No, strong labor markets don’t cause higher wages (never reason from a quantity change)

The first Friday of every month I listen to all the “experts” on CNBC discuss the new jobs numbers. Today they were stunned by the fact that the recent upsurge in job creation has been accompanied by a slowdown in wage growth.  We got a 252,000 figure this month, and another 50,000 from the previous two months.  When all the revisions are finally in we’ll have about 3 million payroll jobs in 2014, well ahead of 2012 and 2103.  Yet wage growth for last month was revised down from 0.4% to 0.2%, and this month came in at negative 0.2%.  The 12-month wage gain is now only 1.7%, down from roughly 2% in recent years.

It was ROFL time for me as one commentator after another expressed puzzlement at why wage growth could be slowing during a time of strong job gains.  And to be fair, I’m just teasing CNBC; their views are quite widespread, as most economists have never heard of a theory called “supply and demand.”  Instead, economists work with a theory called “the supply curve.”  Their (upward sloping) supply curve theory says that as the quantity of workers employed rises, wages go up.  I recommend the alternative “supply and demand theory.”  In my alternative theory when workers lower their wage demands (perhaps because they’ve been unemployed for a long time, or perhaps because extended unemployment insurance ended in 2014, the labor supply curve actually shifts right, and you slide down along the labor demand curve toward higher employment and lower wages.  They have causality backwards.  Jobs are rising fast because wage growth is moderating, just as the sticky wage/natural rate hypothesis predicts.

OK, enough fun and games.  Now that 2014 is in the books, what happened?  The answer is plain as day, but you’ll never even see it mentioned in a Keynesian blog like Conscience of a Liberal.  There was a strong positive supply shock in 2014, which led to faster job growth and falling wage and price inflation.  The price inflation decline may partly reflect lower commodity prices, but the slowdown in wage inflation probably reflects (in part) the end of extended unemployment compensation. (I believe that many states are planning to raise minimum wages next year; it will be interesting to see what the aggregate wage growth numbers look like in 2015.)

Early in 2014 Paul Krugman argued that the fear that extended UI had been inflating unemployment numbers was refuted by the mediocre jobs numbers.  He spoke too soon—we had a tough winter, and at that time Congress was still debating an extension.  Once it was clear the extended benefits were gone for good, and would not be paid retroactively to the long-term unemployed, the jobs figures really took off.  I predict that if Keynesians discuss 2014 at all, it will be through the lens of aggregate demand.  They’ll say demand picked up, whereas it was supply that picked up in 2014.  But Keynesians often assume the SRAS curve is fixed, and that changes in Q (real GDP) are all about demand shifts.  Recall a few years ago when they blamed the slow British RGDP growth on a lack of AD, even as inflation soared above 4%?

Economics professors often bemoan the fact that students don’t really understand S&D, they don’t get the distinction between a shift in demand and a movement along the demand curve.  My question is, “Do the professors understand their model?”

BTW, the unemployment rate is now down to 5.6%.  You might recall that for quite some time I’ve been saying that unemployment will fall faster than most people forecast, as it had been dropping at 0.1% per month for years.  We are still on that pace, and should be at “full employment” or less by the time the Fed raises rates.  Does that mean they should raise rates in mid-year? It depends on what the Fed is trying to do. What is their policy objective? I wish they’d tell us.

(For instance, the “dual mandate” implies they should aim for countercyclical inflation, but I see no evidence that they understand that fact.)


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107 Responses to “No, strong labor markets don’t cause higher wages (never reason from a quantity change)”

  1. Gravatar of roflcopter roflcopter
    9. January 2015 at 06:45

    “perhaps because they’ve been employed for a long time, or perhaps because extended unemployment insurance ended in 2014”

    – shouldn’t it be “because they’ve been UNEMPLOYED for a long time…” ?

  2. Gravatar of ssumner ssumner
    9. January 2015 at 06:51

    Thanks, I fixed it.

  3. Gravatar of Tom M Tom M
    9. January 2015 at 06:53

    Great post!

    Maybe if we had some other policy objective…maybe some kind of nominal target…? There would be less ambiguity on where the Fed will take us next.

  4. Gravatar of PaulJC PaulJC
    9. January 2015 at 07:02

    Someone remind me again why we (or the Fed, particularly) should be so worried about rising inflation when wages have fallen and market inflation expectations are in the doldrums? I find myself in terrible need to refill my quota of inflation-phobia.

  5. Gravatar of collin collin
    9. January 2015 at 07:27

    I have always looked at The Great Recession as a Slow Motion Recovery similar to the S&L bust in early 1990s. And this time:

    1) Has labor supply really gone up in the US? Or is the gap of skilled labor cost of ChIndia relative to the young skilled labor in the US getting smaller? I do work in an office environment in which some of the outsourced office grunt work to India in 2004 – 2007 is coming on-shore to the US today. We hiring a fair amount of young people to take this work away from India. (Also I believe a lot of this is the “farm system of skilled” disappeared and we have to buy more expensive talent that our business does not like.)

    2) We are not seeing a jump in labor participation (against labor supply) here and productivity has had only small gains. This fits the Mandel theory that a lot of productivity gains in the early 2000s was just cheaper outsource labor making our productivity gains look higher. (Productivity is a fairly basic economic equation.)

    3) If the issue is relative wages to ChIndia versus jumps in labor supply, would that making tightening earlier more important. I agree with Matt Yglesias point that the only reason real wages are going up is the effect of lower oil prices.

    4) Long term, it appears the young generation has accepted lower long term expectations and wages. However, this is going to have the effect of putting off family formation. Now that Europe is going down the whole 1990s Japanese road, is this further evidence the developed world Baby Bust has a strong deflationary impact on the economy. (Again, I focus on the high point of the 30 – 50 age group.)

    5) I wondering if we have a slow down in Q1 2015 numbers, as the oil boom has disappeared. While the cheaper oil prices has a net long term positive in the US, the slowdown of oil could lower numbers in Q1. Wall Street is starting to react negatively to good job reports and any further lower oil prices.

  6. Gravatar of Ragout Ragout
    9. January 2015 at 07:53

    Just because the economists on CNBC are clueless doesn’t mean that Keynesians like Krugman are clueless. Keynesians have been saying for many decades that, because wages are sticky downwards, high unemployment (or low aggregate demand, if you prefer) doesn’t do much to cut wages. Similarly, lower unemployment doesn’t raise wages much, until unemployment falls below a certain level.

    In contrast, to Keynesians’ correct predictions, made well in advance, Mr. Money Illusion tells us, in hindsight, that labor supply responds to changes in policy only with a lag. The lag, it seems, is due to the fact that the long-term unemployed have enough savings to sit at home for months, hoping that Congress will restore unemployment benefits. How long is this lag? It seems that the lag is exactly long enough to “prove” the Great Vacation theory of the recession.

  7. Gravatar of Philo Philo
    9. January 2015 at 08:04

    “What is [the Fed’s] policy objective? I wish they’d tell us.” It’s incredible that for all Yellen’s talk about clear communication–continuing Bernanke’s similar talk, which repudiated Greenspan’s delight in intentional obfuscation–she seems not to understand the need to do this. (Granted, she’d have to get the other Fed governors to go along.)

  8. Gravatar of Ray Lopez Ray Lopez
    9. January 2015 at 08:12

    I find Colin’s explanation much more compelling than Sumner’s. I also find it odd that Sumner says: “Jobs are rising fast because wage growth is moderating, just as the sticky wage/natural rate hypothesis predicts.” –“just as’? What? There’s nothing in Sumner’s post about ‘sticky wages or natural rate hypothesis’, except maybe a unproven comment about unemployment benefits running out, and thus workers having to find work again (and this is by Sumner’s reasoning equivocal, “perhaps because…”, mentioned twice). If this drop in wages is the result of shifting Supply and Demand curves, which seems plausible, it’s also a refutation of ‘sticky wages’ which in the extreme form says wages never drop.

  9. Gravatar of foosion foosion
    9. January 2015 at 08:26

    There’s a Fed research paper to the effect that because wages are sticky downward, there’s a lot of pent-up demand to cut wages (that is, employers would have cut wages but for stickiness). Until that pent-up demand is satisfied, wages won’t rise.

  10. Gravatar of ssumner ssumner
    9. January 2015 at 08:27

    Collin, The wage numbers suggest at least some increase in labor supply.

    Ragout, You said:

    “It seems that the lag is exactly long enough to “prove” the Great Vacation theory of the recession.”

    You must be new here, I have often mocked the “Great Vacation” theory of the recession.

    And I am confused about what your first paragraph has to do with my post.

    Philo, That’s the problem, they don’t agree on a common objective.

    Ray, You said:

    “it’s also a refutation of ‘sticky wages’ which in the extreme form says wages never drop.”

    And just when I think you can’t possibly top yourself!!

  11. Gravatar of ssumner ssumner
    9. January 2015 at 08:27

    Foosion, That’s part of it, but ending the extended UI benefits is also a factor.

  12. Gravatar of bill woolsey bill woolsey
    9. January 2015 at 08:34

    I don’t think the standard new Keynesian model can easily add your labor supply and demand model.

    If potential output is below real output, and potential output rises, then the new Keynesian quasi-Phillips curve results in a lower output gap and a more modest decrease in inflation.

    The expectation of a more modest decrease in inflation implies a smaller increase in the real interest rate which results in more real output, and presumably employment, than otherwise.

    Of course, slower wage growth that results in a closing of the gap between the also growing equilibrium wage wouldn’t count as more rapid growth in potential output.

    The slow down in wage growth could count has a factor leading to a negative price level shock. If unexpected, it has no effect on real output or employment. If expected, it raises the real interest rate real interest rate and should depress aggregate demand and real output.

    Or so I think.

  13. Gravatar of Rodrigo Rodrigo
    9. January 2015 at 08:44

    Professor, could the falling long term interest rates and flattening of the yield curve actually suggest the market is pricing in a rate increase sooner than appropriate? Which in turn would lead to lower interest rates in the future? Given that a rate increase would probably lead to an inverted yield curve. Contrary to some “experts” view that a rate increase will actually cause longer term interest rates to move up as well. (Which I doubt you believe)

    Thoughts?

  14. Gravatar of Ray Lopez Ray Lopez
    9. January 2015 at 08:49

    @bill woolsey – good analysis, except for the part about “potential output”, which is voodoo economics. There’s no such thing, unless you feel drawing a trend line is scientific (aka known as ‘chartism’ in stock market price prediction, and about as scientific as reading tea leaves).

  15. Gravatar of foosion foosion
    9. January 2015 at 08:53

    See http://research.stlouisfed.org/fred2/graph/fredgraph.png?g=WAF for the spread between 10 and 1 year treasuries (proxy for the slope of yield curve) over the past five years.

  16. Gravatar of Nick Nick
    9. January 2015 at 08:54

    Ray,
    8 people are employed @ $2 / hour, while 2 are unemployed.
    8 people are employed @ $2 / hour, 1 is employed @ $1 / hour, and 1 is unemployed.
    Average wages drop, but no wages actually paid have dropped. Sticky wages remains fully intact.

  17. Gravatar of collin collin
    9. January 2015 at 09:06

    While I agree the ending of long unemployment has had an impact but the labor participation is still decreasing. That does not sound like a labor supply shock to me. Maybe it is the the current group of young potentially skilled labor have accepted lower wages and this is increasing hiring. Call it generational sticky nominal wages. (FYI I graduated college in 1992 in the middle of that slow recovery. I worked at a variety of jobs I was over-skilled for the next five years before setting on a career and family. So I lived a less exaggerated form of Friends.)

  18. Gravatar of Steve Steve
    9. January 2015 at 09:20

    “I believe that many states are planning to raise minimum wages next year; it will be interesting to see what the aggregate wage growth numbers look like in 2015.”

    If the minimum wage gets to $15, I’m going to retire, and supplement my income by working 20 hours per week in the grocery store. That will be enough to qualify for almost free Obamacare, and, combined with significant retirement savings, I will live like a king!

  19. Gravatar of ssumner ssumner
    9. January 2015 at 09:28

    Bill, Thanks. I don’t look at things that way, but I’ll take your word for it that this describes the NK model.

    Rodrigo, Yes, that’s possible. I also think that global forces are reducing real rates in the US.

    Collin, That data is misleading for two reasons:

    1. It’s partly due to boomers like me getting older.

    2. Part of the group that were once counted as “unemployed” were not actually in the labor force. With extended UI ending, they are back in the labor force.

  20. Gravatar of foosion foosion
    9. January 2015 at 09:55

    Scott, “I also think that global forces are reducing real rates in the US.”

    Reportedly (Hilsenrath) that’s the Fed issue of the day. Believe the obvious message from rates and TIPS spreads or believe that foreign investment is distorting things.

    Do you have a view?

  21. Gravatar of TravisV TravisV
    9. January 2015 at 10:18

    Great stuff! Here’s the way I think of it:

    If you have slack in the labor market and 3% nominal GDP growth, then wages will grow slower than other prices. For businesses, that means revenues (more tied to other prices) are growing faster than expenses (tied to wages). Since firms expect higher margins (revenues minus expenses), they hire more people in order to expand production.

    What minimal rate of NGDP growth is needed to keep this process going? I’m not sure…..

  22. Gravatar of Doug M Doug M
    9. January 2015 at 10:21

    What is the Fed’s policy objective? I wish they’d tell us….

    They have told us… they have been very clear… it is “data dependent.” Which is Fed for, we are making it up as we go along.
    We will continue the current policy until we feel the desire to change.

  23. Gravatar of Doug M Doug M
    9. January 2015 at 10:28

    Economics professors often bemoan the fact that students don’t really understand S&D, they don’t get the distinction between a shift in demand and a movement along the demand curve. My question is, “Do the professors understand their model?”

    !!!

    Our professor argues that labor supply is increasing faster than labor demand. A leftward shift in the supply curve, leading to a lower price of labor (wages) and a higher quantity of labor (jobs).

    Wouldn’t that suggest then that there should also be an increase in people looking but not necessarily finding work? If the professor’s argument is correct, shouldn’t the unemployment rate be slightly increasing even with job creation?

  24. Gravatar of foosion foosion
    9. January 2015 at 10:46

    @Doug. The Fed said its actions are data dependent. The Fed did not say its policy objectives are data dependent.

  25. Gravatar of Ray Lopez Ray Lopez
    9. January 2015 at 11:02

    @Nick–look at Collin’s answer, compare to yours and Sumner’s (who adopts your position). I see your point, but Collin’s scenario could also be true (no sticky wages, youth taking pay cuts just to get a job). Seems like the sticky wage types are simply assuming a can opener. Everybody has their priors, but some of us are aware of them.

  26. Gravatar of Nick Nick
    9. January 2015 at 11:24

    Ray,
    college grads accepting lower nominal wages than people of similar education would have accepted a few years ago also does not speak to wage stickiness. Not that there is much evidence of that. But you are just subbing in a different group that did not have a previously set wage to be rigid about…

  27. Gravatar of Jeff Jeff
    9. January 2015 at 12:13

    Scott,

    James Taranto at the Wall Street Journal would file this under: “Fox Butterfield, is that you?”

  28. Gravatar of The viscera of the labor market | Historinhas The viscera of the labor market | Historinhas
    9. January 2015 at 12:25

    […] On the “wage worry” see Scott Sumner´s post. […]

  29. Gravatar of Jeff Jeff
    9. January 2015 at 12:26

    I know there’s a positive supply shock around here somewhere. I’ll go looking for it as soon as I get back from the filling station….

  30. Gravatar of Tommy Dorsett Tommy Dorsett
    9. January 2015 at 12:29

    Scott — here’s what I’m struggling with. There’s not much evidence of a bump in labor supply from the labor force numbers which fell 273k in December with the m/m wage decline. Prime age participation was flat in December at 80.8%, the same level seen in December 2013. I’m sure there’s *some* positive supply side effect with the expiry of the extended jobless benefits, but it’s hard to see in the data. Year to year trends in wages are consistent with ongoing labor slack. So maybe it’s simply that the wage/NGDP ratio hasn’t fallen enough yet…

  31. Gravatar of TravisV TravisV
    9. January 2015 at 12:30

    The problem with this new QE proposal for purchases of up to 500 billion Euros is that it doesn’t specify a target and it isn’t open-ended.

    http://www.bloomberg.com/news/print/2015-01-09/ecb-said-to-study-bond-purchase-models-up-to-500-billion-euros.html

  32. Gravatar of ssumner ssumner
    9. January 2015 at 12:58

    foosion, My view is that the Fed should stop obsessing over those small details and set a clear target. The day to day data will always be ambiguous.

    Doug, The S&D model has no predictions about the unemployment rate, which is a disequilibrium phenomenon.

    Ray, You really ought to learn what economists mean by sticky wages before you say anything more on the subject.

    Jeff, Good one.

    Tommy, The month to month household survey numbers are very noisy, better to focus on the payroll numbers. For 2014 as a whole they look exactly like they’d look if ending extended UI increased labor supply.

    TravisV, The ECB is so behind the curve it’s ridiculous. Just pathetic.

  33. Gravatar of foosion foosion
    9. January 2015 at 13:02

    Never reason from a single 0.2% movement in a statistic likely to be revised.

  34. Gravatar of Jim Glass Jim Glass
    9. January 2015 at 13:54

    “Why Is Wage Growth So Slow?”, asks the SF Fed.

    http://www.frbsf.org/economic-research/publications/economic-letter/2015/january/unemployment-wages-labor-market-recession/el2015-01.pdf

    (Spoiler: Sticky wages leading to ‘pent up wage cuts’ that have to be worked through, with industry-by-industry data showing the result.)

  35. Gravatar of E. Harding E. Harding
    9. January 2015 at 14:15

    The real wage increases we have today are not just oil: judging by AHETPI deflated by CPI less food and energy, they’ve been going on since December 2012 and are at a much slower rate than their growth in the late 1990s and late 2000s.

  36. Gravatar of foosion foosion
    9. January 2015 at 14:26

    @Jim – see my brief summary of that Fed report and Scott’s reply earlier today

  37. Gravatar of benjamin cole benjamin cole
    9. January 2015 at 14:42

    Excellent blogging. Keep in mind that unit labor costs have been falling the last six months. (Two quarterly readings). Seems assured the next quarterly reading will be down too.
    If so, then unit labor costs will have deflated from 2008—seven years of deflation in unit labor costs.
    Meanwhile they are still jibber-jabbering about inflation at the Fed.

  38. Gravatar of Major.Freedom Major.Freedom
    9. January 2015 at 14:53

    Benjamin Cole:

    Seriously, are prices the ONLY conceivable thing that you can imagine there being a concern with inflation?

    Even flat price trends could mean too much inflation, if prices would naturally otherwise fall due to increases in productivity.

    The main problem of inflation is one, that it is based on aggression, and two, it distorts economic calculation and misleads investors into starting physically unsustainable projects.

    Price levels are a sideshow to what is important.

  39. Gravatar of Major.Freedom Major.Freedom
    9. January 2015 at 14:56

    Sumner:

    “My view is that the Fed should stop obsessing over those small details and set a clear target.”

    No, your view would be for the Fed to set a clear target of NGDPLT.

    For if the Fed set a clear price level target, you’d say that is the wrong thing to do, because it would mean NGDP can fall if output falls, and falling NGDP is a big no no. Remember, you’re the NGDP guy.

  40. Gravatar of Jeff Jeff
    9. January 2015 at 16:50

    Major Freedom,

    I know it is a mistake to engage you, but I do wish you would understand something: There is no such thing as a natural price level. You say that even a flat price level is too much inflation if productivity increases would otherwise mean falling prices (which everyone but you refers to as deflation). But that assumes that something, somewhere is determining the overall level of prices, also known as the inverse of the value of money.

    In a gold standard world, the ultimate determinant of the price level is the supply and demand for gold. Gold is the numeraire, the unit of account, and as such, its nominal price is fixed. The only way the price of gold can adjust to accommodate shifts in either the supply or demand curves for gold is for the overall price level to change, and that is likely to create a lot of unnecessary economic disruption. But what you must understand is that in a monetary economy, something has to serve as the unit of account, and whatever that thing is, its nominal price is fixed. There is no way to keep money demand from shifting unpredictably, so what is needed is a way to insure that money supply shifts in the same direction and by the right amount when that happens. That’s what monetary policy is really all about, and it’s why Scott and I want it based on some objective measure of the demand for money. We both think that expected nominal GDP would work pretty well as that measure, but we also both think a good measure of the expected overall price level would also work, although not as well. But it would be better than what the Fed has been doing since its creation.

    Why is this so difficult for you to understand?

  41. Gravatar of CA CA
    9. January 2015 at 17:46

    Jeff wins. God bless you Jeff.

  42. Gravatar of Major.Freedom Major.Freedom
    9. January 2015 at 19:20

    Jeff:

    Everything you said I understand quite well, and I dare say I understand it more than you because I know it is incorrect while you believe it is correct.

    There is in fact such a thing as a natural price level. The natural price level is the price level that would prevail without non-market activities, that is, in an unhampered market, which requires at minimum a free market in money. In an unhampered market, productivity increases leads to falling prices ceteris paribus.

    The above is a minor point that is not something I want to pretend is in the main set of points.

    I read your comment quite closely. The fact that you concluded it with a rhetorical question of why I cannot understand it, tells me that you are unable to distinguish between understanding and acceptance when it comes to what you personally believe in. I fully understand what you said, but I do not accept it because it is wrong.

    You wrote:

    “But that assumes that something, somewhere is determining the overall level of prices, also known as the inverse of the value of money.”

    No, it does not assume that at all. You are just shoehorning in your (false) theory of markets, and then interpreting what I wrote through that lens as well, and then you saw that it doesn’t make sense in your theoretical language.

    The fundamental problem with what you are assuming throughout your comment, and I imagine most of how you think about markets, is a dependence on a radical monetary monism. You try to explain phenomena that includes both money and real goods and services, from the perspective of an abstract world where all decisions are made from the basis of money, from the valuation of money, and from decisions to accept or offer money. Thus you cannot help but interpret the price level as “inverse value of money”.

    In fact, price levels are an abstract concept that result from the valuations of both money AND goods and services. Price levels can and do change if money is held as fixed, and productivity (supply rises or falls). It is not correct to intepret the price level changes as only changes in the value of money. No, the value of both money and real goods and services are changing. From the side of goods, money is increasing in value, and from the side of money, real goods are decreasing in value. But it is not the case that either real goods or money are rising in value or falling in value as such.

    Value is not, contrary to your belief, a concept that is monopolized by money. Individuals value money and they value goods. When two people have different valuations about the value of a sum of money and a good, and that difference is offsetting, in that one person values the good more than the money, while the other person values the money more than the good, then an exchange is possible.

    Money does not measure value. Money is itself valued (as well as goods).

    What I have quoted of you thus far is I would say only wrong, but what I will quote next from you is egregiously wrong.

    “In a gold standard world, the ultimate determinant of the price level is the supply and demand for gold. Gold is the numeraire, the unit of account, and as such, its nominal price is fixed. The only way the price of gold can adjust to accommodate shifts in either the supply or demand curves for gold is for the overall price level to change, and that is likely to create a lot of unnecessary economic disruption.”

    First, and this is a minor point, I do not advocate for any government imposed money, paper or gold. I advocate for a free market in money. If the issue you describe above is in fact an issue that certain individuals care about, then THOSE individuals will be free to develop and use a money whose supply can be more “flexible” to adjust for market changes, and other individuals who do not consider falling prices based on rising productivity a problem, will not be forced into using a money that is not optimal for their purposes.

    There is a reason why government paper money requires coercion while gold and silver were accepted voluntarily. It is because the issue you describe is not a universal problem for everyone.

    You talk about “economic disruption”. That is a value judgment that you have no knowledge or authority as being true for me or anyone else who would not accept paper in a free market.

    I do not define economic disruption as me losing my job because people started to voluntarily on their own free will value money in the present more than what I offer for sale in the present, unexpectedly from my perspective, such that they spend less on my goods.

    There is a very good reason why I should lose my job if that is the decision made. You are arbitrarily assuming that monetary losses incurres because of people’s peaceful choices, has no good reason to allow happen. You have never bothered to closely scrutinize the causes for it, nor the effects of it, in any detail. To you the economy is a machine that should superficially increase in size, regardless of the inner structure.

    You are playing on my emotions and telling me that economic losses are ipso facto sufficient as an intellectual reason to support initiating force and coercion, which is hardships of its own, against innocent people so those who would otherwise incur losses doing what they are presently doing, continue to work in growing that machine for its own sake.

    There is no good reason why I should support what you are telling me to support. You have your fears and your hatred towards free association, and I am supposed to merely believe in it. Even if your ideology is depraved, I am supposed to support it anyway.

    If the solution to anyone losing their job due to changes in customer’s temporal valuations of money and goods such that they want fewer goods now and more money now, is “government intervention”, then logic dictates that other voluntary actions that result in people losing their jobs must be stopped effectively at gunpoint.

    More important than this however is that your supposed solution isn’t even a solution to the issue you perceive! The solution is more freedom, at minimum. Then, once people are free to implement solutions that do not create new victims, then and only then are solutions for “human” problems found. Your solution of monetary socialism makes it more difficult for people to solve the problems of changing market conditions.

    The worst economic periods on record, in peacetime, by most metrics most universally considered as indicators of economic well being, have taken place with central banks. The record is clear, and yet in your faith based ideology, you believe the next denomination, NGDPLT, will finally, finally work. I do not share your faith. You are as blinded as the “stabilize prices” idealists.

    “But what you must understand is that in a monetary economy, something has to serve as the unit of account, and whatever that thing is, its nominal price is fixed.”

    No, that is false. You are just not willing to think outside the government paper mental box. Yes, if government paper is the money in daily exchanges for goods and labor, but it is redeemable at some fixed rate to a certain quantity of a commodity, then it would be correct to say that the “nominal price” (redundant?) of that commodity is “fixed.”. But it would only be “fixed” the same way a yard or mile or light year is fixed, or better, the same way an ounce or pound are fixed units of weight.

    “There is no way to keep money demand from shifting unpredictably, so what is needed is a way to insure that money supply shifts in the same direction and by the right amount when that happens.”

    No, you don’t know, and I don’t know, and nobody else knows, what “the right amount” of anything should be absent a market in that thing. The only way anyone can know what the right amount of money should be, is through the market process.

    It is how you know what the right amount of anything else should be. It is silly to believe economic laws don’t apply to money as well.

    The mere fact that there is uncertainty in the world is not justification to point guns at people forcing them to be obedient to government paper as money.

    If you can’t handle living in an unpredictable world, then you are free to leave it. Alone.

    Allow the rest of us who are not chicken shits to choose our own money in peace.

    “That’s what monetary policy is really all about”

    Hahaha, no it isn’t. You are so naive! Monetary policy is about special interest groups using government power to aggrandize themselves at other people’s expense.

    Does it make any sense to believe that because millions of slaves who used to work all day everyday for their masters might, upon achieving freedom, be temporarily unemployed, and total output might temporarily fall, that they should be prevented from having freedom?

    The same principle, which is not a comparison of content, but a logical point, is true for government paper money. The fact that freedom after years of degrees of oppression might be immediately followed by reductions in labor hours or output, is not sufficient to establish the belief that force must be applied to prevent the emancipation.

    “and it’s why Scott and I want it based on some objective measure of the demand for money. We both think that expected nominal GDP would work pretty well as that measure, but we also both think a good measure of the expected overall price level would also work, although not as well. But it would be better than what the Fed has been doing since its creation.”

    I do not share your fears or your faith. I have integrity and courage. I do not wish to initiate aggression against you, either personally or by any hired goon. You are not able to give me the same courtesy because deep down you are afraid. I am not afraid of anything, even my own death in the next minute. I do not understand how in the hell you can ever pretend to believe that you have thoughts that I must accept, and if I don’t then there is somehow something wrong with me instead of you. You and Sumner are in the wrong. You have been in the wrong the whole time. Your thoughts, if put into action, are aggressions against me. You are personally too afraid to bring about what you want against me yourself, and so you rely on psychopaths to do your dirty work. You and Sumner are just modern day witch-doctors who encourage and encite brainless thugs to force people to bring about the world you envision from your nightmares.

  43. Gravatar of Jeff Jeff
    9. January 2015 at 20:10

    Wow. Just wow.

  44. Gravatar of Kevin Erdmann Kevin Erdmann
    9. January 2015 at 23:50

    Keep in mind that for 5 months, there has been no core inflation – 0 – except for shelter inflation, which is a supply shock from the complete standstill we have had in mortgage credit. I would argue that, accounting for that, wage growth is quite strong.

  45. Gravatar of TallDave TallDave
    10. January 2015 at 00:40

    Yeah, the great misconception has always been that minimum wages increase worker earnings. They increase the average earnings of workers, but only for the same reason sending away the bottom 20% of students increases the performance of a school: they remove certain jobs from the pool of labor positions.

    Granted, there’s some limited utility in that concept. I’d really like to see someone try Warstler’s idea, though. Incentives matter!

  46. Gravatar of Daniel Daniel
    10. January 2015 at 01:37

    In unrelated news

    Noah Smith can be a total idiot when he picks a side in the culture wars, but he can also be brilliant when talking about other things

    http://noahpinionblog.blogspot.ro/2015/01/sci-jacking.html

  47. Gravatar of James in London James in London
    10. January 2015 at 02:27

    The goal of the Fed is to “normalise monetary policy”. They’ve stated that objective many, many times. :-)

    They still fundamentally believe that monetary policy is ineffective at the ZLB, just like mainstream macro theorises. They prefer not look at the world as it is, otherwise they would have to rethink their priors, and maybe take some responsibility for the 2008/9 collapse. It’s a huge step to admit you were wrong, big-time.

  48. Gravatar of Anon Anon
    10. January 2015 at 02:33

    Major.Freedom, stop writing these wall-of-text with no content. You’re expending real labor with no payoff at all.

    Prices are nothing more than the ratio’s at which one good is exchanged for another. A friction-less market for N goods (which may include currency) only has (N-1) prices. Markets with government currencies get a lot closer to this than the “natural” state with N, or even 2*N prices.

  49. Gravatar of Ray Lopez Ray Lopez
    10. January 2015 at 03:56

    @MF – that was a good diatribe. Indeed Sumner and his cohorts advocate a “plan” that’s speculative at best and sheer folly at worse. Think of all the “plans” in history that failed disastrously.

    Sumner and his minions are like the Pied Piper of Hamelin: http://en.wikipedia.org/wiki/Pied_Piper_of_Hamelin

    Note the Piper’s characteristics (all found in this blog):

    1. a charismatic person who attracts followers
    2. one that offers strong but delusive enticement
    3. a leader who makes irresponsible promises

  50. Gravatar of Carl Carl
    10. January 2015 at 07:02

    MF
    As a great believer in free markets as a means of discovering the value of things, I’m sure you will appreciate my suggestion that Scott switch to a blog format that allows people to down vote and up vote comments. Or maybe I can ask you to set up your own blog, reference it here in your comments, and see how much traffic you generate as a way to market test your ideas. As it stands, you spend your time in Scott’s idea store, to which all of us regularly and freely go, and proclaim the superiority of what you are selling at your non existent store. Not only that, you call all of us shoppers, whom you are presumably trying to attract over to your non existent store, mindless thugs.

  51. Gravatar of Jobs Numbers Are Rising Because Wages Aren’t – Forbes | Everyday News Update Jobs Numbers Are Rising Because Wages Aren’t – Forbes | Everyday News Update
    10. January 2015 at 07:16

    […] We’d probably find Scott Sumner in that second camp judging by this: […]

  52. Gravatar of Jobs Numbers Are Rising Because Wages Aren't * The New World Jobs Numbers Are Rising Because Wages Aren't * The New World
    10. January 2015 at 07:41

    […] We’d probably find Scott Sumner in that second camp judging by this: […]

  53. Gravatar of ssumner ssumner
    10. January 2015 at 07:43

    foosion, Exactly.

    James, You said:

    “They still fundamentally believe that monetary policy is ineffective at the ZLB, just like mainstream macro theorises.”

    Bernanke always strongly denied that monetary policy was ineffective at the zero bound. And mainstream macro never bought into the liquidity trap idea, at least until 2008-09. Prior to 2008 Keynesians were embarrassed by the idea, and kept insisting that even Keynes never really believed it happened, even at the zero bound in the Great Depression. Why did things change after 2008?

    Ray, You said:

    “a charismatic person who attracts followers”

    I’m charismatic?

  54. Gravatar of David R. Henderson David R. Henderson
    10. January 2015 at 07:54

    Scott,
    “I’m charismatic?”
    Do what I do: take the compliments wherever they come from and whatever the intent of the person complimenting.

  55. Gravatar of Jobs Numbers Are Rising Because Wages Aren’t – Forbes | GreatNewsUpdate Jobs Numbers Are Rising Because Wages Aren’t – Forbes | GreatNewsUpdate
    10. January 2015 at 08:15

    […] We’d probably find Scott Sumner in that second camp judging by this: […]

  56. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    10. January 2015 at 08:34

    That SF Fed Economic Letter that Jim Glass linked to above, is a very useful (succinct) explanation of the relationship between wage flexibility and unemployment.

    ‘This Economic Letter examines whether the effects of wage rigidities over the recent recession and recovery can also be seen across industries. In particular, we consider whether industries with higher or lower degrees of wage flexibility have seen different evolutions of wage growth and unemployment. Our findings suggest that industries with
    the most downwardly rigid wage structures before the recession have seen the slowest wage growth during the recovery, conditional on changes in unemployment. In contrast, industries with fairly flexible wage structures have seen unemployment and wage growth move more closely together. These findings provide cross-industry evidence that downward nominal wage rigidities have played an important role in the mode st recovery of wages in recent years.’

    Which seems to be even more nails in the coffin of the minimum-wage-increases-don’t-hurt-employment argument.

  57. Gravatar of Jim S. Jim S.
    10. January 2015 at 08:36

    Frances Coppola has an aggressive argument against the monetary view on the power of central banks at http://coppolacomment.blogspot.co.uk/. I would be interested in Prof. Sumner’s response to her post.

  58. Gravatar of Carl Carl
    10. January 2015 at 09:17

    Patrick
    I agree. I’m puzzled by people who believe in sticky wages yet argue for increasing the minimum wage.

  59. Gravatar of James in London James in London
    10. January 2015 at 09:21

    Scott.
    Point taken. It seems as if “The Fed” turns you into something else once you are inside it, as MM Ben says. Bernanke became captured by “it”?

  60. Gravatar of Edward Edward
    10. January 2015 at 12:08

    I’m sorry scott, I’m going to have to disagree with you on this one.
    The definition of a STRONG labor market is one where workers are scarce, hence their wages climb rapidly. Which means increases in the RATE of wage growth, not just mild positive wage growth . When
    Wage growth and inflation are mild even when the natural rate is reached, it means the nairu estimate is wrong. As it was drying the nineties.

    None of this means that wages didn’t need to fall in order to heal from the recession. But healing from the recession and having a strong labor market are two different things.

  61. Gravatar of TallDave TallDave
    10. January 2015 at 12:20

    Good comment Jeff.

  62. Gravatar of ssumner ssumner
    10. January 2015 at 13:38

    David, That comment should have been directed at you. :)

    Patrick, Good find.

    Thanks Jim.

    James, Bernanke continued to insist the Fed was never out of ammo even after becoming Fed chair.

    Edward, You are entitled to define “STRONG” anyway you like, but that doesn’t really affect this post. I was responding to claims that there was something strange about fast job growth and slowing wage gains. There isn’t. It depends on whether the fast jobs gains are produced by more labor supply or more labor demand.

  63. Gravatar of ThomasH ThomasH
    10. January 2015 at 19:01

    What is surprising is that anyone would think that the anemic recovery in demand we’ve seen would be enough to raise wages. Labor saving technology is presumably still chugging away at 2-3% pa. Of course the real surprise, which Scott finally gets around to in the last paragraph, is that the Fed should have phased out QE and be thinking about raising interest rates before even the pre-crisis price level trend has been re-established, not to mention the pre-crisis NGDPL.

  64. Gravatar of Jobs Numbers Are Rising Because Wages Aren't -RocketNews Jobs Numbers Are Rising Because Wages Aren't -RocketNews
    10. January 2015 at 21:38

    […] We’d probably find Scott Sumner in that second camp judging by this: […]

  65. Gravatar of TallDave TallDave
    10. January 2015 at 22:47

    Jim S.

    I’m aghast. Coppola is insane. She argues we can just force the banks to lend to the government by threatening to shut them down. That is… wow.

  66. Gravatar of Jobs Numbers Are Rising Because Wages Aren’t | The Washington Observer Jobs Numbers Are Rising Because Wages Aren’t | The Washington Observer
    11. January 2015 at 01:19

    […] We’d substantially find Scott Sumner in that second stay judging by this: […]

  67. Gravatar of Jeff Jeff
    11. January 2015 at 03:31

    Jim,

    We are already forcing banks to lend to the government. What do you think all those excess reserves are? Individual banks can get rid of their own excess reserves, but the banking system as a whole cannot. Only open market purchases by the Fed actually extinguish reserves.

  68. Gravatar of Jeff Jeff
    11. January 2015 at 03:32

    Actually, that last comment should have been directed to TallDave, not Jim S.

  69. Gravatar of Philippe Philippe
    11. January 2015 at 07:11

    “Individual banks can get rid of their own excess reserves, but the banking system as a whole cannot”

    Banks are actually borrowing those excess reserves from their depositors. If they wanted to, the banks could get their depositors to withdraw them all in the form of cash. But they don’t want to. Banks aren’t forced to hold those reserves.

  70. Gravatar of ssumner ssumner
    11. January 2015 at 09:19

    Jeff, I wouldn’t say we are “forcing them”, they are being offered above market IOR.

  71. Gravatar of Major.Freedom Major.Freedom
    11. January 2015 at 11:43

    Anon:

    “Major.Freedom, stop writing these wall-of-text with no content. You’re expending real labor with no payoff at all.”

    Anon, you ought not tell me what to do. The payoff from my writing is positive to me, or else I would not write it. I don’t care if the payoff is negative to you. You make your own decisions, and I will make mine. What I wrote shows the errors in what Jeff wrote prior. If you value better ideas over worse ideas, then you would consider what I wrote as a positive payoff.

    “Prices are nothing more than the ratio’s at which one good is exchanged for another.

    That is exactly what I wrote in that last post. Almost verbatim. But you just knew in your gut that what I wrote is false, because it was from me, right?

    “A friction-less market for N goods (which may include currency) only has (N-1) prices.”

    Actually no. If there are N goods, then there are “N choose 2” possible unique pairs, where order does not matter and no repetitions. To find how many unique unordered pairs are possible in a set N, you calculate:

    N!/[(k!)(n-k)!], where k=2.

    “Markets with government currencies get a lot closer to this than the “natural” state with N, or even 2*N prices.”

    So what? Are you therefore advocating a single world currency to “get closer” to some arbitrary mathematical sum?

    Where are the individual valuations in your analysis? Are real world humans to be coerced and subjugated under a mathematical ideal?

  72. Gravatar of Major.Freedom Major.Freedom
    11. January 2015 at 11:45

    Carl:

    “As a great believer in free markets as a means of discovering the value of things, I’m sure you will appreciate my suggestion that Scott switch to a blog format that allows people to down vote and up vote comments. Or maybe I can ask you to set up your own blog, reference it here in your comments, and see how much traffic you generate as a way to market test your ideas. As it stands, you spend your time in Scott’s idea store, to which all of us regularly and freely go, and proclaim the superiority of what you are selling at your non existent store. Not only that, you call all of us shoppers, whom you are presumably trying to attract over to your non existent store, mindless thugs.”

    Where did I call anyone here “mindless thug”?

    If you feel like one, then that’s different.

  73. Gravatar of Major.Freedom Major.Freedom
    11. January 2015 at 11:47

    Jeff:

    “Wow. Just wow.”

    One day, hoepfully, you will improve your knowledge and realize that what you believe in is largely a pile of bologna.

  74. Gravatar of Philippe Philippe
    11. January 2015 at 11:47

    This individual is experiencing an almost identical form of payoff:

    https://www.youtube.com/watch?v=oi9TrbmZtwM

  75. Gravatar of Jeff Jeff
    11. January 2015 at 18:18

    Scott,

    They are being forced. Reserves are created when the Fed buys something, and are destroyed when the Fed sells something. The only other thing that can happen to reserves is that some of them may be exchanged for currency, but since currency pays no interest and excess reserves pay a little bit of interest and can be securely stored for free, it’s always going to be cheaper for banks to hold reserves rather than holding currency. (Unless, of course, you manage to persuade the Fed to impose a negative interest rate on excess reserves.)

    Federal Reserve actions determine the quantity of reserves. The banks have nothing to say about it. A couple of days ago the Fed turned over nearly $100 billion in “earnings” on its assets, assets financed by creating reserves and forcing banks to hold them. If there were no force involved, do you really think the private financial system would have left $100 billion sitting on the table?

  76. Gravatar of Philippe Philippe
    11. January 2015 at 18:30

    Jeff,

    I don’t understand why you think they are being forced to hold those reserves.

    If for some reason banks have more reserves than they want they can either make more loans or they can change the interest rate they pay on deposits to get their depositors to withdraw the reserves.

  77. Gravatar of Philippe Philippe
    11. January 2015 at 18:55

    you might be thinking ‘the banking system can’t get rid of the reserves by making loans’. True, to an extent (more loans does actually usually mean more reserves withdrawn by the public as cash). However, more bank loans means that excess reserves become desired reserves (or officially required reserves). So by making more loans the banking system as a whole can get rid of ‘excess’ reserves by turning them into desired reserves.

  78. Gravatar of Major.Freedom Major.Freedom
    11. January 2015 at 18:57

    Jeff and Philippe,

    Commercial banks are forced to abide by the regulations set forth by the Fed and government in general.

    What they are not forced to do is sell treasuries to the Fed. When the Fed conducts OMOs, they are only paying the price of that which the banks want to sell to them.

    If for whatever reason banks did not want to hold any additional reserves, and they did not sell any treasuries accordingly, then total bank reserves would not increase, at least until the Fed then decides to purchase something from non-banks parties, and then depend on those parties depositing the money into the banks, which become reserves that way, but then if we continue to assume no increase in reserves, then the banks would have to all decide not to accept deposits. It is quite unlikely, but they are not forced.

  79. Gravatar of Philippe Philippe
    11. January 2015 at 19:19

    “Commercial banks are forced to abide by the regulations set forth by the Fed and government in general”

    If you want to operate a bank then it’s true that you are required to abide by the regulations in whatever area you want to operate. But no one forces you to run a bank. People usually do it because it is very profitable.

  80. Gravatar of Philippe Philippe
    11. January 2015 at 21:23

    mf, you seem to have missed the word ‘frictionless’ in Anon’s comment.

  81. Gravatar of Major.Freedom Major.Freedom
    11. January 2015 at 22:43

    Philippe:

    I did not miss that word.

  82. Gravatar of Major.Freedom Major.Freedom
    11. January 2015 at 22:54

    Philippe:

    “If you want to operate a bank then it’s true that you are required to abide by the regulations in whatever area you want to operate. But no one forces you to run a bank.”

    So what?

    If someone does not force you to produce particular food to eat, nor force you to marry the person you want, nor force you to wear particular clothes, nor force you to live in a certain house, nor force you to do anything that will make your life better off without initiating force against others, but will nevertheless fine you if you do any of these things, or throw you in prison if you do any of these things, does not make the fines or prison morally justified, or needed, non-exploitative.

    Nobody ought to be obligated to gain the permission of anyone, including those with badges, before he or she is able to use their own property to produce goods or services for sale.

    Bank owners ought not be obligated to ask the permission of anyone before they can lend whatever they want, to whoever they want, for whatever price. Regulations beyond protection of life and property are nothing but violent exploitation.

  83. Gravatar of Philippe Philippe
    11. January 2015 at 23:10

    “If someone does not force you to produce particular food to eat, nor force you to marry the person you want [etc}… does not make the fines or prison morally justified, or needed, non-exploitative.”

    There’s a problem with your sentence construction there, as usual.

    “Bank owners ought not be obligated to ask the permission of anyone before they can lend whatever they want”

    That’s funny because in your ideal neo-feudalist world they would have to ask people for permission to do exactly that.

  84. Gravatar of Philippe Philippe
    11. January 2015 at 23:12

    “I did not miss that word”

    Oh so you read it but the very stupid part of your brain automatically kicked in to neutralize any effect that it might have had on your train of thought.ok.

  85. Gravatar of Quotes & Links #26 | Seeing Beyond the Absurd Quotes & Links #26 | Seeing Beyond the Absurd
    12. January 2015 at 02:15

    […] 1) moneyillusion.com: No, strong labor markets don’t cause higher wages (never reason from a quantity… […]

  86. Gravatar of TallDave TallDave
    12. January 2015 at 02:27

    Jeff,

    Reserve requirements are not loans, indeed they’re practically the opposite. Loans are handled by Treasury on the open market.

    Even if that were not true, in no sane world does one improve credit conditions by threatening to shut down the banks if they don’t give the government money to spend. Even Third World economics has mostly moved beyond that.

  87. Gravatar of Jeff Jeff
    12. January 2015 at 04:39

    OK, it seems many of you don’t understand reserves. Reserves are a bookkeeping entry at a Federal Reserve Bank. Depository institutions have accounts at one of the Federal Reserve Banks.

    When the Fed buys something from anyone, bank or nonbank, it pays with a check drawn on a Federal Reserve Bank. When that check is deposited in a commercial bank, the commercial bank in turn sends it to its Federal Reserve Bank, and the commercial bank’s account at the Fed is credited. The funds in the commercial bank’s account at the Fed are called reserves.

    There are reserve requirements on transactions accounts. That is, depository institutions above a certain size are required to hold 10 percent of the amount of their transactions account liabilities in their Fed reserve accounts, or in vault cash, which also counts as reserves.

    Currently, total reserves are about $2.65 trillion, of which about $145 billion are required reserves. So, roughly 95 percent of reserves are excess reserves. In the current regime with interest paid on excess reserves, reserve requirements are pretty much irrelevant to monetary policy.

    Here’s the part that many of you seem not to understand. If a bank has more reserves than it wants, it can reduce its own reserves by making loans or buying securities. But when it does so, it pays with a check drawn on its reserve account at the Fed. Whoever gets that check deposits it at his own bank, that bank sends the check to the Fed, and that bank’s reserve account is increased. The reserves never leave the banking system. The only way reserves leave the banking system as a whole is if the Fed sells something (because eventually that ends up as the Fed debiting some bank’s reserve account) or if a bank customer withdraws currency from his bank, because currency that is in the vault of a bank counts as reserves.

    The reason I say that the Fed is forcing banks to make loans to the government is that reserves are created by the Fed buying something, and only the Fed can destroy them by selling something. If a bank has funds on deposit at the Fed and is being paid interest on those funds, and the Fed is a government agency, how is that not a loan to the government?

  88. Gravatar of ssumner ssumner
    12. January 2015 at 06:22

    Jeff, I disagree. The Fed determines the quantity of base money, but the banks don’t have to hold that base money as reserves (except obviously excess reserves.) If they put a negative 5% interest rate on deposits, reserves will flow out into cash in circulation. The Fed is inducing them to hold the reserves by not changing them minus 5% IOR. But no force is involved, it’s all voluntary.

  89. Gravatar of TallDave TallDave
    12. January 2015 at 09:34

    Jeff — in addition to what Scott said, the Fed doesn’t even set the overnight fed funds loan rates, they actually target the rate through OMO.

    This is entirely different than Coppola’s scenario, in which the banks are told they must finance deficit spending at an interest rate of the government’s choosing, or face closure. That’s tantamount to theft, and would result in massive capital flight.

    The basic definition of reserve requirements is funds that cannot be lent out. The fact they’re held at the Fed does not make them a loan, and they’re certainly not the equivalent of Treasuries. It’s true that they are less important as a monetary policy tool since 2008, but I’m not sure why that’s relevant to my statement.

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

    The reserve requirement (or cash reserve ratio) is a central bank regulation employed by most, but not all, of the world’s central banks, that sets the minimum fraction of customer deposits and notes that each commercial bank must hold as reserves (rather than lend out).

  90. Gravatar of Jeff Jeff
    12. January 2015 at 21:40

    TallDave,

    I thought I was clear that I’m talking about excess reserves, not required reserves. Look, if you deposit money in a time deposit at a bank, you are loaning your money to that bank. If it’s a demand deposit, it’s an overnight loan that you roll over every day that you don’t withdraw your funds. The same applies to a bank making a deposit at the Fed, except that the bank really has no choice. A customer comes in to deposit a check, what is the bank going to do? They accept the check and turn it over to the Fed or a clearinghouse. Either way, they eventually get paid with an addition to their account at the Fed.

    Scott, no one has ever charged negative five percent on a reserve account. Not once, not ever. Do you ever wonder why? Is such a thing is politically possible? Could it be unwise for reasons other than narrow monetary policy? When banks complain that reserves are created by the Fed and yet the Fed is taxing them, will the Congress applaud or put a stop to it?

    You say that negative reserve interest will cause money to flow out of the banks and into currency held by the public. I agree that could happen if banks charge their customers negative interest on their deposits. But think about what’s actually happening here. You’re reducing financial intermediation and quite possibly bank lending. If shrinking banks like this is such a good idea, why have banks in the first place? If you think banks do perform important functions necessary to a modern economy, is it wise to shrink them this way? Negative interest on reserves might turn out to be a negative supply shock. It makes much more sense to just raise expected inflation via an expected NGDP or price level target.

    When the Fed grows its balance sheet the way it has over the last 6 years, it necessarily has a huge influence on bank balance sheets. Total bank assets are now about $14.8 trillion, of which $2.6 trillion is reserves. That’s 17.5 percent. Total bank loans and leases (not including reserves) are only about $7.9 trillion, which implies that bank lending could be a third higher were it not for all those excess reserves on the books. Is lending to the Fed really what we want banks to be doing?

  91. Gravatar of Jeff Jeff
    12. January 2015 at 21:46

    An additional note to Scott: I realize I’m saying contradictory things above, first complaining about shrinking bank balance sheets and then complaining about how the Fed has created so many bank assets (reserves). The point I’m trying to make is that policy should be conservative whenever possible. Don’t make big changes when small ones will do. Changing from an inflation target to a level target is a much smaller change than the huge expansion of the Fed balance sheet we’ve seen, or than negative interest on reserves would be. And it would probably work better.

  92. Gravatar of ssumner ssumner
    13. January 2015 at 07:52

    Jeff, You misunderstood me. I agree that it would be far better to use techniques other than sharply negative IOR. It was just a thought experiment. I was trying to distinguish between “force” and the Fed making banks “an offer they don’t find it profitable to refuse.” I completely agree that as a practical matter (in current conditions) banks will hold a majority of the new base money injected into the economy as ERs.

  93. Gravatar of Charlie Jamieson Charlie Jamieson
    13. January 2015 at 08:39

    Jeff gets reserves exactly right, imo.
    If we understand what reserves are, we can make policy or makes suggestions or whatever.
    But if you think the banks can get rid of them by making loans or inducing institutions to withdraw billions of dollars in currency then you are starting from a point of factual error.
    As Jeff says, reserves cannot leave the banking system as a whole if banks increase lending.

  94. Gravatar of ssumner ssumner
    14. January 2015 at 07:18

    Charlie, That’s just false, they can leave as cash in circulation. It’s not even debatable.

  95. Gravatar of Charlie Jamieson Charlie Jamieson
    14. January 2015 at 09:09

    No, they can’t leave them as cash in circulation, not in any practical manner.
    The guy with 10k in his bank account might take his money in cash bills, but an institution with billions in deposits isn’t going to withdraw that in large bills.
    Even the guy who withdraws 10k in cash on Monday, is almost certain to put that cash back into deposits when he begins to make purchases.
    At least you are conceding that reserves cannot leave the system via loans.

  96. Gravatar of Jeff Jeff
    14. January 2015 at 09:38

    Charlie, I agree with what you are saying, but I think your last sentence is kind of crossing the line and insulting our host. Scott is a monetary economist. I’m sure he’s taught hundreds of students the mechanics of how reserves work.

  97. Gravatar of Philippe Philippe
    14. January 2015 at 09:45

    Jeff,

    The banking system as a whole can get rid of ‘excess’ reserves by making loans. By making loans ‘excess’ reserves cease to be ‘excess’ reserves.

    The banking system as a whole can also reduce the total amount of bank reserves in the system by getting customers to withdraw them as cash. (Making more loans also tends to increase the amount of cash withdrawn from the system).

  98. Gravatar of Philippe Philippe
    14. January 2015 at 09:50

    Charlie,

    “an institution with billions in deposits isn’t going to withdraw that in large bills”

    It could do if it wanted to. Instead of holding bank deposits it could hold cash in a vault. Obviously there are reasons why people generally prefer not to do that, but that is beside the point. And banks are not forced to hold people’s cash as reserves either, though they generally choose to because there is no good reason for them not to.

  99. Gravatar of Charlie Jamieson Charlie Jamieson
    14. January 2015 at 10:43

    Phillippe: The debate is whether making loans reduces reserves. I don’t think it does, based on my reading as a lay person, and once you accept that, it changes the way you look at lots of arguments.

    The idea that any large institution is going to hold deposits as pape currency is silly. It is not ‘beside the point’, it is exactly the point. In a way it treats currency as gold bars; it’s a holdover from the era of gold-based money. And as I said, any such withdrawal is only temporary, as any spending goes back into the reserve system.

    If it’s so important that reserves leave the system, then the Fed can sell its T-bonds. The Fed may have thought that if it instituted QE that reserves would increase and loans would follow, but that is a misunderstanding of the system.

  100. Gravatar of Philippe Philippe
    14. January 2015 at 12:18

    “The debate is whether making loans reduces reserves”

    See my previous comment.

    Making loans reduces ‘excess’ reserves. Those excess reserves become ‘desired’ or ‘required’ reserves instead.

    Increased loans usually means increased withdrawals of cash from the banking system. As such it also reduces the total amount of reserves in the system.

  101. Gravatar of Philippe Philippe
    14. January 2015 at 12:23

    “The idea that any large institution is going to hold deposits as pape currency is silly”

    I didn’t say hold deposits as paper currency, I said hold currency instead of deposits. This can be costly, which is why people don’t do it, but that doesn’t mean it can’t be done. If you personally want to store currency in a safe deposit box instead of swapping it for a bank deposit, you can. Large institutions can also store their money in the form of cash in a safe or vault if they want to. There is nothing mysterious about this. It is very simple and obvious. However, most people *choose* not to do this. They *choose* not to do this. Note the word *choose*.

  102. Gravatar of Eschew economic analysis and go straight for the “conspiracy theory” | Historinhas Eschew economic analysis and go straight for the “conspiracy theory” | Historinhas
    14. January 2015 at 14:53

    […] Bob, the late 1990s is a different animal from 2014. In the late 1990s it was labor demand that was increasing on the heels of the positive productivity shocks. In 2014 it´s labor supply that´s increasing. While in the first more employment is associated with higher pay, in the latter, NO! […]

  103. Gravatar of Charlie Jamieson Charlie Jamieson
    14. January 2015 at 16:12

    Sure, if you, me or a financial institution with billions in deposits decides to take all our deposits and put them in a safe, then reserves can leave the system.
    Temporarily.
    But if you take your deposits out of the system on Monday and then buy a cup of coffee on Tuesday, your currency starts going right back into deposits.
    For reserves to be transformed into currency, then you, me and all these other financial institutions must agree abandon the banking system for a cash economy.

    Anyway, this idea appears to be gaining ground as the new conventional wisdom, but seems to be a point of contention here still.

  104. Gravatar of Philippe Philippe
    14. January 2015 at 16:38

    Charlie,

    your original argument was that banks are *forced* to hold reserves. That was incorrect.

    Now you are saying that it would be crazy or silly for banks to not hold all those reserves, because otherwise we would have a bank-less cash economy or something.

    The problem here is that you keep changing your argument.

    Your first point was that the banking system is forced to hold the excess reserves currently in the system. Do you now agree that you were wrong?

  105. Gravatar of Major.Freedom Major.Freedom
    14. January 2015 at 20:38

    Philippe:

    “If someone does not force you to produce particular food to eat, nor force you to marry the person you want [etc}… does not make the fines or prison morally justified, or needed, non-exploitative.”

    “There’s a problem with your sentence construction there, as usual.”

    There is an evasive aspect of your response to my argument, as usual.

    “Bank owners ought not be obligated to ask the permission of anyone before they can lend whatever they want”

    “That’s funny because in your ideal neo-feudalist world they would have to ask people for permission to do exactly that.”

    Continued evasions.

    No, private property is anti-feudalism. Feudalism is a system characterized by a King or Queen or Prince who claims to own all the land, including land homesteaded or purchased by others.

    Feudalism is impossible in a private property rights society. No, one man or group of people violating the property rights of others, and claiming to hold sole property rights of all land, is not a private property rights society.

    In a private property society, if any person or group of people through pooling of wealth build a bank, and offer banking services to the open market, the law of private property is that they can do anything they want, provided they do not aggress against anyone else’s property. Lending to willing borrowers is not an aggression against anyone’s property, and therefore property owners need not in fact acquire the permission of anyone in order to borrow and lend to each other.

    You are falsely characterizing a free society as one that resembles your ideal.

    “I did not miss that word”

    “Oh so you read it but the very stupid part of your brain automatically kicked in to neutralize any effect that it might have had on your train of thought.ok.”

    No, it is irrelevant to what I said in response. If assumed as a premise, it does not contradict what I wrote.

  106. Gravatar of ssumner ssumner
    15. January 2015 at 09:27

    Charlie, The best tip-off that someone is not a serious economist is when they say “banks don’t lend out reserves.” Paul Krugman quipped “it’s a simultaneous system” and as far as I know no MMTer has ever answered that remark. It’s not so much that MMTers are wrong, they are not even making a coherent claim.

  107. Gravatar of Miami vice Miami vice
    16. January 2015 at 10:17

    Banks don’t lend out deposits.
    It’s about loans and deposits being simultaneously created, not reserves. Jesus.

    Your question to MMTers, or people who understand banking and central banking, is ignorant. Try and keep up.

    Who’s incoherent?

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