Don’t underestimate monetarism

A commenter sent me the following:

This slim volume describes a weighty and wonderful event. In 1920, the American economy entered what would presently be diagnosed as a depression. The successive administrations of Woodrow Wilson and Warren G. Harding met the downturn by seeming to ignore it””or by implementing policies that an average 21st century economist would judge disastrous. Confronted with plunging prices, incomes and employment, the government balanced the budget and, through the newly instituted Federal Reserve, raised interest rates. By the lights of Keynesian and monetarist doctrine alike, no more primitive or counterproductive policies could be imagined. Yet by late 1921, a powerful, job-filled recovery was under way. This is the story of America’s last governmentally unmedicated depression.

Sometimes it seems like everyone wants to pick on the monetarists, including to some extent even market monetarists.  Monetarism is ridiculed by Keynesians, Austrians, MMTers, Real Business Cycle supporters, fiscal theory of the price level proponents, etc., etc. It seems out of date, with not many young supporters.  It allegedly “failed” in the 1979-82 monetarist experiment, even though:

1.  That period successfully broke the back of inflation, as the monetarists predicted and others doubted, especially given the Reagan fiscal stimulus.  It led to a severe recession, as the monetarists predicted.  And it was followed by a strong recovery, as the monetarist predicted (but the Keynesians thought unlikely without a rise in inflation.)

2.  Furthermore, the policy of 1979-82 was not truly monetarist (money growth varied), and the monetarists would never have expected velocity to be stable during a period of rapid disinflation. Their argument was that V would stabilize in the long run, if money growth were stable in the long run.  That was never tried.

I find even that weaker claim to be dubious, which is one reason that I am not a traditional monetarist. And of course Friedman made some bad predictions in the 1980s (but since when do bad predictions discredit a model?) Nonetheless, let’s give monetarists their due; contrary to the implication of the quotation above, Friedman and Schwartz’s Monetary History does explain the depression of 1921:

M2 money supply:

May 1920 peak:  $30,304 million.

Sept. 1921 trough:  $27,830 million

December 1922:  $31,920 million

Monetarists would predict a steep recession and fast recovery.  And that’s what happened.

PS:  Rereading the quote, it doesn’t actually say the monetarists failed to predict a fast recovery, but I sort of think that was implied.  Did I misinterpret the quotation? How would the average person interpret the quote?

PPS.  I have not read Grant’s book, but I do believe the 1921 depression is a good example of the natural recuperative powers of a free market economy.  In that sense, it could be viewed as being inconsistent with old Keynesianism, as well as modern variants that say wage cuts will make the depression worse, and that massive fiscal stimulus is needed.  Of course Keynesianism is a slippery critter, which is hard to pin down.  They would probably point to the lack of a zero bound problem. They mention positive interest rates when convenient (1921) but ignore positive interest rates when inconvenient (eurozone 2008-12.)


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86 Responses to “Don’t underestimate monetarism”

  1. Gravatar of Market Fiscalist Market Fiscalist
    19. December 2014 at 07:22

    “May 1920 peak: $30,304 million.

    Sept. 1921 trough: $27,830 million

    December 1922: $31,920 million

    Monetarists would predict a steep recession and fast recovery. And that’s what happened.”

    Had velocity fallen between 1921 and 1922 couldn’t those same number have been consistent with a deepening depression ? (If so, can I copyright a new phrase ? “Never reason from an M2 change”).

  2. Gravatar of W le B W le B
    19. December 2014 at 07:33

    Surely the real success of the late 70s early 80s monetarists was that, in their efforts to control the supply of money, they identified that it was the way the deficit was funded (then private bank lending to public sector) that was creating the considerable increases in the money supply. It mattered less that you targeted M3 or M4 or M4L or the exchange rate. The then problem was this use of bank loans rather than bond sales to fund relatively large PSBRs.

    If you agree, then, their error was claiming that they’d bring down inflation by controlling x, y or z rather than communicating their ideas about PSBR funding. They were discredited on the former though it was the latter that had the considerable impact on NGDP growth.

  3. Gravatar of benjamin cole benjamin cole
    19. December 2014 at 08:07

    Well, there is always some period somewhere that justifies some putative precepts about economics.
    I like to say the 1960s US economy boomed and the top federal income tax rate was 90%, ergo high tax rates on rich people are good for economic growth.
    As for Grant…according to his fervently held principles and predictions, there is little question that the U.S. should have had several rounds of hyperinflation and a few complete busts since 1980.

  4. Gravatar of Ray Lopez Ray Lopez
    19. December 2014 at 08:12

    Kudos to Prof. Sumner for citing this important book, which I am reading now. Indeed, you can I guess look at Grant’s thesis as a sort of vindication of monetary policy, but only if you assume said monetary policy is being done “by the crowd” rather than a sole central banker IMO. That’s the key point (I think) Grant is making, since throughout the book he references A. Smith’s “invisible hand” and puts an emphasis on gold. Here is a key passage to support a sort of “monetary expansion” due to a rate cut by the Fed (Boston) in April 15, 1921 (I will leave it for another day whether the Fed (Boston) was forced by the market to market to make this cut):

    Public policy made one signal contribution, at least , to the improvement in American finances. This was in the all -important matter of interest rates. It was welcome news when the Federal Reserve Bank of Boston cut its main discount rate to 6 percent from 7 percent, effective April 15 [1921]. 5 It was the first easing move by any Federal Reserve bank since the previous spring. The Federal Reserve Bank of New York followed on May 4 with a reduction to 6.5 percent from 7 percent. This move the market correctly interpreted as the beginning of the end of the era of ultrahigh interest rates (high enough in nominal terms, extra lofty when adjusted for the declines in prices and wages). III 6 Bond yields, which had been gently falling since May 1920, now began to nosedive. 7 A more important source of relief for the formerly straitened American money market was the persistent flow of gold into the United States. It came by steamer, mostly from Europe, and especially from Britain and France”” … The United States was by now a great creditor. It exported more than it imported, and it loaned more than it borrowed. Gold was making a beeline for America. Between the start of the depression, in January 1920, and the trough, in July 1921, foreign bullion augmented the American gold stock by some $ 400 million, to $ 3 billion. 13 The vast importation put a spring in Wall Street’s step. It was, the speculative community correctly reasoned , the augury of lower interest rates and easier money.

    Grant, James (2014-11-11). The Forgotten Depression: 1921: The Crash That Cured Itself (p. 182). Simon & Schuster. Kindle Edition.

  5. Gravatar of TravisV TravisV
    19. December 2014 at 08:46

    Krugman:

    “even among normally sensible conservative economists there has been a remarkable determination to see the non-inflationary story as somehow the result of very special circumstances. For example, Martin Feldstein and others have claimed that it’s all about the 0.25 percent, that’s right, 0.25 percent interest rate the Fed has been paying on excess reserves. Without that, they say, quantitative easing would indeed have produced the big inflation they keep predicting.

    So, can we talk about Switzerland?”

    http://krugman.blogs.nytimes.com/2014/12/19/switzerland-and-the-inflation-hawks

  6. Gravatar of flow5 flow5
    19. December 2014 at 08:55

    Grant’s an entertaining writer, but doesn’t understand money and central banking (he’s an historian). Periods before the Great-Depression were self-correcting, afterwards – required gov’t intervention (i.e., subsequent periods aren’t comparable). You can’t eat gold.

  7. Gravatar of Joseph Patrick Tucker Joseph Patrick Tucker
    19. December 2014 at 09:06

    Is it correct that during the 1921 depression M2 was increased by the gold flows into the US due to the trade surplus?

    If not then absent gold coming out of the ground into the economy how did M2 increase so much under a gold standard?

  8. Gravatar of John Becker John Becker
    19. December 2014 at 09:23

    The reason that monetarists are being picked on over this incident is that Friedman and Schwartz blamed the Great Depression on the money supply contraction and accompanying deflation. Grant and others who talk about the 1920-21 period report that prices fell faster than any similar period (I don’t know the money supply comparison off the top of my head) lasting 1 year. In other words, the money drop was sharper in 1920-21 than say 1931-32 but the economy recovered one time and not the other. This indicates that there are other important issues going on than just money supply and price level which explain the divergent outcomes. If money is all that matters, why did money supply and output rebound quickly in one case and not the other?

  9. Gravatar of Saturos Saturos
    19. December 2014 at 09:39

    They always complain about regulation. That’s their job. Let’s look at the track record. Let’s look at the facts. Since I have come into office, there’s almost no economic metric by which you couldn’t say that the US economy is better and that corporate bottom lines are better. None.

    So if, in fact, our policies have produced a record stock market, record corporate profits, 52 months of consecutive job growth, 10m new jobs, the deficit being cut by more than half, an energy sector that’s booming, a clean-energy sector that’s booming, a reduction of carbon pollution greater than the Europeans or any other country, a housing market that has bounced back, and an unemployment rate that is now lower than it was pre-Lehman””I think you’d have to say that we’ve managed the economy pretty well and business has done okay.

    – Barack Obama, in his interview with the Economist (has Scott seen it?) http://www.economist.com/blogs/democracyinamerica/2014/08/barack-obama-talks-economist

  10. Gravatar of Major.Freedom Major.Freedom
    19. December 2014 at 11:17

    M2 is a variable that grows partially endogenously as an economy recovers, as more and more savings deposits and other time deposits pick up as optimism and business activity intensifies. This can add to M2 even if the base is not increasing nearly as much, or at all.

    This is not to say that the base has no effect on M2. It is just that we cannot merely look at M2, see that it increased, and then attribute the recovery to the kind of once every business cycle Fed stimulus that has taken place since then.

    The crash of 1929 was so pronounced that not even abnormally high Fed stimulus that took place could prevent the market from collapsing M2. The argument that the Fed “let M2 collapse” is true from the socialist point of view that the state must have absolute control over whatever variable the socialist wants them to have absolute control over. But from a market based perspective, a collapsing M2 that takes place without the Fed themselves positively destroying money, tells us that M2 in dollars was previously raised by too much.

    The market is always right, as market monetarists say but don’t really mean.

    If credit expanded by the central bank backed banking system, after which credit defaults and reduces the money supply in such large sweeping quantities that causes significant unemployment we don’t expect in a normal market economy, this is not a failure of current Fed policy. It is a failure of past Fed policy that resulted in too much credit expansion and too many dollars created through credit expansion. The market is trying to clean up the mess. Does this mean one has to believe the market wants mass unemployment and output drops? Certainly not. But the market AlSO does not want to begin unsustainable projects that must inevitably fail, and the market does not want to be misled into making the wrong investments.

    Medicine tastes bad, and nobody wants to eat something that tastes bad, but that does not mean they should not eat medicine if they are forced to by the antagonisms brought about by private property protections and activity constrained to it.

  11. Gravatar of TravisV TravisV
    19. December 2014 at 11:45

    On CNBC, Stephen Weiss suggested this news propelled the markets yesterday:

    “Switzerland central bank sets negative interest rate to devalue Franc”

    http://www.cbc.ca/news/business/switzerland-central-bank-sets-negative-interest-rate-to-devalue-franc-1.2877770

  12. Gravatar of ssumner ssumner
    19. December 2014 at 13:34

    Market Fiscalist, Yes, never reason from a M2 change.

    W le B, No, it’s the monetary base financed deficits that are inflationary. Bank financed deficits are not inflationary.

    John, Your facts are wrong, in both depressions the economy began recovering almost exactly when the M2 money supply started rising. There is no difference there. The big difference is that the supply-side policies were much worse in the 1930s, leading to a slower recovery. But this has nothing to do with monetarism–they agree that FDR’s policies were bad.

    Saturos, Australia has done far better, as has Germany. But we lead most countries. And in the kingdom of the blind the one-eyed man is king. The ECB is blind and the Fed has one eye.

    A few months ago Obama was calling for an extension of the “emergency” unemployment insurance program. So we had an unemployment problem that was so bad that after 5 years in office Obama thought we needed emergency extension of the program. Is that now considered success? The soft bigotry of low expectations.

  13. Gravatar of ssumner ssumner
    19. December 2014 at 13:39

    Joseph, No, it’s much more complicated. M2 reflects three factors, the gold stock, the ratio of gold to the base, and the money multiplier. The gold ratio rose sharply in 1920-21, for instance, which is deflationary.

  14. Gravatar of flow5 flow5
    19. December 2014 at 14:32

    “This can add to M2 even if the base is not increasing nearly as much, or at all”

    Say what? The CBs cannot expand because of a rise in the savings rate. But the CBs can expand the money stock even if the public ceased to save altogether. The larger the savings balances in the CBs, the more contractive the economic outlook (that’s what’s wrong with remunerating excess reserve balances). Savings are impounded within the CB system. Never are the CBs conduits between savings and investments. Monetary savings are lost to investment, indeed to any type of expenditure.

    The differentiating question ostensibly illustrating the pseudo-economic reasoning of the last 55 + years is: How is the growth of bank-held savings explained in the consolidated balance sheet? – because monetary savings, from the standpoint of the system, is a function of the velocity or rate of turnover of deposits, it is not a function of volume.

    The growth of bank held savings thus results in no alteration in the “footings” of the consolidated balance sheet. Time-deposit growth signifies a transfer from demand deposits in the same institution, a bottling up of existing savings. And as long as savings are held in the commercial banks either in the form of demand or time deposits, the rate of turnover of these deposits is ZERO.

    In Keynesian national income accounting procedures, savings = investment provided there are no offsetting gov’t surpluses or deficits. By definition, this rules out all unspent savings. This is a world where the pundits universally posit the belief that the commercial banking system is an intermediary type of financial institution, i.e., there are no major leakages.

    It is an incontrovertible fact, the CBs never loan out existing deposits (saved or otherwise), nor the owner’s equity nor any liability item. This is the source of the pervasive error that characterizes the Keynesian economics – the Gurley-Shaw thesis, the DIDMCA of March 31st 1980, etc.

  15. Gravatar of flow5 flow5
    19. December 2014 at 14:50

    Justification for the 2006 FSRR Act: “These measures should help the banking sector attract liquid funds in competition with non-bank institutions & direct market investments by businesses” [sic] Testimony of Treasury

    Absolutely scary. And people wonder why the economy has experienced even lower rates of real economic growth after the Great-Recession. Bankrupt U Bernanke destroyed non-bank lending/investing.

  16. Gravatar of flow5 flow5
    19. December 2014 at 15:07

    The source of time deposits to the commercial banking system is demand deposits, directly or indirectly via the currency route, or thru the CBs undivided profits accounts. Money (savings) flowing thru the non-banks never leaves the CB system as anyone who has applied double-entry bookkeeping on a national scale should know. And why should the banks pay for something they already own?

    See the biggest lie in all of economics:

    Requiem for Regulation Q: What It Did and Why It Passed Away
    Alton Gilbert

    Gilbert is a moron. 1966 is the paradigm.

  17. Gravatar of W le B W le B
    19. December 2014 at 15:25

    “W le B, No, it’s the monetary base financed deficits that are inflationary. Bank financed deficits are not inflationary.”

    Perhaps we are talking at cross purposes. If in 1979 the UK government paid a public sector teacher or nurse with a cheque drawn on its account at the Bank of England would that not create a deposit?

    Was not the UK government in this case in effect using private bank lending to the public sector in a way that increased the money supply because there was not a complete offsetting by a tax receipt or a reduction in the money supply from say a sale of a gilt? (Are you calling that monetary base financing?)

    Didn’t the IMF draw attention to this ‘Domestic Credit Expansion’ process at the time? Was this not the reason why Governments such as both the 1974-79 Labour Government and the 1979 Conservative Government endeavoured to reduce or eliminate this process of money creation?

    In the UK was this not key to the reduction of double digit NGDP growth in the 1980s?

  18. Gravatar of flow5 flow5
    19. December 2014 at 15:26

    The CBs can force a contraction in the size of the non-banks, & create liquidity problems in the process, by outbidding the NBs for the public’s savings. This process is called “disintermediation” (an economist’s word for going broke). The reverse of this operation cannot exist. Transferring saved TR or TD deposits through the S&Ls cannot reduce the size of the commercial banking system. Deposits are simply transferred from the saver to the NB to the borrower, etc.

    The drive by the commercial bankers to expand their savings accounts has a totally irrational motivation, since it has meant, from a system standpoint, competing for the opportunity to pay higher & higher interest rates on deposits that already exist in the commercial banking system.

    The shift from demand to time deposits has converted spendable balances into stagnant money. This transfer added nothing to the Gross National Product, & nothing will be added so long as the funds are held in the form of time deposits. Shifts from transaction deposits, to time deposits, simply increases the aggregate costs to the banking system & adds nothing to the system’s income.

    But it does profit a particular bank to pioneer the introduction of a new financial instrument such as the negotiable CD until their competitors catch up; & then all are losers. The question is not whether net earnings on CD assets are greater than the cost of the CDs to the bank; the question is the effect on the total profitability of the banking system. This is not a zero sum game. One bank’s gain is less than the losses sustained by other banks

  19. Gravatar of flow5 flow5
    19. December 2014 at 15:34

    Note: The DIDMCA created the legal framework for the addition of 38,000 CBs to the 14,000 we already had (all MSBs, CUs, and S&Ls). But it did not give the Fed control of legal reserves (the NBs held larger volume of correspondent balances than the pass thru arrangement required). As predicted, M1A came to approximate M3 during the housing crisis.

  20. Gravatar of Benny Lava Benny Lava
    19. December 2014 at 15:48

    For ABCers it is always 1921. Nothing about the economy is particularly different is it?

    Ironically I find the market monetarists’ explanation much better because it explains both 1921 and 1930.

  21. Gravatar of Kenneth Duda Kenneth Duda
    19. December 2014 at 15:55

    Mostly (but not entirely) off topic, Krugman has another post making the case for MM and NGDPLT:

    http://krugman.blogs.nytimes.com/2014/12/19/the-simple-analytics-of-monetary-impotence-wonkish/

    He argues that the “only” channel monetary policy has at the ZLB to affect the real economy is the expectations channel. Well… exactly !! Why won’t he just come right out and finish the thought? Paul, repeat after me: “If the Fed were constrained to adjust the monetary base as needed for a prediction market to forecast future NGDP to hit the Fed’s prescribed level path, then the expectations channel enables the Fed to gain traction at the ZLB.”

    MM and NGDPLT FTW.

    -Ken

    Kenneth Duda
    Menlo Park, CA

  22. Gravatar of flow5 flow5
    19. December 2014 at 16:11

    The U.S. transmission mechanism is broken (forward interest rate guidance). The money supply can never be managed by any attempt to control the cost of credit. Both, (1) the experience leading up to the Treasury-Federal Reserve Accord of March 1951, and (2) the experience after William McChesney Martin Jr., abandoned the FOMC’s net free, or net borrowed, reserve targeting approach, in favor of the Federal Funds “bracket racket”, beginning in c. 1965 (coinciding with the rise in chronic monetary inflation & in anticipated inflation), should have established the validity of that dictum.

    The Fed emasculated its “open market power” (the power to create new money), when it introduced the payment of interest on excess reserve balances. Thus, it falsely appears that the Fed is “pushing on a string”. Whereas between 1942 and 2008 the CBs minimized their excess reserve balances (non-earning assets), by parking their excess funds (legal lending capacity), in highly liquid, short-term obligations (and counter-cyclically creating new money – obviating the need for gov’t intervention). I.e., the CBs temporarily bought gov’ts pending a more profitable disposition of their funds (3% + NIMs), whenever there was a paucity of creditworthy borrowers (lack of bankable loans/lending and investment opportunities).

    With remunerating reserves, the CBs parked their excess balances in fungible, more profitable, zero-risk weighted, floating rate, inter-bank demand deposits -IBDDs.

    But that’s not the worst of it. Given open market operations of the buying type (quantitative easing), when remunerating excess reserves, it induced dis-intermediation among just the non-banks (82 percent of the lending market prior to the Great-Recession).

    Dis-intermediation is an economist’s word for going broke (an outflow of funds, or negative cash flow). Since the Great-Depression (c. 1933), it’s only been applicable to the CBs. Bankrupt U Bernanke destroyed NB lending/investing as the remuneration rate inverted the short-end segment of the yield curve (double the term structure of the money market). The wholesale money market funds the NBs (by synchronizing and hedging: duration, net interest rate margins, currency fluctuations, credit risk and leverage, via scheduled cash-flows, or the matching of its liabilities against its earning assets).

    In other words, instead of incentivizing risk, remunerating IBDDs reduced the CBs appetite for risk (and thwarted the expansion of the money stock). These policies changed the historical counterparty relationships between the Reserve banks, the commercial banks, and the non-bank public.

  23. Gravatar of flow5 flow5
    19. December 2014 at 16:22

    correction “only applicable to the NBs”

    The “equation of exchange” P=MVt/T embodies the truistic relationship between money flows and the aggregate value of all monetary transactions. P represents the unit prices of all transactions; T the number of “units” of all transactions; M, the volume of means-of-payment money; Vt, the transactions rate of money flows; and MVt, the volume of money flows.

    While the usefulness of the equation is somewhat diminished by the impossibility of quantifying P and T, the validity of the equation is not.

    Accordingly, Dr. Richard G Anderson, former V.P., Economic Research, FRB-STL remarked on Thursday, 11/16/2006: “This is an interesting idea. Since no one in the Fed tracks reserves”…”Today, with bank reserves largely driven by bank payments (debits or withdrawals), your views on bank debits and legal reserves sound right!”

    Roc’s in money flows = roc’s in nominal-gDp (proxy for all transactions in Irving Fisher’s transaction concept – the “equation of exchange”. The evidence is in the market. Both prices and rates have declined in conjunction with the deceleration in the rate-of-change of money flows (proxy for inflation). December is the bottom.

  24. Gravatar of Major.Freedom Major.Freedom
    19. December 2014 at 16:41

    “…in both depressions the economy began recovering almost exactly when the M2 money supply started rising.”

    Correlation is not causation alert!

    Hey guess what everyone, did you know that a bank’s success in earning interest income is almost exactly correlated with the amount of credit unbacked by prior deposits that it issues?

    This clearly suggests that no matter how bad of a shape a bank is in, it just needs to expand credit by more and more until its interest income rises sufficiently to eliminate the insolvency.

    Silly banks, only adding to M2 and thus aggregate spending when they are confident in investment opportunities. We require the correlation to go the other way. We have to convince the middlemen bankers that the lending activity they engage in, which increases deposits and is proximately causes spending to rise, is being so highly controlled by the Fed so as to fadenout of one’s mind the inflation transmission mechanism that actually exists. If only the bankers gave up their knowledge of their own selves, and instead viewed themselves as mere tools of omnipotent central banker minds. Then they would fulfill the self-fulfilling prophecy of increasing bank deposits through lending, and thus increase spending, in order to take advantage of that very same increased spending, which the Fed controls you see.

    After all, if any of us were given enough new money from the Fed, in exchange for our garbage, then the Fed would be able to bring about any amount of additional lending, new bank deposits, and as much new spending from us as it desires. They really do control how much we spend.

    Now if only we trusted the MMs on this and felt like totally cool with unlimited QE so as to convince skiddish lenders to throw caution to the wind. If they are not willing to lend as much, it is because the Fed has not succeeded in convincing them with QE that their lending will increase lending which will increase spending which will increase interest income.

    If only the Fed spent money directly on final goods (GDP). Then they could cut out the scared middlemen bankers altogether. Oh wait, the Fed works for the banks. Darn, guess NGDP will have to collapse if the bankers refuse to lend more. This sucks. The Fed is constrained to the pseudo-gold standard of relying on bank credit expansion, in order to target NGDP. Future new paradigm monetarists will look back and shake their heads at why the Fed constrained itself to banker optimism. They will know that the ideal monetary order according to MM is for the Fed to be the consumer spender of last resort. They can then target NGDP exactly, right down to the penny.

    Wouldn’t that be great everyone? We can have NGDPLT and we can work all day to produce products for Fed employees, and they are gracious enough to put dollars back into the economy for us!

    Wait a minute, that will be too obvious. We have to put a larger distance between the wealth transfer beneficiaries, and the exploited. I know! Let’s invite some people in the market, not everyone of course, but some, to share in this wealth transfer! Then we can pretend it doesn’t exist by lumping all spending into one single variable that apply to both the transfer beneficiaries and the exploited! It’s perfect. We can then start to argue that falling banker spending is bad for the exploited! See? Look at all that unemployment. Do you want to work more for less or don’t you? Would you rather have independence and no job, or a parasite off your life with a job? They don’t pay me to give these false dichotomies for nothing!

  25. Gravatar of Major.Freedom Major.Freedom
    19. December 2014 at 16:46

    Does market monetarism have Jonathan Gruber as an advisor? Just wondering.

  26. Gravatar of flow5 flow5
    19. December 2014 at 17:34

    That’s the equivalent of stuttering when speaking. Time deposits are not a source of loan-funds, rather they are the indirect consequence of prior bank credit creation. The source of time deposits is almost exclusively demand deposits – and the source of demand deposits can largely be accounted for by the expansion of bank credit.

    The CBs do not need to lend to expand the money stock. They can invest. The gov’t is the largest creditworthy borrower.

  27. Gravatar of Major.Freedom Major.Freedom
    19. December 2014 at 19:09

    Flow5:

    So…you agree with what I wrote above.

    I never claimed time deposits are a “source” of loan funds. As you said, they are from demand deposits, which I called just deposits, the source of which is credit expansion. When those time deposits rise, M2 rises.

    CBs that “invest in government bonds” are just adding to bank reserves, and they must rely on banks to expand credit in order to increase aggregate money supply measures and aggregate spending. Barring that, QE is just followed by higher bank reserves without increases in NGDP.

  28. Gravatar of Michael T Michael T
    19. December 2014 at 19:13

    Scott,
    “John, Your facts are wrong, in both depressions the economy began recovering almost exactly when the M2 money supply started rising. There is no difference there.”

    Regarding the 1920-21 episode, you claimed that the trough in M2 occurred in Sep ’21. It was my understanding that the trough was later than that. It’s true that there was a close correlation between money growth and the recovery, but if you look at the numbers more closely, I believe MO, M2 and consumer prices were all decreasing until around Jan/Feb ’22. However, the business cycle trough was over 6 months earlier in ’21. The recovery began well before the money supply and general price level reversed trend.

    “Rereading the quote, it doesn’t actually say the monetarists failed to predict a fast recovery, but I sort of think that was implied. Did I misinterpret the quotation? How would the average person interpret the quote?”

    I didn’t read the quote as a failed prediction. I think Grant was just saying that the economy began growing during a period when there was still fiscal and monetary contraction as both the federal government and central bank did not intervene in any substantive way to spur a rebound, i.e. no keynesian or monetarist countercyclical policy prescription for stimulus was required.

  29. Gravatar of Ray Lopez Ray Lopez
    19. December 2014 at 19:13

    @flow5 (who posts incessantly): Grant’s an entertaining writer, but doesn’t understand money and central banking (he’s an historian). Periods before the Great-Depression were self-correcting, afterwards – required gov’t intervention (i.e., subsequent periods aren’t comparable). You can’t eat gold. Wow, the parody is incredible! is flow5 a troll? flow5 does not make the connection: before Great Depression things were self-correcting because monetary policy was crowd-sourced, albeit constrained by evil central bankers, by the gold standard. Duh!

    @Major Freedom: right on. This is a poster worth reading, though I don’t agree anymore the Fed has any power, even short term.

    @Sumner: John, Your facts are wrong, in both depressions the economy began recovering almost exactly when the M2 money supply started rising. correlation is not causation. Of course velocity increases, as does the money supply, when an economy naturally recovers, as it always does. The rooster crowing at the break of dawn is not the cause of the sun coming up, though it hurts your profession to admit you have no predictive or even proscriptive power.

  30. Gravatar of Ray Lopez Ray Lopez
    19. December 2014 at 19:28

    @myself: so if the Fed has no power, why get concerned over it? Because of the same reason we should get concerned over government robbing Peter to pay Paul: hysteresis. The Fed performs no useful activity, in the same way the Fed., state and local govt’s, which redistribute 40%+ of US GDP, perform nearly nothing of any use. Hysteresis.

  31. Gravatar of flow5 flow5
    19. December 2014 at 19:29

    “Barring that, QE is just followed by higher bank reserves without increases in NGDP”

    No, transactions between the Reserve bank and the CBs are asset swaps, but transactions between the “desk” and the NBs as its counterparty creates both new money (and higher levels of gDp), and reserves.

    And it is impossible for the CBs to expand their deposits, their lending capacity, and their earning assets thru an expansion of time deposits (monetary savings). The bankers (and the ABA), naively believe that savings originate outside their banks.

    @ ray – I’m the best market time in all of history. Go fish.

  32. Gravatar of flow5 flow5
    19. December 2014 at 19:55

    M2 is the wrong metric. Virtually all transactions are consummated thru M1 deposit classifications. You can ignore Divisia Aggregates, FRB-STL’s MSI, etc.

    And from “The Money Supply” (FRB-NY) “Chairman Greenspan added, “The historical relationships between money and income, and between money and the price level have largely broken down, depriving the aggregates of much of their usefulness as guides to policy”.

    Greenspan couldn’t have been more wrong. Nothing’s ever changed in over 100 years.

  33. Gravatar of flow5 flow5
    19. December 2014 at 20:05

    Grant doesn’t know money from mud pie (Grant’s Interest Rate Observer)

    “Both use quantitative methods to build predictive models, but physics deals with matter; economics confronts human beings. And because matter doesn’t talk back or change its mind in the middle of a controlled experiment or buy high with the hope of selling even higher, economists can never match the predictive success of the scientists who wear lab coats.”

    He’s dead wrong. My prediction for AAA corporate yields for 1981 was 15.48%. They hit 15.49%. I got the bottom in bonds. Then I got the top in bonds in July 2012 (my forecast was that was the top in the 31 year bull market).

  34. Gravatar of ssumner ssumner
    19. December 2014 at 20:47

    W le B, I’m not saying your facts are wrong, my point is that it doesn’t matter what the check is drawn against, it matters what happens to the money supply. If the fiscal authorities do 10 billion is fiscal spending financed by BofE checks, but at the same time the BofE sells 10 billion in bonds to prevent the base from rising, it’s not inflationary. Focus on the base, not the deficit. But I would imagine that in the 1970s Britain did money financed deficits, as the inflation rate was quite high.

    Kenneth, What Krugman doesn’t seem to realize (but Nick Rowe does) is that even when rates are not at zero, monetary policy is 98% expectations. I think he overrates the importance of interest rates when we are not at the zero bound.

    Michael, My mistake on M2. It rose a bit after September, but then dipped briefly in January 1922, as you said. Here’s a better description. It fell sharply until July 1921, then was basically flat for 6 months, then rose sharply. When it fell sharply the economy contracted. When if was flat the economy began to recover. When it rose the economy recovered even faster. That’s clearly consistent with Friedman’s “natural rate hypothesis.”

    You said:

    “I didn’t read the quote as a failed prediction. I think Grant was just saying that the economy began growing during a period when there was still fiscal and monetary contraction as both the federal government and central bank did not intervene in any substantive way to spur a rebound, i.e. no keynesian or monetarist countercyclical policy prescription for stimulus was required.”

    But I also read your comment as claiming a failed prediction of monetarism. Monetarist do not claim that monetary stimulus is necessary for a recovery. They believe a recovery will occur naturally once wages adjust. Thus I think 1920-22 is 100% consistent with the monetarist model.

    Ray, You said:

    “Of course velocity increases, as does the money supply, when an economy naturally recovers, as it always does. The rooster crowing at the break of dawn is not the cause of the sun coming up, though it hurts your profession to admit you have no predictive or even proscriptive power.”

    Just stop the madness!!! I can’t see how someone can be so clueless that they don’t even realize what nonsense they are spouting. Have you looked at V in the past 5 years??? Is there any activity going on in your brain before you start typing? You leave multiple comments for every post, crowding out people who might actually have something relevant to say, people who might understand at least the basics of monetary policy. And for what purpose? Are you trying to play the clown? Are you actually MF commenting under a new name?

  35. Gravatar of Saturos Saturos
    19. December 2014 at 21:59

    Paul Krugman on monetary impotence: http://krugman.blogs.nytimes.com/2014/12/19/the-simple-analytics-of-monetary-impotence-wonkish/

  36. Gravatar of Ray Lopez Ray Lopez
    19. December 2014 at 22:03

    @Sumner – “Have you looked at V in the past 5 years???” – no I have not. I just did, here it is: http://research.stlouisfed.org/fred2/series/M2V/

    As you can see, velocity of M2 has collapsed since the Great Recession. Do you disagree? Are you saying because velocity of M2 is still down, but nominal US GDP has resumed growth and/or the US stock market is at record highs, that we’re OK now despite low velocity? I really am at a loss to respond. I hate to be a student of yours, constantly trembling that I might say something wrong, without even knowing what that is. BTW I can post a lot more if I want to, compared to flow5 I post less, and no, Mr. Tin Foil Hat, I’m not Major Freedom’s sock puppet. Over to you!

  37. Gravatar of dtoh dtoh
    19. December 2014 at 22:42

    Scott,
    You said, “If the fiscal authorities do 10 billion is fiscal spending financed by BofE checks, but at the same time the BofE sells 10 billion in bonds to prevent the base from rising, it’s not inflationary.”

    No. You can’t necessarily say that. If the BoE sells the bonds to commercial banks, and the banks pay for the bonds out of deposits they hold with the BoE then it could very well be inflationary (or expansionary.)

  38. Gravatar of James in London James in London
    20. December 2014 at 00:03

    Don’t worry Scott. Keep cool and enjoy the holidays. Only newbies to your site get sucked in to the MF/flow5/Ray Lopez vortex. I did once, but learned my lesson. I think they are sent from North Korea to waste out time.

    PK is beginning to sound like them, too. He seems a busted flush. Ambrose does a decent job of calling his bluff, even if he doesn’t give you the recognition you deserve.
    http://www.telegraph.co.uk/finance/economics/11294510/Ambrose-Evans-Pritchard-Why-Paul-Krugman-is-wrong.html

  39. Gravatar of James in London James in London
    20. December 2014 at 01:08

    I should add, before anyone else does, that Ambrose E-P does get a bit carried away by the end of his piece and drops into fiscal stimulus confusion. Deadlines were tight? And he misses one huge and key piece of the Market Monetarist story, the monetary policy transmission mechanism is expectations, not the quantity of money. A common mistake made by such eminent old school Monetarists as Tim Congdon, whom he cites favourably.

  40. Gravatar of flow5 flow5
    20. December 2014 at 05:37

    Vi – it is wanton apocrypha to presuppose, with if half of Americans living paycheck-to-paycheck, that there is, e.g., no minimum monthly number of bills, and undisposed income? – naught

  41. Gravatar of flow5 flow5
    20. December 2014 at 05:50

    Per the last publication of the G.6 release, 93% of all demand drafts (bank debits), cleared thru demand deposit classifications (525 demand drafts/mo for Vi, as compared to 7.648/qtr for Vi on 10/1/1996). The Fed calculated the G.6 figures by dividing the aggregate volume of debits of these banks against their demand deposit accounts.

    M2 turns over 1.532 times a quarter? non sequitur

  42. Gravatar of flow5 flow5
    20. December 2014 at 05:57

    “the monetary policy transmission mechanism is expectations”

    Interest rates are a coincident indicator.

  43. Gravatar of flow5 flow5
    20. December 2014 at 06:05

    Nominal-gDp is the demand for services (human) & final goods. This concept excludes the common sense conclusion that the inflation process begins at the beginning (with raw material prices & processing costs at all stages of production) & continues through to the end…

    To ignore the aggregate effect of money flows on prices is to ignore the inflation process. To dismiss the concept of Vt by saying it is meaningless (that people can only spend their income once), is to ignore the fact that Vt is a function of three factors:

    (1) the number of transactions;
    (2) the prices of goods and services;
    (3) the volume of M.

    Inflation analysis cannot be limited to the volume of wages and salaries spent. To do so is to overlook the principal “engine” of inflation – which is of course, the volume of credit (new money), created by the Reserve & the commercial banks, plus the expenditure rate (velocity) of these funds. Also, e.g., overlooked is the effect of the expenditure of the savings of the non-bank public on prices (dis-savings). [M*Vt’s] outcome encompasses the total effect of all these monetary flows.”

  44. Gravatar of ssumner ssumner
    20. December 2014 at 06:33

    Ray, That’s funny, I could have sworn the US was in a recovery over the past 5 years. But now I see that can’t be so, as you insist V always rises during recoveries, and it’s fallen in recent years. That’s for clarifying that.

    dtoh, There could be some second order effects, but they’d be tiny compared to a money financed deficit.

    James and Saturos, Thanks I’ll take a look.

  45. Gravatar of ssumner ssumner
    20. December 2014 at 07:31

    James and Saturos, I did a post at Econlog.

  46. Gravatar of Michael T Michael T
    20. December 2014 at 07:48

    “Monetarist do not claim that monetary stimulus is necessary for a recovery. They believe a recovery will occur naturally once wages adjust. Thus I think 1920-22 is 100% consistent with the monetarist model

    Ok, and to be fair, I think some have too quickly dismissed monetarism during this event when the data does closely correlate to the monetarist’s explanation.

    However, I’m still curious what Scott Sumner, as Fed President, would have been saying in March ’21 (assuming the Fed has all of the policy tools that it has today including a fully elastic currency not constrained by gold). At this time, GDP (in both real and nominal terms) and prices (both wholesale and consumer) were still falling off a cliff for over several months, while I believe unemployment was still increasing. This was coinciding with higher money rates and a continued shrinking of both base and high-powered money. I don’t want to misrepresent your views in any way, so what would you have been arguing as Fed President meeting in March ’21 in terms of suggested Fed monetary policy under those conditions at the time? I think it’s easier to look back on the event to show a close correlation in the data to bolster the monetarist explanation of a quick recovery, but would you have been saying the same thing (the market will naturally and quickly recover without Fed intervention) as you were watching NGDP collapse for several straight months?

  47. Gravatar of Ray Lopez Ray Lopez
    20. December 2014 at 08:05

    Sumner: “Ray, That’s funny, I could have sworn the US was in a recovery over the past 5 years. But now I see that can’t be so, as you insist V always rises during recoveries, and it’s fallen in recent years. That’s for clarifying that.

    I implied that, true. And conventional economics, which you are aware of, does say that velocity (and the multiplier effect) increases during expansion and decreases during contraction. Here is an article on this year’s anomaly: a low velocity, despite being ‘out’ of recession. http://www.businessweek.com/articles/2014-01-17/the-recovery-and-the-speed-of-money

    The economy is sick, agree? A symptom is low velocity. If not, you’re sick, or you have the burden of explaining why. If it’s in your FAQ, I’ve not seen it.

  48. Gravatar of Major.Freedom Major.Freedom
    20. December 2014 at 08:20

    M2 velocity has indeed collapsed:

    http://research.stlouisfed.org/fred2/graph/?g=UMW

    It is the lowest it has been since the Fed started collecting the data in 1959.

  49. Gravatar of Daniel Daniel
    20. December 2014 at 08:36

    The economy is sick, agree? A symptom is low velocity. If not, you’re sick, or you have the burden of explaining why.

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

  50. Gravatar of Ray Lopez Ray Lopez
    20. December 2014 at 08:51

    @MF – thanks, a good graph. Frankly I’m surprised Sumner does not cite falling velocity in his theory more favorably. Instead he seems to pretend it is not relevant. Sumner is a strange economist: neither fish nor fowl, saltwater or fresh, and I’m afraid he probably thus alienates most economists who are Keynesian. It could be his theories are radically eclectic, or, dare I say it, he could just simply be ignorant.

    @Daniel–nice lame attempt at trolling. Your Wiki cite: “His closing argument “If Chewbacca lives on Endor, you must acquit” is lampooning the real Cochran’s “If it doesn’t fit, you must acquit”.- you do realize that OJ’s glove had shrunk while it was in the LAPD evidence room (that’s why it did not fit), and, detective Mark Fuhrman most probably did plant tainted blood samples coming from OJ (since it was clear OJ was indeed the murderer, and LAPD practice at the time and indeed all over the US even today, is to make sure the guilty party has no alibi). So in a way, the acquittal of OJ was poetic justice (Google Claus von Bülow for another example of where planting evidence backfired). Just sayin’… I was in LA during the riots and followed the story.

  51. Gravatar of Daniel Daniel
    20. December 2014 at 09:10

    Ray,

    You can’t possibly be that stupid and still be able to breathe and type simultaneously.

  52. Gravatar of Michael T Michael T
    20. December 2014 at 09:43

    And I obviously meant Fed Chairman, not Fed President in my previous comment

  53. Gravatar of Negation of Ideology Negation of Ideology
    20. December 2014 at 12:17

    We’re overlooking an important part of the 1920-21 downturn. We were not on the gold standard at that time. The gold standard was suspended during WWI. We returned to the gold standard in 1923.

    So we recovered quickly when we were off the gold standard in 1921, and didn’t recover quickly when we were on the gold standard in 1929. In fact, we didn’t recover until we left the gold standard in 1933.

    Strange that gold bugs would try to use this example to further their case.

  54. Gravatar of benjamin cole benjamin cole
    20. December 2014 at 15:25

    OT sorta, but fascinating, possibly worth a Sumner post: John Cochran just ran a chart showing that at any point in the last 30 years economists, as a group, predicted higher pending interest rates. Of course the history is the opposite; for the last 30 years interest rates and inflation have, in general, been on the decline. But why? Why are economists exactly wrong for 30 years in a row?

  55. Gravatar of flow5 flow5
    20. December 2014 at 15:57

    “But why?”

    Very simple. The principle determinants: financial innovation peaked in 81 (Vt decelerated). Then Congress turned 38,000 financial intermediaries into 38,000 CBs. Then reserves ceased to be binding. Then more financial engineering: CMOs, CDOs, CDSs, ABSs CLOs, CFOs (securitization & credit enhancements), via (SIVs, SPEs, & other non-banks); then the payment of interest on excess reserves. It was over in 2012 esp. after the end of unlimited FDIC insurance coverage.

  56. Gravatar of Major.Freedom Major.Freedom
    20. December 2014 at 17:59

    Negation if Ideology:

    It is not enough for a government to be “off the gold standard” on paper.

    What matters is what they actually do.

    The argument that the economy recovered after 1920 for reasons X, Y and Z is NOT a “gold bug” argument.

  57. Gravatar of Major.Freedom Major.Freedom
    20. December 2014 at 18:05

    Daniel:

    “You can’t possibly be that stupid and still be able to breathe and type simultaneously.”

    Breathing does not require non-stupidity.

    And obviously because he did type and breathe simultaneously, it is absurd to say he can’t do that.

    Your insults are like sandbox level prattle at elementary schools.

  58. Gravatar of Major.Freedom Major.Freedom
    20. December 2014 at 18:32

    Ray:

    “Frankly I’m surprised Sumner does not cite falling velocity in his theory more favorably. Instead he seems to pretend it is not relevant.”

    It shouldn’t be surprising. His theory presupposes that if the central bank collapses spending to 1% of what it has been for say the last year, and holds spending down for 364 days, and on the 365th day the Fed inflates so much that there is sufficient “catch up” in spending that makes the annual growth in NGDP exactly “on target”, then there should be no nominal side caused problems in the economy.

    No wait, that can’t be right. I got this. What the theory really presupposes is that NGDP must grow “on target” along a nice straight line, which means no months long collapse in soending, but a constant gradual rise over time. That means total spending must be continuously rising, at least every yoctosecond (10exp-24 seconds), ideally an even shorter time frame, at an annual rate of “on target” growth in spending.

    Oh shoot, no that can’t be right either. Not even 7 billion people spending money as fast as they can, can spend money in such a way that in the aggregate there is an expenditure every yoctosecond, It would also be impossible for each expenditure to be small enough that the annual accumulation remains “on target”.

    Looks like we have to think about and assume a definite range of time increments, where we must tolerate an absence of expenditures taking place within time increments smaller than the low end of this range, while we must not tolerate no expenditures taking place within time increments greater than the high end of this range.

    But, you know, we’re not supposed to take into account velocity of money. It is not important. Sumner encourages us to advocate for a NGDPLT that consists of any decline in aggregate spending we want, as long as at some point in the future there is a target maintaining “catch up” increase in spending. Because, you know, velocity does not matter. Velocity can be 0.00000001 or 10000000. As long as after this there is velocity at the opposite side of the extreme to maintain a nice NGDPLT. Because velocity does not matter.

  59. Gravatar of Major.Freedom Major.Freedom
    20. December 2014 at 18:40

    I support NGDPLT. I believe there should be a free market in money that results in volatile NGDP, and then for one day each century, a government takes control over the money supply and inflates or deflates whatever is necessary to bring about 4.5% annualized NGDPLT growth over that last century.

    Spending one dollar a day for 365 days, or spending 365 dollars on Dec 31 each year, it is all the same from a market monetarism perspective. Velocity does not matter.

  60. Gravatar of Major.Freedom Major.Freedom
    20. December 2014 at 19:00

    What I chuckle at when reading anti-gold bug, inflationism types, is what they believe about gold, in the face of the fact that the very people who they want to maintain fiat over gold, are among the world’s largest stockpilers of gold.

    Since they believe central bankers can manage the economy’s money better than private competition, then surely they believe central bankers are more intelligent than the totality of the private market actors. For if it is more intelligent for there to be NGDPLT central bank monetary policy, as opposed to private competitive money derived spending, and private competitors do not bring about constant gradual growths in spending on final products as would central bankers, then it follows that private competitors are not as intelligent as central bankers who do bring about constant growth in spending on final products.

    But if central bankers are more intelligent than the totality of private market actors, because only central bankers can know how to bring about NGDPLT, and central bankers stockpile gold, then it follows that the anti-gold bug types are not as intelligent as gold bug types.

    Excuse me? Did you want to claim that being intelligent in one thing does not mean that everything one does is intelligent? OK, but stockpiling gold is so connected to money that if we assume intelligence in money, then what they do with gold is also intelligent.

    Or, more crudely, if central bankers have monopoly control over the nation’s money, and the money is not backed by gold in any way (right?), then why do central bankers stockpile so much gold?

    It is ironic that gold bug haters appeal to gold bugs for managing the nation’s money.

  61. Gravatar of Bob Murphy Bob Murphy
    20. December 2014 at 23:05

    Major Freedom, I consider myself somewhat of a physics nerd and have never heard of a “yoctosecond” until now. And yet some of these other posters think you bring nothing to the discussion.

  62. Gravatar of Ray Lopez Ray Lopez
    20. December 2014 at 23:31

    @ Negation of Ideology – as Major Freedom pointed out to you, it matters not what governments say but what they do. Read the italics of the passage I quoted from Grant: the US government RAISED interest rates to defend the (fiat) dollar. And Wilson BOUGHT GOLD in 1971, well before the US went back to the Gold (exchange) Standard in 1922 (further, see above, the Fed lowered interest rates in April 16, 1921, which I posit was due to market forces, but even if not, it was a correct move that helped overcome the post-WWI depression. Still, the US did not really go back to a true Gold Standard after WWI, but a Gold *Exchange* standard, managed by central banks, which everybody save our host on this site agrees is not the same as a true Gold Standard (even if said Gold Standard was manipulated via sterilization in the 19th century). Arguably, if the US had stayed on a true Gold Standard we would not have had a Great Depression, and, less arguably, even WWII would have been averted (no fiat war bonds, no money for war). Question for Alt-Historian buffs: would a repeat of the Franco-German defeat of 1870, this time in 1914, where Germany imposed its will on France, have been as bad as avoiding World War I, World War II and the horrors of Hitler? Probably not. So the US WWI isolationists were correct after all.

  63. Gravatar of Ray Lopez Ray Lopez
    20. December 2014 at 23:40

    @myself – Analogy to why WWI should have been avoided by the USA: The Greeks and Turks had many battles in history. Often the Greeks prevailed, often the Turks. Usually the Western Powers stayed out of these disputes, wisely. And usually nothing came of them. Read this: http://en.wikipedia.org/wiki/Greco-Turkish_War_%281897%29 Consider that most of you did not even know about this 1897 conflict in the Balkans. By analogy, why should have the USA gotten into a dispute between France and Germany in 1914? The second since 1870? Recall in 1914 Germany was not bent on genocide (though in any war there are atrocities; there were some in Belgium that year). The US isolationists were right: the USA should have stayed out of WWI (as should have the UK). It was a Franco-Russian-Germany battle. Let them sort it out the same way the Greeks and Turks did and do. And, for you fiat money types, if there was no fiat money bonds, there would be no financing for war. Gold is good for peace too, a true “peace dividend”. It’s no surprise that Charles of Spain in the early 1500s, and Philip afterwards, financed their aggressive and wrong wars against the Dutch and others because they had New World gold and silver to finance their efforts. No financing, no wars. No fiat money bonds, no wars. Nuff said.

  64. Gravatar of flow5 flow5
    21. December 2014 at 05:02

    Vt varied 2.5 times that as the primary money stock over a 50 year period. That’s how M1A turned into M3 before the crash.

  65. Gravatar of Nick Nick
    21. December 2014 at 05:40

    Ray,
    Any alternate history for me on the Cold War? Let’s say the US claws it’s way onto a gold standard you like during the 50s. This destroys the military industrial complex? Is there no arms race with the soviets? Does us adhering to a metallic standard undermine their immoral economic model? Gold seems like the kind of product forced labor camps and strict quotas can produce pretty well. And it’s not kosher to stop people from buying soviet gold since that’s government manipulation of the price of gold, right?

  66. Gravatar of Ray Lopez Ray Lopez
    21. December 2014 at 10:00

    @Nick – I don’t have any immediate opinions on this matter. If the USA avoided WWI and WWII, by staying out of WWI, arguably there would be no Cold War. As for Soviet gold, the USSR was so concerned about the collapse of gold prices after their peak in the early 1980s, that the Soviets actually held off selling gold on the world market, even though they needed the money. So in a way the Soviets were wise stewards of gold. And, as MF says above, if stockpiling gold is dumb, why do so many seemingly smart central banks do it? Including the USA, Russia (a basket case, but not due to gold buying). China has the smallest reserves, so if you are anti-gold buy Chinese Renminbi, and good luck with that as a store of value.

  67. Gravatar of Daniel Daniel
    21. December 2014 at 10:06

    Fiat money is not supposed to be “a store of value”, moron.

  68. Gravatar of Ray Lopez Ray Lopez
    21. December 2014 at 10:06

    Since this thread is nearly dead I will post here some wise words, so our gracious host will not accuse me of ‘crowding out’ thoughts by others (funny, I wonder what our host feels about government debt crowding out borrowing by private companies, which has been thoroughly discredited, but I digress). – RL

    From: “The Little Book of the Shrinking Dollar”– Central bankers like to tell us there is only one kind of deflation: always bad. Economists like George Selgin are doing extensive research on the topic, and they conclude that there are two types of deflation: benign and malignant. The difference is in the cause. The period from 1873 to 1896 was good to many Western nations. The gold standard, you see, placed limits on their ability to offset productivity improvements with monetary expansion. With their hands tied, prices declined. Scholars were ready to label this the first Great Depression, but they noticed something interesting: Every other economic indicator””wages, profits, industrial output, and trade””pointed to growth, even prosperity. In fact, let’s take a closer look. Two economists from UCLA and the University of Minnesota teamed up to check this twentieth-century phenomenon out. Andrew Atkeson and Patrick Kehoe looked at 16 countries in addition to the United States. They concluded that there were far more periods of deflation””enjoying reasonable growth””than there were depressions. On top of that, Atkeson and Kehoe found that many more periods of depression were accompanied by inflation””rather than deflation. So deflation isn’t the boogey man central bankers want you to think it is. In fact, the only episode that links deflation and depression is the Great Depression. (And that’s after the Feds arrive on the scene in a big way . . . and Roosevelt goes on a spending spree.)

  69. Gravatar of Ray Lopez Ray Lopez
    21. December 2014 at 10:09

    @Daniel–you call me moron one more time and by that very fact you will be cursed with a Balkan curse that will result in your getting cancer within five years of said utterance. Go ahead make my day. You don’t believe in Balkan superstition do you? You’re a modern, brave atheist, go on…

    As for store of value, that certainly is supposed to be a function of money, along with unit of account and a few other things I’ve since forgotten.

  70. Gravatar of Daniel Daniel
    21. December 2014 at 10:16

    Like I said – you’re a total moron.

    It is impossible for something to be a store of wealth AND a medium of exchange/account simultaneously, for it requires opposite qualities.

    Gold may be good as a store of wealth (mainly because people are stupid and thus fond of shiny things), but it’s bad a medium of account – the many recessions of the gold standard period are proof.

    Fiat money is pretty good as a medium of account (when central banks aren’t staffed with atavistic morons), but it doesn’t hold its value over time – and this is a feature, not a bug !

    You’d think such a smart 1%-er would have figured that out by now – perhaps too much inbreeding has depressed your intelligence ?

  71. Gravatar of Philippe Philippe
    21. December 2014 at 10:25

    things continue to function as money even if they are not a good store of value. There is no inherent reason why money should maintain the same purchasing power over very long periods, or increase in value.

  72. Gravatar of Negation of Ideology Negation of Ideology
    21. December 2014 at 10:29

    ” And, as MF says above, if stockpiling gold is dumb, why do so many seemingly smart central banks do it?”

    That gold was accumulated mostly before the gold standard ended. The U.S. gold reserve is about the same as it was in the 1970’s. Most of the large gold owning countries have agreed to limit annual gold sales to 400 tonnes so the market doesn’t crash like the silver market did when Germany demonetized silver in 1871. No country wants to be the last to dump their gold, because they’d have to sell it at fire-sale prices. And not all central banks are buyers, some are sellers:

    http://en.wikipedia.org/wiki/File:Gold_reserve_changes_1993-2014.png

  73. Gravatar of ssumner ssumner
    21. December 2014 at 11:05

    Michael, That’s a difficult question. As you know, I believe the best policy right now depends on the expected future policy. Thus my recommendation under a fiat money regime would have been far more expansionary than my recommendation under a gold standard regime (which is what they actually had.)

    Ray, Yes, we all know that V usually rises during expansions. You made the claim it always rises. When I show that’s not the case, you redefine “expansion” as “sick economy.” Whatever.

    And regarding Selgin, is that the same George Selgin that has advocated NGDP targeting?

    Negation, De facto, we were on gold.

    Thanks Ben.

  74. Gravatar of Philippe Philippe
    21. December 2014 at 11:40

    Ray Lopez,

    according to the stats presented here, there were six years in that 23 year period (1873-1896) in which there was both real output growth and general deflation. Other than that, deflation in that period was associated with recession.

    There were many serious economic problems in that period and overall growth was not impressive compared to the post-WWII period. Don’t forget the late 19th century was also a period of territorial and imperial expansion. Your account of it is very misleading.

  75. Gravatar of Philippe Philippe
    21. December 2014 at 11:42

    sorry, forgot the link:

    http://socialdemocracy21stcentury.blogspot.co.uk/2013/02/19th-century-deflation-and-recession-in.html

  76. Gravatar of John Becker John Becker
    21. December 2014 at 13:36

    Scott,

    The whole point of the Austrian arguement about 1920-21 was that supply side policies were better than during 30-33. You have two cases where money supply drops sharply in a year and in one case there is a recovery and in the other there isn’t. This argument isn’t really against Market Monetarists per se but more against the old school people who would say that the WHOLE reason for the Great Depression was the contraction of the money supply.

  77. Gravatar of ssumner ssumner
    21. December 2014 at 13:46

    John, Yes, supply-side policies were much worse during the 1930s, that’s pretty clear. I wasn’t reacting to the Austrian argument about 1921, just a particular quotation that seemed to imply the monetarists could not explain the difference. This post was about monetarism.

  78. Gravatar of Major.Freedom Major.Freedom
    21. December 2014 at 13:59

    Sumner:

    “And regarding Selgin, is that the same George Selgin that has advocated NGDP targeting?”

    The same one who knows central banks cause booms that inevitably end in busts.

    Becker:

    To add to your point:

    The Austrian argument is that a free market is descriptively the best means to heal a real economy disrupted by bad government supply side policies AND by past inflation, and that more inflation will only being about more real side problems, which politicians have shown themselves arrogant in trying to fix by political force, which then causes real problems themselves.

    History was one of bad fiscal and monetary activity on the real side of the economy. Austrians do not argue that ONLY absence of monetary intervention is the best means to heal real problems, especially when there are real problems caused by bad government policies. The economy recovered after 1920 without much if any monetary “stimulus” because the main problems were caused by bad monetary policy prior (to finance WW1 for example), and so there was less of a need to advocate for better fiscal policies as part of the cure. So it LOOKS like, from the outside, from a superficial assessment, that Austrians argue that “tight money cures economies in recession”.

    Only Austrians are actually putting full emphasis on real side caused problems. Market monetarists always end up blaming bad government supply side policies on problems with central banking.

    So libertarians have to put up with two insane groups. On the one hand, we have the Monetarists who end up advocating for inflation to solve problems caused by bad government supply side policies (such as problems that then lead to falling NGDP temporarily), and we have Keynesians who end up advocating for fiscal intervention to solve problems caused by bad government monetary policies.

    Clowns to the left of me, jokers to the right…

  79. Gravatar of Ray Lopez Ray Lopez
    21. December 2014 at 17:34

    @Sumner – thank you for the clarification on velocity. But I am guessing that today’s low velocity is a sign of sickness not health, though the US is technically out of recession.

    @ Daniel – you will cancer on yourself? Wow, some people will do anything to win an internet argument…

    @ Philippe – your own link refutes your own point and supports mine: “Nevertheless, ***outside of the historically aberrant 1873-1896 period***, there were many occasions when price deflation was clearly correlated with recession, as can seen below:” In fact, under the Gold Standard, using data from economist Angus Maddison to 1992, growth in all western countries was nearly the same in the LATE 1800s (not the entire 19th century) as growth post WWII. And if you extend the data past 1992, to today, I bet growth then was greater. Source: Google it, it’s in my HD somewhere. The rest of the 1800s are marred by wars (Napoleonic, nationalist, US civil war, Crimean, etc). That said, as I learned recently from reading Richard N. Cooper’s 1982 paper on gold, gold was ‘sterilized’ in the late 1800s by central banks who did NOT expand the money supply when gold flowed into a country, as required, since they liked to ‘hoard’ gold; likewise, when gold flowed out, these bankers raised rates to keep the gold from leaving, contrary to the implicit gold-standard ‘rules of the game’. Sumner knew this and I did not, which gave him an edge in our earlier debates…sneaky guy. You notice when Sumner knows something, instead of telling his opponent what he knows, he holds back, using it as an advantage. Those clever economists. This blog is not for learning, it’s for ideological bashing and winning points on debate. Compare with Tyler Cowen’s more civil blog…

    Major Freedom: right on! I enjoy reading your posts, it’s like eating a nutritious, delicious T-bone steak.

  80. Gravatar of Ray Lopez Ray Lopez
    21. December 2014 at 17:39

    @MF – Sumner: “And regarding Selgin, is that the same George Selgin that has advocated NGDP targeting?” – it’s true what Scott says, Selgin, sadly, has crossed over to the Dark Side. He’s not the George of old…

  81. Gravatar of Major.Freedom Major.Freedom
    21. December 2014 at 18:00

    Yes, Selgin’s main paper on the productivity rule of inflation was presented as a nominal income targeting rule.

    But I think he went to the dark side when he became convinced anarchism is flawed.

    Note: I am able to live and be happy surrounded by Sith.

  82. Gravatar of Philippe Philippe
    21. December 2014 at 18:13

    Ray,

    “your own link refutes your own point and supports mine”

    No, I said very clearly that in that 23-year period (1873-1896) there were apparently six years in which there was both real output growth and deflation (according to those stats). There were 9 other deflationary years in that 23-year period, and those years were all recessions. That leaves 8 years in which there was no deflation. One of those years was a recession.

    under the Gold Standard, using data from economist Angus Maddison to 1992, growth in all western countries was nearly the same in the LATE 1800s (not the entire 19th century) as growth post WWII”

    Going back to that blog, the figures presented here (including from Maddison 2003) indicate that the average real per capita GDP growth in the 1873-96 period was significantly lower than in the post-WWII period, though the numbers shown only go up to 1990:

    http://socialdemocracy21stcentury.blogspot.co.uk/2014/12/huerta-de-soto-gets-it-wrong-on-gold.html

  83. Gravatar of Nick Nick
    22. December 2014 at 05:44

    @ray:
    I’m disappointed. You are posting all the time, talking about steak … Give me some creativity ova here. Give me hypo a shot … Say we did get into the world wars and then we wised up and wanted to switch to your preferred policy later. Would it still have been great?
    What you say about the soviets and gold in the 1980s is my point! They would have been huge players in any reasonably free global currency market based on gold, I think–not really something I spend a ton of time thinking about.
    I put the question to you around 1950 for a reason … In the ideal case for gold there is no bad time to make the changeover.

  84. Gravatar of ssumner ssumner
    22. December 2014 at 06:47

    Ray, You said:

    “it’s true what Scott says, Selgin, sadly, has crossed over to the Dark Side. He’s not the George of old…”

    Your mistakes are becoming increasingly comical. The “old” Selgin you cite favored NGDP targeting, precisely for the reason that prices should fall when productivity rises rapidly. You don’t seem to understand any of the economists that you quote.

  85. Gravatar of W le B W le B
    22. December 2014 at 09:53

    @ssumner ” Focus on the base, not the deficit. But I would imagine that in the 1970s Britain did money financed deficits, as the inflation rate was quite high.”

    In my original comment I was focusing on the way the deficit was financed in the UK in the 70s and what you imagine was indeed how it was financed. We were not at odds.

    Did you ever come across the Domestic Credit Expansion flow of funds equation?

    I made the point above to support your Top Line: “Don’t underestimate monetarism” and to try to explain why the policy that beat 70s inflation never got the credit and therefore why it was that in 2007/08 no one in political office or among key journalist could see the obvious lessons from monetarism for the catastrophic fall in aggregate demand.

    Nor do I think, despite your personal efforts, that this lesson has been accepted, even now. And similar errors are likely to be made when the next ‘shock’ arrives.

  86. Gravatar of ssumner ssumner
    23. December 2014 at 13:29

    W le B, I fear you are right about lessons not learned, but I do think we’ll be at least slightly more ready. In retrospect, even the Fed admits that money was too tight in 2008 and 2009. And the UK now has Mark Carney.

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