Channels to nowhere

When there is a big crop of apples, the value of apples tends to fall.  There is no need to discuss obscure “channels” such as bank lending.  Apples are worth less for “supply and demand” reasons. When there is a big crop of money, the value of money tends to fall.  Again, no need to talk about “channels.”  This post was motivated by a recent comment, which is something I see pretty often:

The CB [central bank] interacts with counterparties that have little or no propensity to spend and the lending channel is blocked.

That’s a fairly common view, and yet it contains no less than three serious fallacies.  This is what the commenter overlooked:

1.  Counterparties don’t matter.  The Fed buys assets from counterparty X, who almost always immediately cashes the check and the new base money disperses through the economy almost precisely as it would if the Fed had bought assets from counterparty Y, or counterparty Z.

2.  The propensity to spend doesn’t matter for the same reason.  Once counterparties get rid of the new base money, the impact on NGDP depends on the public’s propensity to hoard money, and any change in the incentive to hoard.  In the long run money is neutral and NGDP changes in proportion to the change in M, regardless of whether the person receiving the money has a marginal propensity to consume of 90% or 10%.  Either way they’ll almost always “get rid of” the new money, either by spending it or saving it.  Saving is not hoarding, it’s spending on financial assets.

3.  The lending channel doesn’t matter.  In the long run all nominal prices rise in proportion to the change in M.  In the short run sticky wages and prices cause the new money to have non-neutral effects.  Those non-neutral effects reflect wage and price stickiness, not “channels” of spending.

Here’s where the confusion comes from.  As soon as we move from a world of flexible prices and money neutrality (as with a currency reform) to a sticky-price world, real effects become the most noticeable short run effect of monetary shocks.  This causes many observers to reverse causality. They assume that easy money boosts real GDP, and if output rises enough it eventually triggers inflation. Thus they see real shocks triggering nominal changes.  If that’s your view of the world then channels of causation would seem to make lots of sense.  Why does RGDP change?  And which types of output change first?  Does more real lending cause more RGDP?  Do changes in interest rates cause more RGDP?  These are the questions you would ask.

If instead you think in terms of nominal shocks having real effects then the “channels” approach is totally superfluous.  A change in M causes a change in NGDP for supply and demand reasons, and if wages and prices are sticky then the change in NGDP triggers a change in RGDP.  Because NGDP affects RGDP, it will also affect all sorts of other real variables like real lending quantities and real interest rates.  But those are the effects of monetary shocks, they aren’t monetary shocks themselves.

Because money is a durable asset, expectations of the future value of money play an important role in its current value.  I suppose that is a channel of sorts, but it’s merely a channel connecting future expected NGDP to current NGDP.  To go from there to real variables such as output and employment, you simply need sticky wages and prices; channels like lending and interest rates add no explanatory power.

PS.  Ramesh Ponnuru has an excellent new post on monetary offset.

PPS.  Totally off topic, have other bloggers picked up this story:

The latest attempt by academia to wall itself off from the world came when the executive council of the prestigious International Studies Association proposed that its publication editors be barred from having personal blogs. The association might as well scream: We want our scholars to be less influential!


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106 Responses to “Channels to nowhere”

  1. Gravatar of Gabe Gabe
    24. February 2014 at 19:15

    If the counterparties of QE didn’t matter then the QE mechanism would run through the bank accounts of commoners like me. Instead QE is done through the most powerful private banks in the world like JP Morgan and Goldman Sachs.

    Sumner is trying to spread some real BS here.

  2. Gravatar of honeyoak honeyoak
    24. February 2014 at 20:20

    You are 100% correct Scott, the lending channel does not exist. Much confusion would be avoided if people realized that banks lend to borrow rather than the other way around.

  3. Gravatar of Major_Freedom Major_Freedom
    24. February 2014 at 20:31

    Gabe:

    Agreed. There is a reason the Fed deals only with specific counter-parties, the “primary dealers”. (And, off the books, specific counter-parties they don’t want the greater public to know about). It very much matters who gets the new money first. Sumner’s attempts to debunk all this a while back was a spectacular failure. He ended up making all sorts of loony claims, such as “inflation makes the counter-parties worse off.” Oh really? Then why would those counter-parties accept the funds? It was all rather embarrassing to read.

    This is thing with these monetary socialists. They are in a situation of having to appear as morally normal, but what they’re preaching, once the layers are peeled back, is pure naked violence. So they have to cover it up by pretending as if there is a purely intellectual justification for it all. It’s almost like a sickness. It makes them mentally worse and worse over time, and before they know it, they find they can’t take it any more, and do what Friedman did in his later life, which is repent and say “The Fed should be abolished.” A whole intellectual life devoted to monetarism, completely wasted…

    The first two “fallacies” Sumner “exposes”, where he simply asserts that counterparties will necessarily spend the money they receive from the Fed, is incorrect. You can give me $1 million cash, but it doesn’t necessarily mean I will spend what he expects or wants me to spend. I could very well hoard it, or, if I were a bank, lend it right back to the Fed via IOR and only spend the interest payments.

    In his 2., he just claims as if it were self-evident that “counterparties get rid of the new base money”. Sure, they might spend it, by trading with another bank. And then another bank. And so on. These exchanges don’t end up on Main Street. The whole derivatives markets was formed this way. When money is sloshing around the banking and financial system, it isn’t the case that all the money makes its way to wages on Main Street.

    It takes quite a large cognitive dissonance for someone to claim that QE, and Fed inflation in general, is not a system that benefits specific parties at the expense of every other.

    The fact that banks strive very hard to get on the primary dealer list, and the fact that existing primary dealers would not willingly give up their position, is all the proof we need that it benefits to be first in line to the Fed.

  4. Gravatar of Major_Freedom Major_Freedom
    24. February 2014 at 20:37

    “the lending channel does not exist. Much confusion would be avoided if people realized that banks lend to borrow rather than the other way around.”

    Can you explain that honeyoak? How can you say the lending channel does not exist in the first sentence, but then in the second sentence you say banks lend?

  5. Gravatar of Tom Brown Tom Brown
    24. February 2014 at 20:38

    Scott, in your view, would there be much difference, macroeconomically, between the Fed permanently increasing the stock of base money by $X by purchasing $X worth of Tsy bonds, and the Fed secretly condoning a cartel of counterfeiters who print up $X of super high quality money which passes every test for authenticity (and which of course gets circulated by these same counterfeiters domestically).

    If you say “no difference macroeconomically” then this says there’s no macroeconomic significance to the $X worth of Tsy bonds leaving the private sector in the former case, true?

    But I’m not sure what you’ll say, which is why I’m asking this question.

  6. Gravatar of Tom Brown Tom Brown
    24. February 2014 at 20:49

    … ah, maybe it’s the “secretly” which would be a problem in the latter (counterfeiters) case!

    What if the Fed publicly condoned this, and publicly stated it would allow $X worth to be counterfeited (but just didn’t say who the lucky counterfeiters were who getting this special privilege).

    Shoot, maybe it doesn’t have to be counterfeiters, maybe they just send checks our for $100 a piece in an Haiku writing contest, where the first $X/$100 entries are guaranteed winners: (must be a US citizen to enter).

    Pick whichever “latter” case you want: I think you see the point: in one case $X worth of stuff goes to the Fed, and in the other case it doesn’t: all else being equal. Does it matter?

  7. Gravatar of honeyoak honeyoak
    24. February 2014 at 20:52

    Major_Freedom,
    Banks don’t make profits by borrowing money (as they would just park it short term in a liquid asset). They make money by lending (also called asset formation) and borrowing at the prevailing rate of interest for that particular loan. Unless iliquid/insolvent a banker is never short of funds, but is always short of borrowers.

  8. Gravatar of ssumner ssumner
    24. February 2014 at 20:54

    Tom, It’s better to buy the bonds, counterfeiting makes the economy less efficent, as taxes must rise to cover the cost.

  9. Gravatar of Saturos Saturos
    24. February 2014 at 20:56

    I really love this post; I want to put it in the key blog posts section, or perhaps the Intro Course.

  10. Gravatar of lxdr1f7 lxdr1f7
    24. February 2014 at 23:18

    “1. Counterparties don’t matter. The Fed buys assets from counterparty X, who almost always immediately cashes the check and the new base money disperses through the economy almost precisely as it would if the Fed had bought assets from counterparty Y, or counterparty Z.”

    The base doesnt disperse much at all thats why we are getting excess reserves, increased hoarding of deposits at the commercial banks by QE counterparties and portfolio rebalancing. These counterparties are not spending they are largely just giving up the asset and just rebalancing their portfolios into similar assets to what they just gave up in QE operations.

    The principle beneficiaries of all this asset shifting is existing asset holders through increased asset prices. Assets are very unnevenly held. For example 90% of stocks are held by the top 20% so therefore an increase in stock prices only benefits only the top 20% which also have a lower MPC limiting the effectiveness of policy.

    If the CB would interact with people broadly they would realize greater levels of spending for every expansion of money because the average person has a higher MPC than the existing set of asset holders. Also if people receive money during expansion their net worth would improve making them more accessible to credit. Its not necesary to expand money in exchange for treasuries, money can be created safely if NGDP or inflation is monitored to regulate rate of money expansion.

  11. Gravatar of lxdr1f7 lxdr1f7
    24. February 2014 at 23:30

    ” In the long run money is neutral and NGDP changes in proportion to the change in M”

    Just over 5 years ago M0 (money supply) more than doubled but we havent seen NGDP double. Am I missing something?

  12. Gravatar of lxdr1f7 lxdr1f7
    24. February 2014 at 23:50

    SSumner

    Can you or anyone else show me the chain of causation of increased spending as a result of a QE purchase of MBS with a company like Goldman? I know a company like Goldman or existing asset holders do have an MPC or MPS but it is much lower than average if policy was performed evenly with the broad public.

    All Goldman does is they sell 1 million of MBS to Fed for example. They receive these funds and rebalance their portfolio similar to what it was before QE operation. This moves up asset markets (assuming ceteris paribus). Existing asset holders now have higher wealth and due to wealth effect spend more.

    Goldman wont go and buy 100 thousand worth of clothes, make mortgage repayments, spend 10 thousand on haircuts etc… on the other hand the general public will if you transferred money to them.

  13. Gravatar of Ralph Musgrave Ralph Musgrave
    25. February 2014 at 01:44

    Re Ramesh Ponnuru and monetary offset, monetary offset is the biggest load of nonsense on the face of planet Earth.

    Essentially it consists of saying that if there are two ways (A and B) of doing something, then the greater the extent to which A is employed, the less the extent to which B will be employed (all else equal) and that that proves A (or B) is useless / ineffective.

    There are two ways of imparting stimulus: monetary and fiscal. The fact that employing more of one means employing less of the other does not prove that either is defective or useless.

    There are two ways of getting NASA rockets into space: solid fuel and liquid fuel booster rockets. The more one employs of one, the less one needs to employ the other. Market monetarists will tell you that that proves solid fuel (or liquid fuel) rockets are useless.

  14. Gravatar of Alexei Sadeski Alexei Sadeski
    25. February 2014 at 02:25

    When I saw the title, I was positive that I’d be reading about Comcast-TWC.

    Sometimes it’s nice to be wrong 🙂

  15. Gravatar of Ralph Musgrave Ralph Musgrave
    25. February 2014 at 02:34

    I agree with Gabe who says “Scott is trying to spread some real BS here”. Scott’s insistence that channels (i.e. cause and effect) don’t matter is the sort of reasoning that was popular in the Middle Ages before the dawn of science.

    With a few notable exceptions, like market monetarists, most of us live in the 21st century. That is, if someone wants to claim that A causes B, we want to be shown some VERY DETAILED reasons / channels that explain exactly why and how A causes B.

    It just won’t do to say that assuming an increase in M increases NGDP and assuming sticky prices, then RGDP will rise. That’s about as useful as me saying that assuming the law of gravity ceases to operate in the room I’m sitting in, I’ll float up in the air.

  16. Gravatar of Rajat Rajat
    25. February 2014 at 03:20

    I really like this post too. Scott is very good at cutting through the stories and memes we hear with his own provocative aphorisms. These sorts of posts really make me think and allow me to test my understanding.

    It’s a real shame people can’t stop and think a bit before they rush to make derogatory comments.

  17. Gravatar of Michael Byrnes Michael Byrnes
    25. February 2014 at 03:57

    lxdr1f7 wrote:

    “The base doesnt disperse much at all thats why we are getting excess reserves, increased hoarding of deposits at the commercial banks by QE counterparties and portfolio rebalancing. These counterparties are not spending they are largely just giving up the asset and just rebalancing their portfolios into similar assets to what they just gave up in QE operations.”

    You are making assumptions here without supporting them.

    You are assuming that the massive buildup of excess reserves during QE means that bank lending would have been exactly the same without QE as with it (the new money is just sitting there as excess reserves). I think a more likely argument is that without QE, both excess reserves AND bank lending would be significantly lower than they are today.

    Banks are actively trading treasuries and MBS for reserves – this indicates that they prefer to hold excess reserves rather than assets of similar value (treasuries and MBS). If they didn’t have the option of trading MBS and treasuries for excess reserves, they would have to accumulate excess reserves by other means, such as not lending.

  18. Gravatar of Daniel Daniel
    25. February 2014 at 04:33

    Ralph Musgrave,

    Does fiscal stimulus magically boost output without increasing inflation ?

    My answer is “no” – as should be yours.

    So, if not – what do you think a central bank with an inflation target would react to fiscal stimulus ?

    Unless your answer is “tighten monetary policy”, you are wrong.

    So, if a central bank is given a nominal target, it will actively sabotage fiscal stimulus. Aka “monetary offset”.

    If you think that’s “the biggest load of nonsense on the face of planet Earth”, it is you who lives “before the dawn of science”.

  19. Gravatar of lxdr1f7 lxdr1f7
    25. February 2014 at 05:41

    Michael Byrnes

    “You are assuming that the massive buildup of excess reserves during QE means that bank lending would have been exactly the same without QE as with it (the new money is just sitting there as excess reserves). I think a more likely argument is that without QE, both excess reserves AND bank lending would be significantly lower than they are today.

    I didn’t mention lending in the paragraph you quoted. I was talking about how the expansion in base is limited in its effectiveness through QE because counterparties mostly just rebalance portfolios which mainly affects asset prices and not spending.

    “Banks are actively trading treasuries and MBS for reserves – this indicates that they prefer to hold excess reserves rather than assets of similar value (treasuries and MBS). If they didn’t have the option of trading MBS and treasuries for excess reserves, they would have to accumulate excess reserves by other means, such as not lending.”

    If more money was placed in the hands of the public through MP then demand would pick up with profits and lending instead of accumulating excess reserves.

  20. Gravatar of Benjamin Cole Benjamin Cole
    25. February 2014 at 05:42

    Okay…

    but, in the past, Scott Sumner has said that QE would be more effective if IOER was reduced. And banks have piled up excess reserves.

    That indicates to me there is some Sumnerian acceptance of the idea that people sell Treasury bonds to the Fed’s QE program, but then bank the money. The sellers want liquidity and no interest-rate risk.

    The banks are supposed to intermediate, but now they are not to the full extent possible.

    “Saving is not hoarding, it’s spending on financial assets.”–Sumner.

    But what if I save the $100k from my sale of Treasures to the Fed by depositing the cash into my commercial bank, and my bank sits on the money? In part, to collect IOER?

    To some degree I think this situation is getting better. Bank C&I loans are rising nicely, so perhaps banks are beginning to lend out their QE cash. Real estate is doing better too.

    I still think QE is the way to go, and Milton Friedman was right in saying that if QE doesn’t work, then pour it on and do more QE. Sooner or later it will work, or we will have paid off the national debt, which would be such a boon that we would have a recovery based on that.

    As it is, I think we have liquidate or monetized a few trillion in debt, and “gotten away with it.” There is no need to ever re-sell the Fed QE hoard back to the public, or ever let the the total size of the hoard diminish.

    But I would like some clarity on the role of excess reserves swelling by the trillions.

  21. Gravatar of J Mann J Mann
    25. February 2014 at 05:43

    Ralph, if you go back to Krugman or Delong, they both believe that fiscal stimulus works at the ZLB specifically because the fed can’t (or won’t or might not be able to) hit its inflation target, which prevents the fed from counteracting the effect of fiscal stimulus.

    So if the fed really wants 2% inflation, or 4%, or whatever, but won’t produce it (either because it can’t or because political contraints prevent it from doing so), then fiscal stimulus will have some effect.

    That question – has the fed been constrained for the last 6 years from producing desired inflation, and is it contrained now – is an empirical one that I am not smart enough to answer. But it’s not nonsense to ask whether it is or not. If the fed wants more inflation than it can or will produce, then Scott is wrong, but if it’s able to get the amount of inflation it wants, then he’s right.

  22. Gravatar of Benjamin Cole Benjamin Cole
    25. February 2014 at 05:48

    So there is a large crop of apples, but on the way to market, powerful apple speculators raid the apple convoy and put 90 percent of the apples in warehouses (let’s assume apples are not very perishable).

    Is the analogy that the Fed has the power to grow even more apples, so the sequestering by the apple speculators is meaningless—if the Fed has resolve and keeps bringing apples to market?

    You know, maybe I will quit economics and take up gardening for my next obsession…

  23. Gravatar of Roger Sparks Roger Sparks
    25. February 2014 at 06:42

    Scott,

    I don’t think you correctly incorporate the role of TIME in your critique.

    Your assumption that new-money flows quickly through the economy can be challenged by the observation that new-money seems to always end up in the hands of a few collectors. New-money does not disappear or decay. Instead, it comes to rest in the hands of mostly pension funds and personal savings.

    The challenge to your assumption would continue by pointing out that pension funds(and personal savings)are benefited by smart lending. If smart-lending is not possible, then only dumb-lending remains as an option and lending is likely to slow. Slower lending results in sticky money movement demonstrated by lower velocity measurements.

    Lending never reduces the money supply except to the extent that each movement of money may pass the tax collector which DOES reduce the money supply (at least according to MMT advocates). Lending may also move money past the loan repayment box which could also reduce the money supply. Otherwise, money movement does not by itself reduce the money supply.

    To summarize, I think you are expecting a rapid disbursement of new-money throughout the economy. In contrast, I believe that the disbursement is very slow, with money quickly coming to rest in the form of pension funds and personal savings.

  24. Gravatar of Matt McOsker Matt McOsker
    25. February 2014 at 07:38

    Scott writes:

    “Either way they’ll almost always “get rid of” the new money, either by spending it or saving it. Saving is not hoarding, it’s spending on financial assets.”

    I think this is the crux of most QE arguments. Let’s say nobody is spending the base money on products or services. Let’s say the majority of the QE purchases are from financial institutions (pensions), who after unloading the stuff PREFER to holds reserves and be more liquid or shift top other assets. I guess this might boost profits and capital positions or pension funding, but is it as powerful as spending on products and services? Does it maintain financial institution jobs? The transmission mechanism on this aspect seems more complex to me than direct spending or possibly slower to filter into gdp.

  25. Gravatar of Matt McOsker Matt McOsker
    25. February 2014 at 07:43

    I meant ‘or’ pensions above. Any larger financial entity versus direct household.

  26. Gravatar of Floccina Floccina
    25. February 2014 at 08:11

    Gabe don’t the banks then loose on the other end when the fed starts buying bonds because they are the first to sell?

  27. Gravatar of Major_Freedom Major_Freedom
    25. February 2014 at 08:13

    honeyoak:

    “Banks don’t make profits by borrowing money (as they would just park it short term in a liquid asset). They make money by lending (also called asset formation) and borrowing at the prevailing rate of interest for that particular loan. Unless iliquid/insolvent a banker is never short of funds, but is always short of borrowers.”

    OK, that is something very easy to agree with.

    I still don’t see how it makes sense to say that the lending channel does not exist.

    Lending is the primary means by which new money enters the accounts of people other than those in the Federal Reserve System. That is, in order for NGDP and M3 to rise appreciably, almost equal amounts of bank created lending and debt is required.

  28. Gravatar of Major_Freedom Major_Freedom
    25. February 2014 at 08:15

    Another significant component is of course investing in equity and derivatives.

  29. Gravatar of Ilya Ilya
    25. February 2014 at 08:29

    I do not understand what you mean when you say “The Fed buys assets from counterparty X, who almost always immediately cashes the check and the new base money disperses through the economy”

    What “checks” are you referring to? Doesn’t the Fed just increase the total base existing in the balances of depository institutions, ie., commercial banks?

    And in what sense do these commercial banks “spend” the base money? I understand what you mean if OMOs occurred with the general public like you and me, but they occur through banks, right?

    So, I have to second lxdr1f7’s question. Can you please be much more specific of the chain of causation? I understand the general theory of what you are saying, but since OMOs go through banks I don’t understand the precise mechanism. An example with a hypothetical bank would be useful.

  30. Gravatar of Ilya Ilya
    25. February 2014 at 08:31

    Moreover, what’s to stop these said banks from just holding onto the new base as excess reserves?

  31. Gravatar of Mark A. Sadowski Mark A. Sadowski
    25. February 2014 at 08:58

    Scott,
    Off Topic.

    Roger Farmer argues that sticky prices play no role in explaining why aggregate demand (AD) has real effects by appealing to the Keynesian Cross, a model of AD which assumes prices are fixed, and which in its original form made no reference to aggregate supply (AS):

    http://rogerfarmerblog.blogspot.com/2014/02/a-quiz-for-wannabe-keynesians.html

    February 24, 2014

    My Quiz for Wannabe Keynesians
    By Roger Farmer

    “…The upward sloping green line, at 45 degrees to the origin, is the Keynesian aggregate supply curve. This green line is the Keynesian theory of aggregate supply. It says that whatever is demanded will be supplied.

    The upward sloping red line is the Keynesian theory of aggregate demand…”

    This isn’t Keynes’ AD-AS Model. This is Samuelson’s Income-Expenditures Model, often called the Keynesian Cross.

    It is derived from a pair of 1939 papers by Paul Samuelson on the interaction of the multiplier and acceleration principle and first appeared as the analytical core of his 1948 textbook. Whether or not the analysis underlying the Keynesian Cross is to be actually found in Keynes is still a matter that is hotly debated.

    The Keynesian Cross is a model of aggregate demand (AD) under the specific assumptions of a fixed price level and fixed interest rates. The 45 degree line represents the equilibrium condition where income equals expenditures. The other line represents planned expenditures, and is a function of income. Some textbooks label the horizontal axis as output, production or GDP in addition to income, but this is under the assumption that all points on the 45 degree line are also at the point of intersection between AD and AS, which Keynes termed “effective demand” in Chapter 3 of “The General Theory of Employment, Interest and Money”. However, in Samuelson’s original 1948 textbook, the horizontal axis was simply labeled “national income”.

    Key features of Keynes’ analysis are completely missing from the Keynesian Cross. It is a model of AD in which prices, interest rates and money play absolutely no role.

  32. Gravatar of Matt McOsker Matt McOsker
    25. February 2014 at 09:33

    Ilya – see my post above. It seems that is exactly what banks have been doing – holding the excess reserves – maybe they want to, maybe they don’t, and maybe they have no choice. Even with more lending, excess reserves would simply shift to required reserves.

  33. Gravatar of o. nate o. nate
    25. February 2014 at 10:40

    Because money is a durable asset, expectations of the future value of money play an important role in its current value.

    I think this is the key to understanding this. Talk about “M” is a red herring. The only thing that matters is inflation expectations. If people expect inflation, there will be inflation. Increasing “M” doesn’t budge inflation expectations as long as the Fed maintains it’s 2% inflation target, since people rightly expect that “M” will be withdrawn if and when necessary to hit that target. All the Fed needs to do to increase inflation is to change its inflation target. If the Fed announced it was raising its inflation target to 5%, inflation would happen.

  34. Gravatar of Doug M Doug M
    25. February 2014 at 11:00

    “When there is a big crop of apples, the value of apples tends to fall. There is no need to discuss obscure “channels” such as bank lending.”

    Okay, lets create some apple channels.. If you are an apple grower, and you see the bumper crop of growing on the trees, it is in your interest to sell as many apple futures as you can before the public is aware of the on coming apple glut.

    While not the case for apples it is the case for other agricultural commodities (or has been in history) that there has been a single exchange or a very small set of brokers who work between the producers and the public. It is in these brokers interest to keep the actual supply of “apples” secret and to put newly harvested apples into public circulation at the highest average price that they can. The broker may buy apples to bid up the price in order to sell. And, it has happened that it is in the broker’s interest to destroy a portion of his inventory because that will maximize total revenue.

    If the market is large and liquid, and information is more or less symmetric, the channels become irrelevant. But those ifs are non-trivial.

    On to banking….
    The Fed puts money into its counterparties accounts and tells them that they cannot spend or invest a fraction of that money (required reserves)
    The Fed pays its counterparties to not spend or invest or save as defined above. (interest on reserves)

    This is a great sentence:

    “Either way they’ll almost always “get rid of” the new money, either by spending it or saving it. Saving is not hoarding, it’s spending on financial assets.”

    I agree completely! But, lets look into it. When does the bank not “get rid of new money.” When it is told it can’t and when it is paid not to as described above. But really… when the financial assets that a bank might consider buying do not have adequate reward for the perceived risk. When this happens, like after a financial crisis, we describe the bank lending channel as being blocked.

  35. Gravatar of Matt McOsker Matt McOsker
    25. February 2014 at 11:14

    Doug M,

    Can the banking system get rid of excess reserves? I say no. If someone spends those reserves it goes to another bank as excess reserves – total in system is the same where the position of an individual institution might change. If the bank lends more, then excess shifts to required. The more spending or lending happens (velocity) the better, and I think is the hot potato effect Scott often refers to (hope I get this right). But the only way the total excess reserves changes is if the FED drains it by selling bonds back, the Federal Government runs a surplus, or more lending shifts excess to required.

  36. Gravatar of Doug M Doug M
    25. February 2014 at 11:48

    Matt McOsker,

    “Can the banking system get rid of excess reserves?”

    The Monetary base is reserves plus currency. The reserves may be excess or required, but from this point of view it would appear that the Fed cannot reduce the total level of reserves without reducing the money supply. But…

    When a bank lends money, that banks reserves will fall but total reserves across the system remain, more or less, unchanged, because that money once lent and spent will eventually find its way bank to the banks. But some fraction of that is now required reserves.

    So, yes it can.

    When the Fed pays interest on excess reserves it is creating a disincentive to lend. Lending rates must now be 25 bps higher to be equally profitable.

  37. Gravatar of ssumner ssumner
    25. February 2014 at 11:54

    Thanks Saturos.

    lxdr, I’m pretty sure most counterparties are putting the money in the bank.

    You said;

    “Just over 5 years ago M0 (money supply) more than doubled but we havent seen NGDP double. Am I missing something?”

    Yes, the Fed indicated that the increase would be temporary, and/or IOR would be raised enough to prevent high inflation. I was making a ceteris paribus claim.

    Ralph, Your rocket metaphor isn’t at all applicable, and you don’t seem to understand my point about channels. What is the channel by which more apples makes its value fall?

    Ben, That may be true in some cases, but when I sell stocks and bonds I don’t put the funds into cash, I put it into other financial investments.

    Roger, You said:

    “Your assumption that new-money flows quickly through the economy can be challenged by the observation that new-money seems to always end up in the hands of a few collectors. New-money does not disappear or decay. Instead, it comes to rest in the hands of mostly pension funds and personal savings.”

    That is simply incorrect. Prior to 2008, 98% of all new money quickly went out to currency in circulation. Pension funds hold very little currency.

    More recently most goes into ERs.

    Ilya, it makes no difference who they buy the bonds from. Some are bought from banks, some from non-banks. Prior to 2008 most turned into currency, which was typically not held by the bond seller. Even after 2008 the ERs are often held by banks that did not sell the bond to the Fed. Those are two separate decisions. Bank X might sell a bond, and bank Y might increases ERs.

    Mark, Another great comment.

    o. nate, Yes, but it must also make sure the money market is in equilibrium, perhaps by pegging CPI futures.

    Doug, A financial crisis does not cause banks to hoard reserves, low nominal rates do.

    Matt, Banks can get rid of ERs by lowering the interest on deposits, into negative territory with high service fees. This causes the public to hoard cash.

  38. Gravatar of Doug M Doug M
    25. February 2014 at 12:06

    “Doug, A financial crisis does not cause banks to hoard reserves, low nominal rates do.”

    Low nominal rates for the level of risk cause banks to hoard reserves. And, the perceptions of risk, the capacity to absorb risk, or the capacity to distribute risk are impaired following a financial crisis.

  39. Gravatar of Doug M Doug M
    25. February 2014 at 12:06

    “Doug, A financial crisis does not cause banks to hoard reserves, low nominal rates do.”

    Low nominal rates for the level of risk cause banks to hoard reserves. And, the perceptions of risk, the capacity to absorb risk, and the capacity to distribute risk are impaired following a financial crisis.

  40. Gravatar of Tom Brown Tom Brown
    25. February 2014 at 12:07

    Scott,

    1. if the CB buys $X in Tsy bonds from the private sector, then base money has increased by $X, correct? There’d be $X in reserves that weren’t there before in various commercial banks.

    2. Now what if all the commercial banks merged together into one giant monopoly commercial bank? Same story? $X in new base money?

    3. Now what if this new monopoly commercial bank is nationalized? It’s kept “independent” from the Fed, Tsy and the rest of gov, and it’s essentially run the same as a commercial bank, obeying all the same laws, and managed to make a profit: the same as before it was nationalized.

    4. Now what if instead of Tsy bonds, the Fed buys a new $X coin for $X in Fed deposits from Tsy, and Tsy is not authorized to spend the proceeds of this sale? Assume the coin cost $0 to mint. Any difference between this case and case 3?

    The biggest difference between 3. and 4., it seems to me, is that 3. results in credit being extended in the form of private sector bank deposits to the private sector bond sellers. Are all the privately bank deposits in case 3 (the pre-existing ones as well as the $X in new ones) now considered to be “base money” since this bank can be considered to be part of “government” even though they are still not Fed deposits (reserves)?

  41. Gravatar of Matt McOsker Matt McOsker
    25. February 2014 at 12:40

    Scott writes: “Matt, Banks can get rid of ERs by lowering the interest on deposits, into negative territory with high service fees. This causes the public to hoard cash.”

    Good point, and I assume you mean the public withdraws their deposits as cash. Do you think it that would be feasible politically or operationally for people to stuff billions or a trillion in their mattresses?

    I’d say behaviorally people are already losing on an inflation adjusted basis. I will agree that could increase the hot potato effect as people shift to longer term deposits or other financial instruments being the more likely scenario, and I assume that is the hot potato effect you would be looking for? Will it meaningfully drain reserves? I guess there is probably a price for everything.

  42. Gravatar of Matt McOsker Matt McOsker
    25. February 2014 at 12:45

    Scott I know you are busy (thanks for the replies) and maybe someone else can chime in here too. In the negative rate scenario, so long as the government conducts enough deficit spending, isn’t that keeping a supply of instruments that pay enough for the banks to earn an adequate spread – thus excess reserves remain stubborn? Whereas a shortage of higher yielding instruments creates a different scenario?

  43. Gravatar of Ilya Ilya
    25. February 2014 at 16:04

    Scott,

    If I understand you correctly, are you saying that the transmission mechanism NECESSARILY runs through the monetary base becoming cash and then that cash being spend?

  44. Gravatar of Mike Sax Mike Sax
    25. February 2014 at 16:28

    “Does fiscal stimulus magically boost output without increasing inflation?”

    Actually there can be a fiscal expansion without increasing inflation so it’s not magic. In the 80s Reagan’s deficits didn’t increase inflation. A deficit only increases inflation if it leads to the expectation that interest rates are going to go up.

    “So, if not – what do you think a central bank with an inflation target would react to fiscal stimulus”

    Depends which CB.

    “Unless your answer is “tighten monetary policy”, you are wrong.”

    “So, if a central bank is given a nominal target, it will actively sabotage fiscal stimulus. Aka “monetary offset”.

    Eccles didn’t ‘actively sabotage’ or even passively sabotage fiscal stimulus-ie, there was no monetary offset.

  45. Gravatar of Daniel Daniel
    25. February 2014 at 16:59

    Mike Sax,

    Good to know you’re still a moron.

    Should I head over to your pathetic little blog to read how you, once again, demolished one of Sumner’s acolytes ?

  46. Gravatar of Mike Sax Mike Sax
    25. February 2014 at 17:24

    Good to know you have nothing but a child’s insults and nothing much else. It certainly takes very little to demolish you.

  47. Gravatar of lxdr1f7 lxdr1f7
    25. February 2014 at 17:49

    “Yes, the Fed indicated that the increase would be temporary, and/or IOR would be raised enough to prevent high inflation. I was making a ceteris paribus claim.”

    5 years is temporary? Base has multiplied about five fold since 2008 now also.

    “Ilya, it makes no difference who they buy the bonds from. Some are bought from banks, some from non-banks. Prior to 2008 most turned into currency, which was typically not held by the bond seller. Even after 2008 the ERs are often held by banks that did not sell the bond to the Fed. Those are two separate decisions. Bank X might sell a bond, and bank Y might increases ERs.”

    That money just gets parked at the bank and is saved or hoarded depending on your definition. Similar in effect to excess reserves. Insufficient spending is coming about from this.

    “That is simply incorrect. Prior to 2008, 98% of all new money quickly went out to currency in circulation. Pension funds hold very little currency.”

    If the credit channel is functional then MP effectiveness will increase. But by far the most effective method is through broad interaction with the public which have a higher MPS and will experience positive balance sheet effects of direct money issuance.

    Im not sure what you mean by 98% of new currency went into circulation?

  48. Gravatar of Roger Sparks Roger Sparks
    25. February 2014 at 19:26

    Scott,
    “That is simply incorrect. Prior to 2008, 98% of all new money quickly went out to currency in circulation. Pension funds hold very little currency.

    More recently most goes into ERs.”

    Some MMT advocates (you are not one) would say that the Federal Deficit is all new money, mostly in the form of new deposits but also some small amount of currency. They would say that prior to 2008, most of the new money went to finance the expanding Federal Debt. That was even more true after 2008.

    I am unclear on your opinion of how “new money” enters the economy. From your comment, I gather that new currency is new money but new deposits must be something else.

    MMT is clear in following new-money from creation to deposit to death. Of course, we seldom see government-side-money death but we certainly do see government-side-money withdrawn by contract when the Fed or Treasury sells bonds.

    In my opinion bank-side-money is a second fraction of money supply. Bank-side-money is apparent money supply measured by bank deposits. The decision-making-public makes decisions based on the size of these deposits. That fact leads me to carefully consider how bank deposits interact with the broader Money Supply Concept of macroeconomics.

  49. Gravatar of ssumner ssumner
    25. February 2014 at 19:26

    Doug, T-bill yields need to fall to zero.

    Tom, I don’t follow that, can you tell me where it is all going?

    Matt, Trillions would be politically implausible–not clear why the Fed would want to do that anyway.

    Not sure I follow your second comment, can you be more specific?

    Ilya, No, bank reserves are also important. But cash is the main story.

    Mike, You said;

    Actually there can be a fiscal expansion without increasing inflation so it’s not magic.” That has no bearing on the issue of whether a fiscal expansion can CAUSE higher output without boosting inflation. NGDP growth fell during the Reagan era, so it certainly wasn’t an AD story.

    lxdr, Read my answer more carefully. If there was no IOR and the increase were expected to be permanent then probably we’d have hyperinflation right now.

  50. Gravatar of ssumner ssumner
    25. February 2014 at 19:37

    Roger, I’m referring to the money created by the Fed, the base. Other entities create bonds, deposits etc. I focus on Fed policy.

  51. Gravatar of Doug M Doug M
    25. February 2014 at 19:43

    “Doug, T-bill yields need to fall to zero.”
    T-Bill rates are zero!

    But, there is no incentive to buy T-bills if the T-bill rate is below the cost of funds.

  52. Gravatar of Tom Brown Tom Brown
    25. February 2014 at 20:32

    Scott, I saw your response over on another page (to a similar question, thanks),

    …but,

    anybody else want to give me their opinion? (see above):

    https://www.themoneyillusion.com/?p=26213#comment-320143

  53. Gravatar of Tom Brown Tom Brown
    25. February 2014 at 23:16

    Scott based on your answer here:

    https://www.themoneyillusion.com/?p=26219#comment-320145

    Let me paint two simple cases in a cashless society:

    Case 1:
    CB has $1 of reserve liabilities. Commercial banks have $10 of customer deposit liabilities. Base money = $1.

    Case 2:
    CB has $1 of reserve liabilities. Commercial banks have $10 of customer deposit liabilities. Now the commercial banks are nationalized. So after nationalization base money = $10?

    If “Yes” then we can expect that in the long term, prices in Case 2 will be 10x their initial level (and 10x the prices in Case 1), all else being equal?

  54. Gravatar of Tom Brown Tom Brown
    25. February 2014 at 23:30

    Anybody: I’d also be interested in your answer to my question above:

    https://www.themoneyillusion.com/?p=26213&cpage=2#comment-320280

    Thanks.

  55. Gravatar of Ralph Musgrave Ralph Musgrave
    26. February 2014 at 02:02

    Daniel,

    You ask “Does fiscal stimulus magically boost output without increasing inflation?” Strikes me the answer to that is simple: any sort of stimulus (monetary or fiscal) will not be inflationary as long as the economy has significant spare capacity – i.e. as long as unemployment is above NAIRU.

    J.Mann,

    What you are arguing, if I’ve got you right, is as follows. There are two ways doing something (imparting stimulus). If one is a bit defective, that proves the other works. If it’s not defective, that proves the other doesn’t work. That strikes me as false logic.

    The fact that monetary policy (or solid fuel boosters on a rocket) are a bit defective, tells you nothing about whether the alternative (fiscal policy/ liquid fuel boosters) work or not.
    Moreover, the question as to whether fiscal stimulus works or not is not really relevant. Reason is that Scott’s monetary offset argument assumes that both monetary and fiscal boost DO WORK. His argument is that the more fiscal is used, the less monetary will be used (which is true). But that, contrary to Scott’s claims, does not prove there is anything wrong with fiscal policy.

    And if anyone is interested on what I think the optimum mix of fiscal and monetary policy is, I think there should be $1 of monetary stimulus for every $1 of fiscal stimulus. That’s the policy advocated by most MMTers, far as I can see. And one argument for the latter 50:50 mix is that both monetary and fiscal policies have their defects. But when implemented on a 50:50 basis, the defects of one tend to be counteracted by the other. I did a post on that point here:

    http://ralphanomics.blogspot.co.uk/2014/02/merging-monetary-and-fiscal-policy.html

  56. Gravatar of Daniel Daniel
    26. February 2014 at 04:33

    Ralph Musgrave,

    You do realize that your latest rambling is incoherent, right ?

    First you say you CAN increase output without inflation.
    And then you say “the more fiscal is used, the less monetary will be used”.

    Those two simply cannot be true at the same time.

  57. Gravatar of c8to c8to
    26. February 2014 at 06:32

    IOR = intention over-ruled.

    there is one interest rate that does matter, and thats IOR. lets call it the IOR offset.

    fiscal policy is impotent because of the monetary offset, monetary policy is impotent (ish) because of the IOR offset.

    Thats why the base went through the roof and we barely got a recovery.

    so yes indeed – channels to nowhere – even though scott was trying to be ironic.

  58. Gravatar of Channels to nowhere « Economics Info Channels to nowhere « Economics Info
    26. February 2014 at 08:01

    […] Source […]

  59. Gravatar of Nick Rowe Nick Rowe
    26. February 2014 at 09:53

    Tom: both the supply and the demand for base money go up tenfold, to a first-order approximation. No change to P.

  60. Gravatar of W. Peden W. Peden
    26. February 2014 at 10:04

    “Strikes me the answer to that is simple: any sort of stimulus (monetary or fiscal) will not be inflationary as long as the economy has significant spare capacity – i.e. as long as unemployment is above NAIRU.”

    Sounds like an off-on model of the relationship between inflation and demand. What does that imply for the SRAS curve?

  61. Gravatar of Tom Brown Tom Brown
    26. February 2014 at 10:41

    Nick, thanks! … Why do you say the demand went up tenfold? Because there was a pre-existing demand for commercial bank deposits already at that level, and we just replaced them with national bank deposits?

    So can you explain how something similar doesn’t happen in Case 1 if the bank were to buy $9 in Tsy bonds, thus boosting the quantity of base money to $10? How do we know that demand for base money hasn’t increased by 10x in that case, thus eliminating pressure on P to rise?

    Here’s one way you might argue that this happens, see what you think:

    When the CB buys $9 in Tsy bonds (starting in Case 1), the demand for $9 in Tsy bonds in the private sector has been replaced with demand for $9 in bank deposits. Those bank deposits themselves create a demand at the banks for $9 in additional base money.

    The story is simpler if the CB buys the bonds from the banks: their demand for bonds is replaced by a demand for base money.

    Call these two stories about bonds Case 1a and Case 1b respectively.

    In all three cases: 1a, 1b, and 1c, it seems like you could argue that a demand for something other than base money (bonds, or commercial bank deposits) has been replaced by a demand for base money.

    Where does that argument go wrong?

  62. Gravatar of Tom Brown Tom Brown
    26. February 2014 at 10:41

    … shoot, there’s no Case 1c! … I meant Cases 1a, 1b, and 2.

  63. Gravatar of Tom Brown Tom Brown
    26. February 2014 at 11:27

    Nick,

    You might argue that my case 2 doesn’t offer the public a choice (forgetting for the moment that they voted for nationalization :D): only commercial bank deposits are available prior to nationalization and only national bank deposits are available after. Forget about bonds in this case for now. But I could have a case 2a in which the national bank starts out small, but perhaps offers a marginally better deposit rate, thus putting all the commercial banks out of business: a marginal change in rate thus can cause a huge change in demand for base money, no? Can’t the same be said for Case 1b for example? An offer by the CB on bonds marginally better than the exiting market price suddenly multiplies the demand for base money? After all, it’s base money being demanded vs something else in both cases, right?

    I don’t know if you saw this comment from Mike Sproul:
    http://tinyurl.com/ptbdyo5
    I can’t follow the stock example, but the bank example ties in here I think.

    Thanks Nick, I hadn’t considered that demand for base money might multiply to more or less match a multiplied supply. That’s an interesting concept.

  64. Gravatar of Tom Brown Tom Brown
    26. February 2014 at 12:06

    Nick, it seems I can no longer post at your site. I get an pop-up: “Not a HASH Reference”
    I tried different computers, names, emails, posts.

    Anyway, I was going to leave this last one for you and JW:

    JW, Nick: you’ve lost me now, but if any of us peons deserve a footnote somewhere, you’ll let us know, right? Haha 😀
    (BTW, I can show you how I derived that inequality if you like: it’s pretty straight forward)

  65. Gravatar of Tom Brown Tom Brown
    26. February 2014 at 13:16

    Nick, so another way to summarize your response might be:

    Not all methods the government uses to increase the supply of base money by increasing the quantity of it are equal. Some ways may increase demand for base money as much as they increase supply, which, for example, would thus have no effect on long term prices.

    What lies at the core of distinguishing between methods which increase both supply and demand, and those which only increase supply?

  66. Gravatar of Tom Brown Tom Brown
    26. February 2014 at 13:29

    Scott, Nick Rowe argued that my example above (Case 2) represents one way to increase the supply of base money by increasing its quantity, but at the same time nullifying the effects of this increased supply by increasing demand proportionately:

    https://www.themoneyillusion.com/?p=26213&cpage=2#comment-320391

    Do you agree with him? If “yes” what are some other ways? IOR? How can we tell for sure that a particular method of increasing the quantity of base money does not nullify the effects of increased supply by simultaneously increasing demand proportionately?

  67. Gravatar of Mark A. Sadowski Mark A. Sadowski
    26. February 2014 at 13:37

    Tom Brown,
    “Are all the privately bank deposits in case 3 (the pre-existing ones as well as the $X in new ones) now considered to be “base money” since this bank can be considered to be part of “government” even though they are still not Fed deposits (reserves)?”

    No.

    The monetary base consists of currency and commercial bank reserves. Broad money (usually) consists of currency and commercial bank deposits. It does not matter if the commercial bank is state owned or privately owned.

    For example, most of the commercial banking system in France was nationalized in 1982-86. This made absolutely no difference in terms of the size of the monetary base or the amount of broad money. Moreover there are many examples of state owned commercial banks globally, but this has no effect at all on how monetary aggregates are defined.

  68. Gravatar of Tom Brown Tom Brown
    26. February 2014 at 14:24

    Mark, forget the labels, will these new deposits be equivalent to base money in terms of their affect on the supply of something which has a similar macroeconomic effect? Both Nick and Scott seem to think “yes” … at least that’s what I gather from these two comments:

    https://www.themoneyillusion.com/?p=26219#comment-320145

    https://www.themoneyillusion.com/?p=26213#comment-320391

    Do you agree or disagree? Although Nick says demand is also affected, thus negating the effect on long term prices.

  69. Gravatar of Tom Brown Tom Brown
    26. February 2014 at 14:26

    Mark, sorry, I missed your whole last paragraph there! So it sounds like a definite “no” in terms of my question.

  70. Gravatar of Tom Brown Tom Brown
    26. February 2014 at 14:34

    Mark, how much do you think has to do with perceptions. For example, if the banks are not only nationalized, but the deposits are then maintained at the Fed: so they become Fed deposits effectively. Is the effect here more powerful due to a change on perceptions or is there something going on here independent of perceptions?

  71. Gravatar of Mark A. Sadowski Mark A. Sadowski
    26. February 2014 at 14:49

    Tom Brown,
    I’m not sure what Scott means when he says “reserves are no longer a liability” but other than that I agree with what he is saying. The reserves of the nationalized bank are still liabilities of the central bank. As for what Nick is talking about I am somewhat mystified.

    These hypothetical models are interesting, but in the final analysis, to my knowledge, all currency areas have separate central banks where commercial banks deposit reserves, even in countries where most commercial banking is publicly owned.

    However, if you eliminate the division between commercial and central banks and only have a single (commercial) bank, it seems to me that you have eliminated bank reserves as a concept. Thus the monetary base would consist only of currency, and broad money would consist of currency plus bank deposits as before.

  72. Gravatar of Tom Brown Tom Brown
    26. February 2014 at 15:44

    Mark, thanks for your replies, and the information. After re-reading Scott’s comment, I’m more confused than I was. Part of the problem is I put that comment in the wrong place. He writes:

    “Tom, Bank deposits are not base money, and coins are.”

    I agree too. But I’m not sure he’s referring to the hypothetical nationalized bank, or to our current commercial banks. I thought the latter at first. I guess now it sounds like he could mean in either case, however… when he writes this next:

    “Even in the nationalized bank the bank’s deposits are liabilities of the government. So even though the reserves are no longer a liability, the deposits are.”

    It sure sound like we are now turning to the subject of the nationalized banks (as opposed to the 1st paragraph?), and here he’s saying that in that case we lose reserves as gov liabilities, but we gain nationalized bank deposits. I first read that as “we lose reserves as base money but we gain nationalized deposits as base money.” But now I don’t know. Maybe he means we lose them as liabilities on a consolidated government balance sheet (which is true I think)?

    Nick seemed to read it the same way I did at first… I’m not sure.

    Your final paragraph is very interesting to me. That’s not what I would have guessed. So in my simplified cashless world, if the CB directly took over all banking operations, then we’d consolidate balance sheets (which would make that $1 of reserves disappear) … and that’s it! No base money left at all? So if base money goes to $0 then prices go to $0 in the long term as well then?

    Back on the subject of a nationalized bank for a moment, wouldn’t its “reserves” become similar to any other Fed agency’s Fed deposit. For example, Tsy’s TGA balance: not called “reserves” right, but still a Fed deposit, and not part of “base money?”

    Why am I torturing myself like this? Well in a physical science it doesn’t matter what people think, facts are facts. The world’s not flat, independent of what people believe. But in econ, believing something can sometimes make it true I think. I have a hard time separating the perception independent facts from the facts about perception.

  73. Gravatar of lxdr1f7 lxdr1f7
    26. February 2014 at 16:01

    Tom brown

    Case 1:
    CB has $1 of reserve liabilities. Commercial banks have $10 of customer deposit liabilities. Base money = $1.

    Case 2:
    CB has $1 of reserve liabilities. Commercial banks have $10 of customer deposit liabilities. Now the commercial banks are nationalized. So after nationalization base money = $10?

    If “Yes” then we can expect that in the long term, prices in Case 2 will be 10x their initial level (and 10x the prices in Case 1), all else being equal?

    I think it depends what you mean by nationalization. If you mean the monetary system is structured in the same way but just the commercial banks changes owners then no change. If changes occurred to how the monetary system is structured then yes. For example if old commercial bank deposits (now national bank deposits) became base allowing everyone to directly deposit reserves at the national bank then no because broad money supply would be the same.

    How would base increase 10 fold anyway? If it did increase 10 fold would people also keep their deposits?

  74. Gravatar of Tom Brown Tom Brown
    26. February 2014 at 16:22

    lxdr1f7, my thoughts on this are in a state of flux. I may have misread Sumner’s first response. I thought he was saying nationalization would convert bank deposits to base money and get rid of reserves as base money. I may have convinced Nick of that in the 10 seconds he spent looking at it.

    So I’ll hold off answering for now.

  75. Gravatar of lxdr1f7 lxdr1f7
    26. February 2014 at 16:34

    “A change in M causes a change in NGDP for supply and demand reasons”

    ONly if M is circulated. If it is parked in an account doing nothing like excess reserves then D isnt affected.

  76. Gravatar of Mark A. Sadowski Mark A. Sadowski
    26. February 2014 at 16:38

    Tom Brown,
    “But I’m not sure he’s referring to the hypothetical nationalized bank, or to our current commercial banks. I thought the latter at first. I guess now it sounds like he could mean in either case…”

    He means in both cases. Bank deposits are never base money.

    “It sure sound like we are now turning to the subject of the nationalized banks (as opposed to the 1st paragraph?), and here he’s saying that in that case we lose reserves as gov liabilities, but we gain nationalized bank deposits. I first read that as “we lose reserves as base money but we gain nationalized deposits as base money.” But now I don’t know. Maybe he means we lose them as liabilities on a consolidated government balance sheet (which is true I think)?”

    I think he means that reserves are lost as *net* government liabilities because they are also an asset to the nationalized commercial bank. But deposits are gained as government liabilities. That’s the only thing that makes sense to me.

    “Nick seemed to read it the same way I did at first… I’m not sure.”

    Only Nick can explain what he means. I’m sure it will make sense but right now I’m not even going to venture a guess.

    “So in my simplified cashless world, if the CB directly took over all banking operations, then we’d consolidate balance sheets (which would make that $1 of reserves disappear) … and that’s it! No base money left at all? So if base money goes to $0 then prices go to $0 in the long term as well then?”

    Apart from 1936-42, and since 2009, the monetary base was mostly currency in the US. And just prior to the Great Recession the monetary base was 98% currency. Scott has written several posts on the importance of currency. It’s the most important part of the monetary base.

    “Back on the subject of a nationalized bank for a moment, wouldn’t its “reserves” become similar to any other Fed agency’s Fed deposit. For example, Tsy’s TGA balance: not called “reserves” right, but still a Fed deposit, and not part of “base money?””

    Not from the standpoint of monetary policy. The TGA plays virtually no role in the Fed’s conduct of monetary policy. But bank reserves do regardless of whether the bank is state or privately owned.

    “Well in a physical science it doesn’t matter what people think, facts are facts.”

    I think the problem here isn’t perception so much as the role something plays in the monetary policy process. The monetary base matters precisely because it is through the monetary base that the central bank controls broad money supply and NGDP.

  77. Gravatar of Mark A. Sadowski Mark A. Sadowski
    26. February 2014 at 16:51

    Tom Brown,
    I was looking for the post where Scott put it most succinctly and here it is:

    https://www.themoneyillusion.com/?p=17357

    “Monetary policy is all about adjusting the stock of currency.”

    https://www.themoneyillusion.com/wp-content/uploads/2012/10/Screen-Shot-2012-10-28-at-9.28.30-AM.png

    That’s it in a nutshell.

  78. Gravatar of Tom Brown Tom Brown
    26. February 2014 at 17:28

    Mark, thanks for the links and the rest. Regarding the currency though, it’s not like Scott himself hasn’t indulged us cashless hypothesizers on occasion, for example Case 7 of this post (which I refer to frequently):

    https://www.themoneyillusion.com/?p=23314

    “7. Now let’s assume a cashless economy where the MOA is 100% reserves. Still no change; reserves are still a hot potato. And as I said, IOR changes nothing fundamental. Banks have X demand for reserves at an IOR of Y%. If you double the quantity of reserves and keep the IOR at Y%, banks will suddenly be holding excess reserves. The HPE kicks in. Zero bound? See case 5.”

    It’s certainly physically possible to get rid of currency and also consolidate all banks into the central bank (i.e. making base money stock = $0). And later when the NSA needs to track your ammo purchases, it’s bound to happen 😀 Plus the banks would probably love to ditch their expensive ATM machines, tellers, vaults, security, etc and become almost 100% online institutions (although they don’t want to get nationalized!). I can appreciate that currency may still be the most important part of the base, but it still seems like a decent monetary theory should not break down (on a theoretical level) if something that’s physically possible (elimination of currency & reserves) is surmised.

    So what happens to monetary theory in that case? Do we need a new one? Chaos?

    The CB could still buy and sell and adjust deposit levels that way, just not the base money stock. Do we all get upgraded to “bank” status, and thus our deposits become reserves (base money) again? Is that the way out of that conundrum? That seems like a perception thing.

    I’ll read… maybe the answers lie in store for me. Thanks!

  79. Gravatar of lxdr1f7 lxdr1f7
    26. February 2014 at 17:36

    Mark

    “I think the problem here isn’t perception so much as the role something plays in the monetary policy process. The monetary base matters precisely because it is through the monetary base that the central bank controls broad money supply and NGDP.”

    How does the CB “control” broad money through the base? I see control as too strong a word, influence is better IMO. Expanding base brings down the rate on reserves making lending and broad money creation (deposits mainly) more attractive. If unemployment is too high, if banks perceive lending as too risky then broad money creation is affected. There is factors outside the CB control that affect broad money so control seems incorrect.

  80. Gravatar of Tom Brown Tom Brown
    26. February 2014 at 18:13

    … Summary of my many comments today:

    1. Bank nationalization causes a change in P? No?… because supply & demand are both affected (Nick Rowe case), well then…

    2. What other cases of MB management inadvertently change demand and supply in the same proportion thus leaving P unchanged? Still not right?: Bank deposits are never MB even for nationalized banks? Well then…

    3. That implies if the CB were to completely take over then reserves disappear and so does MB (recall, cashless) so P goes to $0?

  81. Gravatar of Max Max
    26. February 2014 at 18:17

    Tom, if there’s no demand for base money, that doesn’t prevent the central bank from producing it – it just means that the CB wouldn’t make a profit, and the quantity would be entirely discretionary. In that case there would be no quantity relationship between GDP and base money. The CB could have a policy of always maintaining $1 of base money, for example.

  82. Gravatar of Mark A. Sadowski Mark A. Sadowski
    26. February 2014 at 18:23

    “It’s certainly physically possible to get rid of currency and also consolidate all banks into the central bank (i.e. making base money stock = $0).”

    Well, I suppose it’s also possible that pigs may learn to fly someday, but I’m not going to lose sleep worrying that one may drop out of the sky and land on my head anytime soon:

    http://i2.cdnds.net/11/39/618w_pink_floyd_battersea_station_2.jpg

    Incidentally, currency in circulation was 4.2% of GNP in 1929Q1:

    http://research.stlouisfed.org/fred2/graph/?graph_id=128406&category_id=0

    It was 7.2% of GDP as of 2013Q4.

    At that rate it could be a very very long time before e-currency takes the place of today’s wampum and cowrie shells. It seems to me that people just like to hold something tangible in their hands. Evidently technology is progressing much faster than is human nature.

  83. Gravatar of Tom Brown Tom Brown
    26. February 2014 at 18:58

    Mark, I appreciate you won’t loose sleep over this, unlike me 🙁

    … I think I get where you stand, and I’m certainly not claiming that we better get this straightened out before we go cashless… my main concern is to be sure I understand what’s going on, and I often find that simplifications and extreme situations are a great aid to thought experiments (you know, like Einstein imagining himself riding on a light-beam) … yes, I really did just compare myself to Einstein. Ha!… but seriously, is the $0 base money scenario like a monetary singularity? A black hole where normal rules completely break down? It’s hard to believe it’s that extreme.

    Also, I get the thing about having something to hold in your hand… and that it’s guaranteed to always provide a nominal 0% return (which is why Miles’ proposals are difficult I think). Those are strong issues of perception. 😀

  84. Gravatar of Tom Brown Tom Brown
    26. February 2014 at 19:19

    Max, … I’m not sure which of my many posts that’s in reply to. I’m not yet up to thinking about GDP changes: I’m still clinging to the price level change story.

  85. Gravatar of Tom Brown Tom Brown
    26. February 2014 at 21:39

    Anybody (Mark, Scott, Nick, or anybody else):

    If you follow the thread above between Mark and I we come to a place that I’m extremely curious about but which doesn’t interest Mark too much because he thinks it’s as likely as flying pigs. OK, fair enough… I’m happy to have had the interchange I did with him, but I can’t get what we arrived at out of my head. Let me summarize:

    As a thought experiment I proposed a cashless society, at first with a nationalized banking system (separate from the CB). For the sake of argument, I’ll accept all Mark’s points about that. (Nick Rowe I’ll get to later: see his comment above). In particular Mark pointed out that the nationalized bank deposits are still not base money, but bank reserves (liabilities of the CB) are base money. Currency isn’t an option, remember, this is a cashless society. So to modify the thought experiment I proposed that we get rid of the nationalized bank and let the CB take over all its functions. In response Mark reasoned that this means the end of reserves as a concept. So no reserves, no currency, and bank deposits are still not base money: well that means base money = $0. And if base money is $0, then the long term neutrality of money means that prices will eventually fall… all the way to $0 maybe? Sticky wages and prices mean that deflation and maybe a depression are in store for this society.

    Now Nick Rowe brings up a point which makes me wonder if he might counter with an argument like this (analogous to his argument in his comment above): “Well quantity of base money = $0, which means supply is low, but perhaps demand is low too, so it doesn’t matter.” Well, OK, but I don’t get why demand might be low here. To be clear Nick did not make this argument, I’m trying to extend what he wrote above to this case.

    In any case, I doubt Mark would agree with my “mock” Nick Rowe argument here.

    But here’s the ironic thing to me: this new CB, I’ll call it a super-CB, on the surface seems to have gained vast powers over what it previously had. Recall it NEVER had the power to issue currency, so it has only gained powers: it can now directly set any nominal lending or deposit rates that it wants to, including negative nominal rates! It’s literally the only game in town. It can also buy and sell assets just like it did before but now with the effect of only changing bank deposit levels.

    But it’s still utterly powerless in the face of this deflation because there’s no base money to control the quantity of or set the nominal lending or deposit rates for?

    That seems very odd to me. Mark is probably tired of this hypothetical world by now, but perhaps somebody can help me understand. What am I missing? If I’m not missing something, does this really make sense? Thanks!!

  86. Gravatar of Max Max
    26. February 2014 at 21:43

    Tom, reply to 17:28. Change GDP to price level. I didn’t mean to confuse the issue.

  87. Gravatar of Mark A. Sadowski Mark A. Sadowski
    27. February 2014 at 06:06

    Tom Brown,
    Just to be clear…

    1) Combining commercial banks and the central bank into one institution eliminates the need for a clearinghouse for reserves since there is only one banking institution (“The Bank”) and it eliminates the need to hold reserves against bank runs since The Bank is also the lender of last resort.

    2) I’ve been following the Pragmatic Capitalism Forum (“For Tom Brown Re: MM”) on this and I disagree strongly with Cullen Roche on one point. JKH’s CTRB (Central-Treasury-Bank) proposal is an idea to merge the treasury and central bank functions within the context of the Jaromir Benes and Michael Kumhof version of the Chicago Plan.

    The Chicago Plan is a proposal for full reserve banking. It does *not* eliminate commercial banks or reserves. On the contrary it proposes a 100% reserve system. The monetary base and broad money (currency plus deposits) would essentially be the same size but they would still remain distinct. Note also that whether or not a CTRB is created is totally peripheral to what you are talking about.

    3) By eliminating currency from your model you are totally eliminating the thing which is most moneylike from your monetary universe. So essentially you are playing with definitions. And since I think most of the problems that people have with monetary economics relate to definitions and empirical reality I would almost rather this be given the full Rowe treatment complete with variable names.

    However, my basic take is that in such a universe the most moneylike object remaining is now deposits. Furthermore, whether or not you call it base or broad money is apparently irrelevant since there is nothing in this universe that is less moneylike. In such a universe The Bank conducts monetary policy purely by regulating the supply of deposits.

    I also think the question of whether you have eliminated inside or eliminated outside money is totally irrelevant since you have eliminated the distinction. Call it money.

  88. Gravatar of ssumner ssumner
    27. February 2014 at 06:08

    Tom, I would say there is no change in base money, but it’s purely a semantic debate, as Nick points out. Nothing important hinges on how we define these bank accounts.

    Yes, IOR is another way of neutralizing an increase in the base.

    I was assuming the nationalized bank is not a part of the central bank. If it is, that changes things. The base is usually defined as the sort of money directly created by the central bank. It’s better to think about central bank actions under various scenarios, and how they affect the economy. Don’t worry about definitions.

  89. Gravatar of Tom Brown Tom Brown
    27. February 2014 at 11:28

    Mark and Scott, thanks very much for you replies.

    Your comments help clarify quite a bit. I have not yet read the reference on the CTRB: on my to-do list.

    It sounds like one concept I need to consider is “what is the most moneylike thing in this world.” That’s something I personally haven’t encountered here before. Nick Rowe and JP Koning discuss that sometimes: a scale of moneyness. Cullen too.

    I think Nick takes the thing with the most moneyness to be “money”: be it cows, apples, or paintings. Can we just call that thing “base money?”

    The picture I’m getting then, is if you have a CB, the liabilities it creates for the private sector, be they “reserves,” currency or direct customer deposits: those are the things with the most moneyness, and thus “base money” for the purposes of applying the neutrality of money concept.

    So it seems to me that it’s important for a theory about the neutrality of base money to have a very clear definition of base money in all circumstances. So in that sense the definition is important isn’t it? Because the quantity of that base money is very important, so you want to be sure you’re counting it accurately, right?

    OK, thanks again!

  90. Gravatar of Tom Brown Tom Brown
    27. February 2014 at 11:55

    Mark,

    “I would almost rather this be given the full Rowe treatment complete with variable names.”

    I don’t know what you mean by this.

    “Furthermore, whether or not you call it base or broad money is apparently irrelevant since there is nothing in this universe that is less moneylike.”

    I think you mean “more moneylike” right?

    Your last sentence: it sounds like you prefer to call the thing that the neutrality of money concept works on “money” rather than “base money” (in the most general case, like hypothetical worlds that I’m fond of). That fits w/ Scott, because when he just uses “money” he means “base money” I think. I think it works with Nick too: he doesn’t discuss “base money” much if I recall correctly. And he loves hypothetical worlds too… some even more improbably than mine!

  91. Gravatar of Tom Brown Tom Brown
    27. February 2014 at 11:58

    Like Mark, I’m still “mystified” by Nick Rowe’s statement though. I should ask him to clarify. I don’t see how that fits with what you two are saying.

  92. Gravatar of Mark A. Sadowski Mark A. Sadowski
    27. February 2014 at 12:24

    Tom Brown,
    “I don’t know what you mean by this.”

    I mean like this recent post where Nick gave variable names to the policy variables, instruments and targets:

    http://worthwhile.typepad.com/worthwhile_canadian_initi/2014/02/principal-agent-and-the-assignment-of-targets-to-instruments.html

    He truly has a gift for constructing hypothetical worlds. (It must come from doing it 24/7 year after year.)

    “I think you mean “more moneylike” right?”

    At the time I meant it as written, but now that I think about it doesn’t really matter does it?

  93. Gravatar of Tom Brown Tom Brown
    27. February 2014 at 13:00

    Mark, thanks. Yes I’m familiar with that Rowe post… did you see the rate of convergence result I derived for JW Mason in the comments? Not rocket science, but in terms of something concrete I could think about on an econ blog, it was up there (mostly because it had nothing to do with econ).

    It was fun too… I’m positive I’m not the 1st one to come up with that, but it was the first time I’d looked at it.

  94. Gravatar of Tom Brown Tom Brown
    27. February 2014 at 13:01

    Actually, I just presented it as an inequality to test for convergence, but it can really be interpreted as a rate of convergence.

  95. Gravatar of Tom Brown Tom Brown
    27. February 2014 at 13:11

    David Glasner spent 90 seconds on this, and agrees with Nick. He may not have seen all the comments. He goes on to speculate about why demand might increase (Nick just states that it will).

    http://uneasymoney.com/2014/02/20/whos-afraid-of-says-law/#comment-52175

  96. Gravatar of Tom Brown Tom Brown
    27. February 2014 at 13:14

    … I guess it’s funny that an abstract mathematical result seems more “concrete” to me. Well, it’s less fuzzy anyway.

  97. Gravatar of Tom Brown Tom Brown
    27. February 2014 at 13:21

    … “moneyness” for instance… it’d be nice if we could actually measure it numerically for instance. Then we could definitely figure out what had the most of it…. and I wouldn’t feel nearly as queasy.

  98. Gravatar of Mark A. Sadowski Mark A. Sadowski
    27. February 2014 at 14:17

    Tom Brown,
    “…did you see the rate of convergence result I derived for JW Mason in the comments?”

    Yes, but to be honest I didn’t really pay much attention to it.

    Glasner’s 90-second (9-second?) response clarified absolutely nothing. If I were you I’d go badger Rowe.

    I also see that JKH has apparently stated that his CTRB idea fuses commercial and central banking, which in my opinion makes it different from The Chicago Plan, but makes it very similar to what you are proposing.

    As for “moneyness”, currency is accepted nearly anywhere, anytime. It’s zero maturity and is the very definition of liquid. It *is* money.

  99. Gravatar of Tom Brown Tom Brown
    27. February 2014 at 14:30

    “Yes, but to be honest I didn’t really pay much attention to it.”

    … and to think that was my proudest moment. Shoot! Lol 😀

    Actually I still don’t really understand why it’s of interest. It’s clear that just solving for both m* and f* simultaneously is always better. I gather it’s practical problems which prevent that.

  100. Gravatar of ssumner ssumner
    1. March 2014 at 06:42

    Tom, You said;

    “Because the quantity of that base money is very important, so you want to be sure you’re counting it accurately, right?”

    Old monetarists felt the quantity of money is important. Market monetarists focus on NGDP.

    Regarding bank deposits as money, I’d look at the aggregate directly impacted when the Fed does open market operations. If the Fed buys bonds from the public, and credits a bank deposit of someone who sells the bonds to the Fed, then I’m fine with calling that base money.

  101. Gravatar of Tom Brown Tom Brown
    2. March 2014 at 10:07

    Scott, thanks again. OK, so simple cashless socidey example:

    Step 1: CB has $1 reserve liabilities, commercial banks have $10 deposit liabilities. Base money = $1, prices at equilibrium.

    Step 2: CB takes over commercial banking operations and now has $10 in deposit liabilities and $0 in reserve liabilities (after consolidating its BS with those of the commercial banks). Base money = $10? Any long term upward pressure on prices? Do supply and demand for base money both increase by a factor of 10 in this case (like Nick Rowe indicated), thus nullifying any upward pressure on prices? If so, why does demand increase in this case?

    Step 3: CB buys $1 of Tsy bonds from public: CB now has $11 deposit liabilities and still $0 reserve liabilities (reserves no longer exist after CB took over commercial bank operations). So, now what will long term prices do as compared to Step 2? Raise 10%? What will they do compared to Step 1? What happens to demand for base money in this case, and if it’s different than Step 2, why?

  102. Gravatar of JKH JKH
    3. March 2014 at 02:20

    Mark Sadowski,

    “JKH’s CTRB (Central-Treasury-Bank) proposal is an idea to merge the treasury and central bank functions within the context of the Jaromir Benes and Michael Kumhof version of the Chicago Plan.”

    Not correct.

    Two entirely separate ideas that I looked at separately in separate posts:

    # 1

    http://monetaryrealism.com/treasury-and-the-central-bank-a-contingent-institutional-approach/

  103. Gravatar of JKH JKH
    3. March 2014 at 02:21

    # 2

    http://monetaryrealism.com/banking-in-the-abstract-the-chicago-plan/

  104. Gravatar of Tom Brown Tom Brown
    4. March 2014 at 10:56

    Scott, simpler case: cashless society, reserves = R, bank deposits = D. Now the CB takes over banking: R = 0, CB deposits = D.

    1. Did quantity of MOA change by D-R? By a factor of D/R?

    2. Do prices, P, stay the same?

    3. Is the reason P stays the same, rather than changing to P*D/R because demand for MOA changed along with quantity of MOA? I.e. Nick’s explanation above: that MOA (CB deposits) are exchanged for non-MOA (bank deposits) in this case, thus there’s a “demand transference.”

    4. Can this demand transference happen with any other non-MOA goods other than bank deposits? What if the CB took over money market funds too? I.e. the CB takes the fund assets and issues CB deposits as replacements.

  105. Gravatar of Tom Brown Tom Brown
    7. March 2014 at 12:44

    Mark, what I loved about this link you provided:

    https://www.themoneyillusion.com/?p=17357

    Was the lack of agreement in the comments between Sumner, Rowe, Bill Woolsey, and Saturos. hahaha… makes my head hurt.

  106. Gravatar of Tom Brown Tom Brown
    7. March 2014 at 20:53

    For anybody wondering why Mark was “somewhat mystified” by Nick Rowe’s explanation above, that’s resolved here:

    http://worthwhile.typepad.com/worthwhile_canadian_initi/2014/02/keynes-gt-chapter-3.html?cid=6a00d83451688169e201a3fccb4271970b#comment-6a00d83451688169e201a3fccb4271970b

    He was mystified because Rowe misunderstood my question and thought that the CB was taking over the banks rather than the banks being nationalized. I think the implication is that Nick’s explanation is not mystifying to Mark if we’re talking about the CB taking over.

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