There’s a certain group of people who believe that if you want to know how money affects the economy, then you need to talk to bankers. I’m not one of them.

As an analogy, consider the following imaginary conversation:

Fred: I worked at BestBuy during the 1990s.

Me: Was it interesting?

Fred: Yes, it was a period of soaring demand for personal computers.

Me: Um, don’t you mean the supply of personal computers was soaring?

Fred: Well more supply too, but the market was really driven by soaring demand. Extra supply just piles up in inventory if you don’t have buyers. It’s demand that drives the market; supply is just a necessary condition. Trust me, I worked there.

If you’ve studied economics from a textbook that teaches NRFPC (in other words, mine), then you know that Fred is speaking nonsense. To establish whether supply or demand was the driving force in the 1990s, you look at the correlation between quantity and price. And given that soaring sales were associated with plunging prices, we can infer that supply was the key factor.

Fred was too close to the picture to see it clearly. To him it looked like quantity sold was fueled by demand. He overlooked how Moore’s Law was sharply boosting supply, which led to much lower prices and many more people buying PCs.

I often hear people say that bank reserves don’t drive bank lending. That no banker looks to see if he has enough reserves before deciding whether to make a loan. That’s like saying that the BestBuy salesperson doesn’t look at Dell Computer production data before making a sale.

More reserves can lead to more loans in one of two ways. In the Keynesian model, more reserves lead to lower interest rates on loans, and this encourages more lending. In the market monetarist model (my view), more reserves leads to more NGDP via the excess cash balances effect. As NGDP rises, firms and individuals wish to borrow more money.

In the Keynesian model, real bank lending rises, and in the long run monetarist model nominal bank lending rises. In reality, you have some of each.

Here’s Paul Krugman:

Actually, Tobin-Brainard is to many of the controversies that swirl around banks and money as IS-LM is to controversies about interest-rate determination. When we ask, “Are interest rates determined by the supply and demand of loanable funds, or are they determined by the tradeoff between liquidity and return?”, the correct answer is “Yes”— it’s a simultaneous system.

Similarly, if we ask, “Is the volume of bank lending determined by the amount the public chooses to deposit in banks, or is the amount deposited in banks determined by the amount banks choose to lend?”, the answer is once again “Yes”; financial prices adjust to make those choices consistent.

Now, think about what happens when the Fed makes an open-market purchase of securities from banks. This unbalances the banks’ portfolio — they’re holding fewer securities and more reserve — and they will proceed to try to rebalance, buying more securities, and in the process will induce the public to hold both more currency and more deposits. That’s all that I mean when I say that the banks lend out the newly created reserves; you may consider this shorthand way of describing the process misleading, but I at least am not confused about the nature of the adjustment.

Yes, it’s a simultaneous system. Adding reserves (base money) has a million indirect effects on every nominal variable in the economy, and, if prices are sticky, real variables as well. If you don’t want to call that “lending out reserves” that’s fine (I don’t use that phrase either), but we understand the dynamic process.

And this Krugman comment also rang a bell with me:

I’m actually kind of reluctant to even get into this, because any discussion of these issues brings out the people who believe that they have discovered the hidden secrets of the monetary universe, somehow missed by generations of economists. But here goes anyway.

Yes, I know the feeling.

The vast majority of people that die of Covid-19 are old. Nonetheless, I see a tendency for people to understate the Covid risk to non-old people. Here’s some Covid fatality data from December 2 from the Heritage Foundation, by age group in the US:

In fairness, the infection fatality risk is even more lopsided, as there are many fewer people in the 75-84 and 85+ categories. The old really are at much higher risk of dying. However, it’s still true that 48,000 middle-aged people (35-64) have died of Covid and even a couple thousand younger people.

At this point people say, “Yeah, but those middle-aged people have pre-existing conditions like asthma and obesity”, as if that makes it all OK. I don’t get that. I’m 65 and have the pre-existing condition of crappy lungs. If I’d been born in 1800, I might well have died in my mid-30s, like lots of famous artists and composers. But antibiotics likely saved my life and I still play tennis 3 times a week. My mom and stepfather are still alive in their mid-90s. Fat people often live well into their 70s or 80s. Why are middle-aged people with pre-existing conditions now viewed as disposable?

Again, I’m not denying that the risk for old people is more than 10 times higher on a per capita basis, but our society (including conservatives) freaks out about risks that are utterly trivial compared to Covid, such as terrorism. I bet you could find millions of middle-aged people who scoff at the risk of Covid but would be terrified to fly in a MAX737 (where your risk of dying is probably 1000 times lower than from Covid.)

Also keep in mind that the 48,000 figure is a moving target, indeed it’s likely already above 50,000 and will go much higher.

I’m not taking a position here on any public policy issue (I’m skeptical of “lockdowns”, for instance). But people really need to be consistent. If you want to argue that Australia’s success is not that significant because Covid doesn’t kill all that many people who don’t already have one foot in the grave, then you permanently forfeit the right to freak out over any other societal risk that is orders of magnitude less severe.

How many conservatives want to take away the “liberty” of Syrians to move to Germany because the immigrants might boost the murder rate by a few dozen? So what’s more important, liberty or safety?

Where was the conservative criticism of Trump’s various travel bans?

PS. LOL

PPS. LOL squared

I’m still trying to figure out the MMT view of monetary policy. It’s not easy for me, because MMTers seem to think that “monetary policy ” and “changes in interest rates” are pretty much the same thing. I view that as reasoning from a price change, but even some conventional economists make that mistake.

For a brief moment on page 406 of Macroeconomics (by Mitchell, Wray and Watts) it seemed like they understood this distinction:

In a growing economy, it is likely that aggregate demand conditions will improve at times when the market rate of interest rises as the central bank often raises its target rate in an expansion.

Yes! Interest rates are largely endogenous, mostly reflecting changes in output and inflation expectations. When the economy is booming and/or inflation is rising, then market interest rates will also tend to increase. My only quibble is that the authors need not have added, “as the central bank often raises its target rate in an expansion”, as this relationship is true even in an economy that doesn’t have a central bank (say the US prior to 1913.)

But that minor quibble contains the seeds of a major problem, as I don’t know if MMTers even recognize the income and Fisher effects. At times they seem to assume that all changes in interest rates are “monetary policy”, i.e. the liquidity effect.

MWW continue:

[W]e would not observe investment falling when the market interest rate rose because the IRR of each project could also be increasing

So far so good. The internal rate of return will rise with inflation and/or output growth. But then this:

Thus, it is important to avoid applying a mechanical interpretation of the concept of the [Marginal Efficiency of Capital]. Keynes, in fact, did not think investment would be very responsive to changes in the market rate of interest, especially when the economy was in recession or boom.

Woah! The term “Thus” is mixing up two unrelated issues. First, that fact that because interest rates are largely endogenous you often observe interest rates move procyclically. The second (and more dubious) claim is that this is evidence that the economy is not very responsive to interest rate changes. But that doesn’t follow at all. As an analogy, it is true that budget deficits are usually high when the economy is very weak, but even a monetarist like me would never argue that this proves that exogenous increases in deficit spending are contractionary.

In fact, if interest rates decline due to a highly expansionary monetary policy, then it will have a big impact on aggregate demand. On the other hand, if interest rates decline due to the income and/or Fisher effect, then you should not expect an expansionary impact.

In mainstream economics, this can all be easily explained by referring to the gap between the target interest rate and the natural interest rate. But I’m told that MMTers don’t believe the natural interest rate matters, or they think it’s always zero, or something. (BTW, Do they think the real or nominal natural interest rate is zero?)

On the next page (407):

The extreme optimism that typically accompanies a boom also would reduce the sensitivity of investment to changes in the market rate of interest. With high expected returns, firms would be prepared to pay higher borrowing costs.

That seems to confuse shifts in the MEC with changes in the elasticity of demand for investment (as a function of interest rates), unless I’m misinterpreting their claim. The fact that interest rates are higher during a boom doesn’t mean that investment is less sensitive to changes in interest rates.

On page 464, you can see where MMTers’ confused ideas about endogeniety cause them to really go off the rails:

The fact that the money supply is endogenously determined means that the LM schedule will be horizontal at the policy interest rate. All shifts in the interest rates are thus set by the central bank and funds are supplied elastically at that rate in response to the demand. In this case, shifts in the IS curve would not impact on interest rates. From a policy perspective this means the simple notion that the central bank can solve unemployment by increasing the money supply is flawed.

No, no, a thousand times no!!! The final two sentences absolutely do not follow from the first two sentences, which leads me to believe that MMTers misunderstand the concept of endogeniety.

It’s cheating to claim the money supply is “endogenous” and then completely ignore the fact that the interest rate is also endogenous. In the second sentence they mention that central banks “shift” the interest rate. Yes they do, and they do so to prevent shifts in the IS curve from destabilizing the economy. As a result, shifts in the IS curve absolutely do impact interest rates. A rightward shift in the IS curve right after Trump was elected caused interest rates to go up. I could cite 1000 similar examples. Central banks are like the child that runs out in front of a parade and then has the delusion that he is determining the route of the parade.

So the third sentence is wrong; IS shocks do affect interest rates. But the fourth sentence is even worse. The facts cited in the first two sentences absolutely do not imply that the central bank can’t address unemployment by increasing the money supply.

Go back to the late 1970s or the early 1980s, when interest rates were in the 10% to 15% range. Does anyone seriously believe that a huge increase in the money supply would have failed to boost employment, at least until sticky wages caught up?

MMTers would say a big increase in the money supply is impossible because it would push interest rates to zero. But that completely misses the point. Let’s say the Fed just increased the money supply enough to push rates from 12% to 2%. Does that not boost employment?

Another argument I’ve heard is that lower rates don’t matter because interest payments are a zero sum game. Some people pay less interest but others earn less interest. Yes, they may not matter for consumption in a simple Keynesian cross model, but they certainly do matter for investment, even in the simple Keynesian model. Of course I think that the Keynesian cross model is wrong, but excess cash balances also drive NGDP in the monetarist model, so either way (exogenous and permanent) money creation is expansionary, at least when rates are positive (and in reality even when they are zero.)

Just to be clear, I don’t agree with the Keynesian view that easy money lowers interest rates, nor do I agree with the NeoFisherian view that easy money raises interest rates. Both are reasoning from a price change. But even using the flawed Keynesian model (where easy money lowers interest rates), the MMT people are mistaken about endogenous money, unless I’m missing something. And after three weeks of arguing with commenters, I’m finding it harder and harder to imagine that I’ve missed some brilliant MMT insight that explains all of this.

Because they get monetary policy wrong, they also get fiscal policy wrong. Thus on page 506 we are told that one reason why “fiscal deficits do not place upward pressure on interest rates” is because “The official interest rate is set by the central bank”.

Thus in the MMT world, the interest rate is not subject to macroeconomic shocks like other macro variables, it’s just an arbitrary number set by the central bank. IS shocks and fiscal stimulus don’t raise rates because the rates are set by the central bank. And the central bank has no discretion to change the money supply, because doing so would cause interest rates to change. And that would be bad because . . .

Again, I don’t believe “endogenous” means what MMTers think it means.

PS. I have a related critique of MMT over at Econlog.

This will raise a few eyebrows:

Trump Cheers ‘Terrific’ Rise in COVID Cases During Off-The-Rails Vaccine Summit . . .

But after a few minutes of touting the success of Operation Warp Speed, his address morphed into an unspooling of grievances over the election outcome as well as an unfounded assertion that the rising number COVID-19 cases across the country was, in fact, a “terrific” development.

“I hear we’re close to 15 percent. I’m hearing that, and that’s terrific,” Trump said of the percentage of Americans who have contracted COVID-19.

Yes, it’s “terrific” news that the death rate from Covid has shot up to 3,000/day right before the vaccine is being rolled out.

“Horrific” hasn’t changed over the centuries. It was first recorded in English in 1653, the OED says, and still has its original meaning: “causing horror, horrifying.”

But “terrific” is a different story. This adjective originally meant “causing terror, terrifying; terrible, frightful; stirring, awe-inspiring; sublime.”

I recently published a 55-page Mercatus paper arguing that we should not equate interest rates and monetary policy. I’m not sure if anyone actually read the paper, but people do read Twitter. Thus I was glad to see these tweets from Nick Rowe: