Archive for the Category Quantity Theory of Money


Skidelsky on FDR’s gold-buying program

Robert Skidelsky has written a well-reviewed biography on Keynes.  Here he comments on FDR’s gold-buying program:

The gold-buying policy raised the official gold price from $20.67 an ounce in October 1933 to $35.00 an ounce in January 1934, when the experiment was discontinued. By then, several hundred million dollars had been pumped into the banking system.

The results were disappointing, however. Buying foreign gold did succeed in driving down the dollar’s value in terms of gold. But domestic prices continued falling throughout the three months of the gold-buying spree.

The Fed’s more orthodox efforts at quantitative easing produced equally discouraging results. In John Kenneth Galbraith’s summary: “Either from a shortage of borrowers, an unwillingness to lend, or an overriding desire to be liquid – undoubtedly it was some of all three – the banks accumulated reserves in excess of requirements. Reserves of member banks at Fed were $256 million more than required in 1932; $528 million in 1933, $1.6 billion in 1934, $2.6 billion in 1936.”

What was wrong with the Fed’s policy was the so-called quantity theory of money on which it was based. This theory held that prices depend on the supply of money relative to the quantity of goods and services being sold. But money includes bank deposits, which depend on business confidence. As the saying went, “You can’t push on a string.”

Keynes wrote at the time: “Some people seem to infer…that output and income can be raised by increasing the quantity of money. But this is like trying to get fat by buying a larger belt. In the United States today, the belt is plenty big enough for the belly….It is [not] the quantity of money, [but] the volume of expenditure which is the operative factor.”

I’m afraid that his analysis is both misleading and inaccurate.  The US gradually depreciated the dollar between April 1933 and February 1934.  During that period unemployment was nearly 25% and T-bill yields were close to zero.  Keynes argued that monetary stimulus would not be effective under those circumstances, and Skidelsky seems to accept his interpretation (which was published in the NYT during December 1933.)

[Note that Keynes certainly did believe in the “pushing on a string” theory–I frequently get commenters insisting that Keynes didn’t believe in liquidity traps.]

Unfortunately, Keynes and Skidelsky are wrong.  The US Wholesale Price Index rose by more than 20% between March 1933 and March 1934.  In the Keynesian model that’s not supposed to happen.  The broader “Cost of Living” rose about 10%.  Industrial production rose more than 45%.

And the gold-buying program was not an application of the quantity theory of money.  George Warren was an opponent of the QT, insisting that the quantity of money was not what mattered, that the price level was determined by the price of gold.  His views were much closer to Mundell than Friedman.  Keynes’s views on these issues were inconsistent and borderline incoherent.  Only a few weeks after Keynes argued that it was foolish to believe that currency depreciation could boost prices, FDR finally stopped depreciating the dollar.  How did Keynes react?  He congratulated FDR for rejecting the policy advice of the “extreme inflationists.”  By early 1934 prices were rising again.

The “disappointing” results that Skidelsky mentions come from cherry-picking a few misleading data points.  After the NIRA wage shock of late July, the real economy slumped and commodity prices started falling.  The value of the dollar also leveled off for a few months.  This led FDR to adopt the gold buying program in late October 1933. Despite the name, the actual “gold buying” was not large enough to be important–rather it was essentially a gold price raising program–a signal of future devaluation intentions.  This was well understood by the markets, and commodity prices tended to rise on days when FDR raised the gold price.  The broader WPI was relatively stable between September and December, and then started rising briskly again in early 1934.

It’s a mistake to focus on the tiny declines in the WPI during November and December 1933, which partly reflected sharply falling prices in Europe.  The key point is that the WPI and industrial production rose strongly during the period of dollar depreciation.

Skidelsky is a big fan of Keynes, but needs to read his hero’s writings with a more critical eye.  Other modern Keynesians like Krugman and Eggertsson have argued that FDR’s dollar devaluation program boosted the economy in 1933, and they are right.  They would also be horrified to see a Keynesian criticizing QE2:

Now the US, relying on the same flawed theory, is doing it again. Not surprisingly, China accuses it of deliberately aiming to depreciate the dollar. But the resulting increase in US exports at the expense of Chinese, Japanese, and European producers is precisely the purpose.

The euro will become progressively overvalued, just as the gold bloc was in the 1930’s. Since the eurozone is committed to austerity, its only recourse is protectionism. Meanwhile, China’s policy of slowly letting the renminbi rise against the dollar might well go into reverse, provoking US protectionism.

The failure of the G-20’s Seoul meeting to make any progress towards agreement on exchange rates or future reserve arrangements opens the door to a re-run of the 1930’s. Let’s hope that wisdom prevails before the rise of another Hitler.

I can’t see how depreciating the dollar against the euro would cause China to depreciate its currency against the dollar—I would have thought exactly the reverse.  What am I missing?  (Or was that a typo on Skidelsky’s part?)  And it wasn’t protectionism that led to the rise of Hitler, it was deflationary monetary policies in the US, France, and Germany.

PS.  Keynes is not my hero, George Warren is.  Anyone criticizing Warren in the blogosphere can expect a sharp rebuke from TheMoneyIllusion.

PPS.  His statement about the official price of gold being raised after October is also misleading.  The par value of gold rose all at once in early 1934.  The gold-buying price was already well above $20.67 by October 1933.  The focus should be on the market price of gold, which rose gradually over a period of about 10 months.

PPPS.  There is one strong similarity to late 1933; the conservative outrage over the gold-buying program forced FDR to stop it long before he reached his objective of reflating the price level to pre-Depression levels.  Now there are signs that conservative outrage over QE2 may be making it harder for Bernanke to achieve his inflation objectives, which are to return the inflation rate to pre-recession levels.  Plus la change . . .

HT:  JimP

It’s not just the economy that’s deflating

The universe shrank by 95% this year.  At least according to a recent theory of gravity by a distinguished Berkeley physicist:

HoYava’s theory has been generating excitement since he proposed it in January, and physicists met to discuss it at a meeting in November at the Perimeter Institute for Theoretical Physics in Waterloo, Ontario. In particular, physicists have been checking if the model correctly describes the universe we see today. General relativity scored a knockout blow when Einstein predicted the motion of Mercury with greater accuracy than Newton’s theory of gravity could.

Can HoYYava gravity claim the same success? The first tentative answers coming in say “yes.” Francisco Lobo, now at the University of Lisbon, and his colleagues have found a good match with the movement of planets.

Others have made even bolder claims for HoYava gravity, especially when it comes to explaining cosmic conundrums such as the singularity of the big bang, where the laws of physics break down. If HoYava gravity is true, argues cosmologist Robert Brandenberger of McGill University in a paper published in the August Physical Review D, then the universe didn’t bang””it bounced. “A universe filled with matter will contract down to a small””but finite””size and then bounce out again, giving us the expanding cosmos we see today,” he says. Brandenberger’s calculations show that ripples produced by the bounce match those already detected by satellites measuring the cosmic microwave background, and he is now looking for signatures that could distinguish the bounce from the big bang scenario.

HoYava gravity may also create the “illusion of dark matter,” says cosmologist Shinji Mukohyama of Tokyo University. In the September Physical Review D, he explains that in certain circumstances HoYava’s graviton fluctuates as it interacts with normal matter, making gravity pull a bit more strongly than expected in general relativity. The effect could make galaxies appear to contain more matter than can be seen. If that’s not enough, cosmologist Mu-In Park of Chonbuk National University in South Korea believes that HoYava gravity may also be behind the accelerated expansion of the universe, currently attributed to a mysterious dark energy. One of the leading explanations for its origin is that empty space contains some intrinsic energy that pushes the universe outward. This intrinsic energy cannot be accounted for by general relativity but pops naturally out of the equations of HoYava gravity, according to Park.
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The implausible Quantity Theory

Suppose the gold industry was a government monopoly, and also suppose the demand for gold was unit elastic.  Now suppose the government monopoly suddenly doubled the supply of gold.  What would happen to the relative price of gold in terms of other goods?  It would fall in half, wouldn’t it?  And that is true regardless of whether or not gold has any role as money.  We would get a sort of “gold inflation.”  Stuff would cost more in gold terms.  But not in dollar terms.

Now suppose that at some point gold was no longer used for anything other than (full-bodied) gold coins.  No more gold teeth and no more gold jewelry.  Now what happens if the government doubles the amount of gold, say from $100 per capita, to $200?  Again the value of gold would fall in half in terms of all other goods.  But this time prices wouldn’t just rise in terms of gold, prices would double in nominal terms, as gold is now money.  And this is true no matter how small a fraction of our wealth is held in the form of gold.
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Without a QTM anchor, macro is nothing more than undergrad BS

If you’ve ever taught intro to macro, you know that undergrads like to use “self-fulfilling prophesy” arguments for things they don’t understand.  Thus I am somewhat dismayed to see Robert Shiller use the same basic argument to explain why the economy has started to recover.  And yet, despite the derisive title of this post, I am also a bit sympathetic to Shiller’s recent NYT piece:

Consider this possibility: after all these months, people start to think it’s time for the recession to end. The very thought begins to renew confidence, and some people start spending again “” in turn, generating visible signs of recovery. This may seem absurd, and is rarely mentioned as an explanation for mass behavior late in a recession, but economic theorists have long been fascinated by such a possibility.

The notion isn’t as farfetched as it may appear. As we all know, recessions generally last no more than a couple of years. The current recession began in December 2007, according to the National Bureau of Economic Research, so it is almost two years old. According to the standard schedule, we’re due for recovery. Given this knowledge, the mere passage of time may spur our confidence, though no formal statistical analysis can prove it.

.   .   .

President Roosevelt is widely remembered for saying, in 1933, that “the only thing we have to fear is fear itself.” But he was only repeating an oft-told message.

It wasn’t until 1948 that the Columbia University sociologist Robert K. Merton wrote an article in The Antioch Review titled “The Self-Fulfilling Prophecy,” using the Great Depression as his first example. He is often credited with having invented the “self-fulfilling prophesy” phrase, but by the 1930s the idea was already as commonplace as the breakfast toast made with modern electric toasters. (Interestingly, the same Robert Merton documented the tendency for important ideas to be falsely attributed to celebrities.)

Like Shiller, I think that shifts in expectations are the driving force in business cycles.  But what bothers me about the self-fulfilling prophesy approach is that it treats expectations as sort of a free-floating concept, not anchored to fundamental determinants of long-run AD growth.  And I think there is a reason for this.  In some of my early posts I talked about how deflation always leads to a sort of dark ages of macro.  The problem is that economists use the wrong indicators for the stance of monetary policy; focusing on interest rates and the monetary base.  Both of these indicators tend to behave “perversely” during deflation.  Interest rates fall to low levels, and the public and banks tend to hoard base money.  So it looks like monetary policy is easy.  Once monetary policy is viewed as irrelevant, macroeconomics loses the only variable capable of anchoring long run expected NGDP growth.  And without the anchor provided by the Quantity Theory of Money, it’s all just undergraduate BS.  (No disrespect to any undergrads reading this, I am directing the same complaint against an outstanding Yale economist.)

Shiller is hardly the only economist who has written off monetary policy once rates hit zero.  And I give him credit for intuiting that expectations may be a more important driver of AD than fiscal policy.  But in the end, if macro can’t rely on certain basic principles, such as the long run relation between monetary policy and expected NGDP growth, then we really don’t have anything even worth calling a “social science.”

In the Great Depression many economists reverted to the crude prejudices of the man on the street.  It’s happening again.

The quantity equation, the quantity theory, and Bennett McCallum

I’ve always found it interesting that the quantity equation (M*V=P*Y) is linked to the quantity theory of money.  Obviously there is no logical relationship between the two, as one is almost always defined as an identity, while the other is a theory.  But there certainly is a perception that the two are somehow linked.

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