Definitions are not indicators (reply to Carney)

Mark Sadowski sent me to this post by John Carney:

In a recent post I proposed that Scott Sumner, the premier market monetarist, expects too much of an inflationary effect from quantitative easing because his definition of money is too narrow.

Very briefly I’ll run through the QE=inflation view. If you consider inflation to be a monetary phenomenon, more or less, than increases in the supply of money should result in higher prices (all other things being equal). If you also consider QE to be adding to the supply of money because it exchanges government bonds for bank reserves, then QE appears to be inflationary.

It’s the second point that deserves another look: does QE really increase the supply of money? The answer to that, of course, depends on what you consider to be money. The definition of money, however, is notoriously hard to pin down. In fact, as Milton Friedman and Anna Schwartz argued, it may be impossible to pin down on an abstract level.

What we really want is not a “definition” of money that will apply to all and any circumstances. We want one that is relevant to the question we are asking. The definition that best helps us understand the particular aspect of the world and economics that we are looking at.

Sumner appears””I say “appears” because, like a lot of people, I’m never quite sure what Sumner’s saying””to think that when thinking about inflation and QE, “base money” provides us with the most useful metric. The term “base money” was coined by Karl Brunner in his 1961 article, “A Schema for the Supply Theory of Money.” Exactly what should count as “base money” was immediately subject to all the usual two-handed economist revisions and challenges. It also got called a lot of different names: “outside money,” “high-powered money,” “non-interest bearing government debt.” But, roughly speaking, the concept is that base money is the total of currency in circulation plus reserve balances of banks.

I don’t doubt that at certain times and in certain circumstances, this is a very useful definition of money. Or was. It certainly seems to have a lot of explanatory power when looking at the monetary policy of the Great Depression.

First a few corrections:

1.   Base money was a very unreliable indictor of policy during the Great Depression, indeed that was one of the main points of Friedman and Schwartz’s famous book.  (Actually a pretty serious error by Carney on a post devoted to base money.)

2.  Base money is only equivalent to high-powered money when there is no interest on reserves.  High-powered money earns no interest.  So today’s base is not high-powered.

Carney is right that I am often very hard to understand, but that’s mostly because monetary economics is almost as confusing as quantum mechanics.  (See my previous post.)  If you find an article on monetary economics that is easy to understand, it’s probably wrong.  So I won’t take offense at Carney’s implied swipe at my communication skills.  (And that swipe might have been accurate; I’m not Paul Krugman.)

Here’s where I think Carney is confused:

1.  Old monetarists thought M1 or M2 was the best definition of money.

2.  Old monetarists thought M1 or M2 was the best indicator of monetary policy.

3.  I believe the monetary base is the best definition of money.

4.  Ergo I believe . . .

No I DON’T believe the base is a good indicator of policy.  Indeed you’ve be hard-pressed to find anyone who thinks it’s a less reliable indicator than me.  Remember all those people who said; “Money’s obviously easy because the Fed’s pumping trillions into the monetary base?”  I was one of the very few people to respond, “No, changes in the base are not a reliable indicator of policy, which is currently contractionary.”

Carney’s claims that we now have a modern financial system and hence the base is no longer all that important do not affect my views at all, because I don’t define the base as money for the reasons he assumes.  I don’t care if substitutes are replacing it at a medium of exchange; I define the base as money because it’s the medium of account.  It’s “paper gold” to people born before 1933.

BTW, even back in 2007, before the big increase in excess reserves, the base was a bigger share of GDP than in 1929.  Some argue; “Yes, but lots of it is hoarded overseas.”  I know that, but it makes little difference.  Indeed if anything it makes Fed policy more potent, as demand for cash hoards is more inertial than demand for transactions balances, which means in normal times when rates are positive OMOs have a bigger impact than if all cash was used for transactions.

Throwing out a lot of cliches about how the financial system has changed over time is not going to impress a market monetarist unless you understand how we look at things:

1.  The price level and NGDP are determined by changes in the supply and demand for money.

2.  Everything else that seems to affect NGDP (including anything you might mention in the financial system) works through the demand for money, aka velocity.

3.  Shifts in velocity are very awkward for old monetarists, but don’t matter at all for market monetarists.  (Unless velocity goes to zero or infinity, which is very unlikely)  We favor targeting NGDP expectations.

So it’s fine for people on the sidelines to take potshots at how little people like me know about banking/finance/etc, but unless they show me they understand what market monetarism is, I’m not going to be convinced that my lack of knowledge of banking is a problem for MM.

I also know very little about the Colombian drug cartels, another big demander of base money.  I think everyone agrees the Fed can and does offset shifts in the demand for base money from Colombia.  And unless they can explain why the Fed cannot offset shifts in the demand for base money from banking and finance, I will fail to understand why I should try to learn those mind-numbingly boring subjects at age 58.

PS.  Carney probably thinks I opposed the Fed’s decision yesterday, as it reduced near-term base growth. But I actually supported it because it reduced the future demand for base money by more than it reduced the future supply. He tells me that reserves and bonds are close substitutes at zero rates, as if I don’t know that.  He’s still operating on the “concrete steppes” and trying to “teach” (his words, not mine) market monetarist bloggers the basic facts about money.  Good luck with that.

PPS.  In this comment Mark Sadowski provides a long and detailed rebuttal to Carney’s claims about the impact on QE on money-like assets.


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57 Responses to “Definitions are not indicators (reply to Carney)”

  1. Gravatar of Mark A. Sadowski Mark A. Sadowski
    19. December 2013 at 15:12

    Scott,
    Sorry to do this again but off topic.

    Krugman has recent post on the UK that misses the mark in two major ways.

    http://krugman.blogs.nytimes.com/2013/12/18/the-three-stooges-do-westminster/

    December 18, 2013

    The Three Stooges Do Westminster
    By Paul Krugman

    “…The basic fact of UK economic performance since the financial crisis is that it has been terrible “” in fact, as the NIESR documents, GDP performance has been substantially worse than during the Great Depression:

    [Graph]

    The only reason Britain isn’t suffering terrifyingly high unemployment is the fact that, for reasons not clear, productivity has collapsed, so that the shrunken economy is still employing a lot of people.

    Now, however, the economy is finally growing. Why?

    Well, partly because economies do tend to grow unless you keep banging their heads against a wall. And that’s more or less what has happened in Britain. Wren-Lewis uses the OBR numbers; here, telling more or less the same story, is what you get from the IMF Fiscal Monitor. What I plot below is the change in the cyclically adjusted primary balance “” a measure of the extent to which fiscal policy is being tightened.

    [Graph]…”

    1) The effect of policies designed to impact aggregate demand (nominal GDP or NGDP) should be measured in aggregate demand and not real output (real GDP or RGDP).

    2) The proper comparison for recoveries should be times and places when interest rates are at the zero lower bound and not the inflationary 1970s and 1980s.

    The only other time that the UK’s economy was up against the zero lower bound in interest rates was during the Great Depression. The UK was among the sterling bloc of countries (i.e. Japan, Sweden and Norway) that devalued early and recovered from the Great Depression first. So the recovery of the sterling bloc countries is considered the benchmark against which other recoveries from the Great Depression are measured.

    Well, according to B.R. Mitchell the nominal GDP of UK, Japan and Sweden did not surpass their previous peak (in 1929 and 1930) until 1936. (Norway set a peak in 1920 that was not surpassed until after WW II.) In the case of the UK this meant it took seven years to set a new NGDP record.

    This time the UK surpassed its previous peak set in 2008 by 2010. So in terms of NGDP, which is the thing that monetary and fiscal policy have a direct impact on, the UK’s recovery this time is far more successful than it was during the Great Depression.

    What about compared to other currency areas recovering from the Great Recession?

    The following is a graph of the NGDP of the four big advanced currency areas with NGDP indexed to 100 in 2008Q2, that is, before large scale monetary base expansion started in September 2008.

    https://research.stlouisfed.org/fred2/graph/?graph_id=125131&category_id=0

    Note that the U.K. led in relative NGDP growth from 2010Q1 through 2011Q3 with the exception of 2010Q4 and 2011Q2.

    Krugman’s graph of the change in the cyclically adjusted primary balance (CAPB) shows that fiscal policy was especially contractionary in calendar years 2010 and 2011 (in fact more so than any of the other big four advanced currency areas) precisely when the UK led the big four advanced currency areas in NGDP growth.

    So what possible explanation could there be for the UK’s good NGDP growth performance in 2010 and 2011 despite such contractionary fiscal policy?

    As of May 2013 the BOE’s monetary base was up by 348% since August 2008, the Federal Reserve’s up by 260%, the BOJ’s up by 75% and the ECB’s up by 48%:

    http://thefaintofheart.files.wordpress.com/2013/06/sadowski3

    The U.K. led in relative monetary base growth from June 2009 through January 2011.

    The UK’s recent improvement in RGDP growth owes more to an end in the productivity collapse than it does to a surge in NGDP growth. Year on year NGDP growth is currently only about 3.3% compared to the 4.8% and 3.5% rates of NGDP growth displayed in 2010 and 2011 respectively.

    And since the earlier productivity collapse and its recent end have nothing to do with monetary or fiscal policy, and monetary policy has been demonstrably successful at engineering relatively rapid rates of growth in NGDP in the face of severe fiscal austerity, the UK’s recent RGDP performance evidently has absolutely nothing to to do with the fact that the Cameron government paused fiscal austerity in 2012 as Krugman claims.

    P.S. Of course this means that the Cameron government deserves neither credit nor blame for the UK’s economic performance. The BOE deserves the credit and blame for NGDP, with the productivity collapse a mystery that has still to be solved.

    P.P.S. UK employment reached 30.1 million in 2013Q3 up from its peak of 29.5 million before the Great Recession. Employment growth was 250,000 in the third quarter and the unemployment rate is now down to 7.4%. Lars Christensen has a recent post on the UK that inspired this rebuttal to Krugman:

    http://marketmonetarist.com/2013/12/18/imagine-that-us-non-farm-payrolls-were-growing-by-400kmonth-that-is-how-strong-the-uk-labour-market-is/

  2. Gravatar of Geoff Geoff
    19. December 2013 at 15:16

    “No, changes in the base are not a reliable indicator of policy, which is currently contractionary.”

    You keep using that word “reliable”, but I don’t think it means what you think it means.

    If one looks at the monetary base to judge whether the Fed is tight or loose, then that data is certainly “reliable” if the collection and tabulation of the actual amount of base money there really is. The only way it wouldn’t be reliable would be if the people tracking the monetary base are making errors.

    What you have been desperately trying to do for quite some time now, is to present your chosen DEFINITIONS of “loose” and “tight” money, as if they are objective, like two apples plus two apples is equal to four apples is objective.

    There is nothing wrong with defining looseness and tightness in terms of the thing the Fed directly increases or decreases, which is the monetary base. It doesn’t matter if unemployment is rising and output is falling while “money is loose” defined in terms of the monetary base. It’s absurd to believe that we can’t say money is loose in this instance, because of what’s happening to unemployment and/or output.

    If you want to DEFINE looseness and tightness in terms of aggregate spending, then fine, define it that way. But please don’t pretend that you’re proposing anything other than a mere definition, such that all other definitions are “unreliable” or some other silly nonsense.

  3. Gravatar of benjamin cole benjamin cole
    19. December 2013 at 16:21

    Excellent blogging.
    One cavil: You (in PS note) say you support the Fed’s $10 billion taper…but I thought you favored steady ramping up of QE until NGDP targets were hit…
    Also, would lowering IOER by one basis point a month be a good plan?

  4. Gravatar of ssumner ssumner
    19. December 2013 at 17:17

    Thanks Mark, I’ll probably do a post.

    Ben, No, I favor yesterday’s decision, I do not favor the taper. Yesterday’s policy was better than the previous policy (even with the taper), even better would have been to do the forward guidance without the taper.

  5. Gravatar of Mark A. Sadowski Mark A. Sadowski
    19. December 2013 at 18:28

    A correction to the above monetary base link:

    http://thefaintofheart.files.wordpress.com/2013/06/sadowski3_1.png

  6. Gravatar of Michael Byrnes Michael Byrnes
    19. December 2013 at 18:52

    If we were talking about apples instead of money, no one would dispute the claim that the price of apples is a function of the supply of apples AND the demand for apples.

  7. Gravatar of Michael Byrnes Michael Byrnes
    19. December 2013 at 19:16

    Cochrane joining the “perhaps QE is deflationary” brigade:

    ohnhcochrane.blogspot.com/2013/12/what-if-we-got-sign-wrong-on-monetary.html

  8. Gravatar of Michael Byrnes Michael Byrnes
    19. December 2013 at 19:18

    Fixed link:

    http://johnhcochrane.blogspot.com/2013/12/what-if-we-got-sign-wrong-on-monetary.html

  9. Gravatar of ssumner ssumner
    19. December 2013 at 19:36

    Michael, I don’t see him making the same argument as Williamson, but perhaps I misread him. Where does Cochrane discuss QE?

  10. Gravatar of Saturos Saturos
    20. December 2013 at 01:15

    IN THE FUTURE: the Fed announces its FFR targets on Twitter (where I found this link): http://blogs.wsj.com/chinarealtime/2013/12/20/making-moves-on-weibo-the-peoples-bank-of-china/?mod=e2tw

  11. Gravatar of J.V. Dubois J.V. Dubois
    20. December 2013 at 01:56

    Scott: Just to say that after reading Elizier’s Yudkowski sequence on quantum mechanics I no longer think it is confusing. It was the way that it was usually explained by forcefully applying Newtonian intuition (wave/particle duality and all that) which was confusing.

    And I think the same goes for money/macro view of Market Monetarists. Now I do think that to “really” understand what is going on and to be able to answer some really tricky questions one has to have a lot of experience with the model. But basic understanding of MM view of things is not confusing to me.

    On the contrary, thanks to you and Nick and David and Lars and other people there is now a pretty good body of articles tackling different angles of how to look at things. I spent my share of time trying to understand some “heterodox” ideas and Market Monetarism is by far the most friendly to understand, mostly because it is willing to engage in discussion. Actually I was able to understand more about some of these heterodox schools of thought just by following MM and the way how some critique from these schools was discussed.

  12. Gravatar of Saturos Saturos
    20. December 2013 at 03:33

    I have a new book project for you, Scott: http://qz.com/157852/gather-round-children-heres-how-to-heal-a-wounded-economy/#157852/gather-round-children-heres-how-to-heal-a-wounded-economy/

  13. Gravatar of Bill Woolsey Bill Woolsey
    20. December 2013 at 04:49

    Scott:

    While everything you say is true, Market Monetarists are also well aware of how quantitative easing could have no effect. It relates to the zero nominal bound. Where most of us have problems is with arguments that make it deflationary.

    I think the answer to the puzzle is that it doesn’t contract nominal GDP, but it does contract the nominal incomes of the shadow bankers. I know you dismiss special pleading as conspiracy theory, but you don’t have to assume that the shadow bankers understand monetary theory.

    Low corn prices are contractionary. The farmers earn less money. Clearly, that means nominal income is lower. What? Base money, demand for base money, velocity? Come on. The farmers are earning less money.

    Shadow banking is fundamentally about minimizing low interest cash balances. If interest rates are low, there is little benefit to this activity. Those people who arrangement all of the split second financial transactions have less to do. They make less money. Their nominal incomes are lower.

    They come up with all sorts of rationales why their personal problem is a problem for the economy. The reporters that cover them repeat the arguments.

    But, maybe I am wrong. Maybe there is some way that shadow bankers can create more money substitutes with treasury bonds.

  14. Gravatar of Saturos Saturos
    20. December 2013 at 05:12

    J.V., are you saying that this blog is like the sequences for macro? 😉 That’s a bold claim to make!

  15. Gravatar of ssumner ssumner
    20. December 2013 at 06:32

    Saturos, Thanks for the link. A coloring books seems appropriate for MMT.

    Thanks JV. So you think the “many worlds” interpretation of QM is easy to understand?

    Bill, Yes, but it’s not really the zero bound that is the problem, it’s the temporary nature of the injections. Permanent monetary injections at the zero bound remain highly effective, unless the zero bound is expected to last forever. In that case bonds become currency, and the central bank must buy something else. But that’s not the world we live in.

    My objection to Carney is that he criticizes MM without understanding it.

  16. Gravatar of Philo Philo
    20. December 2013 at 07:12

    “I’m not Paul Krugman.” You are a clearer writer than Krugman, in part because you are trying to be clear, while he often seems to be trying to mislead, by suggesting propositions that he would not be willing to assert explicitly.

  17. Gravatar of TallDave TallDave
    20. December 2013 at 07:19

    Carney is right that I am often very hard to understand, but that’s mostly because monetary economics is almost as confusing as quantum mechanics

    Have to disagree, QM is highly testable (indeed QM is by far the best-proven of all the sciences). Ecomomics is much more confusing. 🙂

  18. Gravatar of Jake Jake
    20. December 2013 at 07:31

    Prof. Sumner,

    Thanks for the informative post. Admittedly, I am only on the outside looking in to the world of macro and monetary economics, but here are a couple of things I would point out:

    1) Your point about most people only considering the supply of money is very good. I think almost every non-MM who follows this issue — whether it’s average joe, the media, or even economists — thinks that policy has been extraordinarily expansionary, based on the trillions the Fed has injected.

    I am sure you have done posts on money demand & velocity in the past, but you may consider emphasizing them more going forward. I think people can grasp the issue much more easily if it’s framed as a supply/demand story.

    2) Here’s a question I’ve been wanting to ask for awhile. Correct me if I’m wrong, but you believe that we still have an AD shortfall in the economy, and if the Fed does its job and addresses that, we’ll see an increase in output and a faster recovery.

    But my intuition wonders, how there could be an AD shortfall when we’re still experiencing mild inflation? If inflation is occurring, that leads me to believe that the nominal economy is still growing faster than the real economy (if that makes any sense). So in what way can we expect more inflation (say 3-4%) to help?

    Thanks, and I hope everyone has a great holiday!

  19. Gravatar of John Carney John Carney
    20. December 2013 at 08:12

    Scott,

    Thanks for the reply. I wasn’t trying to make a dig at your communications skills. I was saying that you confuse me and a lot of others. Part of it is because monetary policy is a tough subject; part of it is because a lot of what you write piggy-backs on other stuff you’ve written, so it takes a lot of work to understand what you’re saying.

    For example, I have no idea what this concrete steppes joke is about. Sounds awesome but it’s completely mysterious.

    Here’s another bit that is odd:
    “Shifts in velocity are very awkward for old monetarists, but don’t matter at all for market monetarists. (Unless velocity goes to zero or infinity, which is very unlikely) We favor targeting NGDP expectations.”

    I don’t see why this doesn’t contradict your line about the need to take both supply and demand for base money into account. Maybe I’m just too thick and obsessed with finance to understand this fancy market monetarist stuff.

    More stupid questions. What’s the evidence that “base money” is the medium of account? It isn’t the medium of account that anyone I know or any business I’ve heard of. It’s not like anyone sits around and says, “Well, now that there are all these excess reserves, we’d better start building a new factory because the supply of base money has increased while demand has remained steady.”

    To put it differently, when people are thinking about the supply of dollars that may be available for future spending, why wouldn’t they also take into account savings that are in Treasury bonds, GSE backed debt? Why would they think the supply of the medium of account is restricted to currency in circulation and bank reserves?

    –John

    PS: The base money in the depression line isn’t the mistake you think it is. I’m all too aware of what Friedman and Schwartz had to say in their book.

  20. Gravatar of nickik nickik
    20. December 2013 at 09:02

    @ Jake

    To your second question, you have to think about expectation. If the NGDP was growing at 5% and now its growing at 2%, you might have a NGDP higher then befor the recession but still a AD shortfall.

    So what you trie to do, is to find some pre recession trend and return to it. Or estimate how much ajustment there allready was and set a new trend.

    Or just say ‘Fuck it’ from now on we grow 2% NGDP and then just exept that the market now has to ajust to this new trend.

  21. Gravatar of ssumner ssumner
    20. December 2013 at 09:22

    Thanks Philo.

    TallDave, I agree QM is testable, my point was that it is difficult to understand. That’s a very different assertion from testable.

    Jake, You said;

    “Your point about most people only considering the supply of money is very good. I think almost every non-MM who follows this issue “” whether it’s average joe, the media, or even economists “” thinks that policy has been extraordinarily expansionary, based on the trillions the Fed has injected.”

    That’s why it’s so odd that Carney thought I viewed the base as an indicator of monetary policy. It’s non-market monetarists who typically view the base as an indicator of monetary policy, as you say.

    Inflation is not a useful variable to consider when discussing the macroeconomy. But if you insist on looking at inflation, a AD shortfall can lead to a situation where inflation is falling but positive (which is where we are now.)

    John, “The people of the concrete steppes” is a phrase coined by Nick Rowe, which describes people who visualize monetary policy in terms of concrete steps like QE, not the management of expectations (which is far more important.)

    A medium of account is a good whose nominal price is fixed, and then all other goods are priced in terms of that good. Gold might be a medium of account, for instance. In America base money is now the unit of account, the value of a dollar can never change in nominal terms. In contrast, the nominal price of T-bonds does change, hence they cannot be viewed as “money.” Because the nominal price of the medium of account is fixed, any change in the value of the medium of account must come through changes in the macro economy. That makes the medium of account utterly unlike any other good. If you have more bonds supplied then the price of bonds might fall. If you print more currency the price of currency cannot fall. Thus the only way its value can fall is through inflation. That makes currency special. If everything was priced in apple terms, I’d be obsessed with the apple market (and old style monetarists would be obsessed with the supply of apples.) It makes no difference how small a share of GDP the base is, when it’s value changes, the price level MUST change, by definition.

  22. Gravatar of flow5 flow5
    20. December 2013 at 11:13

    Aggregate monetary demand is measured by the flow of money – not nominal-gDp.

    See: http://bit.ly/yUdRIZ

    Quantitative Easing and Money Growth:
    Potential for Higher Inflation?
    Daniel L. Thornton

  23. Gravatar of flow5 flow5
    20. December 2013 at 11:22

    Bankrupt you Bernanke confessed:

    “Like most crises, the recent episode had an identifiable trigger–in this case, the growing realization by market participants that subprime mortgages and certain other credits were seriously deficient in their underwriting and disclosures. As the economy slowed and HOUSING PRICES DECLINED, diverse financial institutions, including many of the largest and most internationally active firms, suffered credit losses that were clearly large but also hard for outsiders to assess. Pervasive uncertainty about the size and incidence of losses in turn led to sharp withdrawals of short-term funding from a wide range of institutions; these funding pressures precipitated fire sales, which contributed to sharp declines in asset prices and further losses”

    Bankrupt you Bernanke was entirely responsible for the decline in housing prices. Bankrupt you Bernanke literally drain legal reserves for 29 consecutive months (the rate-of-change in the proxy for inflation in every single month was negative, i.e., below zero), from Feb 2006 until July 2008:

    Required reserves & its 24 month rate-of-change:

    2006 jan ,,,,,,, 45496 ,,,,,,, 0.04
    ,,,,, feb ,,,,,,, 43084 ,,,,,,, 0.01
    ,,,,, mar ,,,,,,, 41242 ,,,,,,, -0.02
    ,,,,, apr ,,,,,,, 42920 ,,,,,,, -0.03
    ,,,,, may ,,,,,,, 43648 ,,,,,,, -0.02
    ,,,,, jun ,,,,,,, 43278 ,,,,,,, -0.01
    ,,,,, jul ,,,,,,, 43328 ,,,,,,, -0.03
    ,,,,, aug ,,,,,,, 41162 ,,,,,,, -0.06
    ,,,,, sep ,,,,,,, 40865 ,,,,,,, -0.08
    ,,,,, oct ,,,,,,, 40088 ,,,,,,, -0.08
    ,,,,, nov ,,,,,,, 40543 ,,,,,,, -0.06
    ,,,,, dec ,,,,,,, 41461 ,,,,,,, -0.07
    2007 jan ,,,,,,, 43113 ,,,,,,, -0.11
    ,,,,, feb ,,,,,,, 41214 ,,,,,,, -0.09
    ,,,,, mar ,,,,,,, 39159 ,,,,,,, -0.11
    ,,,,, apr ,,,,,,, 41072 ,,,,,,, -0.09
    ,,,,, may ,,,,,,, 42699 ,,,,,,, -0.05
    ,,,,, jun ,,,,,,, 42034 ,,,,,,, -0.05
    ,,,,, jul ,,,,,,, 41164 ,,,,,,, -0.08
    ,,,,, aug ,,,,,,, 39906 ,,,,,,, -0.07
    ,,,,, sep ,,,,,,, 40460 ,,,,,,, -0.07
    ,,,,, oct ,,,,,,, 40161 ,,,,,,, -0.04
    ,,,,, nov ,,,,,,, 40331 ,,,,,,, -0.04
    ,,,,, dec ,,,,,,, 41048 ,,,,,,, -0.04
    2008 jan ,,,,,,, 42398 ,,,,,,, -0.07
    ,,,,, feb ,,,,,,, 41070 ,,,,,,, -0.05
    ,,,,, mar ,,,,,,, 39731 ,,,,,,, -0.04
    ,,,,, apr ,,,,,,, 41642 ,,,,,,, -0.03
    ,,,,, may ,,,,,,, 43062 ,,,,,,, -0.01
    ,,,,, jun ,,,,,,, 41616 ,,,,,,, -0.04
    ,,,,, jul ,,,,,,, 42083 ,,,,,,, -0.03

    The short fall in the money stock was evident in Dec 2007:
    Bankrupt you Bernanke should have seen the recession coming:

    POSTED: Dec 13 2007 06:55 PM |
    10/1/2007,,,,,,,-0.47,,,,,,, -0.22 * temporary bottom
    11/1/2007,,,,,,, 0.14,,,,,,, -0.18
    12/1/2007,,,,,,, 0.44,,,,,,,-0.23
    1/1/2008,,,,,,, 0.59,,,,,,, 0.06
    2/1/2008,,,,,,, 0.45,,,,,,, 0.10
    3/1/2008,,,,,,, 0.06,,,,,,, 0.04
    4/1/2008,,,,,,, 0.04,,,,,,, 0.02
    5/1/2008,,,,,,, 0.09,,,,,,, 0.04
    6/1/2008,,,,,,, 0.20,,,,,,, 0.05
    7/1/2008,,,,,,, 0.32,,,,,,, 0.10
    8/1/2008,,,,,,, 0.15,,,,,,, 0.05
    9/1/2008,,,,,,, 0.00,,,,,,, 0.13
    10/1/2008,,,,,,, -0.20,,,,,,, 0.10 * possible recession
    11/1/2008,,,,,,, -0.10,,,,,,, 0.00 * possible recession
    12/1/2008,,,,,,, 0.10,,,,,,, -0.06 * possible recession

    Just as gDp was contracting, Bankrupt you Bernanke introduced the payment of interest on excess reserve balances (which induced dis-intermediation within the non-banks, but left the member banks unaffected – just like the 1966 S&L credit crunch). I.e., with the short-end segment of the yield curve inverted, the non-banks shrunk by 6.2 trillion dollars, which the FOMC tried to offset by expanding the commercial banking system by 3.6 trillion dollars, etc.

    And as a by product of Bernanke’s tight money policy, from March 2008 until March 2009, the dollar’s exchange rate was driven up by 24% – decimating the commodity markets (by forcing a contraction in money & safe assets in the Euro-Dollar banking system). See:Trade Weighted U.S. Dollar Index: Major Currencies

    I.e., the “administered” price level would not reflect the “asked” prices (esp. housing), was it not “validated” by monetary flows or MVt, i.e., “validated” by Bankrupt you Bernanke.

  24. Gravatar of John Carney John Carney
    20. December 2013 at 12:09

    Scott,

    I’m definitely not a concrete stepper. I actually view QE as part of the communications stragegy (for the most part). I try to explain, however, that the “concrete” effects are different than what a lot of people think. It’s a swap of reserves and deposits for Treasuries and GSE MBS.

    You’re just wrong about the medium of account. Our medium of account is not reserves, which therefore means it isn’t “base money” (defined as currency in circulation plus reserves). The medium of account is dollars. Reserves are dollar denominated accounts at the Federal Reserve. The price of reserves does change. In fact, this price is what the FOMC targets.

  25. Gravatar of anon/portly anon/portly
    20. December 2013 at 14:04

    “The price of reserves does change. In fact, this price is what the FOMC targets.”

    No, that should be “(borrowing) price” [i.e. interest rate] not “price.”

    But in case anyone thinks otherwise, my own “vault cash” is available for $1.01, in infinite supply. I can even add a handling charge if you’d like.

    Note: this doesn’t include my stash of pre-1982 pennies, which will cost you a bit more.

  26. Gravatar of jknarr jknarr
    20. December 2013 at 14:08

    John, the USD is the legal tender numeraire. Nothing else.

    http://en.wikipedia.org/wiki/Num%C3%A9raire

    The USD is the currency component of the base, and all financial assets ultimately reference deliverable currency.

    Reserves are not tradable in NGDP, but they can be demanded into NGDP at any time: go to your bank, cash in your demand deposit, and withdraw currency. The bank’s reserves then disappear.

    If the Fed similarly bought $3 trillion of dollars worth of assets from the public using physical currency, you’d likely have seen inflation, no? Almost $10,000 cash for every man, woman, and child. If the Fed needs to “buy something”, buy tax account receivables — get paid back in depreciated currency.

    Note also that the supply- and demand- of reserves is what set the interest rate price. The Fed would constantly enter the market to provide or withdraw supply to set rates, but reserves were always priced 1:1 (IOR changes this).

  27. Gravatar of anon/portly anon/portly
    20. December 2013 at 15:03

    “Sumner appears””I say ‘appears’ because, like a lot of people, I’m never quite sure what Sumner’s saying””to think that when thinking about inflation and QE, ‘base money’ provides us with the most useful metric.”

    “Carney is right that I am often very hard to understand…”

    The hard bits are hard to understand, but base money not being a useful metric for “thinking about inflation” is actually an easy bit. An impossible-to-miss bit. TMI readers have not been lightly tapped on the shoulder with this point, we’ve had our skulls bashed in with a sledgehammer.

  28. Gravatar of ssumner ssumner
    20. December 2013 at 15:37

    John, No, the price of reserves never changes, it’s always $1. It’s not even a debatable point. Reserves are basically like cash, except they now earn interest.

    The term ‘dollar’ is the unit of account (actually ‘US dollar’) but the medium of account is the asset that embodies that definition, which is cash and reserves.

  29. Gravatar of Gordon Gordon
    20. December 2013 at 17:12

    Scott,

    When you responded to John in talking about the medium of account and price of currency, because I read your blog all the time I automatically know that when you say “price” you’re talking about the nominal price. But do all economists use the term “price” to strictly mean nominal price? John’s response made me suspect the answer is no.

    And at the end when you said that if the value of the base changes then it means the price level has changed by definition, I knew you meant price as in MV=PY. But as you had just been using the term “price” to discuss the price of currency, there is the possibility that people might not realize you’re no longer referring to the price of currency when you talk about the price level changing.

  30. Gravatar of petermartin2001 petermartin2001
    20. December 2013 at 18:08

    does QE really increase the supply of money? The answer to that, of course, depends on what you consider to be money.

    Well I would consider central bank money to be an IOU of the government. I would consider a treasury bond to be an IOU of the government too.

    If we compare a $100 printed bond with a $100 paper bill we might ask how one is functionally different from the other. If the interest on the bond is negligibly small there can be none. Either could be used interchangeably as printed currency.

    In normal times the bond will have a level of interest associated with it, so its value will be a function of time. Using readily available technology, it would be straightforward to print a bar code on a bond so that its value could be read at the time of use.

    And if there is little difference between bonds and cash then it makes me wonder what all the fuss about QE is really all about. QE is no different, in principle, from swapping 10 X $10 bills for a $100 bill -or bond!

  31. Gravatar of ssumner ssumner
    21. December 2013 at 07:13

    Gordon, That’s possible, but surely when someone says the nominal price of currency is fixed, it can only mean one thing. Obviously the price level is not fixed. But I’ll try to be more careful in the future.

    Peter, I’m guessing you are new here, those issues have all be addressed. I’d suggest my short course on money in the right column.

  32. Gravatar of petermartin2001 petermartin2001
    21. December 2013 at 12:35

    Scott,

    I have indeed read your post “Pay attention to the theoretical world” where you discuss QE. But, as far as I know, no-one has claimed that I’m wrong to suggest that printed Treasury bonds wouldn’t be able to function equally well as dollar bills in the general economy.

    The best opponents of the idea that “Treasury bonds are just another form of money” can do is suggest that they wouldn’t be accepted at a local Walmart store.

    This is actually a real world, rather than a theoretical world objection. As you say ” You need the right theories.”

    You seem fond of comparing economics with Quantum mechanics. If so, you’ll be aware of the importance of the “thought experiment” in understanding QM. Schrodinger raised a lot of issues with a famous thought experiment regarding his cat. Now it didn’t really matter if the experiment involved a cat or a mouse. And there’s no need to do it for real. Just thinking about it is enough.

    So is there any reason why, in principle, the local Walmart store couldn’t accept printed Treasury bonds in exactly the same way as they accept dollar bills?

  33. Gravatar of Fed Up Fed Up
    21. December 2013 at 21:45

    John Carney, I prefer these definitions.

    From:

    http://jpkoning.blogspot.com/2012/11/discussions-of-medium-of-account-could.html

    “The definitions I’m using for medium of account, unit of account, and medium of exchange come from NME (see comment above). Here is an example:

    “A medium of exchange is an asset that is widely accepted in trade and to settle financial obligations. Currency notes or transferable bank deposits are typical examples. A medium of account is the commodity defining the unit of account. A unit of account is a specific amount of the medium of account. For example, for the gold standard the medium of account is gold, while the unit of account might be one ounce or one pound of gold of specific purity. A unit of account is the unit in which the medium of exchange and other assets are denominated and in which other values and prices are expressed.”

    Warren Coats, 1994.”

    For example and using only currency, MOA is the total amount of currency. $1 of currency is UOA. MOE also equals MOA.

    Notice the bank (demand) deposits are MOE. And with 1 to 1 convertibility, I consider them MOA also.

  34. Gravatar of Fed Up Fed Up
    21. December 2013 at 22:07

    Since demand deposits are 1 to 1 convertible to currency, I am not sure why ssumner does not include them as MOA.

    I also believe ssumner would say this scenario does not matter because the monetary base (currency plus central bank reserves) does not change.

    The capital requirement is 10% for computer loans and 100% for computers. The reserve requirement is 0%. Computers depreciate at 1% per month. Ignore interest. Start here:

    A: $2 in treasuries and $20 in computer loans
    L: $20 in DD
    E: $2

    $1 of the DD’s are saved (now not circulating in the real economy). The bank sells $1 more of bank stock (equity).

    A: $2 in treasuries and $20 in computer loans
    L: $19 in DD
    E: $3

    The bank now creates $10 in new (emphasis) DD’s to buy a new (emphasis) $10 computer loan. The $9 increase in DD’s is needed.

    A: $2 in treasuries and $30 in computer loans
    L: $29 in DD
    E: $3

    I would say (and I think you would too) that the purchasing power of the borrowers has increased by more than the purchasing power of the savers has gone down.

    I believe ssumner also says that demand deposits can’t settle a transaction.

    So these questions need to be answered. Does MOA = monetary base, or does MOA = currency plus demand deposits?

    If two entities use the same bank, can demand deposits only be used to settle the transaction?

    I say MOA = currency plus demand deposits. MOA also = MOE.

    Plus, I say demand deposits only can settle a transaction if two entities use the same bank.

  35. Gravatar of Fed Up Fed Up
    21. December 2013 at 22:09

    The 22:07 comment is intended for John Carney or anyone else.

  36. Gravatar of Fed Up Fed Up
    21. December 2013 at 22:23

    John Carney’s article said: “More importantly, Sumner begs the question: are bonds money? It’s not whether money and bonds are close substitutes but whether, when it comes to figuring out whether QE is inflationary, bonds and reserves are close substitutes and should both count as money. And with both bonds and reserves paying a bit of interest these days, and both being transactional currencies considered both safe and liquid, it seems that they are.”

    I agree with ssumner here. I don’t consider bonds “money”. If sold before maturity, there is no guarantee of 1 to 1 convertibility to demand deposits or currency.

  37. Gravatar of petermartin2001 petermartin2001
    21. December 2013 at 23:27

    @FedUp,

    I think you just need to ask yourself who wrote the IOU.Is it a government IOU? If, yes it can be considered to be part of the monetary base – central bank money. I would argue that this should include treasury bonds too.

    At least 95% of what is generally regarded as ‘money’ is actually an IOU of written by commercial banks; the creation of which is outside of direct government control. There is a strong indirect control via the setting of the level of interest rates, though, which is totally under government control.

    This leads to the concept of “endogenous money” which doesn’t fit at all well with quantity theories of money.

  38. Gravatar of petermartin2001 petermartin2001
    21. December 2013 at 23:42

    “Plus, I say demand deposits only can settle a transaction if two entities use the same bank.”

    It’s very easy if entitities use the same bank. It is just a transfer of bank IOUs from one customer to another. Otherwise, transactions are settled by the clearing process. If different banks are involved, all daily transactions can largely be settled by contra (I’ll cancel of of yours if you cancel on one of mine etc), with any remaining being settled by central bank money from the banks’ reserves.

  39. Gravatar of ssumner ssumner
    22. December 2013 at 06:44

    Peter, You said;

    “I have indeed read your post “Pay attention to the theoretical world” where you discuss QE. But, as far as I know, no-one has claimed that I’m wrong to suggest that printed Treasury bonds wouldn’t be able to function equally well as dollar bills in the general economy.”

    First of all almost all monetary economists a would disagree with you. If this were true a country could buy back its entire national debt with currency, and avoid the interest cost. Even Keynesians like Krugman don’t believe that. In addition, there is overwhelming empirical evidence that you are wrong. The only interesting question is why you are wrong–we know that OMPs are inflationary. So the two cannot be perfect substitutes.

    You asked:

    “So is there any reason why, in principle, the local Walmart store couldn’t accept printed Treasury bonds in exactly the same way as they accept dollar bills?”

    There’s no reason “in principle” they could not accept lumps of zinc, at the current market price of zinc, in payment. But they don’t.

  40. Gravatar of petermartin2001 petermartin2001
    22. December 2013 at 11:59

    Scott,

    Countries could only buy back their National Debt with currency if that currency weren’t included in the National Debt. Therefore, it does not make any sense to exclude the monetary base from National Debt. On that basis, all governments who issue their own currency are going to be in debt. If they aren’t , it means they haven’t issued anything!

    Your ‘lump of zinc’ argument is pretty lame , if you don’t mind me saying so. That would be classed as a commodity in any case. A commodity money based economy is possible but is just one step up from a barter economy.

    Governments do like to give the impression that they are financially responsible, raising their funds by borrowing on the open market , paying interest to the lenders etc. If they allowed bonds to double up as printed currency that would rather blow their cover! That’s a much better reason.

    In normal times, when interest rates are higher than now, treasury bonds can be used to set base interest rates. That’s the only real reason for issuing them.

  41. Gravatar of ssumner ssumner
    23. December 2013 at 06:43

    Peter, I’m afraid I don’t understand your comment at all. Do you or do you not believe a country could safely buy back it’s entire national debt with zero interest currency?

    You miss the point on zinc. Use of T-bonds would also be barter, as their nominal price is not fixed.

  42. Gravatar of ssumner ssumner
    23. December 2013 at 06:43

    Peter, I’m afraid I don’t understand your comment at all. Do you or do you not believe a country could safely buy back it’s entire national debt with zero interest currency?

    You miss the point on zinc. Use of T-bonds would also be barter, as their nominal price is not fixed.

  43. Gravatar of petermartin2001 petermartin2001
    23. December 2013 at 13:36

    Scott,

    Buying back your own debt with your own IOUs? That doesn’t make much sense to me. 17 x trillion dollar coins maybe? That would strike me as a nonsense based of some accounting loophole. Like someone forgot to add coinage into the equation?

    What does make sense is the idea of sectoral balances:
    Public Sector Balance + Private Domestic Balance + ROW Balance = 0

    So it would seem that matter of simple arithmetic observation that if you really want the public sector balance to be zero (zero being a minimum figure for not being in debt) you’d also need to remove all financial assets held by the US population and the Chinese and others too. Paying off the debt might not prove to be quite such as good idea as some people might imagine it to be.

    So something that varies in nominal price can’t be considered to be money? It has to be absolutely fixed. Even a variation of +/- 1 cent on a $1,000,000 bond would be enough to entirely change its status in economic theory? That’s an interesting observation.

    Or maybe it would have to be more than 1 cent? If so, where would you draw the line?

  44. Gravatar of petermartin2001 petermartin2001
    23. December 2013 at 14:11

    Sorry to labour the point but it is important to nail this bond /money misperception.

    If I were to write you an IOU for $10, payable at any time,would that be fundamentally different in nature from an IOU for $10 payable after a date 1 week hence?

    If orthodox economic theory, or your brand of monetary theory, considers there is a significant enough difference to count one but not the other as money then I would say you’ve got some serious rethinking to do on that very basic question! You have to get the basics right in any scientific study or everything else that is built on top is just a waste of time, and likely to be wrong too.

  45. Gravatar of ssumner ssumner
    23. December 2013 at 15:53

    Peter, Communicating in monetary economics is very difficult. Therefore it’s important you answer my questions so I know what you are talking about. You said:

    “Buying back your own debt with your own IOUs? That doesn’t make much sense to me.”

    I don’t care whether it makes sense to you, that is the question I would like answered. I want you to consider having countries buy back their entire public debt with currency. Crazy or not, what would be the effect? That’s what I want to know. Until you answer that question I can’t figure out what you are talking about.

    The conventional answer of course is that you get hyperinflation. But not everyone agrees. Do you?

  46. Gravatar of Jim Glass Jim Glass
    23. December 2013 at 17:00

    Buying back your own debt with your own IOUs?

    Debt is an IOU, currency is not.

    It might be more appropriate to here change the acronym to “IOS” for “I owe something”. As to have a debt or IOU outstanding the issuer must owe something. But what?

    If a government issues a bond then clearly the S is currency, it must return the currency it obtained for the bond upon the bond’s maturity and redemption.

    If a government issues fiat currency, what is the S? What does it owe for the fiat currency, when? It seems the answer is nothing, never — no more than it “owed” on gold coins it issued back in the gold standard era.

    Well, if bonds are an IOU/IOS and currency isn’t, that seems a pretty fundamental difference between them — and its buying back its debt with its currency is *not* buying it back with its own IOU.

  47. Gravatar of petermartin2001 petermartin2001
    23. December 2013 at 18:50

    Jim and Scott,

    Yes, the question of whether a currency is an IOU does seem an important one to answer, before we add hyperinflation into the mix.
    Yes – is the simple answer. All modern currencies are. They aren’t backed by gold or anything tangible. If I get a bag of sugar from you and you happen to own one of my IOUs you can use that to pay for it. When I get it back I just tear it up. I suppose I could put it aside to save me having to write out another one at some time in the future, but that’s all. So IOUs can clearly be considered money.
    Similarly if I have to pay a tax bill with government currency the government can tear them up the dollar bills or pound notes too. They often do just that – especially if they look a bit old and worn.
    The payment of tax (and other government fees) incidentally, is the one way that governments can ensure that their IOUs are in demand. Anyone who wants to drive a car has to pay taxes on the fuel and for road registration etc so there’s no getting around the fact that we all need those government IOUs!
    Anyone can write out IOUs which can be used as money. They start off life as a asset/liability pair. The issuer keeps the liability and the recipient acquires the asset. The two net to zero. The commercial banks do that all the time and what most people would consider to be money is actually an IOU of a commercial bank. If the bank is commercially sound then there’s no problem, of course, and their IOUs can be considered to be just as good as government IOUs.
    I would say the definition of monetary base should include all IOUs written by the government which would include treasury bonds and all issued currency.

  48. Gravatar of petermartin2001 petermartin2001
    23. December 2013 at 18:58

    Should be “If I GIVE you a bag of sugar” in the above.

  49. Gravatar of petermartin2001 petermartin2001
    23. December 2013 at 22:38

    PS I should have provided some reference to go along with my assertion. There are lots of others if you Google the terms ‘dollar’ and ‘IOU’

    “A dollar bill is an IOU of the Federal Reserve, and is shown as a liability on its books.”

    http://www.wfhummel.cnchost.com/fiatmoney.html

    You can also Google the phrase ‘I promise to pay the bearer on demand’ which is printed on UK pound notes. That sounds like a throwback to the days when you could swap the note for something which really was a pound so it’s always clearly been an IOU.

  50. Gravatar of ssumner ssumner
    24. December 2013 at 11:17

    Peter, OK, If you refuse to answer my simple question that’s fine. I won’t waste any more time with you.

    My hunch is that you won’t answer it because you know that your answer wouldn’t make sense.

  51. Gravatar of petermartin2001 petermartin2001
    24. December 2013 at 11:45

    Scott,

    Its not a simple question. If countries issued an amount of extra currency, equivalent to their National debt, the effect it would have would be highly dependent on what they did with it.

    In the case of the USA it would be $17 trillion. So, what would happen if the US government printed a single $17 trillion bill and kept in Fort Knox, say? Suppose they kept it a secret? Well of course nothing at all would happen.

    But what if they announced it? I still would say nothing much at all. There may be few people who would react like they did over QE and that would push up the price of gold. But that would be about it. No rational person would think the level of US debt had changed by even one cent!

    On the other hand, if the government tried to spend it, that would be highly inflationary.

  52. Gravatar of ssumner ssumner
    25. December 2013 at 05:59

    Peter, You don’t seem to understand what I asked you. I asked what happens if they print currency and then buy back the national debt. And then you tell me that it depends on what they did with the currency. But I just told you!

    BTW, The last point you make is correct. If they spent it buying back their national debt it would be inflationary, because zero interest cash is very different from positive interest bonds.

  53. Gravatar of petermartin2001 petermartin2001
    25. December 2013 at 12:33

    Scott,

    OK let us take the example of the so-called Chinese debt. Reportedly they are the biggest single holder of US National debt with a holding (according to Wikipedia) of approx $1.3 trillion. The Chinese have sold the US lots of stuff over the years. The Chinese mustn’t have had too much trouble getting paid for all the clothing , mobile phones, or whatever else that they’ve made and sent otherwise they wouldn’t be wanting to send any more.

    So, it might be an obvious point, which I’m sure you are aware of, but the USA isn’t in debt to China in the sense that the USA actually owe the Chinese money. And yet, that is what many people do mistakenly believe.

    What you term ‘zero interest’ cash has ended up at the Fed, after being put there on deposit by Chinese banks. And so the USA is in debt to China in exactly the same way as my bank is in debt to me when my pay check arrives. My bank manager doesn’t lose any sleep about that!

    Presumably the Chinese could have kept their money there as cash, just like we can keep money in our bank current accounts. Presumably they bought treasury bonds at some stage because it gave them a better deal – like a higher level of interest.

    So how is the US supposed to “buy back” this debt? Companies like Boeing would be happy to help reduce that debt by selling the Chinese lots of aeroplanes and that could have some inflationary consequences if too much money was spent too quickly. Actually supplying the Chinese with real goods and services is the only way of eliminating this debt. That is the real liability which the USA holds.

    I suppose they could force the Chinese to swap their Treasury bonds for cash. This would be just like QE and wouldn’t have much affect at all. Apart from a small variation on levels of interest payable, why would the Chinese asset balance change? The US liability balance is equal and opposite to that, and so wouldn’t change either.

  54. Gravatar of petermartin2001 petermartin2001
    25. December 2013 at 14:12

    PS To answer your previous point: Government spending (indeed any sort of spending of) money on Goods and Services will affect the price of those Goods and services. Too much will push up the price if the economy is close to full capacity.

    Government spending on buying back Treasury bonds isn’t quite the same. The Government creates new money but destroys the bonds. IF that money is spent , by the Chinese, or the banks on Goods services it could have some effect on inflation and/or it could move the economy closer to full capacity.

    At some time in the future the Government may re-create the bonds and destroy the money. Or, it may spend the money on Goods and Services. That could possibly be inflationary, and/or it could move the economy closer to full capacity.

  55. Gravatar of petermartin2001 petermartin2001
    27. December 2013 at 14:08

    Scott,

    Does your silence mean you’ve accepted what I’m saying?
    You are partially right. I don’t fully understand what you are saying about the government’s ability to “print currency and then buy back the national debt”.

    Specifically I don’t understand how the Chinese component of National debt can be ‘bought back’. OK the government prints the money but then what? Who gets it?
    And how is it possible for the debt to be shifted away from the Chinese. How is the US liability to them going to be affected in the slightest?

  56. Gravatar of Doug M Doug M
    27. December 2013 at 14:59

    Peter Martin,

    “If I were to write you an IOU for $10, payable at any time,would that be fundamentally different in nature from an IOU for $10 payable after a date 1 week hence?”

    Actually, yes, they are fundamentally different. An IOU that is redeemable at any time has more intrinsic value that an IOU that cannot be redeemed until a week from Tuesday.

  57. Gravatar of petermartin2001 petermartin2001
    27. December 2013 at 17:29

    Doug,

    Is the difference really fundamental or one of detail? And what about when the bond matures? Does it suddenly change its status, as a step function, or is it more a case of one parameter becoming zero?

    Conceptually bonds and currency are the same if we allow for three parameters.

    P,I,t

    P is the principal, I is the interest rate, t is time to maturity.

    Currency just means I=0 and therefore t is irrelevant.

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