Reply to Miles Kimball
Miles Kimball has a new post that replies to my argument for a shadow fed funds target:
. . . in his post “What Ben Bernanke Can Learn from Humpty Dumpty.” Scott talks about a “shadow fed funds rate target.” I considered that phrase for my proposal, but set it aside because I thought it sounded too much like the fed funds rate target of the Shadow Open Market Committee . . . The word “virtual” not only evokes the “virtual reality” of computers that allows the impossible, but also the “virtual particles” of quantum mechanics which can arise even in empty space, stealing the energy for a ghostly existence using the opening provided by the Heisenberg uncertainty principle.
In addition to using “shadow” instead of “virtual,” there is a crucial difference between Scott Sumner’s proposal and mine. I am envisioning the Fed as using the virtual fed funds rate target to communicate what it intends to do in the near future with balance sheet monetary policy. Scott wants the Fed to use a shadow fed funds rate to communicate what it will do in the more distant future. Aside from “doing whatever it takes” to reach a nominal GDP goal, I am not clear about exactly what the Fed is communicating it will do in the future.
Kimball is new to blogging so he doesn’t yet know my fanatical opposition to interest rate targeting. In my post on the shadow fed funds target I was basically saying; “Keynesians are making a tragic mistake with interest rates targeting, but by all means if you insist on setting interest rate targets don’t stop when the economy most needs the Fed to steer it, i.e. when we are in a deep slump.” So my views are closer to Kimball’s than he suspects, I much prefer adjustments in the base as a policy instrument, and would certainly not want to stop doing those adjustments if we used a virtual fed funds target.
In my view even during normal times changes in the fed funds target are actually signals about future changes in the monetary base, so to answer his question “about what exactly the Fed is communicating,” a cut in the virtual fed funds target would be a signal to the market that the future monetary base would be higher than they now forecast. But of course no one really pays much attention to the base; they care about the interaction of changes in the supply of base money and base velocity, i.e. NGDP. So it would actually be better described as a signal about the Fed’s future NGDP intentions. Wouldn’t it be better for the Fed to just come out and say where it would like NGDP to be 2 or 3 years out? Of course, but you go into battle with the Fed you have, not the Fed you wish you had. Kimball continues:
One possible meaning of a shadow fed funds rate target that may or may not be what Scott has in mind is as follows. I hope that Scott will clarify his position, either by saying that the following interpretation is consistent with what he intends, even if he thinks the emphasis is off, or by distancing himself from the following view. Believers in Wallace neutrality as applied to the real world think that the only way the Fed can do more stimulus once the fed funds rate is at zero is to promise to overstimulate the economy in the future once the fed funds rate has lifted off from zero. For example, even with Wallace neutrality, the Fed can stimulate the economy now by promising to keep the fed funds rate at zero so long that the economy will get overheated in the future. This would be very different from what I recommend. The great virtue of balance sheet monetary policy (which works by taking advantage of departures from Wallace neutrality)””and therefore with the virtual fed funds rate target that communicates the stance of balance sheet monetary policy””is that it avoids making promises to do the wrong thing in the future in order to have the right effect now.
In theory Wallace is right and Kimball is wrong, but in practice Kimball is right, because the conditions for Wallace neutrality to hold would probably never occur in the real world. This will take some explanation, so bear with me.
I frequently argue that most people look at liquidity traps through the wrong end of the telescope. They agonize over whether this or that Fed action is enough to move the economy to a certain position. The base is viewed as an exogenous policy instrument. That’s looking at things backward. The right question to ask is how much base money does the public want to hold at each and every expected NGDP growth rate. In general, lower NGDP growth rates (and also lower NGDP levels relative to trend) are associated with lower nominal interest rates and higher demand for base money. During normal times people in most countries want to hold about 5% of GDP as base money. Right now it’s 4% in Australia, and it’s usually about 6% in America, as our currency is more popular with foreign hoarders. But when NGDP growth is unusually slow, the demand for base money can rise sharply. It’s up to about 18% of GDP in America (albeit partly due to interest on reserves) and up to 23% of GDP in Japan, which has an even lower NGDP growth rate.
Suppose the demand for base money exceeded the entire national debt, assuming that NGDP growth was expected to be on target. In that case Wallace would be technically right, at least if you define monetary policy narrowly, as the exchange of base money for government bonds. Consider all the “foolproof” escapes from the liquidity trap. My NGDP targeting idea, Svensson’s currency depreciation, Friedman/Kimball’s massive QE, etc. They are all supposed work by avoiding the zero bound. There is no zero bound for increasing in the base, the price of NGDP futures, or the price of foreign exchange. But here’s what might happen; you might have to buy up more than the entire national debt to hit your target. I actually don’t worry about that for several reasons. One is that you could buy other assets; gold or corporate bonds. But others would consider that fiscal policy, or at least quasi-fiscal policy. But the other reason I don’t worry about that happening is that I don’t think the demand for base money would be very high if NGDP growth was set at an appropriate target.
I am pretty sure that the Wallace claim that you’d need excessive inflation in the future to escape a zero rate trap is based on some combination of assuming inflation rate targeting (rather than price level targeting) and/or assuming that the central bank currently has an appropriate target. I.e. rates are not near-zero because of excessively tight money policy, but rather because the equilibrium interest rate is low even with “appropriate” monetary policy. Hence you need “excessive” monetary stimulus to escape the trap.
I favor level targeting, and I notice that every real world example of “liquidity traps” are cases where the central bank has allowed NGDP growth to fall far below any reasonable trajectory, with no intention to catch up. The one exception was a brief period in 1933 where FDR tired to reflate to the pre-Depression price level, and that policy was instantly effective, producing 20% WPI inflation in an economy mired in 25% unemployment and near zero interest rates. It’s the exception that proves the rule (or actually that proves the limitations of the rule.)
So here’s the right way for people to think about 1930s America, post-1995 Japan, and post-2008 America. They are all cases where the central bank had an excessively low implicit NGDP target, and hence the nominal rate fell to zero and the demand for base money was large. But if you believe level targeting, then setting a higher NGDP target would not be “promising to be irresponsible” (in Krugman’s terminology), but rather promising to be responsible. All three of those cases the central banks wasn’t trying to boost NGDP growth to an appropriate rate. Recall that in Japan, and the US during the 1930s, they even tightened policy on occasion, which shows they were “steering the economy” but along the wrong NGDP trajectory.
Society faces a very simple choice:
1. Set the NGDP target path at such a slow rate that the public wants to hold an amount of base money that exceeds the national debt. In that case rates fall to zero, and bonds become indistinguishable from money debt. You might as well monetize the entire debt. That’s the world Wallace contemplated. Obviously monetary policy doesn’t work, because there is no interest-bearing government debt for the central bank to buy. And by assumption, purchases of non-government assets are called “fiscal policy.” In that world you’d need some other tool for steering the economy. It might be interest-bearing reserves, where the rate can go negative (although interest on currency presents technical problems.) Or it might be changes in the size of the public debt. I strongly recommend against going that direction, at least until we replace currency with all-electronic money—probably around the year 2050.
2. Or you can set a NGDP target trajectory, level targeting, where the public does not want to hold an amount of base money in excess of the national debt. That’s the world we actually live in, which is why I agree with Kimball. Even QE, clumsy as it is, can “work” if done in sufficient quantities. There is some amount of QE that will speed up NGDP growth, without causing an inflation/unemployment combination that violates the Fed’s mandate. But there really are much better ways of doing policy at the zero bound. It would be much easier to set an explicit and robust NGDP growth target, level targeting, than to rely on QE to hit some vague and amorphous fed target that Bernanke won’t disclose.
A footnote. Last night I was revising Chapter 9 of my depression manuscript, and suddenly realized that FDR was using a virtual price of gold to steer monetary policy in November 1933. He kept adjusting upward the official buying price of gold, even though in a sense it was meaningless (it wasn’t the free market price.) And yet it seemed to “work”, in the sense that markets responded to the changes. When I did this research 20 years ago I concluded that it worked by sending signals to the market about future monetary policy—it showed where the government was likely to re-fix gold in 1934 (the actual figure turned out to be $35 /oz. ) Thus every time FDR raised the official price of gold (more than expected) he also raised expectations of the future money supply. Every monetary economist should spend a year studying the interwar period. It’s a gold mine of natural policy experiments.
Update: I did not mean to suggest that zero interest rates imply the public wants to hold a level of base money larger than the national debt. Rather I meant that you could envision in theory (but probably not in practice) and NGDP target path so low that the demand for base money exceeded the national debt. That scenario (unlikely to occur in reality) would also feature near-zero rates.
Tags:
21. June 2012 at 07:40
Scott, this is what happens when you start making compromises. We’ve stopped insisting that an NGDPLT is the only way to go, instead allowing for more “pragmatic” ways out, and the press has taken that to Bernanke. But now he gets to say that stimulus works through printing more money, which makes the exit more difficult as we have to withdraw more money as the economy recovers. Instead the beauty of NGDPLT is that we don’t have to promise more money printing per se, or allow any overheating – we simply insist that next year’s NGDP rise to the appropriate level by whatever means necessary. Since we could definitely do this by permanently increasing the money supply till the year we escape the liquidity trap, followed by backwards induction – the market knows it’s going to happen anyway, giving them the incentive to “do the heavy lifting” for us. Demand for money returns to normal levels, and we evacuate money immediately as NGDP rises to trend next year. No overheating, no making a bigger mess for ourselves to clean up. It’s what Nick Rowe says about inducing the market to “jump” to the correct equilibrium – the Fed doesn’t have to force it on path, it is merely the great persuader. Miles is still looking through the wrong end of the telescope.
I think you’re still giving Miles too much credit, Scott, he’s very much an interest rate thinker and not a monetary base thinker. Worse, he isn’t thinking about how the French could enlarge the sun. Getting stuck in “finance” or portfolio equilibrium conditions when all we’re talking about is changing the “measure” is truly absurd. That is how Roosevelt got out of the trap. In terms of increasing the quantity of the base, yes the ZLB is supposed to make demand for money rise to match – but remember that the way the Fed permanently increases the base is by holding Treasuries to maturity and then essentially handing money over to the Fed. So that is more of a helicopter drop than a substitution – people spend more when they are (nominally) wealthier. Wallace neutrality doesn’t make permanent currency injections ineffective. But that is still the wrong way of thinking. Instead of dragging up the NGDP path by increasing the permanent money supply, we propose lowering the demand for money between now and the (currently) expected end of the recession. By promising that NGDP will jump to its correct path, NGDP does jump to its correct path. No irresponsibility is required – rather the private economy simply stops hoarding money once it realizes that the Fed is going to be cooperative again, to “stop being a bad parent” (to use David Beckworth’s excellent analogy).
I realised this comment works well for both the last two posts, so I’m double posting it.
21. June 2012 at 07:49
Scott,
“But if you believe level targeting, then setting a higher NGDP target would not be “promising to be irresponsible” (in Krugman’s terminology), but rather promising to be responsible.”
I replied the other day to Bob’s (Murphy) blog and I had to think what the difference was between you and Krugman on the promise to be (ir)responsible.
If Krugman is an inflation-targeter he will try to hit the same equilibrium point as you do by raising or lowering a horizontal AD-curve in response to SRAS/AS shifts. You on the other hand don’t want to move the AD-curve around, all that is needed according to you is that the Fed picks a shape and sticks with it (though you would raise it each period).
To use a terrible analogy: you don’t need to move around to stay fit, all you need to do is to stay in shape.
21. June 2012 at 07:58
Scott, surely you’re not suggesting the public currently wants to hold more money than the national debt? Rather they want to hold (without IOR) perhaps twice what they normally do. Then if the Fed swaps money for zero-yielding T-bills, the public will hoard the extra money not for transactions but as a substitute store of value. But if the bills are held to maturity then the Fed passes its earnings on to the Treasury – at which point the injection becomes permanent. Then the permanent increase in the money supply is not entirely hoarded, as higher nominal wealth means more nominal spending in each period.
So zero rates don’t mean the public actually wants to hold more money than the national debt. Although a temporary replacement of all T-bills with money would fail to stimulate, a permanent replacement (monetization) increases the long run supply of money more than the demand for it, and thus boosts the long run NGDP path. But we shouldn’t talk like that – the point is to promise the market that NGDP for each year from now on will be on an adequate level path, and since the market knows that the Fed has the power to make good on that threat we will get there without having to hit “irresponsible” levels of NGDP in any year.
21. June 2012 at 08:01
“remember that the way the Fed permanently increases the base is by holding Treasuries to maturity and then essentially handing money over to the Fed”
I meant essentially handing money over to the Treasury, of course.
21. June 2012 at 08:05
Saturos, I responded to your first comment in the previous post. Regarding the second, I hope I didn’t leave the impression I thought the public wants to hold more than the national debt—I strongly believe the Wallace argument does not apply to the real world. My point was that it could apply, if the NGDP target was set low enough.
I’ll add an update to make that clearer.
Martin, Very good observation, I do think of AD targeting as the Fed moving a hyperbola-shaped AD curve out at 5% per year.
21. June 2012 at 08:10
I added an update.
21. June 2012 at 08:22
Should this, “bonds become indistinguishable from debt,” from the first numbered paragraph, say something different
Perhaps bonds become indistinguishable from money?
Otherwise, I think this is excellent and I would love to see a response from someone like Steve Williamson who argues that QE can’t work.
21. June 2012 at 08:26
Even if the public did want that much money, in equilibrium the public does hold all the money it wants. Then monetary injections are either temporary, causing demand to rise with supply one for one, or they are not, and the public has more money than it wants and excess cash balances raises the NGDP path.
But that’s not what we’re trying to do here. We aren’t trying to drag NGDP up to trend, we simply want to stop pushing it down with negative expectations. (That sounds new age.)
21. June 2012 at 08:28
Yes exactly Martin, that’s how I’ve always seen it. I don’t understand how anyone can make any sense of AD otherwise. But then I’ve always found Keynesianism illogical. (I have a longer post on that topic in store…)
21. June 2012 at 08:50
The public does not control the quantity of base money that exists. The Fed controls that. A higher demand for base money may increase the RELATIVE ratio of base money to aggregate spending (NGDP), but it cannot increase the absolute level of base money. The Fed controls the absolute level of base money.
Regarding absolute quantities of the monetary base, the Fed has slowed the rate of increase of monetary base down to almost zero, and annualized (SA) M2 growth is now declining from a peak of 10% earlier this year.
The 3 month annualized (SA) M2 growth has been declining over the last year, and is now down to 4.4%.
This is why the stock market has been “slumping” recently, why the Philly Fed just printed -16.6, and, with no signal from the Fed for any further drastic easing, why I am now bearish.
If this keeps up, a double dip recession is inevitable.
(No, this isn’t an advocacy for money printing or central banking, it is merely technical).
21. June 2012 at 08:54
MF, you’re exactly right, for a change.
21. June 2012 at 09:37
But if you believe level targeting, then setting a higher NGDP target would not be “promising to be irresponsible”
This is promising to be irresponsible.
Using monetary inflation to maintain a stable NGDP growth rate requires an acceleration in monetary inflation. A constant monetary inflation is insufficient.
21. June 2012 at 09:40
Imagine the major primary dealers gaming the Fed system by not lending or spending the money they acquire from selling their securities to the Fed. The Fed’s targeting of NGDP would enable the primary dealers to stockpile cash over time, in addition to the inflation money they receive and actually spend.
A Fed that promised to target 5% NGDP growth, and yet depended on me to spend the money they give to me, I can game this relationship by simply abstaining from spending money the Fed sends me. The more they send me, the more I will stockpile. I will decide NGDP, not the Fed. The Fed will decide how much cash their buyers receive. Spending is up to me, because they are dependent on me.
Sumner: How can the Fed be considered in control of NGDP, when it is actually up to the primary dealers to spend the money the Fed sends them? Couldn’t the primary dealers collude and agree to spend less money they receive in exchange for t-bills, so that the Fed has to respond by sending them even more money, i.e. paying even higher prices for the securities?
Imagine a housing market collapse, but stable NGDP. The banks have all these worthless MBSs. The banks can collude and agree not to spend any money they receive in exchange for anything other than MBSs, which of course will require the Fed to pay outrageously high prices for the MBSs, which is exactly what the banks want. Then, the banks can spend/lend the money they receive from the sale of MBSs, and hence NGDP will rise as the Fed wants.
It’s a great way for the primary dealers to unload their bad investments to the Fed.
Of course, such oligopolies are sensitive to defection, as the incentive to loan and invest excess money over capital (or reserves) becomes overwhelming, but there is a gain to doing this, which is to keep a lid on lending and investing, so that they can offload their garbage securities to the Fed at prices the lending/investing of which leads to spending that is under the NGDP target.
21. June 2012 at 09:42
Saturos:
MF, you’re exactly right, for a change.
I’m right far more often than I am wrong. That’s how I was able to show you are wrong so often.
21. June 2012 at 09:50
OT, i am definitely less bearish than average. the plebes are getting restless, in addition to the end of the world shows on discovery and Nat Geo (“Doomsday Bunkers”) and gun shows, we now have:
http://www.housingwire.com/rewired/got-2-million-you-can-survive-end-world
21. June 2012 at 09:57
dwb:
FTA:
“And if that fails, the bunker comes equipped with enough food to feed 70 people for quite a while”
How long is quite a while? Suppose the food runs out, and people can’t leave for fear of being poisoned by radiation.
What do they expect to happen?
This has disaster written all over it.
I’d rather take my chances above ground in a $1.9 million radiation protective suit, and $100,000 worth of automatic weapons.
21. June 2012 at 10:34
if the food runs out and the atmosphere is poisoned by radiation, you are screwed either way because the food chain is poisoned, so you cannot even hunt food. Underground is easier to initially defend, but harder to escape. I’d probably want to be underground for a while then move above ground. Be practical and make sure you have small caliber stuff like a 22 because you are not hunting rabbits or birds with automatic weapons. Yep, you should probably have a radiation suit and Geiger counter no matter what. Also, nice cache of seeds so that you can plant crops. Of course, much of this depends on how the world ends: earthquake, fire, flood, solar flare, or just a quiet phhht of hubris.
21. June 2012 at 10:44
dwb:
Good point.
I think though that there will almost certainly be pockets of geography above ground where food isn’t so poisoned as to be inedible. For example way out in the deep seas, where I don’t imagine radiation being as high. Or deep under the ocean, living in a submarine, only coming up to fish (and preserve), then going back down. I think one can live longer doing that then they could in a bunker.
I guess barricading oneself underground does make the most economic sense for most people who can’t afford a submarine, but only if one has enough food to last as long as it takes for the radiation above ground to subside down to levels where you only throw up or grow an extra finger, rather than dying quickly from cancer. Otherwise, I would take my chances above ground.
21. June 2012 at 10:49
Tyler just recommended this WSJ article, which I’ll post in full here since Scott can’t access it (hope you don’t get sued):
21. June 2012 at 10:56
yep: fishing boat, and tackle since the oceans are much more likely to be diluted. I don’t know how a submarine is powered after apocalypse. hard to say if its better to build a boat after the fact or better to buy it beforehand since it all depends on how the world actually ends and what the sea level will be. a Tsunami could wipe out coastal areas so in that case, i definitely want to be inland. On the other hand, if the dead rise and are walking the earth, i want to be in a boat offshore with a flamethrower. All these doomsday preppers – save a very few – have the same problem: they are well protected for one type of argmageddon but not well protected for some other kind. hard to hedge the end of the world.
21. June 2012 at 11:11
Or you guys could, um, find true love?
http://bostonglobe.com/arts/movies/2012/06/21/carell-and-knightley-join-forces-seeking-friend-for-end-world/TDUn2PdFS3NTbLB2ZBnnSI/story.html
21. June 2012 at 11:11
hard to hedge the end of the world.
Tell that to creationists.
21. June 2012 at 11:13
Saturos:
Don’t worry bro, there will be room for you too. You can entertain by making papier-mâché figures out of federal reserve notes.
21. June 2012 at 11:24
Anna Schwartz is Dead: http://www.nytimes.com/2012/06/22/business/anna-schwartz-economist-who-worked-with-friedman-dies-at-96.html?_r=1&pagewanted=all
(Yes, Scott, I did read that post of yours)
21. June 2012 at 11:27
I swear, you remind me of a certain commenter I used to know on chessgames.com . Exact same sense of humor. I wonder if old technicaldraw is still around?
21. June 2012 at 12:01
i’m not smart enough to play chess.
people spend a lot of money on these underground bunkers and supplies, its a real cottage industry. when you see people spend $150k on apocalypse stuff, or $400k on an underground bunker , it really makes me wonder. My first reaction was “wow people are really pessimistic” then i thought “hey they have an awful lot of disposable income” spending like that is a sign of a boom, not a bust.
21. June 2012 at 12:02
“In theory Wallace is right and Kimball is wrong, but in practice Kimball is right, because the conditions for Wallace neutrality to hold would probably never occur in the real world.”
I think you may be vastly understating this Scott.
One of Wallace’s conditions is that the government uses lump-sum taxes to cancel out any net interest payments that it payed to or received from the private sector. Nothing like that ever happens outside of a theoretical research paper.
Moreover not only would Wallace neutrality make QE ineffective, it would make all open market operations ineffective, even away from the zero lower bound. More importantly, if this result holds then not only can printing money not effect GDP, it can’t affect inflation either. As Wallace says quite clearly at the beginning of his paper:
“Irrelevance here means that both the equilibrium consumption allocation and the path of the price level are independent of the path of the government’s portfolio.”
http://www.minneapolisfed.org/research/sr/sr44.pdf
People who invoke Wallace neutrality clearly live in an alternate universe than you or me.
21. June 2012 at 12:18
If the central bank always stands ready to supply banks with base money as needed (which it does), then you can’t talk about a “demand for base money” the way you want to. If you can access water out of the tap whenever you please, you don’t have any demand for buckets full of water.
Economic theory has to be consistent with the institutional details.
21. June 2012 at 12:26
“This is why the stock market has been “slumping” recently, why the Philly Fed just printed -16.6, and, with no signal from the Fed for any further drastic easing, why I am now bearish.”
“If this keeps up, a double dip recession is inevitable.”
“(No, this isn’t an advocacy for money printing or central banking, it is merely technical).”
So Major you’re admitting that only “money printing” can forestall a double dip but you don’t advocate money printing? Ie, you advocate allowing a double dip?
21. June 2012 at 12:45
So Major you’re admitting that only “money printing” can forestall a double dip but you don’t advocate money printing? Ie, you advocate allowing a double dip?
I don’t advocate a double dip, I advocate for that which would prevent inflation being necessary to prevent a double dip, namely, no more inflation in the first place, and privatizing money production, just like we have in potatoes, shoes, and computers.
The reason the economy is so weak and dependent on inflation today, is because it has been weakened with inflation in the past. It is like a crack addict going through withdrawal symptoms. I don’t advocate that he suffer the withdrawal symptoms, but I know that if he is going to get better, if he wants to get better, then the solution, however temporarily painful it will be, is not more crack.
21. June 2012 at 12:47
dwb:
My first reaction was “wow people are really pessimistic” then i thought “hey they have an awful lot of disposable income” spending like that is a sign of a boom, not a bust.
There was a lot of disposable income pre-2008 during the housing boom. It was succeeded by a bust. Isn’t the euphoria maximized just prior to a bust?
21. June 2012 at 12:49
So Major you’re admitting that only “money printing” can forestall a double dip but you don’t advocate money printing? Ie, you advocate allowing a double dip?
And another thing:
Forestalling a double dip with inflation, will only make the distortions that much severe, which will require even more inflation down the road to forestall the greater needed correction. Over time, this means monetary inflation will have to accelerate. Accelerating rate of money inflation is not sustainable.
21. June 2012 at 12:50
Ergo it’s a choice between the lesser of two evils.
I think a humanitarian would choose the lesser of two evils.
21. June 2012 at 12:54
Mike: You say I’m “admitting” more inflation forestalls corrections, as if I have been holding out on that the whole time, or that I should somehow embarrassed in thinking it, considering what else I think.
“Admitting” implies some sort of guilt is present here.
If I say that more crack can forestall a drug addict’s withdrawal symptoms, is that me reluctantly and embarrassingly agreeing that he should in fact take more crack, and that if I recommend anything less, I am some sort of twisted maniac who likes to see people suffer? Of course not. You need to stop viewing me as some sort of masochistic cold-hearted a$$hole for wanting to abolish inflation.
21. June 2012 at 13:10
“Isn’t the euphoria maximized just prior to a bust?”
only if you think people are inherently crack addicts and worried about the moral turpitude of spending. i think a real libertarian does not care what people spend their money on, how much they spend, or whether they derive pleasure from it or not.
booms dont create busts.
21. June 2012 at 13:16
only if you think people are inherently crack addicts and worried about the moral turpitude of spending.
Really? Whether or not there is a general euphoria in the minds of market participants, depends on whether or not I think they’re crack addicts?
i think a real libertarian does not care what people spend their money on, how much they spend, or whether they derive pleasure from it or not.
Agreed, which is why I, as a libertarian, find people caring about what time people take holding on to their earnings before spending it, misguided.
booms dont create busts.
What causes booms is what makes busts inevitable.
21. June 2012 at 13:19
Depending on what one means by “booms” of course.
21. June 2012 at 13:20
MF: “Accelerating rate of money inflation is not sustainable.”
Why not? Aren’t these just numbers on a piece of paper? What’s unsustainable about merely writing bigger numbers?
(Not sure if you got past kindergarten, but just FYI: “30” is not the largest counting number.)
21. June 2012 at 13:35
Don Geddis,
Everyone knows 24 is the highest number. http://www.youtube.com/watch?v=RkP_OGDCLY0
21. June 2012 at 13:41
Why not? Aren’t these just numbers on a piece of paper? What’s unsustainable about merely writing bigger numbers?
It’s truly remarkable how I find myself having to explain, on an economics blog no less, the dependency of the division of labor on a money that is not redenominated every second.
When the currency has to be redenominated so often that money becomes practically useless as a tool of economic calculation, if entrepreneurs and investors can no longer calculate gains and losses due to the fact that the redenomination of the currency is accelerating so fast that no planning is possible, then the entire division of labor will no longer be able to be coordinated. Production would become chaotic. Civilization that has been built on the basis of economic calculation using money, would collapse.
It’s not just about changing numbers. It’s about the practical usefulness of money being erased.
(Not sure if you got past kindergarten, but just FYI: “30”³ is not the largest counting number.)
How cute.
Where did I say anything about 30 being the highest number?
You know, if anyone hasn’t moved beyond kindergarten mentality, it’s you, because you still have the vestiges of believing money grows on trees, and that your parents were just manipulating numbers on their utility bills and bank statements, that there was no long term planning taking place on the basis of stability in the monetary system.
Imagine living in a world where the growth rate of supply for everything increased exponentially. You might think such outer dimension realms of infinity are where you find yourself at home, but down here on Earth, where scarcity exists, exponentially increasing rates of growth lead to practical uselessness.
21. June 2012 at 13:43
Don Geddis:
FYI: “30”³ is not the largest counting number.)
Was it this:
http://research.stlouisfed.org/fredgraph.png?g=89Z
that you were talking about? I was making an argument about a trend, not the absolute end point.
21. June 2012 at 14:01
Cedric: thank you for the correction. I apologize for my earlier error. From now on, I shall use the correct value of “24”.
MF: NGDPLT does not require money to be “redenominated so often” that is ceases to function as a medium of account.
21. June 2012 at 14:06
“Drops sharply is such pessimistic words-so much worse than saying “if that means employment is reallocated, let it.”
Of course the word is not masochism but sadism. Whether or not you want to quibble about the word admit or not -drop the word then it’s not the main point- you’re saying two things-money printing could forestall a double dip and yet you are vehemently opposed to it.
21. June 2012 at 14:08
The above quote is wrong. I meant to quote “You need to stop viewing me as some sort of masochistic cold-hearted a$$hole for wanting to abolish inflation”
To make it easier I’ll bring down my comments:
Of course the word is not masochism but sadism. Whether or not you want to quibble about the word admit or not -drop the word then it’s not the main point- you’re saying two things-money printing could forestall a double dip and yet you are vehemently opposed to it.
21. June 2012 at 15:52
I recently made some time to seriously study Wallace’s paper (very hard for me to make uninterrupted serious time like that, but I really wanted to know if there was much basis for the strong claims). I’m still in the middle, but one thing that looks very clear so far is that heterogeneity of investor beliefs – something that’s obviously big in the real world – will disprove the irrelevance proposition.
What I’m thinking of is adding an Eh vector to Wallace’s model. Currently all investors are clones; identical utility functions, birth and death dates, information, analysis, beliefs. I would take the true state-dependent-future-return-vector X and add the Eh vector to it to give the beliefs of investor h. Throw this monkey wrench in, and it shouldn’t be too hard to show that Wallace’s proof of the Irrelevance Proposition now fails, and by how much and why. So, that’s what I’d like to do when I can make the time, and after I’m finished really going through the paper and trying to understand all the intuition.
21. June 2012 at 16:00
By the way, I ran this heterogeneity idea by Brad Delong and he agreed, “”Yes, investor heterogeneity breaks it…”, at:
http://delong.typepad.com/sdj/2012/06/a-fragment-on-the-interaction-of-expansionary-monetary-and-fiscal-policy-at-the-zero-nominal-lower-bound-to-interest-rates.html#comment-6a00e551f0800388340167673b273c970b
The intuition is that in the Wallace 1981 AER world, where all investors are clones, with identical beliefs, all investors think that the action by the Fed hasn’t changed the fundamentals, and so all of them will sell at more than the current price, and it will not be able to rise.
But in a world where there is heterogeneity of investor beliefs, some investors think that the current price is substantially less than what fundamentals imply. If the price goes up a little from Fed action, they will still not sell, and the price can rest there in equilibrium, or perhaps rise further.
21. June 2012 at 16:01
Also, regarding Wallace, AER 1981, I think there are some significant errors in the paper:
1) On page 268, second paragraph, the expression K(t)x/(t+1) + xY(t+1) should be K(t)x(t+1) + Y(t+1).
2) In equation 2, the two utility functions should be partial derivatives of the utility functions with respect to consumption in states i and j respectively.
Do you agree?
21. June 2012 at 16:02
Saturos:
“remember that the way the Fed permanently increases the base is by holding Treasuries to maturity and then essentially handing money over to the Treasury”
I’m fairly sure this is wrong. Treasury bonds held to maturity by the Fed need to either be rolled over to new treasury bonds, or repaid via collected taxes. It is only the interest on the treasury bonds that is reimbursed to the government, not capital.
21. June 2012 at 16:21
Don Geddis:
MF: NGDPLT does not require money to be “redenominated so often” that is ceases to function as a medium of account.
Yes, it does. It follows from the argument I am making that NGDLT requires an acceleration in the rate of monetary inflation.
Mike Sax:
“Drops sharply is such pessimistic words-so much worse than saying “if that means employment is reallocated, let it.”
Of course the word is not masochism but sadism.
Right, sadism. I mixed the two. I am trying to say I don’t want pain on others. I want to remove what makes the inflation the only way to forestall the corrective pain in the first place.
Whether or not you want to quibble about the word admit or not -drop the word then it’s not the main point- you’re saying two things-money printing could forestall a double dip and yet you are vehemently opposed to it.
The same way I hold that more crack can forestall withdrawal symptoms, and yet I do not advocate that people take crack.
21. June 2012 at 16:52
So in a way Major you’re conceding Sumner’s argument. You admit that the money supply has been tighteniing and if someting isn’t done soon there will be a double dip.
But you don’t want anything done so you’d prefer a double dip. So you really do hold the the “liquidationist” theory.
Yet I think that where the real difference between you and the MMers is money. As you think it’s just another commidity you can believe that there’s no such thing as a general glut and if prices fall low enough there’s some point they will clear the market-though this evidently can take years.
21. June 2012 at 17:01
So in a way Major you’re conceding Sumner’s argument. You admit that the money supply has been tighteniing and if someting isn’t done soon there will be a double dip.
Again, you say “admit” like I have not ALWAYS held that money printing can temporarily goose an economy and prevent an inflation distorted economy from correcting.
But you don’t want anything done so you’d prefer a double dip. So you really do hold the the “liquidationist” theory.
I thought that was obvious.
I also adhere to the shakes and cold sweat theory of weaning off crack.
Yet I think that where the real difference between you and the MMers is money. As you think it’s just another commidity you can believe that there’s no such thing as a general glut and if prices fall low enough there’s some point they will clear the market-though this evidently can take years.
Evidently we have a state tinkers and meddles for years.
Who can remain unemployed for years, if not through being supported by others, and in the state’s case, supported by violence? Remove the violence, and the price system will function far more effectively, and what would have taken years, would take less than years.
Correction is prolonged not because money isn’t a commodity (it is), but because the process of economic calculation is seriously hampered by the state and its central bank in an attempt to stave off the correction.
It would be like our trusty crack addict being given secret doses of crack by a well intentioned but misguided doctor, because he can’t stand to see the addict shake and sweat.
Yes, it sucks that innocent people have to incur the costs of state intervention, and that is exactly why I am so extreme against state intervention. Only the market process can fix the problems, and that means the civilian population. So whatever mess the state makes, the people have to clean it up. If you don’t let them clean it up, if you keep them high on crack, then while you’ll prolong the withdrawal symptoms, you’ll also prolong the needed correction and hurt people more in the long run, as the future becomes even worse.
I am choosing the lesser of two evils. Not evil over good. The good you believe is good, is the worse of two evils.
21. June 2012 at 20:08
MF: “It follows from the argument I am making…”
You have made bold — and loud — assertions. Claims. Statements.
An argument? Not so much.
If only you actually had some justification for your beliefs. What a world that would be!
21. June 2012 at 22:19
Paul Andrews – sorry, yes, you are right. Fed payments to the Treasury are not what permanently increase the base, they simply stop it from falling through interest-payment leakages. The Fed increases the base by stepping up the rate at which it buys securities. I was earlier thinking in terms of the Fed payments to the Treasury being spent immediately and received by the public, which is now slightly wealthier in nominal terms and wants to spend more now. But that may not be right.
But I still say the Wallace theorem is absurd, as it is inconceivable that the public would permanently want to hold money balances equal to their entire nominal income, or the entire national debt. It’s even more inconceivable that the public would hold that much cash (NIOR). In fact Wallace himself seemed to take the “finance” view whereby the only thing that distinguishes money from debt is that it has a smaller denomination. He didn’t see money as a unique commodity, in the form of “bank liabilities” but which ultimately mediates all transaction of real output for real output. The proportion of the public’s portfolio which is money has special significance because it is the medium of account (boosting nominal spending) and the medium of exchange (boosting nominal output). A permanent increase in the available stock of money could only be neutralized in its impact on prices by a permanent increase in desired holdings. But since the liquidity trap doesn’t last for ever, and since the asset exchanges maintaining that permanently elevated money stock do eventually lower the yield on the public portfolio (as interest rates rise once the price level falls to equilibrium and labor is fully utilized again; hence my pointed questions to Scott about how long it takes AS to adjust), the public would not want to hold the money given it through a permanent OMO, and the path of NGDP must rise. But it would be better still to simply repair the public’s damaged expectations of the NGDP path by simply promising that the Fed wants it to return to a healthy level – then rising velocity would lift up NGDP without the Fed overextending itself.
And if even that (absurdly) didn’t work, we could always change the law and ditch the credit monetary injection mechanism entirely (helicopter drop, anyone?). The whole mess is a result of defining monetary policy as being about interest rates – in mechanical terms this leads to the ZLB perfect-substitutes problem, but more importantly in expectational terms it hinders the public from perceiving the Fed’s expansionary capacity at the ZLB. But as Nick Rowe argues that definition is just a social construct.
21. June 2012 at 23:08
If your theory is correct, the fed would make more income y growing NGDP at zero then at 5%. As demand for base money would be much larger under 0% NGDP growth. I find this hard to believe.
22. June 2012 at 01:25
Doc, excess demand for base money causes income to fall. Demand is a positive function of present income as well as a negative function of NGDP expectations, so if the one falls then so must the other to maintain equilibrium.
22. June 2012 at 03:31
No Merlin.
The slower the growth rate of nominal GDP, the higher the real demand for the base. With your zero percent growth, then holding base money when it is gaining value at 3% a year would be great. And, the fisher effect suggests that alternative investments would have very low nominal yields. However, the nominal interest rates on the bonds the Fed holds would be low too–perhaps zero. And so, the Fed would make no money.
A more rapid growth in nominal GDP reduces the demand for the base, but it raises the interest rate the Fed earns on Treasury securities while the amount it pays on currency is zero. And so it makes more money, even though the real base falls. (If it raises what it pays on reserves enough, the base money demand can be kept up, but the Fed makes no money.)
At some rate of NGDP growth, the added income (the bigger gap between the zero interest it pays and the higher interest it earns) is fully offset by the decrease in the real base people are willing to hold. And so more rapid growth in nominal GDP results in less income for the Fed.
If you just skip the nominal GDP growth part, then this is the simple analysis of how inflation is a tax on real money balances.
22. June 2012 at 05:20
Bill Woolsey –
Great comment as usual. I have one minor quibble over terminology – I don’t like the term “tax” in your final sentence. I think it’s more like a user fee, similar to charging oil companies for drilling on the coasts and other public properties. A nation’s currency, or the full faith and credit of the nation, is a public asset no less than the coasts or public lands – thus the nation has the right to profit from it.
Not a quibble, but a note you say when interest rates rise –
“And so it makes more money, even though the real base falls.”
Yes, but isn’t that offset dollar for dollar by Treasury losses? It seems to me real seigniorage has to be defined in terms of the consolidated balance sheet.
But I want to quote you here, because this is priceless:
“At some rate of NGDP growth, the added income (the bigger gap between the zero interest it pays and the higher interest it earns) is fully offset by the decrease in the real base people are willing to hold. ”
Exactly. There is a commonly held belief that “printing money” is always more profitable for the government, which you show to be false. There is a profit maximizing point just like anything else. In the long run, real seigniorage will be higher in a nation that keeps a stable currency than one that undermines the faith in its currency.
And of course, as Scott points out, maximizing seignorage at the expense of the real economy is foolish – you lose more in tax revenue and poverty benefits than you gain. You need to “optimize the whole” – which I believe in the long run market monetarism with stable NGDP growth will do. Like you, I’d pick about 3% (after an appropriate transition) but 5% would work fine too.
22. June 2012 at 06:34
Don Geddis:
You have made bold “” and loud “” assertions. Claims. Statements.
As well as arguments, and explanations.
If only you actually had some justification for your beliefs. What a world that would be!
I have justification for my convictions.
???
What was with that last post? It was nothing but vitriol and empty antagonism.
22. June 2012 at 07:59
Negation:
I favor a 3% nominal GDP trend, zero inflation, interest on reserves, private issue of currency and other money, and approximately no seniorage for the government.
I certainly don’t favor maximizing the revenue for the inflation tax (or seniorage.)
22. June 2012 at 08:51
NoI, I was taught that seignorage = (deltaM)/P. Not sure if that helps. The “inflation tax” is relatively small and mostly paid by criminals who hold lots of cash. This is different to shoeleather costs, which can be bigger and can bring down the economy under hyperinflation. But the real problem is that it’s really difficult to index the present tax code to inflation. Perhaps if my dreams came true and we had my ideal tax code it would be better to have 8% NGDP growth to further ameliorate wage stickiness.
22. June 2012 at 09:00
Bill Woolsey:
I favor a 3% nominal GDP trend, zero inflation, interest on reserves, private issue of currency and other money, and approximately no seniorage for the government.
If you also favor in kind taxes rather than US dollar taxes on private currency transactions, and if you favor the state ceasing its treating of private currency minters as domestic terrorists, then I can agree with you.
I’ll even agree with NGDP targeting (given the Fed has to exist), if the way the Fed inflates is only through every individual holder of US dollars, and not just a privileged group of “primary dealers”, to receive whatever equal sized no strings attached credits to their bank balances as is necessary to result in NGDP rising by 5% each year. That is, if NGDP isn’t rising by 5%, but 4.5% say, then everyone will get another round of equal sized credits to their cash accounts once more, until NGDP does rise to 5%.
This is the fairest method I can think of, and the method that will minimize the business cycle because it would approximately match the non-inflationary consumption/investment ratios.
This NGDP plan can be done through the Fed inflating the money supply through granting equal rates of interest on individual cash accounts, and to increase and decrease the rate in such a way that would result in 5% NGDP out of those cash balances.
So during a boom say, interest payments would fall, and during a recession, interest payments would rise. This has the further benefit of interest rate movements closely matching general interest rate movements, since interest rates do fall when saving and investment, and thus productivity, rises, and interest rates do rise when saving and investment, and thus productivity, falls. This is because interest rates are a function of profits, and profits rise when costs fall relative to revenues (lower relative saving and investment), and profits fall when costs rise relative to revenues (higher relative saving and investment).
So, considering what Sumner said about abandoning NGDP if Major_Freedom accepts it (with huge caveats), does this mean he’ll abandon NGDP targeting?
22. June 2012 at 09:26
Saturos:
I was taught that seignorage = (deltaM)/P.
The problem with this is that we can’t observe counter-factual P in a world without seigniorage.
Suppose we compare the following two hypothetical worlds, identical in every way except for the following:
1. Change in M = 0%. Change in P = -2%.
2. Change in M = 2%. Change in P = 0%.
In other words, if change in M were 0%, then prices would fall 2%, and if change in M were 2%, then prices would remain fixed.
Suppose we are IN world 2. That of course means we cannot observe world 1. If you then observe change in M and P in world 1., you might infer that there was no seigniorage, because while M increased, prices did not. So people are no worse off than they were before. Prices are unchanged, and anyone who complains about monetary inflation in world 1. are misguided because they’re paying the same prices as before in world 1.
Now suppose I come along and say hey wait a minute, there is seigniorage taking place, because we could have lived in world 2. had the increase in M not taken place. So while we’re paying the same prices as before in world 1., we missed out on paying 2% lower prices and live in world 2.
It would be like you eating and working out but not gaining any muscle mass because you have a tapeworm, and then you infer that because you’re the same weight as before, you’re no worse off because of the tapeworm. That, allegedly, only if you lost weight over time, would the tapeworm then represent a problem.
22. June 2012 at 09:40
Darn, I reversed the numbers.
It should read:
Suppose we are IN world 2. That of course means we cannot observe world 1. If you then observe change in M and P in world 2., you might infer that there was no seigniorage, because while M increased, prices did not. So people are no worse off than they were before. Prices are unchanged, and anyone who complains about monetary inflation in world 2. are misguided because they’re paying the same prices as before in world 2.
Now suppose I come along and say hey wait a minute, there is seigniorage taking place, because we could have lived in world 1. had the increase in M not taken place. So while we’re paying the same prices as before in world 2., we missed out on paying 2% lower prices and live in world 1.
22. June 2012 at 11:42
Adam, Thanks, I made that change.
Saturos, Just to play it safe, let’s just do partial copying in the future.
Mark, Yes, I think I did misunderstand Wallace neutrality. If that’s his claim, then I disagree even in theory.
Max, You said;
“If the central bank always stands ready to supply banks with base money as needed (which it does),”
I thought only MMTers believed that nonsense?
Richard, I’d have to look at the paper, but most of those “OMO are irrelevant” models err either in assuming money and bonds are close substitutes, or that fiscal policy drives monetary policy. Both are false in the US.
22. June 2012 at 11:56
Max:
If the central bank always stands ready to supply banks with base money as needed (which it does), then you can’t talk about a “demand for base money” the way you want to.
That’s an excellent point, Max. The supply of base money is determined by the Fed, and they always make sure the banks have enough base money to avoid bankruptcies of the most politically connected banks. Thus, saying banks have a demand for base money is like saying I have a demand for a particular quantity of air that I expect the air Gods to supply me with.
Of course the relative supply of / demand for base money vis a vis some aggregate like total spending can rise and fall on the basis of the lengths of time base money is desired to be held, but this “demand” for base money isn’t a demand for base money over NGDP. It’s apples and oranges. The “demand” here is decided by the quantity of base money the Fed creates, and the Fed has unlimited capacity to supply as much base money as it and the banks want.
22. June 2012 at 13:07
Scott, you need to explain what friction or risk is creating a difference between base money and riskless bonds for banks. As far as I know, the central banks themselves don’t make such a claim. They claim that QE works by “signaling”, or because interest rate risk is allegedly a substitute for equity risk, so there will be a portfolio rebalancing effect driving up equity prices (this is dubious given that interest rate risk is negatively correlated with equity risk under current conditions).
22. June 2012 at 17:04
Max, At zero rates there isn’t much difference, QE is mostly a signal of future monetary policy, if it is effective at all.
22. June 2012 at 21:59
Major Freedom, it’s (deltaM)/P, not (deltaM)/(deltaP).
22. June 2012 at 22:03
Seignorage is the transfer of wealth in the form of the government holding more of the money stock divided by its purchasing power.
22. June 2012 at 22:04
Sorry, divided by the price level to get its purchasing power.
23. June 2012 at 14:18
Saturos:
Major Freedom, it’s (deltaM)/P, not (deltaM)/(deltaP)
Seignorage is the transfer of wealth in the form of the government holding more of the money stock divided by its purchasing power.
Sorry, divided by the price level to get its purchasing power.
I thought seignoriage implied (meaning I’m not saying it is defined as) a change in purchasing power of money through currency devaluation (inflation), which then raises the price level for people but not their incomes right away, thus they end up paying an inflation tax.
If the currency issuer creates more currency, but the price level is assumed constant, then I would say inflation of the money supply has taken place, but not seigniorage at this point.
If you mean seigniorage as a change in money supply, given a price level, then to me that would mean inflation of the money supply, but not use of that additional money. But do those who create new money do so only to hold onto it?