Interest rates and monetary policy

Commenter Fed up asked the following question:

Start at IOR = 0% and fed funds rate = 8%.

Next, move to IOR = 2% and fed funds rate = 6%.

What happens?

If you have an interest rate-oriented view of monetary policy then this must be a bit of a head scratcher.  Higher IOR is “raising interest rates” and a lower fed funds rate is “lowering interest rates.” So which is it?

Monetary policy is not about interest rates; it’s about the supply and demand for base money.  In the first case the opportunity cost of holding reserves is 8%, in the second case it’s 4%.  In both cases banks don’t want to hold significant excess reserves, so the impact of higher IOR on the demand for the medium of account (base money) is trivial.  It’s slightly “tighter money” but without much effect.

The fed funds change is different.  Whereas a change in IOR affected the demand for base money, a change in the few funds rate is an effect of a change in the supply of base money.  That’s tighter easier money in the short run, ceteris paribus.  But whether it is actually tighter easier money depends on how the action impacts the expected future path of monetary policy.  For that you look at the response of the NGDP futures market–just as soon as policymakers figure out that they need to create such a market.

PS.  Lots of people have been sending me articles.  Narayana Kocherlakota endorses level targeting.  San Francisco Fed President John Williams suggests we consider NGDP targeting.  Put them together and you get NGDP level targeting.  Williams also says that the Swedish case shows that the Fed needs to be careful about using monetary policy to address financial instability.

PPS.  Martin Feldstein says inflation has been running well below the Fed’s 2% target over the past 12 months:

The Federal Reserve’s preferred measure of inflation””the price of consumer spending excluding food and energy””rose 1.4% over the past 12 months but increased since February at a 2.1% seasonally adjusted annual rate.

I agree.  Here’s the title provided by the WSJ editors:

Warning: Inflation Is Running Above 2%

PPPS.  Surprisingly, I agree with this:

I like to say to my students “no matter how many good arguments you think you have against real business cycle theory, it explains an overwhelming preponderance of the business cycles in the history of the human race.”

PPPPS.  TallDave sent me an interview where Larry Kudlow asks Alan Greenspan about market monetarism.  The answer is completely unintelligible, but Jim Pethokoukis is kind enough to also provide a much more thoughtful comment by Greenspan on NGDP targeting back when he was . . . younger.

PPPPPS.  Transparency in the Ukraine.

PPPPPPS.  Dogs are Republicans.

Posting will get less frequent over the next few weeks due to some trips I’ll be taking.

 


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155 Responses to “Interest rates and monetary policy”

  1. Gravatar of Jason Jason
    12. June 2014 at 18:15

    Here’s another answer: The interest rate cut is contractionary if the base is small and it is expansionary if the base is large.

    http://informationtransfereconomics.blogspot.com/2014/06/krugman-keynes-and-liquidity-trap.html

    Basically the same thing as Scott’s answer, except it gives a different explanation for the possibilities 🙂

  2. Gravatar of Lorenzo from Oz Lorenzo from Oz
    12. June 2014 at 19:07

    In both cases banks don’t want to hold significant excess reserves, so the impact of higher IOR on the demand for the medium of account (base money) is trivial.
    Because of the post I have just done on hard money not being the same as sound money, this post was a bit of penny-drop moment for me regarding your and Nick’s MoA v MoE debate, as you focus on the monetary system, and money as MoA is the lynchpin as that, whereas money as MoE is more its manifestation within the system.

    How things are framed, it makes such a difference …

  3. Gravatar of dannyb2b dannyb2b
    12. June 2014 at 20:59

    Posted over from previous entry. Hoping to get an answer if possible.

    “Danny, If you have two lakes connected by an open channel of water, it makes no difference whether you put an extra bucket of water in one lake or the other. The water level rises in both. It makes no difference who the Fed buys the bond from. Thinking it does is an example of the fallacy of composition.”

    At the ZLB the new expansions of MB are non permanent when bank’s risk adjusted returns are too low. Therefore the new water doesn’t leave the bucket, the banks just sit on their excess reserves. The general public on the other hand will utilize new “reserves” (assuming they can hold and transact in them) for consumption at the zlb therefore expansions are permanent.

  4. Gravatar of Kevin Erdmann Kevin Erdmann
    12. June 2014 at 21:50

    This is something I’ve mentioned here a couple of times, with no responses, so maybe I’m out of my element here. But, at the current level of reserves, might not it actually be stimulative to raise the Fed Funds Rate while leaving IOR at 0.25%? I assume they would need to use these new repo programs they have been testing. I’m not sure how they would peg the Fed Funds Rate at 2% with all these reserves outstanding, but would it be that much harder than their plan of raising them both together?

    The opportunity cost of IOR would create its own HPE, and the transfer of reserves into treasuries would create a sort of backwards liquidity effect that would allow the Fed to reduce their balance sheet without pushing down bond prices, because instead of creating bond supply, they would just be deciding how much to supply to provide to meet demand.

    There would be some spread between IOR and FFR that would be optimally stimulative, so that moving FFR in either direction from that point would be contractionary.

    If I don’t know what the hell I’m talking about, just let me know, and I shall never speak of this again.

  5. Gravatar of Edward Edward
    13. June 2014 at 04:48

    Scott,
    Whoooo boy!
    Check out Paul krugman’s latest blog post.
    “Wrongness, ok and not ok.”

  6. Gravatar of Nick Nick
    13. June 2014 at 05:04

    Kevin,
    I think this is the danger of thinking of the fed as setting ‘interest rate policy’ …
    You say, ‘I’m not sure how they would peg the fed funds rate at 2% with all these reserves outstanding’
    Indeed.
    The reverse repo’s you are relying on to drive the rate up are the same thing as eliminating the reserves unless I’m gravely mistaken. It should be impossible to drive the rate up while still maintaining a big pile of a excess reserves for IOR policy to matter about.
    Now to throw in my own randin theory: when we consider the bank stress tests / unclear regulatory regime is it possible we have unofficially required reserves? Perhaps the exact quantity of the requirement is unknown, and the penalty manageable (BoA recently). Might there then be a regulatory risk / reward in keeping ‘excess’ reserves that are not truly excess for the IOR rate continue to matter off the ZLB?
    Probably not?

  7. Gravatar of Market Fiscalist Market Fiscalist
    13. June 2014 at 05:18

    “The fed funds change is different. Whereas a change in IOR affected the demand for base money, a change in the few funds rate is an effect of a change in the supply of base money. That’s tighter money in the short run, ceteris paribus.”

    I suspect I may be missing a key point of this post – why is a decrease in rates from 8%-6% “tighter money in the short run, ceteris paribus” ?

  8. Gravatar of ssumner ssumner
    13. June 2014 at 05:18

    Jason, I’m not saying the interest rate cut is contractionary if the base is small.

    Lorenzo, Good point.

    Danny, No, currency and reserves are both part of the base, both have left the bucket.

    Kevin, I can see why a higher fed funds rate seems expansionary, ceteris paribus. The problem is that the thing you must do to get the higher fed funds rate might be contractionary. If you get that higher fed funds rate via open market sales (the usual assumption), it’s contractionary. If you get there through forward guidance it’s expansionary.

  9. Gravatar of ssumner ssumner
    13. June 2014 at 05:20

    Market Fiscalist, Yikes, that’s a typo. I’ll fix it.

  10. Gravatar of ssumner ssumner
    13. June 2014 at 05:23

    Edward, I’m blocked from the section after “read more”. Anything interesting?

  11. Gravatar of Edward Edward
    13. June 2014 at 05:36

    Yeah that happens to me too sometimes. The trick is to wait until the page is partially loaded, than stop loading the page. I’ll send you a copy of krugman’s post word for word

  12. Gravatar of Edward Edward
    13. June 2014 at 06:05

    Here you go Scott:
    Paul Krugman:
    “USA! USA! NYC! Back from Oxford, but still “” as you can see from the posting time “” jet-lagged. I have a steakhouse dinner tonight in honor of Eric Cantor with some business economists; we’ll see if I end up face down in my tenderloin.

    One of the people I expect to see is Barry Ritholtz, who has a nice post acknowledging an error (not at all fundamental) in his column and discussing how to deal with mistakes when you make them “” which you will! I’d like to add that there are mistakes and then there are mistakes, and it’s important to know which you’ve made.I’ve written on this before, but may have a somewhat new way to make the point.

    Suppose that you’re making a prediction “” and every assertion about how the world works has to involve at least an implicit prediction of something, because otherwise it’s empty. This prediction comes from some kind of model “” if you don’t think you have a model, you’re kidding yourself, and your model is all the worse because you imagine that you aren’t using it. For the sake of argument, let’s say that your model takes the form

    y = a + b*x + u

    where y is what you’re predicting, x is some kind of explanatory variable, a and b are parameters, and u represents random stuff (not necessarily really random, but stuff that isn’t part of your model). That last term is important: nobody, and nobody’s model, gets things totally right.

    So, suppose your prediction about y ends up having been pretty far off. What does that tell you?

    It could say simply that, as the bumper stickers don’t quite say, Stuff Happens. There could have been a random shock; or for that matter your explanatory variables may not have done what you expected them to. But it could also say that your underlying model was just all wrong, requiring a rethink.

    And here’s the thing: over the course of your life, you’re going to make both kinds of mistakes. The question is whether to hold em or fold em “” to stick with your basic story, or realize that the story is wrong.

    Let me give four examples, from my own considerable record of mistakes.

    First, back in the mid-1990s I was extremely skeptical about claims of an IT-drive surge in productivity. And I was just wrong: productivity really was surging, although it eventually tapered off. What kind of error was that?

    The answer was, not fundamental. My model of how the world works didn’t at all preclude productivity surges, I was just misjudging the one in sight. One thing I did learn, however, was to take buzz that isn’t in the official numbers more seriously than I used to.

    Second, in 2003 I warned about a US financial crisis driven by fiscal irresponsibility, somehow comparable to the crises in Asia a few years earlier. This was, I now believe, a fundamental error: countries that borrow in their own currency don’t face the same kind of risk as countries that don’t. What really annoys me about this error was that my own analysis was trying to tell me that: I had done quite a lot of work on the Asian crisis, with models that relied crucially on foreign currency debt and balance sheet effects. But I put that analysis aside and went with my gut, almost always a bad idea.

    So this was a fundamental modeling error, calling for a major revision of views “” which I did.

    Third, I worried a lot in 2010-2012 about a euro breakup. And here too I had a fundamentally flawed model. But the flaw wasn’t in my economic model, which has worked pretty well, but in my implicit political model: I simply failed to appreciate the incentives facing European elites and how willing they would be to do whatever it takes, both in debtor countries and at the ECB, to avoid an outright rift. So, fundamental change called for “” but in my political model, not my economic model.

    Finally, Britain is growing much faster right now than I expected. Fundamental model flaw? I don’t think so. As Simon Wren-Lewis has pointed out repeatedly, the Cameron government essentially stopped tightening fiscal policy before the upturn, which means in effect that the “x” in my equation didn’t do what I thought it would. On top of that, there was a drop in private savings, which is one of those things that happens now and then.The point is that the deviation of British growth from what a standard Keynesian model would have predicted, while real, wasn’t out of line with the normal range of variation-due-to-stuff-happening; nothing there that warranted a major revision of framework.

    So you will be wrong sometimes, and need to do your best to figure out why.

    What you should never ever do, of course, is make excuses, or pretend that you didn’t say what you said. Unfortunately, many if not most prognosticators do all the time what nobody should do ever.

  13. Gravatar of Floccina Floccina
    13. June 2014 at 06:58

    PPPPPPS. Dogs are Republicans.

    I am going to take that as evidence that the non monetary benefits of work are even larger than I thought. The non monetary benefits of work are the biggest reason that I cannot support a minimum wage though I would like to because I would like to see low income employees all get a nice raise. A higher minimum wage would be cheap and it might even improve my life by improving the services I get at some business as the worst employees are replaced but I cannot support it.

  14. Gravatar of Tommy Dorsett Tommy Dorsett
    13. June 2014 at 08:39

    Feldstein has been predicting an inflation breakout since 2009. Six years of failed forecasts and yet he keeps pedaling the same line. The statute of limitations on his credibility is up.

  15. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    13. June 2014 at 09:19

    Speaking of admitting mistakes, no one does it more slyly than Brad DeLong;

    http://equitablegrowth.org/2014/06/12/daily-piketty-matt-rognlie-first-rate-critique-thursday-focus-june-12-2014/

    Fresh from stridently claiming Krusell, Smith, James Hamilton et al were just lousy economists, Brad is now praising Rognlie’s analysis which is…agreeing with those lousy economists!

  16. Gravatar of Jason Jason
    13. June 2014 at 09:56

    Hi Scott,

    I wasn’t saying the rationale was the same; I was saying the ambiguity in the effect was the same (I.e. The effect of an interest rate cut depends on other factors).

    However, you could say that when the base is small relative to NGDP, the future path of monetary policy is likely expansionary (hence looser money and higher Interest rates) and when the base is large, it isn’t and the liquidity effect dominates.

  17. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    13. June 2014 at 09:57

    Here’s what J. Bradford’s story is today;

    ‘Matt Rognlie has a first-rate exposition of his critique of Piketty’

    Try and find something in Rognlie that Sala y Martin, Krusell, or Hamilton didn’t say;

    ‘ “Capital in the Twenty-First Century predicts…
    …a rise in capital’s share of income and the gap r – g between capital returns and growth…. Neither outcome is likely given realistically diminishing returns to capital accumulation. Instead-all else equal-more capital will erode the economywide return on capital…. Piketty (2014)’s inference of a high elasticity from time series is unsound, assuming a constant real price of capital despite the dominant role of rising prices in pushing up the capital/income ratio. Recent trends in both capital wealth and income are driven almost entirely by housing, with underlying mechanisms quite different from those emphasized in Capital….’

  18. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    13. June 2014 at 14:36

    Krugman hasn’t made the error of admitting Mankiw was right, and he was wrong about Obama’s growth forecast.

  19. Gravatar of dtoh dtoh
    13. June 2014 at 16:23

    Scott,
    I have said this before but you need to start talking about base money less ER.

    If there is a permanent expansion of the base, but…

    It is absorbed entirely by an increase in ER, and…

    There is no expectation of a future decrease in ER, then…

    Then expansion of the base will have no effect on anything (prices, AD, etc) either short term or long term.

    You need to start making this distinction.

  20. Gravatar of Major-Freedom Major-Freedom
    13. June 2014 at 17:37

    The better question is exactly HOW the Fed would lower the fed funds rate from 8% to 6%.

  21. Gravatar of Michael Byrnes Michael Byrnes
    14. June 2014 at 03:03

    dtoh wrote:

    “If there is a permanent expansion of the base, but…

    It is absorbed entirely by an increase in ER, and…

    There is no expectation of a future decrease in ER, then…

    Then expansion of the base will have no effect on anything (prices, AD, etc) either short term or long term.”

    I think this is the wrong way to look at it.

    First, it is pretty obvious that the massive base expansion we have seen in recent years is viewed as temporary (or sterilized). It’s not credible that inflation could still be so low if the base expansion had been viewed as permanent.

    Second, banks are holding $X in excess reserves and are lending out $Y. Is there any reason whatsoever to believe that if the Fed reduced X dramatically, Y would stay the same? Logic says Y would fall.

  22. Gravatar of dannyb2b dannyb2b
    14. June 2014 at 03:36

    “Danny, No, currency and reserves are both part of the base, both have left the bucket.”

    Ok lets say they have left the bucket. If reserves go to banks at zlb and banks just sit on them because of low risk adjusted investment environment then new reserves expansions should be non permanent. If new reserves are expanded to people in same environment people will actually use these reserves for consumption (assuming people can directly hold and transact in reserves) which means expansions are likely to be permanent. On a comparative basis people gain greater utility from consumption over banks. Banks gain greater utility from investment. Banks are oriented towards making profits from investing.

  23. Gravatar of ssumner ssumner
    14. June 2014 at 05:21

    Thanks Edward.

    Jason, I agree that when the base is small the future course of monetary policy is likely to be expansionary.

    Thanks Patrick.

    dtoh, All these thought experiments are on a ceteris paribus basis. The only case where it would all go into ERs is if IOR is permanently increased, which is a separate policy move.

    Danny, The question of who the Fed buys bonds from has no impact on how consumption is affected, or who has the money after it is injected. When the Fed buys bonds from the public they pay with a check. This check gets deposited in a bank and shows up as bank reserves. Then it starts moving out as cash, but the rate it moves out as cash has no relationship to whether the Fed initially bought the bond from the public, or from a bank.

  24. Gravatar of dannyb2b dannyb2b
    14. June 2014 at 06:30

    “Danny, The question of who the Fed buys bonds from has no impact on how consumption is affected, or who has the money after it is injected. When the Fed buys bonds from the public they pay with a check. This check gets deposited in a bank and shows up as bank reserves. Then it starts moving out as cash, but the rate it moves out as cash has no relationship to whether the Fed initially bought the bond from the public, or from a bank.”

    At zlb in environment of low risk adjusted investment returns if QE counterparties receive this cheque and do nothing with the deposit the demand for cash increases. You want the supply of cash to increase not the demand. If people are receiving cheques then cash increases but its due to supply increase primarily not demand for cash. People will demand cash less at zlb because they will actually consume whereas banks are mainly looking for places to invest.

    Put in another way at zlb demand for cash goes up due to liquidity preference, not transaction demand if reserves are expanded through purchases to large banks/financial instead of people through transfers.

  25. Gravatar of TravisV TravisV
    14. June 2014 at 09:37

    Paul Krugman linked to the 200 most influential economics blogs:

    http://www.onalytica.com/blog/posts/top-200-influential-economics-blogs-aug-2013

  26. Gravatar of dtoh dtoh
    14. June 2014 at 17:32

    Scott, you said;
    “All these thought experiments are on a ceteris paribus basis. The only case where it would all go into ERs is if IOR is permanently increased, which is a separate policy move.”

    Not a thought experiment.

    1. The vast majority of the base expansion was in ER. How is actual policy a thought experiment?

    2. Do you believe NGDP would be at its current level if the economy/market did not think ER would remain at current levels or be reabsorbed by the Fed?

    3. Why would anyone not think that the Fed has adopted a policy under which IOR is permanent or semi-permanent? How can you explain the long persistence of IOR with low inflation, high unemployment, slow growth, and politicians/press/some economists continually screaming about the inflationary dangers of the base expansion? Is the expansion of ER just an unintended and uncontrollable side effect?

    If the Fed expands the base and it simply ends up as ER, it is no different than if the New York Fed exchanged securities for deposits with the St. Louis Fed. It has no impact. Nada.

    Given the current policy regime, the “base” is meaningless. You need to be more accurate and talk about “Base minus ER.”

  27. Gravatar of Major-Freedom Major-Freedom
    14. June 2014 at 22:08

    Sumner:

    “The question of who the Fed buys bonds from has no impact on how consumption is affected, or who has the money after it is injected. When the Fed buys bonds from the public they pay with a check. This check gets deposited in a bank and shows up as bank reserves. Then it starts moving out as cash, but the rate it moves out as cash has no relationship to whether the Fed initially bought the bond from the public, or from a bank.”

    Sumner, you have repeatedly this false statement despite the fact that you have been repeatedly corrected on it.

    Yes, it does matter who gets the money first. In your description of the process, you are ignoring what happens in addition to the check being deposited into a bank. Yes, it is true that a check deposited into a bank becomes a part of its reserves, and that any lending associated with this can reasonably be argued to not depend on exactly where that check came from, meaning who deposited it and what they do for a living. All well and good.

    But what you are ignoring is the economic activity contingent on the specific role of the depositor that is affected by inflation, or “OMOs”. They spend as well you know. Their checking account balance is now larger.

    If the initial reciever invests or lends money for a living, and his bank balance is increased via inflation, then notwithstanding what the bank does given the increase in reserves, that depositor will likely add those funds to the lending pool in the market. If that occurs, then there will be more money in the loanable funds market as compared to the situation where the initial reciever is let’s say a wage earner who does not lend at all. In the latter case, and again, notwithstanding what the bank does given it has more reserves, that depositor will likely add those funds to the consumption demand component of money usage.

    Depending on the economic role of the initial reciever, we can indeed surmise that the resulting activity will be different, and thus conclude that yes indeed it very much matters who gets the new money first.

    You have no good excuse to keep making this same mistake over and over. Is it cognitive dissonance? Is it purposeful ignorance? Whatever the reason is, any uncertainty from your readers shoild definitely not be given any academic/intellectual charity whatsoever. Not at this stage.

  28. Gravatar of dannyb2b dannyb2b
    15. June 2014 at 00:05

    “All these thought experiments are on a ceteris paribus basis. The only case where it would all go into ERs is if IOR is permanently increased, which is a separate policy move.”

    So now that the ecb has negative rates in deposits does that mean that excess reserves will disapear over time?

  29. Gravatar of Daniel Daniel
    15. June 2014 at 01:06

    Major_Moron

    Yes, it does matter who gets the money first.

    So when’s the last time you (or anybody else) sprinted to an ATM ?

    Total moron, that’s you.

  30. Gravatar of Daniel Daniel
    15. June 2014 at 01:36

    Completely off-topic, but relevant for those who actually buy into self-serving Western propaganda.

    http://www.unz.com/gnxp/living-in-a-world-that-is-but-isnt-ought/

    You’d think this blog’s audience would a bit too sophisticated for that … but no.

  31. Gravatar of TravisV TravisV
    15. June 2014 at 06:44

    Prof. Sumner,

    Have you read L. Randall Wray’s criticisms of your macro model below?

    http://neweconomicperspectives.org/2013/11/circular-logic-behind-scott-sumners-claim-feds-policy-contractionary.html

    http://neweconomicperspectives.org/2013/11/scott-sumner-find-mmts-achilles-heel.html

  32. Gravatar of Philippe Philippe
    15. June 2014 at 07:44

    MF,

    “the situation where the initial reciever is let’s say a wage earner who does not lend at all”

    central banks don’t conduct OMOs with people who do not lend at all. They buy bonds.

  33. Gravatar of flow5 flow5
    15. June 2014 at 11:59

    Zero bound is an bad excuse for a false doctrine. The money stock can never be managed by any attempt to control the cost of credit.

    Unless the ratio of non-bank lending/investing to commercial bank lending/investing increases (i.e., the utilization, or velocity, of voluntary savings), monetary policy will have to offset the shortfall.

    This was spelled out in:

    “Should Commercial Banks Accept Savings Deposits?” by Leland J. Pritchard, Edward E. Edwards, and Lester V. Chandler at the 1961 Conference on Savings and Residential Financing in Chicago, Illinois

  34. Gravatar of flow5 flow5
    15. June 2014 at 12:19

    The upcoming shortfall in the money stock (beginning mid-July), portends another set back for the economy. And with a remuneration rate twice as high as all money market wholesale funding rates:

    (1) NIM for the non-banks (the risk takers), has been squeezed at both ends of the yield curve, &

    (2) the Fed’s “open market power” is emasculated (whereas between 1942 & 2008 the CBs bought short-term obligations increasing their liquidity reserves & the money stock, today they just hold just hold more idle, unused, excess reserve balances). It’s the short-end segment of the yield curve that drives the economic engine.

  35. Gravatar of Major-Freedom Major-Freedom
    15. June 2014 at 15:17

    Daniel:

    I’ve already explained to you, what is this, 4 times now?, that withdrawing money from your checking account is NOT a creation of new money, but is rather a conversion of existing funds into cash.

    The argument about it mattering who gets the new money first is not relevant to withdrawing existing deposit funds into cash. It concerns the creation of money that naturally did not exist before.

    How many times are you going to make the same uninformed omment?

    ———————-

    Philippe:

    “central banks don’t conduct OMOs with people who do not lend at all. They buy bonds.”

    They buy bonds from….who? Those who would tend to consume with that new money, or those who tend to lend?

    The fact that new money created is spent differently depending on who gets it first, is the reason why it is false to claim it doesn’t matter who gets the new money first.

    If the Fed buys bonds from those who tend to lend with new money in their possession, then that would result in more money in the lending market RELATIVE to consumption and all other spending. The relative difference is what is important by the way.

    If new money enters the loan markets, then that affects interest rates differently compared to new money being spent on consumption.

    Note that it is also important how money is spent in the second and third “rounds” or “stages” of spending, as it were.

  36. Gravatar of Philippe Philippe
    15. June 2014 at 16:01

    “withdrawing money from your checking account is NOT a creation of new money, but is rather a conversion of existing funds into cash”.

    When you withdraw money from your bank account you convert a bank debt into a state debt (bank deposit into cash). When you sell a T-bond you convert a Treasury debt into a Fed debt (one type of state debt into another).

    Swapping bonds for money is not a creation of new wealth, just as withdrawing cash from a bank account is not a creation of new wealth.

    You seem to think that people spending money today are getting a better deal at the expense of people spending tomorrow. So by your logic you should rush to the ATM and spend all your funds today, so you can benefit at other’s expense.

  37. Gravatar of Philippe Philippe
    15. June 2014 at 16:05

    “They buy bonds from….who?”

    people who own bonds have in effect already ‘lent money’ by buying the bond.

  38. Gravatar of Major-Freedom Major-Freedom
    15. June 2014 at 16:46

    Philippe:

    “When you withdraw money from your bank account you convert a bank debt into a state debt (bank deposit into cash). When you sell a T-bond you convert a Treasury debt into a Fed debt (one type of state debt into another).”

    Some of those debts are legal tender and change hands as medium of exchange, i.e. money.

    Tresury debt is not money.

    “Swapping bonds for money is not a creation of new wealth, just as withdrawing cash from a bank account is not a creation of new wealth.”

    I said creation of new MONEY, not wealth. When the Fed buys bonds, it is adding new money that did not exist before.

    And it is not even a mere “swap” anyway. Market actors value one more than the other. That is why they exchange. When market actors buy bonds, some value the bonds more than the money, others value the money more than the bonds. When the counterparty is the Fed, which is not constrained in dollars, and backed by violence, its decisions are political, not economic.

    “You seem to think that people spending money today are getting a better deal at the expense of people spending tomorrow. So by your logic you should rush to the ATM and spend all your funds today, so you can benefit at other’s expense.”

    I just explained to Daniel that withdrawing cash from an ATM is not the creation of new money. It is converting one money form for another money form. You are making the same mistake as Daniel.

    “They buy bonds from….who?”

    “People who own bonds have in effect already ‘lent money’ by buying the bond.”

    But that is an offsetting act. One investor buying a bond from another investor is a reducing of a loan and increasing of a loan.

    When the Fed buys bonds, it did not already do anything with the money, since that purchase is a creation of NEW money. Every tim it buys a bond, it increases the money supply, and as explained above, depending on who is the initial reciever, the effects will not be the same. That is, it matters who recieves the new money first.

  39. Gravatar of Philippe Philippe
    15. June 2014 at 17:10

    “I said creation of new MONEY, not wealth. When the Fed buys bonds, it is adding new money that did not exist before.”

    You say that when someone sells a bond to the Fed they then spend the money. But their wealth hasn’t actually changed, just as your wealth doesn’t change when you withdraw cash from a bank. If they have chosen to spend or reallocate the financial wealth they previously held in the form of a bond, that really is no different to you choosing to spend or reallocate the financial wealth you previously held in the form of a bank deposit.

    You believe that people ‘receiving new money’ today and spending it today get a better deal than people spending money tomorrow. But the money you own today (in your bank account) is worth the same as the ‘new money’ created/received today, so by your logic you should spend your money today to get the better deal at other people’s expense.

  40. Gravatar of dannyb2b dannyb2b
    15. June 2014 at 19:14

    Phillipe

    New money created as a transfer is an increase in wealth whereas an increase through an asset purchase isn’t. Thats why direct issuance is superior in terms of policy effectiveness.

  41. Gravatar of Philippe Philippe
    15. June 2014 at 19:27

    “New money created as a transfer”

    fiscal policy.

  42. Gravatar of dannyb2b dannyb2b
    15. June 2014 at 19:47

    If a transfer from a central bank is fiscal policy then an asset purchase must also be fiscal policy.

  43. Gravatar of Philippe Philippe
    15. June 2014 at 20:01

    if the CB prints and hands out money for free (‘new money created as a transfer’), that’s basically ‘money-financed’ government spending. The result is a net addition to private sector financial wealth.

    If the CB prints money and buys financial assets like government bonds, then it’s exchanging one type of asset for another, and there is no net addition to financial wealth (keeping things simple). However, there is an increase in the amount of base money in the economy (this is monetary policy).

    I had a look at your site and wasn’t sure what this meant:

    “The rate of growth of direct money issuance to public will be periodically adjusted in order to ensure that on average in the long run no net issuance or contraction of MB occurs through open market operations when interest rate targeting.” Could you explain please?

  44. Gravatar of dannyb2b dannyb2b
    15. June 2014 at 20:26

    “if the CB prints and hands out money for free (‘new money created as a transfer’), that’s basically ‘money-financed’ government spending. ”

    An asset purchase is also gov spending though. So according to MMT monetary policy doesn’t exist, everything is fiscal policy.

    I dont see why an increase in net financial wealth can only be fiscal policy and not also monetary policy. I know MMT has a definition but it appears to be incorrect.

    “The rate of growth of direct money issuance to public will be periodically adjusted in order to ensure that on average in the long run no net issuance or contraction of MB occurs through open market operations when interest rate targeting.” Could you explain please?

    What I mean is that through OMO’s over time the monetary base is increasing under our system historically. All of that increase I would perform through direct issuance so that OMO’s arent the source of the increase in long run. I hope that makes sense. If normally base increases at 5% year through OMO’s I would set the rate of increase through direct money issuance at 5%. Any discrepancies leading to OMO expansions greater than 5% over a period mean you speed up direct issuance and vice versa.

  45. Gravatar of TallDave TallDave
    15. June 2014 at 20:28

    Interesting piece on China. When they are still doing things like ordering all the Christian churches to remove their crosses (and then bulldozing them for refusing), I am very skeptical they can pass Mexican PPP GDP per capita any time soon. China doesn’t have to become Christian to prosper, but it does have to be tolerant.

    If they can do this to churches, how much creative destruction do you suppose established interests will tolerate when it is in their power to crush innovators?

  46. Gravatar of Philippe Philippe
    15. June 2014 at 21:26

    “An asset purchase is also gov spending though.”

    When the CB purchases government bonds, that is not government spending.

    When the CB buys financial assets it is lending and borrowing, like any bank. It is not spending. If the CB were to create and give away money without buying assets it would just be borrowing, i.e. running a budget deficit, i.e. deficit spending.

    “through OMO’s over time the monetary base is increasing under our system historically. All of that increase I would perform through direct issuance so that OMO’s arent the source of the increase in long run…If normally base increases at 5% year through OMO’s I would set the rate of increase through direct money issuance at 5%.”

    ‘direct issuance’ or spending doesn’t have the same effect as OMOs though.

  47. Gravatar of Philippe Philippe
    15. June 2014 at 21:34

    “like any bank”

    well not quite like any bank.

  48. Gravatar of dannyb2b dannyb2b
    15. June 2014 at 22:08

    How is the CB running a deficit if it prints money and can do so without limit? The CB can recognize money as equity on balance sheet too btw.

    “When the CB buys financial assets it is lending and borrowing, like any bank. It is not spending.”

    It is lending and borrowing money. Money is being transferred either to the fed or the other way. The key here is the transfer of money. OMO’s are a money transfer through a purchase of security. When you borrow or sell asset you get money transferred into your account. You could also transfer money without the purchase of asset (spending of money).

  49. Gravatar of ssumner ssumner
    16. June 2014 at 00:28

    Danny, When people receive checks the supply of cash does not increase.

    Dtoh, When I talk about the effects of an increase in the base I am not talking about current Fed policy.

    Talldave, First of all it’s a big mistake to confuse Wenzhou with China. It would be like using a story about Luxembourg to discuss “Europe”. Second, this dispute has little to do with creative destruction. Wenzhou is famous for allowing creative destruction in the business sector. Third, China will easily surpass Mexico, they aren’t even in the same league. China is becoming a developed country. Mexico isn’t.

  50. Gravatar of dannyb2b dannyb2b
    16. June 2014 at 01:07

    “When people receive checks the supply of cash does not increase.”

    Wont people wish to convert a portion of those cheques they deposit into cash in order to facilitate greater consumption (getting rid of money)? If so the supply of cash goes up. I am assuming the people receive the cheques just as transfer payments from the fed to show that there is a difference between interacting with banks through asset purchases and directly with people through transfers at zlb in environment where risk adjusted investment returns are low. In such an environment banks just hold excess reserves and consumption or investment don’t increase.

  51. Gravatar of Daniel Daniel
    16. June 2014 at 02:06

    Monetary offset in practice

    http://www.reuters.com/article/2014/06/14/poland-government-tape-idINL5N0OV15J20140614?irpc=932

    Looking forward to retarded MMT-ers coming up with creative explanations.

  52. Gravatar of dtoh dtoh
    16. June 2014 at 08:06

    Scott, you said,
    “When I talk about the effects of an increase in the base I am not talking about current Fed policy.”

    Well, if you talked about Base minus ER then what you say would also be perfectly applicable to current Fed policy. And, it would totally deflate the arguments or Wray and other idiots of his ilk.

  53. Gravatar of Philippe Philippe
    16. June 2014 at 11:53

    Daniel,

    do you disagree with my explanation of your ‘run to the ATM’ quip?

  54. Gravatar of Daniel Daniel
    16. June 2014 at 12:49

    Philippe,

    Nope, I completely agree.

    However, Major_Moron is much too dense to grasp the implications of his theory. But that comes as nothing new.

  55. Gravatar of TallDave TallDave
    16. June 2014 at 12:52

    Scott — While crushing religious freedom isn’t directly related to crushing economic innovation, you rarely find much of one freedom absent the other. Also, the situation is probably considerably worse outside Wenzhou, which is relatively liberal.

    Maybe China’s entrenched elites are willing to watch their own billions evaporate in the name of free enterprise, but I’d bet they won’t.

  56. Gravatar of TravisV TravisV
    16. June 2014 at 13:05

    Why?

    “FT: The Fed Is Considering Charging Investors If They Want To Exit Bond Funds”

    http://www.businessinsider.com/ft-the-fed-is-considering-charging-investors-to-wind-down-bond-holdings-2014-6

  57. Gravatar of Dustin Dustin
    16. June 2014 at 14:35

    Dtoh,

    Appears that your ‘if but then’ argument relies on increases in monetary base of the low-powered variety.

    Scott usually only refers to adjustments in high-powered money when discussing effects of adjusting the monetary base.

  58. Gravatar of ssumner ssumner
    16. June 2014 at 14:50

    Danny, No, the Fed doesn’t just give people money, that would be fiscal policy.

    Dtoh, they would just say the Fed can’t control the currency stock. It’s hopeless.

    Travis, At first I thought that was from The Onion. Insane.

    Talldave, They aren’t crushing religious freedom. There are tens of millions of Christians in China, and soon there will be 100s of millions. It will become the dominant Christian country in the world. It’s not Saudi Arabia.
    I’m not defending the cross incident, but that’s not representative of the overall situation.

  59. Gravatar of dannyb2b dannyb2b
    16. June 2014 at 15:04

    “Danny, No, the Fed doesn’t just give people money, that would be fiscal policy.”

    Why is a “transfer” by the fed fiscal policy? Isnt an “asset purchase” also a transfer of money to some entity and a transfer of an asset in opposite direction?

    Cant we define expansions or contractions of money by the fed as monetary policy irrespective of whether the money goes to recipient in exchange for asset or not?

  60. Gravatar of dtoh dtoh
    16. June 2014 at 15:24

    Scott, you said,
    “they would just say the Fed can’t control the currency stock. It’s hopeless.”

    It’s not hopeless. You haven’t tried.

    We know OMP sterilized by ER increases has no impact on the economy so say so. Stop talking about the base. And start talking about the base minus ER.

  61. Gravatar of TravisV TravisV
    16. June 2014 at 15:34

    http://www.businessinsider.com/chris-rupkey-on-the-economy-2014-6

    “The Giddiest Thing We’ve Read About The US Economy In A LONG Time”

    “Slack, what slack? This isn’t a recovery anymore, it is a full-on economic expansion. The old peak before the recession in this timely monthly measure of factory output was 100.8 in November 2007, now today it is up 0.6% in May to 103.7.”

    ……..

    “You think the economy is running at a sluggish 2% pace? Think again. Consumer goods up 3.1% the last year, business equipment production up 5.3%, construction up 4.4%, materials up 5.1%.”

  62. Gravatar of dtoh dtoh
    16. June 2014 at 15:35

    Scott,
    And… of course the Fed can control the currency stock. They can obviously control ER; either by fiat “we won’t accept any more deposits,” or by adjusting IOR. Nobody believes the Fed can’t control the level of ER. Given the Fed can control ER, ergo the only way they couldn’t control the currency stock is if they tried to do OMP and got no offers. That’s not going to happen. There is no upper bound on Treasury (or other asset) prices.

    Nobody will argue the Fed can’t control the currency stock. It’s too easy to refute.

  63. Gravatar of Tom Brown Tom Brown
    16. June 2014 at 15:54

    dtoh,

    It’s interesting that you’re recommending focusing on “the base minus ER” since that is not too different than “the cash component of the base” which is what Jason Smith has found is a good value for “M” in his information transfer model of the price level:

    log P ~ (1/κ – 1) log M0

    Where he’s using “M0” for the cash component of MB (M0 works better than MB for this purpose empirically he says). κ is the “information transfer index” which is

    κ = log M0 / log NGDP

    Where again, M0 is the better fit. So when κ = 1/2, his expression reduces to the QTM. He takes 1/2 as a lower bound on κ of sorts, and he takes 1 as an approximate upper bound. Here’s more if you’re curious:

    http://informationtransfereconomics.blogspot.com/2014/06/reconciling-expectation-and-information.html

    He draws a potentially “more realistic” probability distribution for κ in the comments, which I’ll relink to here:

    https://twitter.com/infotranecon/status/478630195134341122

    His uniform distribution approximation for κ on [1/2,1] means he’s being nearly “maximally ignorant” in his assumptions about “human behavior,” including rational agents, expectations, etc. I’m interested to see how far this approach gets him.

  64. Gravatar of DOB DOB
    16. June 2014 at 16:00

    Scott,

    ” If you have an interest rate-oriented view of monetary policy then this must be a bit of a head scratcher. Higher IOR is “raising interest rates” and a lower fed funds rate is “lowering interest rates.” So which is it? ”

    It’s only a head scratcher for those who haven’t read Woodford’s monetary theory bible or thought about it for more than 2 seconds.

    It couldn’t be simpler, the interest that matters for price-level/NGDP purposes is the fed funds rate as that is the overnight nominal return on risk-free nominal assets.

    The spread between FF and IOR is simply the financial opportunity cost of holding money vs risk-free nominal assets. It controls the qty of money but has no effect on the price-level.

  65. Gravatar of Major-Freedom Major-Freedom
    16. June 2014 at 16:01

    Philippe:

    “You say that when someone sells a bond to the Fed they then spend the money. But their wealth hasn’t actually changed, just as your wealth doesn’t change when you withdraw cash from a bank.”

    First, yes wealth has indeed changed. Wealth is subjectively determined, meaning if A values a sum of money more than a bond, such that they trade their bond for money, then yes, their wealth has in fact increased. $1000 used to buy a bond, and a $1000 par value bond, that are exchanged, are NOT equivalent sums of wealth. They are different. When A and B exchange a good or security for money, wealth has in fact increased, since both A and B each own more value that replaced the older, lower values, according to their judgmens.

    Second, again, again again again, the argument concerning wealth transfer that occurs with inflation is predicated on MONEY. Your interpretation and beliefs concerning whether or not one in the same individual’s “wealth” has changed is totally and completely irrelevant to the process being described.

    “If they have chosen to spend or reallocate the financial wealth they previously held in the form of a bond, that really is no different to you choosing to spend or reallocate the financial wealth you previously held in the form of a bank deposit.”

    It is different because in the case of the bank selling a bond to the Fed, the money supply has increased by way of the bank recieving more money, whereas market actors merely transfer existing sums of money.

    “You believe that people ‘receiving new money’ today and spending it today get a better deal than people spending money tomorrow.”

    No, it is not merely spending today versus spending tomorrow.

    It is recieving new money before others, versus recieving that new money after others.

    The key is the real wealth transfer that takes place because of the fact that inflation raises some people’s money incomes first before others.

    “But the money you own today (in your bank account) is worth the same as the ‘new money’ created/received today, so by your logic you should spend your money today to get the better deal at other people’s expense.”

    No, because the money I own in my bank account is money that was already spent by others who benefited from real wealth before my nominal income increased that would have enabled me to offer a higher nominal demand to compete for those goods.

    If I own money in my bank account, then the loss described above has already taken place. The people who spent that additional, newly created money did so before my income rose by virtue of their spending.

  66. Gravatar of Major-Freedom Major-Freedom
    16. June 2014 at 16:03

    Philippe:

    And why are you asking Daniel what he believes about your ATM quip? He is as misled and wrong as you. Him agreeing with you should give you pause if nothing else.

  67. Gravatar of Tom Brown Tom Brown
    16. June 2014 at 16:05

    DOB, I haven’t seen you for a while. Nice to hear from you.

  68. Gravatar of Major-Freedom Major-Freedom
    16. June 2014 at 16:08

    Sumner:

    “Danny, No, the Fed doesn’t just give people money, that would be fiscal policy.”

    Not so. Even those instances of money transfers are not just given. They are bribes and/or payments in exchange for votes and deference.

    True fiscal policy is financial activity backed by state coercion. Montetary policy is therefore fiscal policy. The government mandates that primary dealers be the initial recipients of inflation. The government plays favorites with its counterfeiting operation.

  69. Gravatar of Major-Freedom Major-Freedom
    16. June 2014 at 16:18

    Sumner:

    “Danny, When people receive checks the supply of cash does not increase.”

    When people recieve “checks” from the Fed, the money supply has increased, and the initial recievers recieve more money than they otherwise would have recieved for the goods/securities they sell as compared to if others recieved the new money first.

    Interest rates are low because bond buyers expect the Fed to provide sufficient nominal demand for bonds which keeps the prices artificially elevated. This is true regardless of what is happening to price levels or aggregate spending.

    Those who sell bonds to the Fed consider themselves better off, not worse off, or else they would not sell bonds to the Fed. Thus inflation does not “harm” the primary dealers as has been repeatedly, and quite fallaciously, stated on this blog.

  70. Gravatar of Philippe Philippe
    16. June 2014 at 16:24

    MF

    “First, yes wealth has indeed changed. Wealth is subjectively determined”

    So your wealth increases when you withdraw cash from an ATM?

  71. Gravatar of TravisV TravisV
    16. June 2014 at 16:25

    Interesting, this New Yorker analysis seems to be getting a lot of attention.

    Krugman: “Creative Destruction Yada Yada”

    http://krugman.blogs.nytimes.com/2014/06/16/creative-destruction-yada-yada

  72. Gravatar of Philippe Philippe
    16. June 2014 at 16:40

    MF,

    “No, because the money I own in my bank account is money that was already spent by others”

    You believe that someone selling a bond to the Fed today gets a better deal when they spend money today than someone spending money tomorrow. So it follows that you should spend your money today to get that better deal. Otherwise you will be that guy who gets a worse deal tomorrow. Your dollars are worth the same today as the dollars printed by the Fed today, but according to you your dollars will be worth less tomorrow. So you should spend your dollars today. Run to the ATM and spend all your money, MF. Do it now to get the better deal.

  73. Gravatar of dtoh dtoh
    16. June 2014 at 16:59

    Tom Brown,
    If I were less busy, I’d be interested.

    Because of ER (and current Fed policy), M0 has no correlation with growth or prices or NGDP, or anything else. So it’s a terrible measure. Base minus ER (or cash) is good. Not perfect in the short term…but good. Beyond that, I’m sure you can tweak the numbers to make it better. From a policy perspective however, the thing that you need to know and the main tool you have is OMO. So basically you can make MO-ER go up… or make it go down. Once you’ve decided on your target (NGDPLT, prices or whatever) you just push or pull the level till you get to the target. (Or you can just tell the market what you are going to do, and if they believe you, they will do it for you.)

    Or you can do what Bernanke did. Decouple the lever from the engine by letting ER balloon. In which case, it becomes a kiddy train. Wave you hands, blow your whistle, shout “all aboard,” push and pull the lever, and of course nothing happens.

  74. Gravatar of Major-Freedom Major-Freedom
    16. June 2014 at 18:08

    Philippe:

    “You believe that someone selling a bond to the Fed today gets a better deal when they spend money today than someone spending money tomorrow.”

    No Philippe, once again that is not what I am saying, nor is it what I believe.

    Once again, it is not merely WHEN a person spends an arbitrary sum of money relative to other people.

    “So it follows that…”

    Everything that follows from this is also false.

    Once again, the argument is not merely when an arbitrary sum of money is spent. It is the order of whose incomes are increased prior to others by way of inflation.

    Once again, withdrawing money from an ATM does not change or affect the order of who gets new money first.

  75. Gravatar of Tom Brown Tom Brown
    16. June 2014 at 18:10

    dtoh, re: M0: there is no official designation called “M0” in the US (Wikipedia thinks so, but it’s not true: I went through a back and forth with Sadowski about that, including looking at the relevant Fed documents). However, what Jason means by that is cash in circulation (i.e. cash in bank vaults and in the possession of private non-banks). It’s the cash (currency and coin) component of MB. A word of caution though (if you ever do check his blog out) in some of his older posts he writes “MB” for that, and in even older posts he actually means “MB.”

    The interesting thing is that his model says dP/dM0 is dependent on the ratio of the log of M0 to the log of NGDP. It’s important to include “log” since the unadorned ratio M0/NBGDP can go up and down while log(M0)/log(NGDP) can be strictly monotonically increasing (he has an example plot in the post above). When that ratio (kappa) gets to 1, P becomes insensitive to changes in M0 (again, according to his model). When kappa = 1/2, it’s still sensitive.

    All the logarithms fall out of the information theoretic approach (which isn’t that hard to understand). Basically he’s hypothesizing that purchases transfer information to supply from demand, and he tries to quantify the amount.

    And I’ve simplified yet again above, because instead of M0 and NGDP, he actually uses normalized versions with normalizing constants that change very slowly.

  76. Gravatar of Philippe Philippe
    16. June 2014 at 18:20

    MF,

    the main problem is that you do not understand the sentences that you write. You read these things somewhere, think that they sound meaningful, and then you repeat them ad nauseam without ever trying to think about what they actually mean, like all internet austrians.

  77. Gravatar of Major-Freedom Major-Freedom
    16. June 2014 at 18:45

    Philippe:

    I do understand the sentences I write, and you have not given any reqson for me to think otherwise. You can’t expect me to just take what you are saying on faith. Show me why you think I do not understand, without of course making false claims that I can identify.

  78. Gravatar of dtoh dtoh
    16. June 2014 at 19:15

    Tom Brown,
    Yep. You’re correct. When I wrote M0, I actually meant MB. I was referring to the base not to currency.

  79. Gravatar of Fed Up Fed Up
    16. June 2014 at 20:23

    “In both cases banks don’t want to hold significant excess reserves, so the impact of higher IOR on the demand for the medium of account (base money) is trivial.”

    Same complaint as always. MOA is currency plus demand deposits because they have a fixed conversion rate thru the commercial banks. It just happens to be 1 to 1 fixed.

    That brings up a general point. Set MOA as currency. Is anything that has a fixed conversion rate to currency also MOA? Assume the fixed conversion rate is credible. I’m going to say yes.

    “Monetary policy is not about interest rates; it’s about the supply and demand for base money.”

    I’m going to say it is more about interest rates than the supply and demand for base money, but neither is actually correct.

    And, “The fed funds change is different. Whereas a change in IOR affected the demand for base money, a change in the few funds rate is an effect of a change in the supply of base money.”

    We are nowhere near close to agreeing on that one. That is possible but does not have to be. If the reserve requirement is positive and someone pays back a bank loan, that could lower the fed funds rate. If someone deposits currency in a bank, that could lower the fed funds rate. If the fed lowers the reserve requirement, that could lower the fed funds rate. If the fed buys a bond (usually) and then later sells the bond, that could lower the fed funds rate.

    Lastly, I don’t see any mention of the transfer to the banks from the fed with the 2% IOR.

  80. Gravatar of TallDave TallDave
    17. June 2014 at 06:37

    Scott — Well, China’s ruling class tends to tolerate religion only up to the point they start doing things like organizing protests. But I hope you’re right. I think a more tolerant and more Christian China is in everyone’s best interests, but I’m not sure it’s inevitable.

  81. Gravatar of Fed Up Fed Up
    17. June 2014 at 08:51

    I use monetary base = currency plus central bank reserves.

    Can we agree that currency can always reflux back to the fed the way the system is set up now?

    http://www.federalreserve.gov/aboutthefed/officialtitle.htm

    “… to furnish an elastic currency …”

    Can we agree that central bank reserves may or may not reflux back to the fed depending on what the fed is doing?

  82. Gravatar of Major-Freedom Major-Freedom
    17. June 2014 at 13:10

    Philippe and Daniel:

    I think I figured out why you keep responding with that ATM argument. I totally forgot that this blog is a church of the religion of NGDP, and that what I tell you I am saying is falling on deaf ears because your a priori convictions has made it impossible up until now to think other than reasoning from a spending change, in the abstract.

    So of course you would interpret arguments concerning inflation and wealth transfer and Cantillon effect and so forth in terms of spending in the abstract, and so of course it would make sense to you that my argument implies a trivial solution of “spending” a sum of money in the abstract first before others “spend” a sum of money in the abstract.

    It all must be grounded on “spending”.

    Hence the “Go to an ATM then!” style responses, despite the fact that the argument you are addressing is not grounded on “spending”.

    Now, while the response to your response would be best explained by methods other than reasoning from spending changes, it can still be explained even using your own framework of “spending”.

    To wit, you believe that I can avoid the problem I discussed above by taking money out of an ATM from my checking account so that I can spend sooner rather than later. But have you considered the circumstances of how I came to own that money? I must have acquired it (assuming we’re constrained to a market context, i.e. no theft) from someone else in an exchange.

    Do you see how your solution can’t change what has already taken place in the past? That if I do spend earlier than later, then it’s already too late because someone else experienced an increased income and spent the money before me, such that I was even in a position to acquire that money?

    Please note that what I am saying does not imply that the process works by way of specific dollars in the bailment sense being exchanged from person to person. Rather, it is the increases in dollar equivalent sums that matter. Which specific dollars are spent in a now larger sum is no the issue. It is the increase as such.

    So to reiterate, if I were to rush to an ATM, you are telling me a solution that presupposes the very problem I outloned above. That not everyone is able to spend more a the same time when the Fed inflates. Many people have to wait in line as the increased money expenditures make their way from person to person to person and finally to the individual in question who, during that whole process, had to compete with those initial recievers for goods, given that the latest recievers have not experienced an increased income yet, while the prices they pay for goods are higher because of those initial recievers increasing their nominal demand for goods by virtue of having an increasing money balance that exceeds the increase in the latest reciever’s money balance.

    Again, it is not merely when money is spent that matters. It is the historical process of how people come into ownership of the money they spend.

    Sumner falsely believes that the only beneficiaries of this process are the government, via “seigniorage”, which he of course always tries to present as insignificant (cognitive dissonance FTW). But there is also wealth transfer WITHIN the market population caused by inflation. Just like the government rents seigniorage because they are first to spend, so too do the second recievers, who might be market actors, benefit at the expense of the third and fourth, etc recievers.

  83. Gravatar of Daniel Daniel
    17. June 2014 at 13:59

    Just like the government rents seigniorage because they are first to spend, so too do the second recievers, who might be market actors, benefit at the expense of the third and fourth, etc recievers.

    So why are you wasting your time on the internet ?

    You should be spending your money NOW.

  84. Gravatar of ssumner ssumner
    17. June 2014 at 23:33

    Dtoh, The MMTers will deny the Fed can control the currency stock, and Keynesians like Krugman will say any extra currency will just go into safes.

    Travis, I did a post on IP a few months ago. It’s an important story.

    DOB, Yes, that’s the Keynesian view, and obviously I don’t agree.

    Fed up, There is no difference between the “reflux” of currency and reserves.

  85. Gravatar of dtoh dtoh
    18. June 2014 at 04:53

    Scott, you said;

    “The MMTers will deny the Fed can control the currency stock, and Keynesians like Krugman will say any extra currency will just go into safes.”

    I think I just explained why it’s trivial to refute the MMTers.

    As for Krugman & Co., you’ll need to jettison HPE argument and use the financial asset price transmission mechanism to deal with that one…. but why not just get the MMTers out of the way first.

  86. Gravatar of Philippe Philippe
    18. June 2014 at 05:13

    “The MMTers will deny the Fed can control the currency stock”

    I’m not sure that’s exactly correct. I’ve seen this claim before, however:

    “The point of relevance to Modern Monetary Theory (MMT) is that the central bank cannot control the money supply because as part of its commitment to financial stability it must be prepared to provide reserves to the private banking system.”

    http://bilbo.economicoutlook.net/blog/?p=15104

  87. Gravatar of Fed Up Fed Up
    18. June 2014 at 10:20

    “Fed up, There is no difference between the “reflux” of currency and reserves.”

    Yes, there is. See below.

    “The MMTers will deny the Fed can control the currency stock, and Keynesians like Krugman will say any extra currency will just go into safes.”

    I agree that the fed can’t control the currency stock the way the system is set up now (elastic currency). I also agree that currency can be used as a savings vehicle (stored in safes / put under the mattress). Demand deposits can also be used as a savings vehicle (stored at the commercial banks).

    The fed can’t control the currency stock because the currency can always reflux/asset swap back to the fed. Is there any excess vault cash? Not that I know of. The fed allows the currency to reflux/asset swap back to it for central bank reserves. Are there any excess central bank reserves? Yes, because of what the fed is doing (QE). That means when the commercial banks want to asset swap the central bank reserves for treasuries, the fed does not allow the reflux to happen.

  88. Gravatar of dtoh dtoh
    18. June 2014 at 20:32

    Fed Up,

    Of course the Fed can control the currency stock. They simply refuse to accept deposits or they set a prohibitively low (i.e. negative) rate on ER. This is trivial.

  89. Gravatar of Fed Up Fed Up
    18. June 2014 at 21:26

    “They simply refuse to accept deposits”

    What about the Federal Reserve Act and an elastic currency?

    “they set a prohibitively low (i.e. negative) rate on ER.”

    The fed could do that. The banks could pass that on to depositors. There will probably be a bank run. Entities could use currency as a savings vehicle just about as easily as demand deposits.

    I doubt the fed wants to do that.

    Currency goes up. Demand deposits go down. Not much may change.

  90. Gravatar of Philippe Philippe
    18. June 2014 at 22:10

    “Of course the Fed can control the currency stock”

    In theory.

  91. Gravatar of Merijn Knibbe Merijn Knibbe
    19. June 2014 at 04:06

    Not entirely off topic:

    I was reading the General Theory and you strike me as a Chapter 4 kind of guy. Very much so, even (except for rational expectations). Do you agree?http://rwer.wordpress.com/2014/06/18/keynes-a-closet-market-monetarist/

  92. Gravatar of dtoh dtoh
    19. June 2014 at 07:08

    Fed Up, you said;
    “The fed could do that.”

    I’ll take that as a “yes.”

    Phillipe, you said;
    “In theory.”

    I’ll take that as a “yes” also.

    Scott, see how amazingly easy it is to convince people with the right argument. You should follow my advice on this.

  93. Gravatar of Fed Up Fed Up
    19. June 2014 at 09:11

    dtoh, currency = 1 trillion and demand deposits = 6 trillion. Only 2 trillion in demand deposits is being saved. Convert all to currency. 2 trillion in currency is still being saved. 5 trillion of MOA is still circulating.

    MOA stays the same. The composition has changed.

    You’ll need some way to put a negative interest rate on vault cash.

    There will probably be other consequences.

  94. Gravatar of Scott Sumner Scott Sumner
    19. June 2014 at 13:24

    Dtoh, The MMTers are not “in the way”, so they can be safely ignored. The Keynesians are in the way, but they don’t think the Fed can impact asset prices at the zero bound (very much), so that argument won’t work against the liquidity trap.

    Fed up, The base was 100 percent currency until 1914, so they certainly can control the currency stock if they wish to.

  95. Gravatar of Fed Up Fed Up
    19. June 2014 at 13:43

    “The base was 100 percent currency until 1914, so they certainly can control the currency stock if they wish to.”

    The fed did not exist until then.

    I think the reserve requirement was not 100% then.

    The fed would have to disallow reflux (violate elastic currency) or discourage it with something like a negative enough rate on demand deposits that entities don’t want demand deposits.

  96. Gravatar of Scott Sumner Scott Sumner
    19. June 2014 at 13:58

    Merijn, Great find. I’ll do a post when I return.

    Fed up, Elastic currency is like endogenous money, a vague concept that obscures more than it illuminates. And reserve requirements are no where near 100% even today.

  97. Gravatar of dtoh dtoh
    19. June 2014 at 16:36

    Scott,

    In your earlier comment, you said, “The MMTers will deny the Fed can control the currency stock, and Keynesians like Krugman will say any extra currency will just go into safes.”

    Your latest comment says, “The MMTers are not “in the way”, so they can be safely ignored. The Keynesians are in the way, but they don’t think the Fed can impact asset prices at the zero bound (very much), so that argument won’t work against the liquidity trap.”

    Good. That’s progress. You agree that by cleaning up your argument and carefully talking about the base minus ER rather than the just the base, you can easily refute MMTers (and a whole crowd of other assorted skeptics.)

    So now we can move on to the Keynesians. As I said earlier, you need to focus on a different part of your argument to deal with them. Your last comment is key. You mention “asset prices,” but the Keynesians don’t say anything about “asset prices”. In fact, they don’t like to talk about asset prices; they like to talk about interest rates. Why? …. because their whole argument is based on a zero lower bound. If you construct the argument on the basis of asset prices, what do they talk about? A zero upper bound? Well that obviously doesn’t make sense so you immediately have them on their back foot.

    We can go on to the transmission mechanism later, but for now remember….

    1. Talk about the Base minus ER (not the Base).
    2. Talk about the Fed buying assets (not setting interest rates or issuing currency).

  98. Gravatar of Philippe Philippe
    20. June 2014 at 07:14

    Dtoh,

    theory and practice aren’t the same thing.

  99. Gravatar of Major-Freedom Major-Freedom
    20. June 2014 at 07:51

    Daniel:

    “So why are you wasting your time on the internet ?

    You should be spending your money NOW.”

    It is already too late. The losses have already been incurred by virtue of others experiencing an increased income caused by inflation, which is money already spent.

  100. Gravatar of dtoh dtoh
    20. June 2014 at 17:11

    Phillipe, you said;

    “theory and practice aren’t the same thing.”

    Stating the obvious and not rebutting the argument. I’ll take that as a resounding “Yes.”

  101. Gravatar of Fed Up Fed Up
    20. June 2014 at 17:53

    “Fed up, The base was 100 percent currency until 1914, so they certainly can control the currency stock if they wish to.”

    One other thing. In 1904, have demand for currency go to zero. Every entity turns in their currency for gold. Also, no fed then means no central bank reserves.

    “Fed up, Elastic currency is like endogenous money, a vague concept that obscures more than it illuminates. And reserve requirements are no where near 100% even today.”

    Reserve requirement(s) are not 100% today. I don’t believe they were 100% in the early 1900’s.

    Elastic currency from The Federal Reserve Act was explained to me like this. If there is more demand for currency, the fed supplies it. If there is less demand for currency, the fed takes it back. Reflux is always allowed. That is why there is no excess vault cash.

    You are not going to get endogenous money because you don’t believe demand deposits are MOA. I believe demand deposits are MOA, which leads me to …

  102. Gravatar of Fed Up Fed Up
    20. June 2014 at 18:00

    ssumner said: “Monetary policy is not about interest rates; it’s about the supply and demand for base money.”

    Dtoh said:
    “1. Talk about the Base minus ER (not the Base).
    2. Talk about the Fed buying assets (not setting interest rates or issuing currency).”

    Let’s take an unusual example. Start at IOR = 0% and fed funds rate = 8%.

    Desired demand for currency goes to zero. Desired demand for vault cash and central bank reserves goes to zero. Required demand for vault cash and central bank reserves becomes zero (0% reserve requirement). Entities turn in currency for demand deposits at the commercial banks. The commercial banks turn in the currency for central bank reserves.

    There are excess central bank reserves in the banking system. The fed wants to keep IOR at 0% and the fed funds rate at 8%. They sell all their bonds for the central bank reserves keeping the fed funds rate at 8%. There is zero currency and zero central bank reserves. The fed has no assets and no liabilities. The banking system is in balance at zero vault cash and zero central bank reserves.

    Next, people borrow at 3% over the fed funds rate. They want to borrow from the banking system at 9% but not at 11%. The fed needs more demand deposits for spending. They announce the fed funds rate target is 6%. The commercial banks don’t comply. The fed says watch this. The fed buys some gov’t bonds with central bank reserves. There are excess central bank reserves in the banking system. The fed funds rate starts to fall. It gets to 6%. The fed sells the same amount of gov’t bonds removing the central bank reserves. The fed funds rate is 6%, and the banking system is back in balance at zero vault cash and zero central bank reserves along with zero currency. The next time the fed makes an announcement the commercial banks will comply. Notice the fed funds rate was lowered without the monetary base changing.

    Entities start borrowing from the banking system. The banks issue new demand deposits (liability), and the borrowers issue new loans/bonds (liability). They then swap with the new demand deposits becoming assets of the borrowers and the loans/bonds becoming assets of the banking system. The borrowers then spend on goods/services using the new demand deposits. The new demand deposits can affect prices, real GDP, or both. The new demand deposits do not devalue against currency.

    Monetary policy does not have to be about the supply and demand for base money (monetary base).
    Monetary policy does not have to be about the central bank buying assets.
    Monetary policy could be about setting demand deposits and currency as fixed convertible both ways, setting the fed funds rate, setting the reserve requirement, and setting the capital requirement.

  103. Gravatar of dtoh dtoh
    20. June 2014 at 18:33

    FedUp,

    To put it simply, it’s about the non-banking sector exchanging financial assets for real goods and services with money serving as medium of exchange. It matters little whether you talk about demand deposits or currency. If the non-banking sector is induced to marginally increase its exchange of financial assets (Treasuries, bonds, credit lines, CD, auto loans, credit card balances, etc) for real goods and services, then AD will rise. And it matters little if it is the Fed bidding up Treasury prices or private banks lowering rates on credit cards. It only matters that the private sector is induced to increase its exchange of financial assets for real goods and services.

    And as AD rises (absent barter) there will be a corresponding increase in money balances as well to support the increase in AD. It is integral to the process of exchanging financial assets for real goods and services since it is needed as a medium of exchange.

    (And yes, monetary policy could be conducted solely by setting capital requirements, but since it would be ineffective if banks shed both capital and assets, the Fed would also need to control bank equity.)

  104. Gravatar of dtoh dtoh
    20. June 2014 at 18:36

    Fedup,
    And to add to the last bit, the Fed would need to control both maximum and minimum capital requirements…. or asset to capital ratios if you want to express it in a slightly different form.

  105. Gravatar of Philippe Philippe
    20. June 2014 at 18:46

    dtoh,

    you shouldn’t take that as a ‘yes’, as it wasn’t meant as a ‘yes’.

  106. Gravatar of dtoh dtoh
    20. June 2014 at 19:19

    Philippe,

    It was definitely a “yes.”

    My assertion was a simple one.

    Given a + b = c. If you hold b constant, any change to (a) will result in an equal change to (c).

    If you disagree with my assertion, it can only mean one of two things, either

    i) you believe the fed can not control the level of reserves, or

    ii) you believe there is some limitation on the ability of the Fed to buy or sell assets in the market.

    This is not rocket science.

  107. Gravatar of Philippe Philippe
    20. June 2014 at 20:02

    dtoh,

    I’m telling you that it’s not a yes.

    “i) you believe the fed can not control the level of reserves”

    Could the Fed permanently reduce the level of reserves to zero, tomorrow?

  108. Gravatar of dtoh dtoh
    20. June 2014 at 20:45

    Philippe,
    Of course they could. Reduce the required reserve ratio to zero, and put a negative 100% daily interest rate on ER. It wouldn’t, however, be a smart move, but they could eliminate all reserves by midnight tomorrow.

    You can ask as many tangential questions as you want, state as many obvious generalities as you want, and only partially answer the question, but a “yes” is still a “yes.”

  109. Gravatar of Philippe Philippe
    20. June 2014 at 22:20

    zero reserves. So no settlement balances or new cash at all. I don’t see how that would be possible, practically speaking.

  110. Gravatar of dtoh dtoh
    20. June 2014 at 23:06

    It would certainly be possible, but I can’t see any reason why you would want to do it. Again, my original comment had nothing to do with zeroing out reserves. It related to holding constant or controlling reserves in order to manage the amount of currency.

    I continue to assume your ongoing lack of any further response to that point, is now an unequivocal “Yes I totally agree!”

    [And parenthetically as practical matter, banks could easily set up a common clearing house to hold currency for settlement purposes.]

  111. Gravatar of W. Peden W. Peden
    21. June 2014 at 05:56

    “I don’t see how that would be possible, practically speaking.”

    That’s a very long way of saying “Yes, it would be possible”.

  112. Gravatar of Fed Up Fed Up
    22. June 2014 at 13:32

    “To put it simply, it’s about the non-banking sector exchanging financial assets for real goods and services with money serving as medium of exchange. It matters little whether you talk about demand deposits or currency.”

    It sounds like you think demand deposits and currency are both MOE?

    Are they both MOA (medium of account)?

    “If the non-banking sector is induced to marginally increase its exchange of financial assets (Treasuries, bonds, credit lines, CD, auto loans, credit card balances, etc) for real goods and services, then AD will rise. And it matters little if it is the Fed bidding up Treasury prices or private banks lowering rates on credit cards. It only matters that the private sector is induced to increase its exchange of financial assets for real goods and services.”

    I think there is going to be a difference between the decision to stop “saving” and sell an asset to spend and the decision to “dissave” and sell a liability to spend.

    “And as AD rises (absent barter) there will be a corresponding increase in money balances as well to support the increase in AD. It is integral to the process of exchanging financial assets for real goods and services since it is needed as a medium of exchange.”

    What if no entity borrows thru a bank or bank-like entity?

    “(And yes, monetary policy could be conducted solely by setting capital requirements, but since it would be ineffective if banks shed both capital and assets, the Fed would also need to control bank equity.)”

    I think it would take more than just setting capital requirements, but I agree the balance sheet of the central bank could be zero, making monetary base zero.

    Monetary policy does not have to be about the supply and demand for base money (monetary base).

    Monetary policy does not have to be about the central bank buying assets.

  113. Gravatar of dtoh dtoh
    22. June 2014 at 14:35

    It sounds like you think demand deposits and currency are both MOE?

    Yes

    Are they both MOA (medium of account)?

    No.

    I think there is going to be a difference between the decision to stop “saving” and sell an asset to spend and the decision to “dissave” and sell a liability to spend.

    No, but why do you think so?

    What if no entity borrows thru a bank or bank-like entity?

    Very different economy. I haven’t spent a lot of time thinking about this but in that case I suspect credit is generated through deferred payment for labor.

    I think it would take more than just setting capital requirements, but I agree the balance sheet of the central bank could be zero, making monetary base zero.

    You just need a mechanism for controlling the MOA.

    Monetary policy does not have to be about the supply and demand for base money (monetary base).

    Semantics maybe. We talk about the base because it is the MOA (or was until ER ballooned). We could just as easily make demand deposits or iTunes Cards the MOA and call that the base.

    Monetary policy does not have to be about the central bank buying assets.

    No, but if done properly, it sure as heck is an easy way to conduct monetary policy. I’ve said this before, but you could write an application and make my iPhone the central bank.

  114. Gravatar of Fed Up Fed Up
    22. June 2014 at 14:58

    doth, let’s concentrate on this:

    Why aren’t demand deposits MOA?

  115. Gravatar of Fed Up Fed Up
    22. June 2014 at 15:21

    Sorry, dtoh.

  116. Gravatar of dtoh dtoh
    22. June 2014 at 15:51

    Fed Up,
    I’d be curious to hear your thoughts on this. I have some ideas, but I’m not sure they are well informed.

  117. Gravatar of Michael Byrnes Michael Byrnes
    22. June 2014 at 17:41

    Fed Up wrote:

    “Why aren’t demand deposits MOA?”

    Demand deposits have value because the banks promise to redeem them for currency (the MOA) any time you ask. Beyond the bank’s promise, the government also promises (via FDIC) to step in should the bank fail to keep its promise.

    Imagine that we were on a gold standard. In that case, the bills in your wallet would be redeemable for gold. They would be valued at the price of gold, because you could exchange them for gold any time you wanted to do so. Gold is the MOA, the bills in your wallet are MOE but not MOA.

    But we’re not on a gold standard. The “money” in your bank account are MOE, but not MOA. MOA is the monetary base. The money in a bank account has value only because of the bank’s promise to redeem it for currency any time you choose to do so. Because of the banks’ promises, every dollar of demand deposits trades at the same price as a dollar of currency.

    If banks promised to hand out $1 bill for every dirty sock that was brought to them, then dirty socks would trade at $1 and could function as MOE… but that wouldn’t make them a MOA.

  118. Gravatar of Fed Up Fed Up
    22. June 2014 at 18:10

    dtoh, see here:

    Money and inflation, Pt. 2 (Why does fiat money have value?)

    https://www.themoneyillusion.com/?p=20207

    “The previous post described the long phase-out of the gold standard. During the commodity money era we developed a dual medium of account (MOA), both gold and cash were MOAs. For there to be two media of account, the price of one in terms of the other must be fixed. Once gold prices started rising in 1968, only currency remained a medium of account; gold became a mere commodity. (Silver was demonetized in the 1800s.)”

    Demand deposits and currency have a fixed conversion rate. It just happens to be 1 to 1 thru the commercial banks.

  119. Gravatar of Fed Up Fed Up
    22. June 2014 at 18:15

    Michael Byrnes & dtoh, set a MOA.

    Now have a fixed conversion rate that is credible with another item.

    Does the other item become a MOA also? I say yes just like ssumner said with the gold standard where both gold and currency were MOA’s.

  120. Gravatar of dtoh dtoh
    22. June 2014 at 18:51

    Fed Up, Michael B.,

    Hopefully Scott will chime in on this when he gets back because I think he has given it a lot of thought, but what I would say is.

    1. The MOA needs to be widely accepted as an MOE.
    2. It needs to be bi-directionally convertible with other MOEs.
    3. Its supply needs to be controlled in some manner that is generally acceptable to the market.
    4. It helps if there is some legal basis for it.

  121. Gravatar of Fed Up Fed Up
    22. June 2014 at 19:27

    “1. The MOA needs to be widely accepted as an MOE.”

    I don’t think that one is right.

    Assume currency is MOA but not MOE. That means its velocity is zero. Currency is 1 to 1 (fixed) convertible to demand deposits. Demand deposits are MOE. Double currency. Nothing happens until entities convert currency to demand deposits. Demand deposits double.

    Now double demand deposits. To keep the exchange rate at 1 to 1 fixed, currency needs to be able to double also. I’m calling that a dual MOA.

    Now double demand deposits. If the exchange rate is not fixed with currency, demand deposits may fall in value. That is not a dual MOA.

  122. Gravatar of dtoh dtoh
    22. June 2014 at 20:12

    Fed Up,
    Sorry I’m not following you.

  123. Gravatar of DOB DOB
    22. June 2014 at 22:49

    dtoh,

    “If there is a permanent expansion of the base, but…”

    …it does not result in a different nominal risk-free interest rate curve than if there had not been an expansion, then…

    “Then expansion of the base will have no effect on anything (prices, AD, etc) either short term or long term.”

    Refuting MMT is a bit tricker, they do not believe that the Fed control the currency stock only because they define the currency stock as “net financial assets held by the private sector”. Since the Fed only ever swaps one financial asset for another, their conclusion is a tautology.

    I wrote a critique of MMT there a while back.

  124. Gravatar of dtoh dtoh
    23. June 2014 at 02:10

    DOB

    A few things.

    1. Looked over “there.” Interesting stuff. I’ll read more when I have time. Maybe leave a few comments.

    2. You don’t need a change in the interest rate curve to have an effect on AD. There can be a marginal increase in the exchange by the non-banking sector of financial assets for real goods and services with no changes to nominal rates if there is a changed expectation of future GDP. I.e. even if there is no change in the price of financial assets, if there is an increase in the expected return from buying real goods and services (e.g. a new factory), then people will exchange more financial assets for more real goods and services.

    3. It’s helpful (to me anyway) when thinking about monetary policy to think in terms of the banking sector (Fed plus private banks) and the non-banking sector (firms, individuals and the government) rather than in terms of private vs. non-private sector. It’s even easier to think of the whole banking system (Fed plus private banks) as an application running on my iPhone. If someone taps the “+” button, the app will instantly raise the price of financial assets while prices of real goods and services remain sticky.

  125. Gravatar of Michael Byrnes Michael Byrnes
    23. June 2014 at 02:23

    Fed Up wrote:

    “Does the other item become a MOA also? I say yes just like ssumner said with the gold standard where both gold and currency were MOA’s.”

    Could be.

  126. Gravatar of ssumner ssumner
    23. June 2014 at 03:50

    dtoh, You said;

    “Good. That’s progress. You agree that by cleaning up your argument and carefully talking about the base minus ER rather than the just the base, you can easily refute MMTers (and a whole crowd of other assorted skeptics.)”

    Yes, but I also “agree” you can refute them simply by using the overall base.

    You are still missing the point about asset prices. Keynesians agree that if you could change asset prices there is no liquidity trap, but they don’t think you can change asset prices, or at least to a large enough extent.

    Fed up, The Fed lets the public determine how much of the base is cash, and how much is reserves, I think that’s what you mean. But if the base were entirely cash then it would not be fair to say the Fed responds passively to the public’s demand for currency, unless you specify a policy rule where that is the case (actual policy in the 1960s certainly didn’t follow that rule.)

    Monetary policy is always about the supply and demand for base money. I think what you mean is that the Fed can indirectly impact the demand for base money via policies aimed at demand deposits, etc. I agree.

    Everyone, I don’t think the “Are DDs a MOA?” debate is important. The Fed directly controls the base, and that’s a sufficient condition for controlling NGDP and the price level. The private sector supplies things that are close substitutes, but not perfect substitutes. DDs can default.

    As an analogy, under the gold standard you can view currency printing as either a reduction in the demand for MOA (gold) or as an increase in the supply of MOA (gold plus Cash.) You get the same qualitative effect either way.

    Because the Fed directly controls the base, but not DDs, I find the base definition to be the most convenient.

  127. Gravatar of dtoh dtoh
    23. June 2014 at 03:57

    Scott, you said;
    “Because the Fed directly controls the base, but not DDs, I find the base definition to be the most convenient.”

    So please explain why the tremendous expansion of the base has had so little effect on NGDP.

    You also said;
    ” Keynesians agree that if you could change asset prices there is no liquidity trap, but they don’t think you can change asset prices, or at least to a large enough extent.”

    Or course they think you can change asset prices…just not at the ZLB. The Keynesians don’t think a liquidity trap is the definition of not being to change asset prices, they think it’s the cause.

  128. Gravatar of dtoh dtoh
    23. June 2014 at 03:59

    And Scott,

    The Fed can’t control NGDP by controlling the base. They only control NGDP by controlling the base minus ER. (I don’t see how you could possibly argue otherwise.)

  129. Gravatar of Fed Up Fed Up
    25. June 2014 at 11:45

    “Fed up, The Fed lets the public determine how much of the base is cash, and how much is reserves, I think that’s what you mean.”

    No, the fed lets the non-bank public decide how much is currency and how much is demand deposits.

    “I think what you mean is that the Fed can indirectly impact the demand for base money via policies aimed at demand deposits, etc. I agree.”

    $0 demand for currency, $0 demand for vault cash, $0 demand for central bank reserves. The vault cash and central bank reserves are both desired and required. Some entity saves $1,000 in demand deposits to start a bank. The fed lowers the fed funds rate while keeping the monetary base = $0. The bank creates $10,000 in demand deposits to buy new loans from entities who want to borrow because of the lower interest rate. The $10,000 is spent. There is a $9,000 difference (spent demand deposits) even though monetary base stayed the same.

  130. Gravatar of Fed Up Fed Up
    25. June 2014 at 11:53

    “Everyone, I don’t think the “Are DDs a MOA?” debate is important.”

    Sure it is. 1) MOA is monetary base. 2) MOA is currency plus demand deposits.

    Those two scenarios are different. They are especially different if reserve requirement is not 100%.

    “The Fed directly controls the base, and that’s a sufficient condition for controlling NGDP and the price level.”

    No, it is not. The fed buys a bond from a levered entity. The levered entity delevers and could also save. No change in demand deposits circulating. Central bank reserves will probably have gone up.

    “As an analogy, under the gold standard you can view currency printing as either a reduction in the demand for MOA (gold) or as an increase in the supply of MOA (gold plus Cash.) You get the same qualitative effect either way.”

    Gold supply can limit currency supply with a gold standard. Currency, vault cash, central bank reserves, and demand deposits basically have an unlimited supply.

  131. Gravatar of Fed Up Fed Up
    25. June 2014 at 12:01

    “The private sector supplies things that are close substitutes, but not perfect substitutes. DDs can default.”

    Deposit insurance and good banking practices.

    http://www.fdic.gov/deposit/deposits/

    “The Federal Deposit Insurance Corporation (FDIC) is an independent agency of the United States government that protects the funds depositors place in banks and savings associations. FDIC insurance is backed by the full faith and credit of the United States government. Since the FDIC was established in 1933, no depositor has lost a penny of FDIC-insured funds.”

    Go ask some regular people if they view demand deposits (their checking account) any different than currency. I doubt they will. Fees don’t count.

    Do a model where demand deposits and currency are perfect substitutes.

  132. Gravatar of Fed Up Fed Up
    25. June 2014 at 12:20

    dtoh, assume currency is MOA but not MOE. That means its velocity is zero. Currency is 1 to 1 (fixed) convertible to demand deposits. Demand deposits are MOE.

    There is $100 in demand deposits circulating. There is $100 in currency available. There is 100 oz of copper and 100 apples. Copper is currently priced at $1 per oz, and apples are priced at $1 per apples. Both of those two are not fixed. Double copper and apples to 200 oz of copper and 200 apples. The price will most likely fall to $.50 for both items.

    Start over. Double demand deposits to $200. Keep 100 oz of copper and 100 apples. The demand deposits don’t fall in value. The other items probably rise in value. They both become $2 each.

    Start over. Double demand deposits to $200. Keep 100 oz of copper and 100 apples. Entities think their demand deposits have been devalued. They redeem them for currency. As long as currency can expand to $200, the fixed conversion rate stands and there is no default for anyone. Currency (MOA) goes to $200 because demand deposits expanded. Copper becomes $2 in terms of currency and demand deposits. Apples become $2 in terms of currency and demand deposits.

    Start over. Do the last scenario where currency and demand deposits are both MOA and MOE.

    Does that help?

    Set a MOA. Fix something else to it (fixed conversion rate). That something else becomes MOA also as long as it is credible.

  133. Gravatar of dtoh dtoh
    25. June 2014 at 14:19

    Fed Up,
    I understand what you’re saying, but I don’t know why you think it’s important.

  134. Gravatar of ssumner ssumner
    25. June 2014 at 16:11

    dtoh, You don’t have to convince me, you have to convince Keynesians who say the BOJ can’t depreciate the yen even if they want to.

    100% of economists agree that if you depreciate the yen enough you get inflation.

    That means 100% of economists agree that if the BOJ can depreciate the yen there is no liquidity trap.

    Roughly 73.478% of economists believe in liquidity traps.

    Ergo roughly 73.478% of economists don’t think the BOJ can depreciate the yen even if they want to.

    If my math is wrong, it’s because some economists believe in incompatible ideas.

    Fed up, You said;

    “No, it is not. The fed buys a bond from a levered entity. The levered entity delevers and could also save. No change in demand deposits circulating. Central bank reserves will probably have gone up.”

    That doesn’t refute my claim. If I claim that I am capable of walking to the nearby store to buy a quart of milk, it does no good to say “false, you might take three steps and still not reach the nearby store.” Yes, there are paths that would fall short, but that doesn’t tell me anything about whether I am capable of reaching the destination.

    On the perfect substitute claim, there have been times when DDs paid interest and cash did not. If they are perfect substitutes, then how can their rates of return differ?

  135. Gravatar of Major-Freedom Major-Freedom
    25. June 2014 at 17:01

    100% of economists agree that if you depreciate the yen enough you get inflation.

    That means 100% of economists agree that if the BOJ can depreciate the yen there is no liquidity trap.

    Roughly 73.478% of economists believe in liquidity traps.

    Ergo roughly 73.478% of economists don’t think the BOJ can depreciate the yen even if they want to.

    If my math is wrong, it’s because some economists believe in incompatible ideas.

    Those 73.478% of economists think that a central bank cannot depreciate the currency without banker help, meaning without the banks creating new loans and new deposits in addition to the reserves increased by the CB that would otherwise not serve to increase spending or prices on goods that make up the large part of aggregate statistics like NGDP.

    Not endorsing this view, just telling it like it is.

  136. Gravatar of dtoh dtoh
    26. June 2014 at 00:52

    Scott,
    Economists don’t listen to me; they listen to you. It will help convince them if you talk about the Base minus ER.

  137. Gravatar of Fed Up Fed Up
    26. June 2014 at 08:42

    “That doesn’t refute my claim. If I claim that I am capable of walking to the nearby store to buy a quart of milk, it does no good to say “false, you might take three steps and still not reach the nearby store.” Yes, there are paths that would fall short, but that doesn’t tell me anything about whether I am capable of reaching the destination.”

    You could be walking the wrong direction.

    “On the perfect substitute claim, there have been times when DDs paid interest and cash did not. If they are perfect substitutes, then how can their rates of return differ?”

    Are they perfect substitutes in terms of MOA and MOE? Fees don’t count. Not accepting checks because of the chance of bouncing the check don’t count.

    Is there any entity that won’t accept checks/demand deposits because it worries about fixed convertibility not being available or if it converts a lot of demand deposits, fixed convertibility will change?

    For example, an entity may not accept copper for payment. Copper is not guaranteed fixed convertible to currency. Selling a lot of copper for currency can change the convertibility rate.

    An entity may be more likely to accept demand deposits as MOA/MOE if there is a guaranteed interest rate “attached” along with fixed 1 to 1 convertibility to currency and deposit insurance.

  138. Gravatar of Fed Up Fed Up
    26. June 2014 at 08:49

    dtoh, when the fed lowers the fed funds rate and other interest rates fall, the fed is hoping entities will borrow more (create more debt) from the banking system. That increases demand deposits. MOA/MOE increases.

  139. Gravatar of Tom Brown Tom Brown
    26. June 2014 at 12:30

    dtoh, I’ve noted before how your focus on MB – ER is similar to Jason Smith’s focus on “M0” (they’d be the same if RR = 0%). Here’s Jason’s response to my question “Why M0?” that you might find interesting:

    http://informationtransfereconomics.blogspot.com/2014/06/the-information-transfer-model.html?showComment=1403810948212#c2066261022181540783

  140. Gravatar of DOB DOB
    26. June 2014 at 13:10

    dtoh,

    Responding to your points in order.

    1. Sounds good.

    2. Sure, but those are not consequences of the latest monetary policy action.

    3. Thinking of Fed+Banking Sector feels related to thinking in terms of quantity. I find it easier to not care about how much money is out there, what time of money is it, what’s money, etc. and just focus on: is real return on money/nominal assets above or below the natural real rate of risk-free return. If it’s above -> unemployment, if it’s below -> inflation. (Granted the natural rate is unobservable but that’s a detail ;-))

  141. Gravatar of dtoh dtoh
    27. June 2014 at 03:05

    DOB,

    2. No. Monetary policy or the expectation of monetary policy can change expected future NGDP which in turn can result in an actual increase in AD. It is useful to think of an aggregate preference curve between financial assets and real goods and services. If the price of the financial assets increases, then there will be an marginal increase in the exchange of those assets for real goods and services (i.e. an increase in AD). But… also… a change in expected future NGDP (or the expected future Wicksellian rate if you prefer to think about it that way) can cause a shift in the overall preference curve.

    Alternatively, rather than thinking of a shift of a two dimensional preference curve, you can also think of a three dimensional preference curve with expected future NGDP (or the natural rate) on the z axis. By properly understanding this, you can see how even with a drop in financial asset prices (higher rates), you can still get an increased exchange of financial assets for real goods and services (higher AD) if expected future NGDP increases.

    3. I agree about quantity, but…. Fed OMO are exchanges… so quantity is tied to financial asset purchases like ying and yang. Economic players exchange financial assets (for money) in order to buy real goods and services so you get a tight correlation between increased quantity and increased AD. I think many economists have confused this correlation with causality, and therefore assume quantity drives AD. This, IMHO, is wrong, but it still allows you to produce a predicatively accurate model. So while I agree with you on the unimportance of the amount and type of money, quantity is still needed to conduct a conversation with many economists on the subject of monetary policy. Financial asset purchases by Fed (or banking system to be more accurate) are what drives higher AD, but many people are more comfortable describing this as the Fed “issuing” money.

  142. Gravatar of dtoh dtoh
    27. June 2014 at 03:15

    Tom Brown,
    As I said in my previous comment, I think what measure you use for “money” is not so important. The point I was making to Scott is that the exchange of one asset for another between two institutions wholly within the banking system (e.g the Fed buying Treasuries from a commercial bank in exchange for ER) has no impact on the economy so he needs stop talking about ER like it’s part of the money supply. MB is basically meaningless if changes in MB are mostly or entirely changes in ER.

  143. Gravatar of dtoh dtoh
    27. June 2014 at 03:17

    Fed Up,
    Thanks for the clarification. Have a look at my other comments above.

  144. Gravatar of ssumner ssumner
    27. June 2014 at 07:46

    Fed up, Obviously you can define the MOA anyway you wish. But I don’t see how those definitions have any practical implications.

    There are many vendors that accept cash but not checks, so they are not perfect substitutes. That means the Fed can control the value of cash by controlling its quantity.

  145. Gravatar of Fed Up Fed Up
    29. June 2014 at 12:31

    “There are many vendors that accept cash but not checks, so they are not perfect substitutes. That means the Fed can control the value of cash by controlling its quantity.”

    Is that because of fees or the inability to know if the check will bounce? Set up a system with the ability to know if the check will not bounce, no fees, and deposit insurance. I doubt if any entity will not accept checks. Also, the entities that do not accept checks don’t stockpile more and more currency. They will take a lot of it to a bank. If you do the accounting for paying with a check vs. going to the bank, redeeming the demand deposit, taking the currency to the seller, and the seller taking the currency back to the bank, it will end up the same.

    That means they are perfect enough substitutes in terms of MOA/MOE.

    “Fed up, Obviously you can define the MOA anyway you wish.”

    You can try to define the MOA depending on what it is. I’m pretty sure you can’t define a MOA, fix it to something else, and then say only the first one is MOA. I’m pretty sure you can’t have a dual MOA without a fixed conversion rate.

    “Fed up, Obviously you can define the MOA anyway you wish. But I don’t see how those definitions have any practical implications.”

    MOA is currency/demand deposits with a fixed conversion rate (1 to 1 here). If I save $1,000 in demand deposits and buy some new bank stock, the bank could lend $10,000 in demand deposits thru a loan to some other entity to spend even though I only saved $1,000 in demand deposits. That means there is $9,000 in extra MOA/MOE circulating.

    Better yet:

    Desired demand for currency goes to zero. Desired demand for vault cash and central bank reserves goes to zero. Required demand for vault cash and central bank reserves becomes zero (0% reserve requirement). Entities turn in currency for demand deposits at the commercial banks. The commercial banks turn in the currency for central bank reserves.

    There are excess central bank reserves in the banking system. The fed wants to keep IOR at 0% and the fed funds rate at 8%. They sell all their bonds for the central bank reserves keeping the fed funds rate at 8%. There is zero currency and zero central bank reserves. The fed has no assets and no liabilities. The banking system is in balance at zero vault cash and zero central bank reserves.

    Next, people borrow at 3% over the fed funds rate. They want to borrow from the banking system to spend on goods/services at 9% but not at 11%. The fed needs more demand deposits for spending. They announce the fed funds rate target is 6%. The commercial banks don’t comply. The fed says watch this. The fed buys some gov’t bonds with central bank reserves. There are excess central bank reserves in the banking system. The fed funds rate starts to fall towards IOR. It gets to 6%. The fed sells the same amount of gov’t bonds removing the central bank reserves. The fed funds rate is 6%, and the banking system is back in balance at zero vault cash and zero central bank reserves along with zero currency. The next time the fed makes an announcement the commercial banks will comply. Notice the fed funds rate was lowered without the monetary base changing. It is still zero.

    Entities start borrowing from the banking system. The banks issue new demand deposits (liability), and the borrowers issue new loans/bonds (liability). They then swap with the new demand deposits becoming assets of the borrowers and the loans/bonds becoming assets of the banking system. The borrowers then spend on goods/services using the new demand deposits. The new demand deposits can affect prices, real GDP, or both. The new demand deposits do not devalue against currency even though currency, vault cash, and central bank reserves are all zero.

  146. Gravatar of Fed Up Fed Up
    29. June 2014 at 12:33

    dtoh said: “MB is basically meaningless if changes in MB are mostly or entirely changes in ER.”

    What if MB is zero and only demand deposits are changing?

  147. Gravatar of dtoh dtoh
    29. June 2014 at 15:41

    Fed Up,
    I agree that what you suggest would work as long as the Fed has the ability to cause banks to increase or decrease the amount of financial assets that they are exchanging with the non-banking sector e.g. the amount of loans the banks are making. (Since the amount of DD will also change proportionately, you can also think about this as controlling the amount of DD.)

    But…the question remains…. what would be the advantage of doing this.

  148. Gravatar of Fed Up Fed Up
    29. June 2014 at 20:50

    dtoh, MV = PY

    Assume supply constraints. Assume real AS grows 3% per year. Assume P = 0% (P stays the same). Assume V stays the same or goes down slightly, meaning M needs to grow by 3% to 5% per year.

    The fed lowers the fed funds rate and hopes other interest rates follow. They also hope lower interest rates create more debt thru the banking system increasing demand deposits increasing M.

    The main story is the fed lowers the fed funds rate when below their target and raises it when above their target to attempt to control debt levels, especially of the banking system.

    The minor story is about lowering interest rates to hope to get savers to spend more and raising interest rates to hope to get savers to spend less.

    It is a lot easier to see what is going on with an all demand deposit economy.

  149. Gravatar of Fed Up Fed Up
    29. June 2014 at 20:53

    “But…the question remains…. what would be the advantage of doing this.”

    The fed wants the debt/credit risk and debt/credit allocation in the private sector.

  150. Gravatar of dtoh dtoh
    29. June 2014 at 21:19

    Fed Up,
    Sorry I’m still not really following you. What is the problem you’re trying to solve.

  151. Gravatar of Fed Up Fed Up
    30. June 2014 at 08:34

    dtoh, can a shortage of MOA cause problems for an economy and how did a shortage of MOA happen.

  152. Gravatar of dtoh dtoh
    1. July 2014 at 03:33

    Fed Up
    Sure. But that’s just a question of CB competency. Making DDs the MOA won’t solve that problem.

    Not to put to fine a point on it, but the central problem for monetary policy is that price or real goods and services is sticky while the price of financial assets is not. If this were not the case, monetary policy would both be ineffective and unnecessary.

    When you have a shock you get a drop in financial asset prices without a drop in the price of goods and services. This causes a recession and unemployment. To cure the recession the CB has to buy financial assets. This results in an increase in the MOA. So if the CB is not doing it’s job, there will be “shortage” of the MOA, but the MOA is not really the cause of problem, it’s just a side effect of the problem.

  153. Gravatar of Fed Up Fed Up
    1. July 2014 at 20:20

    “To cure the recession the CB has to buy financial assets. This results in an increase in the MOA. So if the CB is not doing it’s job, there will be “shortage” of the MOA, but the MOA is not really the cause of problem, it’s just a side effect of the problem.”

    dtoh, let me see if you get my point here.

    I pay down some principal of my loan from a bank (basically buying back my liability). Some demand deposits are now not circulating in the real goods/services economy.

    The fed buys an existing savings vehicle from some non-commercial bank entity (a gov’t bond). Demand deposits go back up by the same amount. The entity that sold the bond decides to continue “saving”. It now takes the form of “saving” the demand deposits. Overall, MOA stayed the same, but MOA velocity drops in the real goods/services economy. Central bank reserves increased.

  154. Gravatar of dtoh dtoh
    2. July 2014 at 02:02

    Fed Up,
    I still don’t get it.

    By a savings vehicle do you mean a financial asset?

    Why is the Fed buying the asset.

    What happens to the base money that the Fed pays for the asset?

    What is the relationship between you paying down a loan and the Fed buying an asset.

    In this example are you assuming DD are the MOA?

    Why did the entity selling asset to the Fed do so?

    Not trying to be problematic. Just trying to understand your argument.

  155. Gravatar of Fed Up Fed Up
    2. July 2014 at 09:09

    “In this example are you assuming DD are the MOA?”

    Along with currency, yes.

    “By a savings vehicle do you mean a financial asset?”

    Yes. I’m not sure what the difference would be between a financial asset and a savings vehicle.

    “Why did the entity selling asset to the Fed do so?”

    Not sure. Why did entities sell to the fed for QE?

    “What is the relationship between you paying down a loan and the Fed buying an asset.”

    And, “Why is the Fed buying the asset.”

    Assume a 0% lower bound. Both NGDP and price inflation fell below target.

    “What happens to the base money that the Fed pays for the asset?”

    Assume a 0% lower bound. It just “sits there” (0 velocity) at the bank account of the seller’s bank at the fed. The demand deposits just “sit there” (0 velocity) at the bank account of the seller at the commercial bank.

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