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Beautiful post, Nick.

I have really struggled in explaining MM to my sophisticated friends. These are not inflation derps --- these are very smart investors who get finance. They've watched the Fed quintuple the monetary base, and they've seen all that money just sit there in bank reserves, as traders treat bonds and cash as equivalent. Their conclusion is not that inflation is coming after some delay --- as I said, they're too smart to be inflation derps. Their conclusion is that the Fed *cannot force private parties to spend*. Basically they conclude (whether they like Krugman or not) that Krugman is right, and the Central Bank is impotent at the zero lower bound because the interest rate channel is gone. These people do not see the expectations channel and how the Fed is messing this up. I have basically failed to explain it.

I'm sending pointers to this article to a few folks, we'll see if it lights any bulbs.

Thanks,
-Ken

Kenneth Duda
Menlo Park, CA
kjd@duda.org

Sorry, I should add, it might be nice to post a version of this that avoids the word "derp". Instead of beating on the inflationistas for being the idiots that they are, we should be trying to educate/convince the sophisticated players who still fail to grasp MM, which is most of the economics and finance profession. i.e., how would you explain MM to Krugman? (Why someone as smart as Krugman can't or won't understand MM is one of the great mysteries.)

I would divide the receivers of the loan (donation) into two groups:

1) The first group would believe the donor. The donor is REALLY going to carry out this action of retaliation if the $1000 is used. The first group would strive to have the $1000 available when the donor wants the money back.

2) The second group would NOT BELIEVE the donor. This group might spend the money and let the future be damned. "Eat, drink and be merry, for tomorrow we die." This second group might be basing their decision on the fact that they have nothing now, and after spending the $1000, would have nothing that the donor would be able to use for retaliation.

Now, with two groups, we can predict where existing classifications might divide. I would predict that existing entities with wealth would gravitate towards Group 1. They would have the assets that would be subject to the threats foreseen from the donor. Those assets could be taxed away or eroded by inflation should the donor decide to retaliate.

I would further predict that people without wealth would gravitate towards Group 2. They simply would not have much to lose if inflation occurs or taxes are raised. They likely pay little tax now or even have a negative tax (they get more from government than they pay) so are not vulnerable to tax increases now and may receive more (in the form of negative tax) if inflation occurs.

Is there anything that could be done to convince Group 1 that the donor will not change his mind? Change-of-mind seems to be a feature of a democracy.

And why would a NGDP target be any more believable than any other Central Bank announcement?

I think there is a constituency of cautious people who believe the authorities are trying to inflate their way out of the current situation. They are against this solution because they believe it would have a redistribution effect away from cautious people like themselves and this effect would be worse than just letting things play themselves out.

They are against "inflationism" whether it succeeds or not. Their economics may be off but I do not think there is anything inconsistent in this view.

An inflation derp doesn't have to be a person of the concrete steppes. He can instead argue that the market is wrong about the counterfactual. That the Fed will not reverse the printing presses even when spending picks up. And that once people see this start to happen, the market will change its mind in a hurry about the counterfactual. I think this is the model of a lot (but not all) of the inflation diehards have in their heads.

Imagine this weekend Draghi suddenly announced on Monday the ECB was was setting a new NGDP level target of 20%, come hell or high water. Most of the non-concrete steppes crowd would turn into inflationistas. But what if the market didn't immediately budge? What determines whether someone expects this policy to work anyway? It isn't necessarily their belief in concrete steppes. It's about their belief in market efficiency compared to their own estimates of CB credibility, i.e. the true reaction function over time. I think you'd see large numbers of the inflation crowd equally worried, while a minority would drop out, proving themselves true concrete steppers.

"Printing lots of money causes lots of inflation."

Thomas Tooke told us way back in 1840 that it's the other way around. Inflation causes lots of money to be printed. The central bank loses 10% of its assets and so the dollar loses 10% of its value. Peoples' real balances fall by 10% so they bring bonds to the CB, asking for dollars in return. The central bank complies, since they know that the 10% drop in real balances will cause a recession. The 10% boost in M is adequately backed by the 10% boost in the CB's stock of bonds, so the extra money causes no further inflation.

@Roger Sparks:

> I would further predict that people without wealth would gravitate towards Group 2. They simply would not have much to lose if inflation occurs or taxes are raised.

Be very careful with this line of thinking. It's attractive, but remember that to first order economics arguments such as the one in this post do not permit defaults. Group 2 would never receive the $1,000 in the first place, because they have no assets to ensure repayment eventually.

To the extent that group 2 gets the $1k, then we're still all in the same ballpark: money "lent" to Group 2 has a chance of becoming a *permanent* rather than temporary increase in the money supply, since if they default then the central bank has to eat the loss.

The assurance that QE will actually remain temporary (and not permanent) is precisely the underpinning behind Nick's argument.

> And why would a NGDP target be any more believable than any other Central Bank announcement?

It doesn't have to be, because CB announcements are already very credible. It's just a superior target because it makes "inflation flexibility" something very concrete, in a way that makes near-ZLB (traditionally defined) situations much less likely.

While a NGDP target would be a step forward, I think a more useful concrete steppe would be to give them an easy means to realize it. Let them credit the treasury with the deficiency when at the ZLB. Most everyone would have faith in their ability to spend it, it would appear permanent, and it would counter the growth of debt that people of the concrete steppes fear as much as inflation. No one would have any doubts about their ability to realize it.

First off, I absolutely agree that expectation are very important here.

However, I don't think you thought experiment translates to the current situation. It would be more relevant perhaps to imagine that you had bought $1,000 of Treasuries from me and warned me that if I attempted to spend or lend that £1,000, you would offer to sell them back to me for the then market value. I don't think that would have so much effect.

What you describe sounds more analogous to the government giving me a $1,000 tax rebate, but telling me that as soon as I try to spend it, it will tax it back again. Sort of in-your-face Ricardian Equivalence.

"Printing lots of money causes lots of inflation."

As an amateur, I would say it depends. That's what Krugman is saying I believe. If you have economic circumstances that we've had since 2008 of lowflation; of undershooting the inflation target; of a large output gap; of a historically low labor force participation rate; of an absence of wage inflation; etc. etc. etc., historical experience has shown that "printing a lot of money" if it's still *not enough* will not cause inflation. We know it hasn't been enough because of all of the data hasn't improved very much.

I agree forward guidance helps but they also have to demonstrate concretely that they mean business and that the 2 percent inflation ceiling is something they mean to hit relatively soon, not in another decade or so.

Nick,

You might be interested/amused to know that there's a question about the meaning of "the concrete steppes" on StackExchange: http://english.stackexchange.com/questions/152457/what-does-people-of-the-concrete-steppes-mean/

@Lord:

> Let them credit the treasury with the deficiency when at the ZLB.

And what of the converse, when the NGDP target is being exceeded?

Part of the political problem of the ZLB is that the central bank's range of operations aren't symmetric. Away from the ZLB, the CB responds to too low inflation by manipulating interest rates and to too high inflation by manipulating interest rates.

The symmetric tightening action to "print money and give it to the treasury" is to require the government run a surplus that vanishes into the ether. You've then neatly described MMT.

@Nick Edmonds:

> It would be more relevant perhaps to imagine that you had bought $1,000 of Treasuries from me and warned me that if I attempted to spend or lend that £1,000, you would offer to sell them back to me for the then market value.

Perhaps more that as soon as I spend that $1,000, the CB will buy it back from the merchant with a bond (or mortgage, or whatever), so that the $1k will never return to me as income.

Nice post Nick. I makes your point very well. But if it were completely true, then lowering interest rates in normal times wouldn't spur demand either, but it does. And your post doesn't explain why inflation expectations have dropped below target. But it is still a great post!

I am considering this from the standpoint of institutional preference and making it as easy as possible for both Fed and treasury to do what they like to do and do best. Since the Fed has no means of enforcing a surplus and treasury would find it contrary to their nature, interest rates are still the easiest way for the Fed to act away from the ZLB, and treasury spending the easiest way at it.

Thanks Ken. I decided to change the title, and put "inflation derps" in quotation marks, since it is not a term I would commonly use, and I was quoting Paul Krugman's use of the term.

Roger: I think Majromax is right on this. Your second group probably would not receive loans in the first place.

Mike: It can go either way. If the central bank doubles the price of gold, or doubles the price level target, that increases the demand for money, which increases the quantity of money. But Christopher Columbus did not sail to America to find the gold that would be demanded in the coming Spanish inflation. Causality went the other way.

Lord: But if there is no change in the NGDP or price level target, government spending will not in fact be money-financed. No harm in doing both, of course, if the debt/GDP ratio is OK.

Nick E: "It would be more relevant perhaps to imagine that you had bought $1,000 of Treasuries from me and warned me that if I attempted to spend or lend that £1,000, you would offer to sell them back to me for the then market value."

My brain is saying this ought to amount to the same thing. But it's early morning here.

Peter K: There's a difference here between an inflation target and a price level target. An inflation target means you ignore your past misses, and start afresh each period. As Scott Sumner says, a level target keeps the central bankers honest. They have to correct their past mistakes.

Thomas: that was hilarious! Thanks for that. I thought your answer was very good. Better than I could have done.

Mark: thanks. And that's a good point. I think the answer is: because in normal times, with a credible inflation target, a cut in the rate of interest is interpreted as "The Bank of Canada thinks that we are spending too little to keep inflation at 2%, and wants us to spend more, and will only raise interest rates if we spend even more than it thinks we will spend and wants us to spend." Something like that.

MF: "I think there is a constituency of cautious people who believe the authorities are trying to inflate their way out of the current situation."

dlr: "An inflation derp doesn't have to be a person of the concrete steppes. He can instead argue that the market is wrong about the counterfactual. That the Fed will not reverse the printing presses even when spending picks up."

That is probably true. There presumably are some people like that. But if everyone (or a lot of people) were like that, nobody would want to hold money or government bonds at current very low nominal interest rates. They would want to hold real assets instead. Measures of expected inflation suggest those people are a minority.

Measures of expected inflation suggest those people are a minority.

They are the minority of investors but not necessarily the minority of squawkers. Complaint boxes have selection bias.

dlr: that sounds right to me. Plus, nobody ever became famous by making the same predictions everybody else is making.

Pity though, in a way, there weren't more of them. Then monetary policy would be much more effective, and the Fed wouldn't need to print so much. As it is, the Fed has to keep on printing until the squawkers become a majority!

Exactly. We needed the inverse of the no-short rule. If you wax, blog, tweet, or otherwise editorialize about future inflation you are required to take a commensurate market position in proportion to your net worth. Remember, even China complained. That might have done it.

I just think the bias is more complex and in many ways deeper than a concrete steppe fetish, although concrete steppes often appears to be important once the debate gets going. Many of the smart hedge fund guys I'm most familiar with who have stuck to the inflation-phobic stance are very comfortable thinking in purely expectational and game-theoretic terms. I am fascinated by the thought process of Kocherlakota, who is one of the very, very rare cases of publicly flipping monetary policy views in the last six years, although even then he was never an inflation-phobe.

"There's a difference here between an inflation target and a price level target."

Yes I am in favor of a price level target for the reasons you state. In the meantime I wish the Fed would hit its inflation target ceiling sooner rather than later.

If printing lots of money did cause people to spend it and cause inflation, then central banks would immediately put the printing presses into reverse. They would buy back the money they had printed, and burn it, to stop people spending it and causing inflation. And people expect they would do this. And no individual will spend unless he expects other individuals to spend. So nobody spends.

Hardly anybody expects this - only some economists and some inveterate Fed watchers in the FIRE sector and the blogosphere. Most of the people in the world where people make, buy and sell things, and where actual prices are set by actual individuals for actual things, do not base their decisions on such convoluted and ethereal calculations. If some of the inflation derps are wanderers on the concrete steppes, some of the low-inflation pseudo-explainers are sunk deep down into the abstract abyss.

There are many and varied causes for the fact that people are not currently attempting, in the aggregate, to buy more output than can be produced and sold at prevailing prices. There are many and varied causes for the fact that people who sell things do not expect their customers to be willing to pay more in the near future. Pricing decisions are made by real people who live on the surface of the Earth, each faced with real customers and acting and reacting within a limited space of information and practical local concerns. They don't live down in the abstract abyss.

An absence of spending ... hmm. I wonder who could spend enough to break this cycle and revive the rube we must live in? Class?

"But Christopher Columbus did not sail to America to find the gold that would be demanded in the coming Spanish inflation. Causality went the other way."

Clever analogy, but gold is a commodity and money is just paper and electronic blips. Tooke was looking at prices in Britain, under a paper money system, and he observed that inflation preceded increases in the money supply. If he had been studying the Spanish inflation, he would have found that gold discoveries preceded inflation.

"Suppose I lend you $1,000, at 0% interest. But I warn you that as soon as you spend that $1,000, or lend it to someone else to spend, I will immediately make you repay the loan, or else raise the interest rate high enough to make you regret spending it or lending it. You will not spend that $1,000. You will keep it somewhere safe. What I actually do (giving you the $1,000 at 0% interest) doesn't matter. It's what you expect about what I would do (make you repay the $1,000 if you spend it) that matters."

Assuming that your threat is credible, then it does seem that it will be effective. But do you have an example where you can credibly induce the debtor to spend the money? (Hint: There are movies based on that premise. They are comedies.) Do you have an example that could plausibly apply to a central bank?

Dan Kervick: "There are many and varied causes for the fact that people who sell things do not expect their customers to be willing to pay more in the near future."

What about in places that have raised or are soon to raise the minimum wage?

@Majo "Part of the political problem of the ZLB is that the central bank's range of operations aren't symmetric. Away from the ZLB, the CB responds to too low inflation by manipulating interest rates and to too high inflation by manipulating interest rates.

The symmetric tightening action to "print money and give it to the treasury" is to require the government run a surplus that vanishes into the ether."

You don't need a symmetric tightening to printing money. The printing money solves the asymmetry at ZLB. Tightening via interest rate is (theoretically) unlimited.

Exchange rate tools are much more like printing/destroying money as the only system and have an inverse asymmetry. Exchange rate targeting banks can ease without limit, but cannot tighten without limit.

This argument assumes its conclusion: it concludes that printing lots of money causes lots of inflation - based solely on the unsupported assumption that printing lots of money causes lots of inflation. The reasoning sounds a bit circular to me.

What the author fails to consider is that much of the money supply is not in gold coins, or paper dollars - but stored and spent via credit. Just as the Fed can expand the money supply by changing the credit rules, it can also contract the money supply that same way. It simply isn't the case that telling the Secretary of the Treasury to stop authorizing overtime at the Mint's printing presses has a significant effect on the real money supply - which means that the money supply can be contracted without the need to reduce the number of paper dollars (or gold coins).

Min:"What about in places that have raised or are soon to raise the minimum wage?"

I don't know. Can you point to any press reports or other bits of empirical evidence about people are raising (or not raising) their prices based on their beliefs about the impact of the minimum wage?

I just don't believe there are a lot of people who think that way. I don't think price decisions are often made within businesses on the basis of such considerations.

Businesses have all kinds of experiential knowledge coming from actual, ongoing human business relationships with their customers. They use those relationships to keep a running reading of the state of their customers desires and preparedness to spend, and about what they can get away with.

Nick,

Well it’s the day before the third anniversary of your post here:

http://worthwhile.typepad.com/worthwhile_canadian_initi/2011/10/engdp-level-path-targeting-for-the-people-of-the-concrete-steppes-.html

No doubt a classic in your continuing evisceration of these concrete steppes folks.

Brutal fellow.

Even if they (we?) deserve it, I think you’re making a mistake that falls under the umbrella of some sort of logical fallacy. I think concrete steppes are embedded as contingent actions within expectations and plans and revisions to those things. These things are called scenarios in risk management, and they are usually specified with some minimal degree of concrete clarity. The notion that the central bank may never have to follow through on many things that it commits to or threatens is reasonable – but it doesn’t prove that concrete steppes aren’t required in a conceptual way for contingent visualization of the risks that threaten. In that vein, I also think that your prescription for implicit CB action threats remains quite vague at the end of the day. And vagueness is not a catalyst for credibility and belief.

That said, you do contradict yourself in the context of this logic in the above post – you actually do begin to spell out what it is that would be threatened as possible action in the event that market participants just ignored the threat. It amounts to what the central bank may end up buying. In that vein, I think it matters a lot whether the buying remains with financial assets or begins to extend into newly produced goods and services. If the threat includes the latter, then there is a real issue with regard to the effect on consumption and the distribution of consumption. If not, the entire effect is arguably far more benign, even in extremis. Even if the CB buys all the stocks and all the existing houses, why would the price effect necessarily spill over into goods and services CPI for example? To the degree that these asset classes represent saving, and to the degree that what the private sector now holds instead are zero risk low return assets (money), why wouldn’t the private sector need that inflated capital value offered by the CB (at a lower rate of return) just to restore the level of future cash flow it wants and needs from those savings vehicles?

Moi:"What about in places that have raised or are soon to raise the minimum wage?"

Dan Kervick: "I don't know. Can you point to any press reports or other bits of empirical evidence about people are raising (or not raising) their prices based on their beliefs about the impact of the minimum wage?"

Well, here in the Bay Area employers are threatening to raise prices when (if) minimum wage raises go into effect. Even if that happens, I don't think that there will be much of an immediate effect.

However, if the minimum wage increase stimulates the local economy, I suspect that there may well be some inflation after a few years. It will be interesting to see what happens. :)

I was going to respond to Mike Sproul's original comment in the way Nick did--referring to the "Price Revolution" of the late C15th to mid C17th.

But folks, could we get one thing straight. The key issue was silver. Silver was the dominant monetary metal in Europe (and Asia)--though gold was used in international trade in Europe--and the great inflation was kicked off by vacuum pumps and lead smelting processes quintupling the output of the central European (and then Swedish) silver mines in the last part of the C15th. As output of goods and services did not go up five-fold, the value of silver (the dominant medium of account) fell so, prices rose. Then Columbus did his thing, the Aztec and Incan empires were conquered and looted and then various silver mines--notably the Potosi "silver mountain"--were discovered. American silver (largely minted into Spanish and Portuguese coins) flooded into what became the Atlantic economy and the inflation just went on and on.

Also, Mike, your argument only makes any sense once there are paper notes. They do not begin to emerge seriously until the Amsterdamsche Wisselbank or Amsterdam Exchange Bank was founded in 1609. But, let me assure you, silver coins and gold coins were definitely money. In fact, money way predates coins.

It is conservatively estimated that about 300million silver pesos flowed into China via the Philippines between 1565 and 1820; with each peso being 25.561 grams of silver, that's about 7,700 tonnes of silver. The silver pesos (aka real de a ocho or "pieces of eight") had a transaction premium over weighted bullion (the medium of account in Ming and Qing China) because it was so readily accepted. (Or, perhaps weighted bullion had a discount, because it had to be checked.)

Yuan and Sung China had paper notes, but I am not sure they had any explicit backing. Certainly, both collapsed in hyperinflation in the way way the $Con dollar did in 1865--as the moment when their exchange value would reach zero clearly got closer and closer, prices rose exponentially as their value as money headed towards zero, in a rather desperate game of unload those "hot potatoes" getting hotter and hotter as quick as you could.

Monetary history--fun and revealing.

Lorenzo:

True about silver being the dominant monetary metal. I usually talk about silver, not gold. I don't know what came over me.

On the other hand, nobody ever said that the backing theory applies to goods like silver and gold and apples. So naturally it only makes sense once there are paper notes. But once paper notes exist, the backing theory makes perfect sense. The value of paper notes is determined by their backing, just like stocks and bonds. In cases like China where backing was not explicit, it was the government's "taxes receivable" that provided the asset that backed the notes. The fact that those notes might not have been explicitly convertible into silver has unfortunately fooled economists into thinking that "inconvertible"="unbacked".

I'm for MM, but this is not what The people from the concrete steppes believe.

The people from the concrete steppes want to see proof that your threat can be executed. So when you claim, "I will immediately make you repay the loan", they doubt you can enforce that threat. Lets assume for a moment that you tried to write a contract under US law to force immediate repayment of the loan. Okay, can you make the "immediate" happen? No you cannot. Suppose your threat is for a really high interest rate, can you make that happen under US law? No, you cannot; that's usury and even harder than "immediate repayment". That's the concrete steppes argument: your threat is just words, you have no ability to act under (natural,US,etc) law.

The people from the concrete steppes doubt QE is inflationary--they think it is pushing on string. The infaltion derps are a completely different set of people. They don't care what concrete steps the CB will take to hit an IT or NGDP target, They assume that if the string is loose, the beast will run and are deeply upset that the string is loose.

I think you've complete failed to get into your opponent's head with this one Nick...

Suppose I lend you $1,000, at 0% interest. But I warn you that as soon as you spend that $1,000, or lend it to someone else to spend, I will immediately make you repay the loan, or else raise the interest rate high enough to make you regret spending it or lending it. You will not spend that $1,000.

Wrong, I wouldn't borrow it in the first place. It's a crap proposition.

To the extent that you're referring to a situation as described by Nick Edmunds above:

...imagine that you had bought $1,000 of Treasuries from me and warned me that if I attempted to spend or lend that £1,000, you would offer to sell them back to me for the then market value.

I think you have (deliberately?) blurred the distinction between lending and spending. I can't understand why you would do that. Apart from the obvious legal differences between the two,buying and selling assets by the CB constitutes a zero sum game for the economy. Privately held wealth remains unchanged. There is a portfolio shift away from risk (which isn't paying off at the moment, anyway) into safety. Sounds like a decent proposition in a low growth, low inflation environment.

On the other hand, when a provate entity borrows from a bank, be it a secured or unsecured loan, the pledged asset or income stream remains on private books as part of their wealth, while there is an addition of bank money to the economy against the borrower's credibility to deliver on his obligation.

The prior, undertaken by the CB, is macroeconomically insignificant. The latter, undertaken by banks, is macroecnomically significant. Nominal value is added to the economy. At repayment, that should have been transformed into real value. To the extent that it hasn't, we witness inflation.

None of this denies the importance of expectations.

dlr: "I am fascinated by the thought process of Kocherlakota, who is one of the very, very rare cases of publicly flipping monetary policy views in the last six years, although even then he was never an inflation-phobe."

So am I. My working hypothesis is that he is a brilliant man, and a very public-spirited man, but one who missed out on learning the basics, and so has no "horse sense", but is trying hard to catch up. The best and worst of academic stereotypes.

Dan: "There are many and varied causes for the fact that people are not currently attempting, in the aggregate, to buy more output than can be produced and sold at prevailing prices. There are many and varied causes for the fact that people who sell things do not expect their customers to be willing to pay more in the near future."

There are many and varied things that determine the speed of my car. Pistons, valves, hills, and headwinds, etc. The gas pedal is only one of those things. But all those other things are linked to, or can be offset by, me adjusting the gas pedal. (Not a perfect analogy, of course). We are talking about people spending money. And the central bank is the alpha bank.

Real people think about their future job prospects. Real firms think about future demand for their products. NGDP is (roughly) the flow of money spending.

Mike: when they discovered a load of cowrie shells on that island in the Indian ocean, that caused inflation too, because cowrie shells were used as money.

If you are the monopoly producer of something, or the alpha producer in a cartel, you can set either quantity or price. In the first case quantity causes price; in the second case price causes quantity. It's the same.

RepubAnon: "What the author fails to consider is that much of the money supply is not in gold coins, or paper dollars - but stored and spent via credit."

It makes no difference to anything here if money is recorded on bits of paper (notes), or on a ledger, or on a computer. If I have a $20 Bank of Canada note in my pocket, it is exactly as if I have a $20 credit on my computerised account at the Bank of Canada.

JKH: "I think concrete steppes are embedded as contingent actions within expectations and plans and revisions to those things."

OK. I'm with you there.

"In that vein, I think it matters a lot whether the buying remains with financial assets or begins to extend into newly produced goods and services."

I think it matters only a little whether the central bank prints money to buy a bridge or prints money to buy shares in a bridge. The Bank of Canada's balance sheet is normally, IIRC, only around 5% of NGDP. Total wealth is many multiples of NGDP. The portfolio mix on the asset side of its balance sheet doesn't matter much. But on the liability side, it's the alpha bank.

Jon: I can't see anything that would prevent a central bank selling all its assets very quickly, or raising interest on reserves very quickly.

Oliver: "Wrong, I wouldn't borrow it in the first place. It's a crap proposition."

It makes no difference to my argument if I replace "lend you $1,000 at 0% interest" with "offer to lend".

It makes no difference to my argument if I replace "lend you $1,000 at 0% interest" with "offer to lend".

OK, but I still wouldn't take you up on the offer. I guess my point was that CBs can buy up assets that are on offer at will, they cannot expect to lend at will. In both cases, agents must first want to either sell something they have or want to borrow money in expectance of selling something they don't yet have at a profit in future. In both cases, causation runs from the agents, not to them. Governments are agents, too, CBs aren't.

I think it matters only a little whether the central bank prints money to buy a bridge or prints money to buy shares in a bridge.

I think this is an important issue.

My take:

Firstly, central banks are typically not allowed to buy bridges. In most cases not even bridge stock, but I guess your point is they should be? (Not democratic, in my understanding, but anyway.)

If I were in the bridge building business and you offered to buy my bridges at market prices my guess is, I'd feel inclined to build more of them (whether that's sensible, is another question).

If, on the other hand, you bought up my company stock, I'm not sure that's what would happen. I could just watch my share prices rise, feel very good about myself and leave it at that. Or I could buy up your stock in return and we'd both feel very good. Importantly, no income and no production would have to take place, which I think is a realistic scenario.

Lastly, say you offered to lend me money (say at 0%, for any old period) if I invested in (i.e. specifically for the purpose of building) more bridges that I might or might not be able to sell in future. What would I base my decision on then? The terms of the loan, of course, but also my expectations of future sales. And I'm not sure I'd trust a central banker's words as to how realistic my expectations might turn out to be. I'd probably be looking closer to home, e.g. by monitoring sales of other bridge companies or my past experience of business cycles to generate my gut feeling as an entrepreneur.

I think you're trying to replace governments with (unelected) central bankers.

Oliver: "If, on the other hand, you bought up my company stock, I'm not sure that's what would happen."

What is the difference between the central bank buying a bridge and buying 100% of the shares in a bridge?

Oliver: "I think you're trying to replace governments with (unelected) central bankers."

No I'm not. Please TRY to think abstractly.

What is the difference between the central bank buying a bridge and buying 100% of the shares in a bridge?

In the first case, assuming that the central banks orders a new bridge and doesn't buy an existing one, spending feeds directly into the income / production channel. The world is left with more stuff, both tangible and in numbers, after the act.

To the extent that it's an existing bridge, I'd agree with you that there is no significant difference.

No I'm not. Please TRY to think abstractly.

Sorry, that was meant more abstract than what came out. My feeling was that in your mental model the central bank is furnished with powers (ordering new stuff) that is traditionally reserved for governments or private sector agents.

As a general categorisation, I would say the CB's duty is to change the macroeconomic conditions in a welfare enhancing, but preferably neutral way. I.e. with as little picking winners / losers involved as possible. Governments on the other hand, being subject in theory at least to direct democratic control, can legitimately be furnished with more powers in that respect.

But I'll agree with you that the lines are less clear than an economist might like them to be. And, depending on where one does draw them, both central banks and governments will be more or less potent at, well, enhancing welfare. Or at least at changing things, for better or for worse.

Or in other words, yes my statement was highly normative, probably because I feel you are deviating from what I consider a given normative framework without explicitly declaring it. But I'm open to argument and am also glad to read up on your opinion if you've explained yourself elsewhere. No threadjack intended.

Nick,

My comment was a bit muddled. I tend to agree on the financial versus real asset point. I was considering the expansion of CB purchases from assets to consumption goods and services. Maybe that’s where you draw the line. But on this side of the line – assets – my point is about the effect of replacing private sector held direct real investment or financial assets with CB issued money that has a higher up front comparative capital value but with a lower rate of return on that value.

I question why the future cash flow should be significantly different in the two cases. Future cash flow on investment that is “capitalized” by CB issued money would include a low rate of interest plus a return of capital component which in total would be roughly equivalent to the prior comparative risky asset cash flow - vaguely like a Miller-Modigliani effect in terms of comparing the financial capital structure behind the investment in each case.

Oliver: "To the extent that it's an existing bridge, I'd agree with you that there is no significant difference."

Does it make any difference if it buys used cars or new cars, if the sellers of the used car then buy a new car?

Normally the central bank prints money and buys government bonds, and the government sells bonds and buys bridges. Simplify: the central bank prints money and buys bridges.

Nick's quote "Normally the central bank prints money and buys government bonds, and the government sells bonds and buys bridges. Simplify: the central bank prints money and buys bridges." is accurate and perfect.

The central banks are trading property for property. OK, "financial" property for property.

The problem we must see is that the CB's are creating property with the stroke of pen or keyboard. The property bought with this workless money has required a LOT of work to create. This mismatch in work(labor) required to acquire(create) property forces the deployers of capital to ask how they can judge the wisdom of building new productive facilities. Present demand is the result of workless money - how stable is that?

Workless money can buy things. Can it ever be considered as a stable building block?

Normally the central bank prints money and buys government bonds, and the government sells bonds and buys bridges. Simplify: the central bank prints money and buys bridges.

Are you MMTing me?

I wouldn't ascribe agency to the (central) bank.

Government takes on a loan and simultaneously orders a bridge for public use. It commissions a bank to pay the bridge builder. Simplify: government orders a bridge and new money is created in the process. The government/public now owes the bridge builder goods and services worth a bridge. Money / debt are the corresponding receipts of this transaction.

Same happens if I take on a loan to buy a new car. I commission the bank to pay the car maker and am left indebted to the bank, but with a new car to my name. Simplify: Oliver orders a car and new money is created in the process. I now owe the public goods and services worth a car. Money / debt are the corresponding receipts of this transaction.

I see the bank's role more as that of a notary & cashier who controls for due diligence and pockets a share of his own money in the process.

You don't see banks advertising for new homes or bridges. They advertise their conditions for such purchases. Developers like peddle bridges.

Does it make any difference if it buys used cars or new cars, if the sellers of the used car then buy a new car?

If. My contention is that if you buy up consumption goods (new or old) or services or order new investment goods, that this will have an overall quantity effect. The act will create more of the things than would otherwise have been the case. These are acts typically reserved for governments and private entities.

If, on the other hand, the central bank buys assets that are currently counted towards people's savings, that will predominantly have a price effect, because there was no intention to consume in the first place. That's the definition of saving - non consumption. My aim as a saver is to hold and increase the value of my savings. If my assets increase in value, which is what will happens if a monopolist swoops in and buys them up, I'm content as a saver. I don't go out and buy stuff. Or only to the extent that I figure I've saved too much. Maybe a realistic scenario in a world with a 100% inheritance tax and water proof old age and medical securtity.

Or in other words (ramble, ramble), traditional monetary policy consisting of buying up public debt will have the most indirect effect on NGDP, but is also the most benign in its distributionary effect because it is effectively an act of forgiving the public for what it owes itself.

More unconventional monetary policy may have a more pronounced effect on GDP but at the price of having to choose sectors which to invest in over others - which makes it inherently more political. Private risk is taken on by the public.

And lastly, fiscal policy should, in my opinion at least, be left to an agent that is subject to direct political control.

@Wheel:

> You don't need a symmetric tightening to printing money. The printing money solves the asymmetry at ZLB. Tightening via interest rate is (theoretically) unlimited.

That makes sense, but I think the asymmetry is what makes the money-printing politically unpalatable. Resolving the asymmetry is the imperfect motivation behind the Fed's "threat to revoke the loan" that's the issue of Nick's post here.

@Nick:

> Normally the central bank prints money and buys government bonds, and the government sells bonds and buys bridges. Simplify: the central bank prints money and buys bridges.

That's something of a problem here, since you're assuming an unlimited appetite for the government to buy bridges.

This is economically necessary with traditional CB/government divisions, and it is also optimal finance for the government. But the government is not making purely financial decisions, since it is constrained by messy politics.

The entire ZLB mess in the United States would have been avoided had the government responded as sensibly as a hedge fund manager when offered near-unlimited 0% financing: by leveraging ad infinitum. "The spending will continue until interest rates improve."

Monetarists could call it monetary policy transmission, Keynesians could call it fiscal policy, and everyone would be happy.

"Jon: I can't see anything that would prevent a central bank selling all its assets very quickly, or raising interest on reserves very quickly."

That's fine, but your opponents don't agree. On the inflation derp side they doubt that the CB has the will to take accounting losses required by quick asset sales and that the required IOR would exceed the interest earned by the bank on their holdings. And again they doubt the bank will operate with negative net interest margin.

This depends not on their belief in concrete actions but upon their expectations of how the CB will react when the natural rate rises. Their mistake has been to assume the natural rate would rise. So with that qualification, their prediction is not wrong yet.

Question is why has their prediction of the natural rate gone wrong. This makes it clear they are at odds with the people of the concrete steppes because it is they who doubt the natural rate will rise on the back of QE.

I'm for MM, but this is not what The people from the concrete steppes believe.

The people from the concrete steppes want to see proof that your threat can be executed. So when you claim, "I will immediately make you repay the loan", they doubt you can enforce that threat. Lets assume for a moment that you tried to write a contract under US law to force immediate repayment of the loan. Okay, can you make the "immediate" happen? No you cannot. Suppose your threat is for a really high interest rate, can you make that happen under US law? No, you cannot; that's usury and even harder than "immediate repayment". That's the concrete steppes argument: your threat is just words, you have no ability to act under (natural,US,etc) law.

The people from the concrete steppes doubt QE is inflationary--they think it is pushing on string. The infaltion derps are a completely different set of people. They don't care what concrete steps the CB will take to hit an IT or NGDP target, They assume that if the string is loose, the beast will run and are deeply upset that the string is loose.

I think you've complete failed to get into your opponent's head with this one Nick...

Whenever Nick starts talking about Expectations, I always think of Poker. Poker is a game of expectations wherein you bet according to your expectations and then you find out the truth of your prediction by calling. Bluffing is a legitimate and useful strategy; in fact it may be advantageous to bluff a bit to create uncertainty about what a strong bet from you really means.

So the essential question whenever Nick talks about the Expectations Channel is 'Does the Central Bank ever bluff"? Nick says no, its threats are always credible. I'm not so sure. George Soros showed you can bet against the Central Bank and win.

Still, no theory of expectations can be accepted unless it gives a complete treatment of bluffing.

Determinant: as someone else said, it's like a game of poker, except one of the players can print unlimited amounts of chips.

Oliver and Majromax: remember I introduced the central bank buying bridges in the context of an argument/discussion with JKH about monetary vs fiscal.

Jon: OK. I can imagine a world in which monetary policy is irreversible. So that once the spending ball gets rolling, the central bank won't dare stop it. But Japan seems to be closer to that world, given its debt/GDP ratio. My old post "Is Japan already dead?"

Yep, I'm with you on that nick.

@Nick:

I wonder if a useful question for now would be "what would it take to cause hyperinflation?" 'Inflation derps' seem to be saying that hyperinflation is just around the corner, but that is very much not what mainstream economists are saying.

We have a number of recent examples of situations where hyperinflation happens, but I haven't seen much from 'non-derps' about the minimal set of actions a CB would need to take to cause hyperinflation, especially form a ZLB-ish starting point.

I expect that mainstream economics would put that minimal set of actions well beyond the current Fed, BoC, and ECB policies (noting that those three aren't the same anyway), but that's just a layperson's hunch.

@Fflloyyd:

Well if wealth and income were not so (increasingly) concentrated, marginal propensity to consume by the less wealthy could do a lot of the spending work for us. Absent that, government could step in as the proxy spender for that larger mass of spenders. (Or, just give more money to those high-MPC spenders and let them do it). Properly spent, that money could also have the salutary effect of reducing wealth/income concentration, so increasing the velocity of wealth.

If the Fed were less anxious about the bogeyman wage inflation as a terrifying harbinger of goods/services inflation, they would allow (actually, encourage) the resulting upward spiral, only stepping on it when actual goods/services inflation became worrisome. They might also raise the bar for what "worrisome" means.

@Roth:

Marginal propensity to consume is a partial equilibrium analysis. If I decide to save $100 by buying stock or bonds, then that means that someone else -- a prior holder, or the debt/stock issuer -- has $100 now that *they* have to do something with.

They could save it, but then the process repeats. It's only when the money is "saved" via cash, bank reserves, or sold to the CB (in a monetary contraction) that the currency actually leaves circulation.

What if the developed nations simply have an inability to increase inflation with normal Fed tools? To have inflation you need more demand than supply but the West has had falling populations in the 25 - 50 year bracket. So the issue is not Fed or fiscal policy but too little growth in families. In all reality, all developed nations are doing their version of Turning Japanese.

How does central bank spends money on expected government outlays change expectations?

If the bridge was going to be built anyway who cares?

Unless actual plans for spending are changed, what difference does it make what the interest rate is? Or how much money there is? the central bank buying mortgages increases the demand for mortgages and the supply of mortgages. If the central bank buys government debt without the result being an increase in supply what difference does it make to ngdp?

@ Majromax

Not so if you you're looking at Velocity of Wealth.

http://research.stlouisfed.org/fred2/graph/?g=OfY

Now you could claim that higher velocity of wealth causes there to be less wealth hence the same amount of spending, but it seems the effect of higher spending on wealth would be the opposite: more production, so more surplus from production, more profit, more hiring, etc. Y is higher than in the counterfactual. The see-saw levitates.

A little late here, but I've read the comments and still have a question.
I understand the mistake of the concrete steppists - if the CB is credible in fighting inflation above its (say 2%) target, then one shouldn't make spending/investing/pricing decisions predicated on >2% inflation. Regardless of how much credit is available, spending won't accelerate to the point that inflation exceeds 2%.
All fine. But where I have trouble is the implication that printing money has no effect at all on spending.
"If printing lots of money did cause people to spend it and cause inflation, then central banks would immediately put the printing presses into reverse. They would buy back the money they had printed, and burn it, to stop people spending it and causing inflation. And people expect they would do this. And no individual will spend unless he expects other individuals to spend. So nobody spends. It's a credit deadlock, created by counterfactual conditional expectations about what central banks would do if people did something that they won't do, because of those expectations."

If inflation is running below target, I don't see the "nobody spends" deadlock occurring. The individual sees two possible outcomes: nobody spends, and credit stays cheap, and everybody spends to the point that inflation gets back to target before the CB reverses course. Seems in either situation it's rational to borrow and spend, no?
Also if the CB is lending to you for term (taking duration onto its balance sheet), it may be rational to borrow for term and spend, even if you think the CB will be increasing rates soon in response to the spending.

> If inflation is running below target, I don't see the "nobody spends" deadlock occurring. The individual sees two possible outcomes: nobody spends, and credit stays cheap, and everybody spends to the point that inflation gets back to target before the CB reverses course. Seems in either situation it's rational to borrow and spend, no?

Suppose that the CB lends $100 to me at 0% interest, rolling over on a daily basis. The CB can change its interest rate at the next rollover, and it has indicated that it will do so only if inflation begins to increase towards its 2% target.

I'm the representative agent, but I don't know that. I'm inclined to spend some fraction of that $100, but I'm not allowed to take any actions that will put me in default if the CB refuses to roll over the loan.

So, I my income to remain steady in real terms and nominally increase with the inflation rate. Because of the CB's statements, I expect inflation to remain between 0-2%, and if it gets above that I'll have to repay the loan.

That means that I'll only feel safe spending a small fraction of that loaned amount -- somewhere in the 0-2% neighborhood. That way, if inflation *does* rise and the CB calls in the loan, I'll be able to pay off the portion I consumed with the nominal (inflation) increase in my income.

Now, since I'm the representative agent it turns out that spending comes back to me as additional income -- bonus! But I don't know that's why it came back to me, nor can I be certain it's an increase in my permanent income. To the extent that I'm not certain, that CB-loan-consumption is a windfall. I'll probably figure things out over time, but it will still take me ages to consume the entire $100.

Now, if the CB gave me that $100 loan and said it wouldn't call it in until inflation was above 5% (that is, temporarily changing the inflation target), then I'd be confident to consume a proportionally greater fraction of the loan.

If the CB gave me $100 and said it was never calling it in (a permanent increase in the monetary base), then I wouldn't hesitate to spend the entire amount. In fact, I'd probably rush to do it as quickly as possible in order to outrace others' inflation expectations and price hikes.

The CB giving me a long-term loan is somewhere between the extremes. If it was a 0% loan for 999 years, I'd consider it something like a gift; if it was for two days rather than one then it would make no difference. Term structure would be the CB's way of saying "this is a temporary but long-term increase in the monetary base," and I think politically that would make everyone unhappy.

So the reason prices are not rising is that people expect the Fed to put printing presses in reverse as soon as they start rising.

This makes a lot of sense. Thanks a lot for clarifying that. However I have a few questions:

1) is this a falsifiable theory? What would it take for you to stop believing that is the true reason?

2) If this explanation is true, it is not clear to me why there has ever been inflation in the past. Why was that?

3) What about the claim that, if we count stock prices, inflation did rise? (OTOH, commodity prices are down, so I am not sure on net there was inflation in assets).

> is this a falsifiable theory? What would it take for you to stop believing that is the true reason?

Well, this isn't so much a predictive theory in and of itself as an explanation of why another theory (QE should lead to massive inflation) is false.

This story would be false (or incomplete) if we do see massive US inflation for no other reason than QE. The primary indication there would be something along the lines of hyperstagflation, where real output stays low while inflation goes well above the Fed's target.

This also isn't a theory of "no inflation, ever" -- it's instead a theory as to why inflation hasn't picked up as quickly as many, including the Fed itself, would like. A primary deeper-level piece of evidence in this story's favour is that the greatly expanded monetary base is not reflected in circulating, M2 money stock.

If M2:MBase ratios reach historical levels with an expanded MBase, then it would be fair to conclude that "nobody wants to spend because the Fed will call it in" is false. This could be evidence that either people are spending anyway, or evidence that people think that the expanded MBase is permanent-ish.

> If this explanation is true, it is not clear to me why there has ever been inflation in the past. Why was that?

Because most traditional inflation has been demand-driven, coinciding with (and arguably following) expectations of relatively rapid growth.

> What about the claim that, if we count stock prices, inflation did rise?

Why should stock prices be considered part of inflation? Nobody eats, lives in, or otherwise consumes stocks.

Assets can be highly-priced if, collectively, people wish to save a great deal of their income and/or defer consumption until later. In that case, they will be willing to accept low rents on land and low returns on capital. A farmer's field will still produce the same number of carrots regardless of the underlying land price, so high land prices and low carrot prices say something about people's preferences.

House prices are a bit special because rent-equivalence is an imperfect way of measuring housing costs. In many areas, you simply can't rent the same kinds of homes that you can buy (and vice versa). This argument doesn't apply to nominal-valued savings vehicles.

I will immediately make you repay the loan... to make you regret spending it or lending it. You will not spend that $1,000.

Sorry if this has already been asked: ok, printing money while threatening people from spending it will not cause inflation. But why should we expect it to help exit the depression? I.e. I get why it won't cause inflation, but why should it have any positive effect at all? Thanks

@Maurizio:

> Sorry if this has already been asked: ok, printing money while threatening people from spending it will not cause inflation. But why should we expect it to help exit the depression? I.e. I get why it won't cause inflation, but why should it have any positive effect at all? Thanks

Two factors come into play here.

The first is that "you won't spend it" isn't quite a binary decision. It's more like "you won't spend much" of it, as I noted in my comment above. Even if you're only comfortable spending 1% of that total per year, that's still a small net boost to aggregate demand.

The second factor is that the policy does act as insurance against deflation. As another recent post here noted, the subjective chance of significant deflation in 2008 was quite high. QE acts as a stopgap, which improves the mean expected inflation slightly by cutting off the long, deflationary tail.

Truth be told, the US economy would be better off if the "inflation derps" were correct. If QE was a recipe for significant, near-term inflation in the current economic climate, then the US wouldn't have needed nearly as much of it, nor would its forward-looking inflation expectations still be below 2%.

The second factor is that the policy does act as insurance against deflation.

I see. But then, if it avoids deflation, it is wrong to say it does not create inflation. It does create inflation relative to the counterfactual (i.e. relative to what would have been if the policy had not been enacted).

I think a lot of misunderstanding is caused by this. QE did create inflation relative to the counterfactual, but not relative to the previous price level.

> I see. But then, if it avoids deflation, it is wrong to say it does not create inflation. It does create inflation relative to the counterfactual (i.e. relative to what would have been if the policy had not been enacted).

No, I think that's improperly glossing over a qualitative difference.

While the mainstream thought is that QE prevented modest deflation in the United States, I believe that it did so through not through changing a median estimate, but instead through eliminating the low probability, high-deflation events.

Deflationary fears were supported by the idea of mortgage risk and counterparty risk; it wasn't simply that AD was insufficient, it's that credit was tight because a bank couldn't trust its own balance sheet or its peers. Through outright purchases of mortgage-backed securities, the Fed took that risk on itself.

In the language of Nick's post here, it said "if the mortgages really go under, this expansion of the monetary base will be permanent." In turn, it's not surprising that successive rounds of QE are not having a markedly inflationary impact. Further purchases of government debt and not-risky assets are not changing anyone's ideas of conditional solvency of banks, and at the same time the Fed is unlikely to take a nominal loss if it holds its assets to maturity (meaning there's little long-term barrier to unwinding QE).

On the other hand, the "inflation derp" argument is a median-based one, which looks like the basic quantity theory of money: it suggests that since MBase has gone up markedly (true), much more than potential RGDP growth (also true), ergo the price level must also increase after short-term disruption (maybe not true).

So the mechanisms by which "QE did create inflation relative to the counterfactual" do not directly extend forward. That forms the core of the difference between inflationary and noninflationary interpretations of QE.

if the mortgages really go under, this expansion of the monetary base will be permanent.

Very insightful.

So we can say that the market currently thinks that the mortgages will not go under. Right? (because it treated the monetary expansion as not permanent).

And if the mortgages do go under, the market will suddenly realize it was wrong, and we will have a sudden burst of inflation?

I wonder what is the likelihood that they will go under.

> And if the mortgages do go under, the market will suddenly realize it was wrong, and we will have a sudden burst of inflation?

To the extent that the Fed holds mortgage-backed securities that take a loss, yes. But the monetary base expansion has been half treasuries and half MBSes:

(I don't know what causes the gap in 2008-10, it seems to be a mix of under term loans and the ad-hoc "Other Assets" on the Fed's releases)

However, that effect would be mitigated somewhat by a renewed round of bank losses, depending on whether the mortgage losses are confined to what the Fed holds or what the private sector holds.

> I wonder what is the likelihood that they will go under.

Probably low. If nothing else, the Fed is in a position to hold things to maturity, whereas the banks have a mix of liquidity and solvency issues.


Majromax, thank you for your helpfulness :)

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