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Too Much Fed: "What if there are enough bridges and no more are needed?"

Then we live in Alaska. ;)

Nick:

That was a really awesome post. One of your finest, and it's really helped me clarify a lot of issues in my own mind. There are a few issues where I'm still wondering if we have general agreement or not. What do you think about each of the following statements?

1) (above the ZIRB) low rates cause increased lending which increases M which, if at capacity Y, causes an increase in P. "Neo-Wicksellians," for the most part, would be in total agreement with this description - they just (rightly or wrongly) don't care about money. But there is no disagreement about the underlying *mechanism*.

2) (At the ZIRB) We can decompose QE into two independent actions: a) exchange of money for T-Bills (lets call this "printing money") and b) exchange of T-Bills for risky assets like treasuries or credit risky bonds or stocks ("credit easing").

3) At the ZIRB, "printing money" does nothing. This is the standard "Neo-Wicksellian" case against QE at the ZIRB, which I argued above in my discussion with Luis Enrique. I think this may be one of the few remaining issues at the core of the disagreement.

3) As far as credit easing is concerned, it's really complicated. But the disputes involved are not between the different brands of monetarism since credit easing is not about money creation (see 2 above). The issues are about portfolio allocation and how profits and losses are distributed back to private agents via future taxes and services. 

Nick, Sometimes I think the entire difference between me and Krugman is that he thinks the BOJ tried as hard as they could, and failed, and I think the BOJ got the price level it wanted. He thinks there's an expectations trap, and I don't. That's all. If I'm right about Japanese intentions, and we use his model, we get my results. There's basically no role for fiscal policy.

K said: "1) (above the ZIRB) low rates cause increased lending which increases M ..."

I'm waiting to see if you get some "pushback" from that line.

Too Much Fed: Me too. I hadn't thought of that part as controversial as I wrote it, but I now realize that some prefer to say an increase in M causes r to drop (assuming that's what you mean). Tomato, tomahto, I say!

Actually, not tomato, tomahto. The interbank rate is the marginal cost of funds for loans. Lower rates -> cheaper loans -> more money. The money is at the end.

Nemi: building public bridges is itself a signal of intent to crowd-out private activity. Sure maybe not on its own--e.g., as it would be seen in normal times--but it is now that we've gone through these past nearly six years and been given repeated lessons about the policy ineptitude of the US government.

The private cost of having someone digging a hole is that persons wage. Societys cost, if the person otherwise would have been unemployed, is as a first approximation zero (probably negative if you belive in multipliers, positive if you don´t and belive taxation implies great DWL - but still not as big as the private cost)
This isn't not related to my original remarks but if someone is paid to dig a pointless hole, society gains nothing from this act itself. Nothing is made. If someone is unemployed, society gains nothing either. But I'd also argue society is now worse off, since that someone has been given an incentive to be doing something pointless.

Now all this pointless hole digging may push inflation but then I ask why employ a man to dig a hole? Just have the CB mail her and everyone else a check. Then noone is incentivized to do something pointless but we still produce inflation (if that's what we need).

"Actually, not tomato, tomahto."

Right. Because, in the short run, and away from the zero bound, if the CB withdraws just a small amount of reserves, then the OIR will rise, and keep on rising as there is no mechanism for banks, in aggregate to make up for the shortfall. And if the CB supplies just a small amount of excess reserves, then rates will fall and keep falling until they hit zero.

So the adjustments to the total quantity of outside money affect the rate of change of the OIR, and not the level. A given quantity of reserves is fully compatible with any OIR level (at least, in the short run).

That is why the CB needs only to make an announcement, and the OIR jumps to the announced level.

This is completely different from a supply and demand curve for reserves intersecting at a market clearing OIR.

K: thanks very much for saying that.

I think it's better for me to reply to rsj's reply to your questions.

rsj: "This is completely different from a supply and demand curve for reserves intersecting at a market clearing OIR."

1. What are you implicitly assuming about the elasticity of those supply and demand curves for reserves? (Or maybe think of the supply side as a reaction function, rather than a curve, and have a look at 2 before coming to any definite conclusions).

2. What is it that makes the CB announcement credible? Is it the credible threat that if the overnight rate does not jump down/up to the CB's new desired level, the CB will *temporarily* increase/decrease the stock of reserves creating an excess supply/demand for reserves?

3. Outside money = reserves + currency. Don't forget currency. Bank money is only money, and reserves are only reserves, because they are redeemable in currency that is used as a medium of exchange despite being irredeemable itself. That's where the Bank of Canada's power comes from. That's why it's special. (My previous post).

4. Money =/= credit. The stock of money, and the stock of loans, aren't the same thing. If I lend you $10, the stock of loans has increased, but the stock of money hasn't.

5. If the CB has the credibility, and power, to change the overnight rate of interest, just by making an announcement, without actually doing anything (the only "mechanism" is the credible threat to create an excess demand/supply of reserves if the overnight rate doesn't go where it announces it wants it to go), doesn't it also have the power, and credibility, to change expected future NGDP, just by making an announcement, without actually doing anything? (The only "mechanism" is the credible threat to create a future excess demand/supply of money). In the long run, it is NGDP that adjusts to equilibrate the stock demand and supply of outside money, not the overnight rate of interest.

6. "...if the CB withdraws just a small amount of reserves, then the OIR will rise, and keep on rising as there is no mechanism for banks, in aggregate to make up for the shortfall." What you have just correctly described is the hot potato game (only in this case it's the reverse game of musical chairs). Change the players from banks to people. Change the potato from reserves to money. Change the equilibrating variable from the overnight rate to NGDP. Recognise that the demand for money depends on NGDP, and that in the long run it is NGDP that adjusts to equilibrate demand and supply of money, not interest rates. And you are now a disequilibrium monetarist.

All I'm really asking you to do is keep on thinking the way you are thinking, but "zoom out". You will see the same patterns repeated (like one of those Mandlebrot whatsits) but on a wider canvas and longer time-scale. You are implicitly holding P and Y (and expected future P and Y) constant when you look at banks' demand for reserves. That's what we often do for very short-run partial equilibrium analysis of the game between banks and the central bank. Now think longer run, general equilibrium analysis, where P and Y (and expected future P and Y) can adjust. See the same sort of pattern repeated in the forest, as you are seeing in the trees.

Nick:

1) "What are you implicitly assuming about the elasticity of those supply and demand curves for reserves?"

The demand for excess reserves is absolutely vertical at zero. Period. Take the Canadian system. The BOC keeps, I think, about $25M (that's million with an M) of net reserves in the system just to avoid wasting anybody's time doing pointless trades. Why is this? Because banks don't have a liquidity demand for reserves. Unlike us, they don't need to hold them "just in case the pizza delivery guy doesn't take Visa". They know all their settlement requirements by the end of each day and the short term funding desk then makes sure they *exactly cover* their settlements with other banks. Borrowing through LVTS at the OIR non-interest bearing reserves that they aren't required to hold is not in their business plan.

2) "the CB will *temporarily* increase/decrease the stock of reserves creating an excess supply/demand for reserves?"

How temporarily? The shortest period that matters is overnight, when interest is accrued on interbank loans. If the CB is doing OMO's during the day, everybody *runs*  to make sure those trades are reversed before the 4 o'clock (or whatever) settlement deadline. The excess reserves never actually occur. Excess reserves earn *nothing*. If you hold them it's cause you either 1) borrowed them or 2) failed to lend them at the OIR through LVTS. That makes you stupid. Often the BOC will come in near the end of the day to help out if somebody screwed up and needs to unload cash. So "temporarily" is "never". They just do some OMO's which, if not undone by the end of the day, *would* have introduced excess reserves. But the system makes sure to get them undone, before they happen.

3) "Outside money = reserves + currency"

Above the ZIRB there's no reserves.

4) "Money =/= credit. The stock of money, and the stock of loans, aren't the same thing. If I lend you $10, the stock of loans has increased, but the stock of money hasn't."

Agreed. It's a real mess. There's tons of different kinds of money. Savings deposits that earn real interest shouldn't even be considered money since they aren't hot potatoes. They are just bank bonds. If deposit rates are low they are more like hot potatoes.  The difference between bank lending and deposit rates has a huge impact on the velocity of money. But generally when lending rates are low, people borrow more *from banks* and therefore deposits, *including hot money* tends to increase. But this is exactly my point. All we know is that there exists some bank lending rate below which the supply of hot money will increase, and above which it will decrease.  It's really hard to relate that rate to the "money supply" because we have no idea what the money supply *is*, and we have no idea how velocity responds to the changes in all the different money rates. But we *do* know that lending rates need to be ballpark a bit above nominal growth at equilibrium. And we know that we can effect lending rates through the OIR. So we adjust the OIR until inflation looks about right.

5) "The only "mechanism" is the credible threat to create a future excess demand/supply of money"

No. There is a credible threat to set the banks' *marginal cost of funding*. Every night. Don't forget: If a bank makes a loan, the created deposits don't end up back at that bank! They end up all over the banking system. When the borrower uses the new money to buy his house, the new deposit disappears into the general banking system, at which point the lending bank, has to borrow back that money through interbank lending *at the OIR*. They can do this for awhile, but if a bank keeps racking up an interbank balance because they are losing deposits, they will have to issue longer term liabilities (BA's, bonds, equity, whatever).

6) "Recognise that the demand for money depends on NGDP, and that in the long run it is NGDP that adjusts to equilibrate demand and supply of money, not interest rates."

Tomato, tomahto. Like I said in 1) in my original comment. Sure it's intermediated by the supply of money. It must be. It's good to be aware of that. But we don't know how much money there is, and we don't know how fast it moves as a function of rates, credit, etc. We do know that velocity of new money is *zero* at the ZIRB, and increases as we raise rates from there. That's all we need to know.

"I think it's better for me to reply to rsj's reply to your questions."

:-(  I don't think you addressed parts 2), 3), and the other 3), which I'll now call 4).

Jon: "Now all this pointless hole digging may push inflation but then I ask why employ a man to dig a hole? Just have the CB mail her and everyone else a check. Then noone is incentivized to do something pointless but we still produce inflation (if that's what we need)."

That's actually the point of those who talk about employing people just to dig holes. (Like being in the Army. ;)) They are not really proposing to do that, they are pointing out that just sending people checks would be a good thing, too. (Under the circumstances.)

Nick Rowe: "If the CB has the credibility, and power, to change the overnight rate of interest, just by making an announcement, without actually doing anything (the only "mechanism" is the credible threat to create an excess demand/supply of reserves if the overnight rate doesn't go where it announces it wants it to go), doesn't it also have the power, and credibility, to change expected future NGDP, just by making an announcement, without actually doing anything?"

In general, no. Generally speaking, you only have credibility to do something if you sometimes do it, or something very like it. If then, the threat of your doing something elicits a response from others, the probability of that response is generally less than the probability of your actually doing what you threaten if they do not make that response. The longer the chain of causality, and the more people required, the weaker the causal link, in general. You can't just jump from start to finish. Sometimes magic works, sometimes it doesn't. :)

K: "We do know that velocity of new money is *zero* at the ZIRB"

Not for a counterfeiter. ;)

Is a counterfeiter more powerful than the gov't?

rsj: "A given quantity of reserves is fully compatible with any OIR level (at least, in the short run)."

I prefer to say that excess reserves are always zero if not at ZIRB (but this is not a material disagreement). Any bank that finds at the end of the day that it's about to be holding excess reserves will dump those reserves at *any* interest rate that's higher than zero. The central bank needs to buy them back if they don't want the OIR to drop to zero. The demand curve for excess reserves is the positive x and y axes. It's vertical at zero excess reserves, and horizontal at zero OIR. That's why the CB can either set rates or set quantity of reserves, but not both.

Min: "Is a counterfeiter more powerful than the gov't?"

No. But he's more powerful than the CB. Counterfeiting = QE + fiscal stimulus + burning the assets acquired via QE (which compromises the ability of the CB to reverse the QE). The CB can only do QE. Lame.

K said: "1) (above the ZIRB) low rates cause increased lending which increases M ..."

Define M for me in relationship to that phrase. Thanks!

"4) "Money =/= credit. The stock of money, and the stock of loans, aren't the same thing. If I lend you $10, the stock of loans has increased, but the stock of money hasn't."

I believe the stock of savings needs to be accounted for. As far as the stock of "money" and the stock of loans not being the same thing, I might run that one by the accounting people.

And, "Agreed. It's a real mess. There's tons of different kinds of money."

Which is why I believe the term "money" should not be used because there are too many definitions.

Too Much Fed: "Define M for me in relationship to that phrase. Thanks!"

How about: stuff I can exchange for goods and services weighted by the difference in the interest I earn holding that stuff vs T-Bills. Paper money + demand deposits count fully. Overnight savings deposits somewhat less since they may earn a bit of interest.  In other words, medium of exchange that burns a hole in my pocket; money I want to exchange for T-Bills if I think that there is a low probability of me suddenly needing to spend it.

This is what we should refer to as money. The stuff banks hold at the cb should be called reserves.

"As far as the stock of "money" and the stock of loans not being the same thing, I might run that one by the accounting people."

No, this is true. Banks may fund their assets (including loans) via demand deposits, savings deposits (o/n or term), debt, prefs, common equity. A bank lends you money which creates a deposit. You take that deposit and use it to buy some new shares issued by the same bank. So there's a new loan, and some new shares, but no new deposit.

Too Much Fed: "Define M for me in relationship to that phrase. Thanks!"

Or more relevantly in relationship to that phrase: replace T-Bill with "bank loan to me". If bank loan rates are low I get more of it (the money) because my liquidity preference outweighs the loan interest.

"Bill, Lars: which comments? As usual there were a lot of comments from people who don't know much economics, criticising both quasi-monetarism and Paul Krugman from all sorts of directions, right and left."

Do economists actually know much about economics? If they did, would they still be constantly re-hashing what appear to be some fundamental principles?

K said: "1) (above the ZIRB) low rates cause increased lending which increases M ..."

K, I'm going to simplify that and your other responses to this:

Low interest rates lead to more debt, which is an increase in M. Sound good?

If so, tell that to Nick and see what response you get.

Nick's post said: "2. What is it that makes the CB announcement credible? Is it the credible threat that if the overnight rate does not jump down/up to the CB's new desired level, the CB will *temporarily* increase/decrease the stock of reserves creating an excess supply/demand for reserves?"

Or raise/lower the interest rate paid on excess central bank reserves or raise/lower the reserve requirement?

K, so you define M = currency + demand deposits, which is also medium of exchange?

If so, that sounds good to me.

"This is what we should refer to as money. The stuff banks hold at the cb should be called reserves."

To me central bank reserves are a type of "medium of exchange" used only by the banking system covered by the fed (its member banks). It does not circulate in the real economy.

K's post said: ""As far as the stock of "money" and the stock of loans not being the same thing, I might run that one by the accounting people."

No, this is true. Banks may fund their assets (including loans) via demand deposits, savings deposits (o/n or term), debt, prefs, common equity. A bank lends you money which creates a deposit. You take that deposit and use it to buy some new shares issued by the same bank. So there's a new loan, and some new shares, but no new deposit."

Are you sure the new deposit is not being saved by the bank? For example, after the bank issues the new shares, it saves the new deposit for a day. The next day it spends the new deposit to open a new branch.

Too Much Fed: "If so, tell that to Nick and see what response you get."

:-)))). I'm trying

Too Much Fed: "Are you sure the new deposit is not being saved by the bank? For example, after the bank issues the new shares, it saves the new deposit for a day. The next day it spends the new deposit to open a new branch."

Issuing shares *destroys* a deposit. Ie it replaces one liability (deposit) with another (stock). The next day they could *create* a new deposit and exchange it for some real estate. That's a separate decision. But a bank definitely doesn't *save* a deposit. If it buys it back it doesn't keep it. It deletes it.

Another example of the stock of loans and the stock of money being different would be securities, which are a different entry on the balance sheet from loans.

Also, cash in circulation is a tiny percentage of money, but it is still a type of money.

K, IMO, and to get a better idea of what is going on, I believe you need to consider the idea of save/hide/reappear instead of destroy/create.

A lot of people say that about taxes, but what about a sovereign wealth fund? Don't they only invest what they have saved thru a surplus?

W. Peden, it seems to me that it is possible that securities are involved with medium of exchange (not sure that is phrased right).

And, why can't cash/currency equal some stock of loans?

I think the MM folks are arguing 100 from principle. You've got some good ideas that make sense and I would guess that Krugman and perhaps even Bernanke would find them interesting. The problem is that they are eminently impractical for the current situation due to history and politics. That's not a criticism of what you're doing here--it should and probably will shape academic and, with any luck, policy in the future. But right now the Fed has to deal with crap like this:

http://www.nytimes.com/2011/09/21/business/economy/gop-urges-no-further-fed-stimulus.html

One side of the isle doesn't want to fix the economy now because a bad economy is good for them politically. And the general public is going to be deeply skeptical about new monetary solutions they don't understand. Krugman, I think, is focusing on what might most plausibly work and happen here and now. Fiscal stimulus, if kludgie, would work. With that in mind, pushing MM principles at the margin, like encouraging better communication and expectations formation by the Fed, could be more practical. For example, longer commitments to near-zero interest rates, price-level targeting such that the Fed will ultimately allow 'catch up' inflation to make up for below target inflation during the recession, etc.

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