TheMoneyIllusion

  A slightly off-center perspective on monetary problems.

182 Responses to “Are there any non-QTM explanations of the price level?”

1. Benjamin Cole
   20. July 2011 at 08:21
   

   Some people are anal about money. Call them gold nuts or Japanese central bankers. They cause a lot of harm when they get into positions of power.

   Other people are anal about the English language. At least we don’t harm people.

   With that said, “Monopoly money, and their told to use it as currency” needs to be changed to “and they’re told”

2. flow5
   20. July 2011 at 08:33
   

   “It’d be like adjusting the throttle until the wake looks about the right size to hit the target speed”

   You’d better take a refresher course in math.

   And the money supply can never be managed by any attempt to control the cost of credit. Keynes’ liquidity preference curve is a false doctrine. The data is clear cut however you slice it.

3. Benjamin Cole
   20. July 2011 at 08:37
   

   BTW, no, non-QTM theories about the price level do not hold water.

   I do raise an observation: The US economy is open, in that goods, services, capital, and (until recently) labor cross easily across the border.

   So an increase in the money supply might work to attract goods, services, capital and labor into our economy, meaning the price level was unchanged, although the economy would grow like gangbusters.

   This is yet another reason to 1) leave the borders open, and 2) not worry that much about inflation

4. Philo
   20. July 2011 at 09:05
   

   Is the U.S. ratio of total base money to currency really very similar to the ratios of other countries (as you seem to assume)?

   “The US NGDP was only about 18 times the currency stock in 2007, because lots of our currency is hoarded overseas.” Some of these U.S. dollars abroad may be used in black market transactions rather than being “hoarded.”

5. Scott Sumner
   20. July 2011 at 09:15
   

   Benjamin, Thanks, I changed the spelling. There’d probably be some inflation, but lots of real growth as well.

   flow5, I agree that the Fed shouldn’t be trying to control the cost of credit, or the money supply–if that’s what you are saying.

   The US ratio was a bit lower than average, last time I looked (but that was a long time ago.)

   I seem to recall that Germany, Switzerland, Japan, had even lower ratios, but again, don’t quote me on that.

   Yes some black market transactions, but most is hoarded–much of it in the US, BTW.

6. Lars Christensen
   20. July 2011 at 09:30
   

   Scott, It is simply unbelievable that so many economists do not accept QTM as it is not only logically the only valid price level and inflation theory, but probably also the best empirically documented economic relationship in global history.

   To not accept QTM is like not accepting the law of supply and demand. If more money is printed then the value of money of course drops. As the value of money is the inverse of the general price level – prices will go up when the money supply growth faster than money demand. How could anybody believe otherwise???

   Keynesian economic – New and Old – has led to a serious misunderstanding of money and prices and there is a need to restate some facts:

   1) Interest rates are not the price of money, but of loanable funds
   2) GDP growth and lower unemployment does not lead to inflation
   3) Rising oil prices is an increase in a relative price and not in the general price level
   4) Inflation is always and everywhere a monetary phenomenon…
   5) And if you fear deflation then just appoint Gideon Gono of ECB chief or Fed governor…

7. MarkS
   20. July 2011 at 10:03
   

   Lots wrong here as usual. The QTM assumes that an increase in bank reserves will lead to increased lending and an increase in the money supply. But I’ve already taught you that banks never ever lend their reserves. That is simply not how modern banking works. Now, I know you’ve admitted that you don’t understand banking very well, but you need to stop making this assumption that more reserves = more money in the economy. It’s simply not true.

   How do I know this? I work at a friggin bank. I know exactly how and why we loan money. And it has nothing to do with how many reserves the Fed fires into the economy. It has only to do with our capital position.

   The QTM is wrong wrong wrong.

8. Lars Christensen
   20. July 2011 at 10:12
   

   MarkS, What if you put 1 trillion dollars on Time Square every day won’t you get inflation? And if not, why not just put 100 trillion there every hour…And why do you obsess about the banking sector? There is no reason to assume that the injection of money into the economy happens through the banking sector…

   And if QTM is wrong, then what is your inflation theory? Magic??

   Take a look at this and learn a bit: http://www.youtube.com/watch?v=jE7zxo61Xc8

9. MarkS
   20. July 2011 at 10:14
   

   Scott Fullwiler thoroughly crushes you here:

   http://neweconomicperspectives.blogspot.com/2011/07/scott-sumner-agree-that-mmt-policy.html

10. MarkS
    20. July 2011 at 10:17
    

    Lars,

    You clearly don’t understand modern banking either. The Fed does not have the power to “put 1 trillion dollars on Time Square”. The Fed only has the power to alter reserve balances WITHIN the banking system. Now, people like Scott falsely assume that more reserves = more lending = more money, but it’s totally dead wrong. Banks don’t lend their reserves. That’s just not how it works.

    So, the only way for the Federal government to “put 1 trillion dollars on Time Square” would be through deficit spending. Would that be inflationary. Hell yes it would.

    Scott’s whole framework is wrong because he doesn’t understand modern banking (something he has admitted to on this very site).

11. Lars Christensen
    20. July 2011 at 10:24
    

    MarkS, Why is that?? Print the money. Put it on a truck and drive it to Time Square. How hard can it be? And why is it that Gidion Gono in Zimbabwe was able to do create hyperinflation? Does he understand “modern banking” better than you?

12. John
    20. July 2011 at 10:27
    

    @ Lars – MarkS focuses on the expansion of the money supply through the banking system because that is, traditionally, how the money supply expands. The orthodox line of thought is that the CB boosts reserves which leads to banks expanding loans which means (because banks are reserve constrained in their ability to make loans) that causally the flow goes CB grows M0>>>>banks have more reserves at their disposal>>> M1, M2, etc expand which allow economic activity to accelerate. I know Scott would not necessarily characterize this flow of logic as the way he thinks about the situation but he obviously still believes very much in the importance of OMOs.

    The problem with this line of logic centers mainly around the fact that, as MarkS points out, deposits don’t create loans but instead loans create deposits. Once again (since he does this for a living), outsourced to Bill Mitchell: http://bilbo.economicoutlook.net/blog/?p=14620

    I think if you start with the premise that the aggregate quantity of reserves (which is what the CB operationally controls) does not determine the expansion of the monetary aggregates (that would be private demand that determines those) then you’re at a better place to begin analyzing the way monetary policy operates vis a vis the private banking system (which is, I think, important).

    And yes, that was just a long winded way of saying that the “money multiplier” as treated in mainstream Eco textbooks does not exists per se.

13. MarkS
    20. July 2011 at 10:29
    

    I just explained it to you. The Fed doesn’t “print up bills”. They create reserve balances in the banking system. Only the US Treasury can actually credit bank accounts via deficit spending.

14. Lars Christensen
    20. July 2011 at 10:34
    

    John, I completely understand that money is “normally” injected through the banking system. However, IF there is a deflationary problem and you want to get out of it, it is very easy to get out of it. Personally I do not see a large deflationary problem, but if there was such a problem it would be very easy to get out of it. The Fed could put money on Time Square or just start buying euros, yen, yuan, zloty, krona etc…that would do the job very easy. This whole banking sector blah blah is exactly that …blah blah

15. MarkM
    20. July 2011 at 10:39
    

    MarkS: if bank’s don’t lend excess reserves held at the Fed, then why was that amount close to zero for decades until the moment the Fed started paying interest shortly following the Lehman implosion? Sure, capital ratios are very important to banks, but that doesn’t mean that excess reserve levels at the Fed don’t get lent out (or at a minimum invested in interest generating Treasuries) when the Fed pays zero interest on them.

16. MarkS
    20. July 2011 at 10:41
    

    It’s not blah blah at all. You are not distinguishing between monetary operations and fiscal operations. The Fed does not have the legal authority to deficit spend. Only Congress can do that (which is transacted through Treasury).

    The only way the Fed can put money on Times Square is if their actions of altering interest rates and reserve balances results in MORE lending by BANKS.

    So, when you say that it is easy for the Fed to put money on Times Square you are absolutely wrong. It’s really hard for the Fed to do that. Especially in an environment where no one wants to borrow money!!!!!!

17. Lars Christensen
    20. July 2011 at 10:45
    

    Who talk about legal issues?? Thats not the point. We are talking about whether there is a connection between money and inflation. If the fed prints more money than is demanded then you will have inflation. It is very, very simple…and yes everything else is blah blah…Or said in a another way, why try to raise any public revenue from taxes when printing money does not create inflation? Just print the money and give it to the government…I am not advocating such a thing – exactly because I think printing money is inflationary, but just illustrating that printing money of course will create inflation.

18. david
    20. July 2011 at 11:08
    

    Note that MMT considers helicopter-drops of money to be an essentially fiscal operation (see Nick Rowe on the subject). The real disagreement is not on what helicopter drops do, but what changes in the overnight rate do.

19. Lee Kelly
    20. July 2011 at 11:12
    

    If you think QTM is just about increasing bank reserves and the money multiplier, then you’re wrong wrong wrong.

20. david
    20. July 2011 at 11:21
    

    Attacks on QTM attack via velocity or the money multiplier, generally by arguing for their endogeneity through various mechanisms. I don’t think anyone is going to seriously contend that both velocity and the multiplier are constant; rather the reasonable defense is that neither change so fast that central bank targeting is unable to keep up (and, obviously, that targeting has a nonzero effect of the right sign).

21. Lars Christensen
    20. July 2011 at 11:21
    

    Lee, let me buy you a beer for that one!;-)

22. Brito
    20. July 2011 at 11:24
    

    MarkS I don’t recall Sumner ever suggesting that the inflation is from simply banks lending their excess reserves, in fact I’m pretty sure Sumner explicitly admitted this. He has explained many times that it is mainly psychological, about central bank signalling and beliefs about its commitment, and its corollary psychological effects on the stock market.

23. Andy Harless
    20. July 2011 at 11:44
    

    Consider two theories:

    1. NGDP depends on the supply and demand for government obligations (including both money and debt).

    2. NGDP depends on the supply and demand for money.

    Both of these theories are right, but they both miss part of the picture by treating “demand” as if its relationship to NGDP were exogenously determined. Fiscalists need to recognize that the demand for government obligations depends on the interest rates paid by those obligations, and if more of them are non-interest-bearing, that reduces the overall demand for government obligations and hence raises NGDP. Similarly, monetarists need to recognize that the demand for money depends on the availability of alternative stores of value, including government debt, and if the government issues more debt, that reduces the demand for money and hence raises NGDP. A complete theory of NGDP needs to account for both the total quantity of government obligations and the fraction of those obligations that pay no interest.

24. Morgan Warstler
    20. July 2011 at 11:48
    

    I think we have to get past this:

    “The only way the Fed can put money on Times Square is if their actions of altering interest rates and reserve balances results in MORE lending by BANKS.”

    Let’s say that the Fed announces that they will buy ALL T-Bills that come on market, essentially crowding out all buyers, forcing them to go find other places to put their cash.

    Does ANY of that drip through into loans?

    Of course, there comes a point where inability to get returns will force cash holders to consider riskier loans.

    —

    But it doesn’t matter, MMT fails because its supports are not real stakeholder in the “modern” economy.

    MMT folk don’t count.

25. MarkS
    20. July 2011 at 12:05
    

    Right. Scott says that inflation can also be changed by expectations. The old wave of the wand trick. Right….

26. Lee Kelly
    20. July 2011 at 12:08
    

    Andy,

    Yes, exactly. Fiscal policy works on NGDP by reducing the demand for money, because government debt is, from the perspective of asset holders, near substitutes. However, they are not near substitutes insofar as one can be spent and the other can’t.

27. Rafael
    20. July 2011 at 12:08
    

    Scott,

    I’d like to read your response to this:

    “Finally, just as an aside, Sumner concludes with, “So here’s my question: Are there any non-quantity theoretic models of the price level?” Of course, the price level itself can be anything depending on which year uses as a base year and the value at which the base year is set, so what’s really of interest is understanding changes in the price level instead of the level itself.”

28. Brito
    20. July 2011 at 12:11
    

    MarkS, why is expectations affecting inflation a wand trick? It’s basic micro, if I were to expect high inflation in the near future, I would certainly be disinclined to save and delay purchasing and more inclined to purchase anything I’ve been meaning to buy now before prices go up, increasing demand, and if there is no output gap, raising prices. Why would anyone disagree with that?

29. johnleemk
    20. July 2011 at 12:41
    

    Brito,

    MarkS seems to believe that expectations can have no effect until the expected cold, hard solid action actually takes place. So if Bernanke and Geithner were to say “We’ll be putting $1T worth of cash on Wall Street every hour, starting at noon tomorrow,” nothing would happen at all until noon the next day.

    If you ask me, denying that expectations can drive real behaviour is pretty crazy. I think the study of finance could arguably be redefined as the study of expectations.

30. SurprisedbyMarkS
    20. July 2011 at 13:10
    

    MarkS:

    Prior to this crisis, the growth of bank reserves and the money supply were highly correlated. This implies there is a relationship between them. This can be seen here: http://research.stlouisfed.org/fred2/graph/?g=1cB

    Now one can tell a story that the causality starts with the demand for loans (and the corresponding deposit creation that becomes part of the money supply)and banks in turn increase their demand for bank reserves. However, the demand for loans itself may be–and often is–determined by exogenous changes in the stance of monetary policy.

    Too see this, assume in normal times the Fed unexpectedly says it will be dropping its target interest rate. This improves the economic outlook and cause borrowers to increase their lending in anticipation of better economic future. The Fed, then, responds to the increased demand for bank reserves this creates by supply sufficient bank reserves to maintain the given interest rate target. Note that (1) the Fed gets this process going and (2) it backs it up by providing enough bank reserves. It is the Fed, then, that is influencing the demand for reserves and providing them. It therefore is determining the price level.

    With all that said, the above does not rule out the possibility that banks themselves could decide to invest their excess reserves in other investments or loans. As the economy improves and the risk-adjusted rate of return from other investments and loans goes up, banks will, ceterus paribus, want to make more loans. There is an opportunity costs to not doing so. This, in fact, is the view of the Fed. Bernanke has said repeatedly he will raise IOR if he needs to prevent the excess reserves from leaking out and becoming inflationary. Moreover, just last week in his testimony to Congress he said he would be willing to lower IOR as a form of monetary stimulus should the economy further deteriorate.

    Finally, making one’s case should not depend on being rude and obnoxious as you have been to Scott Sumner. It is easier to listen if there is civil discussion.

31. John
    20. July 2011 at 13:13
    

    @MarkM – You said: “MarkS: if bank’s don’t lend excess reserves held at the Fed, then why was that amount close to zero for decades until the moment the Fed started paying interest shortly following the Lehman implosion? Sure, capital ratios are very important to banks, but that doesn’t mean that excess reserve levels at the Fed don’t get lent out (or at a minimum invested in interest generating Treasuries) when the Fed pays zero interest on them.”

    It’s pretty easy to show that the lack of excess reserves in the private banking system at a given point in time is not a binding constraint on a bank’s ability to lend as is evidenced from the fact that there exists an overnight lending market at all. If a bank’s reserve position were truly binding in the sense that they couldn’t extend loans beyond the reserves they had on hand, then why do banks require overnight reserve loans in the first place? If reserve positions were binding then no such reserve deficiency on the micro level could exist.

    As a matter of operational necessity, the Fed could not allow excess reserves to persist in the overnight market before IOR as a matter of needing to support a positive, non-zero interest rate target. If there had been an aggregate surplus of reserves in the private banking system prior to the implementation of IOR the funds rate would have been bid down to zero and it would have stayed there until a support rate was introduced (IOR) or the excess reserves were drained through OMO’s.

32. Scott Sumner
    20. July 2011 at 13:17
    

    Lars, I agree, but brace yourself, the MMT mob will be here soon.

    MarkS, You said;

    “The QTM assumes that an increase in bank reserves will lead to increased lending and an increase in the money supply. But I’ve already taught you that banks never ever lend their reserves.”

    Well at least you are entertaining. “You’ve taught me?” I must be a slow student. And as I mentioned in this post, the QTM doesn’t rely on banking at all. I assumed no banking sector in my Iceland example.

    You said;

    “I know you’ve admitted that you don’t understand banking very well, but you need to stop making this assumption that more reserves = more money in the economy.”

    And just where did I claim that?

    You said;

    “How do I know this? I work at a friggin bank.”

    What better place to learn about theories in which banking plays no role.

    MarkS, Yeah he “crushed me.” He claimed you can’t do an OMP without IOR. And the reason; because it would change short term interest rates. And of course short term interest rates never change. Perhaps he doesn’t recall the Volcker era.

    John, You said;

    “Lars – MarkS focuses on the expansion of the money supply through the banking system because that is, traditionally, how the money supply expands. The orthodox line of thought is that the CB boosts reserves which leads to banks expanding loans which means”

    Yes, there are people who believe this, but can’t we talk about my post?

    You said;

    “The problem with this line of logic centers mainly around the fact that, as MarkS points out, deposits don’t create loans but instead loans create deposits.”

    This is so simplistic as to be useless. Banks face very complex decisions about the profit-maximizing amount of loans, deposits, etc. There are all sorts of dimensions in which they can adjust these variables. Neither necessarily “creates” the other. Either can be created separately, or jointly. That quotation is at the level of an undergraduate textbook.

    Brito, That’s right, there aren’t even any banks in my model. This whole posts clearly abstracts from banks. Nobody seem to want to critique what I actually said, which speaks volumes.

    Andy, You said;

    “Similarly, monetarists need to recognize that the demand for money depends on the availability of alternative stores of value, including government debt, and if the government issues more debt, that reduces the demand for money and hence raises NGDP. A complete theory of NGDP needs to account for both the total quantity of government obligations and the fraction of those obligations that pay no interest.”

    I’m not sure if this is directed at me, as I’m not really a monetarist. I certainly agree that government debt can impact the demand for base money. But as the Australia/Canada example shows, in normal times the effect is so tiny as to be insignificant. If you want to estimate Australia’s price level you look at currency (or the base, if it’s non-interest-bearing.) You do NOT look at total federal liabilities, as that will give you a nonsensical answer. Adding in the amount of government debt in circulation adds virtually no explanatory power. It’s within the rounding error. But yes, there is a tiny effect.

    MarkS, You said;

    “Right. Scott says that inflation can also be changed by expectations. The old wave of the wand trick. Right….”

    You do know that there are mountains of empirical studies of hyperinflation that support this argument, don’t you?

    Rafael, That quotation confuses the price level with statistical constructs called price indices. Where did you find it?

    Brito and Johnleemk, Yes, and if a massive hurricane were bearing down on Florida, there’d be no impact on orange juice futures until the storm actually destroyed all the trees. Commodity traders are a bit dense.

33. SurprisedbyMarkS
    20. July 2011 at 13:19
    

    John:

    “It’s pretty easy to show that the lack of excess reserves in the private banking system at a given point in time is not a binding constraint on a bank’s ability to lend”

    Yes, banks are not reserve constrained because they can get funding elsewhere. However, given they have excess reserves and sufficient capital, banks have to make a decision as to what to do with the excess reserves given their opportunity costs. They can invest or make loans with the excess reserves, whether it be to other banks, the Fed or the non-bank public.

34. Andy Harless
    20. July 2011 at 13:23
    

    Lee Kelly:

    “However, they are not near substitutes insofar as one can be spent and the other can’t.”

    Another way to say this is that certain government obligations have a convenience yield rather than an interest yield. Because money is issued in small denominations, it is more convenient for certain transactions, and it is therefore advantageous to hold positive balances of it even when it pays no interest. For equilibrium, the nominal interest rate on short-term government securities has to equal the marginal convenience yield on non-interest-bearing money. (Probably more important, though, in the case of the dollar at least, is that currency is easier to hide than T-bills: for large transactions, T-bills as well as money can be spent, but if the transaction involves contraband, it’s considered advisable to use money nonetheless.)

35. John
    20. July 2011 at 13:44
    

    @Scott – You said: “This is so simplistic as to be useless. Banks face very complex decisions about the profit-maximizing amount of loans, deposits, etc. There are all sorts of dimensions in which they can adjust these variables. Neither necessarily “creates” the other. Either can be created separately, or jointly. That quotation is at the level of an undergraduate textbook.”

    There’s really no reason to be rude, it was Mark S who has basically been calling you stupid, not me.

    You apparently didn’t click on the link I provided which is fine but it does go beyond an “undergraduate textbook” explanation of the ‘loans create deposits’ concept so if you’re interested in exploring that beyond what I provided then by all means have a gander.

    As far as relating all this back to your original post: The reason I focused on the ‘loans create deposits’ issue and the problem it presents for the money multiplier is because the money multiplier is the mechanism through which, traditionally, the CB has been said to act on the money supply (represented by the broader monetary aggregates I mean). If there is no operational mechanism through which the CB drives changes in the money supply from base money to the broader aggregates at will then one cannot make the statement that monetary policy controls the price level through being able to exogenously set the quantity of money. Isn’t that the thrust of the QTM in general? That through manipulation of the money supply, a CB can influence these things?

    Incidentally, if you read the whole of Scott Fullwiler’s post you’d see he concluded with this statement:

    “Interestingly, MMT is also a quantity-theoretic model of changes in the price level. The differences are (1) net financial assets of the non-government sector, rather than traditional monetary aggregates, are the MMT’ers preferred measure of “money,” and (2) desired leveraging of the non-government sector is akin to the inverse of what one might call “velocity.” In MMT, the two of those together (net financial assets of the non-government sector relative to leveraging of existing income) set aggregate demand and ultimately changes in the price level, at least the changes that are demand-driven.”

    So I think the statement that MMT’ers completely ignore the QTM are overblown. At some level it seems like a difference in terminology coupled with the fact that MMT’ers don’t see it as an operational possibility that the CB in and of itself “controls” the money supply. But a professional MMT’er would better be able to address that possibility.

36. Nick Rowe
    20. July 2011 at 14:30
    

    Scott: I like the Canada/Australia experiment. It reminds me of an experiment I use in class (Intro ECON):

    After I have taught PPP, I say that PPP isn’t perfect, but it does tell us something. I ask
    “Does any student here come from a country with its own currency that no other student knows anything about?”

    One student raises his hand.

    “Where are you from?”

    “Kenya”

    “What is the unit of currency in Kenya?”

    “The shilling”

    “OK, can anybody here guess the price of a dozen eggs (or whatever) in Kenya, in shillings?”

    Nobody has a clue.

    “OK” (speaking to the Kenyan student) “What is the exchange rate between the Kenyan shilling and the Canadian dollar?”

    He tells me.

    “Can anybody guess the price of a dozen eggs in Kenya now?”

    We usually get in the right ballpark, using PPP, the exchange rate, and the Canadian price of eggs. Which proves that PPP, though not perfect, has a lot of information-content.

    It all comes down to “units”. Nobody knows what a “shilling” means. How tall is the average Kenyan, measured in whatever units Kenyans traditionally used to measure length? Nobody will have a clue.

    http://worthwhile.typepad.com/worthwhile_canadian_initi/2010/05/units.html

    Quine’s example. What does “Gavagai” mean? We don’t have a clue, because it could mean anything. Until a rabbit runs past and the person points and says “Gavagai!”. Then we can at least begin to guess.

    The Canadian dollar, Aussie dollar, and kenyan shilling, are all just names. They could mean anything. Tell us the monetary base, or the exchange rate, and we can maybe translate. Imperfectly, of course.

    And your experiment tells us that base is usually more informative than base+bonds.

    I get the speedboat analogy, but think there should be a better one. Let me think.

37. Scott Sumner
    20. July 2011 at 14:44
    

    Andy, That’s exactly right. The largest demand for dollars is to hide wealth. The second biggest is small transactions. In the entire history of the world, no one has ever bought a item at a store with a T-bill (Well maybe I exaggerate a bit, but not too much.)

    John, You said;

    “There’s really no reason to be rude, it was Mark S who has basically been calling you stupid, not me.”

    Sorry about that, I did get you mixed up. I plead burnout. And yes, I did read those two links you gave me.

    It’s true that some monetarists did focus on the broader aggregates, and also the money multiplier. But I don’t see that as being central to the QTM. I don’t think textbook explanations of the multiplier are necessarily right or wrong. I use Mishkin, and he doesn’t assume the multiplier is constant, indeed he models the multiplier. As long as you model it adequately, you can discuss it. I never use it because I think it has zero value added. I focus on the supply and demand for base money, that’s all you need to get the price level.

    I guess my rudeness came from frustration that some MMTers make fun of those who believe in the assumption that deposits create loans, whereas loans create deposits is just as arbitrary. They both may or may not be correct depending on the circumstances. In a complex general equilibrium framework, everything gets determined simultaneously, and the concept of causation is very fuzzy. But again, sorry that I was sarcastic.

    I don’t understand his final comment about net financial assets of the non-financial sector. What if (as I assumed in my Iceland example) there are no net financial assets of the non-government sector. I suppose his answer is that he includes cash. And he also seems to deny that there is such a thing as the price level. I left a comment over there for further clarification.

38. Scott Sumner
    20. July 2011 at 14:54
    

    Nick, I love the PPP example–I’ll steal it for my classes.

    You said;

    “I get the speedboat analogy, but think there should be a better one. Let me think.”

    I’m sure you will, I knew it was a bit lame. In case you come back here, I have a question. I was actually trying to go beyond the price level issue, and show that modeling the inflation is rate is sort of like modeling the price level at two different times. But we tend to use totally different approaches to the two issues. (The QTM for each of the two prices levels, and various NK models for inflation.) Sort of like that fact that there is one interest rate, but it must be the outcome of both loanable funds and liquidity preference models. Is this obvious? Wrong? Right but uninteresting?

    I.e. if the “OMOs don’t matter” people are wrong about the relative Aus/Can price levels (which seems clear to me), then are they ipso facto wrong about inflation?

39. Nick Rowe
    20. July 2011 at 14:56
    

    To understand though, by way of analogy, where the MMTers are coming from: suppose we lived in a world of fixed exchange rates. The gold standard, for example. Then someone could legitimately say “The price level is not determined by the monetary base. The base is endogenous. It’s the price of gold that determines the price level. Eggs cost more Kenyan shillings than Canadian dollars because the Kenyan shilling is worth less in terms of gold than the Canadian dollar.”

    There’s more than one way to pin down a nominal anchor. The underlying truth to the QTM, that holds regardless of which nominal anchor is chosen, is that the choice of units is, in some sense, irrelevant. The long-run neutrality of money says you get the same relation between the nominal variables whichever anchor is chosen.

40. Scott Sumner
    20. July 2011 at 15:03
    

    Nick, Yes, but they are assuming a fiat money world. In that world you can’t say OMPs don’t cause inflation. At another blog a MMTer said OMPs don’t cause inflation because under interest rate targeting the base is endogenous. But that’s not really an answer. It’s saying OMPs are not inflationary because OMPs are impossible. But the central bank could ignore the interest peg. Or use OMPs to change the peg. In that case OMPs do change the price level.

    We all agree that if you target rates, the base is endogeous.

41. MarkS
    20. July 2011 at 15:09
    

    Scott,

    It’s quite convenient that you’ve removed the banking system from your assumptions. After all, in this comment on June 14th you told me that you “know little about banking” and then later deferred to me as a reference point (because I am a banker and actually understand all of this stuff whereas you’re just working out an old textbook). http://www.themoneyillusion.com/?p=9494#comment-66856

    It is factually false to imply that deposits create loans. That is not how the banking system works. You are working out a textbook myth. Again, you are not a banking expert so if you could please stop pretending to be one that would be great.

    There are mountains of empirical evidence on global warming and the existence of Jesus also. Does that mean it’s all true?

    Your wand waving theory about expectations is interesting. I don’t even deny that it’s somewhat effective. After all, if the Fed promised to print up a gazillion dollars tomorrow that would certainly alter economic activity. But would it result in a long-term sustained change if it was never followed up with by an actual change in the money supply? Sure, that’s like telling your kid that they can swim and then throwing them in a pool. If you believe that works then God help you.

42. Left Outside
    20. July 2011 at 15:50
    

    “There are mountains of empirical evidence on global warming and the existence of Jesus also. Does that mean it’s all true?”

    I think the internet just exploded…

43. Nick Rowe
    20. July 2011 at 16:10
    

    Scott: “I was actually trying to go beyond the price level issue, and show that modeling the inflation is rate is sort of like modeling the price level at two different times. But we tend to use totally different approaches to the two issues. (The QTM for each of the two prices levels, and various NK models for inflation.)”

    Yes. I’m thinking along the same sort of lines.

    Any econometricians here who can help make sense of me here?

    According to theory:

    1. The price level and the quantity of money are cointegrated. (QTM)

    2. The inflation rate and the growth rate of the quantity of money are cointegrated. (QTM in first differences)

    (Note that 2 follows from 1, by differentiation wrt time).

    3. The inflation rate and the nominal interest rate are cointegrated. (Fisher equation).

    But it does NOT follow that:

    4. The price level and the time integral of the nominal interest rate (the area under a graph showing the interest rate against time) are cointegrated. They aren’t. Weimar hyperinflation. Two otherwise identical economies can have exactly the same path of nominal interest rates, but one can have double, treble, whatever, the price level of the other.

    A thought experiment. At time t, you are required to forecast the price level at time t+s. You are given a choice between:
    1. The complete history of the economy up to time t, plus, the complete history of the nominal interest rate up to time t+s.
    2. M and RGDP at time t+s.

    How big would s have to be, before a New Keynesian would choose 2?

    Or, suppose the task is to forecast NGDP at time t+s. And replace 2 with

    2′. M at time t+s.

44. Scott Sumner
    20. July 2011 at 17:46
    

    MarkS, Didn’t the guy who you said “smashed” me also agree with me that inflation expectations matter?

    You obviously didn’t understand my comment about banks. I was critical of this notion of one asset “creating” another. But then you’ve always misinterpret what I say.

    You asked;

    “But would it result in a long-term sustained change if it was never followed up with by an actual change in the money supply?”

    No, and I never said it would.

    Nick, I like the thought experiment at the end. That’s a very good way of thinking about what’s at stake here.

    I want to quibble with the cointegration assumptions, however. I’ve argued for a long time that the QTM doesn’t make any cointegration assumptions, at least vis-a-vis prices and money, or NGDP and money. More importantly, I am pretty sure Bennett McCallum made the same argument–and he carries much more weight. The argument is as follows:

    1. No one believes V is fixed. So the QTM can’t really be tested by evaluating whether V is fixed.

    2. The QTM does assume that changes in P and M are strongly correlated, at least for large changes.

    3. Suppose V is a random walk, (due to random technological change). Also assume that V is not very volatile (say the standard deviation of changes in 1/2% per year.)

    4. If 3 is true, then M and NGDP will not be cointegrated, yet the QTM will still be approximately true for large changes, because M and NGDP will be highly correlated.

    5. I.e. the QTM is about correlation, not cointegration.

    BTW, does the large difference between prices and integrals of nominal rates only show up under extreme events like hyperinflation? Or is it more general? Perhaps nominal interest rates are somehow misleading under extreme conditions (I’d have to think about why–taxes, inflation risk, default risk, etc.)

45. MarkS
    20. July 2011 at 17:59
    

    Scott,

    Professor Fullwiler makes a very specific argument. He said that Fed policy can influence market participants and their expectations, but that it wouldn’t matter if the Fed didn’t directly change the balance sheets of those participants for the better. I have tried to explain to you on many occasions why programs like QE do not improve the actual balance sheets and you keep responding with vague answers.

    When a central bank increases base money it is not necessarily improving the financial standing of the private sector, ie, influencing the real economy through some real change. Rather, it is hoping that the banks will lend more which will result in a real economic change. This is the point that you don’t seem to understand. You keep claiming that programs like QE can influence the real economy, but you can’t explain how. You just keep saying that they alter expectations. That’s the confidence fairy.

    If your kid can’t swim and you throw them in the pool they won’t know how to swim because you convinced that they can. They have to actually be taught how to swim. If the Fed says something that doesn’t mean that private sector actors will be able to do it. They have to be given some real fundamental change that allows them to do it. You have yet to explain the transmission mechanism by which the Fed can currently improve the financial standing of the private sector.

46. Dustin
    20. July 2011 at 18:12
    

    MarkS,

    Do you think the Fed can influence NGDP? IOW, if the Fed was ordered tomorrow to drive NGDP to a 6% annual growth rate for a year, would they be able to do it or not?

47. MarkS
    20. July 2011 at 18:18
    

    Dustin,

    Explain to me exactly how they would do it if they wanted to? You have to describe the exact transmission mechanism and the monetary operations that would achieve it. Thanks in advance.

48. Dustin
    20. July 2011 at 18:41
    

    MarkS,

    I’ll take your question as the answer to my question. You believe that if the Fed was ordered to drive NGDP to 6%, that they would be entirely unable to. Even if they went out and bought up all the Treasuries in the world, and other things as well, NGDP would sit there like a rock.

    I’m not arguing. I simply want exact clarification of your opinion on this matter. In your opinion, there is absolutely nothing the Fed can do to influence NGDP.

    Feel free to correct me if I have this wrong.

49. MarkS
    20. July 2011 at 19:02
    

    I am highly doubtful of the effect that the Fed can have given the current environment. The primary flaw in this idea of NGDP targeting is that it works through the banking system in order to have any real substantive effect on the economy. Otherwise, we’re just changing expectations and hoping that it sticks. But as I keep saying, that’s like telling your kids they can swim and then not teaching them exactly how to get into the water and swim by teaching them. It’s confidence fairy economics.

    Policies like QE work by altering bank reserves. But banks don’t make lending decisions based on the level of reserves they hold. So this whole theory of targeting NGDP by altering bank reserves has no teeth to it. It’s a lot of talk and no teeth.

    The apologists for QE2 are all trying to claim that it worked, but let’s be real here. We wouldn’t be having this discussion if it had worked.

50. MarkS
    20. July 2011 at 19:05
    

    If someone can give me a real concrete proof of how this sort of NGDP targeting works then I am all ears. I’d love to be persuaded. But it looks like a bunch of bollocks to me. And don’t just say we need to alter expectations. Give me a real concrete transmission mechanism. I want my kids to be the next michael jordan, but whispering “65 points” into their ear every night won’t make it so.

51. Tom Hickey
    20. July 2011 at 19:48
    

    Speaking of “Give me a real concrete transmission mechanism,” has anyone read BIS Working Papers No 297, The bank lending channel
    revisited by Piti Disyatat and care to respond?

52. Tom Hickey
    20. July 2011 at 19:52
    

    Oh, I almost forgot “” this one too.

    BIS Working Papers No 269, Monetary policy implementation: Misconceptions and their consequences by Piti Disyatat

53. Y
    20. July 2011 at 20:18
    

    NGDP targeting could work. They would just have to buy really, really weird things, like new bridges and roads.

54. HarPe
    20. July 2011 at 23:14
    

    It’s just that using the money aggregates to measure M in the QTM is misleading. Wouldn’t it be better to use other aggregates, such as total effective demand and total supply? Then it would just be the workings of the price mechanism talking and that’d be easier for all to accept.

55. Lorenzo from Oz
    20. July 2011 at 23:59
    

    Mark S: What part of banking is not about expectations? Bad debts, for example, are about expectations which disastrously failed to pan out. Money in banks is money you are not spending now due to expectations about the future. Loans are things you get due to expectations. Surely, the banking business is all about expectations?

    Back to post: that Economist table certainly puts recent events in a striking perspective. Australia did well to Howard/Costello, the UK did very badly to have Blair/Brown.

56. K
    21. July 2011 at 04:06
    

    MarkS: “If someone can give me a real concrete proof of how this sort of NGDP targeting works then I am all ears. I’d love to be persuaded. But it looks like a bunch of bollocks to me.”

    Here’s one way, seeing as you asked so nicely:

    1) The market expects 0% NGDP. NGDP futures trade at 0%.
    2) Fed buys NGDP futures up to 5%.
    3) People who have projects that depend on 5% NGDP invest in those projects and sell NGDP futures at 5% in delta as hedge.

    But seriously, why the attitude?  You’ve made some extremely questionable claims (deficit spending with currency created by Fed against worthless coins can’t cause inflation) which is fine, but to make those claims with such vehemence and disrespect towards others (and particularly towards Scott who has shown incredible restraint) is ignorant, boorish and tiresome.  I have learned lots from Scott and many other regular contributors to this blog. You, on the other hand, are like a drunken party crasher who barges in, calls everyone stupid, pisses in a flower pot, and then loudly insists that everyone explains to him what they are talking about.  You ought to apologize or go away (but I don’t set the rules).

57. johnleemk
    21. July 2011 at 04:47
    

    MarkS,

    Re expectations, you believe that a “fiscal” policy of putting $1 trillion in cash on the street every hour would boost NGDP, no? But how do people know that $1 trillion will appear on the street every hour? Past performance is no guarantee of future returns. The reason this “fiscal” policy has an effect is because if government is printing the money and putting it there (as opposed to the money being ephemeral and capable of appearing/disappearing at any moment, like manna from the sky), people expect the policy to continue for as long as the government says it will continue.

    Saying that this policy would have no effect until the money is actually on the street is kicking the can down the road. Seeing $1 trillion in cash on the street is in of itself no guarantee that the policy will continue or not be reversed. You basically acknowledge that expectations work, at least in your realm of “fiscal” policy.

58. Scott Sumner
    21. July 2011 at 06:20
    

    MarkS, You said;

    “Professor Fullwiler makes a very specific argument. He said that Fed policy can influence market participants and their expectations, but that it wouldn’t matter if the Fed didn’t directly change the balance sheets of those participants for the better.”

    Wrong, for two reasons. They could be expected to change balance sheets in the future. Or they could indirectly change balance sheets.

    You keep insisting that monetary policy only works through the bank lending channels, but that’s obviously wrong, as in the olden days monetary policy worked fine when there were no banks.

    You said;

    “Policies like QE work by altering bank reserves.’

    That’s only been true in recent years. Prior to 2008 90% of new base money went into currency, not reserves. And of course if the Fed wanted that to happen again, they’d just need negative IOR.

    MarkS, Mishkin’s textbook is the standard in money and banking. I think he has 9 transmission channels for QE. You might want to check it out. As an example, one is the exchange rate. QE lowers the dollar, which boosts net exports.

    Thanks Tom, Can you summarize anything interesting?

    Y, Why?

    HarPe, The right side of MV=PY is total effective demand. I’d prefer we use that, rather than monetary aggregates. Just the base and NGDP, that’s all we need.

    Thanks K.

59. wh10
    21. July 2011 at 08:39
    

    Dr. Sumner- just wanted to make sure you are aware of Dr. Fullwiler’s and my most recent responses at NEP. This is an awesome discussion! This really gets down to the heart of the matter.

60. MarkS
    21. July 2011 at 09:34
    

    K,

    You don’t explain the mechanism. Again, you’re all just saying that the government just has to change the expectations. Didn’t Obama give us “hope” back in 2008. How’d those expectations work out?

    John,

    I didn’t say it would have no immediate impact. I said it would not have a LASTING impact unless the government actually put the bags in the streets.

    Scott,

    You’re still missing the entire point. You can’t just say that QE worked by lowering the dollar. You have to be able to explain why it actually lowers the dollar. Is it because it adds more money to the system? It’s like you’re saying that your car can move forward and when I ask for a transmission mechanism (which would be the operations of the engine) you reply: the car goes 75 MPH.

    PS – I am enjoying your exchange on NEP where you make some of the most absurdly misguided comments about monetary operations that I have ever read. I honestly don’t even think you understand any of this. I know you don’t understand banking very well (your words not mine), but this is just getting downright sad.

    And to think that there are all of these readers here who think you know what you’re talking about and think they’re “learning”.

61. MarkS
    21. July 2011 at 09:39
    

    Here is a simple proof that you do not understand monetary operations. Over at NEP you said:

    “Suppose the fed funds target is 2.0% and the discount rate is 3.0% (as you know , they often differ.) Assume IOR is 0%.”

    This is not even possible. IOR is a de facto FFR. The rate paid on reserves by the Fed is the floor. They can’t raise the FFR without also raising the IOR. This should be obvious to anyone who understands monetary operations, but it escapes you. It is a horribly misguided error. One that I am shocked you could make.

62. wh10
    21. July 2011 at 09:43
    

    MarkS,

    Why the extreme hostility? I obviously align with some of your views on banking operations, but name-calling such as this is not a good persuasive technique! I understand your frustration, but please channel it into a more scholarly and respectful discussion. MMT has already received much criticism for being too prickly of a bunch. It doesn’t help their case, whether the criticism is fair or not. When you think about the most prominent figures that have driven paradigm shifts (if that is in your interest), such as MLK or Ghandi or Einstein, they didn’t succeed by calling everyone assholes!

    Best,

    wh10

63. Greg Marquez
    21. July 2011 at 10:31
    

    Yes thank you very much for allowing the discussion even if it did become slightly heated at times. I think both sides could stand to turn down the heat a little but I’d rather have an open discussion with heat than a perfectly polite closed discussion. Thank you Prof. Sumner

    Now for my question: I’m still not understanding how the Central Bank increases the amount of money in the economy; which is to say that I don’t think it is possible for it to do so. It does seem strange to choose as your mechanisim for controlling the money supply an entity which has no license to print money. The MMT explanation of getting money into the economy is pretty clear, the government spends. But the QTM explanation is anything but clear.

64. MarkS
    21. July 2011 at 10:40
    

    This is my problem Greg. I have been trying to get them to explain this for months now and they can’t do it. They just can’t explain the actual transmission mechanism through which this actually works. So they keep falling back on expectations.

    It makes no sense to anyone who understands how this stuff works. It’s voodoo economics.

65. K
    21. July 2011 at 11:28
    

    MarcS: “You don’t explain the mechanism. Again, you’re all just saying…”

    You need to be excessively polite right now. Try “I just don’t understand.”

    Everyone invests like NGDP is going to be 5%, even though they are only expecting 0%.  They do that because they can hedge their exposure at 5% and get paid the difference if it only comes in at zero, in which case they receive a payment from the futures buyer equal to their expected shortfall on their investment.  If the buyer is the Fed, then the payment is an expansion of the money supply. *To the extent* that your project depends on NGDP, the Fed guarantees the success of you project. That will stimulate lots of investment, which will bring lots of nominal growth.  

    “They can’t raise the FFR without also raising the IOR.”

    Nonsense.  They can do whatever they want.  The IOR, like the rate on excess reserves is an internal Fed policy.  You need to take a long walk, and a few deep breaths, and then come back if *and only if* you are capable of calming yourself down.  I understand that you have some kind of vendetta against Scott and you need to get it out, but at this point you seem to be simply ranting and quite failing to say anything useful or constructive or even coherent.

    I’m still expecting an apology.

    Greg Marquez: “I think both sides could stand to turn down the heat a little”

    Don’t pretend it’s balanced. Only one side has been making ad hominem attacks.

66. johnleemk
    21. July 2011 at 11:37
    

    MarkS,

    “I didn’t say it would have no immediate impact. I said it would not have a LASTING impact unless the government actually put the bags in the streets.”

    Your basic argument thus seems to be:

    1. Expectations have an immediate impact, but this does not last unless the events expected actually materialise;
    2. QE and QE2 were expected to have an inflationary impact, but this did not last;
    3. This is because the central bank did not create any inflation via QE or QE2, since it is powerless to actually do anything about inflation. Q.E.D.

    On point #1 I think everyone here is in agreement. Where we depart is that Scott and other quantity theorists/mainstream economists [should] believe QE and QE2 were working up until the markets saw the Fed signaled it wanted to end these programs, thus crushing inflationary expectations. Contrary to MMT advocates, we believe central banks can and do control the money supply, and the Fed has not created inflation because it doesn’t want to — not because it can’t.

    That I think is a succinct summary of where the crux of disagreement is. As for your faith that the Fed can do nothing about the money supply — fine, you can believe that if you like. We all still agree that expectations matter, and that unless we get more money into the system to boost NGDP, the demand side of this recession will keep screwing the economy over.

    “You have to be able to explain why it actually lowers the dollar. Is it because it adds more money to the system?”

    Yes, it adds more money to the system. There you go. Happy? I’m really curious to see what logic you’ll use to argue that central banks have no control at all over their exchange rates.

    Greg Marquez,

    “It does seem strange to choose as your mechanisim for controlling the money supply an entity which has no license to print money. The MMT explanation of getting money into the economy is pretty clear, the government spends. But the QTM explanation is anything but clear.”

    I don’t know about the legal arcania of the US, but in many (most?) countries the central bank is quite clearly authorised to mint and print money. In almost all such countries as well, central banks carry out open market operations as a proxy for actually physically printing money, and it seems to have worked quite well in affecting the money supply, whatever theory might say. (It would be quite hilarious if say the Reserve Bank of Australia, whose job it is to maintain a particular inflation rate, were only doing things which have no effect on inflation.) You seem to be quibbling over a factual, rather than theoretical, point. The quantity theory itself is silent about how money gets into the economy.

67. MarkS
    21. July 2011 at 11:43
    

    K,

    You obviously don’t understand how banking works. For instance, you said:

    “If the buyer is the Fed, then the payment is an expansion of the money supply.”

    Tell me how the Fed can increase the money supply by purchasing assets? QE does not increase the private sector money supply. When the Fed buys an asset from the private sector they are simply swapping assets. They are not creating net new financial assets. This is a fact of monetary operations.

    It’s clear that you can’t explain the transmission mechanism. Hence, my frustration.

    If there are reserves in the banking system then the Fed can’t just set the FFR at 2%. They would have to first drain the reserves. Hence, Scott’s ignorant comment. If you don’t get this then you just don’t get it.

    Sorry for my tone, but I have no patience for people who pretend to be experts and spread pure unadulterated lies to people who think they are “learning”. As a professor, Scott should be more cognizant of his teachings and make a better attempt to understand all of this. It’s abundantly clear that he doesn’t.

68. MarkS
    21. July 2011 at 11:46
    

    John,

    QE2 does not alter the money supply. Even Bernanke, who is a monetarist, has confirmed that this is not “money printing”. When the Fed buys assets from the private sector they are buying higher yielding paper (bonds) and swapping it out with lower yielding paper (reserves). Where is the increase in the money supply? There isn’t any.

    It’s amazing to me how many people don’t understand this very simple point and continue to think that policies like QE increase the money supply.

69. johnleemk
    21. July 2011 at 11:57
    

    MarkS,

    It sounds to me like you either deny the usual ways of defining the money supply, or are not familiar with them.

70. Richard W
    21. July 2011 at 12:04
    

    If an oil company announced an absolutely huge oil find today bigger than all the existing fields together. The spot price would immediately collapse even though the transmission mechanism of new oil being available to the market would be years away. However, the expectations is that the new oil makes the existing oil less valuable.

    Likewise if the Fed announced that they were going to conduct a QE of $2 trillion. The external exchange value of the USD would immediately depreciate even though there is no immediate transmission mechanism of new dollars. Therefore, expectations do work and matter.

71. MarkS
    21. July 2011 at 12:08
    

    John,

    Explain to me how QE puts more money in your pocket. The correct answer is that it doesn’t. Fed policy always results in changing the amount of reserves in the banking system. Buying bonds and giving the banks reserves does not change the amount of money the private sector holds. It’s that simple. If you can refute that reality then be my guest.

    Richard,

    This is my point. An oil find has a real fundamental change. MORE OIL COMES ON THE MARKET! People like Sumner are saying that we need bigger and consistent QE. They say it didn’t work because it wasn’t consistent. No. It didn’t work because the oil never came on the market. Just like QE doesn’t result in any fundamental change to the money supply.

    Does that make sense?

72. Dustin
    21. July 2011 at 12:15
    

    “People like Sumner are saying that we need bigger and consistent QE.”
    ———————————————————————————————————
    No, people like Sumner are saying we need a monetary policy that targets NGDP. Preferably something like the Nominal Index Futures Market Thingy (I’m not really clear yet on how that works)

    I, for one, would LOVE to see it because it would settle certain things and shut one side up.

73. K
    21. July 2011 at 12:24
    

    MarkS:

    Here’s how it works:  

    You “buy” e.g. $10T of the futures contract at, lets say, 5%. This initial “purchase” does not involve any actual transfer of funds (just some amount of margin that needs to be maintained until the end of the contract). Then at some point in the future the contract “settles” at, lets say, 0%. That means you have to pay (real money now) $10T*(5%-0%) = $500B to the futures seller. If the buyer is the Fed, they just lost (i.e. created) $500B. I don’t believe that you are not capable of understanding this.  I believe that you are not trying.

    “If there are reserves in the banking system then the Fed can’t just set the FFR at 2%. They would have to first drain the reserves. Hence, Scott’s ignorant comment. If you don’t get this then you just don’t get it.”

    Actually, I think this gets to the heart of the disagreement. The Fed doesn’t have to do a single trade to move the FFR.  They just have to announce that that’s what they are going to do and the market (from the ON all the way out to at least 6 weeks) instantly moves to the announced range on the *expectation* that the Fed is going to do what it says it’s going to do. As Scott says, you need credibility in order for your announcement to move expectations.  But the Fed has no shortage of credibility on its ability to move the FFR.  Therefore the FFR moves when the Fed tells it to.

    (I know, I know… I’m stupid, I just don’t get it. Sigh… Bring it on)

74. Richard W
    21. July 2011 at 12:28
    

    @ MarkS

    The point is that the price of oil would fall before the extra supply became available just based on expectations. The spot oil market would immediately adjust without an actual transmission mechanism supplying new oil.

75. MarkS
    21. July 2011 at 12:38
    

    K,

    Setting interest rates and setting NGDP are two very different things. The Fed is the monopoly supplier of reserves for the banking system. The banking system does what’s told because the Fed holds a gun to its head and says to go over there. That’s not expectations. That’s coercion. But the Fed also knows it can’t set rates if there are reserves in the banking system because the bidder will bid down rates to 0 if there are. So in this regard, setting rates is not enough. They have to actually do something to the reserves before announcing the rate. That’s why IOR is required for QE to even be possible.

    The government can’t just set NGDP where ever it wants because it is not the monopoly supplier of output. Buying up futures is like Apple buying up stock. It can try to set the price of its stock, but at the end of the day Apple’s stock price is going to be determined by the real fundamental actions of the company. Same goes for trying to set NGDP.

    Understood?

76. MarkS
    21. July 2011 at 12:39
    

    Richard,

    And what would happen if the oil never came on the market after the huge price decline? The price would rise….Sigh….

77. Richard W
    21. July 2011 at 12:47
    

    K
    21. July 2011 at 12:24

    ” Actually, I think this gets to the heart of the disagreement. The Fed doesn’t have to do a single trade to move the FFR. They just have to announce that that’s what they are going to do and the market (from the ON all the way out to at least 6 weeks) instantly moves to the announced range on the *expectation* that the Fed is going to do what it says it’s going to do. ”

    Exactly. The market almost instantly adjusts to the central bank policy target and none of the central banks actually have to do many OMO to maintain their target. Whether it is expansionary or tightening monetary policy, the market adjusts to the central bank policy stance.

78. MarkS
    21. July 2011 at 12:51
    

    Richard, read my above comment. K’s comments are very misleading. They imply that the government is the monopoly supplier of output.

79. Richard W
    21. July 2011 at 12:55
    

    MarkS
    21. July 2011 at 12:39

    Richard,

    ” And what would happen if the oil never came on the market after the huge price decline? The price would rise….Sigh… ”

    That actually is irrelevant. The point I was making was that expectations would see the price of oil instantly adjusting before the new oil became available. It is a point about expectations not whether people lie.

80. Cameron
    21. July 2011 at 12:55
    

    Richard W,

    I used that exact same example a few months ago, but it didn’t convince him.

    Any argument that a commitment to higher inflation isn’t “real” could be used with regard to the oil discovery as well.

    MarkS,

    “And what would happen if the oil never came on the market after the huge price decline? The price would rise….Sigh….”

    Exactly, which is why the Fed has a credibility problem, not a theoretical one. So long as people believe the Fed won’t reverse policy, they can have a real impact.

    Unless you believe the Fed doesn’t control NGDP, or never will be able to again, this is undeniable. Do you believe those things? (if so, surely that is what we should be arguing about)

81. MarkS
    21. July 2011 at 13:00
    

    This is actually a beautifully easy point to understand. See, Scott doesn’t understand the banking system so he ignores the mechanics of all of this. So, you guys reading him come to false conclusions based in on his misconceptions.

    For instance, K says that the Fed could set NGDP just like it sets interest rates. But there is a huge difference. The Fed is the monopoly supplier of reserves to the banking system. Now, I know Scott doesn’t like to get into the intricacies of banking, but it’s vital in understanding how flawed his theory is. The Fed can only set interest rates because it has a monoploy supply on reserves. So, when the Fed tells the banking system to do it, the banking system does it because they know the Fed can force their hand if they don’t. So, they preemptively act. It’s just like the man who holds the gun to your head and tells you to move. You move because you know he CAN shoot. He knows you’ll move without having to shoot. But he has the ability to shoot.

    The US government can’t do the same thing with the US economy because they don’t have a monopoly supply on output. So, the Fed can’t just come out and target NGDP and expect anyone to do anything because the Fed doesn’t have control over output.

    That should really help simplify my position on all of this. It’s pretty straight forward really.

82. MarkS
    21. July 2011 at 13:04
    

    I don’t see how you can compare an oil discovery to targeting NGDP. One involves a fundamental market change. The other involves saying something.

    I completely agree that the market would move if a huge oil discovery were made. But that’s in anticipation of more supply coming on the market. Do you really think the prices will stay where they were if the supply doesn’t ACTUALLY come on the market? Not a chance. So, you can say that it is irrelevant, but it’s not irrelevant in the real world.

    The problem with targeting NGDP is that you’re basically screaming about a new oil find without ever bringing the new oil on the market. Do you really think the prices will remain high as long as you continue telling (or targeting) a certain level of supply? That’s not how markets work guys. I am kind of shocked that people can’t see how obvious this all is.

83. Brito
    21. July 2011 at 15:30
    

    MarkS: Actually, markets are pretty stupid, even a mere few words uttered by fed officials can cause massive rallies in the stock market, in fact not even utterances, but mere RUMOURS of utterances about POSSIBLE fed policy has caused massive stock market rallies. This is besides the point, you’re assuming the fed has absolutely no control over the money supply, despite this only being a very niche hetrodox view that almost all experts disagree with (and working in bank does not make you an expert, you really don’t actually strike me as someone who knows much about central banking, sorry), sumner has already provided you with the textbook that explains 12 DIFFERENT mechanisms by which monetary policy can increase the money supply, so if you literally don’t know anything about monetary policy it’s not his job for him to teach you basic macro.

84. K
    21. July 2011 at 15:41
    

    MarcS: “They have to actually do something to the reserves before announcing the rate.”

    No they don’t. If the Fed manipulated reserves before 2:15, don’t you think FF futures would move ahead of the announcement? You may work for a bank, but you have not been anywhere near a repo or short term funding desk.

    MarcS:”If there are reserves in the banking system then the Fed can’t just set the FFR at 2%. They would have to first drain the reserves. Hence, Scott’s ignorant comment. If you don’t get this then you just don’t get it.”

    Are you taking that back, or do you actually still not get how the Fed announcing FF at 2% instantly brings FF to 2%. Traders aren’t stupid, you know. They aren’t going to fund at %2.25 if they know they’ll be able to fund at 2%. The Fed sets the rate, the market *instantly jumps* and *then* the Fed adjusts reserves to counteract any residual volatility and keep the market in the new equilibrium.

    “The government can’t just set NGDP where ever it wants because it is not the monopoly supplier of output. Buying up futures is like Apple buying up stock. It can try to set the price of its stock, but at the end of the day Apple’s stock price is going to be determined by the real fundamental actions of the company. Same goes for trying to set NGDP.”

    “For instance, K says that the Fed could set NGDP just like it sets interest rates.”

    You should read what I said. I didn’t say they could *set* NGDP. I said they could stimulate it, by setting NGDP *futures*. And NGDP isn’t “fundamental” to the Fed the way the value of its stock is to Apple. NGDP is part real and part nominal. If the Fed loses money on NGDP futures, that loss increases M which increases the *N*ominal part of NGDP. The point is NGDP futures provide two additional mechanisms of policy transmission over expectations alone: Additional investment due to hedging (risk reduction) *and* a firm commitment to future money creation should the futures contract fall short of the Fed NGDP commitment. That conditional commitment to create (or destroy) money *helps* put NGDP on the desired track.

    This pattern is tiresome. I explain something. You say I don’t understand banking. Then I explain it again. Then you ignore the answer and move on to something else.

    E.g:

    MarcS: “It’s clear that you can’t explain the transmission mechanism.”

    Are you taking that back, or do you actually still not get it?

    MarcS:”You obviously don’t understand how banking works. For instance, you said:
    ‘If the buyer is the Fed, then the payment is an expansion of the money supply.’
    Tell me how the Fed can increase the money supply by purchasing assets?”

    Are you taking that back, or do you actually still not get how Fed participation in NGDP futures can create (or destroy) broad money?

    MarcS: “Understand?”

    There is nothing you have said here that isn’t either:

    1) Already known to me and irrelevant; or
    2) wrong.

85. MarkS
    21. July 2011 at 15:44
    

    Brito,

    You’re missing the whole point I am trying to make. There is a huge difference between the Fed doing something that causes a change in nominal prices, and the Fed doing something that causes REAL change. If Apple comes out tomorrow and increases their annual guidance by 100% the stock will surge. And if they come out with earnings in a year that don’t meet those expectations the stock will plummet. The point is that Apple has to do something in the real world that meets those expectations.

    NGDP targeting is cute and all, but it’s only part of the equation. The Fed has to follow through and actually do something. A lot of people here seem to think that altering reserve balances is the transmission mechanism that is going to cause the dollar to rise or fall or lead to some other result. But that’s just flat out wrong as I have explained on several occasions.

    Is the Fed powerless in the current environment? Not necessarily, but not one single person here has been able to explain an actual transmission mechanism that could actually lead to the real economy being able to generate the targeted NGDP that you claim it could.

    I would love to be convinced, but the more we talk the more I feel like I am totally debunking Scott’s theory.

86. MarkS
    21. July 2011 at 15:47
    

    K,

    Let’s cut the BS. You said:

    “That conditional commitment to create (or destroy) money *helps* put NGDP on the desired track.”

    This is THE most important thing you’ve said today. Now, explain to me EXACTLY how the fed is going to create or destroy money tomorrow if they announce a target NGDP.

    I am all ears.

87. Brito
    21. July 2011 at 15:53
    

    I wasn’t talking about NGDP targeting actually, that’s another issue. At the moment I’m taking issue with your implied assertion that the central bank has no control over the money supply, is that or is that not your position? Or is your position at least that the central bank has no control over the money supply ONCE interest rates are near zero?

88. MarkS
    21. July 2011 at 16:03
    

    Brito,

    I pose the same question to you then. Tell me the EXACT method through which the Federal Reserve should best increase the money supply right now.

89. K
    21. July 2011 at 16:04
    

    They need to put money behind their promise by a credible threat to manipulate the NGDP futures contract. If it doesn’t move then they’ll actually have to trade it, but they shouldn’t have to do much of that (just like the FF market). Now are you going to take the nonsense, mischaracterizations, and insults back, or not???

90. MarkS
    21. July 2011 at 16:10
    

    K,

    You are not explaining the actual monetary operations through which they will add more money to the system. You’re sidestepping the question. You’re saying: “Apple just needs to increase sales to meet their EPS target”. I am asking you, “how will they increase sales”. And you’re saying “they will increase sales”.

    DETAILS PLEASE. I want the actual Fed operation.

91. Brito
    21. July 2011 at 16:13
    

    http://en.wikipedia.org/wiki/Monetary_expansion

92. MarkS
    21. July 2011 at 16:15
    

    Really, a Wikipedia entry? Is this the best the QM minds can come up with? Come on. Hit me. Show me someone here knows something about monetary ops.

93. Brito
    21. July 2011 at 16:17
    

    I am not a QM mind, I am merely a student, but the article seems pretty clear to me.

94. MarkS
    21. July 2011 at 16:23
    

    Okay, well the increasing the monetary base works through the banking system. That requires an increase in borrowing in order for an increase in reserves to result in an increase in the money supply. But as I’ve mentioned a million times here, adding reserves to the banking system doesn’t result in more lending.

    Reserve requirements. More of the same. Banks are never reserve constrained.

    Discount window lending. Again, expands the monetary base. Same story.

    Interest rates. They’re at 0%.

    Got something more specific? Maybe a myth for me to debunk?

95. Brito
    21. July 2011 at 16:32
    

    Aaaah, so you are just Keynesian who is essentially arguing for the liquidity trap (i.e. monetary policy ineffective when rates are at zero). Nothing new really.

    It’s been about two years since I learned anything about monetary policy. What I remember was that there was loads and loads of different mechanisms, I didn’t look into it that much because frankly I never encountered anyone or any theories that deny that the central bank has any control over the money supply, so I didn’t find that line of discourse interesting. One of the mechanisms I remember that has not been mentioned yet is its effect on the yield curve, the CB can flatten the yield curve for treasuries, which effects portfolios strongly because investors need to adjust their hedge ratios in response to changes in interest rates to ensure an optimal sharpe ratio, increasing or decreasing the amount they invest in stocks and other assets in the process.

96. MarkS
    21. July 2011 at 16:44
    

    Not a Keynesian. MMTers are Minskyans. BIG difference.

    The liquidity trap is a load of crap. Krugman spews that garbage every day. Yves Smith showed how wrong it is a few weeks ago.

    Now we’re talking Brito. The Fed could credibly hold down long term interest rates by targeting a rate at the long end of the curve as opposed to a size. That’s why QE2 didn’t do much. Monetary operations are always about price, not size. That’s why the Fed sets a short rate rather than announcing a size for its purchases. Could the Fed reasonably implement a policy of QE3 that was entirely open ended without causing a total freakout by the commodity price speculators? I doubt it.

    But hey, at least someone is thinking around here.

97. Mike Sandifer
    21. July 2011 at 16:48
    

    Mark S.

    I don’t necessarily have to know anything about real transmission mechanisms to argue QE can work. It can be a purely econometric argument, which you can accept or reject.

    This is really silly. To make a Sumnerian statement, if you really think the market’s wrong to rally when the Fed announces new QE programs, you should be investing and making money on that basis. Are you? If not, how can you say you know better than the markets?

98. Brito
    21. July 2011 at 16:48
    

    Hold on, QE2 is all about targeting longer term interest rates, it’s whole purpose is to flatten the yield curve. Read this: http://moneywatch.bnet.com/economic-news/blog/maximum-utility/what-is-qeii/997/

99. MarkS
    21. July 2011 at 16:54
    

    Mike,

    Most people don’t understand how QE actually works. And yes, you do need to know how monetary operations work in order to understand it. See, I understand this stuff because I work at an institution where we are on the other side of these Fed trades. I see how it effects our business. And I can tell you, unequivocally, that it does not result in an expansion of the money supply or boost lending. When we get more reserves from the Fed we are not able to expand our lending operations any more than we could before.

    This is a great myth that QE involves putting more money into the private sector. It just flat out doesn’t. It exchanges our bonds for their reserves. We end up with a shorter duration debt instrument. Scott even admits that QE is not going to alter inflation expectations in this form. He said:

    “1. If the new base money is interest-bearing reserves, I fully agree that OMOs may not be inflationary. That’s exchanging one type of debt for another.”

    NEXT!

100. MarkS
     21. July 2011 at 16:57
     

     Brito, did QE2 flatten the yield curve? Did it cause a surge in lending? Did it result in more mortgage refinancing? Did it result in more home purchases? Did it result in an increase in total loans in the banking system? The answer to all of these questions is no.

101. Brito
     21. July 2011 at 17:03
     

     Why do you keep harping on about lending? I didn’t even talk about lending, I’m talking about investing, my mechanism regarding the yield curve is all about investing, not about banks creating mortgages. You keep assuming that the mechanism is specifically through banks creating loans, even though you have been told about a billion times that it isn’t.

     http://www.project-syndicate.org/commentary/feldstein33/English

     Do you have a source showing that the yield curve did not flatten (at least counter-factually)? Because why wouldn’t a massive surge in the supply of long term treasuries lower longer term interest rates?

102. MarkS
     21. July 2011 at 17:14
     

     Ah yes. The old wealth effect. If the Fed could only keep creating stock market bubbles then we’d all be rich and we could boost consumer spending infinitely. Right? Wrong.

     The stock market represents nominal wealth. So, when the value of your stocks rises you have a paper gain. If you spend that out of today’s income there is no guarantee that you can sustain that spending or that the cash flow will continue into the future. What nominal wealth relies on is a gain in real wealth or real underlying output.

     So, the wealth effect is the Fed’s greatest form of ponzi finance. They get you to buy stocks and feel better, but forget to tell you that this doesn’t necessarily have an impact on long-term real output.

     Of course, propping up the stock market in this manner (now known as the Bernanke Put) is one of their favorite strategies and has been for years. So it should surprise you that the markets and the economy has experienced a series of booms and busts on the back of these various bubble.

     That’s a great strategy for growth. Not.

103. Brito
     21. July 2011 at 17:23
     

     So you’ve been reduced to zero-hedge style idealogical rhetoric rather than actual substance? I give up.

     http://rortybomb.wordpress.com/2011/06/14/interview-with-joe-gagnon-on-quantitative-easing-its-criticisms-and-the-argument-for-qe3/

     “Some might interpret that as saying QE deliberately creates a stock bubble, which makes them nervous.

     Well, there’s two important things to keep in mind. First of all, the harm of a bubble arises almost entirely if it’s leveraged. We have to make sure, through financial regulations, that people are not borrowing to buy stocks. And they aren’t as far as we know. The tech bubble wasn’t leveraged, and when it burst it had little effect. The housing bubble was leveraged, and it had a major effect. If we have an equity bubble, and equities don’t seem to be priced unusually high, but even if we did, we’d want to make sure it wouldn’t cause harm when it unwinds.

     The second is that it’s not clear that it is even a bubble if monetary policy is working through interest rates, as monetary policy always does. You need equities to be priced highly when there’s a recovery, you want to encourage people to invest. Moreover, by creating a healthier economy, monetary policy can increase the fundamental value of equities, which by definition is not a bubble.”

104. Mike Sandifer
     21. July 2011 at 17:31
     

     Mark,

     Your point is irrelevant. It’s merely an appeal to authority and worse, it’s based on the assumption that being a specialized micro actor means you know what’s going on in the macro system. That’s silly.

     In fact, just about everything you type is ridiculous and obviously lacking in anything like rigor. I can have a perfectly atheoretical perspective that says QE works.

     I won’t be surprised if you couldn’t even get a job as a bank teller, much less one that gives you any insight into banking. Give me a break.

105. Mike Sandifer
     21. July 2011 at 17:33
     

     Oh, and again, if you know the market’s wrong to react as it does to QE policy implementation, do you have the investment earnings to show for it?

106. MarkS
     21. July 2011 at 17:47
     

     I don’t read Zero Hedge. That is the most uninformed group of people on the planet.

     NYSE margin debt surged during QE2. It’s the only form of borrowing that increased during QE2. So your point is disproven.

     Oh Mike. Nice try making things personal. This isn’t personal to me. It’s about getting the facts right.

     You guys just don’t have the facts right. Sorry.

107. wh10
     21. July 2011 at 18:05
     

     Uh, QE2 steepened the yield curve http://allstarcharts.com/wp-content/uploads/2011/06/6-3-11-Interest-Rates-Through-QE21.jpg. Rates probably rose because people thought QE2 would lead to inflation, which it probably has contributed to through speculation, cost-push dynamics.

     See the following for a great explanation and also to understand that just because the market is wrong doesn’t mean you can make money right away – http://moslereconomics.com/2011/03/10/qe-and-the-term-structure-of-rates/ and http://pragcap.com/qe2-captblogain-your-ship-is-sinking

     Anyways, here’s Mosler’s bio: http://seekingalpha.com/author/warren-mosler

     Looks like he ran a top ranked hedge fund for 10 years using this stuff.

108. Brito
     21. July 2011 at 18:08
     

     You don’t? Because you sound nothing like a Minskyite, and more like an Austrian.

     Investors anticipated the end of QE2, since investors are forward looking and the end of QE2 is absolutely not a systemically non foretasted event like the housing criss was. Therefore I cannot see this as being a bubble, since portfolios are surely robust to the scheme ending, and this seems to be the case, given QE2 has ended with no sudden deflationary recession.

109. MarkS
     21. July 2011 at 18:16
     

     Right. So if we just do QE^n we could just create infinitely high stock prices. Wow, thanks for fixing the global economy.

110. johnleemk
     21. July 2011 at 18:38
     

     “So if we just do QE^n we could just create infinitely high stock prices.”

     Actually, yes. The real value of those equities wouldn’t change, but their prices would move in accordance with inflation expectations. It’s quite obvious that at the moment, the stock market falters whenever it’s clear the QE program is going to end, indicating:

     1. The recession is still (at least in the financial markets’ view) largely demand driven;
     2. QE (at least in the financial markets’ view) boosts NGDP as long as the Fed continues it.

     Q.E.D.

111. K
     21. July 2011 at 18:38
     

     MarcS: “Now, explain to me EXACTLY how the fed is going to create or destroy money tomorrow if they announce a target NGDP.”
     “DETAILS PLEASE. I want the actual Fed operation.”

     First I am going to assume you agree that Fed can control NGDP futures by manipulating them, or threatening to manipulate them? Then, as I said, two ways, two mechanisms…

     1) People invest more a) because they can offset their NGDP risk by selling futures, b) because they can sell those futures at a higher level of NGDP than they expect, and c) because they see high NGDP futures and they know that that will lead other people to invest, thereby increasing NGDP. I assume you understand how investment increases the money supply, but just in case: people borrow from banks. That creates deposits, or as you call it “the private sector money supply”. But more relevantly, it just increases investment which increases NGDP.

     2) The Fed bids up NGDP futures with their own money. They lose a lot of money as NGDP comes in lower than the average price they paid. Therefore they owe a lot of money to the sellers of those futures. The money is created as follows: Initially, when buying the futures contracts, the Fed posts margin with the clearing broker on the futures exchange. To do this, the Fed creates a liability on its balance sheet (just like it does if it’s going to buy a bond, pay IOR, or pay Bernanke’s salary for that matter). This is like Apple creating a new share “out of thin air” and adding it to its treasury stock. The Fed then sends that liability (lets call it money) via Fed Wire to a Fed clearing bank with whom the futures clearing broker has an account. The clearing bank credits the futures broker’s account with the money and records an equal increase in reserves with the Fed. As the futures contract moves up or down in price, the broker will call for less or more margin, partially reversing or repeating the above process. When the contract settles the margin amount will be equal to the Fed’s loss on the futures contract. Then, the clearing broker takes the Fed’s margin from the broker’s account at the Fed clearing bank and wires it (again via Fed wire) to a bank account of the futures seller. The Fed’s liabilities have now grown by the amount of the loss. An equal amount of reserves as well as an equal amount of checking deposits have also been created.

     The second mechanism is no different from any other loss the Fed might take when trading risky securities: Fed creates money, buys stuff, stuff loses value, Fed sells stuff for less money than it bought it for. Fed left with losses, i.e. created net money. Happens all the time. Yes?

112. johnleemk
     21. July 2011 at 18:42
     

     To clarify, when I say the real value of equities wouldn’t change, that’s assuming QE^n continues to the point that any output gap from the demand side (and not from some Arnold Kling-style PSST crisis) is completely closed. While NGDP is below trend, inflation does help create real wealth.

113. Dustin
     21. July 2011 at 19:35
     

     “Not a Keynesian. MMTers are Minskyans. BIG difference.”

     ——————————————————————-

     Isn’t Minsky considered part of the Post Keynesian school?

114. Fed Up
     21. July 2011 at 21:12
     

     “Suppose you dump 300,000 Europeans on an uninhabited island””call it Iceland. The ship also drops off some crates of Monopoly money, and they’re told to use it as currency. Assume no growth for simplicity. Also assume no government and no banking system.”

     And, “That’s only been true in recent years. Prior to 2008 90% of new base money went into currency, not reserves.”

     Do these two currencies “act” in the same manner?

115. Fed Up
     21. July 2011 at 21:16
     

     Scott, K’s post at 18:38 about NGDP futures.

     Is that what you want to do?

     Additions or subtractions?

116. MarkS
     21. July 2011 at 22:54
     

     K,

     Your solutions all die at the same place. They create reserves in the banking system. Big deal. Have you read anything I’ve posted? This is where this whole idea dies in the water. There is no transmission mechanism.

117. Cameron
     22. July 2011 at 01:39
     

     MarkS,

     “Brito, did QE2 flatten the yield curve? Did it cause a surge in lending? Did it result in more mortgage refinancing? Did it result in more home purchases? Did it result in an increase in total loans in the banking system? The answer to all of these questions is no.”

     Actually the answer to some of those questions appears to be yes.

     http://tinyurl.com/3n5okzs
     http://tinyurl.com/3qu2w9j

     Those highlighted periods reflect the period from the Jackson Hole speech to the announcement that QE2 would end as planned.

     As far as a transmission mechanism is concerned, it’s simple: either you believe the Fed controls NGDP over the medium/long run or you don’t.

     If you do, the Fed can commit to conducting policy to lead to higher NGDP a few years from now. The Fed saying (or implying) they will conduct policy in the future (via a larger base or via a lower fed funds rate or whatever you want) to create higher NGDP in the future is THE EXACT SAME as an oil company announcing an oil discovery with the intention of drilling for it in a couple of years. I point to Fed Funds futures markets as strong evidence that future Fed policy matters and is considered.

     If you don’t believe the Fed controls NGDP, I would love to hear what you think happened in the early 80’s when NGDP growth suspiciously slowed from ~12% to ~6%?

     (I fully expect MarkS to completely ignore my questions and points, he always has in the past)

118. K
     22. July 2011 at 02:46
     

     MarcS: No: They create deposits, M2, broad money. not reserves. And NGDP.

     “There is no transmission mechanism.”

     Transmission to *what*?

119. W. Peden
     22. July 2011 at 02:51
     

     MarkS,

     What about transmission mechanisms that don’t go through the banking sector at all e.g. the asset price mechanism? You can get a QTM with government spending, asset price purchasers and a roughly long-run stable personal sector demand for money. The banking system and lending are ancillary to this mechanism.

     Of course, you can say that that’s not a quantity theory view of the transmission mechanism, but you’d be saying that e.g. Tim Congdon is not a quantity theorist!

     Assuming that the QTM and the MM are in some way necessarily linked has all kinds of strange consequences like this.

120. Ian
     22. July 2011 at 04:18
     

     I don’t know why MMT types are so rude.

     I studied a Money and Banking course at the University of Newcastle a few years ago, which was taught by an MMTer from their special ed centre. The lecturer (and another from COFFEE) displayed the same arrogance, belligerence and rudeness as MarkS displays here. Which is a pity, because it distracts from their arguments.

     MarkS, perhaps you are right – I can’t tell. But as long as you behave this way, I will end up skipping most of your comments and you’ll have a good deal of trouble convincing me (or anyone else).

121. K
     22. July 2011 at 04:58
     

     Ian,

     MarcS could be right. But the main problem is not that he is belligerent and rude. The main problem is that he has not made a coherent argument, and when you answer any objection he makes, he pretends not to hear you, and simply repeats his mantra that you haven’t created real money (despite extensive demonstration with absurd attention to detail that real money has been created).  He has shown little indication of actually understanding banking the way he says he does. So *he* may be right (there is a 50/50 chance of being right about any given issue, if you don’t think about it at all), but *the stuff* he is saying is not coherent.

122. Mike Sandifer
     22. July 2011 at 05:34
     

     I think MarkS should be ignored. There are plenty of other MMT people people who can actually hold a discussion and don’t just try to appeal to unverifiable authority that’s irrelevant anyway.

123. W. Peden
     22. July 2011 at 05:45
     

     Actually, now I look at it again, this discussion about MMT vs. QTM basically ends with Brito’s remark about an investment transmission mechanism. MarkS’s reply was purely rhetorical: “The money illusion mechanism of nominal asset price increases doesn’t increase long-term real output, therefore it has no effect on nominal output.”

     So now MarkS is only willing to criticise the view that an increase in broad money affects long-term real output. Which is a position not only different from, but actually incompatible with, the QTM. Move along, folks…

124. W. Peden
     22. July 2011 at 05:47
     

     (Incidentally, if he was to change his claim to the proposition that there is no linear causation from nominal asset prices to nominal GDP, that would be more relevant but also obviously wrong.)

125. MarkS
     22. July 2011 at 07:59
     

     Peden,

     I am interested in this discussion only because I think it has some merit to it. It’s a creative idea and I give SS a lot of credit for it. I am sorry if my tone has detracted from my points, but Scott has repeatedly tried to brush me under the rug on several past occasions right after proving (and then admitting) that he just doesn’t understand modern banking all that well. So my frustration with him is well founded.

     Anyhow, I am merely looking for an exact explanation as to how the Fed would enact their policy based on the futures contracts. David Beckworth has actually tried to answer this question (whereas no one here has despite the hundred + comments):

     “(2) Purchase assets other than t-bills as needed to make sure the nominal GDP level target is maintained. Thus, if the monetary base and t-bills became perfect substitutes because the 0% bound is reached the Fed should buy longer-term treasuries or foreign exchange.”

     This gets the conversation going it actually contains some of the details I have asked for 100 times here. You guys have to better comprehend how this would work though. For instance, if the Fed were to buy long dated bonds the policy would ONLY be effective if they had an open ended policy. So, if the NGDP target says they need to fill a 2% gap then the Fed would need to step up and be a willing buyer of long bonds at a specific rate and not an amount. This is very important. They would essentially set rates at the long end as they do at the short end.

     This would possibly have some teeth to it. I would be concerned about the market’s response as they view it as “money printing”, etc but it could have some benefits (although they could be entirely offset by cost push inflation through commodity markets). It would also still work through the banking system (which is your big flaw with QE) and that’s an issue in this environment where demand for debt is low.

     Thoughts?

126. Scott Sumner
     22. July 2011 at 08:04
     

     wh10, Thanks, I’ll look after I finish these comments.

     MarkS, You said;

     “You’re still missing the entire point. You can’t just say that QE worked by lowering the dollar.”

     I don’t think anyone disputes that rumors of QE2 depressed the dollar–so why does the mechanism matter? In my view the dollar fell because of a change in expected future monetary policy.

     You said;

     “PS – I am enjoying your exchange on NEP where you make some of the most absurdly misguided comments about monetary operations that I have ever read. I honestly don’t even think you understand any of this. I know you don’t understand banking very well (your words not mine), but this is just getting downright sad.”

     These ad hominim attacks just help me, especially when you don’t have a shred of evidence to back it up. So thanks.

     You said;

     “This is not even possible. IOR is a de facto FFR.”

     How can I put this kindly. We didn’t have any IOR until 2008. So it was zero. So if IOR is the ffr, then the FFR was zero between 1913-2008.

     Greg and WH10, Thanks for being very civil. I appreciate it.

     Greg, You said;

     “Now for my question: I’m still not understanding how the Central Bank increases the amount of money in the economy; which is to say that I don’t think it is possible for it to do so.”

     As far as I know, all economists agree the Fed can increase the monetary base. They do this by exchanging base money (which is mostly currency during normal times) for government bonds. The debate over the effect on the broader aggregates is much more complex. They influence those, but less directly. Indeed the Fed influences all nominal variables, including the nominal price of toasters.

     MarkS, You said;

     “Tell me how the Fed can increase the money supply by purchasing assets? QE does not increase the private sector money supply. When the Fed buys an asset from the private sector they are simply swapping assets. They are not creating net new financial assets. This is a fact of monetary operations.”

     Yes they are swapping assets. but the asset M goes up, and the asset B goes down. There is more money and less bonds.
     And as we can see from the Canadian/Australian comparison, they have very different effects.

     You said;

     “But the Fed also knows it can’t set rates if there are reserves in the banking system because the bidder will bid down rates to 0 if there are.”

     There are reserves in the banking system even when rates are above zero. The level of excess reserves is low in that case, which means most of the new base money injected goes out into currency in circulation. A small portion goes into RR, but we can ignore that.

     You said;

     “And I can tell you, unequivocally, that it does not result in an expansion of the money supply or boost lending.”

     It doesn’t have to boost lending, it raises NGDP in countries that don’t even have banking systems.

     more to come . . .

127. Scott Sumner
     22. July 2011 at 08:16
     

     Brito, I don’t agree that QE2 flattens the yield curve. It could steepen it if it creates expectations of faster NGDP growth.

     Fed up, Yes, I see the Iceland case as being similar to the 2007 case in most important respects. Having a banking system doesn’t affect monetary policy very much.

     I have a post on NGDP targeting. Google “spot the flaw in NGDP targeting” and you’ll find it. I didn’t understand your question.

     Ian and K, I assure you that he is not right. His model can’t even explain monetary policy in an economy w/o banks. And banks didn’t even exit until about 600 years ago, but monetary policy has been around much longer.

128. MarkS
     22. July 2011 at 08:49
     

     “Yes they are swapping assets. but the asset M goes up, and the asset B goes down. There is more money and less bonds.”

     This is ANOTHER blatant misunderstanding of the policy. QE adds reserves to the banking system and removes bonds. Bank reserves are interest paying 0.25% paper. They are nothing more than a different form of government issued debt by a different name.

     The flaws in your thinking are painfully obvious for everyone to see.

     And no, it’s clear that you can’t “assure” anyone that I am not right because you can’t even begin to understand the very basics of modern banking. Which explains why you like to remove the banking system from the entire equation. Because the realities of modern banking ruin your whole theory!!!!!!!

129. johnleemk
     22. July 2011 at 08:53
     

     MarkS,

     Before you continue you might want to familiarise yourself with the various definitions of money/the monetary base in economics, i.e. M0, M1, M2, etc.

130. MarkS
     22. July 2011 at 09:09
     

     Thanks for the snide remark John. You might want to familiarize yourself with how QE actually works to impact those various forms of the money supply. You guys clearly don’t have it right. This one chart shows that excess reserve balances have surged by exactly 600B. End of story. Sumner has fallen for the myth that QE is money printing.

     http://research.stlouisfed.org/fred2/series/EXCRESNS

131. TheMoneyIllusion » Too literal-minded? A theory of the strange world of the MMTers
     22. July 2011 at 09:55
     

     […] did a post trying to figure out whether there are any non-quantity theoretic models of the price level.  It […]

132. K
     22. July 2011 at 10:51
     

     MarcS: “Your solutions all die at the same place. They create reserves in the banking system. Big deal. Have you read anything I’ve posted?”

     Lord, yes!

     Now, I ask you to please reread what I wrote at 21. July 2011 at 18:38. You demanded that I provide “DETAILS PLEASE. I want the actual Fed operation.”  I did as you asked *in excruciating detail*.  If you read it, how could you come to the conclusion that raising NGDP futures only creates reserves. I explained how it creates investment, increased NGDP *and* deposits – real money. You’ve got a lot of nerve claiming I’m not reading what you wrote. Either that or *you* didn’t understand what *I* wrote. I’m strongly suspecting the latter.

     “This is where this whole idea dies in the water. There is no transmission mechanism.”

     Again, I ask you, transmission to *what*?

     Scott: “I assure you that he is not right.”

     Indeed. I just said that as a rhetorical device.

133. MarkS
     22. July 2011 at 11:19
     

     OMG. This is so pointless.

     At least Beckworth described exactly what the Fed would have to buy in order to achieve the targeting and money supply growth (it’s totally wrong, but whatever). This is pointless. We’re clearly not seeing the world through the same prism.

134. johnleemk
     22. July 2011 at 11:38
     

     Finally MarkS gets it.

135. MarkS
     22. July 2011 at 11:57
     

     Yes, I understand EXACTLY how flawed the QM thinking is. Keep drinking the cool-aid ladies and gents. I just hope your neoclassical thinking goes extinct in the next 20 years so you can stop destroying this great nation with your flawed ideas.

136. Fed Up
     22. July 2011 at 12:05
     

     Scott said: “Fed up, Yes, I see the Iceland case as being similar to the 2007 case in most important respects. Having a banking system doesn’t affect monetary policy very much.”

     And, “I didn’t understand your question.”

     I’ll try to rephrase.

     Are there any differences between your Monopoly money currency and your “prior to 2008 90% of new base money went into currency, not reserves.” currency?

     “I have a post on NGDP targeting. Google “spot the flaw in NGDP targeting” and you’ll find it.

     I’ll try to look it up sometime.

137. Dustin
     22. July 2011 at 12:11
     

     Fed Up: http://www.themoneyillusion.com/?p=1184

138. Fed Up
     22. July 2011 at 12:14
     

     Dustin, thanks!

139. K
     22. July 2011 at 12:17
     

     MarcS: “OMG. This is so pointless.”

     It’s not pointless.  I wrote you extensive, coherent answers to every one of your questions.  Please answer mine. They are very simple. Either you know you are wrong, or you are simply incapable of understanding what I wrote. Now admit it, and apologize for being a boor.

140. Good Habit
     22. July 2011 at 12:25
     

     The prive level – is it explained by the QTM – or is it rather the other way around?

     Scott Summner insist that the QTM is a good explanation of the price level.

     He then creates a fictive economy with a fixed amount of currency and states:

     “It’s likely that NGDP will end up being roughly 15 to 50 times the value of the stock of currency.

     ”

     Of course, 15 to 50 times are not a really precise figure, not even as “ballpark” – it’s a factor of 3.3 – so the same quantity of money can have a) stable prices, b) 300 % inflation, or c) serious deflation? – So what does it explain?

     He further states:

     “BTW, prices in Japan are 100 times higher than in the US, and Korean prices are 1000 times higher.”

     Are they? AFAIK, all these countries have their own currency, so there is no common denominator. Comparing “Price levels” without noting that they use different units of account is rather pointless – not all currencies are “created equal”. That’s why there are currency exchange rates. Only if you compare prices (in different currency) at their exchange rate can you compare price levels.

     The actual price levels (in local currency) are the result of economic history. Comparative price levels are usually explained by the rate of productivity in the tradable goods sector. If productivity in the tradable goods sector in country A) is high, those producers can easily compete on global markets, make a lot of profit and pay good wages. This should create a high demand for labor in this sector (pull workers out of less productive sectors), and (due to the high wages/profits earned in the TGS) more demand for non tradable domestic goods and services (like housing, haircuts, dining out etc.).

     So, higher demand for non-tradables, and wage pull from the tradable sector, will pull the wage level up, and with this the general price level. So country A) – due to its higher productivity in the TGS should have a higher price level than country B). (And of course, it has a fair chance to have a trade balance surplus, so money flows in to the country, which expands the quantity of money – but this is an effect – and not the cause).

     So – what else causes inflation (and deflation)?

     If demand rises, and supply is inelastic, or, if supply falls, and demand is inelastic, supply will fall short of demand, and hence, prices will rise. Now, how can this be, if the quantity of money is stable?

     Well, some call it velocity, others call it leverage. Anyhow, people, chasing the rare goods, either liquidate savings, or take credit, to keep buying.

     If supply later becomes adequate again, prices should drop somewhat (but not all the way), but the private sector will be more in debt (relative to GDP) than before.

     If supply stays inadequate for some time, there are two possibilities. If the net money supply doesn’t increase sufficiently, then credit expansion will come to an end, there will be a demand shock, and recession (and quite possibly, deflation) will follow. If, OTOH, government runs a persistent deficit, which adds to net financial assets of the private sector (that is – increases the net money supply), then the rise in the price level (inflation) might persist, and if supply remains insufficient for quite some time, both deficit and private credit expansion can finally result in hyperinflation.

     Or, to put it in other words: an increase in the quantity of money might follow inflation, and an expansion in the net quantity of money (trough new gold mined and minted, a trade balance surplus, or -rather the norm – a government deficit) is a prerequisite for a persistent rise in the price level – but it’s not the cause, it might be an effect.

     If – say under a gold standard – the amount of money is fixed, the price level can’t rise persistently – but it will fluctuate wildly – supply shocks will result in higher prices, but those will soon be offset by demand shocks (or just normalization).

     Increasing the money supply trough central bank lending to private banks doesn’t increase the NET financial assets of the private sector (both assets and liabilities of the banking sector increase). An increase in net financial assets of the private sector can only derive from a government deficit or a trade balance surplus (or, if the central bank directly buys NON FINANCIAL ASSETS – like houses, roads, commodities, or labor..).

     Paying interest on reserves is nothing but a bank subsidy. [In a similar way, paying interest on treasury bonds is a subsidy to bondholders..] And QE is just a special form of subsidy for bondholders – if they can now sell bonds at a market price above parity to the FED, instead of waiting till the bonds are finally redeemed at par at maturity.

     discuss this on http://habit.ch/forum/viewtopic.php?f=5&t=136

141. K
     22. July 2011 at 13:07
     

     Scott: how do you resist the temptation to try to explain *anything* to someone who (along with a pile of other nonsense) thinks bonds normally trade a par?

142. Scott Sumner
     22. July 2011 at 18:12
     

     MarkS, There was no IOR until 2008, and my post specified I was looking at the pre-2008 economy.

     Fed up, No, not much difference between the Iceland example and pre–2008 America.

     Good habit: You said in response to me;

     “BTW, prices in Japan are 100 times higher than in the US, and Korean prices are 1000 times higher.”

     Are they? AFAIK, all these countries have their own currency, so there is no common denominator. Comparing “Price levels” without noting that they use different units of account is rather pointless – not all currencies are “created equal”.

     First of all, to answer your question “are they?” The answer is “Yes.”

     And yes, they use different currencies. I want to know why using different currencies makes the price levels so different.

     I share your opposition to IOR.

     K, Yes, it can be difficult sometimes.

143. Jim Glass
     22. July 2011 at 23:26
     

     “But I’ve already taught you that banks never ever lend their reserves. That is simply not how modern banking works”

     “You’ve taught me? …”

     MarkS, Didn’t the guy who you said “smashed” me…

     Ah, MMTers — if asked, the will proudly tell you their intellectual modesty is their greatest virtue.

     “I don’t know why MMT types are so rude.”

     They feel aggrieved that their modesty is not widely appreciated.
     ~~~~

     it’s clear that you can’t “assure” anyone that I am not right because you can’t even begin to understand the very basics of modern banking.

     Dude, the way you keep harping on this makes you sound like a mad chemist obsessed with denouncing physics because physicists don’t know chemistry. “All your complex equations and crazy models don’t have anything to do with the real world. How can you say the do? None of you even know chemistry! *I* know how real physics works because I work in a bank, uh, know chemistry!”.

144. Jim Glass
     22. July 2011 at 23:37
     

     “why is it that Gidion Gono in Zimbabwe was able to do create hyperinflation? Does he understand “modern banking” better than you?”

     I had the pleasure of discussing just this with couple MMTers in a different forum only a couple days ago. Quotes from the them. My comments much shortened for space.
     ~~~~~~~~~

     “Supply disruptions were necessary but not sufficient conditions helping to create demand-pull inflation when demand became excessive relative to real productive capacity.”

     Demand-pull hyperinflation! LOL [That *is* a quote. 🙂 ]

     “I’m sure you realize your blunder.”

     You give me too much credit. [Another quote — this comes to be a standard line in exchanges with MMTers.]

     “Can you name a case of hyperinflation in the last 100 years that wasn’t preceded by losing a major war, regime change or foreign denominated debt?”

     Starting from the most recent, Zimbabwe. That’s 1 for 1.

     “when you use Zimbabwe as an example of fiscal profligacy causing inflation, you cannot leave out the fact that it did have severe supply disruptions.”

     Let’s consider: Major supply disruptions harm the economy, reducing output, GDP, known as a recession. Recesssions, ceteris paribus, result in disinflation/deflation due to falling demand. (See USA 2008, 1929-32.) Zimbabwe’s real GDP fell 55% — a pretty big fall in real demand. Falling demand and disinflation/deflation simultaneously become rising demand and acclerating inflation … how?

     “Nominal demand became excessive …”

     Nominal demand. A decline in real demand becomes simultaneously an increase in nominal demand — *without* the govt increasing the money supply — how?

     “Acceleration of nominal demand which bumps against a supply constraint will be inflationary.”

     From where do you get a nominal demand increase of more than 231 million percent while real demand is falling 55%? That’s one heck of a “bump up against”! Please explain.

     One might think the increase in nominal demand came from Mugabe printing more than $22 million per month in currency to pay an army to fight an aggressive war to seize Congolese diamonds.
     http://en.wikipedia.org/wiki/Hyperinflation_in_Zimbabwe#Causes

     But you say the money creation doesn’t cause the increase in nominal demand. Which makes your position at this point: “when nominal demand bumps up against a supply constraint you get inflation of more than 231 million percent”. But where does so much new nominal demand come from?

     “You have imprisoned yourself with Say’s Law and your analysis stubbornly assumes full employment of resources…”

     … with continuing changes of subject I couldn’t make sense of, but gave the impression my point had registered.

     I enjoy MMTers, and have ever since I met Mosler himself in sci.econ back in the 1990s. He was actually one of the more pleasant people on usenet, I always gave him credit for that. It’s too bad that particular part of his approach has so little attraction to his minions.

145. Good Habit
     23. July 2011 at 00:49
     

     scott:”I want to know why using different currencies makes the price levels so different.”
     It doesnt.. – or rather – the question is totally irrelevant. Different currencies had a different starting point – they are just unit’s of account, arbitrary defined by governments. When, eg., the Swiss Franc was defined, it had a value of just 1/24 of a Pound Sterling. Should we therefore say that – in 1850 – the price level in Switzerland was about 24 times higher then in the UK? and that in the meantime, the difference has much narrowed? (as of yesterday, the exchange rate was 1/1.33). And that with the introducion of Euro, the price level in Italy fell about 1800 times?
     None of this statements would make any sense at all, IMO.
     The price level, like most things today, are a result of a long and complex history, which can not be shortcut with a single, simple explanation.
     That would be like: “Why do the United States of America exist today? – pick one: 1) Christopher Columbus sailed west
     2)Thomas Jefferson wrote the Declaration of Independence
     3)George Washington held out at Valley Forge, 4)The Union won at Gettisburgh – or ofther a fifth (SINGLE) reason.”
     That would just be a pointless excercise.

146. Rien Huizer
     23. July 2011 at 01:23
     

     Mark S,

     Thank you for your stubborn reluctance to believe that morion will occur upon the creation of expectations. Lots of people share that reluctance (probably without paying too much attention to their disbelief, because they do not read blogs like this one).

     I think your remarks about the role of the banking system are partially valid. I spend some time in banking too in a spot where these issues were highly relevant and I can assure everyone here that banks do not bother a lot about anything but profitable arbitrages, which are constrained principally by capital and secondarily only by access to market fundsand the cost of those. The current situation of the banking system around the world is clearly one where the institutions with access to market funds (unlike like for instance Greek banks) care principally for their capital position and the fact that the regulatory requirements are increasing (and still partially uncertain), hence what happens is that banks do not act as a lending channel to any degree of exuberance. It will take time before that changes (and with emerging macroprudential regimes that may take even much longer) and I have no idea what the path will be that banks (and that now includes investment banks and a few very large previously non bank lenders) will travel from now on.

     But the banking system is clearly acting more like a plug than a pump. And I do not see how monetary policy can change that, except, and that is where monetary policy comes is, except if the public sector (the gvt, the FED, the housing agencies, etc) finds a way to make people expect that ndgp levels will be steadily (and sufficiently fast) growing forever.

     As I share your implicit view that the banking system is an (not necessarily the only) obstacle (like it was in Japan for much longer than anyone expected), the outlook of bank portfolio managers is key. If they expect that ndgp will follow a path consistent with low credit losses, and, the typical follow on cycle of more solvent borrowers having more confidence and attracting more bank marketing attention, loans will grow and that liquidity will move out of market arbitrage into the real sector (from the point of view of bank portfolio managers of course. Two what extent that affects M volume and velocity is another matter. But most likely, the reservoir of pent up real spending (if that does exist) would be set in motion.

     The problem now is twofold:

     (1) the banking system lacks the incentives to make the multipliers work and the rest of the economy (not quite in the state before banking emerged) does not process that liquidity either, because the non-bank channels have been damaged and/or migrated to the banking system.
     (2) no one knows how politics can be made to help remedy rather than aggravate the situation. Fiscal policy is clearly relevant (though not necessarily constructive) but lacks credibility and monetary policy may well be at the point where its credibility gets challenged. As a result there is not much harm that an easy monetary policy would do in the short term, but also, there is probably not much good either until confidence returns (by magic?)

147. K
     23. July 2011 at 03:31
     

     Rien: ” MarcS Thank you for your stubborn reluctance to believe that morion will occur upon the creation of expectations. And I agree with you that E=MC^2″

     Or something like that. The problem is that MarcS said nothing like any of the the things that followed your first sentence. Instead he said ridiculous things like the Fed interferes with reserves before they announce the FF rate. And there is no mechanism whereby NGDP futures targeting can put real money into circulation and increase NGDP. I and others have thoroughly debunked this stream of nonsense.

     What you are doing is like one of those people who “follow” the hands of a catatonic person across a large printed alphabet. “Look! He wrote ‘I love Mommy'”. No he didn’t.

     Apart from that I completely agree with your concerns about the outlook for strategies that involve little more than the Fed telling everyone how good it’s all going to be next year. Raising the inflation target to 4% comes to mind. But I don’t believe that it follows from that that there is not much monetary policy can do. Negative IOR comes to mind.

148. K
     23. July 2011 at 03:52
     

     Rien: Actually, I take it back. I don’t really agree with much of what you wrote. Yes it’s true that banks do arbitrage, but the lack arbitrage opportunities has nothing to do with banks, who are now mostly well capitalized or the regulatory environment which is in no way unusually risky for lending activities. The problem is a shortage of demand for credit, because consumers are overleveraged and failing to consume. If consumers were spending, banks would be lending.

149. Rien Huizer
     23. July 2011 at 06:03
     

     K

     Maybe one more drink?

150. Fed Up
     23. July 2011 at 09:50
     

     “Suppose you dump 300,000 Europeans on an uninhabited island””call it Iceland. The ship also drops off some crates of Monopoly money, and they’re told to use it as currency. Assume no growth for simplicity. Also assume no government and no banking system.”

     And, “Fed up, No, not much difference between the Iceland example and pre-2008 America.” (for those scanning not the real Iceland)

     From what I can tell, I believe that there is a BIG medium of exchange difference between the Monopoly money currency and the pre-2008 America currency.

151. Scott Sumner
     23. July 2011 at 11:48
     

     Thanks Jim Glass, That was entertaining.

     Good Habit, To explain it in terms of exchange rates is to beg the question.

     I don’t follow your “America” analogy, the price level today is vastly different from what it was in the past. I have a model, MMT people don’t seem to have one.

     I agree that the dollar is an abstract accounting entity, I want to know what determines its current value.

     Fed Up, And what is that difference?

152. Fed Up
     23. July 2011 at 12:30
     

     In this particular case, I’m going to let Scott and everyone else ponder about the difference between the Monopoly money currency and the pre-2008 America currency.

     And, everyone should ponder that one.

     In other words, spoilers!!!

153. Good Habit
     23. July 2011 at 13:00
     

     “Good Habit, To explain it in terms of exchange rates is to beg the question.”
     No idea what you mean – and I WASNT “explaining” it in terms of exchange rates…

     “I don’t follow your “America” analogy, the price level today is vastly different from what it was in the past.” And thats the analogy – the US of today is vastly different than at the times of the founding of Jamestown. Both actual conditions are the result of long and complex historical developments – to try to explain it with a simple “single cause” model is absurd.

     “I agree that the dollar is an abstract accounting entity, I want to know what determines its current value.”
     History up to the present day…

     And no – not the quantity of money. To have persistent NGDP growth, you need an expansion of the Quantity of Money – agreed. But money growth is an EFFECT – and not a cause – of NGDP growth. If money is to tight, the central bank can strangle NGDP growth, and if it relaxes, growth might return to trend, if the trend is still intact. But the CB can’t push or pull NGDP growth. Monetary policy can’t create demand. If demand is weak, fiscal policy can pull demand (expand spending) or push demand (cut taxes – usually less effective), or growing exports might pull demand, or (by far the weakest) innovation might generate new demand.

154. Jim Glass
     23. July 2011 at 17:00
     

     To have persistent NGDP growth, you need an expansion of the Quantity of Money – agreed. But money growth is an EFFECT – and not a cause – of NGDP growth … Monetary policy can’t create demand.

     Yet still it remains a mystery to me, because no MMTer will tell me:

     What specifically was the *cause* that created the *effect* of an over 231 million percent increase in NGDP? While real GDP was declining 55%.

     Being that the corresponding increase in money that occurred at the same time was merely a consequence of that increase in NDGP, and couldn’t have caused any increase in demand.

     I mean, 231 million percent folks, that must have been one WHOPPER of a cause, *big* and *obvious* to all!

     Nobody can tell me what it was?

155. Good Habit
     24. July 2011 at 06:45
     

     jim glass
     If you have a supply shock this will cause a extreme contraction of RGDP. With the stock of money constant, NGDP would remain constant, but, of course, prices skyrocket. If the CB would then not issue more money, inflation would stop, everyone would be bankrupt, and NGDP and RGDP would both be at a depressed level.
     Unfortunately, governments sometimes try the easy way out (they try to keep the purchaising power of their employees – bureaucrats, police, army and the like, stable…)Therefore, they follow inflation by increasing pay. But if the supply situation hasn’t improved (RGDP is still down), this will only lead to continued skyrocketing inflation. Rinse and repeat, and faster the prices go up.
     Only once the supply situation normalizes will inflation fall again – or – if the money supply is not allow to follow inflation – this will lead to a final strong contraction, usually as well in RGDP.
     So, in a supply shock, governments should concentrate on increasing supply, and keep prices from exploding by rationing rare goods.
     And of course, this doesn’t apply in a situation where we have a lack of aggregate demand (unused capcity, high umemployment)

156. Scott Sumner
     24. July 2011 at 07:31
     

     Good Habit, You said;

     “Both actual conditions are the result of long and complex historical developments – to try to explain it with a simple “single cause” model is absurd.”

     The QTM is a pretty good model, not perfect. No one else gets you into the right ball park. Yes, things are very different–but which of those different things explain the price level. I say it is mostly money. I see no plausible alternative.

     You said;

     “And no – not the quantity of money. To have persistent NGDP growth, you need an expansion of the Quantity of Money – agreed. But money growth is an EFFECT – and not a cause – of NGDP growth. If money is to tight, the central bank can strangle NGDP growth, and if it relaxes, growth might return to trend, if the trend is still intact. But the CB can’t push or pull NGDP growth. ”

     So the CB can strangle growth, but can’t “pull” it? I’m confused.

     And what if it raises money by 40% a year for decades? Still no causal effect?

     Sustained hyperinflationary money growth will lead to hyperinflation of prices. Budget deficits may or may not. Supply shocks may or may not.

157. Good Habit
     24. July 2011 at 08:26
     

     “And what if it raises money by 40% a year for decades? Still no causal effect?”

     and how does it do that (raise money?). If the banks demand more money, the CB will either comply (provide more money) – or it will not (strangle NGDP-growth). But if the banks don’t demand more money, how will the CB force it on them? The only (non fiscal) way I can see is -Interest on Reserves- then they will take the money(and the interest), and leave it put on their reserve accounts. End of story.

     Only if the CB somewhow bypasses the banking sector, by directly distributing money to consumers or companies (not as loans, but as “gift” to certain groups – usually, you’d call this “subsidy”) could the CB pull NGDP growth, but this would be fiscal policy trough the back door (bypassing legislature).

     BTW, I remember somwehere that you proposed selling NGDP-futures. I can’t see how this should work, because NGDP is not a marketable commodity with a price. But if the FED would sell such futures, would the buyer make a profit if a) the target is met OR b) the target is missed..

     Anyhow, this would also be (de facto) a fiscal operation.

     If it´s a) little effect – buyers of futures can’t really influence the exact level directly, so this offers little chances for buyers, but clear risks.
     If it’s b) (payments get higher as farther the target is missed) – if payments are made if NGDP remains below target, this is like IOR, just much more so – banks have a big incentive to stop lending, as more NGDP contracts, as more payout they get (this will compensate for the collapse of many loans).
     If payments get bigger as further NGDP is above target, everyone (except existing bondholders) has now a clear interest to reach hyperinflation as soon as possible, and as high as possible (the FED will fill the gap) – so hyperinflation you will get.
     If payments are made for both deviations, my bet would be with hyperinfltion.

158. TravisA
     24. July 2011 at 09:36
     

     MarkS,

     Although I agree with Scott on pretty much everything, I appreciate your desire to know the actual mechanism of transmission for QE. I actually don’t think you’ve been that rude 😉

     How is this for a transmission mechanism? If I (a private individual) own a T-Bond and the Fed buys it from me, I then am credited a ‘number’ in a checking account (I use ‘number’ to avoid definitions about money). I can let that number sit there or I can do something with it. If I let that number sit there, and the bank does nothing with that number, then that number becomes excess reserves and nothing happens to prices or NGDP. Do we agree so far?

     So is the question in your mind, what is the trigger that starts people to spend/invest that money in real economic assets and increase NGDP? If so, consider the following thought experiment: imagine that no one starts using these ‘numbers’ to spend/invest. The Fed keeps buying the Federal debt. The Federal debt has now been completely monetized. The Fed buys the entire stock market capitalization. Still no individual spends/invests. The Fed buys the entire housing stock. Still, people don’t spend/invest (they’ve decided to live in their cars and keep their ‘numbers’ in the banking system. Finally, the Fed buys all the cars. Now people need tents to live in, so people start buying tents with the ‘numbers’ in their bank accounts. There is a big tent building boom in the US. Millions of people are employed in building tents and the recession is over.

     Notice that this mechanism doesn’t require the banks to lend a single dollar. It can all be done by ‘numbers’ sitting in checking accounts. The banking system is completely bypassed.

     Now, of course, real economic activity will change long before the Fed reaches the car buying stage of QE, but I think you appreciate my point. At some stage, people will have enough ‘numbers’ in their accounts and few enough other assets that they will either spend or invest the money in real assets, either directly or indirectly.

     Thoughts?

159. Good Habit
     24. July 2011 at 10:07
     

     Travis A

     If the FED starts buying real (non-financial) assets, like houses and cars, thats not QE any more (and not monetary policy either), but fiscal policy (the FED is a government agency) – so they are deficit spending (outside the budget). This would, of course, increase demand, and if it is driven to it’s last consequence, (the FED buying ALL assets), you would end up with a complete nationalization of the economy, aka communism….

160. TravisA
     24. July 2011 at 21:46
     

     Good Habit,

     So do you think that if the Fed bought all financial assets (Treasury debt and all outstanding corporate bonds and all outstanding stock capitalization), that those people who received ‘numbers’ in their checking accounts from the Fed would just let the ‘numbers’ sit in the bank and do nothing?

     The point of my thought experiment is that clearly at some point when the Fed purchases assets, the people who receive numbers in their checking account are going to spend/invest, without any bank loaning a dime. It will occur far before all the treasury debt has been purchased.

     (Remember that a corporate bond and stock is a claim on real assets. There’s little difference between buying a REIT and buying a collection of buildings.)

161. Good Habit
     25. July 2011 at 02:05
     

     Travis
     Why would all those holders be willing to sell their assets. They hold them for a reason. So they FED would have to over an insanely high price to buy all bonds, and they wouldn’t be able to sell all stocks, not even if they bid the DowJones up to a Trillion points. In hyperinflation, people would prefer stocks against cash, because, as you said, stocks are a claim to real assets.
     So, yes, if the FED gives away huge amounts of money by buying way above market expectatons, they could create hyprinflation, but not kickstart the real ecomony. And of course, buying real assets, (or claims on them) is some kind of deficit spending-just not by the official government.

162. W. Peden
     25. July 2011 at 03:34
     

     Good Habit,

     There is no way of causing demand-driven hyperinflation that does not kickstart the real economy. None.

163. Scott Sumner
     25. July 2011 at 06:42
     

     Good habit; You asked;

     “But if the banks don’t demand more money, how will the CB force it on them?”

     I never claimed the Fed would force money on the banks, where’d you get that idea?

     You said;

     “Only if the CB somewhow bypasses the banking sector, by directly distributing money to consumers or companies (not as loans, but as “gift” to certain groups – usually, you’d call this “subsidy”) could the CB pull NGDP growth, but this would be fiscal policy trough the back door (bypassing legislature).”

     Why would the Fed give money away, when they could sell it for bonds?

164. TravisA
     25. July 2011 at 09:21
     

     Good Habit,

     So I guess we both agree that the Fed can create inflation by buying financial assets. That would very likely imply that NGDP would also increase, unless you think that RGDP would decrease 1 for 1 with the increase in inflation — which seems highly unlikely.

     So our only point of disagreement then is whether RGDP would increase with the increase in NGDP. With unemployment at 9% and inflation very low, I say yes. If unemployment were at 4% and we had 6% inflation, I would say no.

165. Good Habit
     25. July 2011 at 12:49
     

     Just a short last word:
     Travis – yes the FED can create inflation by buying financial assets, but it would be one of the most in-effective ways to do this. Buying bonds at anything near market rates will change nothing – so they would have way to overpay to have an impact – thats why I said the would have to “give the money away”.
     Buying stocks could start a stockmarket-bubble, but it would have to be the mother of all stockmarket-bubbles to have a significant impact. And the impact might mostly be on NGDP only, because a fast rising part of all (nominal) income would be capital gains from rising stock-prices. This would -likely- pull an even higher part of available income away from consumption in to stock-market speculation. (THE source of all income).

166. TheMoneyIllusion » Where MMT went wrong
     28. July 2011 at 04:39
     

     […] whole point of my Quantity Theory of Money post (and especially the Canadian/Australian comparison) was to smoke out their views of currency and […]

167. KRG
     29. July 2011 at 10:05
     

     “I mean, 231 million percent folks, that must have been one WHOPPER of a cause, *big* and *obvious* to all!

     Nobody can tell me what it was?”
     You’ve been told a number of times over and just ignored it.

     There was no domestic food supply. That’s all it really took.

     Imagine 10 people on a desert island. They have only one coconut to eat. They decide that the coconut goes to the person who can pay the most gains of sand for it. What is the final price of the coconut?

     Almost any other resource there is a bidding point where people will say “That’s too much for me, I don’t need it right now” and walk away, which limits the ability of that resource to inflate. But food, once it drop below the sustenance level for a population, does not have that cap. People won’t stop bidding for the coconut until they get it or starve. Meanwhile, any other production that they might have funded through consumption grinds to a halt because they’re putting every penny they can get their hands on into bidding on the coconut.

168. ssumner
     29. July 2011 at 18:13
     

     KRG, When you have famine in a country where the money supply is not hyperinflated, you do not get hyperinflation. It’s as simple as that.

169. KRG
     29. July 2011 at 20:08
     

     If I light one piece of paper on fire, it will burn out more quickly than if I light 100 pieces of paper on fire- that doesn’t make the 100 pieces of paper cause the fire.

     The famine causes the hyperinflation, printing money just feeds it once it’s already going. In the more monetarily constrained economy all that happens is that people more quickly abandon bidding for food with money and concentrate more completely on bidding non-monetary assets or resorting to more aggressive measures to get food.

     I don’t think you’ll find any MMT proponent who will deny that printing money will feed an inflationary fire that’s already started (in fact, they’d say that if inflation is the problem, more taxes to soak up the excess money are what’s needed); they just protest the suggestion that hyperinflation will kindle itself base on money printing alone without an explicit constraint to provide the match.

     Put another way- MMT will fully agree that trying to solve inflation by just printing and arbitrarily spending money will only cause more inflation. It recommends taxes as the control on inflation instead.

     On the other hand, the reason that MMT folks talk mostly about printing money solving depressed economies is because, for most of the modern world, depressed economies are what we’re dealing with, because production constraints are fairly rare (to the point of practically non-existent in the case of digital assets).

     Ultimately, I think the argument here is not over what actually happened, but semantic differences over “cause”. From the MMT perspective:
     -The famine in Zimbabwe was the cause of its hyperinflation.
     -Printing money, without actively addressing the famine, fed the existing hyperinflation that was constraining the economy.
     -Failure to sufficiently impose taxes to keep the money supply small enough in comparison to the supply of food allowed the hyperinflation to continue unchecked.
     (There were also compounding effects from printing money to try to pay debts denominated in foreign currency, but accounting for that just helps to improve overall accuracy; it doesn’t change the basic process)

     It seems like the people asking about the cause of hyperinflation mix the first two points together in their meaning of “cause”, while MMT says that it’s important that we carefully keep them separate so that we can assess what happens if we do the second in situations where the constraints from the first don’t exist.

170. ssumner
     30. July 2011 at 11:08
     

     KRG, By “cause” I mean rapid money growth is a necessary and sufficient condition for most hyperinflations. Famine is neither necessary nor sufficent.

     I say “most,” because there are rare hyperinflations caused by the expected collpse of a government, which lowers the demand for its currency–see the confederate dollar example.

171. TheMoneyIllusion » Links to my views on money/macro
     22. September 2011 at 15:03
     

     […] Critiques of MMT here and here. […]

172. The prive level – is it explained by the QTM – or is it rather the other way around? « Good Habit's Forum
     9. October 2011 at 08:24
     

     […] Summner insist that the QTM is a good explanation of the price level.http://www.themoneyillusion.com/?p=10116 He then creates a fictive economy with a fixed amount of currency and states: „It’s likely […]

173. Shining Raven
     28. September 2012 at 01:27
     

     Probably nobody is going to answer this for me, since this post is over a year old, and I only now discovered this blog. But I’ll try nontheless:

     With regard to the NGDP targeting, people keep talking about an “NGDP futures market”. Is there such a thing, or is this a purely hypothetical construction that does not (yet) exist in reality? Or are there any options/futures/whatever traded right now that would be a close substitute to what NDGP futures would be?

     With regard to trading on such a (hypothetical?) market to hedge against losses in real-world investments (I build a factory, but don’t make money because there is no demand and expected NGDP is not reached and I don’t realize my projected return on the investment): how large would the market have to be to insure against these losses? I don’t really know much about finance, so my question is, does it have to be of the same size as the expected NGDP growth?

     Would this be really feasible?

174. Shining Raven
     28. September 2012 at 01:40
     

     When people bring up banking and the effect of banks in this post, Scott says:

     “… banking plays no role.”

     “…but can’t we talk about my post?”

     I find this really disingenuous.

     Yes, sure, in the Iceland-example there are by assumption no banks. Scott then uses this example to derive … something.

     And then he applies this … something … to Canada, Australia, Japan, Korea, …

     Last I looked, these were all countries that did in fact have banks in them. So how can he complain that people bring up banking? Sure, banking would be completely irrelevant, if he only stuck to his hypothetical Iceland example. And I understand the point that models, hypotheticals, and examples are all useful things to learn something from.

     But if you take something derived in a model without banks and apply it to the real world, which does in fact have banks in it, how is it a sensible response to say: “But my model does not contain banks!” Sure, but that is the point of contention: Does that make the conclusions from the model inapplicable to the real world, to which Scott himself has applied the conclusions?

     The critics say that it does make the conclusions inapplicable (and I agree with their arguments), but Scott does not really engage with this objection.

175. Saturos
     28. September 2012 at 04:32
     

     Shining Raven, no it doesn’t exist yet, and it’s not supposed to large or used for hedging. Scott predicts there would be little natural interest in trading in it, so it would have to be subsidized.

176. Saturos
     28. September 2012 at 04:33
     

     We proxy NGDP expectations using equities, real estate and TIPS, but an NGDP futures market would be much much better.

177. Shining Raven
     28. September 2012 at 08:13
     

     Saturos, thanks for the reply. I appreciate it.

     I am really hazy on this, but how could it possibly have an impact if it is small?

     Some people in the thread have explained that people could use it to insure against losses if NGDP comes in below expectations and they realize losses because of this. I would presume that this would imply a significant size for this market. I can see that this might do something, but if it is really not significant, then how would its existence or non-existence affect anything?

     I mean, it probably would not do if the Fed opened an intrade account and opened a market for NGDP on intrade.com (I checked, there is none so far)?

     So how would that work?

178. Saturos
     28. September 2012 at 09:01
     

     Well, in Scott’s proposal, the Fed buys as many contracts as people want to sell at the target price. So as long as the market expects NGDP to be too low, the Fed will go on buying contracts and, in the process, increasing the base money supply and pushing up future NGDP. And vice versa. Take a look at this post (http://www.themoneyillusion.com/?p=1184), and, if you still have questions, you should post them on the latest open thread and address them to Scott himself, who would explain it better than I can. (You could also ask Bill Woolsey, who has collaborated with him on the idea.) I would only add that when monetary policy is effective, the monetary base is only a small fraction of NGDP, so little adjustments have big effects. And if NGDP is expected to be stable then V tends to auto-correct for shocks to M (http://marketmonetarist.com/2012/03/18/how-unstable-is-velocity/)

     Hope that helps!

179. Strange Things Scott Sumner Has Said | Last Men and OverMen
     18. February 2017 at 10:04
     

     […]    http://www.themoneyillusion.com/?p=10116       Next he claims that without believing in the QTM you can’t explain […]

180. Contributing to a Krugman Piece: Major Eco-Nerd Points For Tom Brown | Last Men and OverMen
     18. March 2017 at 05:35
     

     […]      http://www.themoneyillusion.com/?p=10116 […]

181. On anti Gay Discrimination, Chuck Hagel Takes on State's Rights | Last Men and OverMen
     14. April 2017 at 04:32
     

     […]  http://www.themoneyillusion.com/?p=10238     http://www.themoneyillusion.com/?p=10116      In the above link Sumner argued that you can’t explain the price level […]

182. A Scott Sumner-Scott Fullwiler Grudge Match Revisited | Last Men and OverMen
     23. April 2017 at 12:34
     

     […]       http://www.themoneyillusion.com/?p=10116 […]

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