Blue sky money one - the dual mandate

Leland Yeager's (ed.) "In search of a monetary constitution" was the book that most excited my thinking about monetary economics as a PhD student. He asked the contributors to the volume to design a monetary system from scratch. He told them to think "blue sky". I can't remember all the contents. The answers given were less important than the question he asked. It forced you to think deeply about what you wanted a monetary system to do.

I may do more posts like this, so I have called this post "Blue sky money one". I will explain the "dual mandate" bit later.

The blue sky monetary system here is loosely based on: James Buchanan's proposal for "brick money" in the Yeager volume; something Brad DeLong once said in passing about the unemployed panning for gold; and various MMT economists (I've forgotten exactly who, but I don't feel I have to stick to what anyone else said).

Imagine an economy in which physical gold was used as the medium of exchange and medium of account. Gold is money. And imagine that every household had access to a nearby stream where anyone could pan for gold, and the average worker could collect one ounce of gold per day, using labour only, with no diminishing returns.

Any unemployed worker would go panning for gold and earn a wage of 1 ounce per day. If wages in regular jobs ever fell below 1 ounce per day, workers would quit their jobs to go panning for gold. If wages in regular jobs ever rose above 1 ounce per day, workers would stop panning for gold and get a regular job instead.

This monetary system has some very nice equilibrating properties. It would be a "full employment" economy, in the sense that anyone who wanted a job and was prepared to work for 1 ounce of gold per day would have a job, even if it was panning for gold. The economy would also have a nominal anchor, in that the long run equilibrium level of money wages for unskilled labour would be pinned down to 1 ounce of gold per day.

The flow supply of new money responds automatically to: unemployment; and the level of nominal wages. If regular unemployment increased, more workers would pan for gold, and so the money stock would automatically grow, which would increase demand for goods and labour, and so increase regular employment. If regular unemployment fell, fewer workers would pan for gold, so the money stock would grow more slowly. If this were a growing economy, with a growing demand for gold, either as money or for industrial use, this would mean the supply of money would grow more slowly than demand, and so regular unemployment would rise again. In equilibrium, there would be just enough workers panning for gold to make the supply of gold grow at the same speed as the demand for gold.

The flow supply of new money also responds automatically to money wages. If money wages fell below 1 ounce per day, the flow supply of new money would increase, pushing money wages back up. If money wages rose above 1 ounce per day, the flow supply of new money would fall, pushing money wages back down.

It's a bit like a "dual mandate" monetary policy, with both a full employment target and a price level (or rather wage level) target. Except, and this is critically important, "full employment" is not defined in the normal way. Rather, "full employment" is defined as every worker who is willing to work at the target nominal wage has a job.

Normally we follow Phelps and Friedman in saying that any monetary policy that targets "full employment" is doomed to either accelerating inflation or deflation, because there is no nominal anchor. But this monetary system escapes the Phelps/Friedman problem because "full employment" is defined relative to the nominal anchor. If you aren't working, and are searching for a job, but are unwilling to work panning for gold at 1 ounce per day, then you are not "unemployed", by this definition of the full employment target.

Maybe it's not a very efficient system, because a lot of workers would be panning for gold, even in full equilibrium, when paper money would work just as well and with far less effort wasted to produce the money. And we don't all have a gold stream just down the street either.

So suppose the central bank creates an artificial gold mine, where workers can pan for paper money. Why not just call it Employment Insurance. Any unemployed worker can collect EI benefits, whether they lost their job, were fired, or just quit. And EI benefits are financed by newly-printed money, which is the only way new money can be created. It's exactly like a paper gold mine.

The key point is that EI benefits must not be indexed to inflation. The unemployed can mine a fixed 1 ounce of gold per day, or a fixed $W of paper dollars per day. If EI benefits were indexed to (price) inflation, you would lose the nominal anchor in the system. Instead, the level of EI benefits must be fixed in nominal terms. Or else rise at some fixed rate like 3% per year (for 1% equilibrium real wage growth plus 2% price inflation).

That system should work just like the original gold panning system. It has a nominal anchor. Any rise in unemployment or slowdown in wage inflation will set in motion a faster growth in the money supply that will tend to reduce unemployment and increase wage inflation. Any fall in unemployment or rise in wage inflation will set in motion a slower growth in the money supply that will tend to increase unemployment and reduce wage inflation.

But those equilibrating forces could be slow to act. Why not have the central bank speed them up by using open market operations? Otherwise a sudden large increase in demand for money will cause a prolonged period of unemployment while the unemployed produce enough new money to match the increased demand.

Here's a revised proposal. EI benefits still grow at some fixed path like 3% per year. But the central bank has a target rate of unemployment, say 6%. If more than 6% of the labour force is collecting EI, the central bank does open market purchases and creates as much money as is needed to push unemployment back down to 6% as soon as is reasonably possible. (I'm leaving that targeting horizon unspecified). If less than 6% of the labour force is collecting EI, the central bank does open market sales and destroys as much money as is needed to push unemployment back up to 6% as soon as is reasonably possible.

Why 6%? What happens if the central bank targets a lower or higher level of unemployment? And isn't there some natural rate of unemployment out there somewhere? What happens if the natural rate is above or below 6%?

There is a natural rate out there somewhere. But the natural rate of unemployment depends on real (inflation adjusted) EI benefits. The higher are real EI benefits, the lower the penalty to being unemployed, and the higher will be the natural rate of unemployment.

Now in this monetary system it is nominal EI benefits that are fixed exogenously. Given that level of nominal EI benefits, if the central bank chooses a lower unemployment target, the consequence will be a rise in the equilibrium price level, and a fall in equilibrium real EI benefits. If the central bank sets too low a target for unemployment, the price level would rise, and real EI benefits would fall, until workers were desperate enough to take any job rather than starve on EI. A civilised level of real EI benefits would require a higher target unemployment rate.

It's a theoretically interesting monetary system. It shows that it is possible, at least in principle, for a central bank to have a dual mandate. It can target a particular level of unemployment and have a nominal anchor at the same time. It is the exogenously fixed path of nominal (unindexed for inflation) EI benefits that provides the nominal anchor for the monetary system. (Government make-work projects with a fixed nominal wage could also play the same role as the EI paper gold mine.)

But I'm not sure if it's a good monetary system. Any exogenous real shock to employment might require large changes to the equilibrium price level and real EI benefits for the system to re-equilibrate itself.

Comments

[Min]

Verrry interesting, Nick! :)

A few questions:

1) Is this like those local systems where the currency is in terms of hours of work?

2) There is a mechanism for adding money to the system. What about a mechanism for taking it out?

3) What about the creation of money by private banks?

4) Why shouldn't the daily wage in gold units fall below subsistence? Monetary systems have been based upon tobacco or grain. Such a monetary system could be defined so that the daily wage produces some multiple of what is required for subsistence. (Short a catastrophe.) It could also have the property that money is eventually consumed or goes bad, so that money is taken from the system.

[Jim Rootham]

I wouldn't use the term Employment Insurance. An EI system is designed to mitigate the shock to the individual of losing a job and therefor should be close to the lost wage and payed for a period of time.

What you are really describing is an employer of last resort system, or a guaranteed annual income system, depending on whether working for the minimum is required or not.

The unemployment target system is evil, it targets the most vulnerable people in the economy.

[David]

This is Minksy's idea for a Government Work Programme. I think Abba Lerner had the same idea which he discussed in Functional Finance (published shortly after WWII) as an extension to the work of Keynes. And it's certainly an idea that's been picked up by Chartalist / MMT economists as the logical conclusion of the proposition that it is only after governments have spent 'money' that they create the IOUs that the government will accept as payment for a tax liability; in other words you owe the government taxes, you've already sold the government some goods and services that the government paid for with IOUs (monetary base), why don't we cancel the two out and consider the debt and taxes paid? MMT economists tend to describe it as the government being the ELR (the employer of last resort). In fact, I believe that the Center for Full Employment and Price Stability (which is a thinktank /publication forum devoted to MMT economics - www.cfeps.org) takes it's names from this idea that a government-provided employment programme of last resort would provide both full employment and price stability. Whether they're right, I have no idea, but it is an interesting idea.

[nanute]

Nick,
The late Bill Vickrey, published his 15 Fatal Fallacies of Financial Fundamentalism in 96'. Just as relevant today as then. In Fallacy #6, he had this to say: ......Indeed, if we are to control three major macroeconomic dimensions of the economy, namely the inflation rate, the unemployment rate, and the growth rate, a third control is needed that will be reasonably non-collinear in its effects to those of a fiscal policy operating through disposable income generation on the one hand, and monetary policy operating through interest rates on the other.

What may be needed is a method of directly controlling inflation that do not interfere with free market adjustments in relative prices or rely on unemployment to keep inflation in check. Without such a control, unanticipated changes in the rate of inflation, either up or down, will continue to plague the economy and make planning for investment difficult. Trying to control an economy in three major macroeconomic dimensions with only two instruments is like trying to fly an airplane with elevator and rudder but no ailerons; in calm weather and with sufficient dihedral one can manage if turns are made very gingerly, but trying to land in a cross-wind is likely to produce a crash.....http://www.columbia.edu/dlc/wp/econ/vickrey.html Take a look if you think it's relevant.

[Frances Woolley]

Nick, interesting post.

This is like the 21st century equivalent of cowrie shell currency.

Games like World of Warcraft actually have economies that work somewhat like this - people can (and do) pan for gold - but I don't know if anyone has looked seriously at their macro-economics.

[JKH]

Nick,

I found this very interesting, maybe because of the MMT comparison that’s inherent in the second part about EI.

Roughly speaking, you use a similar concept to a buffer stock of labour that is not employed by the private sector. You use EI; MMT uses ELR (employer of last resort).

In both cases, the nominal compensation for this buffer stock is fixed.

The size of the buffer stock varies, reflecting the conventionally defined unemployment rate.

In your final version, you use monetary OMO to alter money supply and by economic effect the size of the buffer stock.

MMT uses fiscal expansion or contraction. (I sometimes think of that process as fiscal OMO.)

The difference in transmission channels I suppose gets down to that old debate about increased money versus increased saving. But the first round effect of fiscal is always money anyway.

So I think it’s comparable in the sense of MMT fiscal channels versus MM monetary channels.

The first part on gold seems weirder to me – Rube Goldbergish.

[Gizzard]

Nick

Another nice post. I was actually going to ask you to do a post where you were appointed Treasury secretary by Rick Perry after he secedes in Dec 2012 following Obamas reelection, and give us a description of how you would *do money* in the new country. This is part of the answer and I actually like it.

Seems to me that what you object to is calling something fiscal policy. Much of what you describe could be called fiscal policy but when you run it via a Central Bank you dont have to call it such. Has fiscal become such a dirty word that it cannot even be uttered in conservative circles anymore?

[Nick Rowe]

Min: "Verrry interesting, Nick! :)"
you are dating yourself, I think. You mean like this?

http://www.youtube.com/watch?v=QczyNaIu9Mo

I loved that show, as a kid in the 1960's, even though I only understood half of it.

"1) Is this like those local systems where the currency is in terms of hours of work?"

Like LETS. Hmmm. I'm not sure. Good question. I don't *think* so, because the LETS money is inside money (a redeemable liability). Gonna have to think about that one.

"2." You don't really need a mechanism for taking money out of the system, if the economy is growing over time. Alternatively, in the simple EI system (before we introduce open market operations) you could use EI premiums to take money out of the system.

"3." The rules of "Blue Sky money" allow you to ignore stuff, like banks and the absence of gold in our backyards. If we introduce banks into the original model, the real demand for monetary gold would fall when banks first appear, so the price level would rise, and workers would stop panning for gold. Over time, if the population grew, and real income grew, the demand for gold would steadily rise, and the price level would steadily fall, and nominal wages would steadily fall, until they started panning for gold again. But the instability of banks would cause bigger fluctuations in the amount of gold panning.

"4." It could. If the demand for gold/money fell by a big enough amount, it would. If the central bank targeted too low a level of unemployment, in the EI system, it would too.

[Nick Rowe]

Jim: "What you are really describing is an employer of last resort system, or a guaranteed annual income system, depending on whether working for the minimum is required or not."

Yep, but the only substantive differences between the EI system in my thought-experiment and (say) the current Canadian EI system are: benefits last forever and are given to anyone (say) 18-65 who is not currently working (you could say that instead of panning for gold they are told they have to pan for jobs); it's money-financed.

"The unemployment target system is evil, it targets the most vulnerable people in the economy."

It is precisely those people who say that unemployment is a terrible thing who usually argue for an unemployment target for monetary policy. I'm going to let you argue that one out with those people (usually lefties) who favour an unemployment target. What I'm trying to understand here is the mechanism through which such a monetary system might work to actually hit that target while not having hyperinflation of hyperdeflation. We actually have to understand that, before we can say that it's an incredibly good thing because it helps keep unemployment low and stable, or the terrible thing you say it is.

[Nick Rowe]

David: thanks for that useful background. I vaguely remember reading about it somewhere before, so that was probably in Lerner. Then I was intrigued by reading one or two of the MMTers on it (Bill?, damn but my memory is going). But what I didn't pick up from those MMTers (maybe I missed it) was that the nominal wage paid in the government job/EI *must be fixed*, and cannot be indexed for inflation, because otherwise you lose the nominal anchor. And then, once you think about the mechanism through which the unemployment target is hit, you realise it is equivalent, *in the long run* to adjusting that real wage/EI benefit until you hit the unemployment rate target. Which takes some of the shine off the plan. But as a short run stabilisation device, it still interest me. It's not an obviously stupid plan. It does have some nice equilibrating properties.

nanute: thanks, that is relevant. Translating Bill Vickrey into standard economese, what he's saying is this: instrument #1 is monetary policy which can control the price level; instrument #2 is fiscal policy which can control the natural rate of interest and therefore investment and long run growth; now, what is instrument #3 that controls unemployment? What I'm saying here is that if you think of the gold panning/EI/guaranteed employment plan as instrument #3, it turns out in practice, in the long run, once you start thinking about it, as the real level of EI benefits. Which is perhaps not what the proponents had in mind.

[Nick Rowe]

Frances: thanks!. I hadn't thought about the cowrie shell example, but I think you may be right. (Anyone could work at collecting cowrie shells, so they had an elastic supply?)

I vaguely remember some macroeconomists looking at WoW.

JKH: Thanks!

"In both cases, the nominal compensation for this buffer stock is fixed."

Aha! I missed that. Maybe didn't read it carefully enough. Translating between MMT and other economics is hard, because they often speak a different language. (One beef I do have with their language is that, it seems to me, they are very fuzzy on the real/nominal distinction). But what I'm trying to show here is some basic isomorphism between different policies/models. At root, the MMT Guaranteed Job plan is the same as (Brad DeLong's imaginary) gold panning example. The only difference is that one uses paper and the other uses gold.

Gizzard: Thanks! I'm not sure whether I actually like the Blue Sky monetary system here though. Gonna do another Blue Sky post soon.

"Has fiscal become such a dirty word that it cannot even be uttered in conservative circles anymore?"

This funny thought keeps running through my head. In a low real interest economy, the conservatives agree to what the liberals want, and in return the liberals agree to stop calling it "fiscal policy" and call it "profitable government investment that meets the NPV greater than 0 criterion".

Just like the old joke that 20 years ago, the Keynesians agreed to all of monetarism, and in return the monetarists agreed to call themselves "New Keynesians".

Really though (and this is in response to JKH too), the monetary policy here can be said to be both monetary *and fiscal*. The government/CB is buying the unemployed's time with newly-printed money.

[JKH]

Nick,

I have to admit that I've assumed from memory that the MMT ELR wage rate is fixed, in the sense that I don't recall any inflation index adjustment and would be surprised to discover that's the case. I could be wrong on that.

[JKH]

But maybe right:

http://mmtwiki.org/wiki/Employer_of_last_resort_-_Job_Guarantee_as_price_anchor

Intro:

"(iii) that wage is not indexed for inflation"

[W. Peden]

On World of Warcraft: here, my generation can certainly help!

http://www.lewrockwell.com/orig7/villacampa1.html

It's very different from an old RPG like the Might & Magic games, where there is a single purchaser (the player), a fixed set of sellers (the game's shops), an infinite supply of most goods*, and fixed prices. In both cases, the supply of money is labour-determined.

* For those goods that aren't infinite in their supply e.g. special items or particular items at particular shops at particular times, the response to demand is the creation of a shortage.

A standard RPG is actually a good way to teach the effects of price controls under inflation, now that I think about it. Assume the case above, then remove the infinite supply of goods and assume that the supply of goods is determined by the ability of producers & sellers to make profits. Then imagine a big increase in the supply of money (e.g. a boss dragon is killed). Because the prices are fixed, they can't rise in response to the increase in the supply of money, and the result is a dramatic increase in shortages instead.

This is roughly how inflation works in real-world economies with fixed prices e.g. the old Eastern Bloc economies. It actually means you can get severe supply-side depressions as a result of an increase in the supply of money, as occured in the USSR in the 1988-1991 period. Far from stimulating the economy, the increase in the supply of money drives up the market prices above the fixed prices and destroys economic activity in proportion to the increase.

And that is what RPGs have to do with monetary inflation under command economies!

[Nick Rowe]

JKH: thanks for checking that.

So, if we wanted to implement the Employer of Last resort/Gold panning plan in Canada, this is what we should do:

1. Stop indexing EI benefits for inflation.

2. Make EI benefits of indefinite duration. Anyone who is available for work (somehow defined) but not working gets EI.

3. Tell the Bank of Canada to stop targeting 2% inflation and instead target X% unemployment, where "unemployment" is defined as "collecting EI".

If we choose X below the existing natural rate of unemployment, given current real EI benefits, the price level rises, and real EI benefits fall, until the percentage of people collecting EI falls to X. The natural rate adjusts to the target rate via a fall in real EI benefits. And we could get the same *Long Run* reduction in unemployment (minus the desirable short run stabilisation effects) by just cutting real EI.

That above paragraph is the part that *some* MMTers really won't like. I expect I'm going to get kickback on this. Oh well. Hang onto your hats.

[Nick Rowe]

W Peden: Neat! The case where an increase in the supply of money causes real output and employment to decline when prices are fixed is part of the old Barro and Gordon 71 paper. Cuba was just like this in the 90's. No point in working, because you couldn't spend the money you already had.

[JKH]

Nick,

“That above paragraph is the part that *some* MMTers really won't like.”

I’m not sure.

The difference is between a buffer stock of ELR employed versus a stock of unemployed.

Both are compensated at a fixed nominal rate.

The buffer stock of ELR employed releases a flow of ELR employed into the private sector according to real resource capacity availability and demand for privately employed labour. MMT would still monitor inflation risks as this process proceeded to higher levels of private employment. It would tighten fiscally in the face of inflation, and the flow would slow down and likely reverse.

So I think the real ELR wage rate would fall with inflation just as would the real EI rate.

What I’m saying is that MMT may have an implicit view of a natural ELR buffer stock level.

They don’t like the idea of a natural rate of unemployment because they don’t like the idea of unnecessary unemployment. But I think they could translate the idea of natural to the ELR population – at least as a statistical expectation for some sort of average “equilibrium” between ELR and private employment.

[Mandos]

Once again it hinges on a kind of impossibility theorem, it seems to me, which is the NAIRU/Friedman Memo/whatever: that we can't have full employment at a living wage without [insert unacceptable consequence] here. And once again the empirical validation of the physical necessity of economic immorality is confined to a single cluster of data points with the explanation given by one man with a known prior agenda, as I mentioned in the "lefties vs. NGDP" thread.

So I have to ask again, what is the purpose of this sort of speculating-assuming-we-have-one-arm-tied-behind-our-backs?

[Mandos]

I think Jim Rootham is using a different language from you, and means something different by "unemployment targeting." I assumed he meant "sacrificing employment to avoid inflation".

[K]

Who cares about unemployment?! :-)

Seriously. Leisure *is* a valuable good. I don't want to work! Why do we insist on ignoring the utility of slacking off. We don't target the quantity of any other good. Why do you all care so much how I spend my time? Can't we just focus on income? (Good post, by the way, Nick!).

[Frances Woolley]

W. Peden: "On World of Warcraft ... http://www.lewrockwell.com/orig7/villacampa1.html"

Great link. What's interesting there is now the fact that there is a single global currency on WoW means that gold farmers from low wage countries can create "money" that causes WoW players in high wage countries to experience inflation. Suggesting that there must be some kind of optimal currency zone for Nick's EI currency.

[Mandos]

I am totally on the same page as you K. I'm in favour of a society where human worth (and the compensation in life that accrues therefrom) is not directly correlated to some arbitrary (ie, market) way of defining, valuing, and remunerating work. Unfortunately, we are stuck with this system for now, so the compromise must involve some system of ensuring well-remunerated work.

[Jacques René Giguère]

"Has fiscal become such a dirty word that it cannot even be uttered in conservative circles anymore?"
In the textbook I use in Introductory macro, there is no mentiono of fiscal drag, automatic stabilizer, Injections-Withdrawls model or the paradox of thrift. The explanations on fiscal policy is so short there is nothing to understand about why and how it could work.

[Nick Rowe]

JKH: You may be right. Maybe they want to distinguish between the ELR as a way of permanently lowering long run unemployment (which is dubious), and ELR as a short run macro stabilising system (which is not obviously wrong and may make sense).

Mandos: The strict natural rate hypothesis says that monetary policy gives you no long run trade-off between unemployment and inflation. Very few economists believe that. Most of us think that somewhere around 2% inflation target gives you about as low unemployment as you can get, and there are no gains from going much higher. If you want to say it's not 2% but (say) 12%, then OK. Just replace my 3% inflation for EI benefits with 13% instead, and it makes no difference to the rest of this post.

Sorry. Normally I spend a lot of time arguing against lefties who think that *tight* money is a capitalist conspiracy designed to screw the workers by creating unemployment in order to keep inflation low. And a few days back I was arguing against a lefty (Alex) who thought that *loose* money is a capitalist conspiracy to create inflation in order to screw workers out of their real wages.

So I'm totally burned out arguing with lefties over this stuff. There is no (OK, little) intellectual coherence on the left when it comes to monetary policy and the Phillips Curve. And they don't draw the thing or write down a model. All I hear is a jumble of words. And the only thing you can be certain of is that, whatever happens, whether monetary policy is tight or loose, it's all a capitalist conspiracy to screw over the workers.

Sorry. I'm burned out after that futile exercise with Alex on the Inflation Fallacy.

[Steve Roth]

Nick, re #3 and MMTers objecting:

The problem seems to be the BoC intervention. (?) Suppose we tell them to stop buying and selling bonds entirely? Would we achieve homeostasis? (Which I'm thinking is a much better term for what we're discussing than "equilibrium.")

[Determinant]

The only theoretical problem with this posited scenario is the one that Min mentioned in his Point 4: what happens when the wage of one ounce of gold falls below subsistence? There is an implicit assumption here that a person can purchase his daily requirement for food, housing and clothes with his wage. But there is no mechanism to enforce this; it may or may not be true, and we must accept that there is a significant portion of time where it may not be true. Else all you could do with that ounce of gold is to play heads and tails with it.

Further Mandos and K are really closer than K thinks. What K is talking about is full-consumption leisure. Leisure to most people is where you don't have to work but are free to consume, especially on good and services that bring pleasure. However if you cannot consume at that rate or anywhere near it you don't have leisure, you have unemployment. This is a far more painful condition than leisure outside work. Unemployment and full-consumption leisure are very different things.

[Miraj Patel]

Certainly very interesting. In some regards Milton Friedman supported a similar system through his support of a negative income tax- a base nominal refund that everyone would get regardless of whether or not they worked.

[Ralph Musgrave]

Nanute:

When Vickrey claims we need three policy instruments for the three policy objectives you mention, he is appealing to the Tinbergen principle. This principle states that government needs one policy instrument for each of its objectives.

I’m a big fan of the Tinbergen principle, and Tinbergen deserves the Nobel Prize he won. But I think Vickrey interprets it too literally and without regard for common sense.

For example, the two objectives “minimising inflation” and “minimising unemployment” can be conflated into one “objective” since the two are very closely related: i.e. inflation and unemployment vary inversely. That is, there is arguably just one objective here: something like “optimising the inflation / unemployment relationship”.

Also, I don’t see that economists can do much about growth in the long term: growth is determined, in the long run, mainly by technological improvements, population growth, the extent to which law and order are maintained, etc etc. Thus it could be argued that just ONE POLICY INSTRUMENT is needed for the three objectives that Vickrey cites.

[Borror0]

@Frances:

Unfortunately, most of my MMO experience is with Dungeons & Dragons Online, a game that has a far less well-developed economy than World of Warcraft, but hopefully I can still accidentally say something interesting.

In Dungeons & Dragons Online (DDO), money is created in one of two ways: money acquired through quests (either as a reward or looted from chests) or by selling items acquired through questing. In other words, money is generated as a result of normal gameplay. However, when an item is bought, the money is removed from the economy. We call that a "moneysink". If there are not enough moneysinks, the value of money continually goes down as more and more money gets created until it loses all value and we switch to a barter economy.

In DDO, there are two ways of trading desired items:
- The Auction House
- A forum post on the official forums

The Auction House (AH) is basically the eBay of MMOs: one posts the items he wants to sell and others bid on the items. However, there is a maximum bid possible: 21 million gold pieces (gp). If you bid that amount, you automatically win because no one can outbid you. It also means that, if the Auction House is the only means big which item can be traded, the maximum value of an item is of 21 million gold pieces. Additionally, the Auction House takes a small cut of the amount (30%) which further reduces the maximum value one can get out of a sale, and acts as a moneysink.

A forum post is drastically less efficient than using the Auction House. If the AH is like eBay, forum posts are like a dating site: you post something, and hope that either a mutually beneficial proposal appears or that you encounter one after hours of browsing.

Compared to the AH and all its neat search features that makes looking for items more efficient, the forums are deeply inefficient: higher search costs, same outcome (a trade). Yet, for several reasons, many trades are made through forum posts (i.e. barter). First of all, the value cap makes it impossible to trade items of value superior to 20M gp. Secondly, there is a money cap of about 42 million gp. Even if you have several characters, that puts a limit on the money one can carry. Thirdly, the 30% tax on all AH transactions is significant.

Through all my time on DDO, I never have hit the money cap, but that's because I didn't try to: I never ran of money for things I needed money for, so I felt no pressure to use the Auction House. I kept all my good items in my item bank, and traded them for items I desired if the opportunity presented itself. Hell, I might have hit it involuntarily, as a byproduct of questing and selling the trash loot accumulated over time.

I'm not sure if anything is helpful, or interesting, but sicne I have written it, I might as well share it.

[Mandos]

Nick,

I *partly* agree with you---I mean, I'd consider myself to be an inflation-tolerant lefty, because I don't think that worrying about the Real True Value of money makes any sense in a situation where it is literally impossible to bargain wages up. I dunno if you would consider this to be a good reason to be an inflation-tolerant lefty, though. But count me as a leftist that doesn't subscribe to the inflation fallacy.

And, in fact, I periodically have these arguments with others of my ilk ;) and I find them relatively frustrating. But you know, there's a reason why leftists don't have a single coherent opinion on this, and I suspect that you can't see it because most economists as trained have a very difficult time putting themselves in the shoes of the left. The truth is, you can construct a credible-sounding argument for and against whatever monetary policy in terms of winners and losers in the wage-dependent classes. (Even if I personally think there is more win than loss.) So the argument feels like rearranging the deck chairs on the capitalist titanic. If there are tradeoffs that pit some groups of workers against other groups of workers, then one should be lending one's intellectual efforts to constructing the post-capitalism in which these trade-offs do not exist.

From that perspective, why would anyone even bother to write these things down? The models, modeling techniques, etc are going to look radically different. (Think Parecon, if you've ever heard of it.)

That doesn't even touch on the epistemological issues to which I've repeatedly referred...

[Steve Roth]

Another inflation-favoring lefty here. Please excuse me asking about what you've gone over a million times. I think I understand the money-illusion inflation fallacy that you argue -- that (in the long run at least) all the flows increase together; nothing real changes.

But doesn't this ignore the stocks? The existence of debt/credit (and perhaps also the fact that there is a much smaller number of creditors than debtors)?

Inflation transfers buying power -- the relative ability to purchase real goods and services -- from creditors to debtors. Instantly and permanently. (Yes, I know this is based on present value of future flows, but still.)

Given the volume of the stocks (gross, not net), it seems like that buying-power transfer effect utterly dwarfs the effects on the comparatively measly flows. A lot more people have (in aggregate) a lot more (relative) buying power, and a smaller number have less.

And assuming marginal propensity to consume is correlated to wealth (measured in buying power), not just income, it seems that inflation's redistribution-of-stocks wealth effect would have an impact far exceeding the flow effects.

Sorry again if this totally misses the undoubtedly oft-repeated point of your argument...

[paine]

again nick gets my head shaking
"this monetary system has some very nice equilibrating properties"
its like i'm watching the model train club
no
its more like i'm watching the model anti gravity flying saucer club
purely conceptual output since

"Translating Bill Vickrey into standard economese, what he's saying is this: instrument #1 is monetary policy which can control the price level; instrument #2 is fiscal policy which can control the natural rate of interest and therefore investment and long run growth; now, what is instrument #3 that controls unemployment? "

no bill has fiscal for employment and the interets rate for capital formation

the third instrument is the collander lerner vickrey mark up market or MAP

yes you need three instruments
or the price level runs amok eventually

[Nick Rowe]

Jacques: This is what I said about fiscal policy in February 2009:

"Fiscal policy is like getting grandfather's musket down out of the attic, where we locked it away to stop the kids (politicians, or perhaps ourselves) playing with it. It's an ugly, unreliable, inaccurate, slow, dangerous, weapon to use, and nobody can remember how the damned thing works. And unorthodox monetary policy is a new weapon that looks good, but hasn't been tested."

http://worthwhile.typepad.com/worthwhile_canadian_initi/2009/02/demandconstrained-and-supplyconstrained-economies.html

Steve: "The problem seems to be the BoC intervention. (?) Suppose we tell them to stop buying and selling bonds entirely? Would we achieve homeostasis? (Which I'm thinking is a much better term for what we're discussing than "equilibrium.")"

Yes, but rather too slowly. Because the unemployed working in the paper gold mine will produce new money at a very slow pace. So there's a lot to be said for using open market operations (standard monetary policy) to speed things up.

Determinant: basically agreed. In the first model, a sudden fall in the demand for money could push the real price of gold down very low, so that gold panners would starve. Exactly the same thing could happen in the later EI model if the central bank targeted too low an unemployment rate. Accepting EI could mean starvation wages. And yes, that is the fundamental flaw with the system. Ultimately, it can only guarantee "full employment" by making the real EI benefit so low nobody would accept EI. They would be better off begging. I'm not sure if the MMTers understand this point. This point wasn't clear to me until I was writing this post.

Miraj: thanks! When writing this post, I was wondering whether to include a Friedmanite version, based on a Negative Income Tax/Guaranteed Annual Income, where the base income was fixed in nominal terms, and the whole tax/transfer system was money-financed. I think it can be done, but it doesn't work in exactly the same way, so I decided to leave it out of the post.

Ralph: I partly agree with what you say. I would need to write a whole post on that question, to address it properly. I think I will leave it for now.

Mandos: I think I sort of see where you are coming from. I find it hard to gather up much enthusiasm to talk about the best way to fix the Euro, since I think the whole system is bad and doomed.

"Parecon" is a new one for me.

Steve: what you say makes sense. But it's not really a *long run* argument. Because in the long run, nominal interest rates should adjust 1% to 1% to inflation, so there should be no redistribution from creditors to debtors, if inflation increases. But the "long run" here could be 30 years or so (there are 30 year bonds), so nobody should ignore your point.

[Nick Rowe]

paine: you must be an old guy. Nobody nowadays remembers MAP (or TIP?). I do. It was indeed hoped to be the third instrument.

[paine]

"If we choose X below the existing natural rate of unemployment, given current real EI benefits, the price level rises"

i think you have a sky hook here nick

are prices here still just the product of wage rates (W) ???

if so wages rise here because too many slackers are being induced by too high real EI benes
and in consequence job markets over tighten raising nominal wages which given the nominally fixed EI
reduces the EI /W ratio
all fine but what kicks this off ?

you have no way to generate shocks or at least you haven't specified one
perhaps some burst of productivity that leads to a new affordable EI
but then the burst evaporates and ...
how about a plague ??
still i want to know how youy get this wrong nominal EI other then at time of institution
and so what came before it ...

you can't escape a history here

assuming an initial state is a simple parlor trick

most common initially we are in equilibrium

really ??

i suspect no market economy is ever "in" equilibrium

[paine]

a buffer stock of ELR employed

becomes a huanist conjured gulag in time
because the spontaneous system based on a profit margin for firm survival
makes the system too employment level wage sensitive

nicks little mechanics here shows the ELR wage rate would needs be
" too low for comfort "

the wage /profit / price spiral has a trigger point or range
that in time lurks at too high a rate of unemployment
and the gulag becomes too big to be carried "happily" by taxpayers

in time the gulag becomes just that a punitive system

[Nick Rowe]

paine. the "shock" is a decision by the central bank to target a lower rate of unemployment. Now, figure out what that does to the price level, and to real EI benefits. I'm sure you can do it, without having to make any assumptions about the economy being in "equilibrium".

Oh, and if you really think this post is a waste of time and just me playing with myself, what exactly are you doing spending a lot of your own time commenting here?

[Scott Sumner]

I like the way you work toward this system one step at a time. I used the same approach in a 2006 paper I published on CPI futures targeting (yes, the referee forced me to change from NGDP to CPI.) You developed a very clever argument.

But I wasn't crazy about this sentence:

"It's a theoretically interesting monetary system. It shows that it is possible, at least in principle, for a central bank to have a dual mandate. It can target a particular level of unemployment and have a nominal anchor at the same time."

I don't think any ever disputed that. What they disputed is that a central bank that wasn't able to control the EI system could target employment. I.e. a real world central bank. And you haven't shown that. If you give the central bank control over real carbon taxes then they can hit a triple mandate, where the third target is global temperatures. I'll stop there, because I've probably already reaching the point of being annoying.

BTW, Back in the 1970s Earl Thompson had an ingenious system for targeting nominal wages--you might want to take a look.

[paine]

i am a marxist precisely because the present institutional arrangement can't resolve these essential conflicts between the job class and the profit motivated hiring elite

yes the MMT model blows up into a price spiral or produces a hideously punitive gulag

why europe can't even maintain a short term safety net let aline a decent social dividend system

not with the constant corporate need to lower the wage/value added ratio

its the great event of my life to witness the arduous end of de facto social democracy as we've known it

why it looked till sometime in the 1980's like eddie bernsteins stylized facts were indefinitately extendable
that wages would grow as fast as value added
and employment and profit rates remain robust and stable over the cycle

no such luck ...eh global north ???

[Nick Rowe]

Scott: "I don't think any ever disputed that. What they disputed is that a central bank that wasn't able to control the EI system could target employment. I.e. a real world central bank."

Agreed. But it wasn't at all clear to me, until I started thinking through this monetary system, and how it worked, that that was essentially what was at the root of the central bank's ability to hit two targets at the same time. And I suspect it may not be clear to those who propose such a system.

And, you gotta think blue sky! Why not hold nominal EI benefits fixed (growing at 3%) in nominal terms?

But that should not lead us to ignore the desirable automatic self-equilibrating properties of this sort of monetary system. Under the gold standard, the bank targets the price of gold by buying and selling gold at a fixed price. We could have a similar system where the bank targets the price of labour instead. And the nominal wage is a better target variable than the price of gold.

[paine]

"I'm sure you can do it, without having to make any assumptions about the economy being in "equilibrium"

i agree
but the CB has to have a motivation to target a lower unemployment rate
has there been a shock to demand ??
the CB has to have a reason not to "live with" what employment rate emerges from the markets

bvill vickrey was completely opposed to NAIRU levels
he wanted to use huge fiscal deficits to drive UE down to under 2%
he contended open macro conditions might allow this without triggering a wage price spiral
which in effect sez there is no NAIRU to worry about at the national level

of course there's trade balance consequences to accelerating domestic income

i bore here with the obvious
and the upshot i don't think bill had answers but he had a challenge
a challenge i contend our present institutional arrangement can't meet

i note he refused to opt for a wpa option
in that he is a lovely macronaut sticking to the market as guide to micro decisions

no wpa to kick around is a virtue worth striving for while trying to get unmemployment
down to frictional levels

but its in media res that policy choices emerge

i hardly think your site exercises are useless
but they certainly are remote and monkishfine
obviously a share a taste for this wonderland...every once in a great while
so forex needs adjustment

[Nick Rowe]

paine: unlike Marxists, I think MMTers would at least have the sense to re-think their policy when they saw it was leading to a gulag.

[paine]

" I think MMTers would at least have the sense to re-think their policy when they saw it was leading to a gulag."

touche ...i love it and agree with you
but none the less they think they have inflation and employment solved...they haven't

thesis price level contro needs to be institutionalized we were on the way there when volckler stranged us into a bout of modration
and the agenda seemed untimely

it never is

price level effects are the great boogey man

like fire inflation must not just be tamed by society but utterly controled by society
for society to progress beyond cyclical bouts of nasty unemployment
and long term structure induced virtual ghettos of excessive debilitating disgraceful
protracted jobless ness

[paine]

"the nominal wage is a better target variable than the price of gold"

and its what the fed really targets when it targets core inflation even if in an imprecise way

but to overtly publically target wages would cause an up roar.. eh ???

lerner in the late 40's had a system he'd designed to control wage rates
but he soon discovere how politically impossible that was

no only prices "seem" neutral to the masses

the tips versus mark up market nicely parallel pollution emission debates
pigou tax versus cap and trade

only the ability to more or less exactly control price level movement is obviously the better course

weintraub versus lerner
lerner by a ko

[paine]

thanx nick for responding
it really matters that you get down into the trenches with your commenters

most successful site operators don't these days
unless say a big shot shows up

is scott s
a big shot ??

well almost
but lots here aren't

and you also allow yourself to be caught out on a limb
also great

[Steve Roth]

Nick: "nobody should ignore your point."

But isn't that exactly what economists are doing when they pooh-pooh "lefties who think that *tight* money is a capitalist conspiracy designed to screw the workers by creating unemployment in order to keep inflation low"? Ignoring the immediate and massively larger effect of creditor-to-debtor wealth transfers, while pointing at the relatively quite small flow effects to ridicule the lefties' position?

(Unless you're saying that tight money causes inflation? That it hurts supply of real goods more than demand for real goods, so...?)

Also: Do most economists really believe that the Phillips Curve goes flat (or vertical, whatever) above 2% inflation? That (I'm guessing) the disincentives to spend on investment associated with presumably inevitable interest rates increases associated with higher inflation dominate and overwhelm the hot-potato consumption *and investment* effect of inflation, even at those low levels?

"in the long run, nominal interest rates should adjust 1% to 1% to inflation"

Right, understood (though I, like you I think, do tend to question how tight the correlation is, statistically or temporally).

But okay, I'm a creditor/bondholder with $100 million in holdings, and I'm expecting 0% inflation this year. Bananas are going for $1 each.

Nick tells me "actually, inflation will be 1% this year."

"Ouch," I say. "At the end of the year I'll only be able to buy 99 million bananas. My debtors are laughing all the way to the bank."

"But not to worry," says Nick. "Interest rates will go up 1% as well."

"Oh GREAT," I say. "Now you're slamming the *nominal* value of my bonds too. You told everybody else too, so they just dropped 5%. Sheesh."

"But you can roll over your bonds at the higher interest rate."

"Yeah. As you pointed out, twenty years from now. Great. Who in the hell knows what *any* economic variable will be 20 years from now."

Bondholders don't need much a spreadsheet to figure how they come out in this deal.

And bondholders, creditors, control the central bank.

It's not crazy to think -- since it's been said that financial incentives matter -- that those central bankers would give high priority to the immediate and obvious self- and crony-benefits of low inflation, while downplaying the decidedly tenuous second-order effects that strong employment will (might) have on their (and their friends'/families') future wealth and well-being.

Let's just put some numbers in here. Total U.S. debt outstanding, private and public, in the ballpark of $55 trillion. 1% extra inflation transfers *$550 billion* per year in relative buying power from creditors to debtors. (Go ahead and net out some of it because some is cross debt -- people/businesses are both creditors and debtors.) We tend to talk in big numbers these days, but half a trillion dollars *per year* still gets people's attention.

By contrast, flows: Imagine all the flow-impact of inflation went in one direction, say from creditors to debtors or households to businesses or whatever. $14-trillion dollar economy, 1%, $140 billion. And that's the maximum possible impact. It doesn't flow all one direction, or even close. Its at least somewhat "neutral".

Does this make sense?

If yes: When economists ignore truly massive effects while arguing vehemently that much smaller (non-)effects demonstrate the validity of supporting creditors' interests, it's also not crazy to wonder whether there are not strong institutional incentives to do so, created via the hiring and education mechanisms described quite convincingly at least as far back as in Manufacturing Consent.

So yeah: lefties make some profoundly dumb arguments. Drives me crazy. (They should be making the argument above, unless I'm completely confused and it is one of those dumb arguments.) But that doesn't mean the positions they're arguing are dumb.

[Becky Hargrove]

Nick,
I lost a comment I left on this post yesterday and didn't know whether it was the spam filter.

[W. Peden]

Steve Roth,

I think the fact that there are a large group of people who think that the central bank is a puppet of creditors and a large group of people who think that it is the puppet of debtors indicates that you don't need some theory of institutional world-views. It sometimes seems that either one thinks that the world is very complex & open to interpretation or one thinks that Chomsky is a great public intellectual.

[Scott Sumner]

Nick, Yes, I'm all for nominal wage targeting. I did a paper back in 1995 proposing just such a policy target.

[Nick Rowe]

Becky: I couldn't find it in the spam filter, sorry. Maybe you forgot to answer the anti-spam question before changing the page?

Steve: It is not *inflation* that transfers wealth from creditors to debtors. It is *unexpected* inflation that does this. If actual inflation comes in higher/lower than was expected when the loan was agreed, that's what causes the transfer to/from debtors.

And this is one strong argument for making inflation *predictable*, so unexpected changes in inflation, either up or down, don't happen, or don't happen much. It's a strong argument for targeting inflation. Or, better yet, targeting the price level growth path. But it says absolutely nothing about what level of inflation you should target. It just says you shouldn't change that target, if you can help it. It does say if you have been targeting 2% inflation for the last 20 years, and people have come to expect 2%, it would be best to leave the target at 2%, unless you have a good reason to offset that argument.

"Also: Do most economists really believe that the Phillips Curve goes flat (or vertical, whatever) above 2% inflation? That (I'm guessing) the disincentives to spend on investment associated with presumably inevitable interest rates increases associated with higher inflation dominate and overwhelm the hot-potato consumption *and investment* effect of inflation, even at those low levels?"

Whoah!

1. Most economists believe the *Long Run* Phillips curve goes *roughly* vertical above *roughly* 2% inflation. Yes. Most think that the costs of inflation probably outweigh any benefits above that sort of level. Raising inflation above 2% (some say 3% or 4%, and others say 0% or 1%) won't give you benefits of lower unemployment (it may even be higher) and will give other costs.

2. Investment depends on *real* interest rates, not *nominal* interest rates. (Same with saving). So in the long run, if the Bank of Canada switches from a 2% to a 3% inflation target, nominal interest rates will increase (roughly) 1%, but real interest rates, investment, and saving, will stay (roughly) the same.

[Nick Rowe]

Scott: I'm now tempted to do a post on the political economy of nominal wage targeting. Because you and I can guess what many (non-economists') reactions to the idea would be. And the post would be about the reactions, not about the idea itself. God, now how could I frame it?

[Gizzard]

"I think the fact that there are a large group of people who think that the central bank is a puppet of creditors and a large group of people who think that it is the puppet of debtors indicates that you don't need some theory of institutional world-views. "

How does it indicate that? The truth of the matter is that Central Bank is more a puppet of bankers and the stockholders of banks. Most everyone owes money to banks and those with higher incomes probably owe more (remember the saying that if you owe the bank a little you might be in trouble, if you owe the bank a lot the bank is in trouble). They dont owe as much relative to their incomes but they owe more. Its a lot easier to go after the little guys who are delinquent on their 70,000 mortgage and 15,000 in credit cards. The developer that owes 10.2 mil on his failing project? He's going to be first in line to get some help.

[Nam Nam]

Wouldn't the more accurate analogy be that there are only gold mines in the economy and a person has the option of going to work all day in the mine for payment in gold or to they can just go to the gold mine's gold pile and take up to a maximum of one once per gold per day?

If the mine pays somewhat more than an ounce of gold per day, most people would choose to work. If it is not much more than an ounce, they would just grab their "free" ounce from the pile?

[Bumpkin]

Golden Grain Money

I have been thinking about the question of sustaining life with this kind of money. The metaphor of a garden in the back yard instead of a gold panning stream means that everybody can, on their own, make enough "money" to sustain life. What is the difference, when we translate the metaphor into unemployment insurance or wages for a guaranteed job? Suppose that the money produced is at subsistence level. Under the gold metaphor the people producing the money are on the edge. They could drop below the level to stay alive. Under the grain metaphor the people producing the money cannot drop below that level. They consume all that they produce to stay alive, while the net money added to the economy is zero. Thinking along those lines, here is a modification of Nick's idea.

Let the central bank, instead of paying for all of the insurance or wages in new money, only pay for that part above the minimum that is needed for subsistence. The subsistence part would be paid for by old money, in other words, by taxes. I don't know what the best relationship between the tax portion and the new money portion should be. The new money portion could be fixed, or it could be in proportion to the tax portion.

[Steve Roth]

Nick: "It is not *inflation* that transfers wealth from creditors to debtors. It is *unexpected* inflation that does this."

'kay I think I get this, it's based on a counterfactual, right? If lenders/creditors/bond buyers had known that inflation was going to be higher, they *would have* demanded higher interest when they bought the bonds. If there's unexpected inflation, the debtors effectively did a better job of predicting the Fed's future behavior, and they are rewarded for that.

I have to think more about this (ex post? ex ante?), but I do tend to wonder whether creditors *could have* demanded higher rates. (This going back to my thoughts about the demand curve for financial assets. Since there's no substitute for them if you want to store money [except real assets, which unlike financial assets depreciate and decay], and since substitution is the sine qua non of demand curves, the concept of this demand curve seems to get very iffy.)

"1. Most economists believe the *Long Run* Phillips curve goes *roughly* vertical above *roughly* 2% inflation. Yes. Most think that the costs of inflation probably outweigh any benefits above that sort of level. Raising inflation above 2% (some say 3% or 4%, and others say 0% or 1%) won't give you benefits of lower unemployment (it may even be higher) and will give other costs."

Thanks. Very clearly put.

1. Do those beliefs factor in the the increased spending that presumably results from the wealth effect of unexpected inflation -- when a large number of lower-wealth/income people (with higher marginal propensity to consume) have more real wealth/buying power?

2. Related: Does the strength of that belief (and/or the level of that break point) vary depending on, for instance, the economy's capacity utilization, or the level of interest rates (especially when they're near/at zero). IOW, when we're in a slump does that number go up (according to most economists' beliefs)?

As always, your engagement with the untutored much appreciated.

[Mike Sproul]

If people lose a job, they can always pick berries, mow lawns, babysit, etc. No need to do something unproductive like panning for gold, or worse, digging through old coal mines for buried jars of bank notes. If you have picked a load of berries, they can be 'coined' into money. Either you borrow against your future berry sales, or a berry purchaser borrows to buy your berries. The loan creates new money either way. Society still gets the needed money just as in the gold panning scenario, but we also have the berries.

[Nick Rowe]

Steve: imagine a demand curve and a supply curve for loans. If expected inflation increases by 1%, other things equal, both the supply curve and the demand curve shift vertically up by 1%, so the equilibrium nominal interest rate increases by 1% too. Borrowers and lenders care only about the (expected) real interest rate.

1. If a past transfer of wealth from creditors to debtors (due to past unexpected inflation) causes increased aggregate demand for consumption, out of given aggregate income, that should only result in a higher real interest rate. It shouldn't effect Long Run Aggregate Supply. (Though you can argue that it might effect LRAS via investment.)

2. If equilibrium real interest rates are lower in the long run, you might argue we need a higher long run inflation target, to keep us away from the ZLB on nominal interest rates. That argument makes sense. Paul Krugman argues something like that.

[Nick Rowe]

Mike: If you argue that the money supply is already perfectly elastic, and responds 1 to 1 to increases in the demand for money, then what is pinning down the price level in your system? And how do we know the money supply is perfectly elastic at the right height?

[Mike Sproul]

Nick:

Backing pins down money value. Each dollar is backed by assets worth 1 basket of berries. If people need more dollars, then they will be willing to offer assets worth 1.01 baskets for a dollar, and banks will eagerly offer dollars at that price. If the economy is glutted with dollars, then a dollar will only buy .99 baskets, and people will eagerly return their dollars to the bank in exchange for asets worth 1.00 baskets.