d had no Fed in 2008 there might have been a Great Depression, it’s also true that if we had no Fed in 2002 there would have been no sub-prime fiasco. Banks don’t do that sort of thing without a safety net. I will be at another conference this weekend, so blogging will again slow to a crawl.
Tags: conservatism, liberalism
18. November 2010 at 08:27
Although I think it will take time for cash to completely fade away, we’re not far from the point where people in the US could probably live a cash-less life. We just need a reliable method for transferring funds person-to-person using mobile devices (like PayPal for phones, hopefully with the ability to use our phones for credit card transactions as well), and we’re getting there. I wouldn’t be shocked if it’s possible in the next 10 years.
18. November 2010 at 09:04
Interesting commentary.
I have to say, for five decades I have heard that we are being hurtled to the uncertain future by technology.
But, except for military hardware, all the new technology actually seems to make life better and easier, otherwise it would not be embraced. It doesn’t seem to come in a rush, except retrospectively.
I do share the foreboding that if certain military weapons fall into the wrong hands….
18. November 2010 at 09:15
ATW, if any of you ever read Heinrich Boll, you will find he often wrote about an all-powerful repressive state, set in Eastern Europe.
Yet one character in one of his novels hires a pretty secretary girlfriend, and keeps a flask of cognac in his office. The character thinks to himself, “At least they cannot take this away from us.” Guests share cognac in his office.
Imagine a typical male executive trying to do this today, in America.
18. November 2010 at 09:23
Brett, I agree, although cash won’t completely disappear for a few more decades.
Benjamin, Good point. Bu the last 5000 years are a blink of an eye in the 2 million year history of man, and people from 5000 years ago would be shocked by our world.
Regarding your second point, you can’t have cigarettes either.
18. November 2010 at 09:31
Excellent point about the right current goal: emasculating, not eliminating, the Fed.
Why is there so little talk of other possible automatic stabilizers?
Here’s my suggestion:
Tax Loans. In a crisis (0.5*% above both the 5* and 10* year average unemployment rates), any individual or corporation can, instead of paying taxes, send in an IOU to the tax authorities with the tax form. Taking on a Tax Loan debt, to be paid back in 3* years after the annual unemployment rate as dropped either by 1.5%*, or is below either the 5 or 10 year average.
The interest rate is the Fed rate*, and must be paid quarterly* for corporations, monthly* instead of withholding for individuals.
Comments on this idea welcome, but especially on the lack of discussion of more policies that would be automatically counter-cyclical.
I’m sure that, without a Fed, there would have been more fiscal policies that are counter cyclical.
The Stalinist oppression of petty Political Correctness is
indeed terrible.
18. November 2010 at 09:42
I am not going to argue strongly that this is due to the Fed.
But there was a significant upward shift in real per capital GDP
growth after WW I.
From 1920 to now the trend growth of real per capita GDP has been
2.4% — calculated as an exponential trend. From 1850 to 1925
it was 1.6%.
This type of comparison of real growth or standards of living was conspicuously absence from the paper on the Fed.
18. November 2010 at 10:39
Spencer, how could you possibly have any confidence in GDP statistics for 1850-1925? Significant numbers of people raised their own food (and hunted it, Palin-like), made their own clothes, built their own homes using wood grown on their own property. That can’t have been officially measured.
Scott, I agree with most of what you wrote, but not that there is less corruption today. We just had an election in which ‘the bums’ were thrown out precisely because the corruption was so obvious.
As I’ve argued, ad nauseum, here before, the current recession wouldn’t have happened absent the entirely corrupt assault on the home lending industry. The state of California is essentially bankrupt thanks to public employee corruption. I’ll bet Chris Christie thinks the same of New Jersey.
Finally, since I’m listening to Mark Steun eviscerate airport security just now on radio, we’re currently mandating behavior from TSA employees that would get any Catholic priest thrown in jail.
18. November 2010 at 10:46
The replacement or modernization of the Fed is likely necessary, but what worries me more than leaving it alone is what would replace it given the hyper-partisan environment in the capitol of late. The Democrats have been unable to approriately deal with the economic crisis, and Republicans seem to want tight money regardless of the consequences. Neither side knows what they’re doing and I shudder to think about what they’d do to the Fed.
One of my daughter’s favorite quotes fits the situation nicely: “When you think things can’t get any worse, it’s because you lack sufficient imagination.” – unknown
18. November 2010 at 11:03
Scott: You said:
“I agree with some of the points made by Cowen, although I’d point out that while it’s true that if we’d had no Fed in 2008 there might have been a Great Depression, it’s also true that if we had no Fed in 2002 there would have been no sub-prime fiasco”
But the Fed let NGDP drop precipituously in 2008! What would have happened in a “no Fed world”? The subprime had much more to do with the other branches of government (especially Congress) than with the Fed itself.
18. November 2010 at 11:23
Scott: I bet that when you started you didn´t expect to be reffered to as a “phenomenon”.!!!
“Ellison argues that research dissemination is changing in the top schools, where one’s institutional affiliation guarantees the quality of one’s research. He ignores the Scott Sumner phenomenon: a scholar at an unranked university can earn an international reputation through blogging, not conventional journal publication”.
http://worthwhile.typepad.com/worthwhile_canadian_initi/2010/11/but-is-it-research.html
18. November 2010 at 11:24
The world’s rate of change is increasing drastically.
For that reason alone, I do not understand why a gentle decrease in prices is not allowed to occur. On the contrary, virtually all prices have decreased except in industries that are heavily regulated by governments; health care, social security, military, education. It is those industries that are bankrupting us despite very obvious methods of restoring them.
That the Fed has been a failure is the largest indictment of economics in the world. For good reason. The hubris of ‘managing’ a complex system is really quite gob-smacking.
I can only say such a thing on Mr. Sumner’s blog because I am aware of his unique and patently patient nature:)
18. November 2010 at 11:31
“it’s true that if we’d had no Fed in 2008 there might have been a Great Depression,”
Before we start to sound like a bunch of worry warts, I do not believe this is true. In fact, quite the opposite. Absent the Fed, we could have shut down the banks in an orderly fashion and sold those assets off.
The market would be restored by now. The Fed is throwing printed money at the problem in an effort to prevent those markets from finding their prices that is prolonging this recession and resulting in stagflation.
18. November 2010 at 12:13
Regarding #4, I wonder if the push for single family home ownership and the nuclear family has produced our paternalistic culture. The shift from Prohibition to paternalism was one of “We shouldn’t drink” in a time when multifamily dwelling dominated to “You shouldn’t drink Four Loko” that seems to be a concern of suburban areas — not urban ones. When your immediate family are your chief interpersonal relationships, instead of your neighbors in your apartment building or small town (in rural communities these people are likely your coworkers as well), the adults in the family seem more likely to view politics from a paternalistic place.
They say that parents are a big reason Prop 19 failed (along with “kids” under *30* not voting).
Another effect of promoting single family home ownership may be to push what society considers a symbol signaling adulthood out of reach for younger people. Twenty-six year-old “kids” generally don’t own their own house, but can now stay on their parents’ health insurance.
(Sorry for the tangent.)
18. November 2010 at 12:46
“Social Security and Medicare really do help older people . . . .” Social Security certainly helped the first couple of generations that lived under it, but beyond that it is a drag on all age groups. It was primarily a one-time transfer of wealth to the early (elderly) beneficiaries, and thereafter a permanent depressor of the economy for almost everyone.
“I suppose for a dogmatic libertarian things are clearly worse . . . .” This is not at all clear. Few libertarians have a definite scale on which they can measure the *amount* of liberty in a given social situation. All they can say is that in some ways we are freer than were Americans 100 years ago, in some ways less free. (By the way, you should drop the ‘dogmatic’ from ‘dogmatic libertarian’: libertarians are all in the same boat as regards comparing different possible social situations. The difference between “dogmatic” and “pragmatic” libertarians is merely one of tactics.)
18. November 2010 at 12:50
Krugman teams up with G Eggertson:
“We envision an economy very much along the lines of standard New Keynesian models – but instead of thinking in terms of a representative agent, we imagine that there are two kinds of people, “patient” and “impatient”; the impatient borrow from the patient. There is, however, a limit on any individual’s debt, implicitly set by views about how much leverage is safe.
We can then model a crisis like the one we now face as the result of a “deleveraging shock.” For whatever reason, there is a sudden downward revision of acceptable debt levels – a “Minsky moment.” This forces debtors to sharply reduce their spending. If the economy is to avoid a slump, other agents must be induced to spend more, say by a fall in interest rates. But if the deleveraging shock is severe enough, even a zero interest rate may not be low enough. So a large deleveraging shock can easily push the economy into a liquidity trap”.
Maybe the “for whatever reason” should read, “due to a steep fall in expected (and actual) NGDP?
http://voxeu.org/index.php?q=node/5823
18. November 2010 at 12:53
@Whisky Jim
You mean “stagdisinflation”. What we have is the opposite of the 70s.
18. November 2010 at 13:10
But there was a significant upward shift in real per capital [sic] GDP growth after WW I.”
Such comparisons overlook all those “troubled (and impoverished!) masses” who came over in shiploads during the relatively open border days before the Great War. Look at the immigration stats (as I have) and you will no longer be inclined to sneer at those “modest” pre-Fed per capita growth rates, or to treat the higher rates of the Fed era as proof that the economy was more productive.
18. November 2010 at 13:29
Whisky Jim,
Stagnation (albeit as a result of tight monetary conditions, not printing money) yes. Stagflation? No.
Professor Sumner
Regarding the Gold Standard, if there was any good case for returning to it, then there would be a much better case for simply having a computer secretly and randomly generate a number at the start of each year. Then, expand or contract (flip a coin to decide this) the money supply by roughly that amount over the course of the year. That would have the additional virtue avoiding having the market for gold distorted by its role in the monetary system.
If that’s crazy, then the gold standard is crazy as well.
Considering the alternatives at the time (discretionary monetary policy led by bankers with a 19th century understanding of economics) however, the gold standard system was brilliant. One can also point to ways that it could conceivably have been handled better in the 19th century e.g. a less ambigious movement away from silver and bimetallism (as Friedman argues in his paper “The Crime of 1873”) would have made the return to the system after the American Civil War a much less painful process.
It’s like the Bretton Woods system: flawed in many respects, but better than having a central bank + a gold standard and a LOT better than the first decade of macroeconomic management that succeeded it.
18. November 2010 at 13:35
Re: real GDP per capita.
Immigration surely has to be taken account when considering this, as George Selgin says.
Of course, the same is presumably true for the often-misunderstood contemporary economic statistics in the US. As far as I know, there has been a big increase in the Latino population in the USA, mostly fuelled by Cuban, Puerto Rican and Mexican immigrants who come to the US with very few skills, few assets and even a limited capacity to speak the native language. Clearly, such workers wouldn’t be coming to the US if they weren’t able to depress US average incomes.
Just as much of the myth of American income stagnation is based on the high levels of Latino immigration into the US in recent decades, so one has to consider the effects of poor migrants to the US on statistics from the period of free immigration to the USA. Equally, with countries like Britain in that period, one has to consider the huge benefits in the 19th century that resulted from being able to shift the overpopulated countryside to the US and the British Empire. I dread to think how much worse the Irish famine would have been in the 19th century if emigration was impossible.
18. November 2010 at 14:14
If it hasn’t been pointed out elsewhere Bill Woolsey has a seminal post on “old” monetarists and “quasi” monetarists.
18. November 2010 at 14:21
Scott,
This may have been touched on in earlier comments, but surely one of the main reasons for the Fed’s raison d’être was to act as LOLR and in doing so resolve the negative externalities that arise when market participants focus on their own risks/liquidity without considering broader systemic risk. So proposals to “end the Fed” (outside of Ron Paul) still require someone to provide this LOLR service.
A proposal that the Fed supplement its LOLR role with a fixed policy rule is, in many ways, not all that radical. This would simply bring the Fed more in line with other central banks — I think the Fed has too much discretionary power than other CBs (after all, it’s long resisted committing to any sort of nominal targeting regime).
However, short of either the Fed changing its policy regime and/or Congress pressuring change, this is probably not that easy for outsiders to effect. Furthermore, the dollar’s reserve currency status allows the Fed to exercise more discretion than other CBs (and of course, exact more seigniorage). Limiting the reserve currency status may go a long way towards limiting Fed discretion.
Alan
18. November 2010 at 14:30
Whiskey Jim writes: “Regarding the Gold Standard, if there was any good case for returning to it, then there would be a much better case for simply having a computer secretly and randomly generate a number at the start of each year. Then, expand or contract (flip a coin to decide this) the money supply by roughly that amount over the course of the year. That would have the additional virtue avoiding having the market for gold distorted by its role in the monetary system.
If that’s crazy, then the gold standard is crazy as well.”
With all due respect, the gold standard didn’t generate random changes in M, or P. If you want to see a random-walk monetary regime (albeit one witgh the added bonus of drift), you have to move forward in time to the post-1970s Fed.
More fundamentally, the gold standard isn’t arbitrary: there are certain stabilizing economic forced at work, including the one relating gold production to gold’s relative price and the one that gears international gold flows to relative differences in national (gold) price levels. The idea that money supply is determined haphazardly under a gold standard simply because it isn’t set by a dozen men sitting on a committee is a very serious misunderstanding.
I say this having (as Scott noticed) not actually argued in the paper that gold is the only or best way to go forward.
18. November 2010 at 14:39
This is excellent! A bunch of top-notch academics and scholars along with amateur shotgun commenters discussing Really Serious Things outside the stultifying Academic-Journal-Culture.
This phenomenon should inform not just monetary policy, but the meta topic of academic publishing, and research in general.
18. November 2010 at 14:54
“This phenomenon should inform not just monetary policy, but the meta topic of academic publishing, and research in general.”
I KNOW! Isn’t it great? I exist therefore… no QE for Scott, unless Ben becomes Austerity cheerleader #1. It’s teh awesome!
What’s crazy is that Scott refuses to factor in the crazy guys with all the money and guns (what I call affectionately “the haves” – the drawn from the top 50% of wage earners and 65% of the likely voters), who think they can force the Fed to let the banksters go insolvent.
The whole thing makes me tingly.
18. November 2010 at 15:56
It is not central banks per se that are the problem. Political interference of central banking is the problem. A good example this week with politicians signing letters telling the central bank how they should conduct monetary policy. Bizarrely also claiming that they are not interfering. In the absence of a state central bank the banks would set up their own anyway to act as LOLR. Therefore, what we want is to retain central banks but have them operating completely independent of the political system.
This is a good Tim Congdon monograph. Central banking in a fee society. It is specifically about the BoE but some of the same issues are pertinent to the US.
http://www.iea.org.uk/files/upld-book450pdf?.pdf
He favours privatising the BoE, and having the banks own the full equity. Moreover, the banks themselves would provide all the capital for the central bank. Bail-outs are still going to happen but it would be up to the banks to bail out each other. The central bank would be the coordinator acting as LOLR. The key thing is there would be no recourse to taxpayer funds. In that system the banks would pressurise each other against excessive risk exposure.
In the Fed era what can never be known is how many crisis did they prevent. I don’t think comparing the nineteenth century is a valid comparison. The twentieth century financial system is considerably more sophisticated than the nineteenth. Whether that is a good thing or bad who knows. Moreover, the US in the twentieth century is much more integrated to the global economy. Calculating the costs and benefits of the Fed requires one to take the benefits to the US of global trade into account. Could US firms have grown and spread throughout the world without a central bank?
The 100 per-cent-backed system does not work because no matter what system one imposes on the banking system they will always develop money substitutes.
18. November 2010 at 16:39
> Banks don’t do that sort of thing without a safety net.
Banks in Iceland had none, disproving your hypothesis.
18. November 2010 at 16:39
Richard W,
I’m glad to see that I’m not the only Tim Congdon fan on here. In fact, now that I think about it, there are probably quite a few.
I do worry about the future political independence of the Federal Reserve. The “End the Fed” movement in the US Congress may be unlikely to achieve their own goals, but they would be useful footsoldiers in any attempt to subvert the independence of the Federal Reserve, for whatever end.
18. November 2010 at 16:46
George Selgin,
(Absolutely no respect due. I haven’t even taken an Economics 101 course.)
But wouldn’t a gold standard system be totally vulnerable to gold rushes (increasing supply) and unrelated rises in gold demand e.g. as a result of an industrial process (increasing demand)?
However, let’s say you’re right (you probably are) one could still replicate the same system, using a computer, without distorting gold prices by tying them intimately into the monetary process, right?
18. November 2010 at 17:56
@W. Penden
“But wouldn’t a gold standard system be totally vulnerable to gold rushes (increasing supply) and unrelated rises in gold demand e.g. as a result of an industrial process (increasing demand)?”
Yep. However, this effect is usually much smaller than the similar effects in a fiat system. The discovery of the new world for example was a massive supply shock in gold.
“However, let’s say you’re right (you probably are) one could still replicate the same system, using a computer, without distorting gold prices by tying them intimately into the monetary process, right?”
Yes, but then the costs to cheating are low. You want to make it extremely politically expensive to cheat the system.
18. November 2010 at 18:08
The example of the discovery of the new world, was an example of a time where there was a supply shock.
18. November 2010 at 18:35
Doc,
Isn’t the answer serialized digital currency. Every unit has a #, we can tell its entire life history, we can see performing loans in levered fractional lending, so we can tell to the unit the statistical chance of losses if things must be unwound, we can tell which bankers are making the most returns, we can create my nirvana: Virtual Mutual Local Banks run out of banker’s homes – all loans exposed covestor style.
Anyhoo, the thing I REALLY don’t get about Scott’s imagining of cashless society is that nothing stops then merchants form taking other currency – and the moment you can use USD or EUR at the shop, MACRO is over. The country that prints is the country that sees their currency ended overnight.
And I can’t see any technical barriers to multiple currencies in a cashless society.
18. November 2010 at 18:36
@Tomasz:
“Banks in Iceland had none, disproving your hypothesis.”
Sure they did. Limited liability means once you are over a certain reasonable limit, you may as well go for broke and pad your salaries as much as possible.
18. November 2010 at 18:37
Also, WRT Iceland, england used terrorism laws to shut down their banking within england on trumped up accusations, which prevented the situation from being as orderly.
18. November 2010 at 18:49
Morgan Warstler,
In other words, something somewhat similar to the “free banking” system that von Hayek, von Mises, Rothbard &c. used to talk about back in the day?
If nothing else, it would be fascinating to see such dynamics in practice, from a purely scientific point of view.
18. November 2010 at 19:35
Scott,
I am surprised that you as “somewhat” of a libertarian would be so happily looking forward to the cashless all electronic society. I would think that someone concerned about liberty would understand that removing cash from society would be a crushing blow to personal freedom.
When the government REALLY knows where all the money comes from and where it goes, we will all be a lot less free.
Don’t get me wrong…I think that it is coming, but I don’t necessarily celebrate it.
18. November 2010 at 19:53
It was hardly trumped up, Doc Merlin. They had announced to the media that the foreign depositors in Landsbanki would only get 5-15% of their deposits. At the same time they were trying to move assets from the UK subsidiary to the Iceland parent to pay domestic depositors in full. The terrorism thing was just using a provision of an Act to stop the flow of funds.
18. November 2010 at 20:11
Scott,
As an anachronism who shares the pain of other anachronisms may I quote an old Don Henley song?
“Out on the road today, I saw a DEADHEAD sticker on a Cadillac
A little voice Inside my head said, “Don’t look back. You can never look back.”
The Gold Standard is Dead. But it might be Dead for good reasons.
18. November 2010 at 20:40
Doc, do you know what the European price level consequence of the New World gold discoveries was? They call is the great European “price revolution”: roughlya quadrupling of the price level in the space of a century.
Now, figure out what that annual inflation rate that translates into. You will find that it is less than the Fed’s old (implicit) target rate of 2%! So much for those horrible gold supply shocks!
Critics of the gold standard like to compare hypothetical P disturbances under an imagined gold standard to some hypothetical ideally managed fiat standard. Well, in that case fiat money always wins. But comparing the actual record of gold to the actual record of even the better fiat monies, gold wins hands down.
18. November 2010 at 22:33
Scott wrote:
“The debate over “ending the Fed” is pointless. There will always be something called “the Fed.” What we need to do is not to end it, but emasculate it. Take away its discretion and simply give it a nominal mandate, and let the market implement the mandate.”
This was the very point I raised in class on Wednesday. Unfortunately I’m not sure they understood my point. I emphasized the need for a constitutionally mandated nominal target that was market determined. Oh, God help me!
18. November 2010 at 22:40
Let me be clear Scott. I’m not begging for your help. I’m begging for God’s. (Although I could use your help as well.)
19. November 2010 at 00:07
Mark, just tell them it will be on the test. They’ll understand it then, right?
I always sat up and started paying attention when I knew something was going to be on the exam.
19. November 2010 at 00:33
@George Selgin
I had no idea it was that slow! That really puts to lie the idea that the modern fiat system is long term stable. If thats true, the modern fiat system has had more inflation during the modern era than the gold standard did during its worst time.
19. November 2010 at 00:41
For a blog called The Money Illusion, there seems to be little understanding of what money is. Money is an abstraction for the value of goods and services, but it has become reified. A dollar is a unit of measurement like a pound or a centimeter, though most of us would be happy to lose a few pounds (also reification!) and collecting centimeters would be absurd. The current problem in the US is that the money supply is no longer an accurate measure of goods and services. The terms NGDP and RGDP are often used, which implies that inflation adjusting the dollar GDP somehow makes it real. Some examples might help. Selling synthetic CDOs in 2007 may have added billions to GDP, but it is not clear what goods and services were created because of it, while a bountiful harvest could actually lower GDP because of the demand curve for agricultural products. One topic I do not see discussed is how the distribution of the money supply affects supply and demand. Reductio ad absurdum, if the “proper” money supply was all in the hands of one person, the result would be total economic chaos. If the “proper” money supply was evenly split between everyone, the result would very likely be rapid price inflation. The inequality of wealth distribution is greater now than any time since the Great Depression. Perhaps this not a coincidence. I believe it was realized in the 1980’s that one could expand the money supply faster than the supply of goods and services without it showing in standard measures of inflation as long as it was concentrated among the wealthy. One may argue about whether this was intentional, but it is difficult to dispute the result of policies over the last 30 years is a great increase of net wealth among the wealthy, and little or no increase of net wealth among the middle and lower classes. This then led to asset price inflation and bubbles as there was a large supply of investment funds looking for good returns. Remember Allen Greenspan speaking about irrational exuberance in 1996? The stock market has nearly doubled since then and I see nothing to suggest that American business is doing that much better.
I believe “The dismal science” is dismal because of its predictive validity. We need better models, models based on resources (industrial, agricultural, mineral, human, etc) and not on money. With those, we could actually develop a sensible monetary policy. Simulate the economy, not stimulate the economy.
19. November 2010 at 01:40
@Mark
‘I emphasized the need for a constitutionally mandated nominal target that was market determined. Oh, God help me!’
With every other prof teaching them nominal variables as if they are something that isn’t real… its gonna be hard. Because contracts, debts, etc specify prices nominally, money is a real variable. This doesn’t mean that oversupply doesn’t raise the price of other goods wrt money just the same way as increasing the supply of any good raises its price relative to other things.
There is nothing magical about money except that its extremely liquid and we have to pay taxes in it, (the Austrians call this salability), but those little pieces of paper/bunches_of_electrons gain their value the same way everything else does. I wish people would repeat this over and over again, “there is nothing magical about money!”
“there is nothing magical about money!”
“there is nothing magical about money!”
Money is just a very liquid, easily transportable good, that has very high demand due, in part, to taxes. That is all.
19. November 2010 at 05:51
Tom Grey, Thanks for that idea, I’ll let others respond because that’s not my area of expertise. I have proposed we do what some other countries do, and make payroll taxes adjust with unemployment. If firms paid lower payroll tax rates in recessions and higher rates in booms, it would help stabilize employment, and essentially offset wage stickiness.
Spencer, Good point, but I doubt it was due to the Fed. I’m guessing it also happened around 1920 in countries whose central banks started at different dates.
Patrick, I agree about the TSA, and mentioned that in my post. And I sympathize with your frustration with public employee unions, etc. But I think we need to distinguish between legal but bad public policy and outright lawbreaking. Look at city government in movies like The Gangs of New York. Yes, some corruption still goes on today. But I think there was top to bottom corruption back then that has diminished somewhat.
Bonnie, I like that quotation.
Marcus, I think he is saying that NGDP would have dropped 30% instead of 3% (or 8% below trend.)
Yes, I was startled to see my name mentioned that way. I think my blog is successful, but his colleague Nick Rowe’s is just as good if not better. Perhaps he mentioned me because Nick is in a strong research program, and my success was more unexpected given my background.
WhiskeyJim, This has come up before. It’s possible that an economy could adjust to mild deflation over time, but the sudden downshift in NGDP growth in 2008 was a sudden shock.
More to come . . .
19. November 2010 at 08:49
@Morgan:
There is something called bitcoin that is an attempt to do something sort of but not quite like what you describe. There is already an exchange rate with the USD for bitcoins, I think its like 0.002 USD per bitcoin.
19. November 2010 at 08:54
I find the initial question of this whole post absurd: are we better off today than in 1929?
Materially, there is no doubt.
What about personal liberty? I honestly can’t imagine how anyone would think that your average individual was “more free” in 1929 than today: I think the loss of the ability to smoke in public, or dump chemicals into watersheds if you owned the surrounding plot, or start a business without having to fill out regulatory paperwork in no way cancel out the gains in not having to worry about being lynched, or dying due to negligence by some private enterprise, or having to keep your thoughts or feelings secret for fear of being sent to a psychiatric institution.
All those supposedly “terrible” changes like the SSA, or Medicare, or Medicaid, or environmental protection, were all democratically approved by voters in the past. Why don’t conservative ever stop to think WHY people freely chose (as they do in our less corrupt elections) to support something like Social Security? Maybe it is because they value to social stability created by such a system of balances more than they do their own fleeting personal desires?
1929 was the eve of many terrible things – clearly the system in 1929 was unsustainable and rotten – the proof of that is in any history book you care to open. The question of our day is whether our current system is also rotten, if in slightly different ways. Pinning for a broken system of old makes no sense.
19. November 2010 at 09:19
WhiskeyJim, You said;
“Before we start to sound like a bunch of worry warts, I do not believe this is true. In fact, quite the opposite. Absent the Fed, we could have shut down the banks in an orderly fashion and sold those assets off”
Which is exactly what we did in the 1930s, and that didn’t prevent the Great Depression.
Jason, Yes, and also greater health and wealth and smaller families play a role. We are more risk averse–much more even that I was a kid in the 1960s.
Every parent who voted against legalizing pot should be required to sign a statement promising to testify for the prosecution (in the sentencing phase) if their kid is found guilty of drug use. They should be required to tell the jury that their child should be sent to prison.
(Yes, I’m kidding, I know that people are complete hypocrites.)
Philo, You said;
“”Social Security and Medicare really do help older people . . . .” Social Security certainly helped the first couple of generations that lived under it, but beyond that it is a drag on all age groups. It was primarily a one-time transfer of wealth to the early (elderly) beneficiaries, and thereafter a permanent depressor of the economy for almost everyone.”
Exactly my point, it should have been set up as a fully funded system with private accounts. (whether stock purchases should be allowed is a separate issue.)
I disagree about dogmatic libertarians. I believe they are “natural rights” people, whereas pragmatists like me are utilitarians or other types of consequentialists. That makes a difference on issues like redistribution.
more to come . . .
19. November 2010 at 11:00
Marcus, I’ll eventually do a post on that paper–needless to say I don’t agree.
George, That’s a good point about immigration.
W. Peden, Certainly in a technical sense no one argues a gold standard is best. I think its supporters point out that growth in gold supplies is fairly stable, and it overcomes time inconsistency issues. My own view is that instability in gold demand, not supply, is the biggest weakness.
Recent immigration may have depressed average incomes, but it’s a closer call than you might think. Many immigrants do very well academically, and start up high tech firms, etc. That boosts our productivity. Among Latinos, incomes are lower than average, but even among that group there are differences–with Cubans doing pretty well. I agree with your point, but I’m not sure how strong the effect is. I think the stronger effect might be on income inequality (Gini) as some do very well and others are very low income.
19. November 2010 at 11:05
Regarding Scott’s comment:
“Yes, I was startled to see my name mentioned that way. I think my blog is successful, but his colleague Nick Rowe’s is just as good if not better. Perhaps he mentioned me because Nick is in a strong research program, and my success was more unexpected given my background.”
I believe this blog is the best economic blog on the internet because of the real time analysis of events and the quality of the people and the arguments they make in the discussions about the economic issues of the day. The ability to get feedback on your comments from a top macro economist is unique on the internet. No other blog even comes close in my opinion.
19. November 2010 at 11:54
Prof. Sumner,
That’s a good point about immigration being more important to Gini than RGDP per capita. Also, it must affect statistics for particular wage brackets e.g. giving the impression of people moving into the poorer brackets and creating an illusion of income stagnation, although there are other more important factors that create the income stagnation illusion.
19. November 2010 at 12:30
@W. Penden:
Yes, immigration from very poor countries should have a massive depressive effect on gini. Its one of the reasons its useless to compare it across countries (which makes it mostly useless.)
19. November 2010 at 14:27
Scott I wish you had the nuts to really deal with this possibility.
Man up. Don’t wave your hand… what if this is right:
“It is also unlikely, as some claim, that the Fed chairman is whipping up a stealth stimulus or orchestrating a currency devaluation. He knows these have been tried and are more likely to destroy jobs than create them.
I have a different explanation for the Fed’s latest easing program: Without another $600 billion floating through the economy, Mr. Bernanke must believe that real estate (residential and commercial) would quickly drop, endangering banks.
Before growth can occur, however, we have to fix what caused a recession in the first place. Often that means drawing down inventory that built up in the last boom, or tightening credit to whip inflation, as then-Fed Chairman Paul Volcker did in 1981. In late 2010, though, we still have banks overstuffed with toxic real estate loans and derivatives. But what about the trillion in bank reserves sitting at the Fed and earning 0.25% interest? Why isn’t it being lent out? Perhaps because it’s needed to offset unrealized losses on these fouled loans.”
http://online.wsj.com/article/SB10001424052748704648604575621093223928682.html?mod=googlenews_wsj
Come on Scott, this is what conservatives REALLY think… answer them.
19. November 2010 at 14:37
JTapp, Thanks, Bill is right about the distinction.
Alan, The LOLR role may be useful, but I’d like to see it strickly separated from monetary policy. Either have the Treasury do this, or a part of the Fed that is strictly separated from NGDP futures targeting.
George, The price level was something close to a random walk under the GS, but there was no inflation drift under gold. So there was substantial uncertainty about where the WPI would be a year or two later (as much as under fiat money), but far less uncertainty (than under fiat money) about where it would be 20 years later.
Thanks Contemplationist,
Richard, No matter what you do with the LOLR issue, there is still the question of the nominal anchor. How do you keep the value of money (or NGDP) stable in a world where the demand for money may fluctuate–especially during financial crises.
Tomasz, You said;
“Banks in Iceland had none, disproving your hypothesis.”
Depositors in IceSave assumed they were protected by deposit insurance–and they were–disproving your hypothesis.
W. Peden, I also like Congdon’s work.
RobbL, You said;
“I am surprised that you as “somewhat” of a libertarian would be so happily looking forward to the cashless all electronic society. I would think that someone concerned about liberty would understand that removing cash from society would be a crushing blow to personal freedom.”
You misunderstood me (my fault.) I hate the idea, and I love privacy. My point was I look forward to having to hear no more whining about liquidity traps (which in my view were never a problem.)
Mark, You said;
“The Gold Standard is Dead. But it might be Dead for good reasons.”
Ditto for 70s music.
As far as teaching advice–always start with basics and work up–never assume knowledge of building blocks.
jwes, You are confusing monetary policy and income distribution. They are basically unrelated. New money isn’t given to the rich, it’s sold at equilibrium market prices.
Gepap, You said;
“What about personal liberty? I honestly can’t imagine how anyone would think that your average individual was “more free” in 1929 than today: I think the loss of the ability to smoke in public, or dump chemicals into watersheds if you owned the surrounding plot, or start a business without having to fill out regulatory paperwork in no way cancel out the gains in not having to worry about being lynched, or dying due to negligence by some private enterprise, or having to keep your thoughts or feelings secret for fear of being sent to a psychiatric institution.”
I mentioned civil rights as the most important reason liberty has improved, so I’m obviously not going to disagree with you. But I don’t think these issues are as obvious as you think. It’s easy to pick out sensitive issues like “lynchings” to ridicule the other side. So I checked the data. There were 3 whites and 7 blacks lynched during 1929. There are over 400,000 innocent Americans now in prison for the “crime” of using illegal drugs. Roughly half are African Americans. That’s far more than 1929. There’s no doubt that (overall) blacks are much better off than in 1929, but in looking at issues like liberty things aren’t always as obvious as they seem. In the end I agree with you, but don’t think the other side lacks good arguments.
Regarding democracy, I’ve argued that we are no where near democratic enough. We should emulate Switzerland. Many leftists don’t like Switzerland because their people vote for lower taxes than most other European countries. Having said that, I certainly agree that the basic welfare state is popular at some level. But things change, and it’s possible voters will turn against it. They turned against other forms of statism in the 1980s (when many democracies privatized SOEs), so one can never say we’ve reached the final system.
You said;
“1929 was the eve of many terrible things – clearly the system in 1929 was unsustainable and rotten”
All systems are somewhat rotten, but in many ways the US in 1929 was one of the best systems the world had ever seen–with the obvious exception that other developed countries at the time had far better records on race relations. But it’s silly to simply call a fairly successful country from the past “rotten;” they all were rotten by modern standards–even Golden Age Greece had slavery. It’s about how they did relative to their own past, and to other countries. We are also “rotten” in many ways.
And the system was certainly sustainable–a pity the Fed had to ruin things.
Bob, Thanks, but if comments continue at this pace it will be hard to keep answering them all.
W. Peden, There is a tendency for children of blue collar workers to go to college, and their jobs get filled by immigrants from places like Mexico. I’m not saying all is rosy (especially in this awful recession) but it possible for the aggregate data to look worse, but for each family to do better than their parents (in whatever country they came from.)
19. November 2010 at 15:48
Morgan, You said;
“Scott I wish you had the nuts to really deal with this possibility.”
Someone around here is certainly “nuts”.
Yes, before growth can occur we have to fix what caused the recession—tight money.
19. November 2010 at 17:50
” Take away its discretion and simply give it a nominal mandate, and let the market implement the mandate.”
If a plane is flying through a uncharted mountain range, you don’t want to put it on autopilot, even if the pilot is not particularly good.
19. November 2010 at 17:54
” it’s also true that if we had no Fed in 2002 there would have been no sub-prime fiasco. Banks don’t do that sort of thing without a safety net.”
I wouldn’t bet on it. There were bad financial crises in the 19th century without there being a safety net.
There would not have been a sub-prime fiasco if there had been more effective regulation. But the Bush administration philosophy of regulation was to put the foxes in charge of guarding the henhouse. The results were predictable.
19. November 2010 at 18:53
Scott, an alternative reality is being presented to you that says Ben does not think this is going to grow NGDP.
That he is FULL AWARE all the other commodity based prices are rising, and his SOLE CONCERN is falling housing prices.
I’m asking you to explain logically how we know this isn’t true. I don’t want your views on housing market.
I want you to show me something Ben would be doing different if his only real goal is propping up the banking industry.
The fact is… if my side is right, we are going to see Ben’s voice get even more and more desperate… he will become more frantic even if Unemployment just hovers at 10%.
There’s no danger of deflation and Ben promises he won’t raise if it gets past 2%… that says to me, Ben KNOWS how far homes prices are able to plummet and offset oil at $120.
19. November 2010 at 19:36
“If a plane is flying through a uncharted mountain range, you don’t want to put it on autopilot, even if the pilot is not particularly good.”
“There were bad financial crises in the 19th century without there being a safety net.”
Full Employment Hawk repeats the usual pro-discretionary central bank banalities, oblivious of the actual historical record, and of the fact that my and my co-authors’ paper–which is after all the subject of this blog–recognizes and rebuts them. Yes, there were crises before the Fed; and yes, autopilots aren’t as good as good pilots. But the Fed has not improved things, because know one has ever demonstrated an ability to fly it straight.
19. November 2010 at 19:43
“That he is FULL AWARE all the other commodity based prices are rising, and his SOLE CONCERN is falling housing prices.”
The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.2 percent in October on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the all items index increased 1.2 percent before seasonal adjustment.
It seems that he is fighting disinflation.
19. November 2010 at 19:49
@George Selgin
Chairman Greenspan was regarded as a “sage”. So much so that a new “specialty” – Fed Watchers – was created to interpret the “sage´s” musings. Without being aware (I know this beacause he says so at the end of chapter 20 of Age of Uncertainty) he “flew straight” – kept reserves pretty much constant – during his watch. More than anything else, I think this was reponsible for the “Great Moderation”. In your paper you dismiss this offhand. Maybe Bernanke´s problem is that he is too “conscious” (and therefore “afraid”)…
19. November 2010 at 19:54
Prof. Selgin,
Do you have a view on Prof. Sumner’s NGDP futures targeting proposal?
19. November 2010 at 23:36
“It seems that he is fighting disinflation.”
No he doesn’t care about disinflation, he cares only about banks being driven into insolvency.
The question is, if banks were not insolvent, what would Bernanke do, and he’d not be printing money.
This is the discussion that Scott won’t peer into the abyss on… the way to ease concerns of the opposition is to push for mark-to-market, a completely rational policy; or any policy that makes the banks desperate and upside down – even more than ending IOR… because after all, if QE is THE solution… the best way to get it from Ben is another Bank Crisis.
Get the Banks crying uncle, and Ben will print the $1T Scott wants printed.
19. November 2010 at 23:55
Smartest thing in weeks:
“The problem with the carry trade unraveling is that you suddenly have an unbalanced market where everyone wants to sell their long term treasuries and there is a dearth of buyers. The Fed will have to step up to fill the void, but at what price level? To forestall the uncertainty and head off a selling surge, the Fed announces it will become the buyer of last resort for these treasuries at current market levels over the next 3 quarters, but calls it QE2. I believe this is Bernanke’s way of telling his banker friends it’s time to unwind their carry trade positions and get back to the business of lending to the private sector. Yes that means taking credit risk, but it also means making loans tied to the prime rate and therefore, loans which adjust with the coming inflation.”
http://blogs.forbes.com/investor/2010/11/16/bernanke-to-banks-unwind-your-carry-trades-now/
20. November 2010 at 03:35
Marcus: “More than anything else, I think this [Greenspan’s conduct of Fed Policy] was reponsible for the “Great Moderation”. In your paper you dismiss this offhand.”
No, Marcus: we survey the studies that have been done on causes of the Great Moderation, and report that most of them attribute it to factors other than improved monetary policy. (I overlooked one important paper that adds demographic change to the list of major contributors to the moderation.)
W. Peden: I’ve myself proposed a kind of spending growth target as a way of approximating what I call a “productivity norm.” You can find a discussion between me and Scott concerning our respective preferences at Cato Unbound.
20. November 2010 at 07:35
George Selgin said:
“..You can find a discussion between me and Scott concerning our respective preferences at Cato Unbound.”
You can find the Sumner/Selgin discussions here:
http://www.cato-unbound.org/archives/september-2009-monetary-lessons-from-the-not-so-great-depression/
20. November 2010 at 08:22
Prof. Selgin,
Thanks. I look forward to reading that.
20. November 2010 at 09:37
In a speech at a conference of central bankers in Frankfurt, Bernanke once again said the Fed cannot save the economy on its own. The Fed’s recent move to add to its ballooning balance sheet by committing to buy up to $600 billion of government debt faces “limits” to its effectiveness, Bernanke said. The rest of the government, the chairman added, could aid the Fed’s efforts by hammering out a plan for stimulative spending. The right kind of spending, he noted, could help reduce the budget deficit over the long-term by first boosting economic growth.
There have been rumors that Bernanke favored additional fiscal stimulus, this shows that they were on the mark.
I think the Fed could provide a lot more stimulus with nonconventional monetary policy that the Fed is willing to do. Ending the interest payment on excess reserves is the most obvious example. And the Fed could buy real estate based securities again.
But while most of the people on this site will strongly disagree with me, I agree with Bernanke that helping the stimulative monetary policy with a second fiscal stimulus would be very effective. But with the current political situation, its not going to happen. Expansionary monetary policy is now the only game in town.
20. November 2010 at 09:42
“No he doesn’t care about disinflation, he cares only about banks being driven into insolvency.”
At the banking conference in Frankfurt Bernanke argued “that additional stimulus is necessary given persistently high levels of unemployment in the United States.”
Bernanke gets it. IT’S THE JOBS, BEN!
20. November 2010 at 09:49
“the best way to get it from Ben is another Bank Crisis.”
Wouldn’t a repeat of the early 1930s be jolly good fun?
Marking the assets of financial institutions to market makes the financial system dangerously unstable because a moderate shock can lead to a domino effect that brings the entire financial system down.
If a moderate shock requires the financial institutions to sell off part of their assets, their prices drop. With the assets marked to market, this will force them to sell additional assets to meet capital requirements, which will cause to prices of such assets to drop even more. Marking them to market will then force the institutions to sell still more assets, pushing their price even lower. etc., etc.,etc.
20. November 2010 at 10:09
You started out: “When I was young I thought I was experiencing a series of events. Now I understand that I was experiencing the feeling of being young.” You should have understood then, and you should understand now, that you were experiencing *both*. We perceive the external world, and we also perceive our own states of mind.
In reply to my comment about Social Security, you wrote: “Exactly my point . . . .” Well, not *exactly*. You had written: “Social Security and Medicare really do help older people . . . .” I objected, and still object, to your using the present tense.
Finally, I was trying to fall in with your usage of the terms ‘dogmatic’ and ‘pragmatic’, as applied to libertarians. I thought you were classifying policy advocates who insisted on first-best policies as “dogmatic,” while those who were willing to advocate more “realistic” second-best policies were “pragmatic.” It now appears to me that you mean, by ‘dogmatic libertarian’, someone who takes liberty as his only intrinsic value, while a “pragmatic libertarian” is someone for whom liberty is only one among a plurality of values, and perhaps not an *intrinsic* value at all. This difference might, indeed, lead a dogmatic and a pragmatic libertarian to differ in their comparative evaluation of two social situations. (It would not lead to any difference of opinion about which situation contained *more liberty*.)
20. November 2010 at 13:47
Scott wrote:
“Ditto for 70s music.”
Don’t write off all 70s music. That was part of my point. While some were indulging in the Disco Craze others were generating real music. (Check out any live performance of “Round and Round” by the Dead during that decade.
And you wrote:
“As far as teaching advice-always start with basics and work up-never assume knowledge of building blocks.”
That’s the advice I deliver novices. And the advice I never am sure I really have taken myself.
20. November 2010 at 14:03
A live performance by the Other Ones:
http://video.search.yahoo.com/search/video;_ylt=A0SO8Zp6ROhM6RgAJk77w8QF;_ylu=X3oDMTBncGdyMzQ0BHNlYwNzZWFyY2gEdnRpZAM-?p=grateful+dead+round&fr=yfp-t-948&ei=utf-8&fr2=tab-web&n=21&tnr=20&y=Search
“No they never stopped rockin’. What a crazy sound…”
20. November 2010 at 14:06
OOps! I meant to link here:
http://www.youtube.com/watch?v=Mh52inNxUTA&feature=player_embedded
20. November 2010 at 14:13
Inflation Hawk, Ben meant extend Bush’s tax cuts.
“The Federal Reserve is nonpartisan and does not make recommendations regarding specific tax and spending programs. However, in general terms, a fiscal program that combines near-term measures to enhance growth with strong, confidence-inducing steps to reduce longer-term structural deficits would be an important complement to the policies of the Federal Reserve.”
Stimulus that ain’t. That’s, “Ok, Republicans are back in the saddle, let’s keep taxes low, and long term figure out how cut Public Employee Compensation by $400BILLION per year.”
They’ll hand Obama the Tax Cuts, rubber stamped by the Senate and say, “Ben says you can’t veto this, and here’s the th long term plan coming right after.
Dude, Greenspan just CAME OUT and said Paul Ryan’s plan is the way to go.
They speak English, stop pretending they are French.
20. November 2010 at 14:33
Morgan,
Even I agree that short term fiscal stumulus is meaningless given the power of money.
But clearly based on previous statements the Republican nominated Bernanke believes that monetary stimulus needs to be augmented by fiscal stimulus. This is in no doubt due to his addiction to the credit channel of MTM thesis.
Attempts to interpret otherwise either betray your stupidity or your willful ignorance.
20. November 2010 at 14:57
Morgan wrote:
“Dude, Greenspan just CAME OUT and said Paul Ryan’s plan is the way to go.”
So Greenspan just came out and said Ryan is also a big idiot?
20. November 2010 at 16:12
@Mark,
“So Greenspan just came out and said Ryan is also a big idiot?”
What exactly do you mean by that?
Are you advocating that fiscal stimulus actually works? or are you saying that Ryan’s plan doesn’t cut enough, or what?
20. November 2010 at 16:25
I’m saying Ryan’s “plan” solves neither our current AD shortfall nor our long term fiscal shortfall. It makes the short term worse and the longer term worser.
And, yes, I think anyone who thinks otherwise is immediately intellectually shorter in my perception. Prove me otherwise.
20. November 2010 at 17:29
And yes, there’s something in the way she moves me:
http://www.youtube.com/watch?v=8u_Jqfw93-4&feature=player_embedded#!
20. November 2010 at 18:04
“Inflation Hawk, Ben meant extend Bush’s tax cuts”
Versus:
The rest of the government, the chairman added, could aid the Fed’s efforts by hammering out a plan for stimulative spending. The right kind of spending, he noted, could help reduce the budget deficit over the long-term by first boosting economic growth.
20. November 2010 at 18:38
@Mark A. Sadowski
‘I’m saying Ryan’s “plan” solves neither our current AD shortfall nor our long term fiscal shortfall. It makes the short term worse and the longer term worser.’
1. Ok, so you DO think that government spending cuts lower AD! This is something I do not agree with.
2. It does cut long term spending, so I don’t see how it makes the “longer term worser” maybe it doesn’t cut the deficit as much or as fast as you would like however?
20. November 2010 at 23:15
Mark, I’ve been making clear for some time, that AFTER the election you would see Ben start to advocate for action that favored Republicans.
This statement OBVIOUSLY supports my premise, suddenly NOW is the time for him to push the banks t start lending again… I GUARANTEE it will fall on the side of the line where everyone not following Fed moves – thinks “boy these Republicans fixed things.”
If you geek out too hard on the math, its hard to remember the timing. How many MONTHS did you guys beg for action, and now who’s going to get the credit?
If Ben wanted bigger government, he’d have played this hand months and months ago.
21. November 2010 at 14:02
“This statement OBVIOUSLY supports my premise, suddenly NOW is the time for him to push the banks t start lending again… I GUARANTEE it will fall on the side of the line where everyone not following Fed moves – thinks “boy these Republicans fixed things.”
Low information voters give the credit or blame for the state of the economy to the President. And half of the people do not even know at this point
that the Republicans have won control of the House.
The more the unemployment comes down by 2012, the better Obama’s chance of being reelected. He higher it stays the worse his chances.
I think the difference in the stance of the Fed is primarily due to the fact that Obama has finally filled two of the vacancies on the BOG with people who take the Fed’s mandate to achieve maximum employment seriously. Before Bernanke did not have solid enough support on the FOMC to move forward with expansionary moneteary policy. If Obama knows what is good for him, he will get the third vacancy filled with Diamond PDQ. If the Senate will not confirm the appointment before the end of the year, the smart thing for him to do is to recess appoint him.
21. November 2010 at 14:06
” Ok, so you DO think that government spending cuts lower AD! This is something I do not agree with.”
So you and Bernanke disagree on this.
21. November 2010 at 14:14
“W. Peden, There is a tendency for children of blue collar workers to go to college,”
With the cost of tuition strongly rising, this is getting more and more difficult.
I am the son of a blue collar worker. Neither of my parents got beyond 8th grade and got a PhD. But at the time I did it, I did not end up being loaded down with crushing debts like people in my position end up with now.
21. November 2010 at 14:56
Doc Merlin,
Ceteris Paribus, spending cuts obviously lower AD. But the effect of fiscal policy is always dependent on the reaction of monetary policy.
Any credible analysis of the Ryan “plan” suggests that it completely fails to address the long term deficit problem.
21. November 2010 at 16:03
“Ceteris Paribus, spending cuts obviously lower AD. But the effect of fiscal policy is always dependent on the reaction of monetary policy.”
The Fed’s timid actions with respect to monetary policy at a time whent the economy is depressed indicate that it will not significantly offset the effects of spending cuts with expansionary monetary policy. On the other hand, Bernanke’s statements indicate that the Fed would not offset the effect on AD of increases in government spending.
21. November 2010 at 18:27
[…] and political chaos that would result from it would be dangerous. So I have decided to agree with The Money Illusion that we should just wait for its eventual death. I think the neocons are liberals without the New […]
21. November 2010 at 19:49
“And half of the people do not even know at this point
that the Republicans have won control of the House.”
No. Likely voters know Republicans won. Even the “low information” voters know. The difference is in the ability to say 60+ seats.
Again, Ben had plenty of time, and FAR BETTER chance of getting more spending by asking for it earlier. How many times has someone here lamented that they seem to waiting until after the election?
He waited. And in order for you to pitch your reality as gospel, you are left raising him up as the only non-political human in DC culture.
I’ll wait it out. In January / February you should see him nodding towards something bold like comprehensive tax reform, Paul Ryan’s thing… Something your side screams about.
21. November 2010 at 21:24
“And half of the people do not even know at this point
that the Republicans have won control of the House.”
This is based on a public opinion survey. The public knows that the Republicans won, but many don’t know what they won.
If Bernake were to get the stimulus he wanted (which he won’t) that would bring the unemployment rate down and help Obama in 2012. As I have said, low information voters give the President the credit or blame for the state of the economy.
I predict that he will definitely not support a Ryan type program. Remember that I said that in February when it has not happened.
21. November 2010 at 23:12
“This is based on a public opinion survey. The public knows that the Republicans won, but many don’t know what they won.”
I think it was this one: http://pewresearch.org/pubs/1804/political-news-quiz-iq-deficit-defense-spending-tarp-inflation-boehner
22. November 2010 at 08:20
I read the survey and the “people are dumb articles” when it came out, you mis-quoted it.
Likely voters are the college graduate skew avg against voting ID – you’ll need to do some math. The number is probably +5 over that avg, likely voters are basically 33-40% of population and the only ones who count. Low information voters will skew lower than likely – but definitely above those genpop numbers.
When you read polls on voting you always have check this stuff.
22. November 2010 at 11:29
“US CPI inflation was an annual 1.2% in October while the “core” rate – excluding food and energy – fell to just 0.6%. These figures have reinforced perceptions that inflation is lower in the US than in other major economies and that pressures are continuing to weaken.
As previously discussed, however, the US numbers are lowered by the inclusion of imputed housing rents, which are estimated to have been unchanged over the last year. If recalculated using the EU’s HICP methodology, US CPI inflation was 1.8% in September (the latest available month for this measure) – the same as in the Eurozone.”
http://www.moneymovesmarkets.com/journal/2010/11/19/is-us-inflation-different.html
22. November 2010 at 11:57
Fed’s Kocherlakota Says Inflation Low, Growth ‘Alarmingly’ Slow
By Steve Matthews and Joshua Zumbrun – Nov 22, 2010 10:30 AM
U.S. economic growth is slowing and inflation is falling, two worrying trends that warrant the new round of monetary easing by the central bank, said Federal Reserve Bank of Minneapolis President Narayana Kocherlakota.
Inflation of about 1 percent is “low” and “more troublingly the inflation rate is drifting downward,” Kocherlakota said today in a speech in Sioux Falls, South Dakota. “Growth has been low in this recovery compared with most. More alarmingly, growth has been decelerating.
Interesting–Kocherlakota has joined the QE2.
22. November 2010 at 12:27
“More alarmingly, growth has been decelerating.”
Time for the Fed to use its new instrument of monetary policy and start cutting interest on excess reserves, eventually to zero.
22. November 2010 at 12:30
“the US numbers are lowered by the inclusion of imputed housing rents”
Housing is an important part of household expenditures and therefore affects their cost of living. One can always torture the data until it confesses what your want it to confess, such as leaving an important part of the cost of living out.
22. November 2010 at 12:52
97 comments and counting–dealing with all of them must be worse than grading a stack of bluebooks! You’d better blow us commenters off so you can provide your readers with more of your posts.
22. November 2010 at 13:01
“Assuming that there is no political prospect of replacing the fiat dollar with a return to the gold standard or other commodity money system, for the dollar to retain its value some public institution must keep fiat base money sufficiently SCARCE.”
If the US paper dollar has value because the Fed keeps it scarce, then why does the Fed, like every other bank that has ever existed, bother to hold assets? It is more sensible to think that the US paper dollar has value because it is backed by the Fed’s assets. That means that the dollar retains its value as long as the Fed holds enough assets to buy back all its dollars at par. Of course, that’s true of any privately-issued money as well, and there’s no reason to think that the Fed does it any better than private banks.
22. November 2010 at 13:19
“It is more sensible to think that the US paper dollar has value because it is backed by the Fed’s assets.”
A common understanding. But nevertheless untrue. The argument confuses the basis of value for inconvertible (“fiat”) money with that for convertible banknotes.
Right now, notes issued by the old Central Bank of Somalia are still used as currency, even though that bank closed its doors years ago.
22. November 2010 at 13:51
“The argument confuses the basis of value for inconvertible (“fiat”) money with that for convertible banknotes.”
The fact that money is not convertible into metal does not mean that it is fiat money (i.e., not backed). There are always many channels through which the central bank’s money can reflux to the central bank: the gold channel, the bond channel, the loan repayment channel, etc. Right now the Fed has closed only the gold channel, but as long as the other channels are open, holders of paper dollars can still redeem their dollars for the Fed’s assets. “Convertibility” can mean a broad range of things, and the suspension of one form of convertibility clearly does not mean that money has lost its backing.
I haven’t heard much about Somalian currency, but I have heard the same claim for the Iraqi Swiss Dinar. The Dinar, however, was eventually redeemed in a new currency, so its positive value could be explained by the prospect of delayed backing. The same explanation could be applied to the Somalian currency. In any case, when we look at banks (central and otherwise) down through history, we see that they universally held assets against the money they issued, even when people commonly thought of the money as unbacked. And when the banks lost their assets, the money they issued lost its value, even when the money remained scarce.
22. November 2010 at 14:04
@Philo
That´s “punishment” from being away too long!
22. November 2010 at 14:06
Mr. Sproul, yours is not the orthodox definition of fiat money: I know of no economist who regards any permanently inconvertible paper money as anything but “fiat,” without regard to what is backing it.
And if the value of a central bank’s money depended on the value of its assets, then we surely ought to have seen an impressive decline in the value of the U.S. dollar when the Fed bought all those worthless mortgage-backed securities while selling off its holdings of Treasuries (and while, for a time, maintaining a more-or-less constant overall stock of liabilities). Yet no such thing happened: on the contrary, the purchasing power of the U.S. dollar rose. If ever there was a nice, clean, natural test of the “backing” theory, this was one–and the theory was proven utterly false.
22. November 2010 at 14:18
@George SelginL
“Right now, notes issued by the old Central Bank of Somalia are still used as currency, even though that bank closed its doors years ago”
I wouldn’t classify it as fiat money though. It is just worth the paper its written on+transport costs (a paper standard if you will, instead of a gold coin standard). Its not convertible into anything, but is worth its own production + transport costs and is still produced by anyone who can.
22. November 2010 at 14:20
“If the US paper dollar has value because the Fed keeps it scarce, then why does the Fed, like every other bank that has ever existed, bother to hold assets?”
Because its a bank and a profit making institution. It creates money and buys interest paying assets.
22. November 2010 at 14:49
George Selgin:
Orthodox economists say fiat money has value for basically the same reason that baseball cards and rare stamps have value: supply and demand. They have claimed, for example, that when the Bank of England suspended metallic convertibility in 1797, the pound went from being backed to being fiat. I suppose they would also have claimed that when metallic convertibility was resumed in 1821, the pound went from being fiat money to being backed money. This view neglects the fact that the Bank of England maintained its assets throughout the period, as well as keeping open its bond and loan channels. After all, the Bank had suspended convertibility every weekend and resumed convertibility every Monday. The pound didn’t suddenly become fiat money on Saturday, only to become backed on Monday.
If those mortgages were actually worthless, then the Fed would have had less backing per dollar. But three factors intervene: (1) The mortgages actually had some positive value. (2) The Fed had positive net worth to begin with, which means that even after suffering a loss, it still had enough assets to buy back its money at the original value. (3) If we think of the Fed as a branch of the US government, then the Fed’s dollars are actually backed by the government’s assets. If the US dollars are first in line as a claim against the government’s assets, then the Fed can throw away quite a lot of assets without affecting the value of its dollars.
Of course, this makes the backing theory hard to test, but several empirical investigations have found that the backing theory fits the data better than the quantity theory (Bruce Smith, Thomas Sargent, Thomas Cunningham, Pierre Siklos, Bomberger & Makinen, Calomiris, and a few others).
22. November 2010 at 20:43
Full Employment Hawk, You said;
“If a plane is flying through a uncharted mountain range, you don’t want to put it on autopilot, even if the pilot is not particularly good.”
You want the most skilled pilot to be in charge of the plane. And the market is much more skilled than the Fed.
You said;
“I wouldn’t bet on it. There were bad financial crises in the 19th century without there being a safety net.”
There was nothing like the sub-prime fiasco.
You said;
“In a speech at a conference of central bankers in Frankfurt, Bernanke once again said the Fed cannot save the economy on its own.”
He’s also said (recently) the Fed can do much more, and discussed several other options. He has said it’s a complete myth that the Fed is out of ammunition. So if the Fed can do much more–why ask for fiscal stimulus? Isn’t that much more costly?
All I ask is that he do what he recommended the BOJ do in the early 2000s. Is that too much to ask?
Philo, You said;
“We perceive the external world, and we also perceive our own states of mind.”
I’d say we perceive the external world filtered through our state of mind.
I meant that pragmatic libertarians are roughly utilitarian, and dogmatists are supporters of the “natural rights” concept. But of course that over-simplifies. I don’t think Tyler Cowen is a utilitarian, but he’s eclectic enough to be called a pragmatist.
Mark, I like some 70s music as well, but there was an awful lot of boring, tiresome, bombastic music in that decade. Unfortunately I listened to most of it. Even the groups that were good in the 60s went rapidly downhill. “Something” is from the 60s.
Benjamin, Yes, I was surprised by Kocherlakota’s statement.
Mike, If those “empirical investigations” include the Colonial currency episodes, then I don’t agree with your interpretation. The version of the QT being tested was a straw man that assumed V is fixed, hence the studies didn’t prove anything.
23. November 2010 at 00:47
“All I ask is that he do what he recommended the BOJ do in the early 2000s. Is that too much to ask?”
No it is not. I agree that he should definitely do this. But considering the howls from Republican and right-wing circles about even this minor action, we should not be surprised of the FOMC will be much too timid to do anything like this.
23. November 2010 at 05:15
Mike Sproul: “Orthodox economists say fiat money has value for basically the same reason that baseball cards and rare stamps have value: supply and demand. They have claimed, for example, that when the Bank of England suspended metallic convertibility in 1797, the pound went from being backed to being fiat.”
Me: “I know of no economist who regards any permanently inconvertible paper money as anything but “fiat,” without regard to what is backing it.”
I used the word “permanently” quite deliberately, to exclude cases, like the BofE suspension, in which it is understood that convertibility will eventually be restored. Mises (among others) put such temporarily suspended paper currency in a special category, calling it “credit” rather than “fiat” or “convertible” currency.
Where there’s no expectation of future convertibility, it simply makes no sense for people to treat the value of the issuer’s assets as bearing on the value of outstanding currency: they have _zero_ claim against those assets; the situation is quite unlike that concerning convertible notes, where (should the issuer fail) the notes’ redemption value will depend on the market value of the issuer’s liquidated assets. When MS writes “If the US dollars are first in line as a claim against the government’s assets, then the Fed can throw away quite a lot of assets without affecting the value of its dollars,” the “if” statement is pure fantasy: present U.S. dollars simply are not claims against the fed’s assets, or against anything at all.
MS (explaining why the value of the dollar didn’t decline when the Fed unloaded Treasuries and took on huge quantities of mortgage-backed securities): “If those mortgages were actually worthless, then the Fed would have had less backing per dollar. But three factors intervene: (1) The mortgages actually had some positive value. (2) The Fed had positive net worth to begin with, which means that even after suffering a loss, it still had enough assets to buy back its money at the original value. (3) If we think of the Fed as a branch of the US government, then the Fed’s dollars are actually backed by the government’s assets.”
Regarding (1), surely the Fed had “less” backing if it’s assets were worth “less.” Regarding (2), this begas the question; it amounts to saying that the value of the dollar depends on the value of the Fed’s assets only once those assets are worth less than the outstanding dollars. regarding (3), the Fed isn’t a branch of the government, and even if it were the government would be under no obligation to redeem the Fed’s notes for anything.
Make all the epicycles you like to try and save it, the “backing” theory remains absolutely ludicrous. Think of any hyperinflation. The central banks in question all piled up assets while issuing notes. Those assets didn’t become worthless. Yet the notes did.
23. November 2010 at 10:46
George Selgin:
1) On temporary vs. permanent inconvertibility: Nobody knows whether a suspension of convertibility is permanent or temporary. But as long as the money-issuing bank has its assets intact, customers know that if and when the bank is eventually liquidated, all its money will be redeemed. When a bank has no assets, then customers know that their money will never be redeemed. That’s why money loses all value when the issuer loses all assets. That’s why we don’t see ANY banks that hold no assets against their money, even though your “money scarcity” theory implies that such banks should be common.
2) On the many forms of convertibility: There might be 100 channels through which money can be redeemed at the issuing bank in exchange for valuable assets. Let the bank close just one of those channels (the gold channel), and not only do you act as if all channels have been closed, you conclude that the closure of that one channel leaves the bank’s money completely unbacked.
3) A quantity theorist is in no position to accuse a backing theorist of making epicycles. It’s the quantity theory that is a tangled mess of tautologies, non sequiturs, undefinable variables, and reversed causation. The backing theory says only that money is valued on the same principles as bonds, stocks, options, or any other financial instrument. When a corporation issues bonds, for example, nobody denies that those bonds are valued according to the assets backing them. If the corporation loses assets, then the bonds might lose value, but only after the stock and other low-priority liabilities have dropped to nearly zero value. We all agree that this is true of bonds, and yet you accuse me of begging the question when I say that the same is true of money.
Scott:
That’s the nice thing about the quantity theory. Any anomaly can be explained as a change in velocity. Any empirical work is going to have holes in it, and it is hard to come up with empirical tests to support either the quantity theory or the backing theory. If you don’t like Bruce Smith’s work, try the others I listed. So far, they are about the only economists who have even tried to test the quantity theory versus the backing theory, and they lean distinctly toward the backing theory.
23. November 2010 at 19:30
Ben Powell discusses Somalian currency in an interview here:
http://fee.org/media/stateless-in-somalia-by-benjamin-powell/
Will Luther has a working paper on “monetary anarchy” in Somalia, but only the abstract is available:
http://perfectsubstitute.blogspot.com/2010/01/working-paper-monetary-anarchy.html
24. November 2010 at 06:55
Full Employment Hawk, You said;
“I agree that he should definitely do this. But considering the howls from Republican and right-wing circles about even this minor action, we should not be surprised of the FOMC will be much too timid to do anything like this.”
We need more howls for the left that we need easier money. Three quarters of academic economists vote Democratic. Why aren’t they howling? Why am I having to the the howling; I’m not even a Democrat?
Mike, You said;
“That’s the nice thing about the quantity theory. Any anomaly can be explained as a change in velocity.”
You act like the quantity theorists came up with changing velocity AFTER the backing people found these anomalies. But serious quantity theorists have never claimed velocity is constant. Remember all those studies by monetarists showing velocity increases sharply during hyperinflation? The backing theorists were attacking a straw man, a version of the QTM that no serious economist believed in the 1970s–even before the studies by Smith, et al.
Thanks TGGP.
24. November 2010 at 07:44
TGGP:
“I argue that monetary anarchy is a feasible alternative; decentralized agents acting in their own self-interest are capable of generating a stable paper currency standard. A counterfeit commodity standard””where any individual can print as many paper notes as desired without obligation to redeem these notes for some commodity””has all the self-adjusting properties of traditional commodity standards (e.g gold standard). ” (Will Luther)
I don’t see why Luther uses the word “counterfeit”. The only way any individual (or government) can get people to accept their printed notes is if those notes give a claim to something of value. But then they aren’t counterfeit.
Scott:
The point is that velocity has always been a will-o-the-wisp that helps to render the equation of exchange a tautology. One could just as well use the equation to explain the value of GM stock. Just let M=number of shares, V=number of times per year that each share is spent, etc. You would have an equation that could ‘explain’ every change in the value of GM. Then if a backing theorist came along and claimed that the value of GM shares is actually determined by their backing, you could reject their empirical work by saying that they assumed V is fixed, hence the studies didn’t prove anything.
24. November 2010 at 19:44
Mike, The equation of exchange has nothing to do with the quantity theory of money.
25. November 2010 at 08:09
Oh. So the stuff Cowen and Tabarrok say on p. 542 of their basic macro book is just a lot of maverick ramblings? Ditto for p. 366 of Mankiw’s book, and for every other widely used macro book on the market?
Don’t get me wrong. I’m the first to reject what’s in those macro books. I’ve had a life-long dream that someday, macroeconomics would just die. But you, as a believer in the quantity theory, don’t have the luxury of just dismissing what what those books say. And they all say, correctly, that the equation of exchange has quite a lot to do with the quantity theory.
If you’re going to be a maverick, do it right and reject the quantity theory in its entirety.
26. November 2010 at 09:28
Mike, I’m not sure if we are arguing about semantics or substance. Everyone agrees the equation of exchange is really just a definition of a ratio:
V = NGDP/M
It shouldn’t even be called “velocity,” as it doesn’t measure the velocity of circulation, it DEFINES a ratio.
Now you could argue that this definition is used in constructing the QTM, but being a definition it has no theoretical implications in and of itself. The QTM also uses other concepts like ‘money,’ and ‘nominal income,’ and ‘causation,’ etc.
My point is that many people (and yes even some textbooks) confuse the QTM and the equation of exchange. One is a theory and one is a definition. To me that means they are unrelated. If you are merely asserting that quantity theorists sometimes explain ideas using that equation of exchange, that’s fine. If you are claiming that 20th century monetarists like Friedman believed velocity was constant, that’s completely wrong.
The simple quantity theory that assumes V is fixed is very similar to PPP and the Fisher effect—an abstraction from reality that is useful in certain circumstances. Everyone knows that PPP doesn’t hold in some cases, and also that nominal interest rates don’t always move in lockstep with expected inflation. But all three nominal conditions are useful concepts that become more useful as the changes in the price level become larger and more persistent.
Consider the following example:
A group of 12,000 Europeans sail to a new island, and settle there. Say New Zealand. When they land they find a chest of $12 million US dollars has washed up on the shore. Also assume that the US is not a factor here. Say the US government has been overthrown by communists, and the dollar is worthless. The settlers have a meeting and decide “let’s not bother with setting up a central bank, why don’t we just share these dollars equally, and all agree to use them as a medium of exchange.” I claim that would work, even with zero backing and even with the cash having no intrinsic value. The value to society of having a medium of exchange is about 4% of GDP. So my prediction is that the NGDP of this newly settled island will end up at about 25 times the nominal value of the cash they found and handed out and agreed to use as a medium of excahnge. Thus NGDP will be about $300,000,000. What is the predicted NGDP of the backing model for this newly settled island? (Also assume no government and no taxes–they are hardy self-sufficient settlers who handle their own affairs. But they like cash because barter is inefficient.
26. November 2010 at 14:46
Scott:
I think the equation of exchange is no more relevant to money than it is to GM stock, so my disagreements with you only begin when you start to say that the equation is useful for anything. But I’d just as soon not bother arguing about its degree of uselessness.
Your New Zealand example makes a much better target for argument.
1) The backing theory says those dollars would have no value.
2) I know of 1 historical episode that seems to contradict (1), after WWII when some sailors bought fruit from some islanders using monopoly money. Years later the natives were still using the monopoly money. The backing theory would explain this episode by saying that the natives either believed the monopoly money to be real, or else found it so rare and curious that they valued it like we value baseball cards and moon rocks. Since this type of episode has been rare, and since everywhere I look I see paper money that is backed by the issuer’s assets, I conclude that backing is the real reason paper money has value.
3) What happens to the value of your New Zealand dollars when the people start using checking accounts, credit cards, gift certificates, etc.? What if people start using money issued by some foreign government? I expect you’ll say the dollar would lose value. But then why would people have ever used them in the first place? Why not use things of real value instead? Well, look at the history of colonies everywhere, and you see that people did in fact use valuable things as money. Then they graduated to using bits of paper that were backed by those valuable things. But except for that island above, in no case did they ever just start trading with unbacked bits of paper.
27. November 2010 at 08:55
Mike, You said;
“3) What happens to the value of your New Zealand dollars when the people start using checking accounts, credit cards, gift certificates, etc.? What if people start using money issued by some foreign government? I expect you’ll say the dollar would lose value. But then why would people have ever used them in the first place? Why not use things of real value instead?”
We know for certain that this argument is wrong because there are all sorts of cases where people use money that is depreciating in value, despite being legally allowed to transact with alternative assets having a more stable value.
I think it is much easier to explain the monopoly money case. A medium of exchange does have real value, just like the oil that lubricates an engine has real value. It reduces frictions. So the islanders were not being foolish. They were being smart not to waste precious effort digging up gold to use as a medium of exchange, or to back a medium of exchange. Rather they used something that was produced costlessly by someone else. It’s brilliant.
27. November 2010 at 09:43
@Scott
“Rather they used something that was produced costlessly by someone else. It’s brilliant.”
This is good if you have very short time preferences. However, with the current western (and Chinese) demographic structure people are more concerned about store of value than short term exchange value/production costs. This makes me think that there will be an international push towards currencies and monetary stores of value that are harder to expand.
27. November 2010 at 12:15
Scott:
If I were on that island, I would borrow dollars and sell them for coconuts, thus taking a short position in dollars. Each time I borrow a dollar I would issue my IOU, and I’d try to make my IOU even handier as money than the paper dollars. That would reduce demand for the paper dollars and reduce their value, and I’d profit on my short position. I’d keep doing it until I had captured all the wealth of the people who were short-sighted enough to accept those paper dollars for real goods. Of course I’d have to act fast, because foreign governments would be eagerly trying to get their currencies to circulate on the island too, in order to grab some of that free lunch.
Of course, any islanders who were smart enough to only trade using things of real value, or paper claims to those things, would be immune to my scheme.
That’s why history shows almost nothing but things of real value (or claims thereto) being used as money. And when we find exceptions, like the monopoly money, they can be explained with the baseball card/moonrock theory.
28. November 2010 at 06:26
Doc Merlin, It’s mainly criminals who hold cash as a store of value. Most people spend cash as soon as they get it, and really don’t care if the price level rises 2/100 of one percent during the week they hold a $20 bill.
Mike, That won’t work because of network externalities. I’m told that there are programs better than Windows, but once most people Windows, then everyone starts using it because everyone’s using it. It’s also convenient to have a single unit of account. No need to worry about the soundness or value of unfamiliar currency notes. Try shopping at a US Walmart with euros or yen.
In addition, the islanders might ban competing units of account, to prevent their own cash hoards from depreciating in value.
28. November 2010 at 09:30
Scott:
My IOU’s would be in the form of checking account dollars, credit card dollars, gift card dollars, etc. They would be denominated in dollars, and so would compete against the paper dollars even if network externalities were present. Of course the fact that foreign currencies commonly circulate in most of the world’s border towns should make you doubt the importance of network externalities in the first place.
If your island example really applies to actual moneys, then we should be able to find a few central banks that hold no assets against their moneys. Instead, we find nothing but central banks that do hold assets against their moneys, just like the backing theory says we should.
Nobody denies the plausibility of backed money, because such money has value for the same reason as any other financial instrument. The quantity theory, on the other hand, has to claim that money, alone among all financial instruments, has value in spite of having no backing. So why do you hold so strongly to the quantity theory in preference to the backing theory?
29. November 2010 at 08:07
Mike, Sure we have lots of cash substitutes, but they are not as good as cash, which is why there is still a huge demand for cash, even during periods where bank accounts pay positive interest.
The fact that foreign money generally doesn’t circulate outside border towns shows how important network externalities are. Stores getting pesos in El Paso know they can use them next time they go to Mexico–where network externalities lead to the peso being the primary currency. Do stores in El Paso accept Japanese yen?
30. November 2010 at 07:56
Scott:
Here’s how that island story would play out in real life: The islanders find the dollar bills. The government has some urgent expense that they would normally pay with coconuts, but it’s out of coconuts, so it declares each dollar acceptable for taxes at $1/coconut and spends a few of the dollars, keeping the rest in reserve. People use the dollars because they are acceptable for taxes. They are, in fact, backed by the government’s assets–mainly taxes receivable. The islanders get all the efficiency gains you mentioned above, but if someone like me comes along and starts issuing rival moneys, the dollars won’t lose value, since they are backed. Rather, if I succeed in introducing some rival money, some unwanted paper dollars would reflux to the government, probably in payment of taxes.
Compare that to the quantity theory story: Even allowing for the historically unprecendented event where people start using them as money without backing, the introduction of rival moneys like checking accounts, credit cards, and even foreign moneys, will reduce the demand for the paper dollars, thus reducing their value and giving a free lunch to the producers of rival moneys.
So I’ll repeat my question: Why do you favor that incredibly unlikely quantity theory story over the backing theory story?
2. December 2010 at 08:05
Mike, Because I don’t see any reason money must be backed. it’s a very useful system, even with zero backing. People accept it because others accept it. When the dollar was no longer backed by gold, nothing happened to its value. It looked exactly like the old gold-backed dollars, and was still accepted. Later when the money supply increased a lot, the value of money went down.
I don’t believe the simple QT that money and prices are proportional, but I think the QT is a useful way of thinking about monetary policy. Double the supply of fiat currency, and the effect in the long run will be to double the price level, because people only care about the real amount of currency they hold, not the nominal amount.
2. December 2010 at 13:44
Scott:
I see a reason why money must be backed: If it isn’t backed, people who value it put themselves on the wrong side of an arbitrage trade. Among financial economists, the possibility of arbitrage always ends the discussion. Among quantity theorists, the logic of arbitrage is the first thing to go out the window.
“When the dollar was no longer backed by gold”…
The dollar became inconvertible into gold. That is not the same thing as being unbacked by gold. Before 1933, the Fed suspended convertibility every Friday evening and resumed it every Monday morning. The gold was still there, so nobody claimed that the dollar became unbacked on Friday and re-backed on Monday. When the Bank of England suspended in 1797, its gold remained in its vaults until resumption in 1821. The pound was inconvertible, but not unbacked. If the Fed were to actually lose its assets, then we could call the dollar unbacked. Until then, the right description of the dollar is that it is inconvertible, but still backed.
4. December 2010 at 10:04
Mike, You keep insisting that money is a financial asset, whereas it is clearly a real good. Motor oil is not “backed,” but it has value because it reduces engine frictions. A monetary system reduces transactions frictions–that has real value regardless of whether or not money is backed. Even Monopoly money has value, when playing the game of Monopoly. It is also “unbacked.”
The problem with your “implicit” gold backing argument is that it is completely unverifiable. No one has a clue as to how much fiscal resources the US givernment will have in the year 2050, including imponderables such as the future value of federally-owned land and future Social Security obligations. So any change in the price level can be “explained” by merely pointing to some subset of government net worth that might or might not have moved in a particular direction.
4. December 2010 at 22:19
Scott:
Backed money reduces those frictions just as well as unbacked money, but backed money is not vulnerable to arbitrage.
Monopoly money is backed by the real estate you buy in the game. Try playing it sometime without specifying deed costs, rental rates, etc. in monopoly dollars.
Yes, it’s very hard to measure the assets that back the dollar. It’s also pretty hard to measure the assets that back GM stock. The fact that a theory can be hard to test doesn’t make it wrong.
5. December 2010 at 06:50
Mike, I don’t understand how unbacked money is easier to arbitrage. If it has value, and serves as a medium of exchange, and if the public is happy with its performance, how is it easier to arbitrage than backed fiat money?
5. December 2010 at 20:36
Scott:
Compare two kinds of paper dollars: Both are just bits of paper, but one kind is backed by a square foot of land, while the other is completely unbacked. Both kinds serve equally well to lubricate the machinery of trade, and neither requires the use of any valuable resources, since the land is farmed even as it backs the dollars. Let’s grant your earlier assertion and suppose that the unbacked dollars are each valued at 1 square foot, and grant that either kind of dollars, once established, would benefit from network externalities.
1. Given that the two kinds of dollars are identical in every respect except for backing, any person or community that had a choice between the two kinds of money would of course choose the backed kind.
2. Even if some series of historical accidents led to the unbacked dollars being used, there is the problem that any new rival moneys that come along would reduce the demand for the unbacked money and thus reduce its value. These rival moneys could take the form of checking account dollars, credit card dollars, gift card dollars, or they could take the form of some entirely foreign money not denominated in dollars.
3. Everyone who borrows unbacked dollars and buys a house with them creates new dollars in the process, but also puts himself in a short position in dollars, thus getting into a position where he profits from the very inflation that he caused–a crazy situation.
4. Backed money is immune to rival moneys, since a backed dollar will always be worth 1 square foot no matter what kind of rival moneys come along.
We all recognize that if the interest rate is 5%, and some bond promises 105 oz. of gold in 1 year, then that bond must sell for 100 oz. today. If it was trading for 101 oz. then an arbitrager would sell the bond for 101 today, set aside 1 oz. as his arbitrage profit, lend the 100 oz. for 1 year at 5%, get back 105 oz. at year-end, and pay off 105 on the bond he sold. That kind of arbitrage prevents bonds from selling for more than their backing, and it would also prevent paper dollars from selling for more than their backing.
6. December 2010 at 19:22
Mike, I don’t agree that backed money is any less susceptible to competition than unbacked money. People will use the money they find to be convenient, they don’t care if it is backed. Gift cards might be popular under a gold standard or under an unbacked fiat money standard.
I don’t buy the arbitrage example, as it doesn’t explain why people will simulaneously hold T-bills paying 5% and a wad of $100 bills paying zero percent, unless I am mising something.
I don’t follow the hosuing example, but maybe my brain is fried right now. How is buying a house creating money?
7. December 2010 at 08:19
Scott:
But you’d agree that the proliferation of gift card would reduce the demand for the unbacked money, and thus reduce its value, right?
People hold backed 30-year bonds that pay 4%, and backed 30-day bonds that pay 1%. No arbitrage possibilities there, although there would be if the 30-day bonds had no actual backing. Then of course people hold instant maturity bank notes that pay -2%. Still no arbitrage possibilities as long as the bank notes are backed, but lots of arbitrage if they are unbacked.
In the housing example I’m just talking about the textbook loan expansion process, where borrowing creates money.
8. December 2010 at 18:40
Mike Sproul, I don’t follow your examples. People are going to hold gift cards whether or not cash is backed. Gift cards are convenient, safe, etc. I will be buying some gift cards this week, and couldn’t care less whether cash is backed or not. That has no influence on my decision to hold gift cards. It slightly reduces the demand for both backed, and unbacked currency.
Let’s assume someone holds a pile of T-bills in their basement for 3 months, and right beside that pile they hold another pile of $100 bills for 3 months. How do you explain why they would hold both assets for 3 months?
Or if you don’t like T-bills, assume they have bank deposits paying 5% interest, and also hold cash. Why hold both, if arbitrage was possible?
10. December 2010 at 14:12
Scott:
My point about gift cards is just that any so-called fiat money will face competition from rival moneys (like checking accounts, credit cards, gift cards, foreign money, etc.) As these rival moneys proliferate, the demand for the fiat money will fall, so its value will fall. This is an untenable situation, since arbitragers need only sell the fiat money short while issuing more rival moneys, thus profiting from the inflation that they caused.
But if the base money is backed, rather than fiat, then the proliferation of rival moneys will reduce the demand for the base money without reducing the value of the base money. Hence no profit to arbitragers.
Your question about T-bills and dollar bills is like asking why people hold 20-year T-bills yielding 5% at the same time that they hold 30-day T-bills yielding 3%. That’s not an arbitrage opportunity. A person who holds 30-day bills has the “option to abandon” every 30 days. This is a call option, and it has value. The 20-year bondholder only has the option to abandon once every 20 years. This option is worth less, so the 20-year bond must pay higher returns than the 30-day bond.
A person who holds currency has a continuous option to abandon, which is worth still more, so currency yields less than bonds, without providing an arbitrage opportunity. That’s before we even talk about the cost of issuing currency compared to bonds, or possible interest paid on currency.
11. December 2010 at 15:37
Mike, You said;
My point about gift cards is just that any so-called fiat money will face competition from rival moneys (like checking accounts, credit cards, gift cards, foreign money, etc.) As these rival moneys proliferate, the demand for the fiat money will fall, so its value will fall. This is an untenable situation, since arbitragers need only sell the fiat money short while issuing more rival moneys, thus profiting from the inflation that they caused.
But if the base money is backed, rather than fiat, then the proliferation of rival moneys will reduce the demand for the base money without reducing the value of the base money. Hence no profit to arbitragers.”
I completely disagree. The advent of gift cards does not cause the demand for fiat money (backed or unbacked) to fall, it causes it to grow at a slower rate. So the government increases the supply at a slower rate, to keep inflation low and stable.
Your arbitrage argument is equally problematic for your gift card scenario. No arbitrage is possible because they aren’t perfect substitutes. Hence your entire argument collapses. Remember, you were the first one to bring up the arbitrage argument.
15. December 2010 at 17:40
Scott:
Sometimes the introduction of rival moneys will reduce demand for existing moneys, and sometimes it will cause demand for them to grow at a slower rate. Either way the rival moneys cause the original money to sell for less than it otherwise would have, and thus reduces the free lunch that the issuers of the fiat money supposedly got. This leads to the crazy conclusion that the issuers of rival moneys have the same effect on the original moneys as counterfeiters.
The arbitrage argument doesn’t depend on them being perfect substitutes. I borrow some fiat money and sell it for goods, thus taking a short position in fiat money. When I borrow the fiat money, I issue an IOU, which serves as a possibly imperfect substitute for fiat money. This reduces the demand for fiat money and reduces its value, at which point I profit from my short position in the fiat money.
18. December 2010 at 05:44
Mike, I don’t see how any of the points conflict with what I have said:
1. I agree that near money’s reduce the demand for fiat money (whether the fiat money is backed or not)
2. I agree that competitive near-money reduces seignorage.
3. It remains true that near money is not a perfect substitutes for fiat money. So the QTM still holds.
21. December 2010 at 12:34
Scott:
1. Fiat money is not backed. Near moneys would reduce the demand for both fiat money and for backed money, but fiat money would lose value as a result, while backed money would hold its value.
2. This leads to the weird conclusion that private bankers have the same effect on the value of base money as counterfeiters. The backing theory doesn’t lead us into this mixed-up world. Checking account dollars issued by private banks do not dilute the value of base money, for the same reason that call options do not dilute the value of their base security.
3. This doesn’t answer my arbitrage argument above.
22. December 2010 at 19:20
Mike, I agree that near money reduces the demand for fiat money, but that doesn’t make it worthless. Apples reduce the demand for oranges, but oranges still have value.
I don’t follow your arbitrage argument. Private IOUs presumably pay interest, whereas cash doesn’t. So where is the profit? The only way that would work would be if people viewed IOUs and currency as perfect substitutes. But they don’t. If you tried to create perfect substitutes, the US government would shut you down.
10. April 2015 at 06:08
[…] doctrine) quite a bit over the years, starting in 2009 and continuing to the present. (link 1, link 2, link 3, link 4, …) Scott rejects the backing theory, while I favor it. I think that printing […]