Excess money: Lower rental cost or lower price?

In the classic helicopter drop thought experiment the excess cash balances are disposed of in one of two ways:

1.  The rental cost of money (i.e. nominal interest rate) falls.  This is the Keynesian story.

2.  The price of money (1/price level) falls.  This is the monetarist story.

Now take a look at a very insightful post by Yichuan Wang:

While his first few posts were filled with mathematical equations, he was gracious enough in a recent post to present a story of what’s going on in the model (my emphasis is bolded)

Next, conduct a thought experiment. What happens if there is an increase in the aggregate stock of liquid assets, say because the Treasury issues more debt? This will in general reduce liquidity premia on all assets, including money and short term debt. But we’re in a liquidity trap, and the rates of return on money and short-term government debt are both minus the rate of inflation. Since the liquidity payoffs on money and short-term government debt have gone down, in order to induce asset-holders to hold the money and the short-term government debt, the rates of return on money and short-term government debt must go up. That is, the inflation rate must go down. Going in the other direction, a reduction in the aggregate stock of liquid assets makes the inflation rate go up.

Translated further, Steve’s story is as follows:

  1. The central bank prints more money
  2. People don’t want to hold onto that money
  3. To make sure people hold onto that money, the inflation rate must fall (to make holding money more attractive)
  4. Hence, printing money lowers the inflation rate.

Any cursory scholar of monetary economics should find that counterintuitive. I would suggest that it’s counterintuitive because it’s, well, wrong. In particular, the jump from (2) to (3) isn’t clear at all. If everybody receives a helicopter drop, and nobody wants to spend it, then how does inflation fall? Or in the words of Paul Krugman: “How does this requirement translate into an incentive for producers of goods and services “” remember, we’re talking about stuff going on in the real economy “” to raise prices less or cut them?”

On the other hand, a much more realistic view would be a “monetary disequilibrium” or otherwise stated as David Hume’s price specie flow mechanism. At the moment that people get more money, the inflation rate is fixed. Hence the rate of return isn’t high enough to hold money, and so people spend that money. This causes prices to rise and generates inflation.

Here’s the fundamental problem with Steve’s model: he acts as if equilibrium conditions are enough to explain causality. Sure, in equilibrium it must be that the inflation rate must equal the liquidity value of holding onto money. But that can happen in two ways. Either the inflation rate could fall (Steve’s story), or people could hold less cash, thereby raising the marginal value of their liquidity holdings.

Note that irony that “New Monetarist” Steve Williamson uses the Keynesian approach. Wang is just a sophomore at the University of Michigan, but this is the single best explanation of the Williamson affair that I have seen.  Nonetheless, I’m going to try to make it even better.

So let’s suppose that at the instant the liquidity shock occurs (before expected inflation changes), the public is holding twice the desired money stock.  One solution (via the hot potato effect) would be for the price level to double.  In that case real cash balances fall back to the desired level, and the inflation rate does not need to fall to induce the public to hold the current quantity of cash and bonds.

Some might object that prices are sticky and thus the rental cost of holding money must fall in the short run.  Perhaps so, but that need not occur through a fall in the inflation rate.  It’s far more likely that other asset prices will change, and that these asset prices changes will produce a higher price level in the long run.

Careful readers will notice that this is the “old monetarist” objection to the Keynesian single-minded focus on the liquidity effect for short term risk-free debt.  The excess cash balances lead to an immediate rise in the prices of stocks, corporate debt, commodities, real estate, foreign exchange, and all sorts of other assets.  When the prices of these other assets rise, their expected rate of return falls, which makes people more willing to hold substitutes such as cash and zero interest bonds, at least until you see the long run adjustment in the price level, at which point the real value of all assets returns to the original level, and money is neutral.

Williamson’s mistake was to assume any disequilibrium is eliminated by changes in the rental cost of money, whereas it can also be eliminated by changes in the price of money.

So can we (market monetarists) now have the “new monetarist” label that we deserved all along?

Update: Nick Rowe had a similar reaction.

Update:  Kudos to Bob Murphy for getting there before I did.  I wonder if the quickness someone gets to the problem with Williamson’s argument is inversely related to the technical skills that person possesses.

Update:  Tyler Cowen makes some good points but doesn’t really address the key issue here. Williamson’s proof is flat out wrong because he simply assumes that a change in the nominal money stock is equivalent to a change in the real money stock.  The QTM says that’s not so, and he doesn’t even mention that fact. Williamson may have some sort of “point,” but he has yet to even make a coherent argument.  We are still waiting.


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63 Responses to “Excess money: Lower rental cost or lower price?”

  1. Gravatar of Benjamin Cole Benjamin Cole
    4. December 2013 at 06:45

    I was hoping Williamson’s cold-fusion-onomics would work. The Fed could pay off the national debt with fresh cash, while strangling inflation.

    Have Your Cake and Eat it Too in Fat City.

    Still, we are seeing very little signs of inflation while monetizing debt. An interesting avenue to pursue….

  2. Gravatar of dtoh dtoh
    4. December 2013 at 06:52

    Scott, I would explain it this way.

    WRONG
    1. The central bank prints more money
    2. People don’t want to hold onto that money
    3. To make sure people hold onto that money, the inflation rate must fall (to make holding money more attractive)
    4.Hence, printing money lowers the inflation rate.

    RIGHT
    1. The central bank prints more money
    2. People don’t want to hold onto that money
    3. To make sure people take the money, the central bank offers to exchange it for financial assets at whatever price people will offer the financial assets. People offer the financial assets because at the higher price they want to exchange financial assets for goods and services. They can use the money as an MOE to effect this exchange of financial assets for good and services.
    4. The increased exchange of financial assets for goods and services raises real spending causing an imbalance in the supply and demand for goods and services which results in an increase in the price level
    5.Hence, exchanging money for financial assets raises the inflation rate.

  3. Gravatar of Saturos Saturos
    4. December 2013 at 07:06

    This is the real smoking gun. If Williamson’s model predicts that Zimbabwe should have had hyperdeflation, then it’s clearly wrong.

  4. Gravatar of Brian Donohue Brian Donohue
    4. December 2013 at 07:06

    Excellent blogging.

  5. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    4. December 2013 at 07:42

    It’s even simpler; to get rid of the new money people will have to SELL it. Which, caeteris paribus, will result in lower prices for the money. I.e. it will exchange for fewer goods and services.

    Now turn the telescope around and look at it from the other end; the money prices of goods and services have risen. You’ve got an increase in ‘inflation’.

  6. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    4. December 2013 at 07:44

    I should have said in the above that EACH UNIT of the now more abundant money will exchange for fewer goods and services, not that the aggregate amount will.

  7. Gravatar of TallDave TallDave
    4. December 2013 at 07:56

    Above commenters nailed it, esp. Saturos.

    I have to echo Nick’s comment the other day that economics has gone to hell. In what other time would anyone seriously argue that printing money reduces inflation?

  8. Gravatar of Philip George Philip George
    4. December 2013 at 07:59

    1. The central bank prints money. It is not given to “people” but used to buy financial assets from owners of financial assets.
    2. The owners of financial assets use the money to buy financial assets from owners of other financial assets.
    3. The prices of financial assets goes up.
    4. Inflation, as we know it, is the increase in prices of real goods and prices. But that can happen only if incomes go up, and since the new money is only used for trading of financial assets, there is little or no inflation.

  9. Gravatar of Philip George Philip George
    4. December 2013 at 08:00

    I meant real goods and services, not real goods and prices.

  10. Gravatar of Bob Murphy Bob Murphy
    4. December 2013 at 08:24

    For what it’s worth Scott, I’m as smart as the sophomore. (You can just skip to the part after the asterisks.) Nick Rowe even said he had a man-crush on me. But I don’t want to be a monetarist.

  11. Gravatar of Michael Tolbert Michael Tolbert
    4. December 2013 at 09:11

    Wang makes a point that has troubled me for quite some time. He says “…the inflation rate must equal the liquidity value of holding onto money. But that can happen in two ways. Either the inflation rate could fall (Steve’s story), or people could hold less cash, thereby raising the marginal value of their liquidity holdings.”

    I agree with Wang. Textbook economics should say the 2nd one is more likely and nothing about the ZLB should make number 2 any less plausible. But we’ve been waiting for years for the economic “kick” (as Noah Smith would say) either from QE, or marginal depreciation, or whatever but to no avail. So here is what troubles me. Maybe it has nothing to do with the ZLB. What if the (global) collapse in safe financial assets was so big, so catastrophic, that the Fed can not practically or reasonably (without setting off a market panic) create enough money to make up for this shortfall (and demand) for safe assets. In that case, it’s not the ZLB that is holding us back but the fact that demand for US dollars can not possibly make up for the shortage of safe financial assets. A problem that has been made worse by the fact that Europe has embarked on a period of financial austerity (forget fiscal austerity, it’s the financial one that has concerned me).

  12. Gravatar of Philippe Philippe
    4. December 2013 at 09:21

    “Either the inflation rate could fall (Steve’s story), or people could hold less cash, thereby raising the marginal value of their liquidity holdings.”

    Maybe Williamson is saying that people are choosing to hold the cash, therefore the inflation rate has to fall.

    You can look at excess bank reserves to see that people are actually choosing to hold the cash.

    I might be wrong.

  13. Gravatar of Doug M Doug M
    4. December 2013 at 10:09

    The rental cost of money is the price of money.

    The rental cost of money is the interest rate.
    The interest rate is the equates the present value of money to the future value of money.

    The interest rate is the price of money.

  14. Gravatar of jknarr jknarr
    4. December 2013 at 10:13

    1. The central bank prints reserves. Bonds are withdrawn from market, former bondholders end up with demand deposits.

    2 (a). People have few liabilities, are unleveraged, and so don’t want to hold onto offsetting demand deposit assets. They spend the demand deposits. NGDP rises, story over.

    2 (b). People are over-leveraged, and need cash as a liquidity hedge / deleveraging / liability immunization asset. They hold on to the demand deposits. NGDP unchanged.

    3. Unchanged NGDP means rising deficits and rising debt/NGDP. Central bank prints more reserves, and withdraws more bonds. People rationally hold greater amounts of created demand deposit as hedge against rising liabilities.

    4. Hence, buying bonds to print reserves lowers NGDP, because it encourages rising debt and growing leverage.

    Zero rates are the clearest sign you can get, that the demand for borrowing is zip, and deleveraging must take place in order for rates to again rise. By definition.

    Helicopter drops only stimulate NGDP after they serve to clear debt and deleverage first.

    The difference between Zimbabwe and US/Japan is that Zimbabwe was not highly leveraged — i.e. did not have a very sophisticated financial system with tons of debt (some 70% of NGDP before hyperinflation, very little private debt).

    In Zimbabwe, yes, “people did not want to hold on to the cash”. In the US and Japan, they want to hold on to the cash. The reason is debt.

    Where rising debt liabilities are the consequence and product of QE, disinflation is quite possible — think rational expectations at the zero bound.

    Think about saving tax cuts, if you are just going to have to turn around pay back all those Treasury bonds, alongside your mortgage, car loan, and kid’s student loans. Surely, this has some reasonable economic pedigree. High leverage is disinflationary.

  15. Gravatar of Philippe Philippe
    4. December 2013 at 10:31

    “In Zimbabwe, yes, “people did not want to hold on to the cash”. In the US and Japan, they want to hold on to the cash. The reason is debt.”

    I think in Zimbabwe the increased money supply was due to massive money-financed government deficit spending (huge as a percentage of GDP). In the US it is due to QE.

  16. Gravatar of Stephen Williamson on the intuition behind liquidity traps and inflation Stephen Williamson on the intuition behind liquidity traps and inflation
    4. December 2013 at 10:52

    […] I do get Scott’s and Yichuan Wang’s argument about the hot potato effect for monetary injections, but I am not sure this can handle the case of […]

  17. Gravatar of jknarr jknarr
    4. December 2013 at 10:53

    Philippe, yes, the Z government issued cash. So, issuing unsterilized currency in a low-leverage economy will spark NGDP. 100% agreement

    And yes, he Fed does not do this. Instead, it creates bank reserves (which effectively collateralize debt), and buys debt.

    The Fed is a debt-creating machine on both sides of its balance sheet. It’s assets are debt, its liabilities collateralize debt.

    This is not the unsterilized issuance of unbacked currency. Debt is not money, and money is not debt. Debt is a derivative of money.

    High leverage — which at extremes causes zero rates, as rates are the supply-demand for loanable funds — is disinflationary.

    Insofar as the Fed issues liabilities that collateralize debt (reserves); and buys debt assets (treasury bonds), the entire QE program creates additional debt-based future liabilities.

    High debt based future liabilities can be disinflationary.

    The Fed could easily choose to avoid creating debt liabilities on future cash flow: simply issue physical currency on its liability side; and simply revalue its gold holdings to $10,000/oz on the asset side.

    This policy would not create debt, and so would be much more effective/inflationary: this is the true helicopter drop.

    (Which in part gets to the central bank problem: banks are in the business of debt, which is different than the business of base money and the economy.)

  18. Gravatar of 123 123
    4. December 2013 at 11:19

    Never reason from a price change. Reasoning from the liquidity premium is reasoning from the changes in two prices. You should reason from the financial turmoil directly, instead of assuming that the only way the financial turmoil affects the monetary base is via the substitution with government bonds. The problem is that the change in the interest rate spread can be caused by the negative demand shock, and it also can be caused by the positive supply shock. Williamson’s view is that AD story has played out, and the only reason QE works today is AS: http://newmonetarism.blogspot.com/2013/12/intuition-part-ii.html

  19. Gravatar of Philippe Philippe
    4. December 2013 at 11:25

    “The Fed could easily choose to avoid creating debt liabilities on future cash flow: simply issue physical currency on its liability side; and simply revalue its gold holdings to $10,000/oz on the asset side.”

    Could you explain how this would work? Who would the Fed issue currency to, and in exchange for what? The Fed can’t just give money out to people for free.

  20. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    4. December 2013 at 11:32

    Doug M wrote;

    ‘The interest rate is the price of money.’

    I recommend David Friedman, Chapter 22 of his ‘Price Theory’;

    http://www.daviddfriedman.com/Academic/Price_Theory/PThy_1st_Edn_Ch22/PThy_1st_Edn_Chap_22.html

    Scroll down to the subhead ‘The Price of Money’, and start reading, especially;

    ‘The distinction between the price of money and the cost of holding money–what we might also describe as the rent on money–is crucial to understanding how the general price level is determined, and confusion between the two is at the root of many of the more common economic mistakes. The price of money is what you must give up to get money; the higher the general price level (the amount of money you must give up to get something else), the lower the price of money. The cost of holding money (more precisely, the cost of holding money measured in money, the number of dollars per year you give up for each dollar you hold) is the nominal interest rate.’

  21. Gravatar of GF GF
    4. December 2013 at 12:05

    I think SW mistakes an adjustment in the absolute return on money (via deflation) with an adjustment in the relative return on money (via higher asset prices), which is the relevant margin where portfolio choice is concerned.

  22. Gravatar of ssumner ssumner
    4. December 2013 at 12:19

    Bob, Excellent! I added an update.

    Philip George, Asset prices may go up, but it has nothing to do with the fact that the Fed is buying assets. If they dumped money out of a helicopter the effect on asset prices would be roughly the same.

    Philippe, You said;

    “I think in Zimbabwe the increased money supply was due to massive money-financed government deficit spending (huge as a percentage of GDP).”

    That’s also true in the US, except our reserves paid interest. Are you claiming IOR is the key difference? Possible, but not certain.

    And they could buy gold with currency at $10,000/oz. That’s Irving Fisher’s idea.

    123, That new post by Williamson still completely misses the point. Why doesn’t he see what people are complaining about? Even if he doesn’t agree, why can’t he explain why?

  23. Gravatar of Mark A. Sadowski Mark A. Sadowski
    4. December 2013 at 12:22

    A commenter at Stephen Williamson’s blog named “Anonymous” pointed out that there is empirical evidence that QE increases inflation, namely, he referred to David Beckworth’s post (“Taking the Model to the Data”) which also mentions my econometric results.

    (By the way, has anyone noticed the large number of commenters named “Anonymous” at Williamson’s blog? I know there’s more than one because they have to keep identifying themself by when they last commented, or what their previous point was. What on earth is that all about?!?)

    Here is Stephen Williamson’s response:

    “In order to properly confront the data, we need a model of how QE works, and then we have to argue that the data is somehow consistent with that. I don’t think we would call that serious empirical work in that sense.”

    http://newmonetarism.blogspot.com/2013/12/the-intuition-is-in-financial-markets.html?showComment=1386177831449#c7314592028317641767

    Of course the implication is that David doesn’t have a model of how QE works (and evidently nor do I). Now, this is of course completely untrue. In fact in that very post, David discusses, and links to, the paper he cowrote with Joshua Hendrickson (“The Supply of Transaction Assets, Nominal Income, and Monetary Policy Transmission”) in which he extends the very same monetary search framework of Lagos-Wright that Williamson uses in order to show the effects of QE.

    But more importantly, the main subject of David’s post isn’t his own model, but Williamson’s model, which as David demonstrates (and as I further demonstrate in comments) is inconsistent with the empirical evidence. So rather than a dearth of economic models, we have a surplus, and the model which is the subject of David’s post seems to be failing the test.

    At this point, it’s taking every ounce of energy I can muster to keep being as civil as possible. But frankly Williamson keeps making factual, empirical and theoretical claims which range from being demonstrably false to being utterly ridiculous. Aren’t there any real world repurcussions for this kind of behavior?

  24. Gravatar of Am I Reading This Right? Am I Reading This Right?
    4. December 2013 at 12:23

    […] coming home to roost from all the times I called Scott Sumner “insane.” In an update to his post on Williamson Scott […]

  25. Gravatar of ssumner ssumner
    4. December 2013 at 12:26

    GF, That’s part of the problem.

    Mark, We have lots of models of how QE works, he just doesn’t accept them, indeed I doubt he’d even consider them to be “models”

  26. Gravatar of Philippe Philippe
    4. December 2013 at 12:36

    Scott,

    “That’s also true in the US, except our reserves paid interest. Are you claiming IOR is the key difference?”

    I think a main difference is the size of the deficit as a percentage of GDP. QE doesn’t increase the size of the government deficit. It just turns pre-existing bonds into reserves that pay less interest.

    If the government increased its budget deficit by printing notes and spending them then the situation would be different.

  27. Gravatar of Keshav Srinivasan Keshav Srinivasan
    4. December 2013 at 12:57

    Scott, did you see Williamson’s latest post? newmonetarism.blogspot.ca/2013/12/intuition-part-ii.html

  28. Gravatar of Philippe Philippe
    4. December 2013 at 13:14

    “And they could buy gold with currency at $10,000/oz. That’s Irving Fisher’s idea.”

    I may be wrong, but I think the Fed would only be allowed to do that if Congress changed the statutory price of gold.

  29. Gravatar of jknarr jknarr
    4. December 2013 at 13:39

    Philippe,

    Buy rusty nails for $1,000 currency from the public — no different than buying maiden lane waste — the asset side of the Fed’s balance sheet does not matter. There is no deliverable. It’s an atavism of the gold standard.

    There is only a mild threat that they will one day have to shrink their balance sheet, and will so need marketable assets. This has never happened, in the entire history of the Fed. But so, reluctantly giving them the benefit of the doubt, say only 20% of their assets need be marketable. The other 80% of asset side of balance sheet could be tin cans held on the books at a billion dollars each.

    Note also that bonds are the worst possible instrument for a central bank to hold: great for creating debt, but terrible for managing an economy. Let alone the leverage-creating ZLB debt-deflation-expectation problems of bond buying, marketable bonds loose value if they actually succeed at stimulating NGDP and yields rise!

    Successful economic management means that those precious high-quality liquid bonds assets won’t be quite as marketable. A better plan is to buy dirt from anybody for $10/bag, than trillions worth of bonds from bankers.

    Bottom line, debt has no place in a central bank’s assets. Much better gold, or yet better, dirt.

  30. Gravatar of Gordon Gordon
    4. December 2013 at 13:41

    Doesn’t the change in U.S. CPI between 1933 and 1934 after the restructuring of the dollar also cut the legs from under Williamson’s hypothesis? http://www.minneapolisfed.org/community_education/teacher/calc/hist1913.cfm

  31. Gravatar of 123 123
    4. December 2013 at 13:44

    Scott:
    “That new post by Williamson still completely misses the point. Why doesn’t he see what people are complaining about? Even if he doesn’t agree, why can’t he explain why?”
    I don’t know. Tyler Cowen is getting what Williamson is saying. Nick Rowe is starting to get it too. It is very easy to explain Williamson in AD/AS language, but Williamson hates it.

  32. Gravatar of Philippe Philippe
    4. December 2013 at 14:07

    “Bottom line, debt has no place in a central bank’s assets. Much better gold, or yet better, dirt.”

    Problem is the Federal Reserve Act doesn’t allow the Fed to buy dirt or tin cans as assets. And I think it can only buy gold for the statutory price set by law (I may be wrong).

  33. Gravatar of Negation of Ideology Negation of Ideology
    4. December 2013 at 14:27

    jknarr –

    “There is only a mild threat that they will one day have to shrink their balance sheet, and will so need marketable assets. This has never happened, in the entire history of the Fed.”

    I believe that’s true, but I don’t think we’ve ever had this level of excess reserves either. Of course, if we ever need to tighten the Fed could raise the minimum reserve ratio to soak up some of those reserves rather than shrink the balance sheet.

    “Note also that bonds are the worst possible instrument for a central bank to hold: great for creating debt, but terrible for managing an economy.”

    Those bonds exist before the Fed buys them, buying them doesn’t create debt. Government debt is created by running budget deficits. If the Fed bought bags of dirt, the Treasury would simply sell the bonds to someone else, perhaps those who sold the dirt, perhaps those who sold something to the dirt sellers. But you would get a tremendous amount of waste, as millions of hours of labor is diverted from productive purposes to digging for and transporting dirt. Plus the government would lose interest income, costing the taxpayers billions.

  34. Gravatar of jknarr jknarr
    4. December 2013 at 14:29

    Yes, but we’re talking about how Fed QE could possibly cause deflation, or at a minimum how it is failing to stimulate NGDP effectively — there are institutional constraints, clearly.

    But, rules are bent to broken all the time under necessity. It’s just that they don’t see the necessity. In fact, high debt and tight money is great for oligarchy.

    But if the FRA’s appearance is important, find that Maiden Lane needs a portfolio rebalance into dirt assets for $10/oz. Could be a move to higher-quality, anyway. Losses are already covered by the Fed, no?

  35. Gravatar of jknarr jknarr
    4. December 2013 at 14:52

    Negation, all assets are already in existence. The question is how to get Fed liabilities into the real economy. Dirt’s just shorthand for something that everybody can get hold of: i.e. when the Fed injects liabilities, it goes into the broad public, not just bank reserves.

    My view is that interest rates are mostly reflective of low debt demand/high debt supply, and that the ZLB means that deleveraging must happen for rates to rise. At a minimum, QE helps stop default-deleveraging by recapitalizing banks, but has not helped reflation because reserves are meaningless at the ZLB: there is little demand for funds.

    I differ with many in that I need a “step 2”. Expectations don’t fly with me.

    1) Print reserves/buy bonds.
    2) ?
    3) NGDP!

    I agree that NGDP cures all. The problem is how to make the cash circulate and NGDP rise. Debt is simply pent-up demand for base money. Note also that these are not clean one-gains-another-loses washes: there is systemic risk and sticky prices across the board. If you are heavily in debt, this affects the wages you want to receive and the price you sell your house: very sticky. A non-sticky economy responds better to policy.

    They’ve preserved the outstanding debt leverage with reserve formation, but also so preserved the deflationary backdrop. QE makes additional debt possible, which makes debt-deflation increasingly larger.

    Re waste, absolutely. Digging up holes to find cash in bottles is wasteful, and gold mining is incredibly dirty.

    I’d suggest, however, that the ultimate result of 3.5x debt to NGDP may be much, much, more destructive — both the warfare-welfare spending that ran the debt up; and the monetization that follows, is much worse than shifting piles of dirt around.

  36. Gravatar of The Market Fiscalist The Market Fiscalist
    4. December 2013 at 15:37

    Suppose monetarism is wrong and what causes recessions is shortages of safe assets.

    This causes a recession where RGDP falls 10% below its capacity and interest rates fall to 0%.

    The CB uses QE to increases the amount of safe assets (and increases the money supply as a side-effect.

    This spurs a recovery where RGDP gets back to capacity. It does this with only a 5% increase in NGDP.

    This causes 5% deflation. If the CB hadn’t acted we would have had 0% RGDP growth and 0% inflation. If the CB had increased the money supply by buying assets that didn’t increase the qty of safe assets again 0% RGDP growth and no inflation.

    So QE causes the economy to move from one monetary equilibrium (with 0% inflation) to another , healthier one (with 5% deflation) just like SW says.

  37. Gravatar of Philippe Philippe
    4. December 2013 at 15:46

    “the warfare-welfare spending that ran the debt up”

    The private debt problem is due to welfare?

  38. Gravatar of Doug M Doug M
    4. December 2013 at 15:50

    Patrick R. Sullivan,

    David Friedman describes a 19th century view of money. Heck, he describes a 14th century view of money.

    Money, per Friedman’s definition is limited to currency. Heck, I have heard Scott Sumner use this definition of the money supply. But, if this is the definition of money, and the only relevant definition of money that is relevant to drive economic activity, then why does the host and commentors on this site spend so much time talking about open market operations, interest on reserves and other esoteric financial transactions that do not influence the quantity of currency in circulation?

    And if we look at paper currency, a huge fraction of it is overseas, and another significant fraction of it is tied up in black-market activities. And how useful is currency really to buy anything? I can’t move more than $10,000 without filing paperwork with the IRS. I can’t buy a house with currency. I suppose I could, it is “legal tender” but I would like to see the shitstorm that arises when I open up my suitcase full of cash.

    I can receive my paycheck via direct deposit and spend it via debit card and live for the entire year and never old but 0.1% of the money I spend as physical currency.

    Can we agree that physical is irrelevant as the primary measure of the money supply?

    So moving along, the cost of money is defined by Friedman is the interest I am not earning on physical currency. But if physical currency is a fraction of the money I hold, and that interest is only a few basis points a year, the cost of money is truly trivial.

    So, getting with the times… banks create money. The interest rate is the price you pay tomorrow to get your hands on money today. The difference between banks’ cost of funds and the prevailing interest rate is the banks incentive to create money. The Federal reserve manipulates the banks’ cost of funds.

  39. Gravatar of W. Peden W. Peden
    4. December 2013 at 16:19

    Doug M,

    You miss the thrust of the argument: the price of money is what must be given up to get money, just like the price of anything else. And what must be given up to get money is something other than money, namely goods & services. So the price of money, in terms of money, is the price level, not the interest rate.

    If interest rates were the price of money, you’d have to pay interest to obtain money.

  40. Gravatar of Doug M Doug M
    4. December 2013 at 16:31

    But, I don’t need to give up goods and services to get money. I can go to the money store and get money today for a promise to provide money tomorrow. All I have to give up is a promise.

    And the bank that gives me the money doesn’t forgo goods or services, either. It gives up space on its balance sheet.

  41. Gravatar of Doug M Doug M
    4. December 2013 at 16:34

    If interest rates were the price of money, you’d have to pay interest to obtain money.

    you do have to pay interest to obtain money. Or someone has to pay interest to obtain money, and then they can transfer that money to you (perhaps in exchange for goods or services).

  42. Gravatar of Mark A. Sadowski Mark A. Sadowski
    4. December 2013 at 17:26

    Another commenter named “Anonymous” said the following in Stephen Williamson’s latest post:

    “David Beckworth empirical results reject your hypothesis.”

    And Stephen Williamson responded:

    “That’s not serious empirical work.”

    http://newmonetarism.blogspot.com/2013/12/intuition-part-ii.html?showComment=1386187907396#c5531693717983569198

    Recall that so far the only empirical evidence that Stephen Williamson has offered in support of his model is a graph of year on year PCEPI inflation which he claims shows inflation has been falling for three years (actually, it’s more like two).

    In contrast David estimates a two variable VAR with 6 and 12 lags in which the impulse response of core PCEPI to the Fed’s Treasury holdings is the opposite of what is consistent with Williamson’s model.

    In addition, in comments I describe my own VAR Granger causality test results, and my own 4-variable VAR estimates which are contrary to the predictions of Williamson’s model. And by my count so far we have found three (maybe four) research papers with VAR estimates contrary to the predictions of Williamson’s model.

    I wonder what qualifies as “serious empirical work” in Williamson’s estimation?

  43. Gravatar of Geoff Geoff
    4. December 2013 at 17:34

    “But that can happen in two ways. Either the inflation rate could fall (Steve’s story), or people could hold less cash, thereby raising the marginal value of their liquidity holdings.”

    “Note that irony that “New Monetarist” Steve Williamson uses the Keynesian approach. Wang is just a sophomore at the University of Michigan, but this is the single best explanation of the Williamson affair that I have seen.”

    Wang’s explanation has an error. People in general cannot hold less cash. If any individual tries to trade away cash, this requires someone else to accept more cash.

    Wang is overlooking the fact that the aggregate money supply can only change hands if any individual tries to trade away their cash.

    What is really taking place when people try to get rid of cash at the same time, is that prices fall relative to the fixed total cash holdings. This makes the purchasing power of money rise, until there is no further need for people in general to hold less cash.

  44. Gravatar of Anon Anon
    4. December 2013 at 17:57

    I think this is the definitive post on this debate. Thanks.

  45. Gravatar of W. Peden W. Peden
    4. December 2013 at 18:16

    Doug M,

    “you do have to pay interest to obtain money. Or someone has to pay interest to obtain money, and then they can transfer that money to you (perhaps in exchange for goods or services).”

    Which is an elongated way of saying that you don’t have to pay interest to obtain money. Someone could quite conceivably go through their whole life without ever paying interest, and yet no go without money. And if one doesn’t have to pay interest to obtain money, then how can interest be the price of money? One might as well say that cheese or mime-artistry is the price of money.

    Consider an Islamic economy in which interest is never paid: are interest rates the price of money in such an economy? Or an economy with no credit markets at all: how can interest rates be the price of money in such an economy.

    “But, I don’t need to give up goods and services to get money. I can go to the money store and get money today for a promise to provide money tomorrow. All I have to give up is a promise.”

    Which is an elongated way of saying that you have to give up a good: an asset to the bank, namely a promise to repay with interest.

  46. Gravatar of Doug M Doug M
    4. December 2013 at 18:35

    “Which is an elongated way of saying that you don’t have to pay interest to obtain money.”

    And I don’t have to pay money to acquire goods. I can trade services to get goods. But the price of those goods will still be denominated in dollars, whether I paid for them with money or with services.

    The price of money is denominated in future dollars, whether I trade goods to acquire money or whether I get money from a bank.

    “Which is an elongated way of saying that you have to give up a good: an asset to the bank, namely a promise to repay with interest.”

    So, we agree! the price of money is the promise to return it with interest!

  47. Gravatar of ssumner ssumner
    4. December 2013 at 19:56

    Philippe, You said;

    “If the government increased its budget deficit by printing notes and spending them then the situation would be different.”

    That’s what they did. Except they printed reserves, not notes.

    Keshav, He is still completely failing to address the question that people are asking. Why does a bigger nominal stock of money imply a bigger real stock of money?

    123, I have not seen any indication that Williamson even understands the objections being raised.

    Gordon, I can’t say, as that’s a very different policy.

    Thanks anon, It’s a very simply point, why won’t he address it?

  48. Gravatar of Saturos Saturos
    4. December 2013 at 20:15

    Ryan Avent has perhaps the best post on all this: http://www.economist.com/blogs/freeexchange/2013/12/monetary-policy

  49. Gravatar of Mark A. Sadowski Mark A. Sadowski
    4. December 2013 at 21:56

    123,
    “Williamson’s view is that AD story has played out, and the only reason QE works today is AS…It is very easy to explain Williamson in AD/AS language, but Williamson hates it.”

    I’ve been thinking about this and in my opinion Williamson’s model doesn’t really translate very well into AD-AS Model terms. QE causes an increase in the level of transactions and hence in the level of real consumption. But it also causes a decline in the rate of inflation without causing a shift in the price level.

    In level terms the price level is fixed in any period and all the central bank can do is choose the level of real consumption. In dynamic terms, real consumption doesn’t change except in jumps, so the only thing the central bank can choose is the rate of inflation. So in the first case you have a horizontal line and in the second case you have a vertical line. Make of it what you will.

    If this interpretation is correct it also raises yet another empirical problem for Williamson’s model. Where is the sudden increase in real consumption due to QE?

  50. Gravatar of 123 123
    5. December 2013 at 01:35

    Scott:
    ” Why does a bigger nominal stock of money imply a bigger real stock of money?”

    Under circumstances Williamson focuses on (QE helping with financial frictions), it can. QE raises AS more than it raises AD, and real rates rise sufficiently so that the real stock of money increases. So theoretically it is possible. Empirically, the best candidate for Williamsonian scenario is Japan, where it is somewhat plausible that prices and wages have achieved the long run, while financial problems still remain.

    While Williamsonian scenario is unlikely to happen in practice, Williamsonian channel may still be important. Suppose we have a string of good news about the supply side in the UK. Then we have two interpretations: 1. AS curve is flatter than we thought. 2. Carney has shifted the AS curve.

  51. Gravatar of W. Peden W. Peden
    5. December 2013 at 04:34

    Doug M,

    “And I don’t have to pay money to acquire goods.”

    No-one said you did.

    “So, we agree! the price of money is the promise to return it with interest!”

    No we don’t agree. The promise to return with interest is just the good given up in this PARTICULAR case.

  52. Gravatar of ssumner ssumner
    5. December 2013 at 07:54

    123, You are being way too generous. He has an argument that is simply false, logically false. He basically claims that in order to get people to hold larger real balances you need lower inflation. David Hume disproved that in the 1700s. You get them to hold more money with a higher price level.

  53. Gravatar of Jim Glass Jim Glass
    5. December 2013 at 12:14

    @ Doug M

    “I don’t need to give up goods and services to get money. I can go to the money store and get money today for a promise to provide money tomorrow. All I have to give up is a promise.”

    Um … delete the word “get” from your vocabulary as its multiple uses seem to be confusing you — as one can “get” something either by “buying” it, paying its price to purchase and own it, or by “borrowing” it, paying the cost of temporarily borrowing/renting/leasing it.

    Dead give-away of the distinction: If you have to return what you obtained with interest, you borrowed it — interest is the price of borrowing. (Try naming one thing that you *own* that you are obliged to return and pay interest upon.)

    OTOH, if you obtain something you can keep forever free and clear, you own it. You “get” ownership by exchanging something for it, such as some other physical thing or labor.

    And what you exchange to obtain ownership of an item is the price of ownership that you paid for that item.

    Owning and borrowing are two different things. As are the price of owning and the price of borrowing. That’s pretty clear, is it not?

    So what you seem to be trying to say — with your insistence on using the phrases “get money”, “obtain money” — is that there is no difference to the economy between money owned and money borrowed/rented/leased, or from the two corresponding prices. Really?

  54. Gravatar of Jim Glass Jim Glass
    5. December 2013 at 12:15

    Translated further, Steve’s story is as follows:

    1. The central bank prints more money
    2. People don’t want to hold onto that money
    3. To make sure people hold onto that money, the inflation rate must fall (to make holding money more attractive)
    4. Hence, printing money lowers the inflation rate.

    #3 is the intervention of the Underpants Gnomes.

  55. Gravatar of Jim Glass Jim Glass
    5. December 2013 at 12:22

    @jknarr

    The difference between Zimbabwe and US/Japan is that Zimbabwe was not highly leveraged “” i.e. did not have a very sophisticated financial system….

    The difference between Zimbabwe and US/Japan is that Mugabe, to finance a war to seize Congolese diamonds when he did not have and couldn’t raise the money to pay the soldiers to do so, very literally ran the printing presses to pay them (and also pay his regime’s apparatchiks and stakeholders whose support he needed to stay in power) with freshly-inked bills. When this very naturally and unavoidably increased inflation, he then had to run the presses faster to keep his ‘payees’ happy with their pay in real terms, and the Zimbabwe inflation was off and running.

    I’ve read a good number of MMT web sites on the Zimbabwe inflation and not one I’ve seen has even mentioned these facts, though they available all over Wikipedia and in every other credible source that tells the story of the region. Of course, we are all entitled to our own opinions, but not to our own history.

  56. Gravatar of jknarr jknarr
    5. December 2013 at 13:12

    J Glass

    Agreed on all counts, so I’m not certain what your point is.

    Printing presses / unsterilized unbacked currency issuance achieved inflation. Who they pay, and why, is moot.

    Mugabe ran unsterilized, unbacked currency issuance with both hands.

    We have Obama who borrows with one hand and spends it back with another.

    All the funds go to regime-supporting apparatchiks.

    One creates currency, and so fires up inflation, the other creates debt, so so fires up deflation.

  57. Gravatar of Philippe Philippe
    5. December 2013 at 18:09

    “#3 is the intervention of the Underpants Gnomes.”

    What about #2? (“People don’t want to hold onto that money”).

    Excess bank reserves appear to indicate that people are holding onto the money. According to Williamson’s theory this means the inflation rate has to fall.

  58. Gravatar of Saturos Saturos
    5. December 2013 at 22:24

    As Williamson fails to understand, the demand for holding money is a function of many variables: the yield on alternative assets, the yield on money, the price level, expected real income, the weight of coinage… http://econlog.econlib.org/archives/2013/12/weight_and_velo.html

  59. Gravatar of ssumner ssumner
    6. December 2013 at 06:11

    Saturos, Great story.

  60. Gravatar of Steve Williamson Steve Williamson
    10. December 2013 at 11:56

    “So can we (market monetarists) now have the “new monetarist” label that we deserved all along?”

    “New Monetarism” was a name Randy Wright and I dreamed up at dinner one night. We thought we could use it to apply to what we and some other people do. It’s a whole approach to modeling financial and banking arrangements, with a lot of peer-reviewed published work, professional meetings, etc., to back it up. What about you?

  61. Gravatar of Mark A. Sadowski Mark A. Sadowski
    11. December 2013 at 11:46

    Scott,
    This by John Carney of CNBC irritated me:

    “…But just because Williamson is wrong, that doesn’t mean his critics are right.

    Sumner, for example, insists on treating quantitative easing as an increase in the monetary base and thinks that must be inflationary. But this is flat-out wrong because it is only looking at one side of the QE ledger””the growth of reserves””while ignoring the other””the shrinking supply of Treasurys.

    (Read more: QE is a sugar pill.)

    Again, let’s return to our QE’d investor.

    He used to hold a claim on a bunch of securities held by his bank, now he holds a large bank deposit. Sumner and other monetarists insist that he’s more likely to spend this bank deposit, triggering inflation…”

    The most glaring error is that they fail to note that since QE mostly involves purchases of Treasuries from non-banks it directly increases the supply of broad money. But that’s obviously only the beginning of Carney’s mistakes.

    P.S. The article argues that QE is not deflationary but links to “FT Alphaville’s Izzy Kaminska post on safe asset shortages” for a “real world observation” totally failing to note Kaminska argues that QE causes deflation. There’s enough double-think in that one article to keep your head spinning for days on end.

  62. Gravatar of Mark A. Sadowski Mark A. Sadowski
    11. December 2013 at 11:47

    Forgot to link the article:

    http://www.cnbc.com/id/101254010

  63. Gravatar of ssumner ssumner
    11. December 2013 at 12:06

    Steve, That was a joke. You can keep the label.

    My publication record is not as good as yours. About 30 articles with only one top journal (JPE.) Six in the JMCB.

    Thanks Mark.

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