Question for David Glasner
Here’s David Glasner:
I can envision a pure barter economy with incorrect price expectations in which individual plans are in a state of discoordination. Or consider a Fisherian debt-deflation economy in which debts are denominated in terms of gold and gold is appreciating. Debtors restrict consumption not because they are trying to accumulate more cash but because their debt burden is so great, any income they earn is being transferred to their creditors. In a monetary economy suffering from debt deflation, one would certainly want to use monetary policy to alleviate the debt burden, but using monetary policy to alleviate the debt burden is different from using monetary policy to eliminate an excess demand for money. Where is the excess demand for money?
Why is it different from alleviating an excess demand for money?
As far as I know the demand for money is usually defined as either M/P or the Cambridge K. In either case, a debt crisis might raise the demand for money, and cause a recession if the supply of money is fixed. Or the Fed could adjust the supply of money to offset the change in the demand for money, and this would prevent any change in AD, P, and NGDP.
Perhaps David sees the debt crisis working through supply-side channels—causing a recession despite no change in NGDP. That’s possible, but it’s not at all clear to me that this is what David has in mind.
Tags:
13. September 2014 at 21:03
Neither central bankers nor anyone else can know any “excess demand” for money without learning the information that only a private property driven (profit and loss) in the production of money itself can reveal.
Whole populations do not want central banks. You can know this by the fact that governments initiate force in order to make central banks possible.
If every individual were free to choose, they would choose a money that cannot be devalued willy nilly. They would choose a money whereby changes to the demand for money holding will change prices, and, most likely keep a large percentage of assets in the form of money, to provide a cushion for unexpected spending changes. With central banks, the incentive for people to do this is significantly lessened.
13. September 2014 at 21:37
Off topic:
Dr. Sumner,
Sorry to bother, but hopefully you will be kind enough to settle an argument between two passionate but untrained armchair economists.
My friend is a hard money Austrian….Nothing is money but gold!
At the same time he sees the logic in Market Moneterism and claims to be a supporter. I tell him the two schools are mutually exclusive. In order for Market Moneterism to be used to full effect an elastic currency is prerequisite.
He tells me ” Hogwash”.
We are both daily readers of your blog so an answer from you, here would put the matter to rest.
Thank you in advance
14. September 2014 at 04:17
Off topic.
One thing that I recall being debated in these parts was, “Why did American base money growth explode in 2008?” Possibilities included (a) a liquidity trap scenario, (b) a huge increase in money demand as interest rates became very low, and (c) increased demand for safe assets during a financial crisis. Finally, there was (d) the payment of interest rates in excess reserves.
The long-run monetary data recently published as part of “Money Creation in the Modern Economy” offers a fairly simple explanation. UK base money growth exploded in Q2 2006, exactly when bank reserves became interest-bearing in the UK. Barring an exceptional coincidence, it does look like the Fed made a huge mistake in September-October 2008 by effectively raising money demand just as the US economy was going sour.
14. September 2014 at 05:26
pnesbitt23, Does he favor NGDP targeting? If so, how do you do that with a gold standard?
W. Peden, Interesting. How big was the “explosion” in percentage terms?
14. September 2014 at 05:38
W. Peden,
Great stuff!
14. September 2014 at 05:56
UK M0 (notes & coin + bank reserves) growth had averaged about 6.5% since Q1 1993, which was roughly when our “Great Moderation” began and when there was a secular shift in M0 velocity as inflation expectations were finally broken. From Q1 1993 to Q1 2006, M0 velocity was notably stable and annualized M0 growth deviated within a range of 11.5% to 3.8% (the peak being just before the millenium).
According to the data to which I referred earlier, bank reserves began bearing interest in Q2 2006, which was when headline M0 statistics were discontinued. In that quarter, annualized M0 growth shifted from 6.7% to 56.3%. Even before bank rate neared zero and QE began in 2009, M0 growth averaged 27.1% between Q2 2006 and Q1 2009.
The outstanding M0 stock was 45,550 million in Q1 2006 and 94,304 in Q1 2009. So the monetary base in the UK more than doubled in that period, and this growth was almost entirely a matter of bank reserve growth. Currency (the Notes and Coin series) grew on average at 6.5% from Q1 1993 to Q1 2006 and 6% from Q2 2006 to Q1 2009.
So if international experience suggests that paying interest on reserves has a huge effect on base money demand (even when interest rates are well above 0%) then why not suppose that this explains the US monetary base explosion, that occured even prior to reaching the ZLB?
14. September 2014 at 05:57
* Mostly explains. I’m not denying that a ZLB, deflation, and a financial crisis will increase base money demand.
14. September 2014 at 05:58
* and 94,304 million, of course, i.e. 94 American billions.
14. September 2014 at 08:29
Scott, I just responded, or at least tried to respond, to your question on my blog.
http://uneasymoney.com/2014/09/14/responding-to-scott-sumner/
See what you think.
Also kudos to W. Peden for unconverng this very interesting evidence on the effects of paying interest on reserves.
14. September 2014 at 08:32
Way off topic, but Lorenzo has another excellent post up;
http://lorenzo-thinkingoutaloud.blogspot.com/2014/09/what-difference-framing-makes.html#comment-form
14. September 2014 at 09:04
W. Peden:
I do believe you are assuming correlation is causation.
In your list of “possibilities”, you did not mention the obvious one: Base money “exploded” because the Fed directly increased the base money supply by engaging in significant OMOs.
If I or a bank “demanded” base money, then if the supply of base money does not increase, the only thing that could happen would be a transfer of ownership title of existing base money. I demand base money by giving something to someone who already has base money.
The only way an increased demand for base money can be associated with an increase in the supply of base money, is if and only if there is a party actively increasing the supply of base money. Base money is created by central banks. The base money supply exploded because the Fed directly exploded the supply of base money.
Sometimes I don’t understand how otherwise clever people can be so blind to obvious facts.
14. September 2014 at 09:11
The reason the BOE and the Fed started to pay IOR at the same time as base money supply exploded is because they did not want the explosion in the supply of base money, that they themselves created, to turn into a much greater increase in the broad money supply via the money multiplier, and cause runaway consumer price inflation.
By encouraging banks to retain base money with the CB, the CB could bail out the banks and keep them solvent, while allowing main street to crash and burn. Keeping the banks solvent was priority number one. NGDP was not on their radar.
Now this “solution” did keep the banking system solvent, but now the banks have all this base money kept at the Fed.
14. September 2014 at 10:10
Major Freedom,
No-one disputes the role of OMOs in the creation of the base money. The problem is explaining why the OMOs took place, which in turn involves explaining why they were needed given the interest rate targets of the relevant central banks at the time, and that in turn involves explaining the rise in base money demand in the relevant time periods.
14. September 2014 at 10:42
W. Peden, you write:
“UK M0 (notes & coin + bank reserves)”
Mark Sadowski and I looked into the various definitions of M0 one time. I even dragged David Andolfatto into it, who in turn dragged one his colleagues into it (if I recall correctly, which I probably don’t). I’m pretty sure I asked Frances Coppola too.
The upshot was that Mark proved to me not to trust Wikipedia on this. I came away with the concept that M0 officially means something in Japan, and that’s about it. It no longer is an official designation in the UK, and never was in the US.
Am I wrong?
14. September 2014 at 10:46
Tom Brown,
M0 was discontinued in early 2006 as an official statistical series, but it can be constructed by aggregating official data on reserves plus official data on the Notes & Coin series.
14. September 2014 at 12:46
W. Peden:
“No-one disputes the role of OMOs in the creation of the base money. The problem is explaining why the OMOs took place, which in turn involves explaining why they were needed given the interest rate targets of the relevant central banks at the time, and that in turn involves explaining the rise in base money demand in the relevant time periods.”
OK fair enough. But then we’re right back to the main question: Why did so many market participants reduce their spending as much as they did, i.e. hold onto money for longer than they used to, that would otherwise result in NGDP/price/profitability declines if not for the CB engaging in OMOs to reverse them?
You cited a study of long-run monetary data recently published as part of Money Creation in the Modern Economy as “an explanation”. However your argument is actually just that the Fed failed to reverse them far enough. You argue the Fed raised the demand for base money by paying IOR, and that this was a bad move. OK, but that does not explain why the Fed was even in a position of having to act the way it had to act according to you such that a “failure” could be averted. In other words, it does not explain why the Fed had to increase the supply of base money as much as it did.
Paying IOR does not increase the supply of base money (other than of course the interest payments).
I think the question you’re asking, and if not then what you might want to ask, is why the Fed did not just engage in whatever OMOs to prevent banking system ownership retitlements (i.e. “banking system collapse”) and not pay IOR at all, rather than engage in whatever OMOs are necessary to prevent ownership title transfer and pay IOR.
I believe the answer to this question, and feel free to critique it, is that the quantity of base money needed to prevent “banking system collapse” was so great, that unless the Fed paid IOR, the required quantity of OMOs would have otherwise led to above acceptable rates of price inflation.
And, alongside this, which is what you are likely thinking, the act of paying IOR itself had an effect on the size of increase in base money. If the Fed did not pay IOR, then there would have likely been a higher level of spending per unit of base money created, which would have helped finance/cover the bank’s outstanding loans, which would have reduced the quantity of OMOs needed to prevent “banking system collapse”.
14. September 2014 at 12:51
I think base money would have still significantly risen post-2008 without IOR, but less so than it did with IOR.
Are we asking why base money had to increase so much in general (rather than not at all, or only somewhat), or are we asking why base money rose by the precise quantity it did? I think those are two different questions that require two non-identical answers.
14. September 2014 at 16:57
Scott, given this topic, I thought you might find the following interesting. I saw this due to a link by Alex Tabarrok:
http://m.dailykos.com/story/2014/09/10/1328813/-The-Astonishing-Story-of-the-Federal-Reserve-on-9-11
15. September 2014 at 06:00
Major Freedom,
“I believe the answer to this question, and feel free to critique it, is that the quantity of base money needed to prevent “banking system collapse” was so great, that unless the Fed paid IOR, the required quantity of OMOs would have otherwise led to above acceptable rates of price inflation.
And, alongside this, which is what you are likely thinking, the act of paying IOR itself had an effect on the size of increase in base money. If the Fed did not pay IOR, then there would have likely been a higher level of spending per unit of base money created, which would have helped finance/cover the bank’s outstanding loans, which would have reduced the quantity of OMOs needed to prevent “banking system collapse”.”
I think you’re explaining at a deeper level, and from what I know, you’re correct on this issue.
“Are we asking why base money had to increase so much in general (rather than not at all, or only somewhat), or are we asking why base money rose by the precise quantity it did? I think those are two different questions that require two non-identical answers.”
I think that the first question is the important one for the theoretical discussions surrounding this issue, i.e. “Was the US economy in a liquidity trap at any point in 2008-2009?”.
15. September 2014 at 09:05
Now that Zimbabwe is out of the money creation business, we could look to what Venezuela has to teach us about the QTM:
http://www.project-syndicate.org/commentary/ricardo-hausmann-and-miguel-angel-santos-pillory-the-maduro-government-for-defaulting-on-30-million-citizens–but-not-on-wall-street
‘Venezuela functions with four exchange rates, with the difference between the strongest and the weakest being a factor of 13. Unsurprisingly, currency arbitrage has propelled Venezuela to the top ranks of global corruption indicators.
‘All of this chaos is the consequence of a massive fiscal deficit that is being financed by out-of-control money creation, financial repression, and mounting defaults – despite a budget windfall from $100-a-barrel oil. Instead of fixing the problem, Maduro’s government has decided to complement ineffective exchange and price controls with measures like closing borders to stop smuggling and fingerprinting shoppers to prevent “hoarding.”’