Bill Woolsey’s new blog

Ever since I went to China I seem to have been in a perpetual struggle to keep up.  One of the things I feel most guilty about is that I haven’t had much time to follow Bill Woolsey’s new blog, entitled Monetary Freedom.  By now many of you may have already read it, but those who haven’t should take a look.  From the very beginning Bill has been my most supportive commenter.  And he has similar (though not identical) views on monetary policy errors by the Fed.

I think his blog will complement mine in several ways.  First, it always helps to have more than one person arguing for the importance of maintaining NGDP growth expectations at an adequate rate.  Bill prefers 3%, but really there is not that much difference, as I would also prefer 3% if we had a forward-looking policy, and Bill agreed that the financial crisis last fall was not the best time to gradually downshift to price stability.  Having more than one person making these arguments, and especially someone as level-headed as Bill, helps make me seem less like a monetary crank.

Bill also comes at this from a slightly different perspective, as he was influenced by Leland Yeager’s work on monetary disequilibrium.  BTW, he got his PhD from George Mason, so that provides another interesting link with my new favorite grad school (replacing the University of Chicago.)  It also means that he knows far more about Austrian economics than I do.  Like me, Bill has done research on targeting the forecast.  Unlike me, he has also done research on free banking.

I think Bill focuses a bit more on money’s role as a medium of exchange, whereas I focus more on its role as a medium of account.  In that context it was interesting to see him recently debating Nick Rowe (another of my favorites) on this very question.  Nick suggested that the medium of account role isn’t all that important and that money’s key role is as a medium of exchange.  I once had a long debate with Nick on this issue, and did not come out ahead.  But I think Nick overplayed his hand a bit here:

The textbooks mention three properties of money:
1. Money is a store of value. So are mackerel (if frozen or canned). Forget that.
2. Money is a medium of account (we measure prices in money). Mackerel aren’t. But so what? Prices are sticky in terms of money. But the price of mackerel is also sticky in terms of money. So prices are sticky in terms of mackerel as well, by transitivity. So no difference there between money and mackerel.
3. Money is a medium of exchange. Aha! Because (outside of US prisons) mackerel is not a medium of exchange. An excess demand for mackerel might cause a general glut and recession in US prisons, but only an excess demand for what the rest of us law-abiding folk use as money can cause a general glut and recession elsewhere.

It is true that both money and mackerel may exhibit price stickiness.  But what makes the medium of account special is that when its value changes, the nominal price of all other goods must change, that is not true of other goods with sticky prices.  As Bill says:

I don’t agree with Rowe about the medium of account. If mackerel were the medium of account, then clearing the mackerel market would require that everyone in the economy adjust their prices. With the price of a mackerel being one, and all the other prices changing, then the price level and nominal income (which is measured in mackerels) would change depending on the supply and demand conditions in the mackerel market.

In many cases Bill knows my arguments better than I do.  In my hasty response to Tyler Cowen’s seven comments, I overlooked some important points.  For instance, after Tyler said:

Yet, in my view, easier money would not have eliminated most of the crisis, given the partial or total insolvency of many financial institutions, the negative AD shock from the collapse of the housing bubble, and the need to halt and reverse the ongoing accumulation of debt, among other factors.

Bill responded as follows:

I believe that there is a need to reallocate resources, and can accept that the partial or total insolvency of many financial institutions can impact the productive capacity of the economy. Bankruptcy involves real costs. If operations stop during liquidation, that obviously reduces productive capacity. And even if operations continue, it is difficult to believe that the process doesn’t impact the effective allocation of resources.

However, I totally reject the view that there is such a thing as an AD shock independent of monetary disequilibrium.

This is an important point, as many people seem to think that a drop in wealth causes lower output.  That is clearly not true for families (who if anything need to work harder if their retirement saving disappears) and it is also not true for the US as a whole.  If a loss of wealth leads to lower real interest rates and lower velocity, and if this drop in velocity is not offset by an expansion of the money supply, then the resulting drop in AD is 100% the fault of the Fed, not instability in the real economy.

There is lots more good stuff to check out.


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15 Responses to “Bill Woolsey’s new blog”

  1. Gravatar of Current Current
    27. September 2009 at 04:27

    The discussion on the properties of money is complicated. I discussed this with Scott once.

    http://blogsandwikis.bentley.edu/themoneyillusion/?p=2331#comment-7707

    In the discussion on Bill Woolsey’s blog folks are trying to pull appart things that are intertwined. In a modern economy the medium-of-exchange and medium-of-account will follow each other, for quite obvious reasons.

    I don’t think that agreements and debts could function as they do today if the medium-of-exchange and medium-of-account were different.

  2. Gravatar of Thruth Thruth
    27. September 2009 at 05:05

    Scott: Welcome back. Nice to have some new posts to mull over.

    “This is an important point, as many people seem to think that a drop in wealth causes lower output. That is clearly not true for families (who if anything need to work harder if their retirement saving disappears) and it is also not true for the US as a whole.”

    The counterargument is that the drop in wealth could be signaling a drop in the productive value of the capital stock (which I’ll define broadly enough to include housing as a producer of housing services). The challenge for this line of reasoning is explaining the drop in employment. I guess this is where the “recalculation” story fits in, though if you believe in those sorts of frictions I don’t see why that would rule out a role for unconventional monetary policies (or certain types fiscal policy for that matter).

  3. Gravatar of ssumner ssumner
    27. September 2009 at 05:13

    Current, They are usually intertwined. But in the 1920s gold was the medium of account, but had been mostly replaced by cash in actual transactions. By then most gold was in central bank vaults. Friedman and Schwartz chose to look at money, I looked at gold markets. I think my approach was more informative.

    Thruth, I don’t like the recalculation story because it doesn’t fit the facts. It predicts.

    1. Less employment in overbuilt areas.
    2. More employment in non-overbuilt areas.
    3. More total unemployment due to frictional effects.

    All three points were true when recalculation really was going on (from mid-2006 to mid-2008), but point two was massively refuted once NGDP started falling in August 2008.

  4. Gravatar of Current Current
    27. September 2009 at 07:41

    Scott: “But in the 1920s gold was the medium of account, but had been mostly replaced by cash in actual transactions. By then most gold was in central bank vaults. Friedman and Schwartz chose to look at money, I looked at gold markets. I think my approach was more informative.”

    I think you’re really talking about something a bit different here.

    Gold coins or bullion were in the time of the international gold standard the “international money”. They were what Mises calls “commodity money” or “money in the narrower sense”. Notes and bank deposits were national moneys, and they were “money in the broader sense”.

    I don’t think the situation is the same as the one with Mackerel that the others are discussing. The market for notes is not similar to the market for mackerel.

    Let’s consider gold and mackerel. One is the medium of exchange the other is the unit of account. Both trade in other markets that are unconnected with those uses. Gold is used in jewllery and people eat mackerel. Each trade in their own market. For this reason the idea presented doesn’t make a whole lot of sense. Why would people keep a stock of gold coins in order to hold a fund of purchasing power in mackerels?

    The same though isn’t true of notes. Before Fiat money banknotes were not independent of gold. The banks actively worked to make their notes a reasonable substitute for gold coins. Where they failed they were ousted from the market and replaced by other banks. Banknotes were not a good independent of gold, rather they were tied directly to gold by the banks.

  5. Gravatar of Greg Ransom Greg Ransom
    27. September 2009 at 21:39

    Scott, is the evidence so clear on this?

    You write:

    1. Less employment in overbuilt areas.
    2. More employment in non-overbuilt areas.
    3. More total unemployment due to frictional effects.

    All three points were true when recalculation really was going on (from mid-2006 to mid-2008), but point two was massively refuted once NGDP started falling in August 2008.

  6. Gravatar of ssumner ssumner
    28. September 2009 at 06:25

    Current, I don’t follow your argument at all. Gold was a medium of account but not a domestic medium of exchange. It seems exactly like the mackerel example to me. Wasn’t Nick suggesting that mackerel could be a medium of account but not a medium of exchange?

    Greg, I don’t have the exact numbers, but I doubt even 10% of the jobs losses since August have been in housing and finance. But certainly far less than 100%.

  7. Gravatar of Current Current
    28. September 2009 at 06:50

    Scott: “I don’t follow your argument at all. Gold was a medium of account but not a domestic medium of exchange. It seems exactly like the mackerel example to me. Wasn’t Nick suggesting that mackerel could be a medium of account but not a medium of exchange?”

    But notes are different from Mackerels. Mackerels are a normal sort of good. Notes would not exist were it not for the commodity money that they act as substitutes for. Banks bring them into existence specifically in order to act as substitutes for commodity money. There is a market in this, those who succeed get a free loan, those who fail get bankruptcy. The two situations aren’t similar. In the 19th century there were many attempts at “bimetallism” where silver and gold were pegged at a fixed ratio. As far as I know all of them failed, because silver and gold are commodities that trade in markets of their own. Banknotes are different though, although many banks failed the general note market never did.

    Is this discussion about Mackerel supposed to be a confusing way to discuss fiduciary media?

  8. Gravatar of Nick Rowe Nick Rowe
    28. September 2009 at 09:05

    Scott: you are probably right in saying I overplayed my hand a little I got carried away, and mackerel are such a fun topic). In general, it is much harder to change the price of a good that is the medium of account, because, as you say, the only way to do that is by changing the price of everything else.

    But there are special cases where it is not harder. Legal price controls are one example of that special case. If there is a binding nominal price ceiling on a good, the only way to raise the price of that good is to lower the price of everything else.

    So I’m just mulling over a new post on a theory that should keep you and Bill amused: “Rent controls caused an excess demand for apartments, an excess supply of everything else (by Walras’ Law), and so caused the current recession!”

  9. Gravatar of Current Current
    28. September 2009 at 09:18

    Nick,

    That point about price controls has been brought up before in Say’s law debates. The “knocking the zeros of the money by issuing new notes with less zeros” technique beloved of south american banana republics is an example where the unit of account can be changed without really changing all prices.

    I still don’t get the purpose of the whole mackerel’s thing.

  10. Gravatar of ssumner ssumner
    29. September 2009 at 16:32

    Current, I don’t think all the attempts at bi-metallism failed. I haven’t studied that issue, but I seem to recall that people like Friedman argued that bi-metallism was superior to the gold standard.

    Nick, I’ll have to think about that one (perhaps you already have it posted as I write this. My first reaction is that price controls can just trigger non–price competition, not excess supply of everything else. But I’ll have to think about it.

    Current, A 1000 to 1 currency reform is technically 99.9% deflation. But it doesn’t feel like it because all wages, prices, and debt contracts are completely flexible in response to this deflation. They all are adjusted immediately.

    I’m also confused by the makerel. I think I have pretty good intuition for monetary economics, but Nick’s mind is always a bit ahead of me on these wacky cases.

  11. Gravatar of Current Current
    30. September 2009 at 06:50

    Scott: “I don’t think all the attempts at bi-metallism failed. I haven’t studied that issue, but I seem to recall that people like Friedman argued that bi-metallism was superior to the gold standard.”

    Interesting. Since both types of metal trade in their own markets how can a situation where the price of one or the other changes be dealt with? Surely whenever that happens Gresham’s law will come into operation? How did these successful forms of bi-metallism work?

    Scott: “A 1000 to 1 currency reform is technically 99.9% deflation. But it doesn’t feel like it because all wages, prices, and debt contracts are completely flexible in response to this deflation. They all are adjusted immediately.”

    Yes. My point was that re-valuing a currency in this way is a akin to a very general price control. In this very general situation there is little difference between changing the price of money and changing the price of all goods. Not very much happens except a South American dictator temporarily looks like less of a moron.

  12. Gravatar of Current Current
    30. September 2009 at 08:09

    Scott: “Nick, I’ll have to think about that one (perhaps you already have it posted as I write this. My first reaction is that price controls can just trigger non-price competition, not excess supply of everything else. But I’ll have to think about it.”

    Yes. If you think about it, you can approach the problem from the good direction too…

    http://www.newsbiscuit.com/2009/09/29/government-to-kick-start-economy-by-promising-terms-and-conditions-wont-apply-363/

  13. Gravatar of Current Current
    1. October 2009 at 03:19

    I meant “the other direction too”

  14. Gravatar of Scott Sumner Scott Sumner
    1. October 2009 at 10:04

    Current, I don’t recall exactly, but I think the bi-metalism argument is based on the fact that two metals make the price level more stable over time. It is true that one may drive the other out of circulation, but not always. But even so, it can help stabilize prices. So in the Great Depression (or 1890s) people would have switched to silver, and the price level wouldn’t have fallen as far. Of course there is the inconvenience of switching over, but Friedman was making a purely macro argument, not a micro efficiency argument.

  15. Gravatar of Current Current
    4. October 2009 at 14:33

    I see what you mean. I think you are right that having two different commodity currencies can make the price level more stable over time. Since, a rise in demand for gold for some industrial use will not affect silver, so agents can choose which to use.

    What you seem to be discussing though is something a bit different to what I mean. I said earlier “In the 19th century there were many attempts at ‘bimetallism’ where silver and gold were pegged at a fixed ratio.” It was specifically this I was criticising.

    When I’ve discussed bi-metallism here I mean the sort of system where silver and gold are pegged together. Not where independent monetary systems exist for the two. (I know both were called bi-metallism in the past). The former situation is not wise because the prices of the two will certainly drift in time and invoke Gresham’s law and/or tax cheating. The latter situation is probably better than a pure gold standard for the reasons you mention above. I think having banks free to issue notes against any commodity is probably wise.

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