Helicopter drops are a really, really, really, really bad idea

So I had the following dream last night:

Me:  Honey, I decided not to teach summer classes this year.

Honey:  Oh Scott, you’ll just spend the time out on the golf course

(I grab a shotgun and shoot off one of my feet)

Honey:  Why did you do that?

Me:  To convince you that I won’t go golfing this summer.

Honey:  Um, you could have just promised not to go golfing.

Me:  But I thought you won’t believe me.

Honey:  But you never even tried to convince me. I might have believed you.

Me:  Oh.

Honey:  I never realized how weird you are.

(Just then my friend Paul walks in to the room)

Paul:  You’re not going to believe him are you?  He could put on a peg-leg and hobble around the golf course.

Honey:  And your friends are even weirder than you are.

If your brain is as twisted as mine, you see the obvious connection to helicopter drops of cash.  To me, there is a sort of surreal quality to discussions of liquidity traps.  The discussion starts with the premise that it is hard to expand aggregate demand when nominal rates are close to zero.  (Which is false.)  Then there is a discussion of all sorts of crackpot schemes like negative interest rates on $20 bills.  Or dropping cash out of helicopters.  Then the liquidity trap proponents come up with ever more far-fetched reasons why this wouldn’t work.

In fact, these discussions are flawed from the very beginning, as they assume there is some sort of “trap” that prevents central banks from boosting AD.  Central banks operating under floating exchange rate fiat regimes can always increase AD if they want to; in all of recorded history there are no failures.  But people think otherwise because they see central banks do things that look expansionary when rates hit zero, and in many cases AD does not increase.

Krugman’s right that a helicopter drop is not necessarily inflationary.  Suppose the government dropped 50 $100 bills for every US citizen out of an airplane.  If the public expected the government to institute a $5,000 per capita tax in the very near future, and retire all that cash from circulation, it would have no effect.  But of course that would be a really, really stupid thing to do.  Taxes have deadweight losses, so the net effect of the money drop plus tax would be simply the destruction of wealth, that is all.  It would be like me shooting off my foot to convince my wife that I wouldn’t play golf, but then putting on a peg leg and going out golfing anyway.  Sure that’s theoretically possible, but why would I do it?  If the government behaves like a bunch of reckless lunatics hell-bent on hyperinflation, it is a good bet that they are a bunch of reckless lunatics hell-bent on hyperinflation.

[You might argue that fiscal authorities do nutty things like this.  Yes, but they don’t have the alternative of using the printing press.]

So I think a big helicopter cash drop would almost certainly boost AD.  But it would still be a terrible idea.  Here’s why.  If the Fed did this without an explicit inflation or NGDP target, then it would likely result in hyperinflation.  The public would be frightened, and I can’t say I’d blame them.  But if the Fed did accompany the drop with an explicit price level target, then the optimal helicopter drop would be less than zero.  Indeed if the Fed committed to say 4% inflation, the public would not want to hold even the current $2 trillion in base money (unless they were paid to do so with an interest on reserve program.)  So to summarize:

1.  Helicopter drops might not work, but almost certainly would.

2.  Helicopter drops are a really stupid idea, especially if the central bank did not first try to inflate using traditional tools.  There are numerous recent statements by Fed officials to the effect that they have the tools they need, it’s just that they don’t think the economy needs more AD.  Why pull the nuclear option without first doing something simple, LIKE SAYING YOU’D LIKE TO HAVE HIGHER INFLATION?

3.  The helicopter drop might result in hyperinflation, which would be worse than what we have now.

4.  Even if an explicit 4% inflation target prevented hyperinflation expectations, the Fed would probably have to reduce the base to hit the target.  I.e., no helicopter drop.

Just to be clear, it isn’t just a really silly idea for the real world because it might overshoot to hyperinflation.  It is really bad to even discuss it as a hypothetical, because it feeds into the view that the Fed, ECB, and BOJ want faster inflation, but just don’t know how to get it.  And that’s false.  They don’t want faster inflation, and they know perfectly well how to get it if they change their minds.

PS.  I agree with Tyler Cowen’s take on this issue.  My only problem with his analysis is that he shows too much respect to the idea itself, and the hypothesis that a helicopter drop might not boost inflation expectations.  Cowen’s right, but as soon as you start trying to defend these ideas in a serious way, you play right into the hands of sort of people who think it is sensible to consider a scenario where someone shoots off their foot with a shotgun, and then installs a peg-leg so they can play golf.

When the day arrives where the BOJ says they want 2% inflation but can’t achieve it, come back to me and we can start talking about shooting off feet with shotguns.  Until then I see no point in having this conversation.  It’s like arguing with 9/11 conspiracy nuts.

And I hate golf.

PPS.  After I wrote this it occurred to me that people might think I was talking about the “drop” of commercial bank deposits at the Fed.  It’s cash to the public I have in mind.  Reserves are too esoteric, and too much like T-bills these days—so they might not affect inflation expectations very much.  I am talking about actual helicopter drops, not tax cuts/open market purchases.


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45 Responses to “Helicopter drops are a really, really, really, really bad idea”

  1. Gravatar of Doc Merlin Doc Merlin
    14. July 2010 at 20:12

    Rofl. Just rofl.

  2. Gravatar of anon anon
    14. July 2010 at 20:27

    Regarding helicopter drops, one economist complicates matters by actually thinking about the real world. How inconvenient:

    http://krugman.blogs.nytimes.com/2010/07/14/legal-question/

  3. Gravatar of Joe Calhoun Joe Calhoun
    14. July 2010 at 20:44

    Golf. Just writing it makes me cringe. Dusting off the clubs scares my wife out of the house. The driving range feeds false hopes of improvement. A former boss suggested I play golf for business purposes. News flash: people are unlikely to do business with you if they see you fling a wedge into the lake or bend your putter like a pretzel. I. Hate. Golf.

    Sorry had to get that off my chest. Helicopter drop? Why waste helicopter gas when the metaphorical version is so much more efficient? Scott, you are indeed weird in a good sort of way…great post.

  4. Gravatar of Joe Joe
    14. July 2010 at 21:10

    Professor Sumner,

    I’m going through Mishkin’s textbook and something is really bothering me about monetary policy…

    In all markets, the goal is to have supply and demand hit at equilibrium, and then everybody goes home happy. Thats what a good market aims for.

    But in all these debates, nobody ever talks about equilibrium in the money market. Not once has anyone ever said, “We should do xyz because that will cause an equilibrium in the money market…”

    If you’re not aiming for equilibrium, then you’ve effectively created a price control, which is always bad, right?

    Instead of price stability, economic growth, low unemployment, etc. shouldn’t a central bank’s stated goal be “to create an equilibrium between supply and demand for money”? I hope this doesn’t sound too crazy.

    Best,

    Joe

  5. Gravatar of Mike Sandifer Mike Sandifer
    14. July 2010 at 21:17

    Didn’t you once share in a post that the Treasury under FDR threatened to simply start printing money to scare the Fed into expanding the money supply?

    Maybe we could do the same thing now.

  6. Gravatar of Doc Merlin Doc Merlin
    14. July 2010 at 23:46

    @Joe
    ‘If you’re not aiming for equilibrium, then you’ve effectively created a price control, which is always bad, right?’

    This is what austrians have been saying for years, in their awkward and needlessly verbose way. According to the Austrians, the way the fed treats the interest rate is very similar to a price control, and it causes oversupply or over-demand depending on how it is set. It it is set too low for too long, there is an oversupply of capital goods when then forces asset values to re-adjust.

  7. Gravatar of Mattias Mattias
    15. July 2010 at 00:45

    Scott,

    Do you think the central banks will lose their independence in the future, if they don’t change their mind? Right now it seems the “central bank community” has succeded in gaining more influence over the administration (via Geithner and Volcker etc) than the other way around. Maybe it’s time to talk about the threat from the central bank industrial complex instead of the military industrial one?

  8. Gravatar of scott sumner scott sumner
    15. July 2010 at 04:17

    Doc Merlin, Thanks.

    anon, I hope Krugman’s piece causes people to stop thinking about this nutty idea. It will never happen.

    Joe Calhoun, Thanks,

    Joe, That is a complicated question. In a sense the money market is always in equilibrium. Ms = Md. the question is which variable needs to adjust to equilibrate the market. If it is interest rates, we have macro instability. In the long run it is wages and prices, and then we have macro stability.

    Mike, That’s a really interesting thought. It won’t happen for all sorts of reasons, but it is interesting. It would create the mother of all panics.

    Doc Merlin. I have a slightly different take. By moving the money supply faster than the overall price level, prices get out of equilibrium. It is as if there are price controls, but the problem is actually sticky prices. The money market is in equilibrium in the sense that Ms = Md at current interest rates. The problem is that interest rates are having to move to unusual levels because wages and prices can’t adjust instantly.

    Mattias, Since 44 out of 52 economists like current policy, I see no reason why they would lose their independence. They are doing what the experts say should be done. (I think the experts are wrong.)

  9. Gravatar of Indy Indy
    15. July 2010 at 04:42

    So, wait. Is this what Krugman believes?

    1. The Fed really is powerless right now *except* that the one tool they have left is that they could also credibly announce a higher inflation target. But this they are ideologically reluctant to do so, and unlikely to be believed in any case.

    Therefore the only hope for the American economy to boost AD and goose the economy back along its normal growth trend lies with the Treasury and more deficit-spending fiscal stimulus, just like Keynes said. But, politically, this is increasingly infeasible, so lost decade here we come and I’ve resigned myself to angrily covering the real and intellectual tragedy, and well as setting myself the mission of convincing people that stimulus works, they should support more of it now and more of it similar future situations, but that it just didn’t work this time because it was botched as to its proper magnitude and conflated in people’s mind with the widely-despised bank bailouts.

    or.

    2. The fed is not really powerless at all right now. In addition to announcing a promise to return to the trend price level, they have other tools (no interest, or even penalties, on reserves, QE, targeting longer-yield notes, etc…), but their minimalist reluctance and delay and aversion to using these tools while letting the economy stagger provides an opportunity to claim they are powerless (they would be doing more if they could, right?) and thereby achieve my stimulus persuasion mission?

    or … what exactly?

  10. Gravatar of MW MW
    15. July 2010 at 04:55

    1) I read that the BoJ refused to commit to anything more than maintaining ZIRP until inflation turned positive because they didn’t think they could do anything more. I will try to find the source (Koo?) and post it.

    2) You seem to be placing much more weight on short than long-term inflation expectations. Please can you explain why? I don’t recall the Fed having an official ‘policy-relevant horizon’ (unlike the ECB and SNB, for example).

    3) I don’t understand how a central bank (presumably viewed as responsible and credible) can commit to first being irresponsible then responsible (as Krugman and Svensson seem to have advocated for Japan) in a pure inflation targeting regime. Isn’t this just, in effect, ye olde price level targeting?

    Thanks and regards, MW

  11. Gravatar of JimP JimP
    15. July 2010 at 06:51

    Indy

    To me the bigger puzzle is what Bernanke actually believes. I have read and linked to a couple articles claiming that he has, right now, full control over Fed policy and could actually do what he wants. That it is not an issue of powerlessness or lack of votes. He actually does want what we now have. Given what he has written in the past, how could that possibly be?

    Bernanke must think that what we have now is better than what would happen if he went aggressive.

    I think it is politics. Obama has not given him cover to go for higher inflation so he is not going to do it. Maybe China has told Obama not to do it and Obama is cowering in the corner, along with Bernanke and Summers.

    In which case none of them deserve to be dog catcher.

    Or – maybe the Obama calculation is the following:

    When Roosevelt came in and devalued, in 1933, the majority of the country was pretty poor and not facing retirement. Now, the “investor class” rules – old people looking at retirement on fixed income, and this “investor class” prefers unemployment to inflation – so Obama can’t do the Roosevelt this. Obama also prefers unemployment to inflation.

    In which case he still does not deserve to be President.

  12. Gravatar of scott sumner scott sumner
    15. July 2010 at 07:00

    Indy, You’ll have to ask Mr. Krugman. I’ve spent years trying to figure out The Man Who Revealed Too Little.

    MW, Don’t believe them. They have tightened monetary policy three times in the past decade. In none of those three cases was inflation a problem. They can also devalue the yen.

    2. I am interested in business cycle frequencies—those are things the Fed can control. This Fed can’t control inflation 20 years from now, it will be later Feds that handle that issue.

    3. You are right, you need price level targeting. I wish Krugman would stop talking about being irresponsible. That’s provoking the worst instincts in central bankers, not the best.

    JimP, I still think Summers and Obama are just missing the point. Bernanke is afraid to act without more of a consensus. I buy into the Tim Duy explanation (which I think you sent me.) He is not as forceful as previous Fed chairmen.

  13. Gravatar of JimP JimP
    15. July 2010 at 07:14

    Scott

    I hope you are right. Then if minds change the policy can change. That would be wonderful. Fiscal policy would go and monetary policy would be correctly understood. That would be grand.

  14. Gravatar of Doc Merlin Doc Merlin
    15. July 2010 at 07:36

    @Scott:
    ‘Doc Merlin. I have a slightly different take. By moving the money supply faster than the overall price level, prices get out of equilibrium. It is as if there are price controls, but the problem is actually sticky prices. The money market is in equilibrium in the sense that Ms = Md at current interest rates. The problem is that interest rates are having to move to unusual levels because wages and prices can’t adjust instantly.’

    Right, that is the Neo-Keynsian story. (also the orthodox one.) That central planning of money is needed because the market fails to adjust quickly enough to downward pressure on wages and prices. My experience says that this reason is baloney. I saw how quickly prices plummeted from the fed’s nominal shock in late 2008, so I am not convinced at all. In addition, the 70’s suggests that this isn’t the reason for unemployment problems either.

    I do agree however with the orthodox, that money is not neutral, but I give it other reasons. I also don’t think we need a monetary authority to arbitrarily tweak the money supply, and I think having one is dangerous.

  15. Gravatar of Benjamin Cole Benjamin Cole
    15. July 2010 at 07:59

    I am not for helicopter drops–too obvious and unsettling.
    But are there any ways to do a helicopter drop without really publicizing it?
    National lotteries in which the payouts are goosed? My fave is to secretly goose racetrack payouts.
    The PPI is down today–we may see a long deflationary recession ahead.

  16. Gravatar of Benjamin Cole Benjamin Cole
    15. July 2010 at 08:10

    BTW, from NYT today–they quoted Warsh (Fed guv).

    Pay attention to what Warsh is saying–he is saying that QE is possible, just needs “scrutiny.”

    That DC-speak. You can’t say “we need a wild-eyed radical departure.”

    Sumner is ascendant? I think so. The tide is turning in Sumner’s favor.

    From NYT “On Wednesday, the Fed lowered its estimate of economic growth for this year, to a range of 3 to 3.5 percent, from the 3.2 percent to 3.7 percent forecast in April. Inflation has been running well below the Fed’s unofficial target of nearly 2 percent, so much so that a few officials fear that the United States is at risk of the kind of deflationary spiral that has hobbled the Japanese economy for the better part of two decades.

    The Fed’s chairman, Ben S. Bernanke, has not embraced that view, but even those who disagree with it say the Fed, whose modern institutional culture was built around fighting inflation, now confronts a distinctly different problem of high joblessness.

    “If federal fiscal policy is approaching its political or economic limits, some believe that the Federal Reserve should do more, including expansion of its balance sheet,” Kevin M. Warsh, a Fed governor who is close to Mr. Bernanke, said in a recent speech to the Atlanta Rotary Club. “In my view, any judgment to expand the balance sheet further,” by acquiring mortgage bonds and debt, “should be subject to strict scrutiny.”

  17. Gravatar of Morgan Warstler Morgan Warstler
    15. July 2010 at 08:58

    My god,

    If the fed unwinds and liquidates its MBS, a good chunk of that $2T will get spent! With plenty of positive effects. Private capital will hand over $200B to the Fed, and suddenly have a far greater balance sheet (up to $1T in assets), they’ll drop rent prices, and start fixing up their million new properties.

    Why are you intentionally overlooking the very thing they want to buy? Why are you keeping their precious from them?

    Snatch up all the foreclosed homes, throw them on the market, AND THEN AFTER PRIVATE CAPITAL IS SATED, you can think about printing more money, scaring everyone with inflation.

    Give the spoils to the winners FIRST, stop plying “white” magic to aid the losers – IT IS UNAMERICAN.

    You method will inevitably be banks based, and allow them to gain on our past largess.

  18. Gravatar of Gregor Bush Gregor Bush
    15. July 2010 at 09:09

    God help us.
    Take a look at this NYT piece on the debate within the Fed:

    http://www.nytimes.com/2010/07/15/business/economy/15econ.html?_r=2&ref=business

    “By resuming its purchases of assets or by being more explicit about its intentions to keep interest rates low, the Fed could lower inflation expectations and long-term interest rates. That could further stimulate borrowing and spending by companies and individuals.”

    Is it too much to ask to have an economist proof read this stuff?

  19. Gravatar of Benjamin Cole Benjamin Cole
    15. July 2010 at 09:59

    BTW, today’s NYT piece:

    http://www.nytimes.com/2010/07/15/business/economy/15econ.html?src=mv

    quotes the same quote from Warsh that I posted here at Money Illusion a few days ago…that suggests to me someone at the NYT is reading Sumner….and paying attention.

    or…the Fed is carefully cultivating the media to prepare the public for QE…the speech in Atlanta was brought to the NYT’s attention not by the posting here, but by Fed officials…who want to test public reaction…

    either way, Sumner’s point of view is getting a hearing….

  20. Gravatar of Benjamin Cole Benjamin Cole
    15. July 2010 at 10:00

    Scott-
    You gotta read the NYT piece and hold forth….

  21. Gravatar of Steve Steve
    15. July 2010 at 10:41

    Scott,

    I am following your blog as you know, but one think always strikes me: why the hell is the Fed not doing what you (and others) are proposing? What I wonder most: in whose interest is the policy the Fed is doing?

    In general: who fears inflation more, the rich or the poor? Businesses or consumers? etc. What do you think?

    Best,

    S

  22. Gravatar of matt mcknight matt mcknight
    15. July 2010 at 10:53

    the really bad news is that in another misguided attempt at fiscal stimulus congress is already starting to acquire the helicopters and fuel required to achieve the drop.

  23. Gravatar of Chiming In «  Modeled Behavior Chiming In «  Modeled Behavior
    15. July 2010 at 11:40

    […] ~ July 15th, 2010 in Economics | by Niklas Blanchard Amidst all of the talk about crazy aerial acrobatics that the Fed could do to boost aggregate demand through […]

  24. Gravatar of azmyth azmyth
    15. July 2010 at 12:34

    Great post Scott – funny and informative. Krugman’s position on this caught me totally off guard. He is assuming a very strong version of Ricardian equivalence which he mocks as unrealistic in other articles advocating fiscal stimulus.

    When it comes to taxes, you can’t take what people don’t have. If people really did expect the government to “tax and burn” the dropped money, they would rush to spend like crazy so when the IRS showed up, there would be nothing for them to take. Because the government uses income taxes and not fixed per capita taxes, increasing people’s exspectations of higher future taxation will cause people to work and spend like crazy today so they can avoid high taxes later. The dead weight loss from high taxes strictly implies altered behavior!

    I think the best way to commit to a higher inflation path is permanent debt monetization. That way you can lower taxes now without worrying about higher future taxation.

  25. Gravatar of azmyth azmyth
    15. July 2010 at 12:39

    P.S. I didn’t mean to imply that your past policy recommendations of getting rid of interest on reserves and announcing a formal target would be a bad idea. I was just thinking that in a world where they had already been adopted, debt monetization would be better than helicopter drops.

  26. Gravatar of Lorenzo from Oz Lorenzo from Oz
    15. July 2010 at 13:02

    In a sense the money market is always in equilibrium. Ms = Md. the question is which variable needs to adjust to equilibrate the market. If it is interest rates, we have macro instability. In the long run it is wages and prices, and then we have macro stability.
    Isn’t money the one market that does not have a current base price (just expectations of future value)? Because money is the thing all the other prices are in.

    By moving the money supply faster than the overall price level, prices get out of equilibrium. It is as if there are price controls, but the problem is actually sticky prices. The money market is in equilibrium in the sense that Ms = Md at current interest rates. The problem is that interest rates are having to move to unusual levels because wages and prices can’t adjust instantly.
    I have a problem with “faster than the overall price level”. What is “the overall price level” but the ratio of money to goods and services? (Leaving assets out for the moment.) Is not the notion here that the money supply is increasing faster than total transactions?

  27. Gravatar of marcus nunes marcus nunes
    15. July 2010 at 16:52

    The Economist discusses low interest rates (and doesn´t see it as a sign of tight MP.
    http://www.economist.com/node/16590877

  28. Gravatar of JimP JimP
    15. July 2010 at 17:52

    Which shows that the Economist is bone ignorant – which comes as no surprise to anyone.

  29. Gravatar of JimP JimP
    15. July 2010 at 17:55

    Just kidding – but still…………

  30. Gravatar of Declan Trott Declan Trott
    15. July 2010 at 18:00

    Scott, I second Doc Merlin’s comment. Funniest post ever. (And if you do have a wife, give her our thanks for all the time you spend entertaining and informing strangers for free.)

    Lorenzo, If you think of supply and demand for money, the role of “price” is filled by the nominal interest rate i.e. the opportunity cost of holding money as opposed to other assets.*

    “I have a problem . . . total transactions?”

    Whether you choose to focus on final output or total transactions is a definitional choice. Either one defines a price level, and the rest of the logic is the same. If the money supply is increased by say 10% but prices do not adjust instantly, then the ratio of money to the price level has increased. This implies a lower “price” for money i.e. a lower nominal interest rate. The money market is still in “equilibrium” in the sense that supply equals demand, but the lower interest rate has a feedback effect on the real economy, which will be eliminated once the price level has time to adjust.

    *OK, it really should be “nominal return on non money assets”, also the inflation rate once it becomes worthwhile to hold real goods instead of money, and it’s assuming there is no interest on reserves, but you get the idea.

  31. Gravatar of scott sumner scott sumner
    16. July 2010 at 07:36

    JimP, I agree.

    Doc Merlin, But wages sure didn’t “plummet” after Oct. 2008.

    Benjamin, It is precisely the public nature of helicopter drops that gives them their punch.

    Benjamin32, Thanks.

    Morgan. Liquidating MBSs doesn’t expand M, it shrinks it.

    Gregor, Typical NYT piece. Sounds intellectual but gets the interpretation wrong.

    Benjamin, Yes, there is definitely more discussion of monetary stimulus–my ideas are getting out there. But I don’t have time to comment on everything.

    Steve, I don’t think the Fed is evil, just misguided. But obviously Fed employees are not exactly the most likely to lose their jobs in a recession, so subconsciously that may play a role.

    Matt, I doubt Congress will do more fiscal stimulus.

    azmyth, That would work, but I fear it would work too well (hyperinflation.)

    Lorenzo, I don’t know what “current base price” means. I’d put it this way; Money is the only good with a fixed nominal price, and a real price that adjusts by moving the nominal price of all other goods.

    No the price level isn’t the ratio of money to goods and services–that would be P/V. Prices over velocity.

    Marcus and JimP, Yes, I’ve always disliked the Economist’s articles on money.

    Declan, Thanks. I do have a wife, but the only golf I play is on courses that have windmills.

  32. Gravatar of Doc Merlin Doc Merlin
    16. July 2010 at 09:03

    ‘Doc Merlin, But wages sure didn’t “plummet” after Oct. 2008.’

    Per unit wages did fall. It is just that productivity grew a lot faster than per unit wages fell. This recession has seen very high productivity growth. Kind of the opposite of an RBC recession.

  33. Gravatar of ssumner ssumner
    18. July 2010 at 04:45

    Doc Merlin, Yes, it’s not an RBC recession.

  34. Gravatar of azmyth azmyth
    19. July 2010 at 09:48

    “That would work, but I fear it would work too well (hyperinflation.)”
    That’s a very anti-Sumnerian criticism. Surely there is some amount of permanent monetization that would lead to more than 2% deflation and less than 100% inflation. Your critics have thrown “but won’t that cause hyperinflation?” at you as well, and you’ve rightly said that’s a weak counter. If one answered “How much monetization is equivalent to an OMO?”, one could theoretically target any nominal aggregate.

  35. Gravatar of Lorenzo from Oz Lorenzo from Oz
    19. July 2010 at 18:53

    Because I do not understand monetary economics (you may notice I usually do not comment on monetary economics directly) but, thanks to your blog Scott, am increasingly fascinated by it, I am free to ask the “silly” questions.

    I found your and Declan’s comments helpful, because I think they are revealingly wrong (he said bravely). The work of Yoram Barzel on property rights awoke me to the importance of considering the attributes of things, their different (albeit linked) characteristics. I have always found the standard description of money as being a unit of account, medium of exchange and store of value somewhat frustrating because economic texts, and economists generally, then go on to talk about money as an undifferentiated lump. The different attributes are cited in the textbook preliminaries then ignored (or, rather, run together in an unhelpfully undifferentiated way) in analysis and comment.

    Scott, you wrote: Money is the only good with a fixed nominal price, and a real price that adjusts by moving the nominal price of all other goods.

    Surely fiat money has no nominal price: it has a unit of account, but no nominal price since there is nothing specific that one gets for a single unit. Fiat money does have “a” real price””how many goods and services one can buy with a given amount: in other words, its value as a medium of exchange.

    So, fiat money has no nominal price, but merely a real price, since it is the thing that nominal prices are expressed in. Or, as you wrote a real price that adjusts by moving the nominal price of all other goods.

    But, responding to Declan’s comment that If you think of supply and demand for money, the role of “price” is filled by the nominal interest rate i.e. the opportunity cost of holding money as opposed to other assets.* … *OK, it really should be “nominal return on non money assets”, also the inflation rate once it becomes worthwhile to hold real goods instead of money, and it’s assuming there is no interest on reserves, but you get the idea, what is not “the” price, or fulfilling the “role” of “the” price of money, is the interest rate. That is merely the expected rate of loss of value in terms of goods and services across time: its discount rate as a store of value.

    If money is “tight” (i.e. relatively scarce compared to goods and services) then the interest rate will tend to be low, due to expectations of continuing relative scarcity. If money is “loose” (i.e. relatively plentiful compared to goods and services) then the interest rate will tend to be high, due to expectations of continuing relative plenty. To think of the interest rate as the price of money, or fulfilling the role of the price of money, is to have a “price” that goes down in scarcity and up in plenty: a very strange price indeed.

    But, of course, it is a standard textbook statement to say that the interest rate is the price of money, hence economists commonly claiming that low interest rates are a sign that money is loose and high interest rates that money is tight (as Scott regularly complains about: quite rightly).

    One has to keep the classic attributes of money (unit of account, store of value, medium of exchange) clearly defined. Thus, wages are “sticky” because contracts are based on money as a unit of account. Yes, wages are set in money because it can then be exchanged for goods and services but the “stickiness” comes from its unit of account attribute, not its medium of exchange or store of value attributes.

    So yes the attributes are linked. Money is a store of value because it can be used in future as a medium of exchange, and the interest rates expresses expectations about its future value as a medium of exchange but, nevertheless, interest rate pertain to its role as a store of value, not as a (current) medium of exchange.

    I am somewhat diffident, since I am aware how much I don’t know about monetary economics, but thinking of things in this way make the various attributes of money make much more coherent sense to me and, I suggest, leads to clearer thinking about money.

  36. Gravatar of Doc Merlin Doc Merlin
    20. July 2010 at 00:12

    I have to echo your thoughts Lorenzo:

    ‘Scott, you wrote: Money is the only good with a fixed nominal price, and a real price that adjusts by moving the nominal price of all other goods.’

    1. Every good has a fixed nominal price wrt itself. If you are pricing dollars in terms of dollars, then yes the price is nominally fixed, the same is try when you price your goats in goats.
    2. Every good has a real price that adjusts by moving the nominal price of all other goods if you were to denominate them in it. This is standard microeconomics.

    You can do this with an Edgeworth box or really, any microeconomic model since prices in micro are all opportunity costs which is the same thing as saying “adjusts by moving the nominal price of all other goods.”

    What makes money special isn’t what you said Scott. What makes it special are these three things:

    1. Taxes must be paid for in money. While some stores in Michigan may accept silver for payment, the US government always demands its own currency.

    2. When calculating taxes, the price of goods is denominated in dollars. This means that when you hold non-nominal assets and the dollar falls in value due to monetary inflation, you have to pay the government. This is despite the fact that your non-dollar assets may have not increased in real price.

    3. The federal reserve produces dollars far, far, far to the left of the MC=0 curve.

  37. Gravatar of scott sumner scott sumner
    20. July 2010 at 04:46

    azmyth, I think I may have misunderstood your argument. If we are talking about just enough debt monetization to hit a NGDP target, then that is simply an open market purchase of bonds, and I am fine with that. I thought you meant monetize all the debt.

    Lorenzo, I am afraid you are mistaken. The “units” for money (in the US) are dollars. And the nominal price of dollars is always fixed at exactly one.

    Here is an an analogy. Beer can be bought is single cans, and it can be bought in six packs, or cases of 24. Dollars come in ones, or “five packs”, or “20 packs.”

    Your comment that high interest rates may be associated with plentiful money is often true, but not always. Prices can be very high, but expected to fall.

    Doc Merlin. You said;

    “1. Every good has a fixed nominal price wrt itself. If you are pricing dollars in terms of dollars, then yes the price is nominally fixed, the same is try when you price your goats in goats.”

    Yes, but this misses the point. Goats and everything else are actually priced in dollars. Yes, that fact that one dollar costs one dollar is not important in itself, it is important because all other goods are priced in terms of dollars.

    I strongly disagree about taxes. Money would be special in a libertarian paradise with no government at all. It is special because other goods are priced in terms of money. We wouldn’t suddenly revert to barter just because there were no taxes to pay. Money is very convenient.

  38. Gravatar of azmyth azmyth
    20. July 2010 at 06:43

    “Money would be special in a libertarian paradise with no government at all. It is special because other goods are priced in terms of money. We wouldn’t suddenly revert to barter just because there were no taxes to pay.”

    There is a talk about the economics of Somalia here: http://fee.org/media/stateless-in-somalia-by-benjamin-powell/

    Somalia, despite being governmentless still operates under a fiat currency. The only denomination, the 1000 Somali shilling, is worth what it costs to print. I think it is cool to be able to have a test of the hypothesis of stateless fiat currency.

  39. Gravatar of ssumner ssumner
    21. July 2010 at 07:32

    azmyth, Interesting, but I am not claiming fiat money would hold its value if the issuing state collapsed. I am saying that there would still be a demand for money of some sort. If the US governemtn said taxes must be paid by check or credit caed, cash would still have value in regular transactions.

  40. Gravatar of Lorenzo from Oz Lorenzo from Oz
    21. July 2010 at 16:27

    Scott: if the price of a dollar is a dollar, in what sense is it a price? A price is some x you pay for some y. A barter system has prices, even if does not have money. In fact, it has far too many prices, which is why money is so convenient: it massively reduces transaction costs (not least by its reduction in information burdens). If you say that, in an economy with money, money is the way all prices are expressed, including its own, I guess that works: but it is still an odd use of ‘price’.

    On the point about about expectations–and continuing my previous argument that focusing on the different attributes of money explicitly makes it clearer–I note that their temporal ambit varies. The unit-of-account role generally arises out of past interactions (hence its role in the contractural-constraint “stickiness” of prices and wages), the medium-of-exchange role is about present use and the store of value role is about future use.

    Obviously, the attributes are linked. Money is a store of value because it can be used in future as a medium of exchange, with it is counted according to its unit of account. Interest rates expresses expectations about its future value as a medium of exchange but, nevertheless, interest rate pertain to its role as a store of value, not as a (current) medium of exchange. While the downward stickiness of wages is based on the implications of its use as a unit of account even though its role as a medium of exchange is why wages are paid in money.

    It seems to me clear to express it that way, rather than an apparently undifferentiated lump for analysis.

    Especially as these roles are not only linked, they interact. If money is declining as a store of value, the inclination will be to spend it, increasing its use as a medium of exchange and leading to more transactions. If money is increasing as a store of value, the inclination will be to retain it, decreasing its use as a medium of exchange, leading to fewer transactions. Hence increasing expectations that money will decline in value is stimulatory, while increasing expectations that it will increase in value is contractionary.

    Merely changing the supply of money will not have an automatic effect on its use as a medium of exchange, however, because such use depends on expectations about future income and about money as a store of value. (Hence the “variable lags” difficulty of monetarism and your point about expectations matter–agree entirely.) But, then, expectations are basic to prices in general (try and find a price that does not depend on expectations) since human actions are so pervasively driven by expectations and prices come from human actions.

    Thinking about the “liquidity trap” and continuing this way of expressing things, if interest rates are effectively zero, then the demand for money as a store of value must be high, based on strong expectations that it is a reliable store of value. Or, at least, sufficiently reliable given current expectations about the future prospects: which may be seriously limited in their ambit. (One way to think of uncertainty is as a realm where there is little or no confidence in forming expectations.) The existence of either (or both) substantial uncertainty or strongly negative expectations encourages flight to assets: such as holding money as a store of value rather than using it as a medium of exchange.

    But the “zero bound” is not a bound as such. Interest rates can be negative. Raising the cost of holding money will discourage people doing so. This can be done by creating expectations of future inflation, reducing its perceived value as a store of value, which is a way of charging people for holding money. Or one can directly charge people for holding money by requiring them to pay fees for holding money. (This is deeply problematic, since one has to know how much cash they have: encouraging people to take money out of accounts and “stick in their mattress” is not a good idea.) Hence the virtue of raising inflationary expectations: it increases the price for holding money regardless of where the money is.

    But there are two sides to holding money: the appeal of holding money depends on how appealing its role as a store of value is given the current level of uncertainty and/or negative expectations. The more uncertainty and/or negative expectations about the future, the less money has to be a good store of value to have holding it be attractive.

    So reducing uncertainty (i.e. increasing the ambit over which expectations can be reasonably formed) and increasing positive expectations will also reduce the holding of money as a store of value and increase its use as a medium of exchange (and thus current transactions). A highly indebted government increasing spending may, far from reducing uncertainty and negative expectations about the future, increase both, negating any stimulatory effect from the spending in whole or in part (pdf). In other words, fiscal stimulus (increasing net government spending) has the same problem as monetary stimulus (in the sense of simply increasing the money supply): it depends on the level of uncertainty and people’s expectations.

    Either way, being clear on what attribute is the current focus of analysis leads to clearer thinking about money.

    So, I believe I am agreeing with you but trying to express it in a way that is clear to someone like me, who is not confident about their grasp of monetary economics.

  41. Gravatar of Doc Merlin Doc Merlin
    21. July 2010 at 17:29

    @Scott
    Thanks for the response.

    ‘The problem is that interest rates are having to move to unusual levels because wages and prices can’t adjust instantly.’

    How do you explain unusual rates that persist for a very long time, like the negative real rates during the last decade? I am curious, because I don’t have a good market explanation for it, the only one I can think of is direct manipulation by the fed.

  42. Gravatar of Scott Sumner Scott Sumner
    23. July 2010 at 06:39

    Lorenzo; You said:

    “Scott: if the price of a dollar is a dollar, in what sense is it a price? A price is some x you pay for some y. A barter system has prices, even if does not have money. In fact, it has far too many prices, which is why money is so convenient: it massively reduces transaction costs (not least by its reduction in information burdens). If you say that, in an economy with money, money is the way all prices are expressed, including its own, I guess that works: but it is still an odd use of ‘price’.

    On the point about about expectations-and continuing my previous argument that focusing on the different attributes of money explicitly makes it clearer-I note that their temporal ambit varies. The unit-of-account role generally arises out of past interactions (hence its role in the contractural-constraint “stickiness” of prices and wages), the medium-of-exchange role is about present use and the store of value role is about future use.

    Obviously, the attributes are linked. Money is a store of value because it can be used in future as a medium of exchange, with it is counted according to its unit of account. Interest rates expresses expectations about its future value as a medium of exchange but, nevertheless, interest rate pertain to its role as a store of value, not as a (current) medium of exchange. While the downward stickiness of wages is based on the implications of its use as a unit of account even though its role as a medium of exchange is why wages are paid in money.”

    I agree until you said interest rates express expectations of money’s future value. Actually, expected inflation expresses this concept, not interest rates.

    BTW, If you go to the bank to buy $2 worth of nickels, they cost $2.

    You said;

    “Thinking about the “liquidity trap” and continuing this way of expressing things, if interest rates are effectively zero, then the demand for money as a store of value must be high, based on strong expectations that it is a reliable store of value.”

    Interest rates are currently near zero in the uS, but demand for non-interest bearing currency has only risen slightly. You are correct, but the effect may be small because of fear of currency being stolen.

    You said;

    “So, I believe I am agreeing with you but trying to express it in a way that is clear to someone like me, who is not confident about their grasp of monetary economics.”

    Yes, we do mostly agree. Many of your ideas are similar to mine.

    Doc Merlin, The Fed can’t control real rates for any long period of time. Savings and investment determine real rates. In the early 2000s savings was high relative to investment.

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